We are thrilled to interview some of the world’s leading investment, economic, and philanthropic minds to provide insight on how institutional investors can survive and thrive in the world of markets and finance.

The View from China with Paul Krake

FEG’s 2020 Approachable Asia event was scheduled for this fall in Singapore, where we planned on venturing abroad to learn first-hand about the unique challenges and opportunities of international investing in a board room setting. Our goal was to provide clients the opportunity to meet with top investment and economic leaders, including local asset managers and companies. 

With the Coronavirus pandemic, we have opted to offer the same content through our Approachable Asia podcast series. Skip the flight and enjoy the conversation!

In this episode, we chat with a leading expert on all things China, Paul Krake. Paul is the founder of the research platform, View from the Peak.

Topics covered include:

  • How does China view its role in the world and how may this evolve in the future?
  • How should we think of Xi Jinping? What other power brokers should we be watching?
  • Have new security laws reduced Hong Kong's ability to be an international financial center? What other cities could take its place?
  • Do the moves in Hong Kong impact the Chinese policy toward Taiwan?
  • Will China overtake Silicon Valley as the world's leading developer of new technologies?
  • What opportunities are there in Chinese capital markets? What about fixed income and equities?
  • What issues is China facing that no one is talking about?


Paul Krake
Founder, View from the Peak

Paul has over 25 years’ experience as an economic and political strategist. He founded View from the Peak in 2011, seeing a need for a truly global, multi-asset class research platform that focuses on the interactions between public policy, economic trends, technology, and geopolitics. View from the Peak takes its name from Victoria Peak, the highest point on Hong Kong Island and the firm aims to look at the world from a 360-degree view with an Asian perspective. Clients include endowments, family offices, government agencies, asset managers, and corporates. The firm has offices in Hong Kong, Chicago, and London.

Greg Dowling
Chief Investment Officer, Head of Research, FEG

Greg Dowling is Chief Investment Officer and Head of Research at FEG. Greg joined FEG in 2004 and focuses on managing the day-to-day activities of the Research department. Greg chairs the Firm’s Investment Policy Committee, which approves all manager recommendations and provides oversight on strategic asset allocations and capital market assumptions. He also is a member of the firm’s Leadership Team and Risk Committee.

Greg Dowling (00:06):

Welcome to The FEG Insight Bridge. This is Greg Dowling, head of research and CIO at FEG. This shows spans global markets and institutional investments through conversations with some of the world's leading investment, economic, and philanthropic minds to provide insight on how institutional investors can survive and even thrive in the world of markets and finance.

Greg Dowling (00:30):

FEG's Approachable Asia 2020 event was originally scheduled for this fall in Singapore. It is an event where we take a handful of our clients for boardroom-style education and to meet with local managers. Well, that was the plan before the coronavirus pandemic hit. The good news is that through a series of podcasts, you can receive the same content and get to skip the 16-hour flight.

Greg Dowling (00:58):

Today we get to speak with Paul Krake, founder of View from the Peak. The "peak" is Victoria Peak, the highest point in Hong Kong. I know it well, because for the longest time when I was in Hong Kong, I would stay with a good friend and his family who had an apartment near one of the trailheads. Before starting the day--and often because I was jet lagged--I would hike up there in the morning. Victoria Peak offers 360 views if you caught it on a clear day. And you can get an amazing perspective of the city and the surrounding islands. And that is really the aim of View from the Peak--Paul takes that 360 view on Asian public policy, economics, technology, and geopolitics with a special focus on China. It is a perspective earned over 25 years of working, researching, investing, and living in Asia. Today, we have him on The Insight Bridge. All right. Welcome, Paul. Thanks for joining us today.

Paul Krake (02:03):

Greg, it's great to be here, thank you.

Greg Dowling (02:05):

Before we jump into all these questions on China and Asia, would you briefly describe your firm and maybe give a little background?

Paul Krake (02:12):

So View from the Peak is a investment research firm that was formed in 2011, back in the halcyon days of independent research when it wasn't the most overpopulated sector that I could think of and it wasn't regulated out of existence. It was formed... And the firm still has its basic premise where we are a--what I describe as a structural ideas factory. When the business first started in 2011, they were sort of the glory days of the hedge fund world and that was the majority of the revenue. I've found that over the course of the last nine years or so, the client base has evolved to be a much more strategic structural client base with more family offices, more endowments and the like--probably similar to what FEG has found with its evolution over the years. But we still do the same sort of thing, which is multi-asset class, top-down investment ideas. The durations got a little bit longer over time. We've always been very focused on being agnostic from an asset class perspective. Asia's always played a big, big role. To deal with the elephant in the room, View from the Peak is Victoria Peak in Hong Kong where the business was first formed some nine years ago. But we do try to look at the world very much from a global perspective, even though Asia is at the center of what we do

Greg Dowling (03:24):

Okay, Paul. So jumping in--and we're going to focus a lot on China, but China has really changed, especially its relationship with others. So over the last call, it may be five or so years, it feels like China has become more assertive militarily, economically, and even diplomatically with the U.S. and its Asian neighbors. What describes this change in behavior from China?

Paul Krake (03:46):

In a word--or two words--Xi Jinping. But I would also push back a little bit on this. And I will say from the outset that I'm an outlier in this thinking. Well, sorry, there's... I'm an outlier with this wonderful academic at Cornell University by the name of Jessica Chen Weiss who has written a lot about how China is not looking to export its model, is very much focused on its own domestic security and domestic stability issues. I think no one would dispute that. So I don't think that China is getting more outward-looking. I think the opposite is occurring. And I think China is looking more inward as it deals with its issues over energy security, food security, increasingly technology security surrounding issues such as supply of semiconductors--and that's something we can talk about, particularly with the big semiconductor mergers we've seen this week--but I don't think that China is looking more outward.

Paul Krake (04:41):

I think the era of Trump has forced China into a foreign policy stance that it probably wouldn't embrace by itself. I do think that from the Chinese perspective that all the criticisms they get--not only from the United States, but certainly increasingly from Europe, Australia, India, etc.--that they haven't played by the rules since coming into WTO, well they don't think they've done anything wrong. I think the best expression of this is the Phase One trade deal where Ambassador Lighthizer, when this whole process started, went to the Chinese--and I think the number was 147 demands that he had of the Chinese. And they ranged from intellectual property protection to banning the exportation of fentanyl, so across the gamut. I think that the Chinese--of that list of 147 things--practically conceded on 3.

Paul Krake (05:32):

And this goes back to the thinking that the Chinese don't believe that they've done anything wrong with this. They're playing by the rules that were set in front of them. For example, China still claims under WTO it's an emerging market. News alert: China ain't an emerging market. Right. So I think that China has been forced to deal with a lot of these issues. I have very strong opinions that the Chinese don't want the renminbi to be a global reserve currency. The Belt Road less about spreading... Yes, it's about spreading influence, but it's also about issues of commodity security and things like this. So I push back a little bit on the premise because I don't think they've been as aggressive or as outward looking as what maybe people think.

Greg Dowling (06:14):

That's interesting. Basically you're saying that if they are being a little bit or seem to be a little bit more aggressive with some territories that maybe are in dispute or with technology, it's really from the lens of the Middle Kingdom and more inward-looking than outward-looking.

Paul Krake (06:30):

And again, it depends on who they're picking up on. Right? I'll use that phrase. I've used the expression that China's doing the "rope-a-dope" right now in regards to the trade deal. And for those who aren't boxing aficionados, it's a strategy Muhammad Ali adopted against George Foreman in Zaire in 1974, the Rumble in the Jungle where he lied back against the ropes and let Foreman beat the living daylights out of him for six rounds until Foreman was so tired he effectively fell over. I think China in the trade disputes adopted a similar thing because China is just leaning back against the ropes and dealing with ZTE bans and Huawei bans and the potential forced sale of TikToK and criticisms over Hong Kong and Xinjiang. And yet the Chinese have done very little in regards to retaliations.

Paul Krake (07:13):

Now, if this was Japan, for example, you'd see orchestrated riots in the streets, you'd see Nissans being burnt. You'd see--in the case of Korea, when they had dispute, I think back in 2015 I think it was--Korean grocery stores were kicked out of China. There's been a slew of things. So the Chinese are very keen to be assertive or pick on those who are not their own size--and you only have to see what they've done in the South China Sea, Philippines, Vietnam, etc. But where it comes to bigger players--the United States particularly, but also the EU--they're a little bit more reserved, a little bit more strategic in the way they're dealing with things.

Greg Dowling (07:52):

So you mentioned Xi, the "chairman for life." How should we think of him and is he as secure as we would think here in the U.S.? Who are the other power brokers behind the scenes?

Paul Krake (08:02):

So the ruler for life thing is certainly multifaceted in everything about China. The key thing here is that when he was at the last planet, there was no succession plan put in place for him to be replaced after the token two-year term, or the implied two-year term that he has now basically obfuscated. But I will say that the party is bigger than Xi Jinping. There are the faceless men behind the scenes--we don't know who they are. We can assume it's not Li Ka-shing because he's been blamed for a slew of missteps along the way. We can assume that he is not as safe as what the West thinks, but there are certainly no heir apparents. And if you remember back in 2008, when Xi made it into the State Council, there were people around him who potentially could have been groomed to be the leader in 2012. We don't have that currently. But I think it's naive to think that he is an equivalent of a Putin, for example, where this is not an autocracy, this is the party first, and the party will outlive Xi Jinping and the party will determine when Xi Jinping has run his course.

Greg Dowling (09:13):

What about some of the corruption crackdowns that he led when he came into power? Has he made any enemies through that?

Paul Krake (09:20):

Plenty is the short answer. But that said, an enemy's only a problem if they have the power to be your enemy. He's annoyed a lot of people, but let's face it, the anti-corruption campaign had two purposes. One was that when he came to office corruption was beginning to decay the Communist Party to the point where it was losing support amongst the masses. Not that it was ever unpopular, but certainly the light that the Communist Party was seeming domestically was not as shining as it was under, say Deng Xiaoping or the like. But also what he did was, the people he got for corruption were not his guys. They were his potential political opponents. So he did a wonderful job at weeding out anyone who potentially could have been a problem. Bo Xilai is an obvious example of that.

Paul Krake (10:09):

So it's not like there are members of Xi Jinping's inner circle who have not profited handsomely from corruption over the years, but his anti-corruption campaign was targeted to a) get rid of his opponents. Now is China a less corrupt place that it was? Yes. Does corruption still exist in China. Absolutely it does. I think that now we're at a stage where it is manageable. And if one of the objectives was to raise the standing of the party within China, the Communist Party has never been more popular in China as it is today. So if you look at the surveys by the Pew Research Center, for example, China's Communist Party has an approval rating in the mid-70s and the U.S. Congress has an approval rating in the low teens. Enough said.

Greg Dowling (10:56):

[laughs] Very well said. So View from the Peak--you mentioned this already--was founded in Hong Kong, and Hong Kong is certainly one of my favorite cities, I have a lot of friends there. Well, I did have a lot of friends there. It seems like a lot of them have left recently. What is the new security laws, what's that going to do to the future of Hong Kong? Is it going to be this international financial center or, as you kind of said earlier, is is Hong Kong going to be more focused on China?

Paul Krake (11:22):

I was there when the handover occurred. There has been this organic progression where Hong Kong has become more Chinese. Now for those people who haven't been to Hong Kong before, that sounds ridiculous, right? But Hong Kong when I was there was a British colony that happened to be close to China. And over time, what you've seen is just a greater cultural penetration of the mainland into Hong Kong daily life. Now what you've seen since the Umbrella Movement now with the democracy protests and the national security laws, and you've seen this acceleration of the tearing up of the Joint Declaration that was meant to control how Hong Kong was governed until 2047. So Mrs. Thatcher's turning in her grave right now because it's just not what was supposed to happen.

Paul Krake (12:19):

Now, what does this mean for Hong Kong as a financial center and the like? Well it still does have British law, for what's that worth. The fear is that the judiciary is going to be the next thing to come under Beijing's purview. Still not there yet, so we still have a legal system in Hong Kong which is still independent, is still looking to adhere to the Joint Declaration and the like, but Hong Kong is becoming more and more Chinese by the minute. And that's in regards to press freedoms, religious freedoms--these sort of things are slowly being curtailed. Is that going to prevent ex-pats from going to Hong Kong as aggressively as they did? You alluded to that at the start of the question. You've got a lot of friends that have left, and so do I. Ex-pats just don't go to Hong Kong like they used to. Non-Chinese firms aren't flourishing in Hong Kong like they used to. Look, over time, this path to being--of Hong Kong, which I tragically describe as "becoming the Greenwich, Connecticut of Shenzen" as in the green leafy suburbs, a great place to live, but really economically does it matter? Not really. And I fear that's where Hong Kong is going.

Greg Dowling (13:32):

Asset management is kind of in a tough spot. That has been the beachhead for many folks who are sort of a pan-Asian fund--maybe at some point in time, they've opened a Shanghai office or a Beijing office. But especially the ex-pats who are there are in a tough spot because they want to sell into China because China is opening up their capital markets, but they're afraid to go against China. And so it seems like you see a slow leakage of people to Singapore, even though they're maintaining a Hong Kong office.

Paul Krake (14:04):


Greg Dowling (14:04):

Is Singapore going to be the next Hong Kong?

Paul Krake (14:07):

They're in strategic competition for the Western financial center in the region, let's put it that way. I think that Singapore has done a lot of things right in the last decade. Look, you've spent time in Hong Kong, Hong Kong. People have this distain for Singapore that it's the world's most boring city. I was well and truly of that view and I sort of evolved a little and said, "Singapore's got great infrastructure and it's slightly less boring than what it was." And now it's a direct competitor. It's just a--I would argue it's a better place for families. The pollution was a major reason why a lot of ex-pats moved from Hong Kong to Singapore. The Singaporean government is incentivizing firms to leave Hong Kong and set up shop. That's only going to continue.

Paul Krake (14:45):

This is a competition between two nation-states, between two wonderful cities at their core. Unfortunately, all the news for Singapore is positive and all the news in Hong Kong--with the security laws and the like--is negative. And frankly, I don't see how that changes. Because again, if you're setting up--particularly a hedge fund, for example--the chances of you being called in by the regulators because you shorted the wrong stock, you can't discount that. Again, if you are setting up a business in Asia for the first time, where is your low-hanging fruit? Well, it's not going to Hong Kong and dealing with security laws, an uncertain regulatory environment, jurisdictionally being unclear about where things are. You go to Singapore, it's clean, it's a clean, easy environment to set up your Asian hub.

Greg Dowling (15:33):

So we've talked about Hong Kong, it's competition with Singapore. I feel like we also have to talk about Taiwan. How real is the possibility that the Chinese do something militarily with Taiwan? it would certainly help their chip problem.

Paul Krake (15:47):

It would certainly helped their chip problem, and they have a major chip problem. I think the way to focus on this is that China and Xi Jinping have spoken on numerous occasions about the need to reunify--50 years is the number that often gets talked about and the like. We often get too fixated on China having this multi-generational of view of the world, which is true in some ways, not in others. But I think the biggest way to look at this is through the lens of the perceived defense shield that the United States has with Taiwan through the 1979 agreement. I don't know, if push comes to shove, if Xi Jinping raids the beaches of Taiwan, whether the United States would risk a hot war with a nuclear power to save Taiwan. I just don't know the answer to that question.

Paul Krake (16:38):

I don't know if Japan would risk it. I don't know if Korea would risk it. And that's the tragedy of Taiwan. Particularly given the fact now you have a Taiwanese administration which is as aggressive, broadly independent as any government, I'd argue, in modern history in Taiwan, who are continually poking eyes at Beijing in regards to accepting effectively state visits from the United States, from the health secretary, and the like. China gets one chance to take back Taiwan. I think their preference obviously is not to do this militarily because the problem is that they try to do it militarily and they fail. There's not many things that could see Xi Jinping all quickly and instantly, but that would probably... A defeat trying to take Taiwan militarily would take down any Chinese Premier.

Greg Dowling (17:27):

One of the reasons--obviously there's that shared history--it's the One China policy. I mentioned maybe a little facetiously about chips, but China is short chips. So maybe if we talk a little bit about technology, it seems like a great investment opportunity for any investor would be to provide capital to this growing industry that's going to supply the domestic market for Chinese chips and semiconductors.

Paul Krake (17:51):

Yeah. And if you can look at this on a 5-year viewpoint, I think the answer to your question is categorically "yes." The trouble is the next 5 years, because... We talked at the start about strategic vulnerabilities. We know about food and we know about energy, and China are doing their best to deal with those issues. But the Trump administration, either through accident or design, have stumbled across what I argue is China's biggest strategic vulnerability, and that's access to high-end chips. So if you look at the embargoes that exist on companies like HiSilicon, for example, Huawei's semiconductor business, basically what the embargoes imply is that if you produce--if 10% of that content of any chip is made by an American firm or in the United States, then that chip can't be sold to HiSilicon and it's going to probably be extended to a slew of other Chinese companies as well.

Paul Krake (18:47):

So Nvidia this way comes out and buys Arm. I would argue Arm is the best chip designer on the planet. Suddenly a supplier of Huawei chips and design has become an American company. So if there was ambiguity over whether or not Arm could have sold chips because there was some American design and they're in some--a complicated issue--the fact that it's now, well it will be probably in 18 months' time, a domicile American company, means that Huawei can't buy those chips. And the way this gets really complicated is that in Taiwan you have TSMC, which is now one of the 10 most valuable companies on the planet. It is the biggest supplier of chips to China. And if you go through their high-end chips, well, there's a lot of American design in those high-end chips. The key question is, is the United States government under Trump--I think this goes away under Biden, but under Trump, are they prepared to embargo TSMC from selling American chips, those chips with American design in them, to China? If that's the case, then China's AI ambitions have real problems because companies like SMIC can make all the mobile phone chips that they like. They can make those low-end chips that we use in all the stuff that you and I use every day.

Paul Krake (20:07):

What they can't produce is the high-end chips that are used in AI research or in autonomous vehicle programs and that sort of thing. And that creates a problem. So depending on who you ask, a company like Huawei, for example, has somewhere between 12 months' and 24 months' worth of chips stockpiled, and they have been buying chips off anyone who would sell them to them for the past 3 years because they saw this coming. Then what? You could literally have a situation where China's AI ambitions stall, their biggest global brand runs out of the stuff that drives--not inconceivable in the next 1 to 2 years.

Greg Dowling (20:51):

Fascinating. Besides technology, it seems as we record this we're in that silly season here in the United States, which is election time. The one thing that Republicans and Democrats both agree on is China, at least the rhetoric towards China. And part of that seems to be a wish--and perhaps it's just a wish--to onshore manufacturing back to the U.S. How easy or difficult is that going to be to bring back basic manufacturing or even pharmaceutical type of manufacturing back to the States?

Paul Krake (21:24):

We did an event last Thursday with the U.S.-China Business Council on the future of the Chinese supply chain. And the overriding observation was that there is no appetite, practically, economically, strategically to bring back manufacturing in medical, semis, apparel, chemicals, industrial--to bring that manufacturing back to the United States. The automotive industry, for example, produces all around the world, but when you've got China as the world's biggest car market and, by multiple factors, the world's biggest EV market, which is where every OEM wants to take their business, they're not bringing that manufacturing back from China to build it in Kentucky when the only place you sell those cars is pretty much in North America.

Paul Krake (22:13):

So the medical supply chain was the fascinating one, because that's the one which has obviously been exposed as a legitimate national security concern under COVID. But if you talk to companies like Merck, like J&J, like Abbott Labs, they're going to say, "Look, if you bring back the production of either generic pharmaceuticals or patented pharmaceuticals, you've got to bring back the chemicals. You've got to bring back the packaging. You've got to bring back all those factors to the United States. And what you do with that is increase your cost base by somewhere--depending on the product--between 25% and 100%." At the end of the day, economically, it doesn't make a lot of sense for them to do this. Now, clearly there are national security pressures on the medical supply chain. For example, I was chatting to a physician and a scientist who's deeply involved in the eventual production of a COVID vaccine. The United States doesn't have enough industrial glass vials to produce hundreds of thousands of doses of a COVID vaccine. I'll give you three guesses where they make all the industrial glass vials.

Greg Dowling (23:17):

I only need one.

Paul Krake (23:18):

You would have to store these doses in industrial medical-grade refrigerators that have to go to -70 degrees. We don't have enough of those. I'll give you three guesses where they're made. Again, we're in this position because when the world went into globalization hyperdrive back in the late, mid-90s, China was the cheapest place to outsource everything. Now it's gone from the cheapest place to outsource everything, to the best place to outsource everything. People talk about, "Well, you can send stuff to India or Vietnam." A great statistic is that China produces roughly 1 in 5 global exports, Vietnam produces 2% of global exports. So to reduce your Chinese supply chain by 10% and move that to Vietnam, you'd have to double Vietnam's export capacity. Simply just can't do it.

Greg Dowling (24:12):

It's not even just the workers and factories. It's the logistics, right? It's getting the railhead, it's getting the ports in to handle all of that. I mean, that's a big lift.

Paul Krake (24:20):

When's the last time you drive from the airport in Mumbai to the center of town? It ain't going to India. Look, India has merit, particularly in the medical supply chain, because it does have a big generic business and industry and the like, but at the end of the day, China just does this better than everybody else. Bringing stuff back to the United States from the low-end manufacturing. Well, here's a good example. United States has banned Huawei from its 5G networks. The dirty little secret is that the UK admitted recently, but the U.S. won't admit, it's gonna to delay the 5G rollout by two to three years. So if you're a... Let's say you're Merck, for example, and you want to bring back production of certain pharmaceuticals to the United States. Are you going to abandon your 5G-enabled factory in China to bring it back to the United States with a less qualified workforce, higher-paid workforce, and the most cutting-edge plant you can build doesn't have 5G capability? Why would they do that unless they are forced to? And the reality is that whilst there could be pressure from the Trump administration to do something, if you look back over the course of the last four years, there has been very, very little movement in regards to structural production coming back from overseas back to the United States.

Greg Dowling (25:36):

It's hard. We are so intertwined with China. Our clients, rightfully so are very concerned about the climate and the impact of climate change. But if we put up a bunch of new solar panels, where are they made? China. If we have more batteries, we need more lithium, we need more rare earths. Where are they made? China. We are attached at the hip to China.

Paul Krake (25:58):

The way I think about this is--and sort of the message we delivered with the U.S.-China series is, "Look, you can't ignore every stakeholder here. So if you want to have a conversation about semiconductors, for example, you've got to have conversations with the Chinese investors, with Chinese academics, with all the stakeholders, and you've got to have tough conversations. You say to the Chinese, 'We'll give you access to high-end chips, but you do something about Shenzhen. We'll give you access to the CPUs that have been produced by or designed by Arm. But you have to give us real guarantees, not faux guarantees, but real guarantees about data security and about you guys backing away from cybertheft.'" So issues where the Trump administration has gone awry is... This whole thing with TikToK is a great example. Could you imagine what the American government and the American population would say if the Chinese woke up one morning and said to McDonald's, "McDonald's we don't like what you do with the data. You need to sell every restaurant to young China."

Paul Krake (26:56):

Yeah. This is corporate extortion. And it's just not the way to act. So America does have cards it can play; the semiconductor card is a big one. And if you have a Biden presidency, I think we'll move more from a corporate reciprocity framework, which we have currently, and there will be a greater focus, I think, on the South China Sea and military issues and human rights, but use this card of chips and say, "Look, this is a to-and-fro. Lighthizer gave you 147 things that we wanted to deal with. You dealt with 3 of them. How about we start with dealing with 20 of them." This is never going to be perfect, but there has to be a back and forth, and currently there hasn't been a back and forth.

Greg Dowling (27:37):

So you are an Aussie, and we're taking this from a U.S. perspective. What's the perspective of other stakeholders, other countries--Australia, EU, Japan? How do they manage this relationship with China?

Paul Krake (27:50):

I think that if the Trump administration didn't go it alone, this era of anti-globalization or the realization that China hasn't played by the rules it had such an ability to change China. You're never going to change China structurally, it's just a different economic, social, and political model to what we have, but the Chinese can handle a trade dispute with the U.S. That's a battle of equals. What it couldn't have done is dealt with a trade dispute that included the EU, included Australia, included Canada, and included Japan. When you put those blocs together, if there is a uniform approach that dealt with issues of data security, cybersecurity, unfair trade practices--particularly if the EU is involved--human rights abuses, and climates, you could have got China to change. Now, what I suspect happens is if you do have a Biden presidency, that Biden is going to go cap in hand to Trudeau, Macron, Merkel, etc. and say, "Sorry about the last four years, our bad. Really, really, sorry. Can we start over? And by the way, we need to do this with China."

Paul Krake (29:04):

What you're seeing--particularly Australia is a good example, which has had a lot of interference by the Chinese and is pushing back hard against the Chinese on a slew of issues. Same with Europe, particularly France. I think that their scope is to get the Chinese to change. But again, first and foremost, if it does occur, the Americans have to go cap in hand and say, "We have to start using those international institutions that have been abandoned in the last four years."

Greg Dowling (29:28):

So one area that it seems China has continued to open up is their capital markets. Talk a little bit about the progression of China being financed only through the local banks to the opening up of the stock market, the bond market, and what that means for international investors.

Paul Krake (29:46):

Again, I'll take the contrarian view here. And I don't think it's as open as what people think. Go back to 2015. China... the IMF allows the renminbi to go into the special drawing rights basket, which is this symbolic basket of goods. I've actually never met anyone who's actually bought an SDR in their lives. So it's just this symbolic thing. The Chinese then turned around and basically closed their capital account immediately afterwards. If you want to know how difficult it is to do a 4x transaction, ring the treasury people at Starbucks and they'll say it can take up to 3 months to get approval for a $10 million wire transfer. This is not an open capital market. Yes, you have the stock connect. Yes, you have the bond connect, which is important, but still relatively small.

Paul Krake (30:28):

So I push back. I think the Chinese capital markets have got more sophisticated domestically. Hong Kong for all its problems, with the national security law is still going to be the preferred place for large Chinese companies to IPO. And you'll see this with Ant Financial. You'll see it with DiDi, eventually, when DiDi eventually goes public. Those sort of things. It's going to get increasingly interesting as there is pressure on Chinese company listings here in the United States, which has stemmed from a--Marco Rubio put through a proposal last year called the EQUITABLE Act, which effectively is the foundation for what standards will need to be met for Chinese companies to list or remain listing on U.S. Exchanges. But at the end of the day, it's very easy to put money into China. It's tough to get it out. The best thing that happens to the Chinese anytime soon is to get Chinese bond weightings in the old Lehman indices and the like, get that elevated because that's effectively, it's permanent capital. And try to love things like MSEI inclusion because effectively it's permanent capital and money can go back and forth by the connect but you're never going to see the real capital flight fears, which is the ultimate concern for Beijing. Because if you control how money leaves your country, you don't have an economic crisis like the world in 2008, or the very relevant one, the Asian crisis in '97 and '98. And it's the primary reason Japan avoided its crisis, because everything was held so tightly in domestic hats.

Greg Dowling (31:56):

But don't they need to eventually expand that? Because they are growing so much through the banks and local banks have a bunch of bad debt and then the government bails them out and you keep doing this over and over again. Don't they need to have a very robust capital market to get to that next level?

Paul Krake (32:12):

I'm not saying their capital markets are not robust. They're just not robust in the ways that we think about it. If you ask free market people in the United States, short selling is a very necessary part of liquidity to the markets and the like. There are countries around the world who routinely ban short selling and their markets still function. It maybe doesn't function like we think they should function, but short selling is one of those things which it's debatable, whether it's the linchpin of a healthy, functioning set of capital markets. Look, China--the bad debt issues often get talked about. Do they underestimate their bad debt position? Yes. Have we in the West predicted 15 of the last zero blowups in the Chinese bond market in the last 25 years? Yes. Still, it's not like they don't have an ability to raise capital.

Paul Krake (32:57):

China's savings rate is still far too high, we know that. I think that there will be a push going forward for structurally a stronger currency, longer term, because that obviously helps with domestic consumption and domestic investment. Hopefully it will be something that can get the savings rate down as well, because that does create inefficiencies. But look, the government is in control of that model. Now, if you put a Western credit model on China, it doesn't work. But I say this a lot, Lehman Brothers would probably still exist if it was a Chinese company because Lehman Brothers was derailed by mark-to-market accounting. You can't tell me there aren't dozens of Chinese companies that have had a similar debt profile to Lehman Brothers except if you mark the loans at book, you don't have a problem. And their argument has been--and frankly, it's worked in many cases--that if you don't mark things to market and you grow at 6% for year after year after year, then eventually you grow your way out of the problem. Now is that sustainable? Probably not, but it's worked so far.

Greg Dowling (33:56):

Are you saying there isn't the same price discovery as we have here in the West?

Paul Krake (34:01):

I'm saying there is not the same price discovery [laughing]. You don't have the same accounting stamp. It's one of the complaints about Chinese listings here in the United States is that, is it too much to ask a Chinese company listed in America, taking American money from American pensions and the like, that they have the same accounting standards as American peers. I have no problem with that at all. I think that is a very valid request from the SEC to have, but the Chinese don't think that's a problem because they don't have those accounting standards. They don't deal in GAP. If you're dealing with different standards--and this goes to the crux of the whole problem that the United States has with understanding China, i.e., it doesn't understand China is because it is such a different model. It's a politically different model, socially different model, economically different model. It has different models of accounting. Just does things differently. And you're never going to get a resolution to tensions until, at a minimum, you appreciate the differences between the two sides.

Greg Dowling (34:57):

From an investment perspective there's a lot of risk, so eyes wide open, but it's also a land of opportunity. How would you advise an investor? What areas of the market would you look? Is it A-shares? Is it RMB? Is it currency? What are those opportunities now and in the future in China?

Paul Krake (35:15):

So for me, it's the equity market. And I think the biggest thing to point out is that the average Chinese household balance sheet has 6% of their net wealth and equity too heavily skewed towards property and savings, as the savings rate would indicate they don't add enough equity. So if you look throughout history at markets that have had a dramatic increase in the percentage of equity held per household, what tends to happen is that they tend to find the equivalent of the "nifty 50." And we have the equivalent now of the nifty 5, which is FAANG, where the vast majority of stable brokerage firms in terms of assets, most of them have Apple, Amazon, Microsoft, Facebook, Google. So where the opportunity set in China, I think is very exciting is that when you develop a mindset of equity ownership--and that will come--what are the 25, 50 stocks that are going to be the staple of every household balance sheet?

Paul Krake (36:12):

The ones that sort of come to mind are the likes of Alibaba, Baidu, Tencent, JD--these sort of companies. So I think it's very tech-focused. You're going to see, eventually when they go public, it'll be stocks like DiDi, Ant Financial will be probably on that list as well. So I think the big pitch or the opportunity is looking at in a similar vein to what you see here is: "What are those 20 companies that are going to change the way that the average Chinese citizen eats, works, entertains themselves, and shops?" If you think about that mindset--particularly here with COVID--and that's why you naturally gravitate towards the Amazons and towards Google and Microsoft. And increasingly Zoom is every--once you become a verb, you know you've made it as a company. I don't know what the equivalent of doing stuff on Alibaba will be, but that is the verb of shopping in China. For me, that's the opportunity set of those, the household names that the household balance sheet must own

Greg Dowling (37:10):

What about the domestic opportunity? Certainly they have the equivalent of the FAANGs, they have the BATs. Outside of that, are there opportunities in some of these smaller companies where maybe for active management it could work a little better in the A-share market than it does here in the West currently,

Paul Krake (37:23):

Look, I think what we're going to face globally is an issue where mega cap companies are going to dominate every facet of life. And whilst there will always be opportunities in small cap companies--you had a natural spring water company just go public in Hong Kong at a thousand times over-subscribed. There will always be examples of companies like that. If you are a passive style-investor in China, if this is not your core holding, clearly from an endowment standpoint, your client base is going to be investing in high-quality managers. But if you're a passive investor looking to get exposure to China, that's not the way to think about it. The way to think about it is in terms of those dozen companies, those 20 companies that are going to dominate every facet of Chinese lifestyle.

Greg Dowling (38:04):

I remember growing up in the early 80s, it felt like Japan was going to take over the world. And we had movies like Gung Ho and others that kind of pointed this out. We saw this on the news. It feels a little bit like that with China. And especially it feels that way right now because they've done a much better job handling COVID. We have civil unrest here in the streets. We have a lot of unhealthy political bickering going on. China seems like they've got it all together. But no country is perfect. You mentioned a couple of things earlier, but what are some of the issues that are hiding behind the scenes? Whether it is food security, demographics, pollution, local debt, what are some of those issues that people aren't talking about, but are real issues that China has to face over the next 10, 20 years?

Paul Krake (38:51):

Key one is demographics. The One Child policy could be one of the great strategic blunders in modern Chinese history. At the end of the day, to put it bluntly, China has too many dudes. It's going to face social issues. There's a class of men who will never marry. If you go back and look at social unrest in the last several hundred years, there is a common theme there, and that is a class of unmarried, unemployed men who don't see themselves as having prospects. And you can't discount the marriage thing, because particularly in strong family cultures like China, if you can't make a good living, you're not a good husband. And these things can feed on themselves. So the demographic issue is a big one. "Does China get old before it gets rich?" Is the way to think about it, which is commonly said. And they are racing against time to do that.

Paul Krake (39:36):

I don't see a strategic rival in the region. I don't think India is there, even though it has a lot of things going for it that China does not. That's certainly a demographic dividend that they can clip at some stage. And look, it's not certain. I think that the tech security issue is a big one for me. The one where it could go awry is a mishandling of Taiwan. Then again, these are very low probability events, but look, I think that we've got a country that is indifferent to the United States that is being centrally planned. And whilst there is going to be misallocation of resources in a centrally planned economy, you get things done.

Paul Krake (40:13):

So a good example is--I was chatting to Representative Rick Larsen who's the co-chair of the U.S.-China Working Group, and Rick was talking about the 5G rollout and how... And I said, "Look, America is three years behind and could be five years behind in very short order." And he said, "Because we're not doing a single 5G rollout, we're doing five 5G rollouts. Because we do one with AT&T, we do one with Sprint, T-Mobile, Verizon, etc." Not having that centralized policy, obviously has its advantages, as the United States is one of the most efficient economies in the world, but it does prevent big infrastructure projects from getting done. And that, I think, is one of the huge advantages that China has and could make this process of them being as strong as they are much more sustainable than other societies before them.

Greg Dowling (40:59):

What about pollution or food security?

Paul Krake (41:01):

They're taking it more seriously. They're taking it a lot more seriously. The pollution side of things was viewed as a social unrest issue. They take it a lot more seriously than what they did and push the electric vehicle programs that they have in no small part designed to make sure that that goes on. The issues around climate are real. I think that if you are going to see a conflict with China over the course of the next decade or two, it could well be with their neighbors over water rights, because there are lots of dams getting built in the Himalayas right now. And Tibet, obviously is the source of--I think the number is a third of the fresh water on the planet sits in Tibet or in the Himalayas, I should say. And that's very, very, very important. But I think they're getting a handle on this. I think they are getting a handle on all of this.

Paul Krake (41:45):

The food security thing I find fascinating, because I think that China is going to be the epicenter of things like plant-based meat proteins, and they're doing a hell of a lot of innovation in those sectors. And again, it's all part of the drive for food security. So if they get this right, they could be energy self-sufficient quite soon. They're obviously going to still remain for a long time a big importer of nat--particularly natural gas from Russia, but their push towards renewables is as aggressive as anywhere in the world, and certainly much more aggressive than what we're seeing here.

Greg Dowling (42:14):

Well, Paul, I've thoroughly enjoyed this and I've learned a ton. So thank you for doing this for our clients. We really appreciate it.

Paul Krake (42:24):

Greg, it was a pleasure. Thanks so much. We'll do this again soon.

Greg Dowling (42:26):

Thank you. If you are interested in more information on the topic, please go to our website where we will have a list of relevant FEG publications. And don't forget to subscribe to our communications at so you don't miss the next episode. Please keep in mind that this information is intended to be general education that needs to be framed within the unique risk and return objectives of each client; therefore, nobody should consider these FEG recommendations. This podcast was prepared by FEG. Neither the information nor any opinion expressed in this podcast constitutes an offer or an invitation to make an offer to buy or sell any securities. The views or opinions expressed by guest speakers are solely their own and do not necessarily represent the views or opinions of FEG.


This was prepared by FEG (also known as Fund Evaluation Group, LLC), a federally registered investment adviser under the Investment Advisers Act of 1940, as amended, providing non-discretionary and discretionary investment advice to its clients on an individual basis. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Fund Evaluation Group, LLC, Form ADV Part 2A & 2B can be obtained by written request directly to: Fund Evaluation Group, LLC, 201 East Fifth Street, Suite 1600, Cincinnati, OH 45202, Attention: Compliance Department. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities. The information herein was obtained from various sources. FEG does not guarantee the accuracy or completeness of such information provided by third parties. The information is given as of the date indicated and believed to be reliable. FEG assumes no obligation to update this information, or to advise on further developments relating to it. Past performance is not an indicator or guarantee of future results. Diversification or Asset Allocation does not assure or guarantee better performance and cannot eliminate the risk of investment loss. The views or opinions expressed by guest speakers are solely their own and do not represent the views or opinions of Fund Evaluation Group, LLC.


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