Is There a Historic Economic Shift Underway?
This interview was originally published on the Institute for New Economic Thinking blog.
Milwaukee-born Jim Chanos, founder and managing partner of New York-based Kynikos Associates, teaches University of Wisconsin and Yale business students about corporate fraud. During his life and career, he has witnessed seismic shifts in economic thinking and the relationship between labor and capital. Chanos shares his thoughts on the world emerging from the election of Donald Trump and the tumultuous political events of 2016.
Lynn Parramore: Leading up to the election of Trump, we had eight years of Obama, and before that, eight years of Bush. Before we get to the president-elect, how do you assess the records of those past presidents in terms of basic policing of markets and corporate fraud?
Jim Chanos: Bush was the MBA president who was going to be pro-business, cut taxes and deregulate. Meanwhile, he had two recessions on his watch, less employment than when he started, and two bear markets in the stock market — probably the worst president for business since Herbert Hoover. The business guy!
Yet, he did tighten up the Justice Department and go after corporate crime. The Ashcroft Justice Department, as bad as it was in lots of other things, went after corporate fraud and accounting fraud, criminally. In 2002, we got Sarbanes-Oxley to curb fraud.
I don’t know that all this was Bush’s predilection — remember, his biggest supporter was Enron. But because of Enron and the other dot.com-era scandals, he got backed into a corner to go hard on them. I’ve joked that the only person who put more corporate executives in jail than George W. Bush was his father during the savings-and-loan crisis.
On these issues, I’d rather have Bush any day of the week than Obama. Both Eric Holder and Lanny Breuer of Obama’s Justice Department said in TV interviews and testimony that they factored in non-judicial aspects as to whether to mount prosecutions. I think that this had political costs to the Democrats. The crony capitalism still bothers people — the idea that Wall Street got off scot-free and they are still struggling. That lack of justice applied equally under the law was corrosive, not necessarily for Obama personally, but certainly for the party following him.
LP: How do you see a Trump presidency in this light?
JC: You and I have talked about how it has become a cost calculus for lots of corporations and financial institutions to cheat. If I get caught, they say, I’m just going to pay a fine. How does this change with new faces in Washington? You still have this very pro-corporate group on Capitol Hilll whose main bailiwick, in my opinion, is to protect the corporate class and the very wealthy. You’ve got what ostensibly is a proto-populist in the White House with a cabinet that is a mÃ©lange of different types, so who knows?
In my overall view, stuff happens to change people. If we go back to Bill Clinton, his “Putting People First” manifesto in ’92 was quite left-of-center, but he didn’t govern that way. If you look at things like NAFTA, welfare reform and cutting capital gains taxes — well, in many ways, Ronald Reagan would have been proud of him.
Events conspire to derail our perceptions of presidents. When we look at their platforms, we think we know where things are headed. But in modern times, the only two presidents that I can think of who really got their ideas and platforms enacted wholesale were FDR and Reagan. Everybody else has gotten compromised, or has had events overwhelm them.
LP: What do you make of the expectations of the economy under Trump?
JC: I worry about the heightened expectations from the people who voted for him thinking that he’s their savior. That’s what scares me — unmet expectations. For the swing voter in the Midwest who voted for this guy because he thinks coal mines are coming back or the plants are going to reopen — it’s not going to happen.
LP: What about the rise in bank stocks since the election? Are banks anticipating deregulation?
JC: 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 doing 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-50-year change in global thoughts about capitalism, then you have to pay attention.
LP: If this is a once-in-50-year change, what’s at stake?
JC: Part of my view is that in the 1930s, we rejected the individuality of the ’20s and before. After the crash and the Depression, we finally put the corporate class and bankers to the sidelines. Whether it was Keynesianism or the New Deal in the West, or state fascism or the advent of Stalinism, you saw more government control over the economy. This was good for workers and large governments. It was more nationalistic and led, obviously, to the next conflict. But the rise of government planning and government involvement was good for nominal GDPs. It was not good for the asset-holding classes—stocks and bonds did terribly over that period, right? You wanted to be a worker, you wanted to be labor, not capital.
The period from the late 1970s to 1980 changed all that. You had Thatcher and the U.K. and Reagan in the U.S. Mao died in 1976, the Solidarity movement in Poland began in 1978, and the Soviet Union peaked in power in 1979. You saw that the pendulum had gone too far and now we’re going to cut taxes on capital, we’re going to be more globalistic, and trade was going to improve. Since then, capital has risen and assets have done better than labor. Taxes have been light on financial assets and heavy on labor. Everything was reversed on its head.
If we look at the events of 2016 — Brexit, the Italian referendum, Trump, and the rise of nationalist China — are these the harbingers of something bigger? Or are they just a coincidence? The ground seems to be fertile for things to change globally. If so, does this give rise to a more nationalistic, protectionist, statist scenario? Are labor prices going to go up again? Are we going to tax capital and emphasize wages?
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.
That’s where the problem and discontent will come — when you’ve sold that dream and it doesn’t happen. In that scenario, Trump begins to have a pretty short honeymoon.
LP: You’ve long been linked with China. What do you make of the positions of China and the U.S. in the international economy, and how do you think they’re changing?
JC: To me, the rise of Xi Jinping is a big event still underestimated in the global political economy. He is more of a personality than either Deng Xiaoping or Mao Zedong, certainly higher in stature internally than his predecessors. He is not first among equals in the Politburo Standing Committee — he’s first. This goes along with the theory about the rise of nationalists such at Putin in Russia. Xi Jinping is also a nationalist. He talks about the China Dream, China getting back to past glories, and not exporting communism. What you would have heard Mao say.
He’s a member the Chinese Communist Party, but the Party exists now as a political apparatus, not an ideology. China would not have the type of capitalism it has today if this were not the case. So these are not Marxist-Leninists, but rather just a fantastic single party in control. We have to understand it in that light.
China is increasingly a geostrategic rival. In the past, China looked toward protecting what it had — making claims on Taiwan and Tibet and ancillary areas, but the Chinese were really content not to compete in the global Cold War between the Soviet Union and the United States. Now we have this multi-polar world, and China sees itself clearly as the prime actor in the Pacific willing to fill any vacuum that the United States begins to pull away from.
Xi Jinping comes in and immediately he rewrites the passport maps. He sets the air traffic and extends the air defense zones. More ominously, he begins to militarize the South China Sea, and puts military bases on the islands, which alarms pretty much everybody. (And yet if you look at a map of the Pacific, the only country that really needs to traverse the South China Sea is China itself —oil going from the Middle East to Japan goes around it. The South China Sea is symbolic more than it is geostrategic).
I think, however, that Trump has decided that China makes a convenient media punching bag. You can claim that China took your jobs and China is a bogeyman. It seems to me that president-elect Trump does best when he has someone to fight against. However, the broader issue will be that foreign policy and national security events have a whole different dynamic than beating up on a defense contractor for an air conditioning plant.
What will be the ramifications? How will China react? What do you do about countries like the Philippines that are in the middle — a country that has elected its own interesting president, someone who seems to want to embrace China after decades of being staunchly a U.S. ally? What does this do for Japan? Japan itself has a nationalist, Shinzo Abe, who wants to increase military spending and take off the yoke of the Japanese constitution block on an expanded military.
There are many questions, but whatever you might think, China and Japan, while big trading partners, are not the best of friends in that neighborhood. Finally you’ve got the wacky guy in North Korea. What’s he going to do?
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.
So stay tuned, it’s going to be interesting.
LP: To turn to Europe, you’re a Greek-American, and you have been critical of the Eurozone’s attitude toward Greece. What do you make of the situation there now?
JC: The key issues for Greece now revolve around two entities that are not Greek. First you have the EU as a whole. We continue to have these bombshells, like the Italian referendum and Brexit — and you’ve also got elections coming up elsewhere in 2017.
I think Greece was sort of the Spanish Civil War to what’s about to be the EU’s WWII in that it was the opening preview of all of the problems that are going to come to the fore if Catalonia wants to become independent, if Italy wants to leave, if France wants to leave. The EU is being held together by chewing gum and string right now.
With this rise of nationalism — if that’s what it is and it continues — the EU is going to find itself increasingly a victim of people wanting self-determination in northern Europe. That’s the first thing. Second is something I’m much more concerned about which nobody’s paying attention to, and that’s the continued rise of ErdoÄŸan in Turkey. He has not only consolidated his power through a series of purges —thousands and thousands of journalists and academics have been thrown in prison since the aborted coup — but increasingly he is becoming more militant and Turkey is becoming a pro-Islamic state that is part of NATO. He’s throwing wild monkey wrenches into the whole Middle Eastern situation by making claims on land that was owned by the Ottomans, pre-WWI, like modern-day Iraq, modern-day Syria, and modern-day Greece and Bulgaria. He's warned the EU that he will open Turkey's borders to undocumented immigrants if EU membership talks are frozen. Like Xi Jinping, he’s putting out these old maps and saying: this is our real land. ErdoÄŸan is yet another nationalist.
Poor Greece is at the crossroads of all these seismic events and Ottoman Empire II. You’ve got the possible weakening or dissolution of the EU, and Greek debt problems are about tenth on the list of issues in that region. They’re going to struggle, no doubt about it. Every time the Greek economy starts to show some green shoots, it seems to stall and fall right back down again.
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.
How would an average worker navigate a rising trade barrier globally? It’s scary. If we look back at the ’30s template, one major outlet was, of course, a giant arms race. By the late '30s, you had the whole world realizing the threats of fascism and rearming rapidly. Keynesian government spending was what pulled up the economies; it just had some really bad repercussions from 1939-45. But if we get into any kind of global arms race with China, either conventionally or otherwise, that would be Reagan-like. I don’t know what the numbers would mean in terms of employment, but you would take a lot of manufacturing people and turn them to making other things.
LP: How do you rate the current moment with big periods of change you’ve seen in your lifetime?
JC: I had this odd personal journey from being a union pipefitter and boilermaker as a college student — I made more money in two-and-a-half months making steel than I did my first year on Wall Street. I went from being a product of the industrial Midwest and putting myself through college by working in a steel mill, to being the beneficiary of the Reagan-Thatcher era. I saw the world change, but I didn’t really understand until years later what an important period the late ’70s/early ’80s was (and a great period for music, by the way!).
If we’re in one of those periods now, if 2016 is like 1932 or 1979 — then you not only have to change your portfolio, you have to change your lifestyle. That’s one of the things we’ve been telling clients. If this is a major shift to populism, nationalism, greater state involvement, and less globalism, then you really have to rethink almost everything in your life.
Certainly, if you were a capitalist in 1932, you might be best served to change your outlook. And if you were a union leader in 1979, it would have been good to change your outlook. The question will be, in 2016, would it be best for the Davos man or woman, the globalists, to change their outlook?