Louis-Vincent Gave: Understanding China’s Economy, and U.S. Competition — #50

The freezing of Russia's Treasuries was the most significant foreign policy own-goal since the Iraq War, as it signaled to the largest commodity producers in the world that they cannot rely on the US to honor reserve claims, causing them to diversify away from dollars.

“I think the nationalization of Russia's reserves was the biggest foreign policy own goal. Uh, you know, since you know, since the probably the start of the Iraq war. Um, you know, I think we cut our nose to spite our faces. We Western policymakers wanted to be seen to be doing something to punish Russia. Um, and what we did is we said, okay, let's tell the biggest commodity producer in the world that they can't use U.S. dollars. And I think we thought like this, they won't be able to sell their commodities and we never stopped to think, well, they'll sell them in another currency, which is exactly what's happened.”

The Chinese government is not a remote dictatorship with unresponsive policy; rather, it conducts extensive surveys about what people think and complain about, and it responds to popular grievances (e.g., high property prices, corruption) by implementing actual policy solutions.

“the Chinese leadership actually spends a lot of time, uh, doing surveys of what people think and what people and more importantly, what people complain about. And so if people complain about high property prices, they actually tackle that issue. If people complain about corruption, then they will tackle that issue.”

Japan's currency (yen) is 'stupidly undervalued' at 150 per dollar, making Japan extremely cheap for travelers and exporters uncompetitive, with Tokyo now cheaper than many developing countries.

“Japan. Japan is one of the biggest industrial powerhouses in the world, and it's got it's got a currency that is just stupidly stupidly undervalued...now Tokyo is the most the cheapest It's like a developing country. I I mean, you go for lunch in Tokyo, like a really nice lunch, it's going to cost you 15 bucks.”

Beyond electric cars, China is now exporting railways, power plants, turbines, and other complex infrastructure; it was not exporting these goods five years ago, indicating a structural shift in manufacturing capability from consumer goods to advanced industrial products.

“Beyond electric cars, you got railways, you got power plants, turbines. I mean, you name it, you know, five years ago. You mentioned that China's trade surplus has gone from 25 billion a month to 75 or 80 billion a month. Uh, and again, that's not because you and I decided to buy three times as many pairs of socks or three times as many, you know, plastic toys. Um, you know, in the past five years, China started exporting a bunch of stuff. They never exported before.”

Japan's yen weakness (trading at 150) creates an enormous competitive advantage for Japanese exporters, making it appear that every car in the world would be produced in Japan if only the yen remained this weak, yet China is still taking market share and becoming the world's largest car exporter.

“I think you wanted to say that the, the manufacturers and high tech companies in China are competing against a very weak yen, yet they're taking market share, uh, have huge trade surpluses, and so it's obviously For anybody else to try to compete with a Japan is, is extremely hard, and the fact that they can do it tells you something, right? Exactly. So when you think of it, they've had to deal with a super cheap yen, um, the real estate bust we mentioned. And on top of that, the American, um, um, restrictions on, yeah, war, but you know, semiconductor restrictions and whatever else. And with that, from nowhere five years ago, China's become The biggest car exporter in the world.”

Treasury auctions have been looking increasingly ugly recently, reflecting market discomfort with the scale of US deficit financing at a time when surplus countries that could recycle capital back into the US are countries the US is antagonizing geopolitically (China, Saudi Arabia).

“Well, lately they've been looking ugly. Um, the, the, the, the simple answer is your last question of how have the treasury auctions been looking? And the answer is they've been looking ugly because look, the US is now, uh, it's the US is 4% of the global population... the surplus countries that could recycle. There, uh, flows back into the U. S. Seem to be countries that the U. S. Is directly antagonizing, like China, Saudi Arabia. I mean, they're, you know, like, what's happening in Gaza with the U. S. backing those activities. It's going to it seems to me going to make the Saudis less and less likely to want to show up at the Treasury auction by a bunch of us that right?”

The simplest explanation for why the US is running massive deficits at full employment with strong growth is political unwillingness to cut spending—policymakers prefer to buy votes with borrowed money rather than make difficult fiscal choices.

“they're buying your votes with your money. And, and so to your point, um, they, you know, how do you protect yourself against that? Well, I think Latin American debt is one of them.”

The US has undervalued STEM in its K-12 educational system (not at the university level) such that most students do not enter university considering STEM, with computer science being the primary exception, while chemistry, physics, materials science, and other fields are avoided.

“We also have to count that the ones being produced in the U. S., a lot of them are going to go back to China anyway. Um, we, we've, we have undervalued STEM in our schooling system, not at the university level, but from, from a much earlier age, uh, so that when kids, kids come in at university, most don't even look at STEM. They're just like blow right past the only thing that kids still look at is computer sciences. exactly. How many, how many of our kids still do chemistry or physics or, you know, you mentioned material sciences or all these things like nobody does.”

The US tax code is approximately 17,000 pages, while the French labor code is approximately 30,000 pages, creating comparative disadvantages for the US in tax administration and France in labor flexibility.

“if the tax code is America's comparative disadvantage, the labor laws are France's comparative disadvantage. because you can't fire anybody, know, you can't, you can't fire anybody. Like, I think the tax code in the US is like 17, 000 pages or something. The labor code 30, 000 pages. Um, you can't, you can't do anything.”

The transition from the traditional 60/40 portfolio model to active portfolio management is a fundamental structural change in what financial life requires of savers.

“no, I think that's exactly right. That's exactly right. But you know what? You don't, you don't get to pick the period you live in. Nope. Nope.”

China's real estate has been consolidating for five years, and affordability has swung from being the most expensive in 20 years to the cheapest in 20 years—driven by mortgage rates halving, real estate prices falling 20-30%, and incomes rising 20-30%—yet the Chinese economy has not imploded unlike historical precedent (Japan 1990s, Sweden 1992, Canada 1994, SE Asia 1997, US 2008, Southern Europe 2011-2012).

“real estate has now been consolidating in China for five years before five years. Um, for a number of reasons, you know, obviously trees don't grow the sky, but also the government actively wanted to take down real estate. They took down real estate. Um, affordability has gone from, you know, being. The most expensive in 20 years to the cheapest in 20 years over the past five years, um, partly because mortgage rates have halved partly because real estate price have gone down about 20-30 percent and at the same time over that same five year period, incomes have come up 20-30%. So, you know, you do your affordability ratio all of a sudden it looks much better. Um, and so China has managed to do a real estate consolidation, which has, you know, hurt growth, which has, you know, killed the sort of like raw, raw feeling the Chinese economy had, but the Chinese economy has not imploded.”

The French Army was professionalizing in the early 1990s after eliminating conscription, resulting in too many officers relative to available soldiers, which made the military eager to allow officers like Gave to leave for other opportunities even if they had paid for their training.

“And I was there at a time when the French army had started to professionalize, because we used to have a conscript army up until the early nineties. And that, that was probably the one. Electoral promise that Chirac kept was, uh, to do away with, uh, the military service, which I think it's ended up being a disaster, but that's a whole other topic. Um, the, um, uh, so he got away with conscription. So I was there, uh, basically the army was professionalizing. And as a result, we were, the French army was a little bit like, The Mexican army, we just had too many officers because we were, you know, we, we, like, we were meant to have all these soldiers and we didn't have them anymore. Uh, so the army was actually happy. If you, if you told them, look, I've got a job offer somewhere else. They're like, go, you know, good luck to you. Um, you know, even if they paid for your training, even if they were just happy to see you go, they had too many of us anyway.”

The moment when US Treasury auctions become a real funding problem is when the Federal Reserve will step in to monetize debt by expanding its balance sheet, which will devalue the dollar.

“before it becomes a problem, the, you know, you still have one more bullet and that the Fed can come in. And monetize a lot of the debt, like once once the government U. S. Government starts hitting real funding issues, the Fed will step in, uh, and then the U. S. Dollar will go down, um, and initially that first drop in the U. S. Dollar will feel great because the U. S. Always overvalued.”

The question is whether the pain from recent fixed income destruction is the complete adjustment (and markets can reset), or whether it's just the first step, with dollar devaluation and currency weakness coming next.

“Do we leave it at that? And it's good that the pain's been taken. And now we're reset and we can start again. Option one or option two. That was the first step. And the next step is the dollar. And the next step is the dollar because the U. S. Government remains incontinent.”

Today, everywhere in the world is harder to run a business than 20 years ago in terms of regulations, but Hong Kong remains easier than London, New York, or Paris.

“I would say that everywhere in the world today is harder to run a business than 20 years ago. Almost, almost. Um, you know, in terms of regulations, you know, if you compare, if you're in London, if you're in New York, if you're in Paris, everybody complains that today is harder than 20 years ago. And in that respect, the same is true of Hong Kong, but Hong Kong is still easier than New York, London, Paris, et cetera.”

Many US universities have dropped Algebra II (high school level mathematics) as a bachelor's degree requirement because so many students fail remedial math courses, creating an impediment to graduation that universities removed rather than addressed.

“Don't, don't get me started on this because, um, you know, most U. S. universities actually, they used to have an Algebra II requirement, so this is like high school level Algebra, uh, that you had to have mastery of that to get your bachelor's degree, and they dropped that because so few students, or so many students on campus were having trouble passing that kind of remedial math class, they just waived the requirement now, so, so it is really a problem here in the United States. Um, you know, this would not be the case at Duke, but at many public universities, it really is an issue.”

Bond bear markets have destroyed approximately $15 trillion of capital, which is substantial wealth destruction for conservative savers who did not take equities risk and have been 'absolutely butchered' by long-duration bond losses.

“but, but, you know. Long dated bonds, like they've just wiped out 15 trillion of capital. Uh, you know, the bond bear market has wiped out 15 trillion of capital. That's, that's proper money. Um, Has been serious capital destruction for a lot, a lot of savers and a lot of savers who were, you know, conservative savers. Uh, we didn't want to go out there on the risk curve and take too much risk, et cetera, and they've been absolutely butchered.”

China's manufacturing and industrial sector is 60% larger than the US manufacturing sector by nominal GDP, and this gap is growing due to the STEM pipeline advantages and ecosystem effects documented earlier.

“even though the Chinese economy is a third smaller than the U. S. industry, your secondary sector is 60 percent bigger than your, um, than the U. S. So Chinese today manufacturing and industry in China is 60 percent bigger than the U. S. already. And that gap is growing for all the reasons we highlighted the stem kids.”

Graduates from the one-child policy generation have a unique economic shelter: four grandparents, two parents, no siblings or cousins, so they can afford to stay home and wait for ideal jobs rather than taking the first available position.

“them. So there's that, but also remember that all these kids are the fruits of two generation of one child policy. Um, so, uh, so they have four grandparents, two parents, no cousins, no brothers and sisters, so they actually also have the option. Of staying at home. And a lot of them do, um, like of waiting for the right job. Um, because, you know, if you have five kids, you tell the kids, you're not staying at home. You guys are out of here. Uh, you know, make, go, go make your way, which was always the way in China, by the way. Right.”

The US economy is 4% of global population yet accounts for 40% of global budget deficits and 60% of global current account deficits, requiring constant inflows of foreign capital to fund these deficits, something the US has historically been able to do but at unprecedented quantities.

“look, the US is now, uh, it's the US is 4% of the global population. It's 60 percent of global budget deficits. If you include sorry, 40 percent of global budget deficits and 60 percent of global current account deficits. So you had all the world's budget deficits. You had all the world's current account deficits. And so the U. S. Needs to constantly attract foreign capital, which, you know, historically had never had any problem doing, but never in those quantities.”

China is a profoundly capitalist country that had socialism imposed on it, while Japan is a profoundly socialist country that had capitalism imposed on it; both are drifting back to their natural institutional orders.

“one of the jokes we tell each other in Asia is that the tragedy of Asia is that Japan's a profoundly socialist country on which capitalism was imposed, and China's a profoundly capitalist country on which socialism was imposed, and that both are Both are drifting back to their natural order of things.”

Being a junior employee at the start of a career during a financial crisis is a blessing because junior employees have few responsibilities, can't be blamed for pre-existing bad decisions, and gain formative learning about how quickly things can unravel.

“when you're starting off your career is actually a blessing. Because first, you don't have too many responsibilities. So, you know, as your business is bleeding everywhere, that's not your fault. And you didn't make any bad decisions. You just got here. Um, and so that was number one. Number two, it's a blessing because you realize how quickly things can unravel. And so for me, it was a great formative experience.”

Instead of accumulating Treasuries as reserves (which leave it dependent on US willingness to honor claims), China is using its trade surplus to build strategic petroleum reserves because it faces geopolitical uncertainty and values energy security more than claim-based reserves.

“if you're China and especially following the Western world's grabbing of Russia's treasuries, if you're China, you think, hold on. I've been accumulating treasuries in the case I needed oil. That was really the main thing. So maybe I just accumulate oil. Like, you know, why the intermediate step where I make myself dependent on the willingness and ability of the U. S. to deliver me my money when tomorrow, you know, they've shown that they can take it away in a heartbeat.”

Focusing on IP theft as the explanation for Chinese technological success is unproductive; even if IP theft were completely halted, the massive human capital advantage (millions of engineers annually) and technical infrastructure mean China would continue advancing and likely widening its lead.

“I don't want to fight that battle. I'll just say, look, let's, let's suppose they stole everything, but they have very competent people making use of what they stole and going forward, just crying about it is not going to solve your problem because they're innovating new stuff as with EVs, as you pointed out, right?”

Last week, the Saudi Central Bank signed a currency swap line with the Chinese central bank (PBOC)—a major monetary development that received little Western media commentary but signals Saudi consideration of de-pegging from the dollar and potentially pricing oil in renminbi.

“You saw, you saw last week what I think was a massive event. The central bank of Saudi Arabia signed a swap line with, uh, the PBOC, the Chinese central bank. Now, why the hell would they do that? Yeah. You know why, why they've got a pegged currency to the dollar. Um, and they've got, uh, what they sell is price in dollars, right? Uh, oil. Um, so why would they need a swap line with China? Uh, you know, signing a swap line with China is in essence saying we're going to need rem and B. Why would Saudi need Remin before? Um, is Saudi's trying, starting to signal that they might deeg to the US dollar that they might start signing long-term deals with China for oil in, in Remin BI don't know the answer. What I know is they announced this, this, uh, this currency swap. And to me that seems like one of the most important, uh, monetary developments of, of the recent years.”

Latin American debts offer attractive real yields and expose investors to governments with polar-opposite policy learning from their own past inflation: Latin American central banks tighten immediately when inflation appears, while Western central banks remained accommodative.

“one of the things I like a lot, Latin American debts, you get high real rates, you have governments that are actually polar opposite of ours. It's always the same story. You don't make your father's mistake, you make your grandfather's mistakes. Um, you know, in Latin America, they had inflation not that long ago. So as soon as inflation appears in the system, the central banks, you know, bang and ministries are financed tight and fiscal policy because they know the long term consequences. Meanwhile, in our countries, ours, whether France or. Or america as when inflation reappeared, you know, all our policymakers were clapping like seals. They're like yay inflation, you know, we want it higher for longer”

Youth unemployment in China reported as very high is likely a statistical artifact: it reflects that so many young people now attend college (60% of cohort) that they're not in the labor force while studying or immediately after graduation, not that the economy cannot absorb them.

“my guess is that this reported very high youth unemployment number is just because so many kids go to college now in China. It was such a rapid transition from very few going to, you know, 60 percent of the kids going to college. Now, all of those kids expect to have white collar. You know, knowledge worker type jobs, and there just aren't that many available in the economy for them right now.”

China is likely importing 0.5-1 million barrels of oil per day more than it officially consumes or produces, suggesting strategic petroleum reserve building that is treated as state secret.

“China's probably been importing a million barrel per day too much somewhere between half half a million and a million barrel per day too much for the past couple of years, which again, I think if you're China makes perfect sense. You've got too many dollars. You don't know what to do with them.”

The concentration of the world's best young research teams in frontier fields (jet engines, satellites, computers) is increasingly in China, with teams skewing young in age composition, indicating sustained innovation capacity and human capital quality at the frontier.

“You can just see it in how young the teams are over there that are doing this world class work, whether it's in jet engines or satellites or computers.”

The Chinese government actively engineered the real estate consolidation and is not helping property developers recover because it wants the consolidation to happen—it views property development as a distraction from technology and manufacturing, and as a source of local corruption.

“the government could come in any time and stop this by creating a sort of FDIC of property developers saying, you know, once you put your money at a with the developer, there's a government guarantee... but doesn't because I think deep down it wants the consolidation in real estate. Deep down the government, you know, they wanted this outcome. You know, they, they wanted, they never liked the property developers. Uh, they always thought they were sort of pariahs and, you know, Donald Trump like characters. Well, I would say that, you know, a lot of the property development activity, although it made certain people rich, it wasn't necessarily developing the technological or industrial capability of the country very much. And secondly, it led to all kinds of problems with local governments raising money by just selling off property. And that sort of caused all kinds of you know, local problems, less control from the center. And I guess now that some of those local governments are in financial trouble right now.”

Iran's economic survival now depends on China, making China effectively Iran's patron; Saudi Arabia recognizes this and therefore seeks accommodation with Iran knowing that conflict with Iran is conflict with its largest economic partner (China).

“the reality is Iran. The only reason Iran survives is at this point, China. Um, and economically, you know, Saudi Arabia try to crush it. The U. S. Tried to crush it, but given that it's got China's backing now, it's, it's, you know, it's, it's not gonna, it's not gonna get crushed. Um, so I think Saudi realizing this says, okay, um, you China can always put pressure on Iran to do what they want. So I might as well get. And if you're Saudi, you only have one enemy. It's Iran. hmm. You're not worried about Israel. Israel's never going to come and attack Saudi. So your only enemy is, and you're no longer worried about Russia or the Soviet Union, like you were in the past. So your only enemy is Iran. So, you know, if you can cut a deal with China to cut a deal with Iran, that takes care of your biggest problem.”

In 2006-2007, the existence of derivatives contracts being executed purely for tax purposes—rather than legitimate economic hedging—signaled that bubble conditions had been reached because too much elite brainpower was being devoted to zero-sum tax optimization.

“I kind of knew, I kind of knew one of the bubbles had been reached around 2006 2007 because I was having sushi with a former physics guy who was in finance, a derivatives guy. We're sitting there eating this whatever 200 sushi dinner thing and two little dudes are sitting next to us talking about some derivatives contract which was being executed purely for tax purposes. And it's just like, well, this is, this is too much, like too much brainpower is going into this right now.”

According to Western media, China is collapsing, yet China has a monthly trade surplus of $80 billion, which annualizes to a $1 trillion annual trade surplus.

“if I follow the Western media today, they tell me China is collapsing. If I turn on Gavekal, I learned, wait a minute, their monthly trade surplus is 80 billion. It's, it's, on an annualized run rate, it's a trillion dollar trade surplus.”

Gold, commodities, value stocks, Latin American debt, and some growth stocks together form a defensive portfolio mix that 'may not hit it out of the park' but should cushion against de-dollarization and inflation.

“So I would say, you know, to answer your question buy value stocks, buy commodities, you can also have some growth stocks in there as well. Of course. Buy Latin America debt, uh, and buy some gold and that may not hit it out of the park, but it should allow you to cushion the portfolio.”