A Den of Corruption

A ruling class, no matter its spots or stripes, is everywhere given to over-privileging its own. And the stronger its hold on power, the greater is its accumulation of wealth relative to those outside the power circles.

I recently had occasion to update my thinking on China, its massive waste generation in the last 10-15 years, and Chinese Communist Party members as major beneficiaries of this massive waste, and therefore also the continued need for Xi Jinping to keep cleaning up the more blatant instances of corruption and wealth transfer.

The commodities boom of the 2000ds proved to be backed by a massive wave of over-production, waste and a social movement to self-enrichment by the privileged class of China. President Xi Jinping in many ways is now contributing to lowering commodity prices as a byproduct of his crackdown.


tien-an-men square

Photo credit: fmh


A few truisms some of us have used over and over again include: China must bring proper growth opportunities to its interior provinces to complete its re-generation, with growth of retail demand being one of the tools; and also equally, for the Chinese Communist Party to retain its Mandate of Heaven (its Tian Ming) it must clean up its act. So far, both these items remain somewhat wanting, despite small steps having been taken.

China has been all about growth and opportunity for elites since the 1990s. Almost all the companies I looked at after I got my China credit research skills at a French bank in HK-China in the early 1990s were large behemoths lucky enough to be approved by the State to convert their financial statements from nonsensical Gosplan derived enterprises into virtual corporations that wasted capital, human labor, raw materials and investors’ money.

One of the only “productive” things they did (and still do in many cases) was to allow senior executives, quite often elite Communist Party (CCP) members (or their allies), to transfer money from the combination of labor and capital (OPM) of the many workers and investors including government to the few members of the senior elite.

Onlookers from outside still don’t fully understand this is the largest wealth transfer the world has yet seen and what it means for China. This is why China still has not and will not properly rebound despite many years of consolidation which many banks thought would be over by now.

Often the transfers of excess capital from excess production ended up in Hong Kong, Canada, Australia, the US, as property renters and owners in places such as Vancouver (or middle class workers in Hong Kong!) know only too well. In the case of certain key officials who remain in China, like General Xu Caihou, a retired PLA officer, it appeared their stash was closer to home, given the mountains of cash, gold and jade confiscated.

See http://en.wikipedia.org/wiki/Xu_Caihou for the general’s bio. …And more on his associates at http://en.wikipedia.org/wiki/Gu_Junshan.

How twisted the irony is that history’s largest wealth transfer came from CCP members turning Marx and Lenin on their heads several times over. To understand the full extent of this endemic corruption one cannot simply look at individual stories of this general or that CEO. One needs to look at the patterns.

And not only the patterns but the drivers. It has not been only the general, but often also the assistant generals who were named as replacements. And it wasn’t only the CEO, but the assistant CEOs and even the secretarial staff supporting the CEO. It wasn’t necessarily or only the senior official, but the entire family and relatives of the family. It wasn’t only a few families, but entire swaths of families and relatives.

It wasn’t only one specific faction or group such as the Shanghai Faction under Jiang Zemin, it was many groups and factions. It was just about the entire Communist Party, with certain exceptions and variances in scale. President Xi Jinping has an unenviable job. He is a hero for doing it even if he isn’t perfect and despite concerns his purges are only targeting opposing factions.

The target cannot be just people and sumptuous banquets, but wasteful growth that served little purpose but to inflate factory sizes and production, as well as overgrow and over-pollute city centers, and ultimately overstate prices. Now that

we are in deflation and low growth this is an immense challenge. Where the growth challenge still remains (as it was 20- 30 years ago) is to bring growth inland rather than growth to the “Forbidden Cities” of wealthy Party and connected members of society.


The Waste Effect (and its Impact on Overstated Growth)

In order for China to “leapfrog” its economy to the same size as the US today, China had to waste massive amounts of raw materials and human capital. This was the main game in town – excessive industrial growth. The more production and transport of coal, ore, steel, copper, aluminum, the more cookie cutter transaction fees are racked up and the more values of assets are driven up.

On the one hand, it brings trickle down wealth to many and appears to build out a dream scenario of growth where low per capita per GDP or poverty once reigned. But it also leads to over-appreciation of land values and over-production of material beyond what a lower-waste, more stable growth pattern can bring a nation. Outside major cities, almost by definition the major beneficiaries of higher land prices were largely local leaders, though there have been wonderful stories of entrepreneurship as well.

At first, China had both capital and labor in ample supply. Later it found itself importing more and more iron ore, oil and other commodities to feed its mills, energy needs and property developments. During the twin peaks of 2006-08, rates for ships to transport raw materials into China traded up close to 8 or 9 standard deviations. And commodities kept on going into 2011-12.

Only recently did China as a nation realize it killed off many of its lakes and rivers and turned parts of cities into heavily polluted areas requiring many to constantly wear face masks and install air filtration systems at home just to breathe.


1-China air pollution Feb 03 2015 (original chart)North and East China Pollution Index, 03 February 2015… over 100 is unhealthy (South Korea and West Japan included for reference; Source: http://aqicn.org/) – click to enlarge.


How did pollution get so bad? …It was many things, including lack of enforcement of regulations on waste output by factories. The less the enforcement, the bigger the profits for local officials. But looking at the chart of increases in coal output over the long term certainly gives us a graphical representation. Look at the acceleration after 2003 (which is correlated to the shipping boom of 2003-08 to a great extent).


2-China coal outputLong term coal output comparison, China – Coal Production and the 2003 Acceleration, 1965 – 2013 (in m tons oil equivalent), source: BP Statistical Review 2014 (2013 final data) – click to enlarge.


One of the first overseas listed Chinese companies (“H Shares”) I analyzed was Maanshan Steel following its 1993 IPO. Visiting the Anhui province blast furnaces and speaking to employees it was easy to tell much of the production was low quality and that much of the steel could not be used for high grade projects. The purple-green-black smoke coming out of some of the older furnaces numbed my senses.

In the early 1990s I recall that it was estimated that about half of China’s total steel production was sub-standard. This implied tremendous amounts of waste. A large portion of iron ore and coking coal was transported to go into the production of steel that would not make the cut. And it was going into many projects below the radar that would also not make the cut.

The steel that would not go into low quality projects would partly also get sent back for recycling or perhaps to electric arc furnaces. During all that, revenues and profits were overstated and waste understated. If one had time one could document hundreds of millions of tons of over-produced steel that never contributed positively to society.

Just to summarize steel over-production and not spend too much time on it here: China went from 37m tons of 716m tons produced globally in 1980 to 822m tons of 1.65bn tons globally in 2013 (1). With over-production, global steel plant utilization levels generally declined from the mid-80s to the mid-70s between 2007 and 2013. China was the main driver (2).


3-Maanshan SteelMaanshan H Share Price since IPO (Sept ‘93)…(shares generally lower than HK$2.27 IPO price; source: bigcharts/Marketwatch) – click to enlarge.


The Upside of Waste and Environmental Degradation

Waste appeared good for China in a trickle down format. First it kept GDP growing at unprecedented long term growth rates of 8-9% (now 6-7%; even if we don’t believe these numbers fully). Second it contributed to the process of getting China from a country of 1.2bn people (1993) with some 72% living in rural areas to a country of 1.4bn people (2014) with the 53% living in urban areas we see today. Third, it contributed to China moving slowly from a “made in China” label which meant low cost items with a high component being “junk” to a “made in China” meaning middle quality products that can be quite decent at times.

Today, China has also taken over many middle end products once labeled “Made in Japan” or “Made in S Korea” – and this side of industrialization has been called a victory. But it has also led to a situation where now over 70,000+ officials (and counting…) have been investigated for corruption by President Xi Jinping’s Central Commission for Discipline and Inspection. There are over 85 million members in China’s Communist Party and it has been widely discussed that most of the corruption comes from there.

Less discussed is the legacy of waste China’s younger generations will be left with to absorb (a challenge many other countries face to varying degrees as well). Waste during the last 25 years of hyper growth has manifested itself everywhere: raw materials consumption, metals, power generation, shipbuilding, residential buildings and shopping centers construction, and so many other sectors of the economy. Growth in other words has been overstated in the sense of over-production. One consolation is that overproduction as a percent of production is likely a lot less today than in the early 90’s. But in absolute numbers the waste must be staggering. The worst stage was probably post 2008 when global growth belched and China was left in need of its own massive domestic stimulation policies (3).

And the outlet for this waste was tens of thousands of enterprising businessmen mostly from the Communist Party who took advantage of every loophole or self-created opportunity for self-enrichment. The top tricks for moving these riches became Hong Kong, with cartloads of suitcases of cash going into over-priced HK property as well as other money centers around the world.

For corporates it was many questionable letters of credit opened for putative trade overseas, which netted nice commissions for round trip fund transfers. And senior executives at shipping companies, for instance, could enjoy side deals for ship orders booked overseas, and eventually shares for IPOs of their State-sponsored companies. This is all well known. But it remains misunderstood from the perspective of waste generation, degree and extent of corruption, and commodity prices.


Waste and the Benefits of Waste for the Elites in Shipping

COSCO Shipping Group remains a case study in waste and mismanagement – starting from the top. For anyone wondering what happened to the COSCO CEO, who misspent billions of dollars on badly timed vessel purchases. Rumors of his house arrest a year or more ago (never fully confirmed) were updated in June 2014 with relatively firm confirmations that he now lives in the US.

Recall this Davos loving savvy senior executive had his daughter in a senior COSCO position in the US, got himself paid multiple times on overseas COSCO boards, and more likely that not received many other side payments (4). Often commissions on vessel sales or charters benefit directly those conducting the transaction, even if they are not actual owners. The difference was the massive scale of COSCO and China Shipping vessel build-outs, and the absolutely horrible timing for COSCO.

Another side story, was that the CEO, and no doubt others, would often see their staff collect payments for arranging meetings for the CEO, also a sea Captain. If payment was not made, the standard answer would be “sorry the Captain is not available.” This only illustrates the porous nature of side payments in this organization, which could as easily be documented for many other companies in China. (REF story on the CEO’s assistant: http://theloadstar.co.uk/ex-cosco-executive-expelled-party-corruption )

COSCO Holdings, the HK Stock Exchange listed company, was likely the biggest example of corporate waste in shipping, with billions of dollars of badly timed vessel purchases. But it also contributed to a self-reinforcing cycle of more orders, more over-building, and more competition among Chinese and global shipping companies. The positive side effect is that while massive amounts of capital were wasted, global consumers have access to even cheaper goods as a result of lower transportation costs.

The Koreans prior to the Asia Crisis of 1996-1998 had led the charge in wasteful growth in shipping when they learned the practice of hiding loans in short term payables and receivables offshore to boost their shipbuilding industry (5). China’s shipping and shipbuilding companies didn’t need to focus on as many outside tricks – they had massive growth from policies encouraging waste at every turn.


4-Cosco HoldingsCOSCO Holdings Share Price, 2006 to present (source: bigcharts/Marketwatch) – click to enlarge.


Paying the Piper

And what has China had to pay for this? Since 2008 it has experienced one of the most rapid credit buildups in history, with debt/GDP going from 153% of GDP in 2008 to 243% of GDP in 2014, according to a Goldman piece (Asia in Focus) in January 2015. According to the Financial Times, 5 Feb 2015, China’s debt to GDP has risen 83% to 282% of GDP since 2007.


5-income per capita and debt-GDP

Debt to GDP ratios vs. income per capita (source: Goldman Sachs, Jan. 2015)


To put it another way, a large amount of the debt/GDP increase since 2003 and especially since 2008 has gone into wasteful production and pollution generation above what could have been generated with more reasonable growth targets. And the by-products of excess waste ended up inflating revenues from Macau gaming as well as in the bank accounts of China’s elite.


Cleaning up the Mess and Strategies

In my view, many in the Chinese Communist Party understand the challenge: to reduce corruption in the Party is to clean up the Party’s image with the Chinese People. It is also to save the Party from getting thrown out of power. We already knew this issue even a decade or more ago from an intellectual perspective. Now, Xi Jinping and others are doing what they must do to save the Party.

Of course there is the view that they are merely eliminating the opposition and not dealing with corruption amongst all factions. The jury is still out. One litmus test could be how the Dalian Wanda story is handled. A couple of years ago Bloomberg Journalists tried to come out with a story that could affect the current leadership and potentially Xi Jinping (6). My take on this, however, is to look at how this story continues to develop. The question is: if Xi Jinping’s family is implicated, how will he face the challenge?

Current relevant stories on the Dalian Wanda thread can be found here:


The current focus of the Work in Progress should be concentrated here. Another front for this analytical work is to follow the progress of PLA-related companies such as CITIC. One clue here is that CITIC recently raised capital from C Itoh, among others. Having a Japanese company buy into a PLA-related company, to my mind, speaks volumes.


Author’s disclaimer:

Although I studied Chinese history, literature and language, and spent more than a decade studying China in grad school, Taiwan, HK and China, and even knew a little about the Communist Party some years back, I cannot claim to be an expert in China’s current context. My main training in business was Shipping and Transport including China Transport. The piece above is based on publicly available information.



(1) For World Steel Production data from 1980 go to: http://www.worldsteel.org/statistics/statistics-archive/annual-steel archive.html For a good global steel recap, refer to, among others, a Goldman research report, Melting Pot: Getting off the super-cycle from April 21 2014. See also good updates such as: http://qz.com/196766/chinas-steelmakers-have-branched-into-shadow-banking-which-is-funny-since-they-owe-484-billion/


(2) One of the most useless statistics I saw over the years was steel per person output comparisons with other countries during stages of industrial development. “Look China tons per steel per person still has upside compared to South Korea!” Nowhere did I ever see attempts at adjusting the data to provide a proper basis of comparison.


(3) Waste and property: An analyst friend and head of China research told me a few years ago how he had bought this nice duplex town house outside Shanghai, only to find 1-2 years into owning the place that his living room ceiling had caved in one day. Many of us often joked about the quality of some of the homes we saw in China. Ironically, many of us also moan about the quality of the rentals we live in on Hong Kong Island. Sardine boxes that have rented for $5-6,000/month in the mid levels in recent years, and where you can hear the neighbors left, right and overhead sometimes. … Note: I don’t consider transport infrastructure to be in the same category for over-production. Even though infrastructure can be developed for the wrong reasons or too rapidly, its longer life cycle usually implies it will be coming into its own at some point.


(4) It is important to flag that this COSCO CEO, Captain Wei Jiafu, was only a decade ago vying for political office after heading the nation’s largest shipping company. But instead of heading higher in the CCP, he is now enjoying life outside of China.


(5) This Korean practice was never fully exposed and was subsumed within Korea’s overall capital binges prior to the Asia Crisis. But the practice was well known to shipping bankers, who described how vessels could be financed offshore and never fully brought into the stock of debt identified with South Korea – and tracked carefully by the World Bank (or so they thought). See these articles to explain the process:

https://jica-ri.jica.go.jp/publication/assets/JICA-RI_WP_No.51_2013.pdf And….



(6) See stories such as:



A list of recent reads on China:

















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One Response to “China’s Waste and the Largest Wealth Transfer in History”

  • Calculus:

    Some argue that it’s the cost of the environmental cleanup that will bankrupt China.

    Easy to a degree to sort out a bankrupt company or even industry, just take a logical plan and money, then bingo. Not so with pollution. Yes, a good plan is needed but also an almost bottomless pit of money plus years and years of time.

    From my own experience whatever the cleanup bill is quoted at, double it by a minimum if not more. That’s the problem that the Chinese bureaucrats are going to face. Either they will lie about the true costs, or their advisers will tell them what they want to hear, the costs will be ‘manageable’. They won’t be, they will quickly spiral out of control like they always do when it comes to environmental matters.

    However, this is China we’re talking about so even if they do try to clean things up they will try to cheat hence making the problem worse. Personally I can see it taking 50 years or more and even then there’s no guarantee it will work. Take the top soil problem for example, ie it’s gone from a lot of the country, try getting that back easily.

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