Q&A

Question: I started to read, but I didn’t finish yet, the Nicholas Lardy book The State Strikes Back, where he predicts that the government is taking a bigger and bigger share in Chinese economy, which is going to be as you already denied, another debunked theory of Chinese slowdown. What do you think of this book? Thank you.

David Goldman: The great Chinese slowdown has been predicted for 20 years, and it hasn’t come. If you look at the details of what China is doing, China, for example, installs more robots than the United States and Europe combined. It’s still increasing the productivity of its population by moving very large numbers of people from countryside to city. It is rapidly modernizing its industrial production.

The biggest problem China has, in terms of growth, is that it has a generation of people who came from the country to the city 20 years ago when they were young. They are now in their 40s, they’ve been working in semi-school jobs, and there is really no place for them to go. They are parked in state-owned industries, which are unproductive and often require subsidies. And that’s a drag on Chinese productivity. So it will take a while for Chinese reforms to redeploy those people to other jobs. Services have been growing at the expense of manufacturing. There are entire new cities in the center of China that American tourists [have] never heard of with 20 million people that are the center of China’s rapid economic growth. So I don’t believe that there is any inherent obstacle to Chinese economic growth. I think they are management problems and China will comfortably be able to maintain five to six percent economic growth for another decade, which means its economy roughly doubles over that period.

Question: [Inaudible.]

David Goldman: Well, there’s always a political risk that the so-called Chinese left-wing will arrest China’s development, but I think it’s extremely unlikely because the Chinese Communist Party has as a principle objective staying in power. It will stay in power if it can continue to meet the aspirations of its citizens, and it won’t do that by going back to methods which nearly destroyed it during the Great Leap Forward and the Cultural Revolution. So, I’m not privy to the deliberations of the politburo but I think that’s a very unlikely outcome.

Question: [Inaudible.]

David Goldman: Steve Bryen, who used to run the Export Controls Office at the Pentagon, has written about this [and], I think, made a great deal of sense that there are a lot of technologies we simply don’t want to let them have. K.T. [Kathleen Troia] McFarland, the other day, pointed out that during the Cold War, we wouldn’t even let the Russians buy [a] Xerox machine. They were still using mimeographs when communism fell, so there are a lot of technologies that we simply don’t want to let the Chinese have. Silicon Valley can say what it wants, but there are a lot of things you are not going to get from the Europeans. There are things we can stop them from getting, for example, machines for chip design you can buy from the United States.

But you can also buy them from Siemens in Germany, and I very much doubt that the Germans could be cajoled or threatened into cutting off exports from China. Siemens has been enjoying ventures with Huawei since 2004, 15 years, so that’s not going to happen, but we can certainly slow them down. But the most important thing is to do better than they do. Produce better products. It’s a very poor strategy to try to stop someone else from doing something that they do better than you. You can throw your weight around, but your weight will never be enough to stop them. We need to unleash American innovation and drive their products out of the market by producing better ones.

Question: [Inaudible.]

David Goldman: Well, everybody imitates everybody else. The Bessemer process in steel was invented by Sir Charles Bessemer, not by Andrew Carnegie. The lightbulb was invented by a British physicist, not by Thomas Edison. Industrial espionage is vastly overrated. Somebody gets into a plane with a briefcase full of blueprints and flies to Beijing, [and] people can look at the blueprints. That’s not really the issue. If you set up a factory, you’ve got a bunch of engineers who learn to do the process, then you hire them away, and they can do it for somebody else. You learn by creating the team that does the entire process.

That’s how technology really is transferred, which means you don’t want to let American companies do certain kinds of things at all. For example, I wouldn’t let Boeing produce aircraft in China. That would be an example of something I’d stop. I am much more concerned, though, about new technology. I’ll give you an example: semiconductor manufacturing. The latest Taiwan semiconductor manufacturing chip fabrication plan will cost $20 billion. That’s an astonishing sum for a single factory. That might be the most expensive factory in history. Don’t quote me on that, but it’s certainly way up there. These are enormous presses. There’s research at MIT [Massachusetts Institute of Technology] that uses an application of quantum mechanisms to grow circuits as opposed to squishing the material down into them, which costs a tiny fraction of what that does. It would wipe out several hundred billion dollars of investment.

When we have the level of R&D that we had during the Reagan years, we don’t know exactly what we’re going to get out of it. For example, the process for chip manufacturing, which became standard, complementary metal-oxide-semiconductor chip manufacturing, was invented, well, theoretically by Fairchild, but RCA labs perfected it, because someone at Pentagon decided they wanted fighter pilots to do weather forecasting in the cockpit, and they needed a lighter, faster chip. So the RCA guys came up with this process which became the standard for chip manufacturing in 1976. By 1978, it was used for look-down radar and F-15s, and by 1982, the Israelis demonstrated at the Beqaa Valley Turkey Shoot that this and other avionic advances could wipe out the Russian advantage and surface-to-air missiles. That was the first death knell of communism.

So, I don’t know exactly which technologies are going to succeed. I know certain things we absolutely must develop, like quantum computing, but the most important thing is to recreate the network of corporate laboratories, defense agencies that fund basic research, national laboratories, universities, which we had in the 1980s and which made us the wonder of the world.

Question: You talk about what we should do, but when I look at what happened, I look at Bell Labs, for instance, Nokia, the reminisce of Belcor, the research arm of the Baby Bells, Erickson, semi-tech: I guess still exists, but I don’t know what was our reaction to the semi-conductor issue in the 80s. I mean, even our influence with economic development in third-world countries, like The Organization of the Petroleum Exporting Countries and the United States Agency for International Development, it doesn’t seem like it’s enough. Why did we allow ourselves to get into this situation in the first place?

David Goldman: Well, I think the answer is the Clinton peace dividend. After the fall of communism, we were so strong that we couldn’t imagine that we would ever need to do anything militarily again. We would just sit there. So the whole federal research and development effort was built down vastly. That was under [President Bill] Clinton. We also, as Walter McDougall of University of Pennsylvania recently wrote in a superb essay for Law & Liberty,[9

Walter A. McDougall, “McDougall Responds on NATO,” Law & Liberty, April 30, 2019, https://www.lawliberty.org/liberty-forum/mcdougall-responds-on-nato/ (accessed Sepember 25, 2019).
 ] we also saw that NATO should be like a social welfare organization as opposed to a military organization that everybody should join, kind of like the United Nations Educational, Scientific and Cultural Organization (UNESCO). You know, UNESCO with blue uniforms or something, and that was disastrous.

And then we had the Bush Administration, of which I’ve been a very severe critic since the beginning. President Trump estimates that we spent $7 trillion chasing the fandom of nation-building around the world. I don’t know if that’s the right number, but it was trillions. And at the same time, we vastly neglected basic R&D. We just couldn’t do both at the same time. We made a terribly poor choice, and we got nothing but a lot of heartache and humiliation for our investment in nation-building. We built no nations. And meanwhile, we neglected our basic industry inter-technologies. Corporations who no longer had the relationship with the federal government, which subsidized their basic R&D, moved out of it.

The other thing that happened is the Chinese pushed us out of it. The Asians have always subsidized capital-intensive industry. That’s the Asian model. The Japanese did it in 1900. It’s not new. The difference is China is 1.4 billion people. They are gigantic. The gravitational pull of that Chinese subsidy chased all American money out of hardware [and] into software. Out of capital-intensive into so-called capital-light investments. Now how do you deal with that? Well we can go to the Chinese and say, “Change your economic system or we’ll tax furniture” or whatever. I’m exaggerating slightly. I don’t believe we can force the Chinese to change their system. That’s been the Asian system since 1868. They don’t know any other way to run a business. So we’ve got to do some things on our own, and that will in some cases require subsidies. The way we give subsidies to defense companies. I hate subsidies. They lead to corruption, they leave inefficiencies, they’re the wrong way to do things, but in a national security situation, sometimes you do things in a suboptimal way. Having the Marines close, engage, and destroy is not exactly an economic value-added proposition either, but you do it for national security reasons.

Question: Could you speak to the currency and the strategy that the Chinese have?

David Goldman: Yes, absolutely. The Chinese would like to see the Renminbi (RMB) become a global reserve currency and challenge the dollar. They are very cautious about moving in that direction. They have created RMB payment networks, which roughly doubled their volume in the last couple of years. That’s very useful for countries subject to sanctions, like Russia, Iran, Turkey, and so forth. So they basically run the equivalent of a little money laundering operation and RMB on the side, benefiting from the difficulties that sanctioned countries have using the dollar-based payment system.

Do you want to keep your checking account in a Chinese bank and RMB? Well, obviously not, and neither does General Motors, neither does Siemens, neither does Mitsubishi. Until such a time that China develops a capital market, which is free and open and efficient, you can’t have a reserve currency, because people don’t want to keep their reserves in your currency. They don’t want to hold their balances there. But over the next 10 to 15 years, the Chinese certainly want to move in that direction. One of the areas of market opening that they’re most eager to do is the financial sector. J.P. Morgan, Goldman Sachs, Blackrock: All of these companies can’t wait to get into China. I mean this is the savings of a billion-and-a-half people, vastly profitable business. The Chinese want Western expertise in managing a banking and asset-management system to help them advance toward this goal. So it is a significant threat to the United States over the long term.

I think many accounts of Chinese intentions to make the RMB into a reserve currency have been alarmist, because it’s much more difficult than a matter of signing a few laws. You have to gain the confidence of the world. In terms of the RMB’s present value, it’s definitely in China’s interests not to let it fluctuate too much. They don’t want to depreciate it aggressively, because they want confidence in their capital markets. They’ve depreciated it a bit, which helps take some of the edge off the tariffs, but I don’t think they will allow it to depreciate seriously if they can possibly avoid it, since they’ve got a little over $2 trillion in reserves. They’ve got quite a war chest. I don’t think the RMB in the short term is going to be very volatile.

Question: I’m personally very interested in the rise of China and the effects it’s had on its own people investing in real estate in the United States and the effects that has had on my generation. And I’d like to know your opinion on the matter of Chinese citizens investing in residential real estate around the world.

David Goldman: Well, during the great housing bubble of 1998 to 2008, the United States ran a current account deficit each year of about $600 billion; it was enormous. And the whole world was flushed with savings. The Chinese were enormous savers—and many others, not just the Chinese. I was at that point the head of debt research for the Bank of America, and we sold vast amounts of mortgage-backed securities to the Chinese and thought this was safe with houses. This helped create a bubble in housing in the United States, supported [by] some very bad credit decisions; in order to create these bonds that we could sell to the Chinese, we dragooned every drunk off the street we could and put a mortgage in front of them and got them to sign it. I mean we lowered credit standards; we did outrageous things as bankers. It’s one of the reasons I left the industry. So that created a housing bubble, which pushed your generation out of the housing market. It pushed housing out of reach, so it had a terrible consequence for you.

That is a bit different than the personal investments of Chinese in real estate around the world. As my old boss at Reorient Group, John Kho, once told me, every generation of Chinese for the past thousand years has been expropriated, so we all want to keep some money outside of China. And real estate is viewed as a safe investment. Those flows have diminished a great deal partly because the Chinese have been effective in putting capital controls on, and I think the effect is much diminished since the 1980s.

Question: I was curious because I’ve seen a bunch of blowback from other Asian countries, like Japan, with China’s gaining power and trying to become a hegemony. My question is, what role do you think that those counties will play in helping either hinder, postpone, or prevent the potential hegemony that China can get in the next coming decades?

David Goldman: I think the Japanese are keeping their powder very dry; they are being very cautious. For example, let’s say hypothetically we had a war where the United States’ interdicted energy suppliers to China. They could do that, but since every barrel of oil that goes in the Persian Gulf goes through the South Asian Sea, not a barrel of oil would reach Japan either. The last thing Japan wants is a conflict between the U.S. and China, because collateral damage would be catastrophic.

The Japanese and Chinese don’t like each other. Japanese certainly are prepared to develop nuclear weapons very quickly if they have to, they are investing in their own defense. But at the same time the Chinese market is hugely important to them, and I think they are opportunistically lying back waiting to see who wins and what kind of deal they have to make. If the United States is strong and assertive, I think the Japanese will certainly be on our side.

Japan has more foreign assets than China. Japan certainly could be the major funder of an alternative to the Chinese Belt and Road Initiative along with South Korea, which is extremely active in foreign investments in South East Asia. To some extent, India, though India is more challenged because it really has its own internal development problems to deal with before it expands overseas. So I certainly think there would be potential if we had a clear policy to ensure American hegemony, but since our policy has been very uncertain, everybody is gaming us. I think that’s the simple way to put it.

Question: What do you make of the Committee on Foreign Investment in the United States review process as it currently stands? Is it effective? Do you expect that it will be effective in the future? And is it the kind of direction you’d like to see the United States go in terms of trying to put some control over what products end up in Chinese hands?

David Goldman: I think the Committee on Foreign Investment in the U.S. has been better under [President] Trump than it certainly was under [President] Obama. It has improved a great deal. I’m less concerned about Chinese investment in the U.S. than I am about U.S. export of technology to China. But these are obviously similar things. I’m for an extremely tough policy. I would try to deny China access to key technology either by investing in the U.S. or by American companies operating in China. But that will only work if we’re simultaneously investing in better technologies on our own. So it’s a matter of offense and defense. Defense at best delays your enemy. You win by offense.