China’s Closed-Door Politics Risks Blindsiding Traders After Bo

China’s ouster of senior Communist Party official Bo Xilai last week added a new dimension to an opaque leadership transition under way in Beijing this year: news about the succession has become tradable.

Speculation of a coup yesterday spread on the Internet, helping spark the biggest jump in credit-default swaps for Chinese government bonds in four months. China’s capital was calm hours after the alleged disruption, with foreign executives including former U.S. Commerce Secretary Carlos Gutierrez attending a meeting in the Zhongnanhai leadership compound.

The lack of a free press and democracy in China, as well as the absence of a transparent mechanism to pick new leaders in the second-biggest economy and the world’s biggest online population, escalate the risk of rumors and their potential impact.

“Chinese politics are a complete black box,” said Zhang Ming, a political science professor at Renmin University in Beijing. “It’s inevitable that this would have global financial and economic impact, and it’s possible that some investors want to amplify the issue and make profits. It’s an opportunity.”

The coup rumor was spread in part by the Epoch Times, a New York newspaper linked with the banned Falun Gong spiritual group. After publication of the report, the cost of insuring Chinese government debt using credit-default swaps jumped 10 basis points to 107, set for the biggest daily gain in basis points since Nov. 9, according to data provider CMA. Today, contracts to insure China’s sovereign debt for five years against non-payment fell 1 basis point to 106 as of 12:11 p.m. in Hong Kong, according to Royal Bank of Scotland Group Plc prices.

‘Be Very Wary’

Qin Gang, head spokesman at China’s Foreign Ministry, said in a telephone interview last night that he “hadn’t heard anything about” the Epoch Times report.

“You should be very wary of this newspaper report,” Qin said.

The removal of Bo, 62, as Communist Party Secretary of central China’s Chongqing municipality was announced a day after Premier Wen Jiabao told reporters in Beijing that the city’s leaders had to “seriously reflect” on an incident in which Bo’s former police chief spent a night last month at the U.S. consulate in Chengdu, in neighboring Sichuan province.

Wang Lijun’s stay sparked speculation he was seeking asylum and set off an official probe. The New York Times, citing what it said was an official Chinese document, reported March 19 that Wang was removed by Bo as police chief to impede a corruption investigation involving Bo’s family. The document said Wang had sought asylum at the consulate because he feared for his safety after he fled Chongqing.

Weibo Search

News and speculation about Wang and Bo spread across the country on Sina Corp.’s Weibo Twitter-like microblog service. The company said on Feb. 28 that Weibo had more than 300 million registered users. Searches today and yesterday for Bo’s name on Weibo produce a notification saying that “based on relevant laws, regulations and policies, ‘Bo Xilai’ search results cannot be displayed.”

“The best way to prevent the severely damaging result of these sensational rumors is to open mainstream media” and move to democratization, Li Cheng, a scholar at the Washington-based Brookings Institution said in an e-mail. “It will be a tough decision to make from the authorities’ perspective, but sooner or later China will move in that direction as state-society relations have profoundly changed.”

Standing Committee

Bo is a member of the Communist Party’s ruling Politburo and had been mentioned by Brookings’ Li and other analysts as a top candidate for inclusion in the elite Politburo Standing Committee, the group, now with nine men, that exercises supreme power in China.

Membership in the Politburo and its standing committee is determined by bargaining and consensus at the top levels of the Communist Party, which holds a congress later this year to pick the next generation of leaders who may run China for the next decade.

This year’s congress will mark the first time since the People’s Republic of China was founded in 1949 that the leadership succession is not determined by a paramount political figure such as Chairman Mao Zedong, according to Ding Xueliang, a social sciences professor at the Hong Kong University of Science and Technology.

“Investors should expect more rumors to come until the 18th party congress,” Ding said in a phone interview. “Every group will do their utmost to achieve their goals during the leadership change.”