Q&A With Peter Zeihan: Part 2 – China, North Korea And Trump

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We met with Geopolitical Strategist Peter Zeihan for a quarterly update right before the French presidential elections. In addition to calling Macron’s win, Peter outlined the three most important geopolitical shifts for US financial advisors to watch in the coming months. In order of priority:

  • What’s next for Brexit? This is important because the UK’s moves are the most public and also the most likely to nudge talks on the European Union one way or another.
  • This fall, China will choose its future leaders. It’s time to really start watching the leadership transition in China because this will be the main driver of Xi’s policy: everything else is a subset.
  • The U.S. and President Trump: We’re all guessing at this point, and the president is involved in both of the above topics.

We’ve split the interview into two parts. Last week, we shared part 1, our Q&A with Peter on recent developments in Europe and what’s next for Brexit and the European Union. Today we share part 2, covering China, North Korea and the United States. Recent moves by President Trump on each of these topics appear in both. We hope you enjoy the discussion. Please send questions you would like us to ask Peter next time to [email protected].

KLC:What’s the US plan in North Korea, is President Trump trying to do another Syria?

Peter Zeihan: Theintelligence community’s best guess on North Korea goes back to 1993. Kim Il-sung, the grandfather, fought the Japanese and founded North Korea. Kim Il-sung slipped in the shower and fell on some bullets. Our best guess is that he was killed by his own people, because three days later, he was supposed to be in Seoul working out the practical mechanics of the reunification of Korea. Because Tiananmen Square had come and gone, and the Soviet Union had just collapsed a year earlier, they realized that their system was not going to work. Kim Il-sung was trying to figure out the replacement system, so his generals killed him, because they knew that would mean the end of their position. Because you don’t need an extra million man army in a reunified Korea. So, Kim Jong-Il took over. He was nuts. He was raised in North Korea, grew up drinking the Kool-Aid and ran the country into the ground. His whole generation did, and created the famine that killed three million people. So the generals decided to take the third generation –that whole cadre –and send them abroad to study, so they can find out how the world really works. Kim Jong-un, the current leader, went to school in Switzerland with a friend of mine. The problem was Kim Jong-ildied too soon, and Kim Jong-un was brought back to lead the country. He was only 23, and he wasn’t finished, none of the third generation was prepared to take over. But the first generation couldn’t take the second generation anymore, so they ejected the second generation from power and put the third generation in to run the place. Now if you’re Kim Jong-un, you’re in the worst job ever. The first generation will kill you if you move too fast, and the second generation wants you dead now. So you purge members of the second generation whenever you have the opportunity. Then at some point, you have to have a Night of the Long Knives, when you kill everybody who’s left in the first and second generation on the same day. And if you miss one, you’re dead. So what to do? You appear erratic. You bomb a South Korean town, you sink a South Korean ship, you make everybody think that you’re crazy. The only way he can stay alive is to be unpredictable. This is internal crisis management. This is what dynastic secession looks like. Because everybody’s spies have been killed, nobody really knows for sure what goes on in North Korea, but this is the best guess. It fits the facts, but that doesn’t mean it’s true. So now, the best guess is Kim Jong-un is willing to throw things abroad in order to keep his internal situation manageable.

KLC: So then why does President Trump want to insert himself as the enemy with that internal dynamic is going on?

Peter Zeihan: There’s the strategic argument. This has been simmering since the 70s. There are 70,000 artillery pieces filled with incendiary weapons pointed at Seoul. And by the time the first shell lands, there would be a million shells in the air. That’s 10 million people dead in 24 hours, and the US has just been kicking the situation down the road. So finally finding some way to actually close this down, there’s a real strategic justification for the US to end this somehow. Second, as Kim Jong-un has made his regime seem more and more erratic, the Chinese feel like they’ve lost control. The last major diplomat to be killed in North Korea was Chinese. Until then the Chinese were convinced that they knew what was going on, but then Kim Jong-un killed him. Now the Chinese don’t even have one hand on the wheel any more, but they are the primary outside power that is supporting North Korea. Trump has figured out that the Chinese are as upset with North Korea as the United States is, and that’s an opportunity. So, when Xi was in Florida, he said, if you help us with this, we can talk trade. Not a bad plan.

KLC: What would be markers of progress in North Korea?

Peter Zeihan: The Chinese have done more in the last two weeks than they’ve done in the last 30 years. They shut off the coal exports from North Korea, for one, and the Chinese actually use that coal, in their steel industry. So they’re actually bringing levers to bear. Whether it’s going change the view in Pyongyang is another topic. They sent their top nuclear negotiator when we had the rumors of the USS Carl Vinson already being there. He went there to basically convince the North Koreans that it’s for real this time. How much impact any of that has had, I don’t know. As far as how the US responds, it all comes down to what the Chinese are doing, and how the Trump administration views it. Everything comes down to that, and I just don’t know. It’s all behind the scenes.

The dream scenario for me, as a modern American nationalist that would actually like to see world peace one day, is that the Chinese and the Americans threaten North Korea at the same time. My guess on what will actually happen is the Chinese will sufficiently talk down the North Koreans to make real moves that the IAEA (International Atomic Energy Agency) can confirm on the nuclear program, because the Chinese have already committed to eliminating the nuclear deterrent in Korea. That’s not something that I think that the Trump administration will let them go back on. If you can do that, and if you can just move them away from weaponization, I think that’ll put this back in the box for now. That allows everybody to declare a win. North Korea still exists, the Chinese were the honest broker, and Trump got something that he wanted.

KLC: Let’s talk about China, which appears to have been doing a lot of government spending over the last year.

Peter Zeihan: From what I can tell, they’re trying to make some meaningful shifts in their financial sector. But they’ve lost control of the banks, so the banks are going deeper and deeper into the shadow sector, and the authorities are having a hard time following. For example, there was a while, late last year, where all the rage for getting money out of the country was Bitcoin. Then the government showed that it was perfectly capable of shutting Bitcoin down, and we saw something like an 80% reduction in Bitcoin trade in China in a 1-week period. The regulators have gotten into the financial sector, and they’re trying to channel the money a lot more effectively, and they’re having the same problem they’ve always had. They don’t want to loosen credit in the aggregate, because they don’t want to deal with the political instability that would come from it, but they want to make sure they at least have a good understanding of where the money is going, so they can divert it as necessary. They’re having less success than ever, but they don’t want to bring out the really big hammers, because of the political side of the equation. We have the Party conference this fall, and this is where Xi will either appoint his successor or not, and my bet is that he will not. So he doesn’t dare have an economic upheaval right now. In my opinion, he’s preparing to shut China off from everybody else. It’s like the financial sector has added so much credit in the last six years that it’s just egregious even by Chinese standards. They’ve now lost control of even the Chinese state banks, much less the smaller and mid-tier banks.

KLC: If the Chinese are about to close off their economy, where’s the motivation to come make a trade deal with President Trump?

Peter Zeihan: Trump has the ability, with a trade war –with not even a big trade war –to throw the entire Chinese political and economic system into disarray. So, Xi’s feeling very vulnerable. He’s seeing the regional splits getting heavier. The Hong Kong protests have not gone away, they’ve spread. The financial system is spinning out of control. It hasn’t led to any sort of broad scale meltdowns right now, but I think the new estimates from international financiers are that the NPL ratio is probably around 20%. The Chinese will not retreat from trade if they have an option, but when it comes to the point of making a choice between trade and political unity, they’ll choose political unity. And in Xi’s best case scenario, he’s able to at least have a meaningful, not hostile relationship with Trump. He doesn’t think they can handle a political transition right now, and that’s probably correct. So he will transition to himself, and he will be the president for at least another 10 years, as opposed to the five that have been penned in so far. Xi hopes relationships around the world, particularly with the United States, don’t go completely off the rails, and that China continues to grow, continues to develop the interior, and develop that consumer market economy they’ve now been talking about for 25 years. Maybe this will be the magic 5-year period where it finally happens. None of the data is pointing in that direction, in my opinion, but it’s good to have dreams. And if that doesn’t happen, then he’s completely consolidated the political system, and he and the Party hopefully can survive the crash.

KLC: Survive a Chinese banking crisis, you mean?

Peter Zeihan: I hope it’s just a banking crisis. If some of my other fears are correct, a real estate crisis, the trade breakdown, supply chain breakdowns and war with Japan. All of that can theoretically be addressed by him continuing this hypercentralization. China wants to be able to restrict credit without crashing the economy, and that requires funneling the credit to more productive purposes. The traditional Asian development model, it’s all about throughput, rather than profit. They’re trying to, in bits and pieces, for all the right reasons, get away from that. But every time they do, their tools are so blunt, that they risk derailing growth. Which risks derailing public stability.

Peter Zeihan China, North Korea And Trump

KLC: How do you think Silicon Valley is adjusting to President Trump?

Peter Zeihan: Trump and Elon Musk seem to be getting along great. There are political protests going on in Silicon Valley, of liberal stalwarts, trying to help, or trying to lead efforts to convince investors to divest, of all things, Solar City, and Tesla, because Musk is clearly an evil collaborator now. Teslasare built 100 percent in the United States, so Trump loves him. While Musk might not like Trump’s politics, if the president likes what you’re doing, you should probably take his phone calls, so they’ve got a great relationship now. The rest of the tech sector is a whole different world. Silicon Valley is a fairly liberal bastion, and they’re trying to figure out, how do we stand up to Trump without pissing off half the population? Silicon Valley has not been high on Trump’s to-do list so far. He’s got plenty of other things to wrestle with.

KLC: Are you watching any new developments in shale?

Peter Zeihan: The newest thing in shale is DNA. As it’s been explained to me, you go through the drill tailings and the mud that comes up, and you test the fossilized critter DNA to help you figure out, specifically, what type of petroleum is stuck in the deposit, so you can change your frack fluid based on that. Supposedly it can drop production cost by 5-10 percent. Now, whether it works, whether it can be carried out on an industrial scale, I think it’s far too soon, but, as a chemist, I think it’s interesting. They keep coming up with new tricks.

Peter Zeihan China, North Korea And Trump

KLC: Any other pockets of innovation you are watching?

Peter Zeihan:In automotive, I think we’ve seen some of the supply chains constrict in Asia. Mexico has been pretty aggressive in going out and trying to prove to the Americans that they’re absolutely essential to the North American supply chain system, which they are. They’re going out and trying to attract further investment in Mexico. It’s actually fairly clever. Here’s how it works. Let’s say that you build the engine block in Canada, you build the frame in the United States, you build the wheels in the United States, and you build the mirrors in Malaysia. The Mexicans go out and get the mirrors moved to Mexico. They’ve had some meaningful successes. Remember thereare 30,000 pieces in a car, so whether this is a trend that will hold, who knows. But whenever we finally do get that summit between the Mexican president and the American President, they’re going to have a lot more on the table because Mexico now has something to offer and will displace or replace the Asian supply chain, which would be more in our interests anyway.

KLC: What are your thoughts on the Trump administration, 100 days in?

PZ: I’m starting to get really worried about the tax reform program, because this is something that Representative Ryan has been working on for six years, and he apparently doesn’t have anything ready to go. That’s a problem. Now, I realize that they have to make it revenue-neutral in order to get past the filibuster. And it could just be that.But Ryan was very clear that this was tax reform of the code, of a scale that we have not seen since the first Reagan administration. And it’s desperately needed. But we should’ve seen a plan by now. Reform is one of those things that creates winners and losers. Simply cutting taxes, and potentially having a bigger budget deficit, doesn’t appear to create a loser, except for the next generation who will have to service those debts. And the president doesn’t want to appear to create a loser. I’ve always thought that we were going to have bigger deficits under Trump. I’m surprised we haven’t seen more of that. The path of least resistance, that’s definitely where we are now. This is a freshman president that has no one on his cabinet who’s been in government before. That takes us one direction. The last government was a freshman president who had no one on his cabinet who had been in the private sector before. We’re seeing the two extremes. Neither of them work very well.

KLC: What’s going on in Washington on the regulatory side?

Peter Zeihan: Regulations are getting gutted and torched left, right, and center. It’s pretty straightforward. Anything that the Obama administration put in place during its last eight months, one act of Congress, which has already passed, basically puts it all in abeyance, and it can just be plucked. It is being plucked. The last eight months of regulations are going to be shredded over the course of the next few weeks.

Technically, there’s a review period where people can make comments, but that’s a formality at this point, because they were never actually implemented. There’s a second stage for regulations that were in the final process of being implemented. Those have been held in abeyance, and also are getting gutted. They can’t be struck off the books in the next six months, but they can in the next year.

KLC:Like the Department of Labor rule for the finance industry?

Peter Zeihan:Yes, exactly, that’s one. There’s another on natural gas flaring, which is big with the energy sector. All of those may go away unless Trump decides he wants to tweak them and put his own stamp on them, which he can. Then there are all the other regulations that Obama put in place during his first six years. For those, you actually have to go through a review process, but because none of them require acts of Congress, the cabinet heads can choose to interpret the review process however they want.

My bet is they’ll all be gone within two years. In the meantime, the President is just not enforcing any of them. So from a regulatory point of view, we already have taken a 10-year step back. The only question is, how fast does it get codified?

KLC: How does that work, if the President decides to instruct an agency like the EPA not to enforce rules?

Peter Zeihan: The first regulation was on Obamacare, and President Trump’s instruction was that whenever there is a split between enforcement of the regulation and the interest of the citizen, and you have any leeway, you are always to side with the citizen. So he’s basically applied that principle writ large across the entire sector. In places where there’s a problem with a lack of leeway, he’s just gutted the agency. This is why we’ve got that 30 percent reduction in the EPA’s funding for this coming year, and then probably another 60 percent next year.

KLC: What do you think of Trump’s relationship with Janet Yellen?

Peter Zeihan: It seems to be warming quickly. I’m not saying she’ll be reappointed, but that relationship seems to be going quite fine. I think Yellen is concerned about a deficit-enhancing tax cut, and what that would force her to do with interest rates, but I don’t think that is what President Trump is thinking. He’s not shy when he has an opinion, and he just hasn’t said much about monetary policy at all. We’re at the end of an 8-year expansion, tightening policy makes sense for a mix of reasons. Economic growth can be constrained or empowered by different factors, and Yellen, now, because of the way the balance sheet has been expanded over the last decade, has a lot more options for fine-tuning policy that didn’t exist before 2007. So, she can raise interest rates bit by bit. She can pare back the balance sheet bit by bit. She can do less with asset-backed securities bit by bit, without losing her flexibility. Trump is really only concerned with the headline figures.

Peter Zeihanis the best-selling author of “The Accidental Superpower” and “The Absent Superpower.”

Article by Knowledge Leaders Capital

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