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By Elizabeth M. Lynch, January 24, 2010

Thomas Friedman

It is dangerous to use financial analogies to describe a non-financial event; the comparison usually misses the mark and often overly simplifies a complex issue.  Thomas Friedman fell into this trap last week when he recommended short selling the Chinese Communist Party (CCP) in his op-ed.  In attempting to predict the CCP’s fall, Friedman failed to do his due diligence and realize that like most things in China, it’s not all black and white.

First, the metaphor of “shorting” non-financial products has to stop.  Or at the very least be explained.   For readers of this blog and Friedman’s column who are not day-traders, “shorting” is a specific financial term.  When you “short” a stock, you borrow shares of the stock from a third party and sell these borrowed shares on the assumption that the price will decline in the near future.  When the stock is trading lower, you purchase it and return the shares borrowed, thus making a profit.   In essence, “shorting” implies that the product is presently overvalued and the value will decrease in the near future.

While you can’t actually “short” a country or a ruling party, Friedman uses the analogy to imply that the CCP is currently overvalued and its value, or in this case its power, will eventually decline.  According to Friedman, the CCP’s power will decrease because of its insistence on suppressing the Chinese public’s freedom to information, specifically over the internet.  For Friedman, this pits two different segments of Chinese society against each other: “Command China” which he defines as “traditional state-owned enterprises” and other extensions of the CCP and “Network China” which is made up of “highly entrepreneurial” companies that feed off of the creative energy of a free internet.

In drawing this distinction, Friedman paints with too wide a brush.  If the Chinese business world could easily be divided into decrepit, state-owned industries run by the Party and vibrant, Silicon Valley-like companies that are independent of the Party, the CCP’s demise likely would have already occurred.

Network China is not as independent of the CCP as Friedman makes it out to be.  A company’s success in China, even a

Shorting the CCP?

small technology company, is often dependent on the owners’ connections with government officials.  The companies of Network China are not outsiders to the system; they are very much insiders and largely profit from good relations with the CCP.  Take for example Baidu, China’s homegrown search engine.  Although Google’s search engine is at least as good as, if not better than Baidu’s, due to Baidu’s close relations with the government, it has a much larger share of the Chinese market.  Government and Party connections are important assets on a company’s balance sheet and, at times, are instrumental to a company’s success.  The companies of Network China continue to profit from their connections; it is unlikely that they will be the ones to seek change.

Furthermore, Command China and Network China are inextricably linked.  The Chinese banks that provide loans to the start-up companies of Network China are state-run and members of Friedman’s Command China.  When it comes to loaning money, the Chinese leadership has more than a bully pulpit; it can out right force its banks to provide these loans, as it did for much of 2009 while banks in other parts of the world constricted their lending.  In many ways, the government’s control of the state-run banks has been a boon for Network China.  Why change it?

The Chinese government’s increasing censorship of the internet is troubling, and not just for those of us abroad.  The Chinese people themselves have been in an uproar about Google’s threat to leave China and realize the damage that a censored internet can have on their development.  Just don’t expect change to come from Friedman’s Network China; these companies are already co-opted by the system.  If change is to come, expect it to come from average Chinese netizens and expect it to be a long process; not exactly ideal for short selling.