WEBVTT - China Must Decide On Growth Or Deleveraging: Magnus 0:00:05.800 --> 0:00:08.720 Welcome to the Bloomberg P and L Podcast. I'm Pim Fox. 0:00:08.760 --> 0:00:11.560 Along with my co host Lisa Abramowitz. Each day we 0:00:11.640 --> 0:00:15.120 bring you the most important, noteworthy, and useful interviews for 0:00:15.200 --> 0:00:17.840 you and your money, whether you're at the grocery store 0:00:17.960 --> 0:00:20.720 or the trading floor. Find the Bloomberg P and L 0:00:20.840 --> 0:00:30.800 Podcast on Apple Podcasts, SoundCloud, and Bloomberg dot com. The 0:00:31.000 --> 0:00:35.280 topic is China and how to absorb what some describe 0:00:35.320 --> 0:00:41.320 as industrial quantities of the most indigestible stuff had a 0:00:41.440 --> 0:00:46.080 grapple with China's economy and its political system. Here to 0:00:46.159 --> 0:00:49.680 tell us about it is none other than George Magnusi, 0:00:49.760 --> 0:00:53.640 an associate of the China Center at Oxford University, former 0:00:53.720 --> 0:00:56.639 chief economist for UBS, and the author of a new 0:00:56.720 --> 0:01:01.520 book entitled Red Flags Y G's China Is in Jeopardy. 0:01:01.600 --> 0:01:03.720 George magnus thank you very much for being with us. 0:01:04.200 --> 0:01:07.400 Tell us what you want people to take away from 0:01:07.440 --> 0:01:11.959 your book. Well, I think the main thing is that 0:01:13.040 --> 0:01:18.240 China is facing a number of economic issues which are 0:01:18.280 --> 0:01:22.720 not necessarily unique to China. Um, they're very special in 0:01:22.760 --> 0:01:25.679 the kind of China's case. But the main thing really 0:01:25.880 --> 0:01:28.680 is that since Seijing pin came to power in two 0:01:28.720 --> 0:01:33.560 thousand and twelve. There's been a very substantial shift in 0:01:33.720 --> 0:01:36.800 the way in which China is governed, in what we 0:01:36.880 --> 0:01:40.280 might call its governance system. And this is not the 0:01:40.360 --> 0:01:46.039 China that we thought we knew, that erupted onto the 0:01:46.040 --> 0:01:49.160 world scene, so to speak, during the last kind of 0:01:49.160 --> 0:01:53.720 twenty or thirty years. It's obviously still in certain years, 0:01:53.720 --> 0:01:55.760 are much more powerful China than it used to be, 0:01:55.960 --> 0:01:58.000 and it's a much richer China than it used to be. 0:01:58.240 --> 0:02:01.440 But the governance system has changed a dramatically. And what 0:02:01.480 --> 0:02:02.920 I've tried to do in the book is to set 0:02:02.920 --> 0:02:06.880 out what difference this makes to the chances of yet 0:02:06.960 --> 0:02:10.800 another transformation which China has to make if it wants 0:02:10.840 --> 0:02:13.120 to aspire to all the things that it says it 0:02:13.200 --> 0:02:16.200 wants to be. So, George, can you connect that sort 0:02:16.240 --> 0:02:19.919 of shifting governing structure in China to what we're hearing 0:02:20.440 --> 0:02:22.880 with respect of the tensions between the US and China? 0:02:22.880 --> 0:02:26.160 In other words, is the US misplacing some of its 0:02:26.200 --> 0:02:31.519 concerns about the dominance of China, And is China going 0:02:31.560 --> 0:02:33.960 to become less of a threat than than China than 0:02:34.040 --> 0:02:38.040 US officials seemed to think UM. Now I kind of 0:02:38.040 --> 0:02:39.760 picture the other way, to be honest. I mean, I 0:02:39.800 --> 0:02:43.280 think that, you know, one of the remarkable transformations that 0:02:43.400 --> 0:02:46.720 China has has done over the last thirty or forty 0:02:46.800 --> 0:02:48.720 years is, you know, once upon a time, it used 0:02:48.720 --> 0:02:52.320 to be a very um, you know, a magnetic customer 0:02:52.440 --> 0:02:56.800 for global companies and particularly for Western companies, and gradually 0:02:56.800 --> 0:02:59.680 it's sort of evolved into a very feisty competitor, not 0:02:59.800 --> 0:03:03.760 just in low value goods, but increasingly in in medium 0:03:03.800 --> 0:03:07.720 skill and medium technological level goods and serve one services, 0:03:07.800 --> 0:03:11.800 but certainly goods UM. And now it's become also, of course, 0:03:11.840 --> 0:03:16.800 a very feisty and very considerable competitor and and adversary 0:03:17.440 --> 0:03:20.360 to the United States and some degree to to the 0:03:20.400 --> 0:03:23.200 Western world as well. And I don't really see that 0:03:23.200 --> 0:03:26.000 this is going to change any time in the future. 0:03:26.040 --> 0:03:29.359 And if anything, I think that the trade war, which 0:03:29.360 --> 0:03:31.720 of course consumes us all and it's kind of almost 0:03:31.800 --> 0:03:36.040 front page news kind of every day, UM, is something 0:03:36.080 --> 0:03:39.360 that we should expect to continue and perhaps to become 0:03:39.480 --> 0:03:43.640 even starker and spill over to other areas in the future, 0:03:43.680 --> 0:03:48.480 because it does signify a kind of an adversarial relationship 0:03:48.640 --> 0:03:51.920 which at the moment, neither of the two presidents of 0:03:51.960 --> 0:03:54.960 the two countries, a President Trump and President sieging Ping, 0:03:55.360 --> 0:03:57.200 you know, seemed to be, you know, one of them 0:03:57.240 --> 0:03:59.720 is following an America first policy, the others following a 0:03:59.800 --> 0:04:02.920 chi in the first policy, and that sort of dialogue 0:04:02.920 --> 0:04:06.920 that America and China used to have has has clearly 0:04:06.960 --> 0:04:08.840 kind of broken down, at least for the time being. 0:04:09.880 --> 0:04:15.880 Can China pursue policies for speedy growth and simultaneously reduce 0:04:16.040 --> 0:04:20.160 the risk of financial instability? M Now that is the 0:04:20.200 --> 0:04:23.200 sixty four trillion you are in question, um, And the 0:04:23.240 --> 0:04:27.359 answer that very simply is that I think is no. UM, 0:04:27.400 --> 0:04:30.040 so as I think a lot of people who are 0:04:30.040 --> 0:04:33.280 watching China kind of realize and understand. Since the end 0:04:33.320 --> 0:04:38.720 of two thousand sixteen, China has embarked on a quite 0:04:38.800 --> 0:04:44.360 quite a seriously minded course of deleveraging the financial system 0:04:44.440 --> 0:04:49.680 to try to unhook the economy's dependency on debt and 0:04:49.760 --> 0:04:54.120 on credit creation, and to some degree they have been successful, 0:04:54.200 --> 0:04:57.760 but only to a limited degree. Now that the economy 0:04:57.880 --> 0:05:01.240 is also slowing down and falter a little bit in 0:05:01.440 --> 0:05:05.720 the wake of this de leveraging policy, but also supplemented 0:05:05.839 --> 0:05:13.279 increasingly by the consequences of the tariffs and the trade conflict. Um. 0:05:13.320 --> 0:05:16.560 We can see quite a number of bits of anecdotal 0:05:16.600 --> 0:05:20.240 evidence where the government and the People's Bank of China 0:05:20.279 --> 0:05:23.480 a kind of rowing back a little bit from the 0:05:23.560 --> 0:05:27.839 intensity of this kind of deleveraging squeeze. So I think 0:05:27.880 --> 0:05:33.200 there is an unresolved conflict in China between the almost 0:05:33.200 --> 0:05:35.240 the kind of the mantra that we have. You know, 0:05:35.279 --> 0:05:39.120 they have to have elevated or high rates of economic growth, 0:05:39.600 --> 0:05:43.359 and in the conviction that certainly many Chinese leaders have, 0:05:43.880 --> 0:05:46.760 which is that they need to reduce their dependency on debt. 0:05:46.920 --> 0:05:49.800 But I don't think they've resolved yet. You know how 0:05:49.839 --> 0:05:54.160 those two incompatible objectives actually can co exist Because they can't. 0:05:54.240 --> 0:05:56.359 You have to choose one or the other. Although Georgia, 0:05:56.520 --> 0:05:59.159 some people would say the fact that China is easing 0:05:59.400 --> 0:06:05.040 again actually prolongs this cycle and gives China more time 0:06:05.120 --> 0:06:07.560 to sort of right size itself and fix that some 0:06:07.640 --> 0:06:10.400 of the structural problems that it faces and avoids a 0:06:10.480 --> 0:06:15.040 hard landing. Do you agree with that? Um? Not not really. 0:06:15.200 --> 0:06:18.320 I mean I think that the there is an argument 0:06:18.400 --> 0:06:21.960 that you know, if you if the Chinese authorities can 0:06:22.000 --> 0:06:26.320 basically just hold the line on credit creation and deleveraging 0:06:26.360 --> 0:06:30.480 for long enough that you know that faster growth will resume. 0:06:30.600 --> 0:06:35.680 But I think that this conflates to kind of things 0:06:35.720 --> 0:06:39.880 which actually are entirely dependent on one another. The reason 0:06:39.960 --> 0:06:43.080 that China can have and has had during the last 0:06:43.080 --> 0:06:47.479 ten years relatively elevated rates of growth, maybe not quite 0:06:47.520 --> 0:06:51.240 as elevated as official numbers suggest, but certainly quite high 0:06:51.360 --> 0:06:55.359 rates of growth is because of the because of the 0:06:55.400 --> 0:06:58.560 credit creation that's underpending. It Once you take away that 0:06:58.640 --> 0:07:02.560 credit creation mechanists, and growth will almost certainly drop off 0:07:02.640 --> 0:07:06.039 quite significantly. So this is the this is the acid 0:07:06.120 --> 0:07:10.680 test of Chinese policy making and of seizing pings kind 0:07:10.680 --> 0:07:13.480 of governance, shall we say, in terms of macroeconomics over 0:07:13.520 --> 0:07:16.559 the next kind of two or three years, is will 0:07:16.600 --> 0:07:19.280 they be willing to kind of bite the bottom lips, 0:07:19.320 --> 0:07:23.040 so to speak, and allow the economy to slow down 0:07:23.480 --> 0:07:28.640 materially whilst this deleveraging takes place, or or will they 0:07:28.680 --> 0:07:31.480 kind of give up and and go for growth. They 0:07:31.560 --> 0:07:36.600 still have a system of setting annual growth targets, and 0:07:36.680 --> 0:07:40.480 if that were ever to be abandoned, which has been 0:07:40.560 --> 0:07:43.640 mooted but it hasn't happened yet. If that were ever 0:07:43.680 --> 0:07:47.040 to be abandoned, I think we would see certainly a 0:07:47.360 --> 0:07:49.920 big shift in the way in which, you know, policy 0:07:50.040 --> 0:07:53.400 was being conducted in China and the tolerance that would 0:07:53.400 --> 0:07:57.800 be implicit for weaker economic expansion. But so far that's 0:07:57.840 --> 0:08:00.440 not been the case. George Magnus, thank you so much 0:08:00.440 --> 0:08:03.000 for being with us. Wonderful to get your insights on 0:08:03.040 --> 0:08:06.040 this very important topic. China, of course front and center 0:08:06.120 --> 0:08:10.240 for the entire global economy, not only the US. We 0:08:10.320 --> 0:08:13.600 respect to the tensions. George Magnus economist and associate at 0:08:13.640 --> 0:08:17.480 the China Center at Oxford University, also a research associate 0:08:17.720 --> 0:08:20.760 at the School of Oriental and African Studies, and formerly 0:08:20.880 --> 0:08:35.199 he was chief economist at u b S. Ongoing questions 0:08:35.600 --> 0:08:41.079 are continuing about China's hacking of hardware that is used 0:08:41.200 --> 0:08:46.080 by a lot of different US agencies, governmental companies, as 0:08:46.080 --> 0:08:49.640 well as defense units. Matt Choti joins US now vice 0:08:49.679 --> 0:08:54.200 president chief information security Officer at Redlock from Philadelphia. Matt, 0:08:54.240 --> 0:08:56.280 thank you so much for for coming back with us. 0:08:56.720 --> 0:08:59.360 There was a story yesterday that our Bloomberg Business Week 0:08:59.360 --> 0:09:05.640 reporters broke talking about additional signs that China had implanted 0:09:06.080 --> 0:09:09.559 some sort of micro chip to be able to hack 0:09:09.679 --> 0:09:15.800 into computers for a major US to telecommunications company. And 0:09:15.880 --> 0:09:19.120 this was using information given by somebody who is using 0:09:19.160 --> 0:09:22.959 their name on the record. What did you make of this? So, 0:09:23.000 --> 0:09:25.480 you know, this is really really interesting for a couple 0:09:25.520 --> 0:09:28.240 of reasons, right, First is that this is the first 0:09:28.280 --> 0:09:32.199 time that we've got some indication possibly around which industry 0:09:32.360 --> 0:09:34.959 this is affecting. And the second thing, like you mentioned, 0:09:35.160 --> 0:09:38.280 now we have a known hardware security expert who seems 0:09:38.280 --> 0:09:41.240 to be backing up these claims really for the first time. 0:09:41.679 --> 0:09:44.079 And the thing that's different right this hack is different 0:09:44.160 --> 0:09:46.320 from what we heard about last week, and that this 0:09:46.440 --> 0:09:49.200 is not an embedded chip in the motherboard but rather 0:09:49.360 --> 0:09:52.440 directly onto the servers network port. And I think the 0:09:52.440 --> 0:09:54.920 other thing that's important, and hold on one second before 0:09:54.920 --> 0:09:57.560 you continue, what does that mean? What's the difference here? 0:09:58.200 --> 0:10:00.439 So the difference is that it's just from from a 0:10:00.559 --> 0:10:04.280 skills perspective, it is it's much more difficult to do 0:10:04.320 --> 0:10:06.360 what we were talking about last week. We were talking 0:10:06.360 --> 0:10:09.680 about that really small embedded chip. In this case we're 0:10:09.679 --> 0:10:13.520 talking about it has been reported that the server's actual port. 0:10:13.600 --> 0:10:15.720 So where it's called an Internet jack where you plug 0:10:15.720 --> 0:10:18.960 a computer into the network that the actual port was 0:10:19.040 --> 0:10:23.800 replaced with a device that now can do those remote communications. 0:10:23.840 --> 0:10:26.600 How would a company or an individual check to see 0:10:26.600 --> 0:10:30.079 whether they are affected? So you know, this is again 0:10:30.120 --> 0:10:32.240 we don't know the scope of this right now. That's 0:10:32.320 --> 0:10:35.240 that's part of the challenge, right. So there is newer 0:10:35.320 --> 0:10:38.920 technology that exists, surely not that a consumer would have, right, 0:10:38.920 --> 0:10:42.479 but there's technology that exists today that utilizes X rays 0:10:42.520 --> 0:10:45.640 and machine learning to compare chip designs. Right, so you 0:10:45.679 --> 0:10:47.400 show it this is what a good chip looks like, 0:10:47.679 --> 0:10:49.880 and then it will compare it. And so this type 0:10:49.880 --> 0:10:53.520 of technology can help provide assurances, but today it's use 0:10:53.640 --> 0:10:56.000 is very limited. So Matt, I want to go back 0:10:56.000 --> 0:10:58.800 to this idea that you're talking about, where the prior 0:10:58.880 --> 0:11:00.600 story that we were talking at about how to deal 0:11:00.600 --> 0:11:03.280 with them planting a chip on the motherboard. This is 0:11:03.320 --> 0:11:07.720 an easier way of accessing information going through the ethernet port. 0:11:07.760 --> 0:11:09.840 I'm sure I'm butchering this, but I'm just wondering from 0:11:09.840 --> 0:11:13.600 your perspective, is it also easier to detect from sort 0:11:13.640 --> 0:11:16.480 of a security standpoint or does it just sort of 0:11:16.720 --> 0:11:19.960 raise the fear that this type of hacking and in 0:11:20.000 --> 0:11:22.480 these types of implants are all the more prevalent than 0:11:22.480 --> 0:11:26.120 anyone could ever imagined. Surely, in this case, this is 0:11:26.160 --> 0:11:28.480 something that was visibly different. I think I remember reading 0:11:28.480 --> 0:11:31.040 that it was you know that one is normally plastics, 0:11:31.120 --> 0:11:34.080 this sport, and this one was metallic. So surely this 0:11:34.120 --> 0:11:37.080 would be easier to spot just visually. But I think, 0:11:37.120 --> 0:11:39.480 you know, the thing that's really important remember is that 0:11:39.559 --> 0:11:42.560 this is not a super micro issue, right, this is 0:11:42.559 --> 0:11:45.200 an industry wide concern that's actually gone back for a 0:11:45.240 --> 0:11:48.640 number of years. Um. I found a report from that 0:11:48.760 --> 0:11:51.760 the Department of Defense issued. It was called the Cyber 0:11:51.920 --> 0:11:55.400 Supply Chain, and in there they identified concerns similar to 0:11:55.440 --> 0:11:58.320 what's been reported, and they actually made a couple of recommendations, right. 0:11:58.320 --> 0:12:01.800 The first was training, the SEC was developing new technical 0:12:01.840 --> 0:12:04.920 methods to identify malicious hardware. And the last one was 0:12:05.120 --> 0:12:09.040 new regulations that would require all defense suppliers to report 0:12:09.120 --> 0:12:11.840 hardware issues. So this, again, this is not really new. 0:12:12.080 --> 0:12:14.640 It's just the first time that the general public has 0:12:14.679 --> 0:12:17.079 been made aware of it. Matt, do you think that 0:12:17.160 --> 0:12:22.000 this will become a factor in the approval or disapproval process, 0:12:22.080 --> 0:12:27.679 the review process for US companies combining with Chinese companies 0:12:27.800 --> 0:12:31.600 or Chinese foreign investment in the United States. I think 0:12:31.600 --> 0:12:34.200 it's certainly going to add a whole new level of 0:12:34.360 --> 0:12:39.600 rigor in review. Right. So today companies they spend billions 0:12:39.720 --> 0:12:43.840 to secure software, but almost nothing for hardware. So definitely 0:12:43.880 --> 0:12:46.640 it will definitely become a point of contention. But again, 0:12:46.679 --> 0:12:49.079 it's not just a super micro issue. This is an 0:12:49.120 --> 0:12:53.400 industry wide concern. All right, So Matt, let's let's say 0:12:53.440 --> 0:12:56.040 that this is an industry wide concern and its evidence 0:12:56.080 --> 0:13:00.160 that China is trying to infiltrate big companies as well 0:13:00.200 --> 0:13:04.600 as possibly governmental units. I'm just wondering from your perspective, Uh, 0:13:05.360 --> 0:13:07.520 how how how do you sort of counter it on 0:13:07.600 --> 0:13:10.120 a broad level? And have you heard any I mean, 0:13:10.120 --> 0:13:13.120 you talked about regulations, but have you heard any movement 0:13:13.240 --> 0:13:16.959 in that direction. I have not personally seen that. I 0:13:17.000 --> 0:13:19.280 haven't read anything about it. But I guarantee you this 0:13:19.480 --> 0:13:21.440 is going to spurn it. That's why I think, you know, 0:13:21.520 --> 0:13:26.520 regardless if what's being reported accurate, this news will have 0:13:26.640 --> 0:13:29.400 a positive effect, and that it's going to spurn companies 0:13:29.400 --> 0:13:33.000 and governments worldwide to begin investigating the security of their hardware. 0:13:33.040 --> 0:13:35.760 All right, so let's let's actually go with that, because 0:13:36.120 --> 0:13:37.960 a lot of people I tweeted out the story and 0:13:38.000 --> 0:13:40.760 a lot of people were saying, hmmm, well, all of 0:13:40.800 --> 0:13:43.880 the governmental agencies and all of the companies are denying 0:13:43.960 --> 0:13:46.240 that this is the case, when at least the initial 0:13:46.280 --> 0:13:49.400 story they're saying that there was no microchip that was 0:13:49.440 --> 0:13:52.719 implanted in their hardware. Uh So, you know, with all 0:13:52.760 --> 0:13:55.439 of those denials, could it be that somebody is trying 0:13:55.480 --> 0:13:57.760 to get out this story or a lot of people 0:13:57.800 --> 0:14:00.720 are in order to prompt change, but that perhaps aren't 0:14:00.760 --> 0:14:03.880 getting the facts totally right. That's absolutely true. I mean, 0:14:03.960 --> 0:14:06.319 that could absolutely be the case. The other thing to 0:14:06.440 --> 0:14:09.080 keep in mind, right, if this really is a top 0:14:09.120 --> 0:14:12.880 secret government investigation, no doubt, each one of these companies 0:14:12.920 --> 0:14:16.040 would have received a national security letter, and if they 0:14:16.040 --> 0:14:18.679 receive that national security letter, it may have very well 0:14:18.760 --> 0:14:21.840 to have one that has a non disclosure provision, in 0:14:21.880 --> 0:14:25.960 which case they are legally prevented from even talking about it, 0:14:26.080 --> 0:14:28.440 and it would be in their best interest to stringently 0:14:28.480 --> 0:14:30.520 deny it. We don't know if that is the case, 0:14:30.680 --> 0:14:34.640 but it's certainly probable given the wide ranging nature of 0:14:34.680 --> 0:14:38.960 this reported issue. If you're an individual that has responsibility 0:14:39.000 --> 0:14:41.240 for the security of a network, or you had a 0:14:41.280 --> 0:14:44.840 team that has such responsibility, what kind of money are 0:14:44.880 --> 0:14:47.720 we talking about that's necessary in order to do the 0:14:47.840 --> 0:14:51.000 right kind of review? You know, it's it's really going 0:14:51.040 --> 0:14:53.520 to take in terms of investment. It's hard to say 0:14:53.560 --> 0:14:56.600 what it would be for a specific company. Certainly would 0:14:56.640 --> 0:14:59.560 depend upon, you know, just the scale at which that 0:14:59.600 --> 0:15:02.480 company operating. You know, for example, my company, right we 0:15:02.560 --> 0:15:06.600 operate all our compute capacity in for example, the Amazon 0:15:06.640 --> 0:15:10.840 Web Services cloud. We've outsourced in a sense that hardware 0:15:10.880 --> 0:15:14.160 security to Amazon and they do a phenomenal job at that. 0:15:14.480 --> 0:15:17.480 But for companies that are still operating traditional data centers, 0:15:17.800 --> 0:15:20.320 it could be a really large and very expensive effort. 0:15:20.520 --> 0:15:23.800 As I mentioned, we know that companies are spending billions 0:15:23.800 --> 0:15:27.280 of dollars on software security, but almost nothing for hardware. 0:15:27.600 --> 0:15:31.120 That's going to need to change quickly. So, just in general, 0:15:31.160 --> 0:15:33.920 from your perspective, how concerned should people be about this 0:15:33.960 --> 0:15:37.400 in a broad level? I mean, I think that the 0:15:37.520 --> 0:15:41.080 at the consumer level, I wouldn't be that concern right now, 0:15:41.120 --> 0:15:45.040 simply because we really don't have specifics of around how 0:15:45.120 --> 0:15:48.240 this may affect a consumer. Now, if I am a 0:15:48.280 --> 0:15:52.320 business owner, if I am protecting very expensive, very sensitive 0:15:52.320 --> 0:15:55.640 intellectual property, if I am a government right we're talking defense. 0:15:55.840 --> 0:15:58.720 I'm very concerned over this, and this is something again 0:15:58.720 --> 0:16:01.120 that's going to require a lot of investment. Again, I 0:16:01.160 --> 0:16:03.680 mentioned that report. This is something that's been around for 0:16:03.720 --> 0:16:06.240 a while. It's not new. It's just the first time 0:16:06.280 --> 0:16:09.680 that this has been brought to such public attention, so 0:16:09.760 --> 0:16:11.240 you know. And the only thing I've mentioned too is 0:16:11.360 --> 0:16:13.600 there's been a lot of academic research on this just 0:16:13.640 --> 0:16:16.080 in the last two years, so the information on how 0:16:16.080 --> 0:16:18.320 to address this is out there. It just seems like 0:16:18.520 --> 0:16:21.640 this may actually be the stimulus to finally get something done. 0:16:21.880 --> 0:16:24.360 Matt ki Audi, thanks very much for being with US 0:16:24.480 --> 0:16:39.000 Vice president chief Information Security officer for Redlock. Tesla has 0:16:39.040 --> 0:16:41.920 been the focus for many who wished to short sell it, 0:16:42.000 --> 0:16:45.360 basically betting on its demise or at least it's swoon, 0:16:45.480 --> 0:16:48.000 and certainly it shares a fall in thirty four percent 0:16:48.200 --> 0:16:51.760 since August seven, so it has been a pretty big swoon. 0:16:52.000 --> 0:16:54.640 But is there more to come here? Molly Smith joining 0:16:54.680 --> 0:16:57.880 US now corporate finance reporter for Bloomberg News Molly, you 0:16:57.920 --> 0:17:00.520 wrote a story that I thought was really important because 0:17:00.680 --> 0:17:03.040 people can talk about the short interest on Tesla, people 0:17:03.080 --> 0:17:06.159 can talk about the business model of Tesla, but really 0:17:06.280 --> 0:17:08.520 what you need to focus on is the debt. Please 0:17:08.560 --> 0:17:11.199 explain why, right, I mean, the debt right now is 0:17:11.240 --> 0:17:14.880 really Tesla's uh, it should be at least their first 0:17:14.880 --> 0:17:18.520 and foremost priority. Right now, everyone's really been looking at 0:17:18.560 --> 0:17:22.679 this million dollar maturity that's coming to in March on 0:17:22.720 --> 0:17:27.080 a convertible bond, and Tesla Elon Musk in particular, has 0:17:27.080 --> 0:17:30.520 said that he plans to repay, not refinance this bond, 0:17:30.640 --> 0:17:33.680 which is pretty strong language, especially given that the company 0:17:33.720 --> 0:17:36.879 had two point two billion dollars of cash as of June, 0:17:37.119 --> 0:17:41.120 so it would, in most analysts and investors opinion, be 0:17:41.280 --> 0:17:44.520 very prudent to do another capital raise or try to 0:17:44.760 --> 0:17:49.480 refinances bond instead of pay it outright. How much debt 0:17:49.600 --> 0:17:52.400 does Tesla have right now at eleven and a half 0:17:52.400 --> 0:17:57.000 billion dollars worth and the likelihood that they would be 0:17:57.040 --> 0:18:01.680 able to raise capital any s demn No, I don't 0:18:01.720 --> 0:18:04.400 think there's any indication right now the capital markets are 0:18:04.440 --> 0:18:08.920 closed to Tesla. The equity valuation is still incredibly strong. 0:18:08.960 --> 0:18:12.760 I mean, thet bllion dollars is still an incredible sum 0:18:13.359 --> 0:18:16.400 regardless of what the debt is trading at. But even 0:18:16.400 --> 0:18:18.720 if you do look at the bonds right now, they're 0:18:18.720 --> 0:18:21.280 trading in line with other triple C rated peers, which 0:18:21.320 --> 0:18:24.399 is what these bonds are rated. They're not showing any 0:18:24.560 --> 0:18:28.280 imminent panic or distress levels. So yes, it would be 0:18:28.400 --> 0:18:31.080 expensive to go that root of an unsecured bond, but 0:18:31.440 --> 0:18:35.000 doing another convertible bond or equity or possibly secured debt, 0:18:35.080 --> 0:18:37.959 those are definitely options that have been raised. So has 0:18:38.000 --> 0:18:42.200 anyone looked at just how much interest they can take on, 0:18:42.280 --> 0:18:44.960 how much how much they can actually afford to pay 0:18:45.000 --> 0:18:49.240 out in interest payments to lure in new investors, given 0:18:49.280 --> 0:18:52.320 the fact that they're burning through cash and they need 0:18:52.359 --> 0:18:56.439 to increase their profitability, their productivity. I mean, they've got 0:18:56.440 --> 0:18:58.520 a lot of needs and wants here and kind of 0:18:58.600 --> 0:19:01.439 does the math work. I haven't seen any numbers that 0:19:01.520 --> 0:19:05.480 actually put out Tesla's interest payment capacity, but that would 0:19:05.520 --> 0:19:07.560 be a really interesting stat to nail down. But that's 0:19:07.560 --> 0:19:10.480 exactly right that there is. There are just so many 0:19:10.560 --> 0:19:13.680 needs that the company has right now, between servicing the debt, 0:19:13.720 --> 0:19:17.040 between funding the operations and are we going to finally 0:19:17.040 --> 0:19:19.520 see positive free cash flow and a profit for the 0:19:19.560 --> 0:19:22.280 first time in this company's fifteen year history. Well, and 0:19:22.320 --> 0:19:24.520 just to put into perspective what we have seen in 0:19:24.640 --> 0:19:28.000 terms of price action on the Tesla bonds maturing in 0:19:28.960 --> 0:19:31.000 they're currently trading at less than eighty four cents in 0:19:31.040 --> 0:19:33.679 the dollar. August of last year, they were trading at 0:19:33.720 --> 0:19:35.240 more than a hundred cents in the dollars. So this 0:19:35.280 --> 0:19:37.359 has been a huge swoon. People are pricing in a 0:19:37.440 --> 0:19:40.240 much bigger risk today, uh than they were a little 0:19:40.240 --> 0:19:42.840 bit more than a year ago, even though in general 0:19:43.119 --> 0:19:46.439 triple c's have actually rallied right right, and at Tesla 0:19:46.520 --> 0:19:49.600 bonds right they were issued at part. They have never 0:19:49.720 --> 0:19:52.680 traded at parts since they were issued. These were fell 0:19:52.960 --> 0:19:55.600 right out of the gates and have been you know, 0:19:55.720 --> 0:19:58.439 I guess, uh whenever there's you know, some kind of 0:19:58.480 --> 0:20:01.320 event that drives the bonds down on maybe a Musk 0:20:01.440 --> 0:20:04.960 tweet or an SEC lawsuit for example, that you've seen 0:20:05.000 --> 0:20:07.080 them go down as low as I think somewhere in 0:20:07.080 --> 0:20:09.560 the two eight three range maybe, but they tend to 0:20:09.600 --> 0:20:13.800 come back into this eight seven level, and that seems 0:20:13.800 --> 0:20:16.919 to be the sweet spot right now, but exactly in 0:20:16.960 --> 0:20:19.240 line with the triple ceas, which, like you said, yeah, 0:20:19.240 --> 0:20:21.280 are the best performing part of the high yield market 0:20:21.400 --> 0:20:25.080 right now. Who owns most of the debt it's not 0:20:25.160 --> 0:20:28.399 institutional hands. I can tell you that every traditional asset 0:20:28.480 --> 0:20:30.439 manager who I've talked to has said they will not 0:20:30.560 --> 0:20:33.920 look at these. They want companies with proven free cash 0:20:34.000 --> 0:20:36.840 flow that they can show ability to service their debt. 0:20:37.080 --> 0:20:40.879 It's mostly short money that's in it. Uh make an 0:20:40.920 --> 0:20:45.040 individual money managers like about Post Group, White Box Advisor 0:20:46.160 --> 0:20:50.920 without naming names. Yeah, alright, so just looking forward, let's 0:20:50.960 --> 0:20:53.000 talk about just how much do they have coming do? 0:20:53.720 --> 0:20:57.199 And you know, has Testla started to have conversations with 0:20:57.280 --> 0:21:00.600 investors about what their potential, uh post abilities are for 0:21:00.680 --> 0:21:03.199 raising additional cash From those that I have talked to, 0:21:03.440 --> 0:21:06.560 it doesn't sound that way, but the company is still 0:21:06.600 --> 0:21:09.320 really maintaining this stance that they're going to be able 0:21:09.680 --> 0:21:12.640 to pay out this bond in March, and there's also 0:21:12.680 --> 0:21:17.439 a maturity do in November on convertible bonds issued by 0:21:17.480 --> 0:21:20.360 Solar City, which these bonds are what we would call 0:21:20.440 --> 0:21:23.480 out of the money, Like there's uh the conversion price 0:21:23.520 --> 0:21:25.960 would be so high for Tesla to be able to 0:21:26.000 --> 0:21:29.040 convert the bonds into stock, that it looks like they 0:21:29.040 --> 0:21:31.720 will have to pay the two million dollars of principle 0:21:31.840 --> 0:21:35.280 outright to holders, just as a quick reality check. Does 0:21:35.480 --> 0:21:38.919 anyone who you speak to believe that Tesla really doesn't 0:21:39.040 --> 0:21:46.239 need to raise additional cash? No? Alright, I mean, but 0:21:46.240 --> 0:21:48.680 then that's telling. I mean basically that that Elon Musk 0:21:48.720 --> 0:21:50.879 is saying we don't need to do it, and not 0:21:51.080 --> 0:21:53.920 one person who has been studying corporate finance for their 0:21:53.960 --> 0:21:57.360 lifetimes believes that that's the case. They will all tell 0:21:57.680 --> 0:22:01.480 Some will tell you definitely. I've definitely heard people say, yes, 0:22:01.560 --> 0:22:04.760 they have the money to pay the maturities to do 0:22:04.840 --> 0:22:07.960 what they say they can do. Is that a wise move? 0:22:08.080 --> 0:22:11.480 Is that what they should be doing? No, everyone will 0:22:11.480 --> 0:22:15.280 tell you no. Well done. Thanks very much for being here. 0:22:16.000 --> 0:22:19.399 Molly Smith our expert for all things related to the 0:22:19.440 --> 0:22:22.880 debt markets and of course talking about Tesla and it's debt, 0:22:23.119 --> 0:22:27.600 and you can follow Molly Smith on Twitter at Molly 0:22:27.600 --> 0:22:41.760 Smith News. Our next guest is Jim Paulson. He is 0:22:41.800 --> 0:22:44.840 the chief investment strategist for the Luthhole Group, helping to 0:22:44.880 --> 0:22:49.320 manage nearly one and a half billion dollars based in Minneapolis. Jim, 0:22:49.359 --> 0:22:51.719 I want you to define a couple of terms for us. 0:22:52.040 --> 0:22:56.320 Let's begin with toggle switch. What's a toggle switch? When 0:22:56.400 --> 0:23:00.520 it comes to Wall Street? Well, damn us to do? 0:23:00.960 --> 0:23:03.840 Um UM. I think people are looking. You know, the 0:23:03.920 --> 0:23:09.520 question everywhere today is what yield level bites stocks? And UM. 0:23:09.560 --> 0:23:11.920 I think people when they look back historically, they go, well, 0:23:12.200 --> 0:23:14.600 let's look back historically. You know, yields had to get 0:23:14.600 --> 0:23:17.000 the five per cent or whatever on the tenure before 0:23:17.040 --> 0:23:20.399 that happens. And I think it's not about a yield level. 0:23:21.160 --> 0:23:25.639 It's about an attitude that develops. And that attitude I 0:23:25.680 --> 0:23:30.280 think is captured by the correlation between stocks and bonds. 0:23:31.040 --> 0:23:35.119