Motley Fool Hidden Gems Investing - Peter Zeihan on China, Apple, and Europe

Episode Date: May 28, 2023

Who has the upper hand when Apple’s CEO walks into a room with the President of the People’s Republic of China? Peter Zeihan is a geopolitical strategist and the author of “The End of the World is Just the Beginning: Mapping the Collapse of Globalization.” Bill Mann caught up with Zeihan to discuss: - Why Apple is diversifying production away from China - What an aging population means for the United States economy - Why de-dollarization is less likely than many think Company discussed: APPL Host: Bill Mann Guest: Peter Zeihan Producer: Ricky Mulvey Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siyaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better. Apparently, that's how I roll.

So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. I would just warn you before you short China, that the other side has to survive for you to profit from the short. It has been the fate of most stock markets throughout history to go to zero. It is only in the globalized order that the luxury of shorting things has existed. We're going to be going back to a little bit older of a system. I'm Mary Long, and that's Peter Zahan, a geopolitical analyst and bestselling author. Bill Mann caught up with Zahan a few weeks ago for a conversation that Motley Fool 1

subscribers got access to first. Now we're sharing it with you. Bill and Zahan discuss the probability that China won't be an economic superpower in a decade, the status of the U.S. dollar as the world's reserve currency, and a demographic problem that the Fed is closely watching. so i thought what would be a fun conversation is you know from your work that there are a lot of things that are in the common knowledge maybe as you know as mark twain wanted to put it the things that get you in trouble are the things that you believe that ain't so fair so what i

thought would be a fun conversation, given your expertise, is if I were to tee you up on certain topics, and maybe you can talk about things that are common knowledge that aren't so. That works for me. Fantastic. Let's start with number one, the largest or maybe second largest country in the world, depending on the day and how it's measured, which is China. So, obviously, China is some form of superpower. What are some of the things that people believe about China or are led to that are widely thought about China that are so? Okay. Technological leader, on track to be the largest economy in the world, a massive manufacturing superpower that doesn't need help from anyone a military especially a

navy that could take on and defeat the united states on the verge of having the global currency all of this is utter horseshit fair why don't we start with any one of those and actually one of the topics that i was uh that i was going to bring up was de-dollarization or the the brick reserve currency currency which i also happen to believe is a pile of nonsense given that it is it is underpinned by two dying commodities countries plus the most indebted country in the world you're being very kind to them that's right so you led with a very cheerful prognostication which is that we are, uh, within the last 50, 50 years or so of the end of China. Yes. Where should we start? Okay. Let's do, um, let's kind of do the historical backdrop. Cause that'll

kind of set the stage for everything else. Perfect. In the world before world war two, you had a series of competing empires, uh, who had good land and good internal transport and a technological edge and they dominated the world and they fought over everything. And those fights brought us World War II and it all came crashing down. And then the Americans found themselves facing Stahl and were like, oh, he's kind of scary. We're going to need some people to stand between us and him. And since everyone who was a potential candidate who had just gotten out of the world's most horrific war, they needed some incentive. So we paid them. We used our Navy, the only Navy of size to survive the war, to patrol the global ocean so that anyone could

trade with anyone else and access any commodity in any market at any time. In exchange, you had to side with us against the Soviets. And that created NATO and the Japanese and the Korean and the Taiwanese alliance. And ultimately, by the time we got to 1980, it involved China as well. That political and security deal is globalization. And the Americans have been backing away from that now since 1992. The fact that the Americans saw it as a security deal, everyone else saw it as an economic deal, the Americans never invested their economy, everyone else did, you can see where I'm going here. Without that sort of security overwatch, none of the rest of it works. That's only piece one, though.

Piece two is when everyone started trading, they started specializing. When we were all living under an imperial system, most of us were farmers and kids were free labor, and would have as many as you could, plus one, because that's how you found out you had too many. But when the world started to urbanize and industrialize, we started taking manufacturing and services jobs, and none of those were on the farm. They were in town. And when you move into town, kids go from being free labor to a free source of migraines. So you have fewer. Fast forward 75 years, the world isn't running out of children. That happened 40 and 50 years ago. The world is now running out of working age adults and countries that joined this system

later that started urbanizing later could basically pick up the idiot's guide to making a city and do it a lot faster because the technology had advanced. There were more countries with experience and one of the last ones to do that was China. So the Chinese urbanization experience really didn't get going until 1980, but it happened so fast that in a single generation, they've gone from an average of five to seven kids to in places like Shanghai and Beijing, 0.7. And so we're looking at complete population collapse across a lot of the world. But in China, it's going to be so dramatic. It's also going to trigger civilizational collapse. They no longer have the young people to consume or build. Their

labor costs have gone up by a factor of 15 since the year 2000. And they now are on the verge of being the grayest country in the world without any replacement generations coming up from behind. So the idea that they can be the world's largest economy is just, it's silly, even if you believe Chinese statistics. And the last time the Chinese issued a bit of an oops, they disclosed that they overcounted their population by over 100 million people. Kind of a lot. Yeah. The scale of the disconnect here between reality, Chinese statistics, and popular belief is just shocking. So when we look at a place like China versus another country in, I guess, what you would call a secular or demographic decline like Italy, is it because the amount of disparity between the

haves and the have-nots is so wide that that compact is breaking down? Well, the have-have-not thing doesn't meet as much when you are in a dictatorship. So, I mean, social stability, political stability matters, but they're really in a one-man government system, and they have a cult of personality. So, it's certainly there kind of grinding under the surface. It's not a plus. But if you had the degree of economic inequality of China in a place like Germany, I mean, things would break.

I think it's more of an issue that Chinese agriculture was never particularly productive. It was very labor intensive. It was basically think the Jews in Egypt in 4000 BC or whatever the year was. It's slave labor where people are living a subsistence existence under the tutelage or control of the state. You can only go one way out of that because there was so much labor. It was actually pretty productive per hectare. But now that everybody's moved into a city and everyone's been in a city for 20 years, they've forgotten how to farm like that. They can't go back. And the type of agriculture that the Chinese need to grow their food in the areas they need to grow it can't be mechanized very easily. So we're looking at a population collapse and a food collapse. At the same time, we're likely to see a manufacturing collapse and a political collapse. I mean, there's a long list of bullets that are in the magazine that is in the gun that's pointed at China's head right now.

So, why don't we pivot just about 100 miles to the east, and we'll look at Taiwan. So, Taiwan, to me, I mean, obviously, there's a lot of saber-rattling. Do you view that to be a response to domestic pressures within China? Well, remember, China is a one-man state now, so it's really hard to decide what the political system even means anymore. Fair. Which would you describe? I just want to make sure that we set the table right.

Would you describe that as being a five-year phenomenon, or is that something that you feel is consistent since the time of …? Oh, no. It's been a progressive thing. When Ding Xiaoping took over after the death of Mao, he had a collegiate cooperative group, a really large political elite that ran the country, because he never wanted to see it return to the one-man state of Mao and the horrors of the Great Leap Forward and the Cultural Revolution that killed tens of millions of Chinese and set them back 50 years. He wanted

to do something different. And so he set the stage for the China we know today, which is the industrial power. And he gave way to a pair of guys, Jiang Zemin and Hu Jintao, who represented different factions. And each of them ran the country for 10 years and they were chosen by Ding while Ding was still alive. So who knew he was going to start in this year and finish in this year and he knew that 15 years before he got the job and that has worked reasonably well for them but ding realized he couldn't see forever so he knew that by the time they got to the next guy he wasn't going to be able to choose that person so he assigned the zhang faction and the who faction to come together and pick jointly someone new and that is xi jinping the current guy so

xi jinping originally it was thought that he was going to be in the middle of a tug of war between these two big factions, he spent the first five years of his presidency destroying those two factions. And he spent the next five years of his presidency destroying any other pole of independent power within the country, whether it was in business, local government, or the bureaucracy. And he basically took anyone in the country with intelligence and the capacity of forming an independent thought and exiled them, imprisoned them, intimidated them to silence, or just shot him. And there's now no one left. It's just Xi. And so no one wants to bring him information because you might get shot for that. You don't know the status of the conversation of

the voices in his head. And so we're seeing increasingly stupid decision-making from the very top with no one willing to challenge him. This is how you get that spy balloon, which is the dumbest thing I've seen a government do in 20 years. And if you think the last 20 years, there's been a lot of dumb. This is how you get people disinfecting airport runways, because they think that's what the leader wants. And we're seeing this in finance and in agriculture and manufacturing and subsidies and across the governance space. How does Taiwan fit into that entire situation? Probably rhetoric. Now, when you decide, I mean, threatening Taiwan, saying we're going to integrate it forcibly if necessary, this does get popular support. People like the

idea of one China because, you know, the Chinese are right throughout their history when it hasn't all been in one piece. It's been a freaking disaster. And so there could be something to it, but I don't think so. So when you decide you're going to invade a country, you don't just like wake up and pull the trigger. You build your military with that goal in mind. And that means for years, sometimes for decades, you have to make certain assumptions about how you think the war is going to unfold. And what the Russians have provided for the Chinese is proof that the Chinese chose wrong on everything. So, assumption number one, it's going to be an easy fight. Not as easy as invading Ukraine, because you can walk to Kiev, you have to swim to Taipei,

but still easy. Well, clearly it wasn't all that easy. Number two, Russian weapons are awesome. So, let's steal all their IP, just like we do for everything else, and spend $3 trillion manufacturing clones of those weapons for our crews. Well, they're having some serious buyer's remorse, or I guess it would be thieves remorse. Just remorse. Just remorse. Third, Russia is too important. We are too important. So if there is a war, everyone will just suck it up and make do. Oops. But I think what is really terrified the Chinese government is the boycotts. Because the sanctions hurt. There's no way around that. But the boycotts hurt a lot more, at least a factor of four more. And you had companies that

had sunk in excess of $20 billion into Russia. They just walked away. And the Chinese don't even have a concept for the idea of corporate or citizen agency, much less an understanding of what they would do if they lost access to foreign corporations, technology, and markets. That's an entire development model. So every guess they've made, they've guessed wrong. And they would be suicidal for them to now act because they also don't control the high seas. So they'd also lose all their manufacturers' exports, all their commodities, imports, and all their energy. So best case scenario, where they capture Taiwan without firing a shot, they still de-industrialize and have a famine in under a year. This is not a winning scenario here. Even the winning scenarios

are awful. So normally I would say- Bad news, you won. Yeah, exactly. Normally I would say they wouldn't even consider it, but it's a one-man show. Yeah. And so it's entirely possible that Xi will pull the trigger or some overenthusiastic idiot bureaucrat will pull the trigger, not realizing the damage he's about to cause and cause the downfall of China as an industrial power. It's still possible. It's just not sane. When you get to a system where there is no feedback loop, though, the insane becomes possible. Right. And we've seen that in our country. Yeah. Let's go into a meeting into which neither you nor I were invited. About a month ago, Tim Cook from Apple was in China

and there is obviously a drive amongst many companies, including Apple, to diversify their manufacturing out of China. Some are full bore pulling out, but a company like Apple that has so much of its manufacturing in China, China can cause some real mayhem within an apple. Beyond painful. If it wasn't for a company with Apple's cash reserves, it would be a system ending event. Yeah, that's right. A lot of countries, a lot of companies have seen the writing on the wall for a while. And whether it was because of COVID disruptions or Trump or now the Biden subsidies, whatever it happened to be, the descent into narcissistic nationalism, people have been backing away. Labor costs are a big piece of that too. With different speeds from

different starting points with different exposures. But the writing on the wall has been absorbed by everyone in the international business community, with the exception of Apple. Now, about a year ago, Apple did start relocating, or maybe a year and a half ago now, did start relocating the AirPods manufacturing to Vietnam. And that was the first thing, the first product that they actually decided, yeah, maybe we shouldn't put it all in China. So they are the last company to come to the conclusion that there might be a problem. Yeah. Now, in Apple's defense, the very concept of globalization is underwritten by the American security order. And the Americans have never said flout out that they're done. It's just kind of

been a bit by bit retreat. But now that it's more obvious, and now that the Biden administration is codifying Trump's policies, and now that labor costs in China are so high, and now that the Chinese government is actually criminalizing the act of owning data by private corporations. That's a new one this month. That was delicious. Apple is realizing that maybe, just maybe we shouldn't have 91% of our supply chain steps involved in China in some way. No matter how fast they relocate at this point, they can't get out fast enough because an iPhone is a lot like a car where if you miss one of those pieces, you just have a paperweight. That's right. Exactly.

Most vehicles that are sold in the United States are 85% manufactured here. Getting the last few pieces, there's already a network effect going for you in the United States and Mexico and to a lesser degree, Canada. There's nothing like that with Apple. They're going to have to rebuild the entire ecosystem. That is a minimum of five years. Who do you think had the power in that conversation, though? Was it she or was it Tim Cook? It's hard to say that she has any power because of the lack of information. So he certainly has the authority to shut things down, but he can't necessarily do anything to help Tim Cook because that means going against the

demographic and strategic realities of the country, not to mention Xi's own personal aura. Cook says he would like to leave, but remember, we are now dealing with a Chinese leader who is a son of the cultural revolution. And if for the low, low price of a famine and strategic defeat de-industrialization. He can retain power. He probably thinks that's okay. So the sort of leverage that Apple would normally have with a normal country just doesn't exist here. This was probably a conversation around people who were desperate in their own ways, who realized the person across the desk really couldn't do much to help them out. Just the capacity for mayhem.

Yeah. And there's plenty of that. Yeah. I have actually taken a drive from Hanoi to Halong Bay and you go past the Foxconn facilities, and they are some of the largest buildings I have ever seen in my entire life. You're driving past them for minutes, and you can see exactly what is coming in an environment in which China is no longer a partner. Now, there's one slightly less bad aspect to that. Those Foxconn facilities, for the most part, this is an overgeneralization, but for the most part, they're assembly facilities as opposed to manufacturing facilities. And that means of those 91% of the supply chain steps, a lot of them,

various parts come to China are assembled into another part, which is then sent out and incorporated in another part. That goes over and over and over again. So assembly, while a critical part of the manufacturing process, is a little bit simpler. I wouldn't say easy, but simpler to replace somewhere else. The problem we're going to have, not just with the iPhones and cellular, but electronics in general, is that the Chinese for the last 20 years have provided fingers and eyes for the assembly process, as opposed to going an automation route. Because the numbers have been there, they've been there in volume, and the security environment has allowed them to be co-located with a lot of those manufacturing facilities. If we lose that, there is no

singular place anywhere else in the world that has that number of fingers and eyes at scale. India doesn't have the quality control, and they're not all in the same infrastructure. Mexicans are too skilled. So, we're going to have to assemble in a different way than we have in the past. So, I had started with a question. You have spent the last 20 minutes answering it. I'm going to throw it out there anyway, if for nothing else, for a little bit of a chuckle. But so, in the thought of investing in anything to do with China. I would just warn you, before you short China, the other side has to survive for you to profit from the short. It has been the fate of most stock markets throughout history to go to zero.

It is only in the globalized order that the luxury of shorting things has existed. We're going to be going back to a little bit older of a system. I have a beautiful old chart that was put together by the Bank of Japan, and it shows interest rates over an 1,100-year period, starting everywhere in which fractional banking was practiced. The lowest point in terms of interest rates over that 1,100-year period was in the last decade. Oh, and that's demographics as well. How so? As you get older, you get more money, and your consumption changes. In your 20s and your 30s, you're buying homes and houses and raising kids and your income is low, so you have to borrow. So capital is relatively scarce in an

environment where there's a lot of 20 and 30 somethings. But once you hit about 45 and you start thinking about retirement and your kids are moving out, you've already bought your house, maybe you upgrade your car, but it's never going to be as big of a hit to the economy as buying your first one. And you're probably going to start thinking about downsizing. So you're actually negative on housing, but your income's the highest it will ever be. So societies that have more people in their mid-40s and on to early 60s are very capital rich, which pushes down borrowing costs, including interest rates across the board. Well, during the late 60s to the mid-80s, the baby boomers were in their 20s and 30s. From roughly 1995 until roughly 2020,

the baby boomers were in their late 40s to early 60s, and now they're retiring. So we've gone through, in this globalization period, one of the most capital-tight environments we've ever had, followed by one of the most capital-rich environments we've ever known. And now we're on the verge of mass retirement, where all the money goes away again. Right. Money looking for something to do, and now money is no longer looking for something. And what money is available isn't only available in smaller volumes. It has to support a massive and growing retirement environment. So we should expect capital costs to skyrocket regardless. And we're only in this calendar year and last calendar year at the very, very early stages of

this. I would be very surprised if the headline prime doesn't hit at least seven. I think nine is a more realistic expectation over the next year and a half. You're then calling for a melting down of many more banks in the United States. Maybe. I mean, OK, so here's the thing. When capital is cheap, things like tech do really well, because they require a lot of young people who are wired together to do things that haven't been done before, to invent new processes, to prototype, to operationalize, then ultimately to implement. We've been in that environment since 1995, and it's been great for tech overall. But now that the 20s and 30s are not available in the same numbers, labor costs are going

up. Now that the baby boomers are retiring, labor costs are going up more, capital availability is going down. tech was always going to crash. That was always hardwired in. But when the Fed looks at this, they're looking at a demographic crisis because they know that outside of the United States, Mexico, and a very small handful of other countries, there just aren't enough countries out there that have a lot of people in their 20s and 30s who consume. Well, what is monetary policy if not a set of tools to regulate consumption? Either encourage or discourage. That's your

choice. They're looking at the current environment. Is Silicon Valley in trouble? Yeah. That was going to happen anyway. Do we have some banks under pressure? Yes. The most vulnerable ones are linked to Silicon Valley. That's not a surprise. Do we have tools to deal with the rest of the banking environment? Yes. Will they be enough? We're going to find out. But it's not an unknown for them. What the unknown for them is, is if they don't get enough conventional monetary policy tools, interest rates, in their back pocket soon enough, forget this potential recession. we just exited the last period ever of global demographically led growth and if they don't have enough tools for the next recession one that's an american-centric recession the best case scenario for the united states is that we will turn into japan and never have

positive economic growth again and so if they have to hurt silicon valley and stress the banks in order to get tools they're going to do it because they're concerned about the monster that's munching on the horizon, not the little problems right in front of us. Right. And at least in some ways, the banks that are most at risk are the ones who have not been reading the tea leaves all along. And so if you have institutions that can at least theoretically take care of the aftermath, you do it. Yeah. They're hoping, counting on maybe even is a better way to phrase that the reconstructions we did in the aftermath of the financial crisis in 07-09 are sufficient to provide bulwarks for the broader system. I'm leaning positively on that because, I mean,

here, it's been a year. Interest rates have gone up faster than they ever have in history, and only four banks in one subsector have crashed. This is a reasonably good start. Yeah. So I love the thought of our regulators just crossing their fingers and moving forward. But I think that's in some ways when you are talking about, you know, you're talking about an environment where there really is this level of a shift from a high growth environment driven by super low interest rates to the reality of tighter capital. In some ways, the cross fingers and make the right play, that's an arrow they keep in their quiver. Well, and the advantage that the U.S. and Mexico have is conventional monetary pools

still work here because we still have consumption-led growth, but it doesn't work in Europe and it doesn't work in Japan and it doesn't work in China. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We're off tomorrow for the holiday, but we'll be right back on Tuesday. See you then.