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Szn 4, Ep. 2: The Nascent Sino-U.S. Financial Cold War, with James Fok

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James Fok joins the podcast to discuss his book ‘Financial Cold War: A View of Sino-US Relations from the Financial Markets’. In Fok’s view, the fates of China and the U.S. are highly intertwined, and neither country’s leaders want the conflict to escalate — but that could easily change.

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Nathaniel E. Baker
Welcome to the contrarian investor podcast, season 4, episode 2 here with James Fok in Hong Kong, joining us from Hong Kong to discuss his book, ‘Financial Cold War: A View of Sino-US Relations from the Financial Markets.’

James, Sino-US relations and the Chinese economy is something that comes up quite a lot on this podcast. A lot of people, as I’m sure, you know, have views on this often very opinionated views one way or another. But you are in a unique position. Maybe you can tell us about your background later on in the show, but I want to talk about this book first. And your ideas for it. Because like as like the book suggests there is and it’s already been used this term cold war between the US and China. But for all the reasons you point out in the book, this is not like a traditional Cold War, like we saw between the US and the Soviet Union. The two countries have many entrenched interests, a lot of trade going on. Your premise is basically that this this Cold War, to the extent that it can be called that it’s going to be fought along financial markets. And so very curious to have you on the show. Have you talked over this a little more? So without just let you take it away? And tell us about this book?

James Fok
The financial Cold War, as I define it in the book, is the invisible conflict embedded in the structure of the global financial system, and national financial policies, which have been driving ever higher levels of wealth, income inequality. And what this has led to is a rise in social tensions in China, in America and in other countries, which has been driving conflict. And in the financial sphere, this has spilled over into some of the more obvious things that people talk about when they think about financial called was, which I call actually a geo economic world, where people are putting sanctions or countries are putting sanctions on each other’s then limiting access to markets. And they’re using that their financial heft to try and manipulate or contain their strategic rivals. And what I’m worried about, and the reason particularly why I’ve written this book, is that this now risks spilling over into ever more aggravated conflicts.

Nathaniel E. Baker
And that you mentioned that the trap of Thucydides, the Thucydian trap here, which is that a rising power be rising economic or military world power, and an entrenched the existing world power almost always, in fact, always meet militarily at some point. And there’s many examples of this throughout history going back to the Peloponnesian War, right. That’s always where it comes from. Right. But so talk to us about that. And whether you think that a military conflict between the US and China is inevitable?

James Fok
No, I don’t think it’s inevitable, but it’s depending is highly dependent on the individual, many individual decisions taken by leaders on both sides. And your the fact that we understand today that, you know, there are these kind of cyclical dynamics in great power relations that can lead to things like the Thucydides trap, means that your we should be or we should be better equipped to avoid them and avoid repeating those historical mistakes.

Nathaniel E. Baker
Should be and may well be, but yeah, there is obviously a lot of tension that has been rising, you know, over the last couple of years, you know, through the Trump presidency, of course, and more recently over over Taiwan, and other things. Where do you see the US the sino us the US China relationship right now? In terms of Yeah.

James Fok
It clearly is. It’s not been in a great place. And I think part of the problem is that, you know, as social pressures have risen in both countries, there’s been attendance See for politicians on both sides to deflect the problems on to others, and particularly to pursue relatively populist and nationalist rhetoric, we should simply compounded that those feelings of the feelings of enmity towards each other. I think that’s far from helpful.

Nathaniel E. Baker
No question, what are some ways out that we can and we are, like we said, we’ve already had the economic, you know, interaction between the US and China. But maybe some could argue that this has come down a little bit recently with the US offshoring a lot of manufacturing that by no means all, by no means even most. And China is still a factory to the world. So it would seem that it is in the best interest of the China of the US and Western powers to keep things the way they are, right.

James Fok
Well, I think, really, the fates of the two countries are highly intertwined in the globalization of the past 100 years, it has meant that, you know, we are ever more tied together through trade, and international investment. And actually, by and large, that’s been a good thing, because it’s helped less prosperous countries become more prosperous. And it’s certainly driven higher levels of growth and development than we otherwise would have had. But you’re clearly there have been imbalances in that. And one of the key problems that I point to in the book is the role of the US dollar, in the global monetary system. Because the dollar was put at the center of this system at the end of the Second World War. And, you know, really, that the system was a bad design from the outset. And, you know, that wasn’t widely recognized until over a decade later. But your by that point, it became very difficult to unwind that role of the dollar. And so you’ve had, as global trade and global investment have increased over time, you’ve just had an exponential increase in those imbalances. Each side kind of Hell’s accusations that each other in terms of what the problems are, if you’re sitting on the US side, you’re accusing emerging markets of really holding artificially holding down their currencies to steal us jobs, if you’re sitting on the side of the emerging markets, you’re sitting there at the mercy of your the volatility of the dollar, because quite often times, your companies and your governments have had to raise money in US dollars. So when there’s been a big fall in your currency against the dollar, then you’ve had difficulties in repairing that’s which have led to bankruptcies which have led to unemployment and huge human misery in those countries. And ultimately, this comes down to the fact that it was never sustainable in the first place for the dollar, to play both the role of the US national currency, and the role of this global utility that everyone needs to use when they’re interacting internationally in trade and investment.

Nathaniel E. Baker
Yeah, interesting points. But, of course, this also serves the US has purpose to have the US the dollar as the reserve currency in the world. And right now, are there any realistic options to replace it in the foreseeable future?

James Fok
Well, I think when you say that it serves, the US has purposes, you have to really look at this carefully. Because I don’t think that that actually holds true at all levels of US society. So of course, if you’re, if you’re a wealthy shareholder of large US corporate, that because the US dollar has been structurally over value, you’ve been able to offshore, your manufacturing to lower your costs and increase your profit margins. It’s been great. I wouldn’t say it’s been so great. If you’ve been a US manufacturing worker over the last 40 years or so. Ultimately, this is your this comes down to a question of whether it is working for the majority of society. And one of the key points that I make in my book is actually this belief that the dollars global role is good for the US is a fallacy. Actually, for most people in the US today. It’s actually hurting

Nathaniel E. Baker
Interesting. But yeah, the US would not be able to run its current its current account deficit and continue to, you know, inflate away at its its, you know, issue Treasury if the if the dollar was an issue treasury bonds if the dollar wasn’t the reserve currency of the world, right. And

James Fok
it Sorry, sorry to sorry to interrupt you at all. But actually, if the US wasn’t playing this role, if it wasn’t artificially overvalued, to the extent that it is that the US might not need to run those sorts of deficits.

Nathaniel E. Baker
Right. But, but what What choice does the US have, as far as like, you know, whatever social spending, whatever, you know, government, things there are, it’s got to be paid from somewhere. Right.

James Fok
That comes, that comes to a different question. And the fact is that the US government has spent well beyond its means for a very long time. Now, part of the reason why I was able to start doing that, in the first place was because there was this almost bottomless pool of international demand for dollars. But actually, that that’s not the case today, what what’s actually happening, what, actually, over the last six, seven years that the total balance of international holdings of US Treasuries hasn’t really increased? Well, who’s been buying that debt? It’s been the Fed. And so at some point, you know, although markets can stay irrational for longer than your I can stay solvent, at some point, reality is going to catch up with the dollar. And if we don’t take active steps, at an early enough stage to deal with those problems, then the collapse at some later point could be quite catastrophic.

Nathaniel E. Baker
Okay, so what is China doing now to, to kind of take these steps to get away from US dollar. Obviously, the the Yuan has, you know, entered the IMF ‘s currency basket. Right. And they are doing some stuff around digital currencies? What can tell us about that?

James Fok
Well, I think, first of all, I’ll say that, you know, actually, I think China is a very, very long way from usurping the dollar. And in fact, I don’t think that China, having looked at the costs of the dollars global role to US citizens, it actually has an aspiration to turn the renminbi into a replacement for the dollar. But certainly it has been making steps to internationalize the renminbi. And actually, a lot of these steps kind of started out, because of very practical reasons, then more. China was very closed, there were a lot of people traveling overseas before. Now there are hundreds of 1000s of Chinese students all over the world, Chinese businesses are becoming more international. And so necessarily, China has had to make steps or take steps to allow its currency to become more convertible, just to facilitate these sorts of international interactions. But but their own is still relatively is still relatively tightly controlled, and the capital account is still largely closed. China’s been making some steps you talked about the digital renminbi or the Chinese central bank digital currency. It’s been taking steps to modernize its financial system, but those are still relatively domestically focused. The digital currency is really just something which is initially intended to be used by demand for domestic retail payments. So I think, you know, from the perspective from the perspective of becoming an international currency and becoming a global reserve currency, China, if they want the renminbi to play that role, would have to take far larger steps to internationalize the currency and particularly what they would have to do is start allowing many many more renminbi denominated securities to be issued offshore. Because if you if you receive renminbi today, through a commercial trade transaction, you’re still sitting there you’re Malaysia, Indonesia, you’re still sitting there scratching your head and saying, Well, actually, what am I gonna do with these? You know, if I get US dollars, I can put them into treasuries, I can buy any number of financial assets. And she if I get these renminbi, there’s really not that much I can do with it outside of mainland China.

Nathaniel E. Baker
Yeah, so and that’s kind of the crux of the matter here. So, you know, how do you get that kind of credibility? If you are China? Or how do you switch away from dollars so that the, the USD is not this this weapon? Yeah, like, what options do you realistically have?

James Fok
I think, to insulate itself from US financial sanctions is practically very difficult. China has taken some small steps, particularly through creating its own payment systems that bypass things like the SWIFT network, is created the digital currency, where actually that entire payments via the digital currency could bypass many of the infrastructures through which dollar payments are made and settled today, but it’s it’s far from it’s far from perfect in insulating China from US financial pressure, just simply because China’s sought dependent on the dollar in its international trade, not just with the US, which has now only about 14% of its global trade, but its trade with all other countries.

Nathaniel E. Baker
Yeah, it sounds like that is kind of the main thing that needs to happen here. So the world just needs to not just China, but the entire world needs to become less US dollar dominated. Right, if this if this kind of financial Cold War is going to resolve itself. Is that a fair statement?

James Fok
That that’s a fair statement. And you asked how they would get there. And I think that solving this is a gargantuan Lee complex problem. But there are precedents so when Sterling the pound sterling handed over that status to the US after World War Two. Britain followed, I think quite a quite a stringent policy of removing the pound from that global reserve role. In 1947. Pound sterling accounted for 87% of all global foreign exchange reserves, over a period of 30 years, that the country pursued capital controls that pursued several rounds of devaluation. And had a couple of instances of IMF support, and was supported by many other countries, and gradually wound down the role of Pan Sterling, which set the UK up, in fact, by the 1980s, then to actually significantly outperform many other European countries.

Nathaniel E. Baker
Hmm, that’s interesting. But it’s still pretty unpalatable. Politically, right. I mean, if you’re a politician in the US, why would you go down try to go down that route? Well,

James Fok
the reasons the reasons why the UK did, were really because after the Second World War, there were certainly a large constituency, as opposed to doing that, in the UK, not least that the financial services sector which was very powerful in the City of London, but after, after the Second World War, Winston Churchill got voted out of power, and you had a Labour government to come into power. And when they looked at it all said and done, Britain, for Britain to continue playing that role meant continuing to absorb all the financial imbalances from the rest of the world. And what that translated into was the loss of British competitiveness and the loss of British jobs. And so, it certainly wasn’t the wasn’t an easy decision or a decision that was taken lightly. But it was a decision that actually benefited ultimately, the majority of the electorate in the UK.

Nathaniel E. Baker
Interesting, okay. But it does sound like there would probably need to be some kind of economic major economic recession or major crisis even in the US for that to become possible. ability politically, one would think, no.

James Fok
We’ve had we’ve had no shortage of financial crisis. Yeah.

Nathaniel E. Baker
I know. Yes. Right. But there’s still the status quo still exactly the same. Right.

James Fok
I think I think that it certainly will need it will need significant political impetus for that to happen. But it’s not always it’s not also, of course entirely within the US has control in other countries may gradually start to move away from the dollar themselves, which actually, you’re seeing, you’re seeing happening to an extent in that other countries, central banks are no longer buying US Treasuries at the rate that they were 1015 years ago. And so I think, you know, as that as that transition happens, people will look for more attractive places to park their capital, and that that may well become other country’s financial assets. Okay. I think I think this this is a is a process which can take place via a number of different routes. What what I would advocate is that it’s done in a collaborative manner, that actually then manages the process and avoids many of the messy disruptions that you might see otherwise.

Nathaniel E. Baker
What are these? curate what are these countries buying if it’s not US Treasuries,

James Fok
but they decided to buy they started buying more other country’s sovereign bonds. But okay, a significant there’s been a significant increase in the purchase of other risk assets, so Okay, equities, foreign direct investments, and so forth. But one of the things one of the things which China’s done, instead of putting more money into US Treasuries, is actually starting to invest in infrastructure development in other countries through what what it calls the Belton Road initiative.

Nathaniel E. Baker
Interesting, interesting. That is interesting, because I was gonna say there’s not too many I mean, if Okay, equities is one thing, but there’s risk with that. And, you know, the US Treasury, the right now to 10 year yields 1.7, or some percent, maybe even more, as of today. Haven’t looked, but, and the German bonds have a negative yield. And most other European bonds do too, which is the next safest thing. So why wouldn’t you put it into treasuries if you’re getting 1.8? versus zero? Right, like,

James Fok
you could you put you put my Chinese government bonds, the 10 year rate is around three and a half percent now? Sure. So this in the sovereign debt in the sovereign debt game, given? How leveraged many sovereigns are around the world, actually, this is a this is more of a game of the least bad option, rather than rather than necessarily, your people actively wanting to put their money into treasuries or EGB. Sure, some investors, some investors, of course, have no choice because they’re forced to hold a certain number of them.

Nathaniel E. Baker
Which brings up another question, but another problem, potentially, but yeah, that’s, that’s, that’s good. That’s a good point. All right. How else is this, you know, financial Cold War? Do you see it playing out? And what does it mean for asset prices in the US and China?

James Fok
Well, I think the other ways in which the financial called boys played out have been through international tax competition, which has driven actually, in many countries, far more regressive, and unfair tax systems, simply because the countries have been raised to attract capital and investment, capital tends to be much more mobile than labor. And so this is driven. This is driven, slightly bombI tax systems in which actually, the very wealthy are paying far lower rates of taxation than average middle class workers. And so that and I can go down and the book goes down into many more individual country policies that have contributed to this financial Cold War, things like antitrust enforcement or the lack thereof. Industry. Real policy, executive compensation structures and other financial incentives. So I think in terms of how this in terms of how this plays out, I think if you if you look at the historical cycles, you’ve gone through periods of huge wealth accumulation, which is what we’ve been through over the past 3040 years. And following those periods of wealth accumulation, one of two things happens. The first option, which I think is by far the preferable is that there’s been some political consensus, which has driven a level of wealth redistribution, through higher taxes on the rich, greater investment in social welfare, and other programs. Or you’ve had the violent redistribution where it’s essentially precipitated civil wars, internet, international wars and other conflicts, in which many people have their lives turned completely upside down. It’s not, frankly, great for anyone who lives through any of those periods of time, but ultimately ends up in the redistribution of wealth, income and other resources in a more fair and egalitarian way. Okay.

Nathaniel E. Baker
All right. Which scenario Do you see is more likely?

James Fok
I would strongly hope. We give them what we know and understand about these cycles today, that we choose the format. Yeah, no

Nathaniel E. Baker
question. I think we all do. I want to take a quick break here, give our sponsors a quest a chance to make themselves heard. And if you are a premium subscriber, do not touch the dial, you will not get the break, or welcome back. Everybody here with James folk have. I’m sorry, you don’t actually represent the firm now do you? Author, right. So but curious to hear about your background, I read about it a little bit in the book, I know you hail from from Hong Kong, or you’re born there. And so maybe tell us a little bit more about about that about your professional background, how you got to be where you are now and how you came to write this book.

James Fok
I was born and grew up in Hong Kong, and attended boarding school in Scotland. After that went and spent time in University in Beijing and ended up getting a job working in an investment bank in London had a very interesting career in investment banking, across Europe, and in Asia. And in 2012. It was changing jobs. I got, I got a call from someone working at the exchange saying, Hey, what are you doing? Can you come and help us out on something. And it turned out to be the acquisition of the London Metal Exchange, which is the largest commodities exchange for trading base metals in the world. And so thereafter, I end up on a pretty wild ride over 10 years working at the exchange and getting involved in the internationalisation of China’s capital markets, which gave me certain insights working at this intersection between financial markets and policy on your how the global financial system works. And the reason for writing this book was that I felt that there were many things that even top policymakers and people who are who’ve been in financial markets for years, didn’t understand well, and needed to understand better. Hmm,

Nathaniel E. Baker
cool. Very interesting. So how do you see things now in China, the economy has been slowing a bit. There’s been real estate issues, you know, the real estate market, as I’m sure you’re aware, but yet, but these seems that they’ve been able to combat it as they have other previous crisis that that that they’ve had over the last decade or so. So where do you think you see things going from here and in China economically?

James Fok
The Chinese government has done a remarkable job engineering, China’s growth from being dirt poor. That the answer to the 1980s to being today, on average, a moderately prosperous country If you go to any of China’s major cities are actually a very modern and technologically advanced society. But China’s development model has depended very much on the harnessing of Chinese people savings, to pursue investment in infrastructure and other development where it should have enabled the growth of its export economy and the growth of its technology businesses. And you’re what Well, that’s a very effective means of operating at the outset of economic development, as you gone for longer. That’s very tight control of the pricing and allocation of capital tends to lead to significant capital Miss allocations, which have serious economic repercussions. And for China that the biggest challenge today, I would say is the fact that it has the one of the most rapidly aging populations in the world, that the demographic cliff that the country faces is very considerable. And, you know, over time, if you keep investing in more housing, more industrial capacity in the face of a falling population, at some point, you are going to have a financial blow up because the growth in population to support that growth in consumption just isn’t there.

Nathaniel E. Baker
We talk a lot about the China and the other parts of everybody in the world relying on the US for growth. And it is, like I mentioned at the outset, China factory of the world. Obviously, most of their customers are actually not about most but many customers in the US. And that’s certainly true for other export nations. But what about if? How much do you know if the US corporations sell into China? And how much is that dependent on their growth? And if there is a slowdown in China there already is and if it gets worse, how might that affect the fortune of these companies in the US and in the West? Many of whom are very dependent on China to to Yeah, to get growth?

James Fok
I think there’s there’s quite a, there’s quite a good precedent for that if you look at what happened to Japan between the late 80s. And today, in fact, if you look at if you look at the numbers, the decline in China’s working age population, as a percentage of the total population, is likely to be much steeper than in Japan, because you have this extended period of one child policy. And so I think, certainly, China is still at the moment on the path of becoming more and more wealthy. And so I believe that that US companies and international companies that are selling into China’s consumer market will continue to see growth. You’ve also got technology driven factors in that you’ve got a large move of the vehicle fleet from petrol and diesel engines into electric vehicles. So I think many companies will continue to do very well, but companies that are solely dependent on a growth in population may find themselves disappointed.

Nathaniel E. Baker
Interesting, all right. What are your like ask, what are what is your biggest concern with this whole situation, or just even anywhere else economically, right now, as we record this on whatever Today is January 10 2022.

James Fok
The economic problems are fairly clear for everyone to see. And the things that worries me more the implications of those economic problems if we don’t deal with them, but particularly in terms of the social upheaval, and conflicts that they might precipitate, because you know what? Well, we can sit in our offices and crunch models about how economies and markets and revenues and growth that the reality is that if you end up with a huge social unrest or wars, which nobody wants, but history has shown Countries are perfectly capable of sleepwalking into. Yeah. All bets are off economically.

Nathaniel E. Baker
Yeah, yeah. Unless you’re a weapons manufacturer, I guess, probably their stocks would do. All right. And that comes from this. Now we come full circle, like how likely do you say that? If you’re if you’re Wargaming? This if you’re gaming this out, you know, the, you know, China pretty well, you know, the US pretty well, you certainly know, Britain also. So how do you how do you see this going out? Do you think that this is the type of thing where the interests are entrenched enough? And the lessons from history are strong enough? Where there won’t be any military interaction? Or could it be more along the lines of what we did see in the Cold War, where we had, you know, client, client versus proxy, state type of things, you know, Russians in Afghanistan, the US and Vietnam, etc, etc.

James Fok
So first of all, very clearly, neither country, neither sets of leader wants to see a war between China and the US. And I think if you take a step back, that scenario is highly unlikely, unless the politicians are put into or are backed into positions where that they can’t get out of them. That the risk, the risk is really, in fomenting this nationalist, populist type of rhetoric is that leaders back themselves in two corners, where they find it difficult to de escalate, when there are accidents? Or maybe you have a, maybe you have a plane crash, maybe you have an accident here, or a misstep there. And that is probably the most likely scenario in terms of precipitating some escalation conflict.

Nathaniel E. Baker
Interesting. Yeah. I mean, and if you but if you go back to, like, let’s take 1914 There’s everybody’s favorite example, type of thing, right? I mean, you had to hear these empires in Europe, all of whom also had entrenched interests, and there was a lot of free good movement of goods and services and people and capital, maybe not so much services, but you know, between these countries, and it was not in their best interest to fight a four year war and ended up literally killing most of them. And but it still happened. Now, obviously, the situation there with alliances, etc, is maybe not entirely comparable, or at all comparable. But it does show that and you mentioned this before, that the countries don’t always act in their self interest sometimes when it comes to these things.

James Fok
No, they don’t. But I would hope that too, particularly having taken the lesson of the events that led to the First World War, we’re now better equipped to avoid them. Yeah.

Nathaniel E. Baker
Fair enough. All right. Do you see any a Chinese China activity as far as the US through the Belt and Road or elsewhere that maybe hasn’t been covered all that much in the West, that is of interest? Because when we talk about Cold Wars, we also have these. And again, I know you said financial versus, you know, typical, but we you know, you also you do have these client states and a lot of them, especially in Southeast Asia and in the South Pacific, or have kind of been a bit of a kind of diplomatic battleground between the US and China. And most of them kind of are play both sides against each other. But some have kind of fallen into China’s camp and others have gone to the US camp. Is there anything there update that you’re following? That is at all interesting to listeners?

James Fok
I would say that sometimes the Belton Road initiative is is looked at with a high degree of skepticism in the West, but I think it’s certainly done in in some places. An awful lot of good in China has is built an entirely new subway metro system in Hanoi. It’s linking up is linking up rail transport routes, to places like Laos and other parts of Southeast Asia that should bring greater mobility and economic prosperity to these places. So I think, you know, when, when some of the accusations about China deliberately creating debt traps, I think that that’s often far from the truth. But certainly, you are right But countries in Southeast Asia and around the region don’t really want to get caught between China caught between China and the US. And as best they can, that they’re trying to manage their diplomatic relations with both. And you could say that, in some instances have taken advantage of the desire of both countries to bring them more into their respective orbits.

Nathaniel E. Baker
Yeah, fair point. All right, cool. James, folks, thank you so much for joining contrarian investor podcast. Maybe in conclusion, you can tell listeners, finally, I’ll put this in the show notes as well, where they can find out more about you where they can find out more about the book.

James Fok
Thank you very much, Nathaniel. You can find out more about me on my website, James, a Focke JSAF okay.com. And that the book is available from major booksellers and on Amazon.

Nathaniel E. Baker
Yeah, your website has a link to all that. And like I said, I’ll put that in. You’re not on the social media. Are you on other than LinkedIn, which we’ll leave alone for now? But you don’t want you’re on Twitter or anything like that?

James Fok
I’m not I’m not a big social media user. No.

Nathaniel E. Baker
All right. Well, that’s probably very wise of you. Cool. Well, thank you all for listening. Thank you, James, for coming on the show. And that thank you for being with us this this week, and we look forward to speaking to you again next time.

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