Hardcover:US: Free cash flow with Chinese characteristics

To hear analysts talk, Industrial & Commercial Bank of China Ltd is one sizzling stock. Of 43 recommendations on its Hong Kong shares, 88 percent advise “buy” or “outperform.” Not a “sell” in sight.

What does a share in China’s largest bank represent, though? Not ownership, let alone control. The government holds some 70 percent of Industrial & Commercial, and its executives obey Communist Party bosses, as Carl E. Walter and Fraser J.T. Howie show in their sobering book, Red Capitalism.

Set aside, for a moment, the vapid chatter about the Chinese “miracle.” Forget that clever clogs at Goldman Sachs Group Inc invested in the bank before it went public.

Recall instead the US$42 billion that investors poured into Industrial & Commercial and two other state banks in initial public offerings. What happened to that money? It cascaded right into the state’s coffers as dividends, the authors say. Call it free cash flow with Chinese characteristics.

“Why wouldn’t international investors keep the cash in the first place?” they ask. The question is especially worth asking now that China has surpassed Japan as the world’s second-largest economy.

Walter and Howie have lived in China for 25 years and worked at banks including JPMorgan Chase & Co and Morgan Stanley. They recognize that the country’s economic resurgence and opening to the world have lifted more than 300 million people out of poverty. They also understand that China’s Party bosses still control the economy, thanks partly to the ministrations of Goldman Sachs and other banks, they say.

“China is a family-run business,” not a market economy, they write. And the families are the political elite.

When most Westerners think about China, they picture the crane-bristling export juggernauts of Guangdong and the Yangtze River Delta. Led by private and foreign-invested companies, these are the regions that earned China’s US$2.85 trillion in foreign-exchange reserves, the authors say.

Yet there’s a parallel economy, a domestic one dominated by state-owned corporations, “national champions” such as PetroChina Co and China Mobile Ltd. That’s what the Party wants to fortify, as this book shows in convincing detail.

The national champs have the trappings of Western corporations — professional lawyers, accountants and bankers. No surprise there: They were created and sold to international fund managers by the likes of Goldman, doing “God’s work,” the authors say.

Red Capitalism is on the dry side. We get no tales of “princelings with their hands in the till,” as the preface cautions, and the text sometimes chokes on abbreviations such as MOF (Ministry of Finance) and PBOC (People’s Bank of China). If you soldier on, though, the book rewards your patience with cogent analysis and muscular conclusions.

Chart by chart, Walter and Howie peel back China’s capitalist veneer to expose the cadre of rapacious oligopolies beneath. The array of data they bring to bear is astonishing, especially given that the numbers come from public sources.

Nothing in China is as it appears, judging from this account. Its bond markets, for example, boast thousands of participants and the paraphernalia of ratings agencies and industry associations.

Yet they lack the engine of normal bond markets — risk and the ability to measure and price it. The state controls the interest-rate framework, and banks hold more than 70 percent of all bonds. So much for financial diversification.