The curious case of Wong Kwong-yu (also known on the Chinese mainland as Huang Guangyu) came to light a few days ago when the person usually thought of as China’s richest man suddenly disappeared altogether from the public eye. As chairman of the national retailer GOME (Hong Kong stock exchange listing 0493), specializing in electric appliances, Wong was a man to reckon with for manufacturers of various consumer goods in China.

On the face of it, Wong’s arrest and his replacement within the company by Chen Xiao appeared part of a well-rehearsed script that has become all too familiar for shareholders of leading Chinese companies. Previously, other highflying tycoons such as Yang Bin, Gu Chujun and Zhen Zhongyi have came to grief for alleged corruption or corporate mismanagement.

I wrote last year about issues with corporate governance and valuations in China (see What’s the Chinese for Ponzi, Asia Times Online, 2007 over a year ago. It appears that no meaningful improvements have come about in China during this period as the most recent cases testify not just to bad behavior but also to knee-jerk reactions from the government.

Already, China’s banks have developed a reputation for unveiling ugly surprises both from their domestic lending operations and their offshore investments. Even recently, the government was forced to take some US$130 billion in problem assets and inject over US$20 billion in capital into the Agricultural Bank of China as it prepares for a stock exchange listing over the next few months. Any bank that can make that many problem loans into an economy growing at over 10% a year consistently for the past decade or so certainly deserves a few “medals”; more so even than all the silly bankers who bought “triple-A” rated mortgages from US investment banks.

Recently, the high profile case of Hong Kong-listed CITIC Pacific having to write off almost US$2 billion also came to light, putting the diversified conglomerate that is controlled by Beijing-based CITIC in the same category of mismanaged Chinese companies as some of the country’s leading banks among others.

What made the Wong case a bit more strange is that the move to arrest the GOME chairman was taken apparently almost a year after the investigation into the share manipulation of two Shanghai-listed companies controlled by his brother had ended. Last year, GOME had announced that the enquiry had ended without any charges being filed.

Still, the rather complicated situation of his subsequent arrest has created a number of new questions to be raised, including the specific evidence that led to his recent incarceration, information exchange with the company’s other major shareholders – which include one of the world’s largest private equity firms – as well as the (potential) involvement of other company officials in the matter.

Following a press release on November 24, wherein GOME denied that its chairman and controlling shareholder was being investigated by the police as was reported in a Hong Kong financial newspaper, the company reversed course on November 28, admitting that the Beijing Security Bureau had informed company officials verbally that its chairman had been arrested in turn necessitating a change of management.

Deja vu Russia

We cannot know much more until the transcripts of the case are released to the public, or when Wong Kwong Yu is formally produced in a court to be sentenced. Until then though, the pattern of arresting some of the country’s richest people on a sporadic basis suggests that China has yet to overcome the effects of tainted wealth that were produced by rampant corruption during the Jiang Zemin era.

A number of members of Jiang’s Shanghai clique (he was mayor and Communist Party chief of the city before rising to be the country’s president and party general secretary) have been purged since Jiang retired from senior positions between 2002 and 2004. Yet notably Wong Kwong Yu, whose date of birth is variously given as 1969 or 1970, was not even a member of the party. This made his climb to dizzying wealth all the more notable, albeit for many of the wrong reasons that the Shanghai clique has been accused of in the past, including rampant corruption and overt nepotism.

In making these arrests, it appears that the Chinese government is trying to reinstate justice, particularly when those who became rich by corrupting government officials do not then reform themselves to avoid further problems with the law. In the case of Wong Kwong Yu, we may not be too startled to discover that some level of intervention by persons acting on his behalf into the previously concluded investigation was the main cause of the current prosecution.

Still, it is difficult to escape the feeling that China is in many ways also emulating the Russian examples under former president and now Prime Minister Vladimir Putin. Much as Putin cracked down on many oligarchs, or particularly rich businessmen and industrialists, who had otherwise refused to toe his line, it may seem that the Chinese government is also weeding out “undesirable” behavior among the newly rich Chinese billionaires.

However, there is a big risk that the government will throw the baby out with the bathwater, much like the Russian government has done to date. For example, for much of this year and even before the commodity boom had started reversing, Russian companies were valued at lower multiple of earnings than their counterparts in other emerging markets including Brazil and South Africa.

This was because global investors feared the chances of a government crackdown on any specific oligarch could be unforeseen, and therefore chose to create a market discount for all Russian companies. In doing so, these investors may have inadvertently pushed Russian companies to borrow a whole lot more from their banks and bond investors than would have been needed if their equity values had been higher.

In any event, this vicious cycle of low equity valuations leading to higher debt soon erupted when commodity prices shrank dramatically from September, in turn pushing down the value of all Russian companies while leaving their debt unchanged. This is the primary reason for the net capital flight from Russia accelerating as commodity prices fell, as debt investors had reasons to fear a sharp rise in payment defaults.

Russian oligarchs have seen their net worth erode dramatically as a result of these changes in the past few weeks, leaving many of them nursing losses that now run into hundreds of billions of dollars. Those that are fighting to survive can only do so under the auspices of Russia’s state-controlled banks; in turn this makes the companies even more dependent on the Kremlin than before the crisis.

In effect, Putin may have reversed all the benefits of opening up the Russian economy in the past two decades and presided instead over a renationalization of various companies. That virtually guarantees that the time for Russians to stand in bread and meat queues would be just around the corner as well.

China must be careful to avoid this fate, if only because the government has now realized the importance of more balance between domestic consumption and export orientation. In order to encourage greater consumption, avenues for growing wealth domestically must also increase; for this to happen Chinese investors must have greater confidence in their stock markets among other avenues for improving wealth.

While no one has sympathy for people who garner wealth by illegal means, the Chinese government must also be careful to avoid giving the impression that all rich people are potential criminals who walk around freely only as long as they can please Beijing bureaucrats. That would do incalculably more harm to the Chinese economy than what the US recession would deliver in the next few quarters.