Rusted Metal An Investigative Report

Investment scandals such as the government-backed Kunming Fanya Metal Exchange scheme recently uncovered in China’s Yunnan province suggest that the country’s economy will stagnate without measureable political reform, according to experts.

Fanya collapsed in July 2015, leaving 240,000 investors short around 43 billion yuan (U.S. $6.5 billion). Officials in Yunnan had backed the exchange, which authorities now say engaged in unlawful activities to bilk investors out of their money.

Stakeholders are demanding that authorities return their capital because government support led them to trust the scheme, which was also promoted by state-owned banks and the official media, but experts say the money is almost certainly unrecoverable.

To date, only Fanya chairman Shan Jiuliang has been arrested for his role in the scandal, but none of the members of the exchange’s official “Promotional Work Leadership Group”—all of whom are government officials—have been excused from their positions or stripped of their membership in the ruling Chinese Communist Party (CCP).

Xia Ming, a political science professor at the City University of New York, told RFA’s Mandarin Service that government officials and ranking CCP members routinely use their influence to get rich through investment vehicles in China and called the country’s financial market “a huge Ponzi scheme.”

“Officials use their powers to set up ‘casinos,’ but the gambling is different from that overseen by organized crime syndicates,” he said.

“This kind of casino has an official gold-lettered signboard, an official government platform … and political leaders dividing up the spoils in the background.”

Xia said the elite of the CCP are “indifferent” to the interests of the people because making money through traditional means has become more difficult.

“In light of this, they use a virtual financial Ponzi scheme to scam money directly,” he said.

“And meanwhile, though China's current political structure is highly corrupt and highly centralized, the CCP is doing everything possible to build up its own public image as ‘great, glorious and correct.’"

Need for political reform

Other observers suggested that even with a better regulatory system in place, China’s underlying political system will allow for unscrupulous activity to continue in the country’s investment market.

Mei Fengjie, a U.S.-based expert on China’s economy, told RFA that implementing a securities registration system in China without changing the political system will do little to prevent companies from scamming investors. The country currently employs an inspection process to approve investment vehicles.

“The Chinese judiciary is not independent, crony economics and power-for-money deals are rampant, and whoever has money can be partners in crime with the government,” Mei said.

“Although China has developed detailed laws and regulations, execution is a problem.”

Little oversight exists in the financial market aside from what is provided by the media, Mei said, and whenever someone protests against injustice or fraud in the system, authorities accuse them of trying to “subvert the government.”

“China's economic reforms have lacked the necessary political reform to support them, so at this point a lack of further reform will allow corruption to increase, but change carries the risk of creating chaos in the system that will breed market fraud,” he said.

“And since the Chinese political system lacks a separation of powers that provides for press freedom and judicial independence, in many circumstances economic reform is now unable to continue to progress.”

According to Mei, the Fanya scandal occurred because of a lack of effective oversight in China’s financial market.

“Fanya depended entirely on false propaganda to create a big scam and now that the scam was exposed—because it involved the interests and inside information of too many officials—the government is unable to conduct fair trials,” he said.

“This suggests that without the support of underlying political reform, [economic reform] would only result in surface level changes—essentially its own system with ‘Chinese characteristics.’”

Instead, he said, China’s government continues to attempt economic reform while maintaining the existing political system—the results of which have “proven that’s impossible.”

“Unless there’s a sudden political change in the next decade, China's financial system will stagnate,” Mei said, adding that the country should follow the example of Western countries that have built impartial judiciaries and stringent regulatory systems that punish crimes of fraud.

West and East

Zou Tao, an independent financial analyst based in Shenzhen, believes that while China’s financial market is underdeveloped, its prospects for growth are good if the government embraces a combination of Western regulatory practices and measures more suited to the country’s specific needs.

But he cautioned that whatever market reforms China pursues, they will be ineffective without accompanying political change.

“The reason China's reforms haven't been successful and can be problematic is because the financial system doesn't interact well with the political system,” he said.

“China's regulatory structure, including the securities regulatory industry … has no effective accountability system for its officials.”

Zou called officials in the sector “subservient yes-men for the top leadership” who are no longer accountable to the public, which he blamed on institutional problems.

“If the system is not reformed—just as the Fanya and [other] incidents occurred—tomorrow there could be another event,” he said.

“Government regulations currently only work by waiting until something happens and then putting out the fire, rather than through strict supervision beforehand.”

_{Reported by Wen Jian for RFA’s Mandarin Service. Written in English by Joshua Lipes.}