Chinese Accounting

Jim Chanos aptly described the collective group of Hong Kong listed Chinese Shares as a "roach motel", suggesting that almost all of theses shares had accounting irregularities.

My good friend John Hempton has also demonstrated in extreme detail how Focus Media just cant be taken seriously with their fairy-tale accounting along with numerous other Chinese companies listed on foreign exchanges.

And now Paul Gillis has produced a powerful work on the VIE's (Variable Interest Entities) for Asianomics that politely argues how the structure just doesnt work any more. (Did it ever work?)

For those that believe in the China miracle, I would suggest you take a long hard look into the accounting of Chinese companies. The prolific number of frauds and accounting irregularities that are in the Chinese foreign listed companies is creating a trust gap.

The world economic system is built on trust. If there is a failure of trust in the economic systems, then capital flows can break down. Whilst China just recently overtook US as the highest country for FDI (foreign direct investment), I would suggest that further accounting scandals and frauds could turn this capital flow on its head very quickly.

What happens in this space over the next few months and years could be very interesting. So far very little has been done by the Chinese to attempt to fix these issues. Any further deterioration in trust does not bode well for the Aussies betting on the permanent China growth story.