The Golden Age of Fraud in Finance

this is Rob Johnson president of the institute for New Economic thinking I'm here today with an extraordinary man well I've known back to the days when I worked in finance but uh knowing him and being able to keep up with them are different things this is Jim chanos he has his own investment firm has been involved in the markets now for over 40 years recently he's been teaching a course I guess recently for the last 13 years he's been teaching of course called a history of financial Market fraud a forensic approach Jim has written things on the inet website and in many other places related to financial instability he's written about China and he is one of the people that when I look at who is successful Independent high integrity courageous and practices what he preached Jim chanos fills that bill as well as anyone I've encounter Jim thank you for being here today well well thank you for that that uh that over-the-top introduction Rob it's good to be here well you got to have a bubble before you can have a crash but we don't quite have a crash today but uh but let's start talking about uh recently the phrase the Golden Age of greed you've talked about how what you're observing what kind of things are happening in the United States and perhaps in the world economy and uh with a Global Financial Market it's not even clear where the sovereigns are sometime but what did what did print the picture for us what is the Golden Age of greed well it's actually worse than that it's the Golden Age of fraud um and and so I I coined that term a couple years ago as I started to see you know uh post pandemic uh the excesses really begin to build in the financial markets both public and private uh culminating in in 2021 which was the most bucket of year uh that I've experienced in in the markets in over 40 years um and and one of the things I teach in my class Rob is that the fraud cycle follows the business and financial cycle with a lag that is the longer you have an expansion the longer a bull market goes on um the the more the incidence of fraud occurs as it as it matures and and then of course uh once things turned down you begin to get fraud exposed because many frauds are at their basis a Ponzi scheme and need to raise new and New Capital um and so the poster child for that obviously is what we saw happening crypto last year which was the red hot kind of culmination of speculative uh frenzy lack of oversight lack of law enforcement and and just pure unadulterated greed that that got caught up and and then exposed in all kinds of schemes that were at their very nature simply Ponzi schemes and and I think that that now we see another aspect of what I teach in the class and that is when people ask where's the regulation where's law enforcement one of the things that is as old as financial markets is that we don't see oversight or new laws and regulations until after people lose money and and that is certainly now the case in crypto where after the fact we're going to see much more regulation as we speak the SEC is cracking down now on both onshore and offshore uh crypto firms um and and and so on so it it dovetails with with what I teach um in real time um in fact last year uh anecdotally um the now Infamous uh interview in Bloomberg with Sam bankman freed was released on a Monday afternoon in April I teach my class at Yale on Monday afternoons and I was reading this while I was having my coffee before class and and I ran up to our audio video guys to to ask them if they could put this interview that I was reading on my smartphone up on my PowerPoint for that afternoon's class because it's very rare that in real time you see an industry luminary discussing his industry by describing it as a Ponzi scheme which is exactly what SPF did in that interview in late April with Matt Levine and Joe weissens all on Bloomberg and and so you know it all came together last spring and summer in in this particular Subspace of the financial markets to to talk about uh to to to prove what what we've been talking about what I teach about these cycles of greed and fraud that occur in financial markets when things go too long and and oversight becomes Lacks and do you see uh which Michael a recipe or a vision for a corrective structure of governance that would diminish these like how overreaches or these calamities that follow excess yeah it all depends and I know that's a that's kind of a weasel answer but but in in past Cycles where we've seen large amounts of speculation and large amounts of fraud the evidence is mixed um so for example if we just look at the the market since the 20th century I mean after the crash of 29 and the resultant amount of fraud that was exposed and people forget about that if you look over my uh my right shoulder back there there's some stock certificates of Ivar Kruger's firm um the the great match King is written about by Frank Portnoy um and and the Securities acts of 33 and 34 which came after the crash was not really about the crash it was about all the various different pieces of paper that were floated on American investors through state regulatory Vehicles the um and so-called Blue Sky laws that ended up you know basically being worthless and and so that was the real impetus to to get the framework for the SEC and and the Securities laws that we still use today so they're the backlash was tremendous but if we go to uh if we go to uh say uh the global financial crisis I mean we got Dodd-Frank but there was a lot that was undone or not done after that wave of fraud and excess that we saw in the residential real estate market and of course part of the problem there politically was was that lots of lots of everyday people were committing the fraud right people relying on their mortgage applications and then Wall Street was packaging Wall Street was going in on the LIE or looking the other way or did willful blindness and look the other way as these things were packaged in to leverage Securities and then distributed throughout the global Financial system so it became very very difficult to prosecute the bad guys when we were kind of all the bad guys and then you can look at the corporate waves of fraud in the.com Era with Enron and Worldcom and and then also go back to the Savings and Loan crisis where George Bush Senior put thousands of Bankers into jail for uh for simple loan fraud uh and uh back in 1990 and 1991 so it all depends I mean it it's we've seen pendulum swing where the public gets outraged loses lots of money and and and demands change uh and Justice and then there are other times where the public kind of shrugs and says Ah they're all Crooks what are you going to do so we'll see you know I uh would guide our uh audience to look at this or listen to this uh podcast it's a six or seven part series by Alex Gibney and David Sirota called meltdown and it was not about the Meltdown of the financial markets in 2008 it was a meltdown in the confidence of governance regulation and expertise that fostered Tea Party fostered Occupy Wall Street yeah a republican House of Republican Senate and uh I guess Donald Trump yeah the feeling and the feeling that everything was rigged right that that's the rigged on behalf of the the rich guy and Market participants and not rigged on the on to the detriment of the public but what's really crazy Rob is that in the 10 to 12 years that followed that um that the public decided the way they were going to get even was to speculate themselves in Crazy Securities in 2020 and 2021 so they started buying crypto they started buying uh worthless meme stocks they started buying spax and and to get back and if you you get on social media and read what's in the mindset of these small investors is they want to get back at the at the man they want to get back at hedge funds and and Regulators in the SEC and not understanding that in fact they're the ones that are being basically duped again um to buy these Securities it's it's a remarkable experiment in human psychology yeah it's almost like imitation of the person that harmed you uh there's got to be a Freudian term identification with the aggressor I think was the Freudian phrase for replicating the practices of mostly abusive I kept pointing out to to a number of them on social media during the meme stock crazes and there's been a few of them that that overpaying for worthless pieces of paper is not going to stick it to the man it's going to stick it to you it's going to stick it to your portfolio and and you know and and making these statements in the markets is can be dangerous um and so it it really is um it really has become a bit more of the Wild Wild West and certainly so in 2020 and 2021 and I think we're going to be paying for that going forward and maybe some unspecified ways in the middle of 2021 I was down in Coronado Island for an event celebrating the life of a man that was extraordinary and one of my friends came up to me and said you used to be really interested in all these financial markets and he said I've been making lots of money and I said I didn't know you were a financial guy I thought you were a surfer he said in these financial markets you get your toes on the nose and you ride the front of the board and I said be careful be careful there are sharks out there with their jaws open and uh but but it was just a kind of a silly thing he was so enthusiastic this is June of 2021 and he was he was very what I'll call emotionally intoxicated we're still seeing the echo chamber of that option trading is hitting new records and what has a lot of people like me concerned is that it's that now the the volume is all coming in what's called zero DTE options zero days to expiration meaning people are buying options for stock prices on that day that expire and so this is like literally gambling going down and just betting on red and black and and and and and so we've really gotten a casino like culture coupled with the equity culture um that that is is a bit frightening um in terms of Market structure and and again I mean Regulators have kept their kind of hands off this um I I don't want to date myself too much but you know if we go back far enough you know one of the one of the ideas was that the Fed was supposed to not only take away the punch ball but was supposed to warn people when when things were were getting overheated by by such indications as raising margin requirements they're completely quaint and Antiquated in today's markets but nonetheless would send a message and and as we know really since volcker um the fed and others have have had as their third mandate um Financial Market stability and some might say maintenance and and that's that's now the unlegislated third mandate for all central banks and in and of itself after enough years where people get used to that the so-called fed put um it breeds its own instability because people take more risks than they otherwise would assuming that the government has their back and every once in a while they find out to their horror and misery like 2002 and 08 that doesn't necessarily happen that way and so um it's concerning and and and then of course we overlay on that the fact that that in this golden age of fraud as I've called it we're seeing all kinds of egregious corporate actions that I think really should be cracked down on and aren't um the the most prominent when people say well where is the fraud occurring right now the most prominent is is right in front of our faces by the aggressive use of pro forma reporting metrics by Corporate America uh if you look at most corporate reports right now they do not publish at first and foremost in front and center their Gap results they report adjusted metrics so uh ge stogio ge is a great example of this ge put its earnings out two weeks ago and uh ge had 16 pages of adjustments in its earnings report for the fourth quarter to get you to the number that they wanted you to get to as to what their they thought their profits would be adjusted not what they were what they were adjusted if you take out a bunch of bad stuff and Silicon Valley has taken this almost to to a a an absurd level um I have companies that are going to report that that have 40 or excuse me 80 of their revenues are share-based comp expense where they're just issuing stock instead of cash to their employees and and under the current guys companies add that back to their p l they say that's not an expense so increasingly it gets to this equity-based you know equity-based world that we're in more and more companies particularly aggressive companies are paying their employees lavishly in stock because they don't consider it an expense and and the SEC has guidelines on this that it is just not enforcing um and so routinely you'll hear you'll hear someone like an Uber or or or a company like that talk about adjust we are now adjusted profitable and this is the first time in 10 years we're a prop and then you look at the financial statements closely and you realize they're still losing money and that is to me kind of black is white and white is black and and uh I think it's something that that you know the FCC and other Regulators should have cracked down on a long time ago um you know I'd love to report to my partners our investment results without the bad stocks I guess wrote in jail if I do that yes yes well it's an interesting uh Dilemma to see all these machinations that you can be because of your expertise alert to we're also seeing a lot of the public that you mentioned a few minutes ago wanting to catch up but they don't have that Insider that equipment and then you have uh let us say the large number of people that don't do much Beyond subsistence and as the despair in all these categories starts to rise in the loss of faith and governance like you'd said system is rigged which was kind of a mantra of Donald Trump's 2016 campaign and I always encourage people to look at the video of the three-minute speech that he made on on the night of game seven of the World Series which was the Sunday before the Tuesday election when the Chicago Cubs were striving to overcome I think they had one since the early like 1904 or something and the the turnout for those games were huge he played this ad six or seven times over the course of the game to the National audience and he kept saying the system is rigged and the only people strong enough who could band together to fix it are the American people and it was this piece of propaganda that showed Lloyd blankfein With Hillary Clinton or Hillary Clinton with Xi Jinping or George Soros and others in the background and he's casting all of this we call um Discord and then saying we're going to fix it and a lot of people bought into that the guy who took seven of his six or seven of his companies bankrupt and I was short a number of his Securities in the 90s in the early Millennium um in in the junk bond market and the equity market and and uh you know being short Donald Trump's companies was uh was like watching numerous slow move moving ICE uh ocean liners hitting multiple icebergs I said that on a fundraiser and President Obama loved that and stole the line um but uh um it's true I mean to have Donald Trump give us a lecture on the system being rigged is is high comedy in my eye that has nothing to do with these other politics it's just as an observer of financial markets um you know he was a master of that and and so um it really is ironic but what's even more frightening as we've alluded to is that the outrage of 2009 and 2010 which was Occupy Wall Street and tea party as you mentioned has turned itself into well I'm just going to go to the casino myself and put it all on red and you know I I that to me is even more frightening um because it's as if and someone said this the other day at a meeting I was at he said it's kind of like the public is that is that guy at 3am in the casino at the roulette table with eight or nine drinks in him and half his stack is gone but he's going to be damned if he doesn't get his money back before he goes to bed and and you know it it's you know he's going to lose everything and and I just worry that where this is going to put us politically come the next true bear Market where a lot of these small retail investors who are in the market like never before get wiped out and and they're going to get wiped out and and so I think that that that would worry me as an observer of political economy through the lens of Finance um and then what will the backlash be what will people want to do at that point um and so will that be will it be anti-wall Street it will be anti-corporate America will it be some combination of both uh and and how will the politicians on both sides of the aisle you know Stoke that fear yes well Martin Wolf the famous uh columnist for the financial times has just released a book on the crisis of capitalist democracy and I've worked with him quite actively on the book and we just did a podcast a couple weeks ago it just came out on 7th of February and who's he comes from a family not his mother and father but relatives who were destroyed by the Nazis and the ominous sense that he has it's not it's not even what will the government do what kind of government will people submit to in the despair say in the after the fall down of the markets in the next recession or breaking deeply and then the last piece I guess I want to add to make this tension even greater is we have the baby boom aging out now and those people with 401ks or whatever if those all evaporate given the cost of Elder Health Care what kind of Crisis are we going to have when the people who need support money evaporated and the size of the working age population relative to the retired population is at an all-time low there's a lot of stress on the horizon so two thoughts there so the first one on on on Martin Wolf's book and I look forward to reading it is that what was really terrifying and what brought forth the 30s particularly in Germany and and Italy um it was the and even Soviet Union was was the the first crisis of the early 20s right and and then Amplified by the global crash in 29 and so you had you had in in Germany and Italy and and of course through Civil War and Soviet Union you have this horrible Wipeout of of savings and capital in the early 20s in Germany through hyperinflation um and and uh in in Italy through economic depression and in Soviet Union through Civil War and and then just as things were sort of maybe trying to write themselves even though politically it polarized those countries well certainly Germany and Italy then you had the crowd cash for 29 and 32 and and that's what brought Hitler in for example was the fact that that not only did people lose their life savings and the hyperinflation in 23. but then everybody hit the bread lines in 1930 31-32 and at that point people said I have nothing to lose I'm going I'm going to either vote communist or or national socialist and we know what happened and and that's the that's what worries me is that that if this occurs you know within within anyone's memory of 0809 um and and and then the backlash is going to be I think significant number one um number two is it turns a 401ks and health care costs I really do think that that that one of the other aspects of what we've seen in the the equitization of society and the financialization of society is is beyond just the fed put in the markets is now a general sense particularly post pandemic that well if worst comes to worse the government will will send me a check will make me whole will will open up the floodgates and we'll get National Health Care or whatever it might be and and that is that is the flip side monetarily and inflation deflation side of of what happened post pandemic we now have a belief in light of what the government did to stem the pandemic what makes people actually think they won't open up the floodgates in the next depression or recession and and probably they will and that's fine but I'm just saying that that we now can see a different script from the deflationary 40 years from 1979 to to 2020 um when I got on Wall Street in 1980 rates were 14 going to zero and and that's not going to be repeated and so we saw labor ascended in the late 70s I was earning 14 an hour working in a steel mill in Milwaukee Wisconsin to pay for my college education and I got all the hours I wanted at night weekends holidays because the union workers there were making a lot of money and all had you know Lake homes and and whatever and and you know when I got on Wall Street in 1980 I made more money in two months in the summer of 79 working in steel that I made my first full year on Wall Street imagine that today but that was that was the peak of Labor that was Thatcher's election in 79 and Reagan and 80. and the Pendulum has swung back and now of course it's all capital and no labor and and if that pendulum swings back the other way and it's you know we've seen it happen a couple times in American society in the last 150 200 years you know people are going to be wrong-footed and and there will be like we've seen when those things change you know wholesale societal changes and political changes so it it will be very interesting yeah and the uh movement they now are calling deglobalization may play a role in that that might it might indeed to our friends in China yes well you know the how would I say people like Bronco milanovic and others have made a good point which is God wasn't necessarily born in Pittsburgh and Detroit and the globalization development did create a rising tide for living standards for many many people on planet Earth but that process perhaps was maturing but also with some of the breakdowns related to adversarial nationalism and the pandemic and so forth I would edit he may not have been born in Detroit or Pittsburgh but he ended up vacationing in Davos [Laughter] yeah man the uh yeah Peter Goodman will have to put that on the jacket of his paperback edition of Davos man but I think the uh the sense that I have now is that we are in a what I'll call an unstable dynamic and there is all kinds of tension uh directed at governance uh I know a lot of people the other night who said um the State of the Union Address was brilliant it but can we practice what we preach and uh and I said somebody said to me later and it reminded me of your comment moments ago Trump preached what he practiced but with a mask and Biden has put out something that whether it's dealing with the cost of medical care for elders or financial transparency or I mean he just went through a whole laundry list of things but the sophisticated people I know are saying how is he going to implement that in the world of money politics and and I don't want to Fan the Flames of cynicism and drive us further towards that authoritarian alternative and I do myself find myself grateful that the president United States did which you might call shine a light on directions he would like to see us go for better balance not necessarily every single thing he said but the thrust of it but uh but nonetheless uh it his stepping out like that made me think we really are in a treacherous place that the the impetus to his breaking away and making that speech is probably related to concerns of Despair within the White House yeah I I can't I you know I I I can't speak to that I don't know but I I would say that um you know the inability now I think obviously like most presidents he got whatever legislation he's going to get through he got through in the first half of his term and now you know it's going to become incredibly difficult with the Republican house so it has to be via executive uh action and and the regulatory system um and so that's why you see the initiative about things like junk fees and and and and and and and things like that but um but even then I mean it becomes more and more difficult um and and and politicized as we get closer to a presidential election uh because if if the White House does do that and I think they should in many cases um you know it will be painted as as regulatory overreach and big government you know stomping down on business and um and so it's it it it's a tough road to hoe without a doubt politically yeah well as I mentioned Bill Grider used to say the FED is independent he'd say the independent from whom and now people are saying how how are we going to protect Freedom when the only freedoms that seem to be protected are things like a space program for Elon Musk or Jeff Bezos on his own and where where's the common good this where where's the protection of students from the prophets of gun makers and I'll go one step further with Tesla and that's the company we're short in the interest of full disclosure is uh is nipsa allowing them to test they're a full self-driving beta software on roads um that you are you and I are on where other other automakers you know legitimately use test tracks and test for years um he's testing them on our highways and and you know I think if it was any other company if it was Toyota doing this um the the federal regulatory apparatus would have told them to stop it immediately but because it's Elon Musk he gets a pass and part of that gets back to the equitation of of this country and the financialization of this country that I've talked about uh he's held up as a hero and Tesla is the most owned stock by retail investors in the world and so he's gonna get he's going to get I think special treatment yeah I think that's an interesting hypothesis I hadn't thought about that broad-based retail Coalition that might be underpinning it and he can play the he can play The Common Man in the theater of the financial markets now that's wow the uh let me let me uh reach back a little bit in history uh my former wife was the head of Japan analysis in the 80s for the Federal Reserve under first volcker and then Greenspan and we watched that Bubble Burst and we watched that country aging And yet when you look at satisfaction on life you look at surveys longevity whatever whatever measures you want the Japanese didn't collapse and I guess I want to contrast that with some of the ominous things that you and I have put on the table uh how was Japan and how they say these are still Dynamic things the the downturn could still be tomorrow but were they able to step aside and have a U.S China positive multiplier be the rising tide that raised all boats and sustained them to avoid a crash or uh or or are there things we can learn from them so that we don't uh fall off the cliff well one thing that everyone forgets about and the Japan and applies to China than the US but when everybody forgets about that uh the the 30 40 years no 35 years at this point that Japan has stagnated is that Japan has had declining population so it's flat GDP over that period or up slightly on a per capita basis is actually up in line with the EU in the United States or not far off and so uh that that because the company the country is shrinking um again the math the way the math works is is people really haven't individually felt it um and so that's a really important Point people should consider however I mean Japan in 1989 at its peak had eerily eerilies is eerily similar to China um in terms of the economic model and I have a slide in my my China deck about this you know Japan was uh was heavily heavily an investment driven GDP model although nothing like China it was at its peak uh it was investing about 30 percent of its GDP in investment China is uh is in the mid 40s and has been for for a better part of 15 years um it uh it was investing in Greater Asia um now in China's case they're they're investing internally but but greater China is supporting that in terms of Hong Kong and Singapore and South Korea um it had a basically government-driven economic model if you remember Mitty and Minnie uh were directing Investments by corporate Japan in many cases um it had an export driven economy and with a pretty controlled currency so there were a lot of similarities between the Japanese economic model of the late 80s which was the miracle and and the Chinese economic model from say five to ten years ago when it was still putting up those big numbers and then the final similarity which is the most ominous was Japan had a real estate bubble and had a banking system that peaked out at about 400 percent of GDP in terms of assets and now let's go to China and take a look at what happened in China over that period so when China entered the WTO in 2001 it had an economy about one trillion dollars U.S in terms of GDP it had a banking system that was about 1 trillion Us in assets 40 of those assets were bad they were loans to state-owned Enterprises that ultimately had to be worked out over time they wrote some of them off over time because they had to recapitalize their banking system in the Western financial markets uh in Hong Kong in New York and so it took them a while to work that out of their banking system fast forward to today Rob and China's economy is about 15 trillion U.S and Assets in their banking system are roughly well actually over 60 trillion so they're 4X that's very similar to where Japan was at the peak it's very similar to where some of the bad European countries were in 0.708 like Ireland and Spain and Iceland and and so you start to get up the banking system that's four or five times the size of your economy and it's the banking system that that the banking system tail that Wags the economic dog and how does this happen well it almost always happens because of Real Estate um which is a leveraged asset class I joke that Chinese apartment prices are the second most important price you got to know other than U.S treasury rates um because it's roughly a quarter of China's GDP as residential real estate and and trying to keep is still building 20 million Flats a year even though it doesn't need them a declining population yeah and and China I've joked long that China is the only Advanced country that knows its annual GDP on January 1 of that year they can preset it and by legally right I mean and it's an accounting identification if half of your economy's investment you could literally direct investment to make a GDP number if you never right off if you never write off the the bad bad Investments in a dynamic sense these buildings or these what you might call excess Apartments don't add to productivity and therefore income to service that growth in the balance sheets of the banks or the financial institutions and so if if they were investing in productivity enhancing resources human capital or physical capital or whatever you might have a more optimistic sense which they were which they were in the dang Xiaoping reforms after Tiananmen Square and even in the first 10 years of the new you know New Millennium after they entered the WTO it was until after the GFC that this went crazy and and we've seen this massive increase in banking assets and and apartments and apartment loans driving GDP and and you know a lot of it was government driven right I mean they they needed to make numbers the the way the the Communist Party worked was the local party was set targets by by the National Party you need to grow seven or eight percent this year well what's the easiest way to grow seven or eight percent stick of shovel on the ground now the problem with this is is that you can't segue into a consumer-driven Services economy which is what most modern economies are because you remember your macroeconomics rob you know s equals I right so the fact that if you're going to invest 46 of your economy every year you've got to save 46 and and and thus the problem the segue to a consumer-driven economy will create speed bumps the lake of which no no Chinese Premier wants to encounter and every time that they try to sort of rein this in they've tried three times since I've been following China closely in 09 three times they've tried to hit the brakes and all three times they've let up and hit the accelerator again because the economy immediately goes into stall speed and they panic and and I've called it the treadmill to health they they can't get off it and and and and and there's no other Playbook and so the inevitable reset is going to happen it's just a matter of when and from what level where like Japan Japan hit this reset in 89 and and Japan's alternative is to muddle through for 40 years with no growth I don't know if China has the the cohesion internally and politically and they might to do that um and and that that is either that or you're going to have to face a severe downturn clean out the system clean out the bad debts and and start over um I don't know if they have the stomach to do that and and or if they don't try to find foreign Adventures to offset that risk you know starting 2019 in Hong Kong now the saber rattling over Taiwan um you know and that that's always a possible response policy wise as well yeah you know ominous for all parts particularly with an end game of nuclear threat uh it's interesting to me I spent a lot of time going back to the time of Tiananmen Square in China and I remember there was a place probably around 2012. where a lot of professors at universities were saying to me we had this old model where you'd run around the country say the equivalent of high school students and test who are the best and the brightest you'd bring them in and teach them to be the government but now in the Advent of the digital age there's a whole lot of what I'll call private sector potential and there are a lot more people who want their children educated whether it's in engineering or or you know the skills the three R's or what have you and these professors were talking to me about their frustration that the economics of the support for the universities by the state wasn't what I would call working to upgrade human capital where all the potential lied and they said you know we've had a lot of people migrate from the Farms to the cities and they work many times with their hands in then they moved in manufacturing in the beginning then they moved to construction of infrastructure and construction of real estate but we're not building the human capital and I think I guess just to conclude that that vision the way in which Jack Ma has been dethroned is sending a very negative signal about technology is creating what I'll call Freedom and Independence that maybe the government doesn't want the society to to inhabit well as as we know from our own wrestling with big Tech big Tech becomes a power center literally in and of itself and and that's the one thing the Chinese Communist Party won't won't Broach right it won't Broach any political uh uh Power by a new a new power base you know technology entrepreneurs big technology companies like like Alibaba Baidu 10 cent and so that's that's why we saw that those those companies and those Executives were getting fabulously wealthy and that that became a political threat that that the CCP was just not going to tolerate so that's number one number two it's coincided with the the globalization as you've called it you know and and and a little bit more hard-headed look at Chinese technology through the National Security lens and and you know whether or not we want Huawei equipment or or tick tock on our phones and so increasingly that's going to be an issue um and so you know it's tough because the Chinese labor market having gotten wealthier has priced itself out of making sofas and bicycles and things like that those are made elsewhere uh for for Walmart and and uh and and and really they were supposed to go up the value change through technology and and uh more advanced products but but with this deglobalization trend yeah it's going to be more problematic for China and so they have a they have a series of issues on their table that are not pleasant and Alternatives that aren't that Pleasant right now um and and that's what makes me worry a little bit about the saber rattling because one of the classic classic misdirections for any authoritarian government is to set up enemies outside the Border um that's the cause of our problems not not our own policies yes and uh I know my friend Orville shell who's spent a lot of time studying China and uh he wrote a book with the John John delari uh uh called wealth and power and it was about what he saw as a coming crisis between the U.S and China which was from the humiliation they call the century of humiliation from the Opium Wars through the Japanese invasion the idea that China has to what you might call regain its stature at the head table is very powerful at the same time you have the United States leading the Western system doesn't want to be a partner it wants to be the captain and the United States comes from what I'll call a Cartesian Enlightenment system the Taoist Confucius the the Eastern philosophy in China means that it's quite possible for the two sides to misunderstand each other because they make projections from their own imaginative mindset onto the other that so big Brzezinski talked about this a great deal in 2010 and 11 that it was going to be very hard to have a G20 but as this distrust is reinforced by what you might call a stammering or sputtering economy and Discord within both the United States and China that that Bismarck recipe find something that you can dislike outside and unify the people behind you seems to be as a matter of fact one of the other teachers at Yale uh Stephen roach formerly at Morgan Stanley uh I did a podcast with him a couple of months ago about his new book on these questions and uh I read something by Chaz Freeman last week about what you might call uh a lose-lose framework or an on on unnecessary losses that might be on the horizon don't underestimate also the the the fury that China has uh uh toward our Ally Japan who's announced a re-armament program because for whatever whatever differences between West and East there are in philosophies and the ability to misunderstand each other in any kind of policy square off there is just outright hatred in China for the Japanese much of it legitimate I might add for what happened in World War II and and and and we we forget that that there was a massive land War while we were fighting our way across the Pacific you know via VR Navy and Marines there was a massive land war going on in China you know between the Japanese Army and the Chinese Army replete with you know many of the atrocities we saw from from you know the Third Reich and and so that has not been forgotten in China I can assure you and and so the the fact that Japan is now embarked upon a new policy um to to rearm itself is is Raising strategic issues in Beijing that heretofore it didn't worry that much about worried about the U.S but but you know re-armed Japan is a it's a different animal in the in the Pacific so um yeah it's it's something they talk about a lot more than we do obviously yes and uh I guess uh it's hard to figure for me what the Chinese government thought it was doing in siding with Russia when so many of their trading partners are on the other side I've wondered if that decision while it's a way of showing you know how to say beating your breasts or stiffening your spine in some simple way if it's not going to exacerbate the economic stresses because the Australians the EU and others are going to step back themselves well keep in mind that that Xi Jinping um the first thing he did when he became the leader back in 2013 was uh was give a speech about the weakness of the Soviet Union in allowing perestroika and how it was one of the biggest disasters of of the 20th century was was the fall of the Soviet Union and there's actually an Institute for the study of the fall of the Soviet Union in China um and but but perhaps you know more interestingly anonymously uh remember that the only major foreign leader that attended the the Sochi Winter Olympics that were Putin's uh showcase was Xi Jinping and this was before the uh the the well before the Ukrainian Invasion so um there has been a a growing warmth between Russia and China I think because of shared interests against the West uh for a while now yes yeah I think that's right in in my own work when I was running the quantum emerging growth fund I used to ride around all of these countries in emerging Asia and read their novels and watch their movies and seeing from that you know how you say I'd like to read the analysts reports but I also like to get the kind of which might call the cultural Vibe that's coming forward and one of the things that haunted me in recent years was the movie wolf Warrior 2 which absolutely characterized China as the savior of the global south from the global North a bit led by America but America and Europe oppressors and all kinds of things including the national museum exhibit in China we're emphasizing more and more and more which I call Pride on their side and Defiance and it feels to me like at a very subtle level but that's now accelerated that these tensions that Orville shell and you and others have foreseen are are quite ominous they're really they're really coming to the surface what would you do if the president called you in tomorrow and said what do we got to do to take the steam out of this how do we come back to a win-win situation well it's tough because I mean we we have one one major obviously issue sitting there right in South China Sea called Taiwan and Taiwan is important not just because we have backed Taiwan but because Taiwan along with South Korea and to a lesser extent Japan is the center of of the most important commodity in the global economy right now which is semiconductor chips semiconductor chips are to the economy today what oil was to the global economy in the 70s and 80s and and it it's crucial that we keep that Supply going now we are trying to you know build up domestic production but if there were to be a shooting war in Taiwan and or Korea that would disrupt uh Global chip supplies I mean it would make it would make the uh you know the pandemic look like Child's Play in terms of how quick everything would would collapse and so that's a problem and and and I think that that first and foremost you know I think the West needs to buy time to de-globalize in effect um and and onshore the the importance of uh of semiconductor chips that are essential to our economy that's number one um so so Taiwan is everything um and and and how you defuse that I don't know because the the rhetoric is getting more and more bellicose uh you know what if China puts a what if China does a naval blockade around it I mean you know what do we do I mean there's lots of scenarios that are at pay grades above my level that I'm sure you know the National Security apparatus is kind of trying to think through um as it relates to financial and economic policy um China is is kind of got the best of all worlds with access to Western financial markets um without being a full participant um one of the things I rail about it in in finance is the the Chinese Vie structure for example which has enabled companies like Alibaba and others to raise billions of dollars in the West in what's basically a fraudulent kind of a structure governance structure the Chinese courts do not recognize the Vie structure and and for the listener and the viewer what it means is is that Western investors cannot own the corporate assets inside of China by law for the most part there's some exceptions but uh Elon Musk for example owns his plant in Shanghai so so go figure but uh but for the most part you and I can't own alibaba's actual assets within the People's Republic so what they've done is they set up this artifice where they set up a holding company in the Caribbean in the British Virgin Islands the Cayman Islands and you can buy the the stocks and bonds of that holding company the only asset you have is a piece of paper and a safe in the British Virgin Islands that says you will share in the economics of this Enterprise in some sort of unspecified way going forward proportionate to your ownership but it doesn't really mean anything legally in China so to the extent that something happens in China to those corporate assets you have no recourse the Chinese courts won't recognize you so for example years and years ago when uh when Yahoo and SoftBank owned a piece of Alibaba um and one day they woke up and they found out that the financial arm of Alibaba had been stripped and and sold to a group of Affiliates of Jack Ma for a bargain price and and the company said well the the Chinese Regulators told us we can't have Western indirect investors in financial services so we had to do this well to this day they've never told people what those who've shown those people what those regulations were or what the order was and the Western investors in Alibaba were left holding the bag with no recourse um and so this is the problem right that that they have access to our financial markets but we have no governance uh on on their companies um so all these kinds of things are going to play into any future uh you know increasing level of of uh conflict with China um and I I mean obviously I tell my clients to be as disa disassociated with China as you possibly can um in in any case because the risks aren't worth the rewards it is interesting to me um say just I'm thinking about directions of innovation when Silicon Valley starts then it starts moving towards China but not just the plants for assembly but the use of I don't know things like smartphones or laptops or what have you you can see the benefit to the consumer then I remember meeting with Chinese leaders who said a little bit like the movie uh that Tristan Harris and others made the social dilemma you are the product and they started saying okay these are platforms for commas but they're also data sets for intelligence and we've got to figure out how those are governed how those are Blended but what I'm seeing now is there are things for instance some of the things huawei's created with the 5G stuff and so on that the the direction of this tension has reversed now some of those things could be deployed in the continental United States but is it opening a window to Espionage and surveillance on the part of the Chinese well I mean yeah I mean look at just two big examples Tick Tock which is owned by a Chinese company uh which is one of one of the largest social media platforms uh and and of course uh we're not on it right now but Zoom you know how many how many Zoom calls have you been on since the pandemic I don't I don't have enough fingers and toes to count uh well those a little bit over and over again a lot of those calls get routed through China yes you've got these servers so yeah you know uh it's it's it's interconnected in many ways and and these are all these are all issues that that people are thinking about you know in terms of the de-globalization and our interconnectedness with China as you point out yeah and it's but I guess what I'm alluding to is there are potential losses for the well-being unless which you might call a technological firm in America can imitate those things and um put them into the marketplace very quickly uh the the source of all innovation in the early Silicon Valley days was largely the United States now the source of innovation is more which my quality is more spread around a little bit like what happened with the Auto industry where Japan and Korea started to take the lead in some respects right the good news is is that that like Japan uh the Chinese financial situation is probably not a huge contagion risk unlike the the US and EU financial situation and the global financial crisis where where we were all interconnected and lending to each other and distributing the highly leveraged products you know to to West German Landis box and and Norwegian Pension funds um that's not the case by and large uh with with uh the debt the real estate debt in China That's held on the Chinese banking system for the most part there's some bonds that are held offshore but um for the most part uh the contagion risk is like Japan it's basically centralized in their banking system so they can deal with it internally um by flooding the their own economy with currency but uh but there's not as much a transmission risk as there was in 08 but between Western Banks well Jim I remember uh I just wanted to I always say take our audience on a broader voyage they can look at your reading lists and so forth vis-a-vis Yale in your course I I listened to a podcast with an Irishman I think his name was David McWilliams that she did recently that explored some of the things we have but other dimensions also quite Vivid and I particularly want to encourage our young scholars to engage in following your writings and your interviews and so forth and think about the financial markets with the which Mark called depth and breadth that you do because there's a whole lot of pressure to just be a member until like you've said several times here where the until the vote goes over the waterfall and then you find out you got Hoodwinked again we all have take responsibility for not getting Hood winked and you're about as good at smelling a rat and also seeing the price as any financier I've ever met well thank you rob yeah thank you for being here today and I look forward to another episode and uh how they say in in guiding our young people young scholars initiative to learn from your example and from your ranks my pleasure

Channel: New Economic Thinking

Views: 14,588

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Id: W0B7Faly-DQ

Length: 61min 14sec (3674 seconds)

Published: Fri Mar 03 2023