Even in a country known for rampant corruption, the Xiamen smuggling case gripping China is a stunner. Over the past few years, some $10 billion worth of oil, cars, telecom equipment, and cigarettes has passed illegally through the Fujian port across from Taiwan. China's biggest-ever bust has spread from customs men to top officers in the People's Liberation Army. Now, with the possible involvement of Jia Qinglin, Beijing's Communist Party Secretary and a close associate of President Jiang Zemin, the scandal threatens to undermine the authority of Jiang and his reforms.

The mess in Xiamen could wreak havoc on several fronts. In partnership with Premier Zhu Rongji, Jiang has spent the past two years trying to pump life into a spluttering economic-reform process. High on their list has been a campaign to force the PLA out of business--legal and otherwise--and back into the barracks. Now, with evidence leaking that the PLA was into the Xiamen smuggling game up to its epaulets, the repeated press reports that Jiang and Zhu have successfully clamped down on the PLA sound like so much Mao-era bluster. "The military, the party--everyone comes out of this looking bad," says a Western diplomat.

RED FACES. Neither does the scandal do much for China's credibility across the Taiwan Strait, where presidential elections are less than two months away. Beijing has long advertised Fujian province as a military staging area from which it could intimidate Taiwan if the island makes any move toward independence. It's not merely the embarrassing exposure of senior officers trafficking in illicit goods--some of which almost certainly came from Taiwan ports. With tensions rising in anticipation of Taiwan's March elections, a command structure this corrupt raises questions of security and control--and weakens the PLA's credibility even further.

Finally, there is China's expected entry into the World Trade Organization. After a flood of smuggled goods into the country during the Asian economic crisis, Beijing has been eager to plug its porous borders to strengthen ailing industries, including oil and autos, before it lowers trade barriers. But sealing the borders now turns out to be another victory the leadership has claimed too early. With the WTO in view, Beijing's leaders have been eager to demonstrate that they are in charge. Now they look both ineffective and out of touch.

BIG ARRESTS. Jiang is cracking down hard. With discontent rising as the economy struggles, he probably has little choice. Hundreds of investigators have descended on Fujian--and have made numerous arrests already. Key officials, including Fujian's vice-governor and Xiamen's mayor, are being replaced.

But efforts to keep the scandal out of Zhongnanhai, Beijing's leadership compound, are proving difficult. Beijing party chief Jia has been sullied by the reported arrest of his wife, Lin Youfang, who heads a Xiamen trading company. That's getting a little too close for comfort: Jia's ties to Jiang extend back to the 1960s. China's leaders, says Fred Hu, senior economist at Goldman, Sachs & Co. in Hong Kong, "are really afraid that epidemic corruption will undermine the party legitimacy."

The fallout from Xiamen is unlikely to reach to the top--whether or not it is traced that far. But that sword cuts two ways. While Jiang and Zhu will remain, their housecleaning is unlikely to do the job. Xiamen doesn't signal the end of the corruption problem. It's a reminder that China's credibility as a maturing power must still be questioned--and that a slow rot is eating away at the party's precious authority.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE