Forbes - Carson Block - 13 March 2018
Based on China’s conduct in the aluminum industry, foreign capital markets, and what I’ve come to understand from many years of living and doing business there, I have no doubt China is breaking the rules across numerous industries. The focus on new tariffs the U.S. is levying on steel and aluminum, and our trading relationship with China misses this bigger point. The entire multilateral trading system – not just the U.S. – is the victim of China’s cheating. Government ownership of China’s banking system, and the enormity of its state-owned enterprise sector give China the tools to illegally subsidize industries in ways that are hard to detect. To be clear, China’s activities are not the same as a country exploiting the economic principles of comparative advantage. China has also allowed the engineers of literally hundreds of stock frauds to get away scot-free with tens of billions of dollars fraudulently taken from western investors. It is disheartening that only the U.S. thus far seems fed up with China’s cheating.
The aluminum industry is a clear example of China’s cheating. We have observed the cheating first hand through research my firm and I have previously conducted on the sector. Research we conducted in 2015, under the name Dupré Analytics, showed that state-owned banks in China made billions of dollars in loans to shell companies to purchase aluminum from China-based aluminum giant, China Zhongwang. It is highly unlikely that these loans, which were made to entities that were not even remotely creditworthy, occurred without approval from the highest levels of the Chinese government. Late last year, the U.S. Department of Justice filed a complaint against a California company called Perfectus Aluminum, alleging that Perfectus was an affiliate of Zhongwang and leveling a different accusation—that Perfectus had evaded $1.5 billion in U.S. import duties. (Perfectus has denied the DOJ’s allegations, and the case is pending. Perfectus is also suing my firm for claiming its aluminum was fraudulently obtained.)
Last year, a different Chinese alumnimum giant, China Hongqiao Group, was also alleged to be cheating. Hongqiao, which is listed on the Hong Kong stock exchange, claims to be the world’s largest aluminum producer. Research firm Emerson Analytics released a report alleging Hongqiao was vastly overstating its profits and committing widespread fraud. One of the points Emerson Analytics raised was the company’s reported expenses on electricity, which they claimed were too low to be true. Hongqiao’s major outside electricity supplier is owned by a local government.
In response to the report, the stock was halted. Soon thereafter, its auditor took the extraordinary step of resigning and calling for an internal investigation into the fraud allegations. China Hongqiao ignored these calls. Despite the controversy, it then received fresh financing from state-owned CITIC bank. The stock subsequently resumed trading, and within a week was trading about 80% above its last close prior to the halt. Because it’s hard to believe that the report, halt, and auditor actions made the case that Hongqiao is more valuable, I believe the price spike was caused by manipulation. If I’m correct, this manipulation was effectively a subsidy in real-time. As a corollary, in true communist memory hole fashion, Hongqiao sued Emerson in Hong Kong, and received an injunction that has made it significantly harder to find the report online.
Another industry in which I have first-hand knowledge of China’s cheating is the capital markets. The upcoming documentary The China Hustle chronicles the wave of reverse merger frauds from the last decade in which literally hundreds of fraudulent companies from China listed in the U.S., collectively raising tens of billions of dollars from investors. The funds were sent to China, separated forever from those wronged by the fraud. Virtually nobody from China has been imprisoned for these crimes, highlighting the discrepancy between China and the West when it comes to upholding the rule of law. In contrast, Kun Huang, a researcher from a short-selling firm that exposed numerous U.S.-listed frauds, was imprisoned in China for two years in inhumane conditions.
More to the point, I also believe that China has a concerted strategy to degrade the economies of, and transfer wealth from western countries. My view seems to be supported by the recent statements of FBI Director Christopher Wray who warned that China is a “whole of society threat.”
The Trump administration fortunately seems to understand the dangers to a greater extent than its predecessors did. Unfortunately, our major trading partners do not seem to be aware of the enormity and dangers of the problem. In my view, the multilateral trading system is not to blame – it is the right approach to raising standards of living in the U.S. and abroad, and building international security. The problem is that one major player thinks playing by the rules is for suckers. I would strongly urge that rather than unilaterally impose tariffs that make the U.S. look like the rule breakers, we should work with the rest of the G7 to compel compliance by China through coordinated forceful trade action. At the end of the day, China has much to lose from being isolated from the international regime, and would almost certainly respond to coordinated insistence on compliance.