China Must Decide On Growth Or Deleveraging: Magnus

grapple with China's economy and its political system. Here to tell us about it is none other than George Magnusi, an associate of the China Center at Oxford University, former chief economist for UBS, and the author of a new book entitled Red Flags Y G's China Is in Jeopardy. George magnus thank you very much for being with us. Tell us what you want people to take away from your book. Well, I think the main thing is that China is facing a number of economic issues which are

not necessarily unique to China. Um, they're very special in the kind of China's case. But the main thing really is that since Seijing pin came to power in two thousand and twelve. There's been a very substantial shift in the way in which China is governed, in what we might call its governance system. And this is not the China that we thought we knew, that erupted onto the world scene, so to speak, during the last kind of

twenty or thirty years. It's obviously still in certain years, are much more powerful China than it used to be, and it's a much richer China than it used to be. But the governance system has changed a dramatically. And what I've tried to do in the book is to set out what difference this makes to the chances of yet another transformation which China has to make if it wants to aspire to all the things that it says it

wants to be. So, George, can you connect that sort of shifting governing structure in China to what we're hearing with respect of the tensions between the US and China? In other words, is the US misplacing some of its concerns about the dominance of China, And is China going to become less of a threat than than China than US officials seemed to think UM. Now I kind of

picture the other way, to be honest. I mean, I think that, you know, one of the remarkable transformations that China has has done over the last thirty or forty years is, you know, once upon a time, it used to be a very um, you know, a magnetic customer for global companies and particularly for Western companies, and gradually it's sort of evolved into a very feisty competitor, not just in low value goods, but increasingly in in medium

skill and medium technological level goods and serve one services, but certainly goods UM. And now it's become also, of course, a very feisty and very considerable competitor and and adversary to the United States and some degree to to the Western world as well. And I don't really see that this is going to change any time in the future.

And if anything, I think that the trade war, which of course consumes us all and it's kind of almost front page news kind of every day, UM, is something that we should expect to continue and perhaps to become even starker and spill over to other areas in the future, because it does signify a kind of an adversarial relationship which at the moment, neither of the two presidents of the two countries, a President Trump and President sieging Ping, you know, seemed to be, you know, one of them

is following an America first policy, the others following a chi in the first policy, and that sort of dialogue that America and China used to have has has clearly kind of broken down, at least for the time being. Can China pursue policies for speedy growth and simultaneously reduce the risk of financial instability? M Now that is the sixty four trillion you are in question, um, And the answer that very simply is that I think is no. UM, so as I think a lot of people who are

watching China kind of realize and understand. Since the end of two thousand sixteen, China has embarked on a quite quite a seriously minded course of deleveraging the financial system to try to unhook the economy's dependency on debt and on credit creation, and to some degree they have been successful, but only to a limited degree. Now that the economy is also slowing down and falter a little bit in the wake of this de leveraging policy, but also supplemented

increasingly by the consequences of the tariffs and the trade conflict. Um. We can see quite a number of bits of anecdotal evidence where the government and the People's Bank of China a kind of rowing back a little bit from the intensity of this kind of deleveraging squeeze. So I think there is an unresolved conflict in China between the almost

the kind of the mantra that we have. You know, they have to have elevated or high rates of economic growth, and in the conviction that certainly many Chinese leaders have, which is that they need to reduce their dependency on debt. But I don't think they've resolved yet. You know how those two incompatible objectives actually can co exist Because they can't.

You have to choose one or the other. Although Georgia, some people would say the fact that China is easing again actually prolongs this cycle and gives China more time to sort of right size itself and fix that some of the structural problems that it faces and avoids a hard landing. Do you agree with that? Um? Not not really.

I mean I think that the there is an argument that you know, if you if the Chinese authorities can basically just hold the line on credit creation and deleveraging for long enough that you know that faster growth will resume. But I think that this conflates to kind of things

which actually are entirely dependent on one another. The reason that China can have and has had during the last ten years relatively elevated rates of growth, maybe not quite as elevated as official numbers suggest, but certainly quite high rates of growth is because of the because of the credit creation that's underpending. It Once you take away that credit creation mechanists, and growth will almost certainly drop off

quite significantly. So this is the this is the acid test of Chinese policy making and of seizing pings kind of governance, shall we say, in terms of macroeconomics over the next kind of two or three years, is will they be willing to kind of bite the bottom lips, so to speak, and allow the economy to slow down materially whilst this deleveraging takes place, or or will they

kind of give up and and go for growth. They still have a system of setting annual growth targets, and if that were ever to be abandoned, which has been mooted but it hasn't happened yet. If that were ever to be abandoned, I think we would see certainly a big shift in the way in which, you know, policy was being conducted in China and the tolerance that would be implicit for weaker economic expansion. But so far that's not been the case. George Magnus, thank you so much

for being with us. Wonderful to get your insights on this very important topic. China, of course front and center for the entire global economy, not only the US. We

respect to the tensions. George Magnus economist and associate at the China Center at Oxford University, also a research associate at the School of Oriental and African Studies, and formerly he was chief economist at u b S. Ongoing questions are continuing about China's hacking of hardware that is used by a lot of different US agencies, governmental companies, as well as defense units. Matt Choti joins US now vice

president chief information security Officer at Redlock from Philadelphia. Matt, thank you so much for for coming back with us. There was a story yesterday that our Bloomberg Business Week reporters broke talking about additional signs that China had implanted some sort of micro chip to be able to hack into computers for a major US to telecommunications company. And this was using information given by somebody who is using

their name on the record. What did you make of this? So, you know, this is really really interesting for a couple of reasons, right, First is that this is the first time that we've got some indication possibly around which industry this is affecting. And the second thing, like you mentioned, now we have a known hardware security expert who seems to be backing up these claims really for the first time.

And the thing that's different right this hack is different from what we heard about last week, and that this is not an embedded chip in the motherboard but rather directly onto the servers network port. And I think the other thing that's important, and hold on one second before you continue, what does that mean? What's the difference here? So the difference is that it's just from from a skills perspective, it is it's much more difficult to do

what we were talking about last week. We were talking about that really small embedded chip. In this case we're talking about it has been reported that the server's actual port. So where it's called an Internet jack where you plug a computer into the network that the actual port was replaced with a device that now can do those remote communications. How would a company or an individual check to see whether they are affected? So you know, this is again

we don't know the scope of this right now. That's that's part of the challenge, right. So there is newer technology that exists, surely not that a consumer would have, right, but there's technology that exists today that utilizes X rays and machine learning to compare chip designs. Right, so you show it this is what a good chip looks like, and then it will compare it. And so this type of technology can help provide assurances, but today it's use

is very limited. So Matt, I want to go back to this idea that you're talking about, where the prior story that we were talking at about how to deal with them planting a chip on the motherboard. This is an easier way of accessing information going through the ethernet port.

I'm sure I'm butchering this, but I'm just wondering from your perspective, is it also easier to detect from sort of a security standpoint or does it just sort of raise the fear that this type of hacking and in these types of implants are all the more prevalent than anyone could ever imagined. Surely, in this case, this is something that was visibly different. I think I remember reading that it was you know that one is normally plastics, this sport, and this one was metallic. So surely this

would be easier to spot just visually. But I think, you know, the thing that's really important remember is that this is not a super micro issue, right, this is an industry wide concern that's actually gone back for a number of years. Um. I found a report from that the Department of Defense issued. It was called the Cyber Supply Chain, and in there they identified concerns similar to what's been reported, and they actually made a couple of recommendations, right.

The first was training, the SEC was developing new technical methods to identify malicious hardware. And the last one was new regulations that would require all defense suppliers to report hardware issues. So this, again, this is not really new. It's just the first time that the general public has been made aware of it. Matt, do you think that this will become a factor in the approval or disapproval process, the review process for US companies combining with Chinese companies

or Chinese foreign investment in the United States. I think it's certainly going to add a whole new level of rigor in review. Right. So today companies they spend billions to secure software, but almost nothing for hardware. So definitely it will definitely become a point of contention. But again, it's not just a super micro issue. This is an

industry wide concern. All right, So Matt, let's let's say that this is an industry wide concern and its evidence that China is trying to infiltrate big companies as well as possibly governmental units. I'm just wondering from your perspective, Uh, how how how do you sort of counter it on a broad level? And have you heard any I mean, you talked about regulations, but have you heard any movement in that direction. I have not personally seen that. I

haven't read anything about it. But I guarantee you this is going to spurn it. That's why I think, you know, regardless if what's being reported accurate, this news will have a positive effect, and that it's going to spurn companies and governments worldwide to begin investigating the security of their hardware.

All right, so let's let's actually go with that, because a lot of people I tweeted out the story and a lot of people were saying, hmmm, well, all of the governmental agencies and all of the companies are denying that this is the case, when at least the initial story they're saying that there was no microchip that was

implanted in their hardware. Uh So, you know, with all of those denials, could it be that somebody is trying to get out this story or a lot of people are in order to prompt change, but that perhaps aren't getting the facts totally right. That's absolutely true. I mean,

that could absolutely be the case. The other thing to keep in mind, right, if this really is a top secret government investigation, no doubt, each one of these companies would have received a national security letter, and if they receive that national security letter, it may have very well to have one that has a non disclosure provision, in which case they are legally prevented from even talking about it, and it would be in their best interest to stringently

deny it. We don't know if that is the case, but it's certainly probable given the wide ranging nature of this reported issue. If you're an individual that has responsibility for the security of a network, or you had a team that has such responsibility, what kind of money are we talking about that's necessary in order to do the right kind of review? You know, it's it's really going to take in terms of investment. It's hard to say

what it would be for a specific company. Certainly would depend upon, you know, just the scale at which that company operating. You know, for example, my company, right we operate all our compute capacity in for example, the Amazon Web Services cloud. We've outsourced in a sense that hardware security to Amazon and they do a phenomenal job at that. But for companies that are still operating traditional data centers, it could be a really large and very expensive effort.

As I mentioned, we know that companies are spending billions of dollars on software security, but almost nothing for hardware. That's going to need to change quickly. So, just in general, from your perspective, how concerned should people be about this in a broad level? I mean, I think that the at the consumer level, I wouldn't be that concern right now, simply because we really don't have specifics of around how

this may affect a consumer. Now, if I am a business owner, if I am protecting very expensive, very sensitive intellectual property, if I am a government right we're talking defense. I'm very concerned over this, and this is something again that's going to require a lot of investment. Again, I mentioned that report. This is something that's been around for a while. It's not new. It's just the first time that this has been brought to such public attention, so

you know. And the only thing I've mentioned too is there's been a lot of academic research on this just in the last two years, so the information on how to address this is out there. It just seems like this may actually be the stimulus to finally get something done. Matt ki Audi, thanks very much for being with US

Vice president chief Information Security officer for Redlock. Tesla has been the focus for many who wished to short sell it, basically betting on its demise or at least it's swoon, and certainly it shares a fall in thirty four percent since August seven, so it has been a pretty big swoon.

But is there more to come here? Molly Smith joining US now corporate finance reporter for Bloomberg News Molly, you wrote a story that I thought was really important because people can talk about the short interest on Tesla, people can talk about the business model of Tesla, but really what you need to focus on is the debt. Please explain why, right, I mean, the debt right now is really Tesla's uh, it should be at least their first

and foremost priority. Right now, everyone's really been looking at this million dollar maturity that's coming to in March on a convertible bond, and Tesla Elon Musk in particular, has said that he plans to repay, not refinance this bond, which is pretty strong language, especially given that the company had two point two billion dollars of cash as of June, so it would, in most analysts and investors opinion, be very prudent to do another capital raise or try to

refinances bond instead of pay it outright. How much debt does Tesla have right now at eleven and a half billion dollars worth and the likelihood that they would be able to raise capital any s demn No, I don't think there's any indication right now the capital markets are closed to Tesla. The equity valuation is still incredibly strong. I mean, thet bllion dollars is still an incredible sum

regardless of what the debt is trading at. But even if you do look at the bonds right now, they're trading in line with other triple C rated peers, which is what these bonds are rated. They're not showing any imminent panic or distress levels. So yes, it would be expensive to go that root of an unsecured bond, but doing another convertible bond or equity or possibly secured debt,

those are definitely options that have been raised. So has anyone looked at just how much interest they can take on, how much how much they can actually afford to pay out in interest payments to lure in new investors, given the fact that they're burning through cash and they need to increase their profitability, their productivity. I mean, they've got a lot of needs and wants here and kind of

does the math work. I haven't seen any numbers that actually put out Tesla's interest payment capacity, but that would be a really interesting stat to nail down. But that's exactly right that there is. There are just so many needs that the company has right now, between servicing the debt, between funding the operations and are we going to finally see positive free cash flow and a profit for the

first time in this company's fifteen year history. Well, and just to put into perspective what we have seen in terms of price action on the Tesla bonds maturing in they're currently trading at less than eighty four cents in the dollar. August of last year, they were trading at more than a hundred cents in the dollars. So this

has been a huge swoon. People are pricing in a much bigger risk today, uh than they were a little bit more than a year ago, even though in general triple c's have actually rallied right right, and at Tesla bonds right they were issued at part. They have never

traded at parts since they were issued. These were fell right out of the gates and have been you know, I guess, uh whenever there's you know, some kind of event that drives the bonds down on maybe a Musk tweet or an SEC lawsuit for example, that you've seen them go down as low as I think somewhere in the two eight three range maybe, but they tend to come back into this eight seven level, and that seems to be the sweet spot right now, but exactly in

line with the triple ceas, which, like you said, yeah, are the best performing part of the high yield market right now. Who owns most of the debt it's not institutional hands. I can tell you that every traditional asset manager who I've talked to has said they will not look at these. They want companies with proven free cash flow that they can show ability to service their debt. It's mostly short money that's in it. Uh make an individual money managers like about Post Group, White Box Advisor

without naming names. Yeah, alright, so just looking forward, let's talk about just how much do they have coming do?

And you know, has Testla started to have conversations with investors about what their potential, uh post abilities are for raising additional cash From those that I have talked to, it doesn't sound that way, but the company is still really maintaining this stance that they're going to be able to pay out this bond in March, and there's also a maturity do in November on convertible bonds issued by Solar City, which these bonds are what we would call

out of the money, Like there's uh the conversion price would be so high for Tesla to be able to convert the bonds into stock, that it looks like they will have to pay the two million dollars of principle outright to holders, just as a quick reality check. Does anyone who you speak to believe that Tesla really doesn't need to raise additional cash? No? Alright, I mean, but

then that's telling. I mean basically that that Elon Musk is saying we don't need to do it, and not one person who has been studying corporate finance for their lifetimes believes that that's the case. They will all tell Some will tell you definitely. I've definitely heard people say, yes, they have the money to pay the maturities to do what they say they can do. Is that a wise move? Is that what they should be doing? No, everyone will tell you no. Well done. Thanks very much for being here.

Molly Smith our expert for all things related to the debt markets and of course talking about Tesla and it's debt, and you can follow Molly Smith on Twitter at Molly Smith News. Our next guest is Jim Paulson. He is the chief investment strategist for the Luthhole Group, helping to manage nearly one and a half billion dollars based in Minneapolis. Jim, I want you to define a couple of terms for us. Let's begin with toggle switch. What's a toggle switch? When

it comes to Wall Street? Well, damn us to do? Um UM. I think people are looking. You know, the question everywhere today is what yield level bites stocks? And UM. I think people when they look back historically, they go, well, let's look back historically. You know, yields had to get the five per cent or whatever on the tenure before that happens. And I think it's not about a yield level.

It's about an attitude that develops. And that attitude I think is captured by the correlation between stocks and bonds. And when the correlation UH is positive between the stock market and yields, which it has been most of the time in the last twenty years, what that says is that good good news comes out and it pushes yields up. But because the attitude on Wall Street is mostly concerned about weak growth, that's good news for stocks as well.

It just means we're farther away from recession or depression. Um. But occasionally this this correlation is turned negative, that is to say that higher yields caused stock market to fall. And I think that's because good news becomes bad news for stocks. And and it's a shift in the Wall Street attitude from worried about we growth to worried about

overheat uh and inflation conditions. And we just actually, if you update this correlation, the fifty two week trailing correlation between stock movements and yield movements, that just went negative or the toggle switch just went off as it's toggled from positive to negative correlation. And in the past when this has gone negative, it has not been a good sign for the stock market. Alright, So basically taking taking a big step back to try to get this sort

of ten thousand foot picture here. Uh. The Fed another central banks suppressed rates across the board, brought down overnight rates, purchased bonds to lower longer term rates. They're stepping away from that rates rising. We don't have to reach for yield anymore, so people are not needing to go into equities. UH. And and to risk your corporate that we're seeing some pretty big outflows overnight, actually some of the biggest I've

ever seen. And I'm just trying to understand from from your perspective, how bad could this get right and what sort of the threshold of yields at which things really start to heat up in terms of losses for stocks. Well, you know, it's I think it's been building for a while UM already, Lisa, in the sense that yields that came up earlier this year at the yield rise pause for a while, but eventually you kind of saw defensive stocks.

A lot of those stocks. Utility stocks have been have been matching the market, for example since January of this year,

and uh staple stocks have been matching since April. You know, you're seeing a similar type of matching with the SMP dividend aristocrats and with low valve the SMP Lovaland my point is is that even the stopped going up for a while, defensive stocks started to help perform the leadership of the market for the last few years, technology started to underperform, and so a lot of this has already

been building. You look at the narrowing of the market, the equally weighted SMP has been falling relative to the market cap. For example, small cap stocks have started to underperform UM. So I I think it wouldn't take a lot more for this too turn into more of not just to sell off, but a panic to some degree. I don't really see the conditions for a recession or bear market, but I certainly do see rising conditions for a really healthy correction that scares a lot of players.

Jim Paulson, Just to your point about the utilities, the Dow Utility Index has gained thirteen and a half percent since mid June. Is this because investor sentiment has changed or is there something underlying the actual corporate fundamentals that has changed well? Or might be both? Yeah, it might be. I think it is maybe a little both, but I

do think it. Uh, It's very interesting that in the year where the economy by all accounts has been better than it's ever been in this recovery, and that people feel very excited about conditions on main Street and super excited about profits, that in the last you know, six months or more, and and particularly this last move to a new high we just did in the last couple of months was led by defensive stocks. Now what is that saying? What when defensive stocks start to outperform in

a good economy, when financial is no longer outperformed? Uh, in a in a good economy. When raw industrial commodity prices have a ten fall since June, what's the message of that. I think it's a message that weaker growth is coming on mas read in the stock markets already starting to pick it up. Jim Paulson, thank you so much for being with us. Jim Paulson, Chief Investment Strategies at the Luthhold Group. Thanks for listening to the Bloomberg

P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm Pim Fox. I'm on Twitter at Pim Fox. I'm on Twitter at Lisa Abramo. It's one before the podcast. You can always catch us worldwide on Bloomberg Radio.