Jim Chanos on Donald Trump and Current Events

I ran across a very good interview with Jim Chanos by the Institute of New Economic Thinking that I found interesting (h/t Naked Capitalism). It is mostly about politics and very little to do with investing per se. I excerpted some of his points below but you should read the whole thing if you are interested in econopolitics. (As usual, bolds are by me.)

source: "Chanos: Is a big change underway in global capitalism?" by Lynn Parramore for the Institute for New Economic Thinking, Dec 21 2016.

Lynn Parramore: What about the rise in bank stocks since the election? Are banks anticipating deregulation?

Jim Chanos: Almost all stocks are going up, mostly because of the belief of lower taxation. But after Obama’s election, most stocks went down and kept going down until the following March — and then they tripled! So I wouldn’t read a lot into the first month or two.

It could be that banks are anticipating deregulation, but so what? Deregulated to what end? They’re still going to have the capital requirements, which are international. Putting capital standards on them is the biggest way in which they were regulated.

In the bigger picture, if you think this is an uncertain presidency and we’re not quite sure where he’s going and how events will conspire, it’s not that important to get too worked up because things will happen and you’ll have to react. If, however, this is a once-in-a-fifty-year change in global thoughts about capitalism, then you have to pay attention.

I think the rumour of lower corporate taxes, including the possibility of overseas repatriation tax holiday, certain plays a role in the rally. But I still don't understand how stocks can be rallying while bond yields are rising and US$ is rising. Corporate profits should go down if US$ rises (makes US companies less competitive and their overseas earnings are worth less) and rising bond yields is also generally negative (increases cost of debt financing and also, theoretically, the discount rate has risen and the value of the firm should decline).

LP: Going back to Trump’s promise to bring jobs back to the U.S. — can the government even do that?

JC: In the case of the ’30s, you had massive public works spending and government spending, so you created construction workers. But on that front, we’re not going to compete anymore, as the Carrier guy said. Mexican labor is $3 an hour. No amount of retraining for a lower-skilled assembly job is going to change that. The only thing that will replace that Mexican worker himself is a robot. And a robot is infinitely cheaper than even the cheapest labor.

Surveys show that there are jobs open in the economy, but there’s just not a skill level to fill all of them. Our problem is the displacement in things like mining, assembly, low-end manufacturing – that’s where the job losses have occurred. It is just very hard under almost any scenario no matter what your politics are to see where those jobs are going to come back.

To the extent that you have wholesale, large, construction-like projects, then you will put people to work at relatively high rates, but the jobs are episodic and not necessarily career paths. When I was making $14 an hour working steel in Milwaukee in the summers in college, a steel worker could basically say, “all right, as long as I understand that I’m going to work in this factory, I can have a nice living for my family.” Those jobs are gone. The plants closed. So the whole idea that someone can now say, “I can work in the Carrier plant for $20 an hour and be assured of a job for life and security and put my kids through college” — that doesn’t exist anymore.

Pretty much concur with Chanos here. I always find that governments and citizens are generally fighting the last war. Infrastructure spending does not have the same stimulative effect as it did 50 years ago--at least in rich, developed, countries (different story in undeveloped or developing countries). No one, let alone the government, knows where the future job growth will come from. For instance, the information technology sector is around 20-30% of the US economy now but almost no one, including people working with cutting-edge computers in the 1970's, would have imagined how transformative it would end up being. Similarly, the best we can do right now, is to assist people who have lost jobs and ensure retraining/welfare/education/etc programs are in place. Spend money on infrastructure if needed to replace failing assets past their life but don't overdo it. If anything, government will probably be better off building something no one even talks about--say Internet infrastructure or genetic engineering or even space exploration--than the commonly-cited transportation infrastructure (but in addition to lack of public support, something like that can't happen because those areas likely need highly skilled people and the ones losing jobs aren't those people). But this is a tough problem to solve and I don't really have any answers; you just can't predict the future.

On China:

JC: ...This whole area just keeps quietly but relentlessly getting to be more dangerous. I think that at some point in the first four years of the Trump administration, the Pacific is going to heat up again.

People are talking about starting a trade war with China but they haven’t really thought it through, because if you talk to corporate execs in the United States, they’re sort of quietly terrified.  Often the supply chain, even in U.S. manufacturing, relies on parts from Mexico and China coming in. We are pretty interconnected. Lots of businesses, and workers, too, will get disrupted in ways we can’t even think of in a trade war. There’s a reason why people studied the 1930s with the tariff walls that went up and the disruptions that happened. It’s negative for growth.

My biggest concern with Trump, other than stripping of liberties (such as his plans to track Muslims and blocking Latin Americans from using banking system to send money to their home), is the potential for a trade war with China. Trump definitely seems to be on a path to a trade war, now that he has picked Peter Navarro as one of his key advisors. It's not clear how any of this will play out. Trade war is definitely a big risk that may or may not materialize.

LP: What do you hope might happen in this emerging world?

JC: This is the tough thing about being in the financial markets. You can have opinions on all this stuff and either get it wrong or have it not matter.

First, I hope our system of free trade holds up. That’s one thing I believe in fervently. The evidence seems to be that a rise of tariffs and trade walls and barriers will be bad for global growth. Given the debt overhang that’s out there, which is relentless, the ability of economies to service debts in a global trade war will be greatly curtailed, so I’m clearly watching that.

I also continue to be concerned, on a stand-alone basis, with the giant debt bubble occurring in China. It has done nothing but just gotten bigger since you and I last sat down. Despite all the talk of reform, there really hasn’t been any. The Chinese are more reliant on the state than ever — on state lending and state banks. The debt continues to grow at twice the rate of growth, and now the currency is depreciating.

We’re getting a situation where the Chinese economy is still a very important driver of global growth, but increasingly it is using the old methods that the Chinese themselves said only a few years ago that they would have to change. But they can’t, because every time they try, the economy slows too fast.

China continues to be half of the demand for global commodities. It basically supports Africa and countries like Australia and Brazil. Almost 40 percent of global GDP is either China or commodity-exporting countries whose prime market is China. That’s considerable. So we have to look not only at China’s role with us, but China’s role on its own because it is such a driver for global growth, Chinese growth represents 1 point of the 3 percent GDP growth, so if China were not growing at all, we’d be at 2 percent. Doesn’t sound like a lot but it is. We have to keep our eye on what’s going on there. A global trade war would probably send China into a really steep recession.

I have shared similar views as Jim Chanos for many years--and been completely wrong (so far). I remain bearish on China and believe it is in an epic bubble. I was already bearish on China 5 years ago but it was a creditor nation for the most part and their debt situation wasn't that bad at that time. Now, I'm amazed that China has gone on to be a major debtor nation, all within a few years. The credit growth in China is just crazy and reminiscent of Japan in the 1980's (not sure if it is a coincidence but just like Japan in the 80's, Chinese companies and citizens have been on a global buying spree snapping up many assets, including many Hollywood studios, residential real estate in Canada, and so forth).

Commodities looked like a bubble a few years ago, driven by the massive fixed asset investment in China, but it's tougher to say what the situation is right now. A slowdown in Chinese growth will definitely impact commodities--it will impact everything but the question is, are commodities even worse off--but it's hard for me to tell if they will see material declines. Earlier this year, many commodities appeared to be trading near long-term historical prices so it may just drop back to those levels. Commodity supply started coming off around those levels so there is a high chance those are long-term stable prices. All this is assuming you are bearish on China like Chanos and I.

Overall, I think the investment climate over the next few years is going to be quite unexpected.