Author, Nuclear Showdown: North Korea Takes on the World and The Coming Collapse of China
Editor, True Wealth,True Wealth Systems,True Wealth Opportunities: China,True Wealth Opportunities: Commodities,
Steve Sjuggerud joins Buck this week to break down the mixed messages you've been seeing on China's economy, proposed US trade tariffs, and why "Trump's China" is based on an outdated perception and vastly different from reality in Beijing. Steve reveals the one thing that matters most when it comes to investing in China's markets, and why the trade war volatility is presenting a unique investment opportunity. Steve tells you the easiest way for foreign investors to get exposure to local Chinese stock markets.
Author and Daily Beast columnist Gordon Chang joins the conversation to tell you why a China trade war has been coming for quite some time. Buck asks Gordon if China is in a better trade negotiation position than the US, and whether-or-not President Xi Jinping's communist leadership will fall in line with US requests on intellectual property. Will a crisis of confidence in China put a damper on its hyper growth policies?
A listener writes in with a timely question about China's aspiration to become a more relevant player in global currency markets. Does it make a difference to the US, Europe, and Japan if China pushes the yuan as a reserve currency?
Travel to China with Steve this summer for a "boots on the ground" investment experience when you register for the 2018 Asia Investment Opportunities Conference Series in Shanghai on June 5th and Hong Kong on June 8th.
Buck Sexton: Hey, everybody. Welcome back to another episode of the Stansberry Investor Hour. I am nationally syndicated radio host and amateur ribeye chef, Buck Sexton. With me here today are two special guests who are going to break down everything we can think of about China, and how all the recent news stories and developments you've been seeing on weighing on investors and businesses.
Joining me will be Steve Sjuggerud, editor and analyst of the True Wealth franchise at Stansberry Research. Steve last appeared on the podcast during Episode 36, discussing his "Melt Up" thesis for U.S. stocks. Steve's episode has become our most popular video on the Investor Hour YouTube channel, with over 11,000 views and counting.
Episode 36 itself has an additional 13,000 downloads, making it one of our most popular episodes ever. Steve's here to tell you today why a trade war with China could be good news for investors, how China's "National Team" will rescue its stock markets in times of trouble, what to make of president for life Xi Jinping, and what's next for the MSCI story.
Also, joining us today will be author and Daily Beast columnist, Gordon Chang. Chang lived and worked in China and Hong Kong for almost two decades, most recently in Shanghai. He's here today to talk about his latest article, "Trump's Right to Say He's Not Launching a Trade War With China, He's Doing Something Bigger."
And with that, let's get started. Mr. Steve Sjuggerud, good to have you, sir.
Steve Sjuggerud: Thank you for having me, Buck. It's always a pleasure.
Buck Sexton: Absolutely. I'm very interested in to hear what you have to say about China, because it's crossed right over into my world of the daily news cycle now. There's been a lot of China talk by all the different talking heads. Let's start with this one: You seem like you are not overly concerned, Steve, about the prospects of a trade war, and how that could really negatively affect investment decisions in China.
Steve Sjuggerud: That's right, Buck. The way I see it is I feel like Trump is actually, he's really just posturing for something bigger, and the problem is, though, is that I feel like the Chinese see right through it. But in the long run, I believe that it's bad news for both sides, and it's particularly bad news for Trump's voter base, and you are much more of an expert on the political scene than I am, for sure. I would love to get your take on this, as well.
But it seems absolutely foolish for Trump to want to penalize his riskiest base in Middle America. So, it doesn't make any sense to actually go through with this trade war. How do you feel about that from the political side, Buck? I'm happy to answer more, but I'd love to hear your take on just the politics of it.
Buck Sexton: It's a promise that Trump made all throughout the campaign, so from the perspective of keeping faith with his base, he said he was going to stand up to China. And I got to tell you, I think he's actually moved the needle quite a bit on what the consensus or the smart set consensus has been about how the U.S. should deal with China, because the theft of intellectual property of all kinds, commercial, military, everything that's been going on with China for a long time is a massive problem, and we haven't figured out anything up to this point to try and even, really, attempt to get them to stop it in any meaningful way.
I think that's been a shift in the discussion. I think that keeping faith with the base is an important part of what Trump is needing to do to try to keep a Republican majority in the midterms. And then also, you have the optics of people saying that they're going to be bringing businesses back on U.S. soil, and particularly with the different steel mills that they've talked about reopening or going back to full capacity.
There are going to be some winners among those who are affected by this directly, and Trump is going to highlight them. From a political perspective, I think unless the stock market just tanks, it's actually going to be pretty strong for him going into the midterms, and I think that some people are surprised by how quickly the window of acceptable options with regard to China has shifted.
Steve Sjuggerud: I think you make a great point on the intellectual property side of things, and I'm hopeful that all of this posturing is really, "We'll drop the trade war stuff as long as we accomplish something on the intellectual property side." But at first, and a lot of the Trump-China rhetoric, and I'm not coming from any political bias here.
I think Porter and I share some similar political views, but I believe when I listen to Trump on the campaign trail that he was talking about a China that existed 20 years ago, talking about people working in sweatshops and earning nothing, and meanwhile, you go to Beijing or Shanghai today, and these cities are more futuristic than any city we have in America.
If you want an apartment in Shanghai or Beijing, you're going to pay $1 million, and you're not going to get a view of anything, and you're not going to get anything special. The American perception of China and the reality of China are two hugely different things, and for me as an investor, the important thing is to find those moments where perception and reality broadly diverge, and there's always money to be made when you can find a situation like that.
We have that in China today, but I do think and I hope that Trump's understanding of China is more nuanced than the simple version that was portrayed on the campaign trail. And I realize politicians simplify things, but what's your take on that, by the way, on his understanding of China? Do you think that he was using the rhetoric about basically low-end goods and such?
You can't produce a T-shirt for $5 when it costs you $1 million a year, and when it costs you $1 million to buy an apartment. Do you have any thoughts on that?
Buck Sexton: Absolutely. I think that there's been a lot of dishonesty with American politicians on both sides about how we can get a return of the lost manufacturing base. Look, it's popular rhetoric, particularly in the U.S. heartland. I was just out in Indiana a couple weeks ago. And if you want to get a crowd riled up, you talk about how, in those parts of the country, places where cities or towns have turned into virtual ghost towns, because major industry, things related to the car industry, or manufacturing in any capacity have gone elsewhere.
But to your point about China and the perception of it from the administration, I don't think that there are a lot of folks who really get a sense of how the very, very cheap goods manufacturing that they think of as being Chinese has really moved. It's in Vietnam now, its in Indonesia. You have these other developing – I'm sorry?
Steve Sjuggerud: I said Bangladesh.
Buck Sexton: Yeah, Bangladesh. You have other places that are doing the lower-level cheap manufacturing that would have been associated with China, particularly back in the '90s and the early 2000s, and yeah, there's no – my girlfriend works in the fashion industry, and I'm always very interested to hear about how trying to compete, particularly in textiles and some of those more baseline manufacturing industries, with U.S. laws that are in place about labor practices, and just supply and demand, everything else that's coming into play, you have no shot.
Those are industries that are never coming back here, and I think people need to get used to that idea, but that's not necessarily a bad thing. To your point about Trump and what do I think about him saying this, I think a lot of it is driven by just a narrative of national resurgence, and that's a bigger focus for politicians, as I said, on both sides of the aisle, than the specific economics of what's going to be best for us.
Steve Sjuggerud: You know, Buck, I know you're supposed to be interviewing me, but we are talking a really political thing, and this is your area of expertise, not mine, so I do want to ask you one more question here. I saw Peter Navarro, I've seen him a couple times, and quite honestly, his China views have scared the heck out of me, and I'm really thankful that Larry Kudlow has come on board to hopefully lend a voice of reason.
But I'm concerned that if Peter Navarro has Trump's ear that we may not have a rational policy towards China. And am I off on this or do you have a take on this?
Buck Sexton: Yeah, I think that there are certainly some concerns, because I have not come across anyone who shares Navarro's specific views on China. Of all the experts that I've talked to, and I've been working with folks who do geopolitical analysis for sure, for going on two decades now. Of all the folks that I am familiar with, Navarro is an outlier.
Already, that's a bit concerning. But you mentioned Kudlow. You also have some of the other senior folks around Trump in D.C. still that I think will be a tempering influence. And my assessment is that there will be a – that this is really the opening of negotiations with China.
And we've seen this with Trump on a number of things, on immigration where he came in incredibly hawkish. People were talking about very large levels of deportations back during the campaign, talking about building a wall, talking about these concrete actions that would have really separated Trump from the past.
He comes in and all of a sudden he's talking about giving Deferred Action for Childhood Arrivals, DACA people, giving them permanent status, and is negotiating really, at least in terms of the deal points in good faith on that. I think we may see, Steve, a shift towards that with China.
So, the opening salvo is kind of like an anchoring position for the negotiation, or it's meant to have big effect, big impact. It's like talking-point shock and awe. I don't think that Trump is going to be nearly as hawkish on this, even with Navarro whispering all this stuff in his ear, as a lot of people would assume at this point, based on what's happened with other key policy areas for him.
You see what I mean? I think that it's going to be a much more moderated position in time than it sounds like it'll be today vis-à-vis China and trade.
Steve Sjuggerud: I hope you're right, and I'm actually banking on you being right from the perspective of an investor. But there are a couple very big stories. I seriously doubt that Trump wants to derail the entire global economy and end up in a planet like we had to kick off the Great Depression with the Smoot-Hawley tariffs and such.
It's not a direction that I think that we want to go in. I think that you're right, where it's an opening salvo, and hopefully, we'll moderate. But what that's done is it's created a buying opportunity to me, both in U.S. stocks and in Chinese stocks. And if you ask me which I think could be a better investment over the next few years, yes, I believe in a U.S. Melt Up coming in U.S. stocks.
But I actually believe that you could make more money in Chinese stocks in the near term in the next few years than you can in U.S. stocks. And there are a lot of things coming together. As you know, I've talked about this idea of China is not a part of any global stock market index at this point. The local Chinese shares, China is the world's second-largest stock market. But as of this point still in the major global stock market index is China is not a part of those indexes. The local Chinese shares, the world's second-largest stock market, this is a wrong that is about to be righted starting this coming summer.
And what it will ultimately mean is hundreds of billions of dollars, ultimately up to $1 trillion will flow into Chinese stocks. So my idea is: "Hey, let's get our money there first." Over the last dozen years, Chinese stocks have soared by triple digits three separate times.
And all those moves happen in less than 18 months. So, when Chinese stocks get moving, crazy things can happen. Let's just have our money there first. And there's a lot more to this story, but that's the basic idea.
Buck Sexton: Now, people always say, and I look at this in the perspective of how we deal with China as an adversary, and you'll have folks, that ties into the economic picture, but it's obviously looking at it from a different lens, Steve. But people will say that China's growth, it's certainly exaggerated, that they've always been hitting whatever it is, the specific number to one-tenth of a decimal point for many years now, or they were for many years.
And that it's, at some point, going to run out of steam – and we may already be there – that Chinese growth is necessary for domestic political reasons and that growth is the answer that the Communist Party offers to the people as to what's your plan. We're just going to keep growing and growing the economy.
Some say that that magic will stop at some point, and that could be now. What do you think about that?
Steve Sjuggerud: It's a great point, and China has continually been lowering their own forecast. They've been lowering the bar that they've been hitting every year, which is fine. They recognize that the era of super speedy growth is over and less speedy growth is the future. And so, they have been lowering the bar that they continue to hit, as you describe.
But the thing is, you're bringing up one of many points of what the naysayers say about China. "There are the ghost cities, there's very large debts that are not clear in the shadow banking system, this and that." There are an infinite number of stories of why not to invest in China.
And people hear those stories, they look at them, and then they say, "OK, that was all I needed. I didn't want to invest anyway, so now I have my little albatross that I can hang around my neck, and say I'll never succeed. I'm not even going to try."
But what I try to find is the one thing that matter in a market. And so, many years ago, I had this idea of the Bernanke asset bubble, where when we came out of the great real estate bust, the great financial crisis, I came up with this concept that the Fed will lower rates lower than you can imagine and keep them there for longer than you can imagine, and that will cause asset prices like stocks and real estate to go higher than you can imagine.
And that one basic thought that the Fed would lower interest rates lower than you can imagine and keep them there longer than you can imagine was all you needed to know. There were plenty of reasons why you could be fearful of U.S. stocks any time over the last nine years, but all you needed to know was that one sentence that I just – and it was exactly the right sentiment.
What I try to do is find the one thing that will matter, the one thing that matters. And to me, the one thing that matters is hundreds of billions of dollars are about to flow into China, whether or not it's a good investment. It's the greatest tailwind. If you had told me, "I've been doing this 25 years, Buck, and I never imagined I'd see a moment where no one was invested in the world's second-largest stock market in the world's second-largest economy."
And all of that is about to start, and you have the ability to get some money there before the crowd. So, that, to me, is going to be the one thing, just like I described, the one thing in the U.S., and we have so many little associated tailwinds. I call it China's National Team. Whenever the market will dip, we've seen it in global markets, the government will kind of sneak in and buy shares on the dip.
And meanwhile, no one is currently invested, so the downside is not huge, because there's no one left to sell. Meanwhile, the upside is dramatic. How many people in your daily life, Buck, if you're talking about investments, how many people would you say have said, "I'm buying local Chinese shares. I'm loading up on local Chinese stocks"? Nobody.
Buck Sexton: Zero.
Steve Sjuggerud: Zero, right. Meanwhile, it is the world's second-largest economy and the world's second-largest stock market. So, it's just a wrong that needs to be righted, and will be righted starting this summer. You will start hearing the story starting in May, and we can just get our money there first.
As I said, I can go on. I don't want to – why don't you stop me and then point me in any direction that you want me to talk in, because I –
Buck Sexton: Can I ask, because I'm very curious about this, because I'm a believer in your thesis here, and I know a lot of people that are China skeptics for a whole bunch of reasons, but I think you're right on this one. I want to poke around a little bit more. Why do you know all this money is going into China, and could any of that be affected by the current uncertainty, volatility, whatever people want to call it?
I see all these people going on TV, talking about the market in China. I'm like, "Well, that doesn't even make sense, but I guess it sounds good." The stuff that's going on with Trump in the trade war, could that affect this tailwind as you put it of the hundreds of billions going into the Chinese market?
Steve Sjuggerud: You're hitting the nail on the head right there, and the beautiful thing is the answer is no, it cannot affect that. What's happening is that the reason that China is the world's second-largest stock market and second-largest economy and nobody's invested is because China had made it difficult for foreigners to invest.
And so, large institutional investors said, "Look, you can't in good faith put China into a global index when China makes it difficult for you to get your money in and out." So, China has spent years basically fulfilling all of the MSCI, the major global index providers, they set up all of these hurdles that China had to exceed in order for China to be admitted to the global club for investors to easily invest in and out of China.
And China has now met all of these hurdles, and so global investors are going to – when I say they have to invest, the way it works, Buck, is your fund manager, your money manager, you might think he's a smart guy, but really, what he is is what you call a "closet indexer," meaning that he just tries to mimic the performance of his benchmark index.
What is he doing why does he do this? It's very simple, Buck. Being a money manager is a good job. It's an easy job, as long as you perform close to in line with your benchmark index, you get paid extremely well. And if you take a risk and happen to underperform your benchmark index, you end up losing your job.
So, your prospect is copy my benchmark index, and get a huge bonus, and keep my job, or veer off of my benchmark index, and take a risk, and invest in China, or invest in something that's not in your benchmark. And if you're wrong, you lose your job.
Everybody in the industry is basically trying to – they're acting in their own self-preservation, and they don't invest outside of their benchmark indexes. Not dramatically, very, very tiny degree off of their benchmark. So, China, starting this summer, China will start to be added to these global benchmark indexes.
So, all of these money managers who like their cush jobs are going to allocate money to China, they have to. And regardless of a trade war, Trump cannot affect the trade war, either side is not going to be able to affect this situation. This is not part of the argument. And it won't be.
So, regardless, to me, the trade war really just creates some value and opportunity for us to buy into this at a better price ahead of the crowd.
Buck Sexton: What is the timeline, Steve, and the horizon that people should be thinking about, or listening to the podcast right now, for quite honestly, whether your thesis here is right. And what would be the upside possibly, or how long do you think this could be a ride for people that get in now ahead of this flood of money? How long could people ride this wave in the Chinese stock market?
Is this a 12-month investment we're talking about here, or is this a five- to 10-year investment in your mind?
Steve Sjuggerud: These are great questions, Buck, because you get it and you're nailing it here. When it comes to other countries, when they added, for example, UAE to the benchmark indexes, UAE soared in advance as people front ran the trade, and then UAE didn't perform as well after the announcement.
But that was just a one-time addition. But China is such a big market that you can't all of a sudden put up to $1 trillion in a market in one day. So, what's going to happen is over the course of a few years, starting this summer, the main global indexes are going to add a little bit of China each year until there's the full amount of China that they want in those indexes.
But that's good news, because every year, there's going to be yet another buying opportunity, yet another push. It's not just a one-time push. This is a multiyear trade. I believe it'll take five to seven years to play out. But what I think is the right way to play it is as I said three times in the last dozen years, Chinese stocks have soared by over 100% within 18 months.
So, there will be this bitcoin moment, and I can't tell you if it starts today, or if it starts a year or two from now. But during this five- to seven-year period, I strongly believe, I have incredible confidence that we will see that type of mood, that crazy triple digit move in 18 months.
And I just want to have my chips in place to participate in that move.
Buck Sexton: Are there some individual stocks, by the way, that I know you cover and write on them, and I read the pieces you put out on them. But for example, Tencent, one that's very well known, are you particularly bullish on how Tencent will do as part of this wave? It's kind of a rising tide, lifts-all-boats situations, one would think, and given that Tencent's already a very cash-efficient business, very profitable, doing very well, it's huge, is that another play that people should be thinking about?
Steve Sjuggerud: You're actually just hitting on so many good points here. Tencent, it's been a fantastic story for me, for my subscribers. I was at the Masters golf tournament last week, and multiple subscribers walked up to me on the course. I don't know how they recognized me, and one of 'em said, "You're a much better-looking guy in the videos." I was like, "That's the first thing you say to somebody?"
But they all thanked me for the Tencent recommendation that they've doubled their money on, and I'm excited for them for those reasons. I do believe that Tencent can still become the world's largest company.
However, and this is a specific thing that came up by you asking this. Tencent is not traded on those local Chinese indexes that I'm talking about. So while Tencent has gone up 100%, the other local Chinese shares have not. And when you ask about specific stocks, if you're going to buy local Chinese shares, there's really one great way to do it.
So what we're banking on, and I'll tell you what it is right now, but what we're banking on is it's called inclusion, it's including China in these global indexes. There is a fund called the MSCI China A Inclusion Index Fund. So, it literally owns the stocks that will be part of this inclusion process. That's all it owns. And so, that's the fund that you want to own, instead of trying to bet on an individual stock here or there, and it's challenging for individuals like you and me to buy locally in China.
What I recommend is this fund that is benchmarked to the China inclusion index, and that fund symbol is KBA. It's the KraneShares Bosera MSCI China A Fund. K, B as in "boy," A, is the symbol.
And instead of trying to outsmart it with an individual stock, I think the right way to do it is just to own a fund that is targeting this inclusion process.
Buck Sexton: Let's bring Gordon Chang into the mix here. Gordon Chang is a columnist at the Daily Beast, and author of Nuclear Showdown: North Korea Takes on the World, and The Coming Collapse of China. Chang lived and worked in China and Hong Kong for almost two decades, most recently, in Shanghai.
His writings on China and North Korea have appeared in the New York Times, the Wall Street Journal, the Far Eastern Economic Review, the Weekly Standard, National Review, and Barron's. He speaks at colleges, industry meetings, and conferences all over the world, and has presented briefings at the CIA, the State Department, and the Pentagon.
Chang has appeared on CNN, Fox Business Network, CNBC, the Daily Show With Jon Stewart, and is a regular co-host and guest on The John Batchelor Show. Please welcome to the Stansberry Investor Hour, Mr. Gordon Chang.
Mr. Gordon Chang, great to have you, sir.
Gordon Chang: Thank you so much.
Buck Sexton: Gordon, people are concerned about a trade war. I've been talking to Steve about it so far in this podcast, but you actually think the trade war's been a long time coming.
Gordon Chang: I think the trade war has been in existence for a very long time. China, over the course of decades, has been engaging in malicious policies intending to undermine our economy and the economies of its other trading partners. It's especially gotten worse during the rule of Xi Jinping, who is currently in Beijing.
And clearly, this is part of a long-term plan on the part of China to make sure that it can obtain technology by illicit means, and also, to dominate certain sectors. We have to understand that whether we call this a trade war or not, this is a long-term campaign from Beijing's point of view.
Buck Sexton: Now, Gordon, we're on a what is a finance and investment podcast, and so people are understandably concerned about what this is going to mean for the bottom line for the United States, for everybody out there who's investing and thinking about what's going to happen with the stock market, their 401(k)s, perhaps their particular business segment that may be affected by this.
Do you think that this is – my sense of it is that Trump often comes out very strongly on some of these issues, but then he goes into a negotiation posture. Do you think there's going to be some moderating influences on his China position going forward? Do you have any concerns that this could spiral out of control and really start to affect the economy here in a way that's detrimental?
Gordon Chang: Certainly, there's the possibility of this spiraling out of control. If this were just a question of economics, Buck, I wouldn't be too concerned, because the U.S. holds all the high cards, and the Chinese know that they cannot sustain a trade war against the United States.
So, for instance, we know that last year, 88.8% of their overall merchandise trade surplus related to sales to the United States. We had a $375.2 billion trade deficit with China last year. Trade deficit countries don't worry about trade friction. We have a much larger economy than China's, $19.4 trillion last year.
China claims $12.8, but it's probably smaller than that. Big economies push smaller economies around. But the real problem here though is not economics, it's really politics. Xi Jinping wants absolute control. That means he's absolutely responsible for everything that happens. That's OK when things are good, but when things are bad, and they could very well end up being bad for China, it means that he realizes that he's got to prosecute this trade war, even though it makes no sense, because his political future depends upon it.
So, right now, we all have to be concerned, and this is a Chinese political issue more than anything else.
Buck Sexton: Gordon, is there a possibility in your mind that China just backs down in time from this, though, or is willing to be a more transparent and beneficial trade partner with regard to some of the complaints that the administration has leveled against them? Because I keep seeing a lot of analysis out there. I'm sure you've read some of it or come across some of it, of "China could just cut us off from the precious metals market, because we're so reliant on the Chinese."
Or China could sell all U.S. Treasurys to just collapse the U.S. economy, which sounds to me like the equivalent of being an economic suicide bomber. That wouldn't work out well for China. But there seems to be a perception that China is in a better position than we are going into this, and therefore, we're going to get hurt worse than they are.
I know you reject that, so does that mean the Chinese may actually fall in line?
Gordon Chang: I think the Chinese could fall in line if they came to their senses, but we got to remember that they're part of a political system, and that the trade violations we're concerned about are absolutely core to that system.
For instance, Xi Jinping has been not only closing off the Chinese economy to foreign competitors, but also to a certain extent, for domestic Chinese companies, as well. He really believes in the state enterprise being the core of the Chinese economic system, and at the core of the Chinese political system.
Chinese theft of U.S. intellectual property, which ranges in the hundreds of billions of dollars a year, according to the IP Commission, which just estimated America's losses at $225 to $600 billion a year, most of that, of course, is China.
So, this is a real problem. If China had a much better political system, this trade friction would have been settled at a much earlier phase, but it doesn't, and we have to remember that the nature of political systems matters. That's what we learned in the Cold War, that's something that we forgot in the last couple decades. We're going to learn that again, Buck, and we're going to learn it after probably a fair amount of pain and turbulence in the global markets.
Buck Sexton: What would it look like if China did back down, Gordon, in terms of if the Chinese government, if Xi Jinping, as you said – we've gone from authoritarian to totalitarian politics in China. If Xi Jinping decided, "Fine, we'll make some of these concessions that the Trump administration wants, and that's why we're at this point of tariffs and talking about retaliation for tariffs."
Would that necessarily be a bad thing overall for China? Would it hurt them more politically to cave or economically to cave to U.S. demands when it comes to their trade policies?
Gordon Chang: It would certainly hurt more from a political point of view, because it could very well mean that Xi Jinping would lose his position. You could see even changes in the Chinese political system itself. From an economic point of view, it makes sense for the Chinese to back down. They don't have any cards.
And when we look back at this series of economic relationships that we've developed with the Chinese, we've done that because we wanted to integrate China into the international system. We've had very generous policies.
But it just hasn't really worked that way, because of the political system in China. I think that essentially, we're going to see a much tougher policy on the part of the administration. You alluded to maybe Trump backing down, and that's a real possibility. But long term, just because that these trade problems are at the core of the Chinese political system, this friction will continue, even if they force Trump to back down. Trump will have to strike back at some point, or his successor will have to.
This is a long-term competition, because what Trump is really trying to do is protect U.S. intellectual property. That's the core of the American economic system these days, innovation. And if you don't have – you can't protect innovation in America, you just don't have an economy left.
So, this is not really a Trump question. This is a question that now is the U.S. protecting its future.
Buck Sexton: Gordon, can I just focus in on one thing you said there, and I just want you to extrapolate a little. The notion of trade policy at the center of Chinese political reality and political policy, I just wanted you to expand on that.
Gordon Chang: Xi Jinping has reversed many of the reform in opening up policies of Deng Xiaoping. Mao Zedong's successor. We see that Xi believes in state enterprises. His economic policies have bolstered over the course of his five years in rule. He's doubled down on industrial policy with his "Made in China 2025" initiative. He's really attacked the competitors of the state enterprises.
And he's got, of course, a much more political, a more coercive political system. You put all this together, he's going back to something that Mao Zedong, the founder of the People's Republic, would find familiar. Now, of course we're not there yet, but nonetheless, that's the direction.
He's reversed, as I mentioned, the reform in opening up policies of Deng, and this is very bad long time for China, but in the short term, it can gain the system, and because of that, we're in for a rough ride, because this is not just a question of trade disputes. This is a question of Xi Jinping prosecuting his vision for a much less benign China.
Buck Sexton: I wanted to ask you, also, Gordon about growth. Chinese policy has put growth above all else in recent decades. And there is something that seems almost miraculous in terms of how much wealth has been created in China in a very short period of time, and you have hundreds of millions, which is still not a majority of the country, but hundreds of millions that have been brought out of poverty.
But do they still have some tricks up their sleeve to keep that growth growing? Where does the Chinese economy, if it wanted to be as positive an international player as possible, Gordon, and if it wanted to grow without antagonizing the U.S., and by being a better trading partner in every sense, what would the Chinese government do? What would that policy look like?
Gordon Chang: It would look like, for instance, stop attacking foreign companies. And they do that in a number of different ways through other national security laws and regulations, forcing U.S. companies to turn over valuable technologies and source codes. They would stop using their legal system to these discriminatory cases, in both the antitrust and the corruption areas.
They don't do that against their own companies. You look through all the things that they have been doing, and it's just comprehensive. They'd have to take down their tariff walls. They would have to stop subsidizing their state enterprises, just you name it.
And that is not going to happen with Xi Jinping, because as I mentioned, even though there was a lot of hope for reform in 2013, those hopes have been dashed, and we've seen a Xi Jinping who believes in the power of state enterprises, the whole concept of national champions.
This is a story where we've seen this in the last couple thousand years of Chinese history where you have a strong-willed Chinese leader close up China to the world, and it's always worked out eventually where the economy falls apart.
Under Xi Jinping right now, the only reason why they're keeping it together is because of accumulation of incurring debt. The Chinese economy is growing about 2% a year of reality, but it's accumulating debt at a pace of about 20%. You can do that in the state dominated system, but you can't do it for very long. And that really is the overriding reality for China right now.
Buck Sexton: Steve, do you have anything you wanted to ask, or are we good?
Steve Sjuggerud: That's a pretty bearish case he lays out there, for sure. I guess one thing that I could add is when I launched my China investment opportunities letter, the goal wasn't for it to last for 30 years out into the future. We sold it as a lifetime subscription from day one, because I didn't know if the newsletter was going to be in existence for two years, or five years, or seven years, or whatnot. It's just very specifically to take advantage of the hundreds of billions of dollars that are about to flow in to China, regardless of what happens.
Even if Gordon's extremely bearish case comes to pass, I still think that these are not mutually exclusive. You can make a lot of money in China in the next few years before Gordon's scary scenario comes to pass.
Gordon Chang: We don't know when the Chinese crisis will hit. I thought it would occur a lot earlier, but when you accumulate debt at a much faster pace when you're growing, you know that eventually, there has to be an adjustment. Now, that adjustment can be like Japan's, which is decades of recession or recession-like stagnation, or it could be a complete failure of the economy.
But when the governor of the Chinese central bank, when they did this last October – talk about China's Minsky moment – and when we're hearing in the last month or so many more Chinese voices talking about the failure of China's markets, you know that something's going to happen.
The only thing that is keeping this economy together is confidence and Xi Jinping as long as he can keep some appearance of growth to maintain confidence. But we know that they can't do it forever. We saw this in 2015 and 2016 with abnormal capital flows outward, perhaps $2.1 trillion worth of net capital outflow.
The only reason they were able to stop that in 2017 was through the imposition of even more draconian capital controls, many of them which were unannounced, making China look like a Latin American banana republic. Yes, you can do this if you have a coercive political system, and a state-dominated economy.
But long-term, this can't work.
Steve Sjuggerud: You really hit on something important there, that the moment is when the crisis of confidence hits. There was a powerful book by a couple economists looking back at centuries of major busts in financial markets. I'm trying to think of the name of it. Maybe one of you would remember it.
But basically, they said there was no moment, there was no economic statistic that could reliably predict the day that, debt to GDP equals X, therefore the markets fall. There was no moment. It was simply the crisis of confidence. And I think the same can actually be applied to the U.S. in many ways, where a lot of people have been predicting, "Oh my goodness, we have an incredible entitlements problem that is certainly going to spiral out of control, and there's very little we can do about it."
There's incredible growing debts at many different levels in the U.S., and at what point do these things come home to roost? And really the historical record basically shows that it's simply a crisis of confidence. It's a downward spiral that is hard to predict, the day that it arrives.
Buck Sexton: The book, is it This Time Is Different by Reinhart and Rogoff?
Steve Sjuggerud: That's it, exactly, yep, This Time Is Different. And they always say during each of these booms that this time is different, and then the bust comes, and then it's no different than the other bust. It's not a statement of "this time it's actually different" – it's what everyone says during every boom, and they always end the same.
Yeah, Reinhart and Rogoff, their conclusion was that "Sorry, guys, we looked at every crisis over the last few hundred years, and the only conclusion we can share with you is that it's a crisis of confidence, not a specific number."
Gordon Chang: And the reason why this time is important is because instead of the U.S. having a policy that is supportive of China, because in the past, past administrations saw that the success of China's communist party was the goal of American foreign policy. Now we've got a president who doesn't feel that way. We've got a president who is standing up for American rights, and clearly, this is a very different posture.
And just a little bit of change that Trump can cause with this trade friction really could mean that people will lose confidence in China, which is a fragile economy after all.
Buck Sexton: Gordon Chang is the author of The Coming Collapse of China, and also, you can read his latest at GordonChang.com. Gordon, really appreciate you joining, man. Thank you so much.
Gordon Chang: Thank you, Buck.
Buck Sexton: Steve, you may have picked up Gordon is bearish on China politically, but I still think that the thesis, and I read all of Gordon's stuff, I've been familiar with his work for a long time now. But to your point about what that means for the opportunity there, I still buy into the whole thesis. I think there's going to be a lot of money going into the Chinese stock market.
I believe that China has beaten – look, Gordon wrote the – let me just make sure I give you the right date, The Coming Collapse of China, your point about – that was the title of his book. I think he wrote it back in – oh gosh, 2001. And so, China hasn't collapsed. Yeah, I think he's right maybe over the long term, they've got a big – but if they're right in 20 years, and you're right in two years, that matters a lot.
Steve Sjuggerud: Right. Buck, you could actually take that down to a Porter vs. Steve level, as well, because I was alluding that point a little bit. By the way, I didn't know that Gordon was still on when I was saying that, but that was fine. Like Porter's been saying, there's this debt bubble that's going to take down America.
He's going to be right. There is entitlement spending like you've never seen, and you can't imagine how this can possibly be turned around, and he's right. You can tick off the list of things, the student loans, whatever it is. There are bubbles waiting to burst, but when is the day of reckoning?
And it is stunning, and I'm sure you can see it as a student of political history, but we see it in financial history, economic history. It's stunning how long these things can continue to stretch themselves out, how many different ways you can kick the can down the road, as they say, before the day of reckoning actually arrives.
And then when it arrives, there's almost no turning it back, because once the confidence goes, as we sort of saw in 2008, once the confidence goes, there's not much you can do.
Buck Sexton: I have to say, with America, for example, and I was thinking that too, when Gordon was talking about the long-term structural challenges. I think that somebody who, let's just say, 10 years ago, roughly coinciding with the U.S. financial crisis, 10 years ago, somebody who said, "Nothing is going to change, politics will determine economic policy, not the other way around. People aren't going to be willing to tackle the debt and the entitlement spending problems. Everything else that structurally makes the U.S. unsound for the long term."
If someone had taken that position and just invested in food, gold, and storable food, gold, and ammunition, they would have missed a whole lot of really big opportunities to make a lot of money and do very well over the last decade.
Steve Sjuggerud: That's right.
Buck Sexton: I think they may be right, but if they're right in 20 or 30 years, the world will be a very different place, and I'd rather be making money for the 20 or 30 years in the interim.
Steve Sjuggerud: I don't know if – this is the biggest question, and I would love to get your take on it. How do we, from a political perspective again, I know you're supposed to be interviewing me, but I think I've asked you more questions if we counted 'em up. How do we get out of this with entitlements and the rising debt?
This is the biggest question, but how does it actually happen? You could probably talk for hours on this, but is there a concise version of what would – instead of saying, "Well, it won't happen," what do you think is the likely mechanism, the likely path for us to reduce our entitlement spending and the size of the debt?
I know Porter has his own views, but you come at it from a different perspective than Porter and me, so do you have any thoughts on this?
Buck Sexton: I think we are heading headlong into the crisis. I think there's zero political will in either party to tackle entitlement spending and just the debt crisis. I think the Trump signing a $1.3 trillion omnibus spending package just a few weeks back shows that the Tea Party was really a way of mobilizing ideological opposition to the Democrat left.
But it wasn't really, at the end of the day, the mobilization was using whatever they had that could bring people together at the time. It wasn't a do-or-die issue for people, as much as they maybe thought it was at the time. Because it's now we don't want their guys in charge of all the spending, but actually, we kind of do like the spending.
And also, we don't want to hand the reins of power over to the other side, so we'll play along and act like all the spending that we're doing isn't really the existential, economic, and quite honestly, political threat that we know it to be, but we're just going to avoid it. There's no chance of any major shift, in my opinion, in the U.S. spending until people feel pain. Because right now, it's like there's a Santa Claus that's just giving everyone stuff.
Right now, there's no reason for elected representatives to act with foresight – I'm talking about from their perspective – act with foresight, make tough choices, perhaps lose their positions, and oh, by the way, they can always just say, "If we do that," and you would expect it to come from the right – the left doesn't even talk about government spending as a bad thing, so they're in a whole other universe of this.
But the right can always say, "If we do that, we lose power now, and now the crazies who will spend us into oblivion even faster are in charge." And so, they always have a way of evading accountability on this. I think the answer to your question is that we are just as discussed in that book you mentioned, This Time Is Different, we are going to head to a crisis, we don't know when it's coming, and when it comes, it'll be too late.
But that is the mechanism for change, because there is no way, based on any of the political headwinds that I see right now in any direction, there's no way that this changes. People like the government giving them free stuff even when it's not free.
Steve Sjuggerud: Even the CBO isn't trying to make the government look bad – it's just trying to project with numbers that it's given from the government, and it shows that just interest payments, and interest on the national debt, and entitlements will eat up all government revenues, essentially assuming there's not a single government employee. All you're doing is paying entitlements and paying the interest on the debt in a very short period of time. It depends on which number you're looking at.
But it could be as soon as 20 years or less that all government revenue is eaten up by interests and entitlement spending. This is clearly not a sustainable existence. As you mentioned, the Reinhart-Rogoff book, This Time Is Different, it seems like virtually every instance, as you said, a crisis was required, and then basically no one said, "Gee, look, this math doesn't really add up. Maybe we should change this."
It's seemingly always just went headlong into a crisis, and then you had to pick up the pieces. Unfortunately, I think you're right. I was hoping that you'd have a more elegant solution other than crisis, but that seems to be the only outlet. I was hoping for maybe a long shot of some sort.
Buck Sexton: I would just tell you this. Steve, I worked for a guy who got a couple 100,000 people together on the National Mall back in 2010 to protest the accumulation of government debt under the Obama administration. We are now at over $20 trillion and just spent another additional $1.3 trillion in the most recent omnibus. I'm not seeing any marches in the streets. No one seems to really care.
I take that as a very negative indicator for a responsible approach to dealing with this problem. It's also intergenerational theft, and not to throw the Boomers under the bus here, but this is a problem that people don't really understand how bad it's going to be, because for a lot of folks, they feel like it's not really going to be bad for them.
And when that's the case, now you really have no political will to deal with anything, because the people that are voting, and have money, and resources today, are like, "If this happens again in 20 years, not really my problem." That's not good.
Steve Sjuggerud: Exactly. You look at Trump coming in – what was his career? He was essentially a real estate speculator. He would borrow money, borrow incredible sums of money, and hope things worked out. And if they worked out, then he would become extremely wealthy, and if they didn't work out, then that project or that business would declare bankruptcy or something.
It was just a leveraged bet. Basically, we'll figure it out later. We'll borrow a bunch of money, throw it at this idea, and hope it works out. And that seems like that's the MO. He's done that for decades in his own business career in real estate, and it's not just him. That is the life of a big real estate mogul, is leverage, and timing, essentially. And I think he's doing the same thing right here, hopefully spend your way to success and hope it works out.
Buck Sexton: Unfortunately, it's very effective politics. You see this – a great way to understand what the country's doing to itself, is you look at the unified political control that the Democrat left has in some cities with regard to public sector employees, and more specifically, with teachers' unions.
What ends up happening is they can't give the teachers huge salaries, or let's just say public sector union people in general. But teachers maybe are a more acute example of this, because there were some walkouts and protests recently. What they do is they give them really great benefits, but they try to push the benefits off deep into the future.
And a lot of it has to do with retirement benefits, and health care, and things that people can't really feel today, and they get put on the budget sheet for later. In return, those teachers' unions, and the members of them, make sure that the Democrat who's pushing for all those benefits, gets elected.
The Democrat then runs out and says, "Hey, guys, I have the backing of the teachers' union. It's all about our children. It's all about the future," and then of course, slips in usually a raise on property taxes, or at some point, maybe has to do a little financial engineering.
But anyone who comes in and says, "Hold on a second, you're going to bankrupt this municipality in 20 years," they get shouted down with, "Do you not care about the children? This is about teaching. This is about the teachers." And they never break that stranglehold, no matter how crappy the school district is, no matter how terrible the state's financial shape is, because of the way the political machinery works.
That is effectively now happening in a bipartisan way at a national level in this country right now.
Steve Sjuggerud: Well, Buck, I live in Florida, so our voters, our retirees, they're not voting for education, so the teachers have it pretty rough down here. I get your point.
Buck Sexton: Think about it in the case of Wisconsin. Wisconsin would be a much better case study than Florida, but yeah.
Steve Sjuggerud: Well, Buck, thanks for answering so many of my questions. It's the reality of it, and like I said, I'd hoped that you would have maybe a more elegant, even if it was a low percentage solution, but it seems like we just have to careen towards crisis.
Buck Sexton: Ultimately, when people push for doing anything about this, there's almost a Reagan nostalgia fundamentalism creeps in, "Don't worry, we'll grow our way out of this." There is no way we are growing our way out of $21 plus trillion of debt with nothing but trillions more to come.
So, that's unfortunately a delusion, but it's a comforting one for some folks.
Steve Sjuggerud: It's too big a number. You can't grow your way out of it, and you actually can't tax your way out of it, because the number is too big to possibly tax your way out of it. So, really, ultimately what a crisis allows is basically the devaluation of a currency, and then you can pay off those promises in a much-devalued currency, and that's one of many scary potential outcomes.
Buck Sexton: Steve, I'm hoping that you and the Stansberry team are going to help me make enough money in the interim that I can buy my little island off the coast of New Zealand. So by the time the crisis comes, I'll be OK. That's my plan.
Steve Sjuggerud: That's funny, but that's a bit of my thesis is that we need to make money while the sun's shining and be prepared for the inevitable in the long run. I am a strong believer still in my Melt Up thesis concept that we'll have – this great bull market can't end any other way, in my opinion, then a larger-than-dot-com-style Melt Up in stock prices, in asset prices.
And we haven't seen that yet, but then on the flipside of that, we'll have the "Melt Down," and whether it occurs over the course of 10 to 15 years, or it occurs in a very short period, I think that we are looking at a very rough seven to 10 years in stock prices.
So, now is a great moment to take advantage of great opportunity in stocks, or great opportunity in real estate. But at some point in a couple years' time, right now, we need to play good offense, but plan on playing good defense for a very, very long period of time. And that's my script for the next 10 or 15 years right now.
Buck Sexton: Buck and Sjug are going to get into the mailbag now. Thanks everybody for writing in and filling our inbox with the useful feedback. People like Art P., Dennis H., Joe V., Rose M., Matt V., Paul W., and Phil J., just to name a few helpful folks who did some get Stansberry Research gear for sending us fantastic questions.
Keep it coming, write to us at [email protected]. Now, No. 1 in the mailbag this week. "Dear Porter, Buck, Country Club Guy, and yes of course, Mr. Sjuggerud, you have noted over the years how China has been entering the financial mainstream. The Yuan has surpassed the British pound in international trade, and was accepted by the IMF as an official reserve currency.
"I heard a report last Monday, March 26, 2018, noting the start of trading of oil futures in Asia, in Chinese yuan." Got two questions here, lined up, and I'm going to hand these over to Sjug.
"One, do you know if other commodities will soon begin trading in yuan, or what other commodities already are traded in yuan? Two, what impact will this have on the supply and demand for the U.S. dollar, and the Chinese yuan, and related currency markets?" Steve, this is all you.
Steve Sjuggerud: There's a lot of questions hiding in there, and the person's done their homework. It's interesting, I think most people have no idea that China's currency has actually been an incredibly strong performer. It's been strengthening vs. the U.S. dollar. The Chinese currency's up about 9% since Trump got into office.
China's currency's very strong. Interestingly, this week, it's another angle in the trade war, but China as of this week has said, "We're thinking about devaluing our currency as a way to retaliate in the trade war." Which would be effective, actually. But Buck, can you give me the CliffNotes version of the question again? There was a lot of pieces in there.
Buck Sexton: What commodities will be trading in yuan?
Steve Sjuggerud: Getting to the main question there, oil futures, oil trading in yuan specific is what they were asking about. It just makes sense. Why does Thailand have to buy oil for China, or China have to buy oil from Thailand in U.S. dollars? Is there a reason for that currency friction? There is no good reason, other than it's the industry standard.
I think it's just evolution and globalization. But man, look, it's an incremental change, but I don't think you have to worry about the dollar crashing in the near term or anything like that. I think we will continually see China take its place among the global currencies.
But if we looked at global trade, I don't have the numbers in front of me, but I would assume the U.S. dollar is somewhere between two-thirds and three-quarters of U.S. global trade, transacted in U.S. dollars. The euro's second, and everything else is a long way back. And I'm sure China will just take a little bit of that U.S. dollar slice, a little bit of that euro slice. But it's an incremental change.
And I think it's a correct change. I think it's a nice fear story for Americans that China's trying to take over global trade and its currency, but it's more of a fear story than something we need to actually fear. It's really just a more efficient world, where China's transacting with its trade partners in China's currency.
I do believe that China will continue to gain, that its currency will continue to gain strength and gain market shares, so to speak on the global stage, but I don't think it's going to cause the U.S. dollar to crash in value or really even have a significant effect at all.
Buck Sexton: That's all we got for the mailbag this week. If you got a question for us folks, please do write to [email protected]. If we use your question, we'll send you some goodies, courtesy of Stansberry Research. Love us or hate us, just don't ignore us.
I want to say a special thanks to Mr. Steve Sjuggerud here for co-hosting this podcast this week and doing a phenomenal job.
Steve Sjuggerud: Thank you, Buck, for answering all my questions.
Buck Sexton: Mr. Sjuggerud, I appreciate 'em. I read all your stuff. I'm a subscriber and a reader, so it's really a special treat to get a chance to actually chat with you about all the subject matter. And everyone should check out what Steve's got. Steve, when's the next publication, courtesy of Sjuggerud coming out?
Steve Sjuggerud: We usually have something going out about weekly, but unfortunately, we have the week off so to speak, so True Wealth, our flagship product comes out next week. But people can find us for free every day at DailyWealth.com, and just because it's free doesn't mean it's not valuable. We put out great stuff every day for free, so make sure everyone's checking us out at DailyWealth.com.
Buck Sexton: Have a great rest of your week, everybody. We'll see you back next week with our main man himself, Mr. Porter Stansberry, back in action.
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