<HTML><HEAD> <META name=GENERATOR content="MSHTML 8.00.6001.19019"></HEAD> <BODY> <H1 class="cN-headingPage prepend-5 span-11 last">Investors begin to wonder if the great China crash is finally coming </H1> <DIV class="push-0 span-11 last"><!-- cT-storyDetails --> <DIV class="cT-storyDetails cfix"> <H5>William Pesek </H5><CITE>June 25, 2011</CITE> <UL></UL></DIV> <DIV id=googleAds class="ad adSpot-textBox"></DIV><BOD> <DIV class=articleBody><!-- cT-imageLandscape --> <DIV class=cT-imageLandscape><IMG alt="Is the great Chinese crash coming? ... a labourer works at a construction site in Shanghai." src="ctsipad-art-wide-china-4-420x0.jpg"> <P>Is the great Chinese crash coming? ... a labourer works at a construction site in Shanghai. <EM>Photo: Reuters</EM></P></DIV> <P>Suddenly the finance god John Paulson is not looking so omniscient. The New York hedge-fund manager was the star of the 2008 subprime crisis, capitalising on Wall Street's misrepresentations to the tune of $15 billion betting against US mortgages. Now fraudsters may have taken him in.</P> <P>That is, if a June 2 report by Muddy Waters LLC is correct and Sino-Forest Corporation lied about its finances. I do not know, and neither do investors such as Paulson, the biggest shareholder in the Canadian-listed, Chinese timberland owner. Paulson &amp; Co said this week that it sold all its stock, which has plunged more than 90 per cent in the past few weeks.</P> <P>Even though Sino-Forest rejects claims that it exaggerated its landholdings, investors are taking no chances. That gets at a bigger issue than short-sellers trying to undermine one company. The skittishness of markets reflects the sense that we are one step away from replaying the world financial crisis.</P> <P>The global backdrop offers no comfort. Post-tsunami Japan is a mess; the US recovery is faltering; and Europe poses a Lehman Brothers-like risk if Greece's debt crisis cannot be resolved. The sudden collapse in confidence in some Chinese investments adds to the anxiety for the markets.</P> <P>Why is it a surprise that some Chinese companies have dodgy finances? One reason we are so quick to assume the worst is that Lehman, after months of vehement denials in 2008, really was a house of cards. Before that, WorldCom and Parmalat really had cooked their books as Wall Street looked the other way.</P> <P>So why are markets quick to believe a little-known investor such as Carson Block, the head of the Hong Kong research firm Muddy Waters, when he questions China? Few short-sellers make lots of money betting against China, but the ranks of Carson and his ilk are growing. That is partly a reflection of the fear that the great Chinese crash is coming.</P> <P>One worry is that the first wave of bad loans from China's huge 2008-2009 stimulus is about to hit. The bigger concern is how growth in recent years left the domestic financial system less resilient.</P> <P>China's expansion relies on a variety of counterproductive policies: an undervalued, non-convertible currency, off-balance-sheet arrangements to mask debt and ample credit to politically connected firms that do not necessarily make the most productive use of capital.</P> <P>China does have a rather large margin for error, mostly in the form of $3 trillion in currency reserves. Yet it has made little progress towards developing a more transparent and open financial system. That, too, is making some investors more inclined to short China than to bet on continued growth.</P> <P>China is less of a market-based economy than a vast family-run business controlled by the political elite, says Fraser Howie, a co-author of the book <EM>Red Capitalism</EM>. It is important to remember that when a company such as Industrial and Commercial Bank of China goes public, majority ownership stays with the Communist Party in Beijing. Good corporate governance does not always follow.</P> <P>Is the new scrutiny of Chinese companies a game changer? ''I certainly hope so,'' Howie says. ''We know China is a difficult and corrupt place to do business, so funny dealings are rife.</P> <P>''Certainly, small Chinese companies are coming under the spotlight, but will it translate to the big state-owned enterprises as well? That I am not so sure of. I think too many investors will shy away from questioning the big guys.''</P> <P>It is important that investors start asking those questions. As potential irregularities come to the surface, they will fuel a broad reappraisal of corporate-governance practices at foreign-listed Chinese companies. As scepticism and activism widen, China Inc will be subjected to much more intense scrutiny than in the past.</P> <P>That would be a plus for China's long-term development. In the short run, the fact that markets are so riled about reports that a small company like Sino-Forest might be exaggerating revenue hints at the broad erosion in confidence over the fate of the world's major economies.</P> <P>China is now the world's second-biggest economy, but there is a growing sense that it is due for a setback. The country has proved it can live without consumers in Japan, Europe and the US for a couple of years. But a third or fourth year as the world heads into an economic soft patch or worse?</P> <P>Everyone liked having a bright spot amid the gloom after the world financial crisis. Now China's prospects are becoming as murky as the governance of its companies. There's a reason Block called his firm Muddy Waters.</P> <P><STRONG>Bloomberg</STRONG></P></DIV></BOD></DIV></BODY></HTML>