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Big Changes Are Coming to China

This historic, tremendously significant transformation was, sadly, reversed when the Hu-Wen government took over in 2002. The few surviving SOEs, though nominally "publically traded," quickly formed an untouchable alliance with the government and banks (mostly state-owned and publicly traded themselves) and dominated the landscape.

They are, of course, notoriously inefficient in every way except regulatory arbitrage and pluropoly. But they are the original too-big-to-fail. They have practically unlimited sources of cheap financing and monopoly-like pricing power. Life cannot be easier and more glorious than theirs anywhere or anytime on this planet.

Except it has led to enormous inefficiency and abuse in capital allocation and utilization, as well as contributed to rampant corruption and social discontent, in recent years. In every sense, the SOEs are the pinnacle of structural socioeconomic ills of China today.

If the incoming government manages to re-reverse the tragic trend of the past decade, there is actually a fair chance for the Chinese economic engine to keep chugging for a long time and for the country to continue its three-decade-old, historic transformation. The impact to the world cannot be over-estimated.

In comparison, the pathetic competition of "who talks tougher on China" during the presidential campaign is utterly irrelevant. The rational and wise approach is to embrace, encourage, and influence the transformation in China. But I suspect that's exactly what the U.S. will do, despite the president, whoever it may be.

In the short term, as policy thaws from cryogenesis, I expect to see Beijing taking some concrete actions in the weeks and months ahead. The yuan will probably be nudged lower in some ways. As inflation continues not to explode and fear of leakage from QE3 subsides, some form of monetary stimulus other than the timid reverse repo operations by the central bank, which has been the tool of choice during the cryogenesis, is likely to take shape.

The economic structural shake-up will probably start with the financial sector, with a myriad of regulatory changes. The net effect in the longer term, if successful, would be to stabilize the real-estate market, control growth of bad credit (mostly from local governments and SOEs), and increase market-driven competition in the financial sector.

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