Chinese authorities have uncovered a massive smuggling ring that allegedly brought in an estimated $10 billion worth of oil, cars, telephone equipment and semiconductors from Taiwan and Southeast Asia and whose tentacles, Chinese sources said, reached into the leadership of the Communist Party and the Chinese military.

Hundreds of Chinese agents have descended on Xiamen, a southern port on the Taiwan Strait famed since the Ming Dynasty as a pirate redoubt, to probe a case that, because of its scope and the rank of officials involved, is being called the biggest smuggling scandal since the Communist revolution in 1949. In November, the agents moved from two guest houses to a newly constructed 28-story hotel, where they have sealed off the lobby with blue paneling. They are keeping scores of officials under house arrest in the hotel.

Chinese sources said the case has already implicated a Politburo member, senior generals in the People's Liberation Army, a company listed on the Shenzhen stock exchange and scores of local officials in at least three provinces. Among those alleged to have ties to the case are Lin Youfang, the wife of Jia Qinglin, the Communist Party secretary of Beijing, and relatives of Gen. Liu Huaqing, a former deputy army commander, Chinese officials said.

Lan Pu, one of Xiamen's deputy mayors, his wife, and Lai Chongxin, a businessman who is at the center of the probe, are believed to have fled the country. Several high-ranking provincial police and security officials, including Xiamen's police chief, Chen Yaoqing, have been arrested for abetting their escape. China has requested that the Australian government extradite Lan Pu to China. Sources in Xiamen said another 159 government officials, including top bankers, are being held incommunicado in the Jinyan Hotel for interrogation.

Major Case 4-20, as it is called here, is seen as a test of the Communist Party's resolve to fight the smuggling and corruption that have emerged as a serious threat to the party's rule in China. China's cities and countryside have been wracked by thousands of small protests over the past years as malfeasance has grown to record levels.

In a recent speech, believed to have been prompted by this scandal, President Jiang Zemin warned that "party organization and leadership [are] lax in a great number of regions and units" and that danger lies ahead if the problem continues.

"No matter who it is," Jiang pledged to the party's Central Commission for Discipline Inspection, if he is convicted of corruption, "there will be absolutely no leniency."

But while popular discontent forces the party to stamp down on corruption, most of the investigations ultimately involve high-ranking party officials or their relatives. Many investigations are stopped halfway for fear of roiling the upper echelons of China's party and military.

Beijing party secretary Jia, for example, has been a Jiang ally since the mid-1960s, when the two overlapped at the First Ministry of Machine-Building. He started working in Fujian in 1985 as the provincial deputy party secretary, moving into the top job in 1994. Jiang brought Jia to Beijing in 1997 after an earlier corruption scandal--the downfall of Beijing party secretary Chen Xitong, who received a 16-year prison sentence in 1998 for embezzlement.

Jia is rumored to have divorced Lin Youfang on Dec. 14 because of her involvement in the case. A day later, Lin was detained by party anti-corruption officials, sources said.

So far, only one Chinese newspaper has written about the case--a short article in November in the Beijing Evening News. Since then, the party's propaganda committee has imposed a blackout, although details have become public through Hong Kong, Taiwan's freewheeling media and the Internet.

Major Case 4-20, so named because the party formed a task force on April 20 last year, has opened a window on the workings of China's economy and state: pricing policies that create a market for smuggled goods, connections between government, business and the underworld and the difficulties the central leadership finds in breaking those ties.

"There are dozens of Xiamens all over China," said a Western banker there. "They will smash this one, but the problem will pop up somewhere else. This is not a case of a few bad eggs, this is a flaw in China's system."

Case 4-20 revolves around a private firm called the Fairwell Group and its president, Lai Changxin. According to sources, Lai, a native of Fujian, opened a business in the early 1980s and slowly cultivated government officials, such as Lan Pu, one of Xiamen's deputy mayors who was responsible for military relations.

"Lai had a great way about him," said a prominent Xiamen businesswoman. "He bought one banker by bringing $250,000 worth of Chinese money into his office in a suitcase and just leaving it there. He didn't say anything, didn't apply any pressure. After a few days, the banker took the money."

Lai cultivated army officers in other ways. He employed their sons and daughters; the head of the sales department for Fairwell City, the Fairwell Group's huge real estate development in Xiamen, was the daughter of a high-ranking naval officer, sources said. Lai also gave them access to the Red Mansion, a private club he ran in Fairwell's corporate headquarters in the Huli Industrial Park in Xiamen.

"I knew many, many generals and colonels then," said a dance hall girl named Liu Hong who worked at the Red Mansion. "Mr. Lai treated us well. And the generals treated us well, too."

Somewhat wistfully, Liu described the inside of the club as "beautiful like a dream." Ample marble and chrome gave it an opulent feel, she said, adding that one wall was painted with flecks of gold. "The generals liked the big hot tubs, too," she said, "because many of them were a little fat."

In exchange, sources said, the army, the police and the customs department facilitated movement of tens of thousands of barrels of oil and other products into Xiamen's port. Lai's firm had its own dock there, sources said. Among the smuggled goods, officials said, was $141 million worth of telephone equipment made by the telecommunications giant Nokia Corp. Officials from four Fujian-based state-owned telecommunications firms, including the provincial telephone company, have been detained in connection with the case.

By law, Lai, as a private businessman, had no right to import goods into China. So he needed permits from state-run firms. One such firm was the Fujian Jiuzhou Group, owned by the Xiamen government, Chinese officials said. Jiuzhou is listed on the Shenzhen stock exchange. Since October, its share price has plummeted almost 50 percent as rumors have circulated that its executives are under investigation.

Lai is also believed to have obtained licenses from Jia's wife, Lin Youfang, who was the party secretary of the China (Fujian) Trade Holdings Corp., Fujian province's biggest state-owned import-export company.

Chinese officials and a variety of press reports have placed the total value of smuggled goods at about $10 billion over about five years.

Lai had a ready market for those goods, especially oil and semiconductors. In an effort to protect its lumbering state-run oil firms, China keeps its oil prices higher than the international price. Before a crackdown in late 1998, Western experts estimated smugglers like Lai were moving almost 42 million barrels of oil into China each year. In addition, semiconductors and telecommunications equipment were highly taxed at the border to protect China's fledgling electronics industry.

As a result, profits were high. Fairwell paid close to $4 million to buy the Xiamen soccer team, which it renamed Yuanhua, Fairwell's name in Chinese. In 1993, Lai paid $1.9 million for a glitzy apartment in Hong Kong. In 1997, he bought the eighth floor of Hong Kong's Far East Finance Center for $14 million. That year he also bought a 63-foot long pleasure boat for $565,000, Hong Kong government records show. He paid millions for land in Xiamen on which he planned to build Fairwell City.

Chinese sources said Premier Zhu Rongji, during a 1998 trip to Xiamen, offered Fairwell a deal--a hefty fine, with the promise that it would not be prosecuted for smuggling and could continue its legitimate businesses. Lai, sources said, agreed but then continued smuggling to raise the cash for the fine.

The central government found out and dispatched a team to dismember Lai's empire. But the team met resistance. It discovered its phones were being tapped by the local state security bureau and suspects were refusing to provide any information.

The team, led now by Liu Liying, the daughter of party old-timer Liu Bochun and a well-respected deputy secretary of the party's Central Commission for Discipline Inspection, complained to Zhu and Jiang, who threw their weight behind the investigation.

At that point, Lai's firm began collapsing fast.

Fairwell City was supposed to be the site of an 88-story skyscraper, the tallest building in Fujian province. Today it is a gaping crater, filled with water. Behind it stands the shell of the Fairwell International Hotel, an unfinished 30-story concrete monstrosity.

Similarly, the Red Mansion has been sealed by police and looks from the outside like a tornado struck it. Windows are open and shreds of curtains billow in the sea breeze.

Late last year the soccer team changed its name to the Xiamen Football Club. Investigators removed an ironic sign from the roof of Fairwell's headquarters. "Paying taxes is glorious," it said.