Speaker 1:
From the library of the New York Stock Exchange, at the corner of Wall and Broad streets in New York City, you're Inside the ICE House, our podcast from Intercontinental Exchange, on markets, leadership and vision and global business. The dream drivers that have made the NYSE an indispensable institution of global growth for over 225 years.
Speaker 1:
Each week, we feature stories of those who hatch plans, create jobs and harness the engine of capitalism, right here, right now at the NYSE and at ICE exchanges and clearinghouses around the world. And now, welcome Inside the ICE House. Here's your host, Josh King of Intercontinental Exchange.
Josh King:
Over our 300 episodes, we've offered our audience an array of perspectives on major topics shaping global markets. In an episode last year with Admiral James Stavridis about his book of predictive fiction, 2034: A Novel of the Next World War, we discussed the potential flare up of economic and political disputes between the US and China, leading to a real actual hot war.
Josh King:
Now, it hasn't come to pass yet, but in the year since that conversation, the global stage has seen several turns that have evolved the situation between east and west. We've talked about several of those turns, including the environmental commitments made at COP26, evolution of the pandemic and of course, the Russian invasion of the Ukraine.
Josh King:
The military capability of that perennial cold war arrival came up in my conversation with Admiral Stavridis. In his book, Putin is still running an expanded Russia, which finds a way to join the global conflict taking place on the pages.
Josh King:
In discussing the current state of Russia, the Admiral told me, accurately and clairvoyantly, that I'm going to quote here, "The Russian military is sort of ghettos and penthouses. Much of the Russian military is conscript driven. It's old equipment. It's outdated tactics in many ways, but there's a few penthouses. The pent houses are their submarine force, which is highly capable and their offensive cyber, which is very, very good." That's what Admiral Stavridis told me.
Josh King:
Now, a subplot of the ongoing conflict and the result in global response, is how China is reacting to Russia's aggression. The two nations have a complicated history, of course, as both allies and rivals. China's economic growth has long surpassed its Western neighbor. And the way Xi Jinping has expanded his country's power, sits in stark contrast to Putin's playbook.
Josh King:
Which brings us to our guest today, James Fok, a leading expert on market structure. He played a central role in the internationalization of the Chinese capital markets, while working at Hong Kong Exchanges and Clearing.
Josh King:
He recently spoke to the New York Stock Exchange's vice chairman, John Tuttle, on how China's growth and ambitions have and will continue to shape global markets.
Josh King:
Of course, we wanted to follow up with the pod, as soon as John told us about that conversation. So, coming up right after this.
Speaker 3:
And now a word from on holding NYSE ticker O-N-O-N.
Speaker 4:
Pause is essential. It's part of the process.
Speaker 5:
Training doesn't end when my body stops moving.
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Recovery looks different for every athlete. We have different needs, different goals, different abilities.
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One thing we share our bodies need time, time to heal.
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The moment I stop training for the day, what people maybe don't realize is that the training is still going on.
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You know why the training never ends. The journey just starts again.
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Pause this sanctuary, familiar your spaces and comforting routines. It clears your mind and rebuilds your body.
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Let the healing begin. Time to reset there's power in pause.
Josh King:
Our guest today, James Fok is the author of Financial Cold War: A View of Sino-US Relations from the Financial Markets. James has written and spoken extensively about market structure issues and the intersection between geopolitics and international finance. Previously, James was a senior executive at Hong Kong exchanges and clearing and sits on the board of several financial institutions. James began his career in investment banking, specializing in the financial services sector. Welcome James inside the ICE house.
James Fok:
Thank you very much for having me, Josh,
Josh King:
I guess it's about 7:30 in the morning there. When does your Workday start?
James Fok:
I've got young kids. So I've gone to the habit of getting up very early before they start milling about the house. So I can get a few hours of useful, productive reading and work done before they get up.
Josh King:
Have you been burdened by the Hong Kong's crackdown on COVID in the way that a lot of Westerner's lifestyle has been affected?
James Fok:
We've been under quite heavy restrictions. The schools were closed. Most people were working from home and most of the restaurants were shut. We are relatively fortunate in that we have a little bit more space than most people typically have in these Hong Kong homes, but it wasn't great.
Josh King:
The term cold war as we were talking about in the introduction brings to mind a combination of military political and also financial arenas where the USSR, the United States, and more recently, China competed for during the latter half of the last century. How does a financial cold war differ from this definition?
James Fok:
Well, first of all, I mean, actually most people, when you use this term financial cold war, they immediately jump to the idea of sanctions, trade wars and so forth. But by the time you get to that point, I would say that you are already in a financial hot war. The financial cold war is the much slower underlying factors embedded in national financial policy and the structure of the global financial system, which have been driving the two countries towards conflict. And the main driver of that is actually respectively the increase in wealth and income disparities in both countries, which unfortunately neither sides leaders have really taking the steps to address the underlying root causes of-
Josh King:
I mean, talking about seeing the perspective from the other side, James, your Chinese grandfather used to say that Eurasian have two brains. So I'm curious, how does your dual upbringing help you bridge these two audiences and shape your understanding of the issues?
James Fok:
I think growing up in two different cultures and two different languages, you just instinctively pick up a lot of the unspoken and unwritten characteristics of a particular society in a particular culture. Those societies and cultures tend to have their embedded biases. And you feel all of those. I mean, I'm not saying that they're necessarily good or bad, but you feel instinctively all the same feelings as both sides individually are feeling in their interactions with each other. I mean, sometimes it makes for a huge amount of internal conflict to be articulate each other. And it certainly a recipe for a certain amount of schizophrenia, I think. But I think it really helps you to understand on a really instinctive level, but what the underlying issues are.
Josh King:
So outside of the Fok household, then, I mean the roots of the US, China rivalry go back really decades, and you've had this front row seat really in the past decade to the evolution of both nations financial markets. How did you actually become involved in markets in Europe and how did your career progress from there?
James Fok:
I had a very typical Hong Kong upbringing. I went to school here and then got chopped off to boarding school in the UK. I eventually got quite bored of being in the UK and went to study as an undergraduate in Beijing, then ended up in London and started working in JV Morgan as a graduate trainee. And so spent years working in Europe, including several years in Russia and the former Soviet republics. And then my wife and I decided that we were going to move back to Hong Kong in 2008, kept working in banking for a while. And then suddenly the Hong Kong exchange came along and said, "Hey, we're looking at this deal in London. Can you come and help?"
James Fok:
And it turned out to the London metal exchange acquisition. I went into that deal thinking, honestly, that the Hong Kong exchange didn't have a pray in winning that ICE was one of the leading contenders-
Josh King:
Sure.
James Fok:
At the time and CME, and there were vastly more experienced in international M&A than the Hong Kong exchange group. But somehow we managed to come out of that, the winner and I was asked towards the end of that process to stay on, to work as Charles Dee's, chief of staff. And so that then started a 10 year career of rollercoaster ride, really that took us through all the things that the Hong Kong exchange group achieved during that time.
Josh King:
Seeing Charles several times speak at the futures industry association gatherings in Boca Raton and in Chicago. You told the essential podcast that in many ways, the idea of the book came out of a conversation you have with a gentleman named Fu Hao at the Shanghai Stock Exchange, what brought you both together and how did you shape your understanding of the disconnect between, I guess what I'll quote the international market practice and the Shanghai Stock Exchange?
James Fok:
Fu Hao run and still runs the in international business development division of the Shanghai Stock Exchange. And by that time was running group strategy for Hong Kong exchange. So he was my opposite number. And during the negotiations to establish what became the Shanghai Hong Kong Stock Connect Program, we had a lot of interaction around the various kind of my new shy of implementation. There are a lot of differences in the way that the Hong Kong market works versus the Shanghai market. And we had to find a way for, or we had to agree certain parameters under which that the stock connect scheme would work. And so it happened that there was a point at which we came to disagree on something. And I was frustrated with him because I thought that he wasn't agreeing with what he wanted to do simply because he didn't understand.
James Fok:
And he asked me the question, "Well, why do you think it should be done your way?"
James Fok:
And I said, "Well, this is the way that it's done all over the world. This is international market practice."
James Fok:
And he turned around to me and said, "But why the penny suddenly dropped?" And I realized it wasn't that he didn't understand, or he hadn't looked at it was that he'd looked at it in the past and he didn't agree. And I, unfortunately, I'm ashamed to say that I hadn't done my homework to really understand how the mainland Chinese market operated. And I suddenly couldn't explain why international practice was as it was, but for the fact that it just was that way. So it drove me certainly out of a sense of embarrassment to do a lot more work, to try and understand why the Chinese market structure had come about as it was.
Josh King:
How then did that contribute to what we see now, tensions between the US and China?
James Fok:
If you step back first over the last 40 years, China has come leaps and bands in terms of its economic development and provided a huge uplift in the standard of living for hundreds of millions of people. But through that process, it has inevitably seen a widening of wealth and income disparities. But in terms of the transformation in capital markets, it is hard to understate the transformation of the last 10 years. What one of the most stark ways of looking at this is that if you remember back to the late 90s, when you had the Asian financial crisis, China really glided through that compared with its Asian neighbors, largely because it had no capital markets interaction whatsoever. So if most of the investment in China at that time was through foreign direct investment. And just as the markets were tanking doesn't mean that Volkswagen or General Motors are going to pull their plants.
James Fok:
That was largely the same case during the global financial crisis in 2008, over the last 10 years through the introduction of the stock and bond connect schemes, and particularly the inclusion of Chinese securities into some of the major global benchmark and indices such as NSCI emerging markets, the amount of foreign investment in China's capital markets has ballooned and actually a particularly stocks statistic to look at is that in 2011 foreign liquid securities investments, as a percentage of China's foreign exchange reserves stood at 14%. That number now stands at over 60%.
James Fok:
So China's capital markets. Although, the proportion of foreign investment of in them is still relatively low by international standards. China's capital markets are now highly integrated into the rest of the world. And so any dislocation in international markets and particularly US monetary policy is likely to have an exponential effect on China and the Chinese economy in a way that China has not experienced in the past. And in many ways, vice versa, Chinese markets will now start impacting the US economy and US livelihoods in a much more profound way than they ever have done in the past.
Josh King:
So we've been talking about the relationship between China and the US. Let's add a little twist to that. I mean, certainly finances play a role in all of the ongoing issues between Russia and the rest of the world. What has been the impact on the Chinese markets, not just from its neighbors hostilities, but how the world has brought its economic mic to bear on Putin.
James Fok:
The Chinese leadership are in a very difficult position over Russia, and in many ways are conflicted within themselves in that. China has a very long established principle of non interference in the affairs and the sovereign territory of other countries. So the military aggression in Ukraine certainly is something which is aberrant to China and the Chinese on that score. Nonetheless, there is a certain amount of sympathy with Russia's sensitivity around its border security, and particularly the sensitivities that the Russian leadership have about the expansion of NATO right up to their borders. The Chinese leadership can't afford to throw Russia under the bus, largely because there are huge interdependencies. China shares a 2,600 mile land border with Russia. Russia is absolutely critical to the security instability of a number of central Asian countries on China's Western borders, but more pertinently in the past decades or more recent years, China has come to depend more and more on Russia as a source of energy and of food in these two commodities.
James Fok:
China is not self-sufficient and it has to import those from outside. Historically, it's imported them from places that ship them via sea routes that pass through the Malacca strait, that narrow strip of water. And unfortunately, as geopolitical tensions with the US have risen China and the Chinese leadership have become quite nervous about the potential choke hold that the US Navy has over that strip of water. And so it is forced them to diversify their sources of supply of food and energy, and that's made them much more dependent on Russia than in the past. They also have huge dependencies on the United States and particularly the dollar system. They certainly don't want to attract US sanctions on them by doing anything that offends the US. So they are right now walking on extremely fine tightrope.
Josh King:
What do most people not understand about currency issues and the role that the United States plays in it?
James Fok:
Well, very simply that it takes two to tango. The fact is that the US dollar system that was put in place after the second world war has had a huge number of benefits to the whole world, because it's provided a common unit or common language that has facilitated international trade and investment, as we've seen it grow. But for the United States, it is created a huge number of headaches because in order to support the growth in trade and investment around the world, the US has had to continually supply dollars to the rest of the world. And that was all well and good while the US economy was growing at least as fast as the rest of the world. For many years now, through catch up and their own technological advances, other countries have been growing quite a lot faster.
James Fok:
And what that has meant is that the US is having to enter into ever more precarious levels of debt in order to support the US dollars international utility role, another factor of it is that demand for the US dollars in international trade and investment has led to a structural overvaluation the dollar, which depending on where you sit in US society has hit you differently. Have you happened to be the wealthy shareholder of a large US corporation? That's been able to take advantage of that overvaluation and outsource production to places where you've had undervalued currencies. You've managed to lower your costs, increase your profit margins. The share price have gone up and you've done very wide. But if on the other hand, over the last 40 years, you've been a US manufacturing worker, your experience has not been so rosy, it's been one of displacement job loss at best long term wage stagnation.
James Fok:
And ultimately this is a policy choice on behalf of the... On the part of the United States. That the fact is that the dollar has been a remarkably useful thing for the whole world, but for the United States, it's been a mixed blessing. It's allowed the US to consume a lot more than it otherwise may have been able to. But that's come at the cost of a now very large segment of US society and made their lives and livelihoods far more precarious than they had been in the past. And so, in that sense, I would say that although for a long time, China did deliberately hold down the value of its currency. That was certainly the case between 1995 and 2005. It is not necessarily the case that the Roman B is overvalued, certainly relative to other major currencies like the Yen or the Euro, but that the dollar has not been allowed to structurally weaken because you've had this underlying demand in international trading investment that's not allowed the US economy to readjust as it might have done to new economic realities.
Josh King:
How has that affected the growing middle class in China?
James Fok:
Well, I mean, the middle class in China actually faced with many of the same issues. So during the early stages of reform and opening up, China issued large amounts of borrowing from the rest of the world, which at that time was the typical emerging markets development pattern. And instead, what they did was that they harnessed the savings of the baby boom generation in China, through their control over the state owned banking system and channeled those savings into investment in Chinese infrastructure and other development priorities that necessarily required China to use policies that held down Chinese consumption. And so as China's middle class was developing and growing that they tended to save more and spend less than middle classes in other countries.
James Fok:
What you've seen now is that China is now making a very conscious shift to put a greater amount of spending power in the pockets of the Chinese consumer, and that's beginning to transform. But at the same time, all the same kind of technological and other disruptions have been going on in China, you've seen China is the largest user of industrial robots. You've seen a huge amount of automation happening in Chinese manufacturing. And so many of the same things that are happening to US manufacturing workers are now the experience of Chinese manufacturing workers. And at the same time that the middle classes are being squeezed because urban housing has become extremely expensive relative to incomes. Part of the underdevelopment of China's domestic capital markets has been manifested in a huge flood of capital into the limited investment classes that exist and primary amongst those is residential property.
James Fok:
And so it is becoming tougher for young Chinese and Chinese middle classes to get on the housing ladder. And your wages are not going up in the way that they were in the past. And you're starting to see the outsourcing of low end, low skilled manufacturing jobs to lower cost centers like Bangladesh, Cambodia, Vietnam. And so in many ways, the Chinese are experiencing many of the same issues as American workers.
Josh King:
After the break James Fok and I discussed the lessons, he hopes readers are going to gain from his book and the future of the financial cold war. That's coming up right after this.
Speaker 3:
And now a word from Stelatis, NYSE ticker S-T-L-A.
Speaker 8:
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Josh King:
Welcome back before the break, I was talking to James Fok author of Financial Cold War: A View of Sino-US Relations from the Financial Markets, about James's career and the recent history of China's capital markets and economic ambitions. So, James, you wrote about the need to combat inflation and quoted John Maynard Keens. And I'm going to quote him here, "there's no sufler no sure means of overturning the existing basis of society then to debotch the currency."
Josh King:
In your view, how have the central banks fared in walking the line of cutting debt without setting off unintended consequences?
James Fok:
With a huge amount of difficulty? I think we've unfortunately dug ourselves into an extremely deep hole over the last four decades. And unfortunately, we are now going to face a massive hangover for a huge amount of monetary and fiscal irresponsibility and the hangover, unfortunately, the main price of that is going to be paid by most likely our children's generation. You could choose austerity. And the fact is that has been extremely unpopular and it's quite difficult to implement in democratic societies. But default, as we saw it in very stuck circumstances in the Lehman brothers insolvency during the global financial crisis can have huge spillover effects into the real economy. Inflation is one means, but inflation falls very unevenly on different segments of the population and can have severe societal impacts. And so they're not really any great options.
James Fok:
And the fact is that we are so leveraged as a global economic system that any attempt to normalize monetary policy is inevitably going to result in an awful lot of pain. But the fact is also that this financialization of the global economy has coincided with a huge acceleration in technological disruption, which in and of itself is something that was always going to generate a huge amount of societal disruption. We are now seeing a level of disruption in society that is unprecedented. There is no historical precedent for the level of societal disruption that we're now experiencing. And inevitably, a lot of people are going to be scared that they're going to be worried about themselves, the futures of their children, and that's generating a lot of anger. And unfortunately, that anger it is looking for an outlet. And in that sense, we now live in extremely dangerous times, both domestically and internationally and geopolitically.
Josh King:
Given the societal disruptions that are looking for an outlet as you say James, what role do taxes play in that conversation?
James Fok:
Well, globalization has created a lot of challenges there in that as trade and investment around the world have globalized, all countries have wanted to attract investment to themselves. And one of the means of doing so is through setting lower rates of taxation. It is a simple fact that it's a lot easier to move capital than it is to move labor. And so the tendency has been for governments to set lower rates of taxation on capital earnings than on labor earnings. And this has driven some quite wacky tax systems in which that the extremely wealthy pay far lower rates of tax than ordinary middle class workers, which has exacerbated that the wealth and income divides that have opened up.
Josh King:
Last year, I think 136 nations signed a global minimum tax rate deal and agreement that with recent inflation and other market unrest is already coming under pressure. What are your thoughts about that solution?
James Fok:
It was certainly a necessary step, but the G7 agreement last year was really a baby step and an awful lot more needs to be done. Unfortunately, given that these... We now live in a globalized world, it's impossible for any one country to address this problem on their own. And it does require international coordination in cooperation. And unfortunately, given the geopolitical tensions that exist around the world, we don't seem to necessarily have the environment of trust and openness that is required to achieve some of those agreements. I've been very lucky to have been able to have conversations about my book and about other thoughts with some Chinese policy makers. And I think there's a tendency to feel if you're sitting on one side that the other side is sitting there cooking up evil plans to try and mess you up or screw you over.
James Fok:
But the fact is that, I come at this from the perspective that, I go and visit friends in Beijing. I talk with friends in Shanghai and friends in Hong Kong and my wife's American. So I do the same in New York and in Boston and other places. And many of the conversations that we have with our peers and contemporaries are pretty similar in both countries, you're worrying about your kids, the education, the cost of housing. You're getting your kids into good schools, avoiding some of the pitfalls that kids can fall into.
James Fok:
What I see is not the differences, but the incredible similarities between the two, but unfortunately we sit behind divided by a large ocean and divided by language and to an extent culture. And it certainly hasn't helped over the past two and a bit years that there's been very little travel between China and the United States, which I think has exacerbated the types of paranoia that are really quite unhelpful in the relationship, because the reality is that I see far more points of commonality than I see differences. But in the absence of real interaction, I think that both sides are sitting there imagining that the other side are there cooking up sort of dastardly planned about each other?
Josh King:
How much is it encouraged and how accessible to the average Chinese citizen are the capital markets and wealth creation and wealth growth.
James Fok:
There are 160 million individual investor accounts in China share trading accounts. So there are a huge number of participants in China's capital markets. But the fact is that most people who are participating are doing so with very, very small amounts of money and a very small proportion of their savings. 78% of urban household wealth in China is held in the form of residential real estate. Both as homes and as investment vehicles that compares with the brand 35% in the United States. And the fact is that there hasn't been a lot of confidence in the Chinese capital markets, because they've been structurally prone to booms and bust. And so many Chinese savers kind of look at the Chinese markets as a little bit of a casino that there's obviously a huge kind of maturation process that the Chinese capital markets need to go through.
James Fok:
And they are doing that. But in the meantime, the lack of a viable set of alternative assets to invest in China's second largest pool of savings sits in cash deposits at banks as of the end of 2021 that stood at 35 trillion us dollars. This is the largest untapped capital in the world. And you have to look at the fact that China's got a very rapid aging population, that aging population is going to put a huge amount of burden on the state, for reasons of helping themselves see themselves through a what will hopefully be long and healthy retirement. Chinese savers need to get more of their savings into high yielding or higher returning assets. And the government needs to do the same because it needs to defray what is already going to be a very significant rise in social welfare spending needs.
James Fok:
And that has been a major driver of many of the steps towards capital internationalization that Chinese policy makers have pursued. Whether it's through the direct access schemes or through schemes like stock connect and bond connect via Hong Kong, it is the desire to allow Chinese savers to put more of their savings into capital markets. The Chinese capital markets aren't big enough and deep enough to absorb that amount of capital without generating huge asset price bubbles.
James Fok:
And so some of that capital has had to come out into international capital markets. The big challenge of course, facing them now is that given the geopolitical tensions for the US and the control that the US has over the infrastructure supporting international capital markets outside of China, beyond Hong Kong, that there is a serious national financial security risk associated with further steps to internationalizing China's capital markets. Chinese policy makers don't want to see Chinese citizens and Chinese businesses subjected to the same types of sanctions that the west has being able to level on Russia. And so we are sitting, unfortunately in this kind of rather self-defeating stalemate the moment, because it would certainly be in the rest of the world's interest to tap into China's savings that could generate a huge amount of investment around the rest of the world. And it's certainly in China's interest to get that savings out. Though the challenge now is finding a secure path that Chinese policy makers feel comfortable with, and that policy makers in other countries feel comfortable with.
Josh King:
In the introduction I spoke about Admiral James Stavridis vision for 2034, the hot war between the United States and China also involving India and Russia. Let's go from the hot war to the financial cold war. What do you think is the best and worst case scenario for 2034 of the financial cold war?
James Fok:
The best case is that China, the US and other major countries are able to set aside their differences, sit down and really pursue a wholesale redesign of the global monetary system that will allow a gradual reduction in the imbalances that have been allowed to build up. It's unlikely that will be addressed by 2034, but it is going to take decades, but hopefully they can set themselves on the path towards doing so. If they fail to do that, I think we now sit in quite a precarious point in markets, because over the last 30, 40 years, you've seen a gradual levering up of the system which has made monetary policy makers, central bankers, largely impotent. And at the mercy of the financial markets.
James Fok:
We've already passed through a number of points that might have resulted in a collapse of the dollar system, whether it's through the huge amount of public borrowing that the US has taken on, the enormous monetary stimulus and debasement of the currency that we've witnessed. And more recently through the weaponization of the dollar in international markets against strategic rivals. All of these things are leading us at some point to a demise in the dollar base global monetary system.
Josh King:
Well, on that note, James, I hope you'll allow me to sort of hope for the best case rather than the worst case by 2034 and beyond. But thank you for giving us this glimpse into the future of US-Sino Relations and the Financial Cold War. It's been a great conversation.
James Fok:
Josh, thank you very much. Let's all hope for the best.
Josh King:
And that's our conversation for this week. Our guest was James FA author of Financial Cold War. A view of Sino, US relations from the financial markets, the books available, wherever books are sold. If you like, what you heard, please rate us on iTunes. So other folks know where to find us. And if you've got a comment or a question, you'd like one of our experts to tackle on a future show, email us at [email protected] or tweet at us at ICE House Podcast. Our show is produced by Pete Asch with production assistance from Ken Abel Indian Wolf. I'm Josh king, your host signing off from the library of the New York Stock Exchange. Thanks for listening. Talk to you next week.
Speaker 1:
Information contained in this podcast was obtained in part from publicly available sources and not independently verified, neither ICE nor its affiliates, make any representations or warranties express or implied as to the accuracy or completeness of the information and do not sponsor approve or endorse any of the content herein. All of which is presented solely for informational and educational purposes. Nothing here in constitution offered to sale, a solicitation of an offer to buy any security or a recommendation of any security or trading practice. Some portions of the proceeding conversation may have been edited for the purposes of link and clarity.