Advancing a Free Society

Caveat Inauguror

Thursday, May 10, 2012

The government of China has just given yet another reason investors should be wary of operating in the Chinese market.  The Chinese Ministry of Finance has announced regulations, requiring western auditing firms to give control to local partners by the end of 2012, effectively ending the independence of firms operating in the Chinese market.

This comes on the heels of several high-profile cases of accounting fraud in recent years, and the Securities and Exchange Commission charging accounting firm Deloitte for refusing to hand over documents in a fraud case of a Chinese firm listed in the U.S. (Deloitte claims it would violate Chinese law to do so).  The Finance Ministry’s action will be read as validating concerns about the opaque and often corrupt practices of Chinese firms.

Given the collusion of Chinese government and business, both through state-owned firms and politicized decisions on everything from bank lending to police investigations, the regulatory take-over of auditing firms bodes ill for investors getting reliable information on the business practices of companies in which they take an interest.

Academics and politicians often marvel at what French Finance Minister (and later President) Valery Giscard d’Estaing called the “exorbitant privilege” that accrues to the United States by the U.S. dollar being the world’s major holding currency.  And it is a privilege, often undeserved by us, as now, when our government proves unwilling to make sensible choices about economic fundamentals such as debt reduction.  But it merits remembering that American dominance is not alone a function of American choices.  It also results from the choices of others.

For all the talk of a rising China, they are making quite a number of choices that will keep the dollar a safe harbor of value and call into question the reliability of information so important to encourage investment.  China may not rise either so far or so fast as predicted unless they reform the crony authoritarianism that looks to be the hallmark of their economic model.