Thornhill Capital LLC - consulting, financial, accounting, compliance, due diligence, risk management, translation and other services, B2B, USA, China.

Published on Jan 31, 2013 in Asia, China, Newsletter, slider

Keeping Your Head Low in China

        imgres Last week I was having lunch with a friend of mine in Shenzhen, China when I asked him when he thought he would start seeing private planes flying throughout China, now that the government had approved their use with certain flight restrictions. My friend, who is a Chinese fund manager, told me that he thought the market for private planes may be limited as most wealthy Chinese and government officials now want to keep their heads low. They don’t want to let people know they’re rich.

There are two reasons for this, he explained. The first is that China’s new leader, Xi Jinping, is making the fight against corruption his number one priority. As Mr. Xi put it, corruption could lead to “the collapse of the Party and the downfall of the State.” The second is jealousy as business competitors, neighbors, and someone who just doesn’t like you will talk to the local government and will accuse you of tax evasion. And in China, that’s like pointing to the sky and saying that there’s a cloud to be found there.

Tax evasion and corruption are pervasive throughout China, and have been, in one form or another, since the dawn of time.  The government knows it, has somewhat condoned it in the right circumstances, and was hoping it would stay under the covers and out of the public eye. That didn’t happen. The issues with Bo Xilai and his family’s reported wealth uncorked an already leaky bottle. The government is now forced to deal with these issues as things have gotten out of hand and public anger over these issues threatens China’s social stability.

To be clear, you would expect someone who underreports their income or accepts bribes to keep a low profile. This thought is not Nobel Laureate material. But in China it could well be. According to Jeffrey Hays of Facts and Details, those in China that have money, whether earned or stolen, seem bent on ostentatiously displaying their wealth. They live in gaudy mansions, drive expensive cars, send their children to schools abroad, wear flashy clothes and diamond studded Rolexes – and they brag about it!

In China, where the average government salary is $790.60, it’s difficult to explain how you can own several houses, luxury watches, and even have a mistress. The mistress part notwithstanding, Jaime FlorCruz of CNN further adds that a senior official, now known as “Uncle House,” was found by government officials to own 21 houses despite being on a meager income; a lowly bureaucrat, dubbed “Brother Watch,” was found to be wearing expensive-looking watches on various occasions; and various other government officials were found to own luxury villas, expensive jewelry, and other trappings of wealth.

In China, where an individual or company seldom, if ever, pays their fair share of taxes, and wages for government employees is uniformly low, it’s hard to justify the possession of these luxury goods when someone turns you into the local government. The government doesn’t have to go much further than its own tax records to gauge one’s ability to own these luxury goods. As a result, the Chinese are now very sensitive to anything that will put one on display for having a great amount of wealth, especially in the case of government officials. The Chinese people have become increasingly unhappy with outward displays of wealth and the free-spending ways of the government. Therefore, wealthy people and government officials are increasingly avoiding outward displays of wealth. The government, in an effort to show the people they’re taking aggressive action, wants to put some people in jail and take away all their worldly possessions. It wants to make an example of corrupt officials and those who flaunt their wealth while avoiding the payment of taxes. In doing so it hopes to regain the confidence of the people and improve social stability. Therefore, everyone wants to stay out of this spotlight until the government has something else to focus on.

In my opinion, the actions of the Chinese government have always been like a pendulum – they go from one extreme to the other, never staying in the middle, or a moderate position, for very long. Most laws against corruption and tax evasion have been in effect for quite some time, in one form or another, and I believe they’re every bit as strict as our laws. The only difference is that many times the Chinese government doesn’t choose to enforce these laws until a violation appears in the foreign press, embarrassing the government, or the Chinese people express their unhappiness with the government. When that happens the government will usually act in a draconian manner to bring the situation under control, demonstrating it is in control, and everyone should have confidence in the government. The pendulum of government action is either to the far right or to the far left, but seldom in the center.

Currently, the pendulum is on the draconian side. The government, effective October 1, 2012, imposed a “frugal working style” rule which, according to Farah Masters at Reuters, bars government employees from spending public money on lavish banquets or luxury cars, as well as accepting expensive gifts (luxury goods). In December alcohol was banned at all military events.

In fact, according to Reuters, this crackdown has already resulted in a marked decrease in the purchase of luxury goods with Kweichow Moutai’s baijiu liquor, a premium fiery clear liquid used at official banquets, falling from 5th to 13th place in the “best brand for gifting by men” with a resulting 12.5 billion yuan decrease in market value. In addition, Swiss watchmaker Longines came in at 15th place, replacing Rolex, which was previously in ninth place but has now fallen off the list.

I think that “keeping your head low in China” will continue for a time until the government feels that it’s accomplished its goals in the eyes of the people or there’s another national priority that shoves it to a lower rung on the ladder. Until then I expect a continuing decrease in the over-the-top manifestations of wealth in China. I also expect a continuing number of Chinese to apply for permanent residency or green card status in foreign countries as a way of diversifying their assets out of China and hedging their bets if the government seizes their assets for corruption or tax evasion. In that event their family, as well as a portion of their money, will be safe offshore. According to Willy Lam in his China Brief, published by the Jamestown Foundation, 60% of residents in China’s upper-income bracket are in the process of doing exactly this.

Tax evasion and corruption in China aren’t going away. It’s just morphing and going under the covers.  In the meantime wealthy individuals and government officials are keeping their heads low and out of the spotlight until the government feels it has adequately addressed the situation in the eyes of the people and social stability is no longer imperiled. You can also expect influential Chinese to continue to diversify their assets overseas and avail themselves of liquidity options that were unavailable in past generations.

        

If you have any questions please e-mail them to info@thornhillcapital.net