China's Revolution Risk

We all know by now about the simmering leadership crisis in China. The Bo Xilai affair has lifted the lid on a hornet's nest. I had not realised quite how serious the situation has become until listening to China expert Cheng Li here at the Ambrosetti forum of the world policy elites on Lake Como. (My hardship assignment each year.) Nor had anybody else in the room at Villa d'Este. There were audible gasps.

The rifts within the upper echelons of Chinese Communist Party are worse than they were during the build-up to Tiananmen Square, he said, and risks spiralling into "revolution".

Dr Cheng — a Shanghai native — is research director of the Brookings Institution in Washington and a director of the National Committee on US-China Relations. He argues that China's economic hard-landing is intertwined with a leadership crisis as the ten-year power approaches this autumn. The two are feeding on each other. "You cannot forecast the Chinese economy unless you have a sophisticated view of the political landscape and the current succession crisis," he said.

There has of course been a basic policy error. The government thought it could cool of the property boom with surgical tightening, leaving productive industry intact. That was an illusion. "They didn't expect the market reaction to be so strong and bring down the whole economy," he said.

It remains to be seen whether this is a variant of errors made by the Fed in 1928 and the Bank of Japan in 1990 when they tried to calibrate a soft-landing after an asset bubble had already run out of control. Charlene Chu from Fitch Ratings issued a note last week warning that China's banking sector assets are near $21 trillion, up from $9 trillion in late 2008. This is extraordinary rate of banking growth. Even a modest shock could "wipe out the sector's entire earnings," she said.

Be that as it may, Dr Cheng said fears of a disintegrating political model are now eating in economic confidence. "This legitimacy crisis is worse than in 1989, and may be the worst in the history of the Communist Party. People are afraid that it could lead to revolution if it is not handled well."

The worry is that the transition could go badly awry as 70pc of top cadres and the military are replaced, the biggest changeover since the party came to power in the late 1940s. "That is what is causing capital flight. All the top officials are trying to get their money out of the country," he said.

Dr Cheng grew up during the Cultural Revolution. That makes one very sensitive to the risks of sudden lurches in the Chinese ruling system, not always for the better. He said the scandal around Bo Xilai and the party machine in Chongqing – and the fight-back by Mao nostalgics – is a symptom of a much broader crisis. The word in Beijing is that Bo Xilai alone has squirreled away $1.3 billion, but there are other even worse cases. Mr Cheng said a former railway minister – known as Mr 4pc — had ammassed $2.8 billion. "This level of corruption is unprecedented in the history of China and unparalled in the world," he said. (I would have thought Russia's oligarchs are right up there, but never mind).

Frankly, I don't know what to make of this. I pass it on to readers for your own judgement. Like everybody else with an interest in world affairs, I have been watching the escalating disputes in the South China Sea and the East China Sea with astonishment. We had a fresh clash this morning after Japan vowed to press ahead with the purchase of the Senkaku/Diaoyu islands. Chinese president Hu Jintao, no less, rattled a sharp sabre. "It is illegal and invalid for Japan to buy the islands via any means. China firmly opposes it. China will unswervingly safeguard its sovereignty. Japan must realize the severity of the situation and not make a wrong decision," he said at the APEC summit.

Personally, I rather admire the team of Hu Jintao (without wishing to get into the Tibet issue) and premier Wen Jiabao. They fully recognize that China's investment-led (50 per cent of GDP) development model is well past its sell-by date. They have been trying to rein in the hotheads and militarist adventurers. It is the possibility of what comes next that keeps one awake at night. As Dr Cheng said: "We shouldn't be afraid of China's success. We should be much more worried about China's failure."

Ambrose Evans-Pritchard