VULNERABILITIES IN CHINA’S FINANCES; RISKS FOR U.S.

The U.S.-China Economic and Security Review Commission has issued its annual report to Congress. The New York Analysis of Policy and Government will periodically present summaries of their work.

In 2020, the Chinese government leaned on state control to contain the economic fallout of the COVID-19 pandemic, instructing banks to lend to companies hard hit by the virus and deploying the country’s financial system to absorb the pandemic’s shocks. While Beijing’s response has enabled a rapid recovery in China’s economy, it has done so by fortifying the role of the state in managing economic activity and promoting policies.

The Chinese government is beginning to experiment with breaking this implicit guarantee and to defuse risks in China’s financial system as regulators embark on a cleanup of the banking sector and assess systemic problems caused by a decade of rapidly accumulated debt (see Figure 6). Confronting the scale of these problems, the Chinese government increasingly views foreign capital as part of the solution. Beijing’s financial opening in recent years thus reflects a calculated strategy to secure foreign investment inflows and use them to shore up the domestic economy and strengthen its companies. As this opening continues, exposure to unique risks in China’s financial system rises for foreign investors, and their financial wellbeing becomes increasingly staked on Beijing’s management of the Chinese economy. China’s financial opening is also deepening U.S.-China financial integration just as the U.S. government takes more concerted steps to confront China’s unfair economic policies and threats to U.S. interests. Of particular concern is the rising inclusion of Chinese securities in global investment indices. These inclusions are funneling hundreds of billions of U.S. investment dollars toward a financial system that lacks transparency, adequate pricing of risks, and regulatory oversight (see Figure 7). They are also financing companies whose operations are otherwise antithetical to U.S. national security and foreign policy objectives.

There is every indication that China’s quest for foreign capital will continue. Local governments shoulder crushing debt levels, banks remain undercapitalized, and increased public expenditure on caring for an aging population will erode national savings. U.S. portfolio investment inflows to China are also poised to grow significantly, especially if China recovers from the pandemic ahead of other economies, making Chinese financial markets more attractive. As these trends converge and U.S. exposure to risks in China’s financial system rises, doubts about whether deepening U.S.-China financial integration is desirable are coming into sharper relief.

Key Findings

China’s formal financial system is dominated by state-owned banks, whose position has been strengthened in the wake of the COVID-19 pandemic in 2020 (see Figure 8). These banks favor state-owned enterprises (SOEs) and privileged companies, leaving other Chinese companies starved for capital. Between 2008 and 2016, a large and unwieldy shadow banking sector emerged to fill this gap, leading to a proliferation of risky financial products and rising leverage across China’s financial sector.

▶ In 2016, Beijing launched a financial de-risking campaign to rein in shadow banking activity and clean up the financial sector. This campaign choked off small private companies’ access to financing. The COVID-19 pandemic has further deteriorated the financial health of these companies, forcing the government to ease its regulatory tightening and prioritize economic stability over financial de-risking. With such vulnerabilities remaining unaddressed, investors in China’s capital markets are increasingly exposed to structural problems in China’s financial system.

▶ As Beijing strategically opens its financial sector to secure foreign capital and global investment indices shift asset allocations toward Chinese securities, U.S. investors’ exposure to the unique and significant risks accumulated in China’s capital markets rises (see Figure 9). These risks center around the opacity of China’s financial system and Beijing’s interference in market activity to advance its political objectives.

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▶ Increased financial exposure to China threatens to undermine U.S. efforts to defend against China’s unfair economic practices and protect U.S. policy interests. Several Chinese companies included in global investment indices are subject to U.S. export controls but not investment restrictions. This mismatch enables problematic Chinese companies to continue raising U.S. capital and reduces the strength with which the United States can defend against companies that threaten national security.

▶ While China’s leadership speaks of developing more dynamic capital markets, liberalizing interest rates, and imposing market discipline on the banking sector, these ambitions are tempered by a low tolerance for market instability and a strong bias in favor of state

owned companies to maintain economic growth and safeguard employment.

▶ After years of unbridled lending, China’s financial system is facing

▶ Beijing continues to deny U.S. audit regulators full visibility into the financials of U.S.-listed Chinese companies in line with U.S. accounting standards. These evasions from effective regulation and oversight, together with U.S.-listed Chinese companies’ complex ownership structures, deprive U.S. investors of both full transparency and the opportunity for legal redress in cases of accounting fraud, eroding the integrity of U.S. capital markets.

▶ The COVID-19 pandemic has exacerbated key risks in China’s already strained financial system. Although a full accounting of economic damage is still underway, China’s first economic contraction in four decades will make it more difficult to tackle the country’s debt burden, resolve nonperforming loans, and efficiently allocate capital.

▶ Beijing’s imposition of the national security law in Hong Kong has accelerated the territory’s assimilation into China’s national governance system, which could erode its status as a global financial hub. As the Chinese government calibrates financial opening, it may lean more on Hong Kong to raise foreign capital and serve Chinese companies and continue to rely on the territory as an extension of mainland capital markets.

Photo: Pixabay

Quick Analysis

Judge Merchan continues to deny justice to Donald Trump

In August of 2024, we discussed the US Supreme Court’s decision in Trump v. United States. We described the three tiered system enunciated by Chief Justice Roberts to determine whether or not the actions taken by the President of the United States are entitled to immunity from criminal prosecution or not. The first tier are acts within the President’s constitutionally mandated authority which are subject to “absolute immunity.” The next are acts that may have “presumptive immunity,” and are subject to examination with evidence that rebuts the presumption of immunity. The third are acts which are unofficial, and which enjoy no immunity. In September, we also discussed the effect this decision should have on the New York County criminal case currently pending against President-elect Trump before Judge Juan Merchan. We cited to a CNN report, which described the evidence used against Donald Trump at the trial of that matter: “Trump’s lawyers pointed to testimony at trial – including from White House officials Hope Hicks and Madeleine Westerhout – they argued should not have come before the jury…'[a]ll of Hicks’s testimony concerning events in 2018, when she was serving as the White House Communications Director, concerned official acts based on [Presidential] authority for which President Trump is entitled to absolute immunity,’ Trump’s attorneys argued. ‘[the Supreme Court’s ruling] specifically forbids prosecutors from offering ‘testimony’ from a President’s ‘advisers’ for the purpose of ‘probing the official act.’” Sure enough, as Chief Justice Roberts stated in the Presidential Immunity decision, “[a]llowing prosecutors to ask or suggest that the jury probe official acts for which the President is immune would thus raise a unique risk that the jurors’ deliberations will be prejudiced by their views of the President’s policies and performance while in office. The prosaic tools on which the Government would have courts rely are an inadequate safeguard against the peculiar constitutional concerns implicated in the prosecution of a former President.” At the time, we stated that “Judge Merchan allowed testimony regarding Donald Trump’s official acts as President, acts which enjoy absolute immunity and which cannot be used against him, or even be entered into evidence in a criminal trial, a situation which could have been avoided had Judge Merchan delayed the trial until he’d received the guidance of the US Supreme Court.” Nonetheless, we predicted that Judge Merchan “will find a way to justify his actions once again, and let stand the unlawful conviction of former President Donald Trump.” You know how much we hate to say we were right…but…we were right. “This Court…finds that the evidence related to the [President-elect’s] claims relate entirely to unofficial conduct and thus, receive no immunity protections,” Judge Merchan wrote in his December 16, 2024 decision. “Further, even if this Court were to deem all of the contested evidence…as official conduct falling within the outer perimeter of Defendant’s Presidential authority, it would still find that the People’s use of these acts as evidence of the decidedly personal acts of falsifying business records poses no danger of intrusion on the authority and function of the Executive Branch, a conclusion amply supported by non-motive-related evidence.” In so ruling, the Court denied Donald Trump’s motion to dismiss his New York County conviction. Let us examine these findings, in light of the evidence admitted at the President-elect’s trial, and then compare that evidence to the acts granted absolute immunity by the US Supreme Court. In his decision, Judge Merchan discusses the testimony of Hope Hicks, who served as the Communications Director for the Trump White House. “Defendant argues that in her roles at the White House, any communications between Ms. Hicks and Defendant must receive absolute immunity…as Defendant’s ability to speak freely to Ms. Hicks was a core function of the Executive. According to Defendant, because Ms. Hicks wielded executive power on his behalf, authority that exists pursuant to Article II of the Constitution, any communications [President Trump] had with [Hicks] are subject to absolute immunity,” the Court wrote. Judge Merchan also noted that “[t]he People argue that the communications Defendant had with Ms. Hicks…constitute unofficial acts not entitled to any level of immunity.” In his inevitable agreement with the arguments presented by Manhattan DA Alvin Bragg’s office, Judge Merchan wrote “Defendant’s argument that any communication he had with Ms. Hicks is subject to absolute immunity by virtue of the position she held in the White House is mistaken…the President himself may speak in his unofficial capacity as a candidate or party leader, and certainly he can do so in his private capacity as well. Any argument that private conduct transforms into official conduct by communicating about the same to an individual with a particular title is without merit.” Thus, it is Judge Merchan’s position that the conversations Donald Trump had with his Communications Director are not entitled to immunity, even though those discussions were held at the White House, while Donald Trump was serving as President of the United States, merely because those discussions were not related to official Executive Branch activities. Sounds possibly reasonable – until you examine the Presidential Immunity decision more closely. In September, we wrote that “the statement made by Chief Justice Roberts in his majority opinion in the Presidential Immunity case [is significant]; ‘Presidents cannot be indicted based on conduct for which they are immune from prosecution…[t]estimony or private records of the President or his advisers probing such conduct may not be admitted as evidence at trial.’” This statement by Chief Justice Roberts points to a blanket immunity for ANY discussions had between the President and his advisors, regardless of the nature of those communications. Further, we noted that the Supreme Court issued the following warning: “[t]he government…contends that a jury could ‘consider’ evidence concerning the President’s official acts ‘for limited and specified purposes,’ and that such evidence would ‘be admissible.’” In rejecting that argument, Chief Justice Roberts states “[t]hat proposal threatens to eviscerate the immunity we have recognized. It would permit a prosecutor to do indirectly what he cannot do directly – invite the jury to examine acts for which a President is immune from prosecution […]