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Green Eyeshade War

Patrick Chovanec points out a growing conflict between the United States and China:

China and the United States are on a collision course — over accounting. Last week, the U.S. Securities and Exchange Commission (SEC) charged the Chinese affiliates of the world’s top five accounting firms with violating securities laws for refusing to hand over information on suspect Chinese companies to investigators. The move is the latest, most dramatic step in an escalating standoff that could easily lead to a financial version of Armageddon: the forcible (and unprecedented) delisting of all Chinese shares currently traded on U.S. exchanges, including big-name stocks like Baidu, Sinopec, and China Mobile — causing losses of billions of dollars and damaging the perception that the United States is friendly to Chinese businesses.

How serious could this get? Pretty serious:

Chinese companies won’t be the only ones affected if SEC-qualified Chinese auditors go the way of the dodo. Plenty of multinationals listed on U.S. markets, many of them headquartered in the United States, have substantial parts of their business in China. Yum Brands takes in 44 percent of its revenues from the KFC and Pizza Hut outlets it has in China. Car sales in China account for 34 percent of General Motors’ profits. These numbers matter to their global bottom lines, and to sign off on their SEC filings, their lead auditors in the United States need a PBAOC-registered Chinese auditor to vouch for them. If no such auditors exist, these companies have a problem. (There may be clever workarounds, such as dividing up the work among so many auditors that none of them is vouching for a “substantial” part of the business, but it’s a costly and cumbersome solution. Nor is it clear if easy loopholes can be created for multinationals with substantial China operations without tearing a big hole in the fabric of U.S. securities regulation).

If there’s one lesson we should have learned over the last half dozen years it’s that the international financial system has grown beyond the capacity of national and international institutions to control. The bailout of AIG, the largest bailout of a private company in U. S. history, was instigated because of actions taken by its financial products division, headquartered in London. Many of the counterparties with claims against AIG were foreign banks—Société Générale, Calyon (now Crédit Agricole Corporate and Investment Bank), Deutsche Bank, and Barclays, just to name a few—and the company’s failure could have taken down the entire international banking system.

Real shootin’ wars have been fought over seemingly trivial things. The War of Jenkins’ Ear between the United Kingdom and Spain in which 25,000 were killed, was not just about Robert Jenkins’s ear. It was about trade in the Caribbean and Spanish America. The War of the Oaken Bucket, in which 2,000 people may have lost their lives, wasn’t just over the theft of a bucket. It was based on the trade rivalry between Bologna and Modena.

An argument over accounting rules may seem trivial but the underlying issue is the oversight of international finance. Trillions of dollars are involved. That’s a lot more than an oaken bucket.

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About Dave Schuler
Over the years Dave Schuler has worked as a martial arts instructor, a handyman, a musician, a cook, and a translator. He's owned his own company for the last thirty years and has a post-graduate degree in his field. He comes from a family of politicians, teachers, and vaudeville entertainers. All-in-all a pretty good preparation for blogging.

Comments

  1. john personna says:

    I am very surprised that Chinese companies managed to get listed on US exchanges.

    It is sufficient that they trade in Shanghai or Shenzhen. Punters who are willing to risk overseas accounting may take a chance there.

    Like or Dislike: Thumb up 1 Thumb down 0

  2. Dave Schuler says:

    To be honest, that’s pretty much my view. If you sup with the devil, you need a long spoon.

    Like or Dislike: Thumb up 0 Thumb down 0

  3. Tsar Nicholas says:

    Meh. This is the warmup act. It’s the tip of the iceberg.

    The real issue is what happens if and when a nationalistic Taiwanese leader goes a few steps beyond what happened a while ago and instead of asking for “special state to state relations” flat out declares that they’re an independent sovereign state, not part of China, and China can go stuff it up their arse.

    The Chinese will go ballistic again, right? Like they did last time around, but with even a more heavy hand.

    So we’ll then say to China: “Step off, chumps.” And they’ll say: “Yo, stay out of our internal affairs or we’ll commence short selling U.S. Treasury debt with leveraged put options.” And we’ll say: “You won’t devalue your own Treasury holdings.” And they’ll say: “Over Taiwan we will. And besides we’re tired of earning such puny interest rates in any event.”

    That’s when the rubber will hit the road.

    Owing money is a bitch. Owing trillions of dollars to a rival sovereign who possesses grand ambitions is a real bitch.

    Like or Dislike: Thumb up 0 Thumb down 3

  4. Ben Wolf says:

    @Tsar Nicholas: The Chinese have been selling their Treasurys since 2010 and it hasn’t made a scratch in yields. How much longer are are you going to carry the same tune when it’s off-key every time?

    Like or Dislike: Thumb up 1 Thumb down 0

  5. michael reynolds says:

    @Tsar Nicholas:

    So, in your scenario both the imaginary new leader of Taiwan, and the leaders of the PRC become self-destructive? And we. . . what, exactly?

    Like or Dislike: Thumb up 0 Thumb down 0

  6. Franklin says:

    I didn’t bother to click through, but in a nutshell: why won’t/can’t the Chinese comply? Their approach to capitalism leaves something to be desired.

    Like or Dislike: Thumb up 0 Thumb down 0

  7. Ben Wolf says:

    @Franklin: Accounting requirements for Chinese firms are virtually non-existant. They won’t comply because they can’t. I question whether a single major Chinese corporation could survive a real audit.

    Like or Dislike: Thumb up 2 Thumb down 0

  8. GeoffBr says:

    @Ben Wolf:

    This doesn’t really answer the question. According to the link, they won’t comply because Chinese securities regulators tell them that compliance may violate Chinese state secrets laws, potentially subjecting auditors to life imprisonment. I probably wouldn’t comply in that case, either.

    As an aside, it’s not clear to me that the situation is as dire as the post predicts. Investors can always purchase shares on Chinese exchanges if they’re willing to take the risk. US firms with Chinese subsidiaries are more problematic, but I suspect there are viable workarounds.

    Like or Dislike: Thumb up 0 Thumb down 0

  9. Franklin says:

    Ahhh, unregulated capitalism, the modern Republican dream!

    Like or Dislike: Thumb up 1 Thumb down 0

  10. Drew says:

    Oh, I dont know. Can it be worse than US Government accounting?……..

    Like or Dislike: Thumb up 0 Thumb down 1

  11. Harvardlaw92 says:

    @Drew:

    What exactly is problematic about US Government accounting?

    Like or Dislike: Thumb up 0 Thumb down 0

  12. john personna says:

    @Drew:

    If it isn’t worse then we didn’t really need that whole Cold War.

    Like or Dislike: Thumb up 0 Thumb down 0

  13. Ben Wolf says:

    @GeoffBr: The “state secrets” which would be lost by compliance are hard data on the actual performance of the Chinese economy, rather than the massaged junk they shovel out to the world. Too many Chinese corporations are insolvent and rely on an incestuous relationship with the government. Compliance would be an embarrassment.

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  14. grumpy realist says:

    @john personna: The way Chinese companies get “listed” on the US stock exchanges is through what’s known as a reverse merger. Basically, a Chinese corporation purchases a US company that’s about to go belly-up.

    There’s also several SEC regulations that make it pretty easy for foreign companies to get listed on US exchanges providing they have the same sort of protection for investors that the US does. The main reason that most foreign companies’ stock gets listed on US exchanges only as ADRs is because of the horrisble tax hassles (US international taxation is a bitch.)

    At present, Chinese accounting bears about the same semblance to reality as Soviet economic projections.

    Like or Dislike: Thumb up 0 Thumb down 0

  15. I like reading through an article that can make people think.
    Also, many thanks for allowing me to comment!

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