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China needs Carson Block to help keep it honest

Nothing ruins a chief executive officer’s year faster than hearing the name Carson Block.

Allen Chan can attest to that. In April, he resigned from Sino-Forest Corp., the Chinese forestry company he co-founded two decades ago, after being targeted by Block’s Muddy Waters LLC. The short-selling firm shot to fame by correctly betting on declines in stocks of Chinese companies listed in North America, much in the same way that David Einhorn rose to prominence for being right on Lehman Brothers Holdings Inc.

This hasn’t gone over well in China, where foreign critics can trigger an intense level of nationalistic suspicion. When Greenlight Capital Inc.’s Einhorn shorts Japan, officials in Tokyo, while not happy, move on. But when Jim Chanos of Kynikos Associates Ltd. bets against China, hostility abounds. In September, a group of more than 60 Chinese entrepreneurs and executives signed an open letter accusing Citron Research and other short sellers of manipulating information and misleading investors.

Rather than circle the wagons against Block, China should realize that some good can come from his tactics. Many of China’s companies need serious scrutiny.

One reason China could just join him and welcome domestic short sellers is to go after dodgy U.S. companies that make a mockery of capitalism.

Hewlett-Packard Co.’s accounting scandal is but the latest reminder that U.S. practices are far from ideal. After Wall Street’s crash and the shenanigans at Enron Corp. and WorldCom Inc., Chinese have reason to do their own police work on the United States. The real benefit, though, is domestic.

Real fire

I’m not defending all of the practices of short sellers. Anyone who manipulates stocks or bonds by introducing false information into the market should be scrutinized, too. Sometimes, though, there really is fire where there is smoke. Consider how many times Lehman Chairman Richard Fuld denounced the traders who turned out to be right about his company. Or how many times Sino-Forest executives dismissed Block as a complete nut.

None of this means Muddy Waters is right about all of its strong-sell reports. And it might not matter, as Block is de-emphasizing his positions on China — for now.

Singapore’s Sunny Verghese, CEO of Olam International Ltd., is Block’s latest fixation. No one knows whether Muddy Waters is correct that the giant commodity trader is on the verge of insolvency. All we know is that someone will end up with mud on the face. But why turn away from China?

“China has gotten harder in the sense that the government has really taken the side of the fraud,” Block told Bloomberg News on Nov. 27. “The government is working with a number of these companies to try to conceal records that are public. When you are up against that sort of strength of the ability to revise history, it becomes difficult. That is one of the reasons we’re not that interested in China anymore.”

That’s why China’s top-down capitalism needs pressure from the inside, from investors on the ground. At a time when corruption is on the rise, China needs a chorus of homegrown voices asking questions. It is too loaded and charged when the criticism comes from the outside. Chinese should become stakeholders in their system, not just shareholders.

China knows no bigger bull market than applications to join the Communist Party. Why? The big money is in government. It’s in dubious land grabs, insider trading and old-fashioned rent seeking.

Big scandals

The big scandals of 2012 bear that out. One surrounding Chongqing politician Bo Xilai shined a bright light on the vast wealth amassed by his extended family. In June, Bloomberg News reported on the accumulated wealth of the family of Xi Jinping, China’s next president. More recently, The New York Times alleged that the family of departing Premier Wen Jiabao has made billions of dollars.

China’s response to sensitive news reports is to silence the messenger. Both the Bloomberg and Times websites were blocked in China. Censoring cyberspace doesn’t change the fact that Transparency International ranks China behind Tunisia, whose leadership fell amid the Arab Spring movement, in its Corruption Perceptions Index.

Say a mainland investor thinks a state-owned company’s balance sheet doesn’t add up. Or an economist doubts gross domestic product or trade data. Would he or she feel safe airing those views? Jack Welch can blab all he wants about U.S. jobs data he thinks are cooked, though he’s wasting his breath. The lack of dissenting views to challenge the conventional wisdom doesn’t help China; it holds the country back.

China’s markets are so blatantly rigged in favor of the political class that it impedes needed reforms. The will to deregulate the economy, clean up banks and strengthen corporate governance shrinks as overseas bank accounts swell.

What the Blocks of the world do, if they are acting ethically, is question the status quo. They poke holes in profits that look too good to be true, balance sheets that are too opaque for comfort, and executives who use mergers and acquisitions to hide weaknesses or losses. China could do with its own swarm of market players doing just that.

Pesek is a Bloomberg View columnist.

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