What We’re Reading (Week Ending 24 October 2021) - 24 Oct 2021
Reading helps us learn about the world and it is a really important aspect of investing. The legendary Charlie Munger even goes so far as to say that “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” We (the co-founders of Compounder Fund) read widely across a range of topics, including investing, business, technology, and the world in general. We want to regularly share the best articles we’ve come across recently. Here they are (for the week ending 24 October 2021):
1. The Triumph and Terror of Wang Huning – N.S. Lyons
Wang Huning much prefers the shadows to the limelight. An insomniac and workaholic, former friends and colleagues describe the bespectacled, soft-spoken political theorist as introverted and obsessively discreet. It took former Chinese leader Jiang Zemin’s repeated entreaties to convince the brilliant then-young academic—who spoke wistfully of following the traditional path of a Confucian scholar, aloof from politics—to give up academia in the early 1990s and join the Chinese Communist Party regime instead. When he finally did so, Wang cut off nearly all contact with his former connections, stopped publishing and speaking publicly, and implemented a strict policy of never speaking to foreigners at all. Behind this veil of carefully cultivated opacity, it’s unsurprising that so few people in the West know of Wang, let alone know him personally.
Yet Wang Huning is arguably the single most influential “public intellectual” alive today.
A member of the CCP’s seven-man Politburo Standing Committee, he is China’s top ideological theorist, quietly credited as being the “ideas man” behind each of Xi’s signature political concepts, including the “China Dream,” the anti-corruption campaign, the Belt and Road Initiative, a more assertive foreign policy, and even “Xi Jinping Thought.” Scrutinize any photograph of Xi on an important trip or at a key meeting and one is likely to spot Wang there in the background, never far from the leader’s side.
Wang has thus earned comparisons to famous figures of Chinese history like Zhuge Liang and Han Fei (historians dub the latter “China’s Machiavelli”) who similarly served behind the throne as powerful strategic advisers and consiglieres—a position referred to in Chinese literature as dishi: “Emperor’s Teacher.” Such a figure is just as readily recognizable in the West as an éminence grise (“grey eminence”), in the tradition of Tremblay, Talleyrand, Metternich, Kissinger, or Vladimir Putin adviser Vladislav Surkov.
But what is singularly remarkable about Wang is that he’s managed to serve in this role of court philosopher to not just one, but all three of China’s previous top leaders, including as the pen behind Jiang Zemin’s signature “Three Represents” policy and Hu Jintao’s “Harmonious Society.”
In the brutally cutthroat world of CCP factional politics, this is an unprecedented feat. Wang was recruited into the party by Jiang’s “Shanghai Gang,” a rival faction that Xi worked to ruthlessly purge after coming to power in 2012; many prominent members, like former security chief Zhou Yongkang and former vice security minister Sun Lijun, have ended up in prison. Meanwhile, Hu Jintao’s Communist Youth League Faction has also been heavily marginalized as Xi’s faction has consolidated control. Yet Wang Huning remains. More than any other, it is this fact that reveals the depth of his impeccable political cunning.
And the fingerprints of China’s Grey Eminence on the Common Prosperity campaign are unmistakable. While it’s hard to be certain what Wang really believes today inside his black box, he was once an immensely prolific author, publishing nearly 20 books along with numerous essays. And the obvious continuity between the thought in those works and what’s happening in China today says something fascinating about how Beijing has come to perceive the world through the eyes of Wang Huning…
…Also in 1988, Wang—having risen with unprecedented speed to become Fudan’s youngest full professor at age 30—won a coveted scholarship (facilitated by the American Political Science Association) to spend six months in the United States as a visiting scholar. Profoundly curious about America, Wang took full advantage, wandering about the country like a sort of latter-day Chinese Alexis de Tocqueville, visiting more than 30 cities and nearly 20 universities.
What he found deeply disturbed him, permanently shifting his view of the West and the consequences of its ideas.
Wang recorded his observations in a memoir that would become his most famous work: the 1991 book America Against America. In it, he marvels at homeless encampments in the streets of Washington DC, out-of-control drug crime in poor black neighborhoods in New York and San Francisco, and corporations that seemed to have fused themselves to and taken over responsibilities of government. Eventually, he concludes that America faces an “unstoppable undercurrent of crisis” produced by its societal contradictions, including between rich and poor, white and black, democratic and oligarchic power, egalitarianism and class privilege, individual rights and collective responsibilities, cultural traditions and the solvent of liquid modernity.
But while Americans can, he says, perceive that they are faced with “intricate social and cultural problems,” they “tend to think of them as scientific and technological problems” to be solved separately. This gets them nowhere, he argues, because their problems are in fact all inextricably interlinked and have the same root cause: a radical, nihilistic individualism at the heart of modern American liberalism.
“The real cell of society in the United States is the individual,” he finds. This is so because the cell most foundational (per Aristotle) to society, “the family, has disintegrated.” Meanwhile, in the American system, “everything has a dual nature, and the glamour of high commodification abounds. Human flesh, sex, knowledge, politics, power, and law can all become the target of commodification.” This “commodification, in many ways, corrupts society and leads to a number of serious social problems.” In the end, “the American economic system has created human loneliness” as its foremost product, along with spectacular inequality. As a result, “nihilism has become the American way, which is a fatal shock to cultural development and the American spirit.”
Moreover, he says that the “American spirit is facing serious challenges” from new ideational competitors. Reflecting on the universities he visited and quoting approvingly from Allan Bloom’s The Closing of the American Mind, he notes a growing tension between Enlightenment liberal rationalism and a “younger generation [that] is ignorant of traditional Western values” and actively rejects its cultural inheritance. “If the value system collapses,” he wonders, “how can the social system be sustained?”
Ultimately, he argues, when faced with critical social issues like drug addiction, America’s atomized, deracinated, and dispirited society has found itself with “an insurmountable problem” because it no longer has any coherent conceptual grounds from which to mount any resistance.
Once idealistic about America, at the start of 1989 the young Wang returned to China and, promoted to Dean of Fudan’s International Politics Department, became a leading opponent of liberalization.
He began to argue that China had to resist global liberal influence and become a culturally unified and self-confident nation governed by a strong, centralized party-state. He would develop these ideas into what has become known as China’s “Neo-Authoritarian” movement—though Wang never used the term, identifying himself with China’s “Neo-Conservatives.” This reflected his desire to blend Marxist socialism with traditional Chinese Confucian values and Legalist political thought, maximalist Western ideas of state sovereignty and power, and nationalism in order to synthesize a new basis for long-term stability and growth immune to Western liberalism.
2. It Sounds Crazy – Collaborative Fund
So what happens when the world lurches but opinions lag?
You get situations where what’s true sounds crazy because people’s beliefs haven’t caught up with reality…
…The S&P 500 gained 27% in 2009 – a fantastic return. Yet when asked in early 2010, 66% of investors thought it fell that year, according to a survey by Franklin Templeton. The idea that the market was surging sounded crazy because “the market crashed” was such a powerful narrative after 2008. People just clung to it…
…China’s demographics are so poor it’s going to face labor shortages in the coming years like few other countries have ever dealt with. Its total population is already falling. That sounds crazy because it’s the most populated country on earth and synonymous with rapid growth and endless pools of cheap labor. But its working-age population will decline by more than 20% over the next 30 years.
3. What If Central Banks Issued Digital Currency? – Ajay S. Mookerjee
The impetus for more radical change is coming from China, whose central bank has been running an experiment with a form of cash called Central Bank Digital Currency (CBDC), which it envisions as the cash of the future, ultimately eliminating the need for paper money.
In a CBDC world, the digital code for each virtual currency unit will be held in a digital wallet and transferred seamlessly by the wallet-holder to other people’s digital wallets, very much as we see with today’s fintech and Big Tech digital wallets (think Venmo and ApplePay) and the wallets offered by the traditional banks (such as Zelle, a cooperative of six-banks including Chase, Bank of America, and Wells Fargo). In China, these services will be licensed to four state banks and three telecommunications companies, who will act as wallet distributors rather than cash depositories. Users will scan barcodes on their phones to make in-store payments or send money to other mobile wallets. The People’s Bank of China (PBOC) will periodically receive copies of customer transactions, stored on a mixed central and blockchain database.
The Chinese pilot began with the distribution of 100 million digital Yuan through lotteries in nine cities, including Shenzhen, Suzhou, Chengdu, Xiong’an, and the 2022 Winter Olympics Office Area in Beijing. By the end of September 2021, the digital currency pilot had recorded around 500 million transactions with 140 million users. E-Yuan will be fully rolled out during the Winter Olympics in February 2022, and if bilateral agreements with foreign monetary authorities are reached, tourists and business travelers in China will be able to obtain a Chinese e-wallet on their own phones…
…But China is not the only the only country interested in CBDCs: Sweden, Singapore, and South Korea are among 13 other countries testing pilots. The US is likely to follow suit; the Federal Reserve Bank of Boston, in collaboration with MIT, is currently designing a CBDC prototype. Possibly the US is worried about being left behind and the potential threat from China’s digital Yuan and its potential emergence as the global reserve currency supplanting the US dollar.
Ultimately, the technology underlying CBDCs will be Blockchain, the technology that enables Bitcoin. It consists of time-stamped record blocks with encrypted transaction activity, continuously audited by all verified network participants. Blockchain decentralizes the storage and trustworthy transmission of money. Although Blockchain remains slow and cannot yet support large-scale applications, the technology is expected to mature over the next three to five years and is likely to overcome its limitations. At a certain point, therefore, the existing digital infrastructure will be replaced, which will eliminate the dependence of new entrants on the resources and capabilities controlled by incumbent financial institutions…
…Paper cash is essentially a bearer IOU issued by a central bank, for the bearer to spend (or put under the mattress) at any given time. Today’s digital currencies are predicated on the convertibility of the digital codes issued by commercial banks into paper cash, which is dependent in turn on the commercial bank having paper money on hand to use for the conversion. It’s that link to paper cash that gives the digital currency issued by commercial banks value and makes it safe to use.
But CBDCs are direct liabilities of the central bank, just as paper cash is, which makes CBDCs a safer form of digital money than commercial bank- issued digital money. The situation is equivalent to a scenario in which every citizen has, in essence, a checking account with the Central Bank. Their pay and investment payouts arrive in their central bank accounts, and they can keep cash in there, on which the central bank can, if it chooses, pay interest. Unlike a traditional deposit or checking account at a commercial bank, however, the depositor carries no risk, as a central bank is a sovereign credit, backed, at the end of the day, by the government’s ability to tax, not on a cushion of reserves and equity capital. There are no “runs” on the central bank, which eliminates the necessity of protecting depositors from bank runs through insurance plans. And at the level of the overall banking system, all liquidity (and credit) risk are spread across the entire population, not just each individual bank’s depositor base.
4. Skill and Luck – Michael Batnick
Over the last 5 years, Apple is up 430%, more than 3x the return of the S&P 500. If you held Apple over that time, if you didn’t hold a lot of cash, and if you didn’t jump in and out of the market, you probably beat the market by a decent amount.*
How much of this was skill versus luck? I was thinking about this because a reader asked:
Curious to hear your take on beating the S&P index as an individual. The past few years I’ve done pretty well with picking individual stocks, beating the S&P 500 by a considerable amount in my Roth IRA. I’m not sure how much of this is skill, versus me being lucky. Any thoughts on this area? How long of a track record of beating the S&P do you think one would need to have to say you’re good at picking stocks, versus just being lucky? 5 years? 10 years?
Before answering this question, we should talk about the role of luck in stock picking. Michael Mauboussin, the author of the best book written on this topic, put it well. He says:
“There’s a quick and easy way to test whether an activity involves skill. Ask whether you can lose on purpose.”
5. The Death and Birth of Technological Revolutions – Ben Thompson
What was especially remarkable about Carlota Perez’s Technological Revolutions and Financial Capital was its timing: 2002 was the middle of the cold winter that followed the Dotcom Bubble, and here was Perez arguing that the IT revolution and the Internet were not in fact dead ideas, but in the middle of a natural transition to a new Golden Age.
Perez’s thesis was based on over 200 years of history and the patterns she identified in four previous technological revolutions:
- The Industrial Revolution began in Great Britain in 1771, with the opening of Arkwright’s mill in Cromford
- The Age of Steam and Railways began in the United Kingdom in 1829, with the test of the ‘Rocket’ steam engine for the Liverpool-Manchester railway
- The Age of Steel, Electricity and Heavy Engineering began in the United States in 1875, with the opening of the Carnegie Bessemer steel plant in Pittsburgh, Pennsylvania
- The Age of Oil, the Automobile, and Mass Production began in the United States in 1908, with the production of the first Ford Model-T in Detroit, Michigan
- The Age of Information and Telecommunications began in the United States in 1971, with the announcement of the Intel microprocessor in Santa Clara, California
Perez’s argument was that the four technological revolutions that proceeded the Age of Information and Telecommunications followed a similar cycle:
6. Sam Bankman-Fried – Creating a Perfect Market – Patrick O’Shaughnessy and Sam Bankman-Fried
[00:37:33] Patrick: So you came late to this ecosystem, and I don’t mean the word mercenary in a negative way at all, but in a world that was previously filled with so many pure missionaries, like zealots for crypto as the solution to everything, which I wouldn’t characterize you as that. Because you had this late, relatively speaking late, and pragmatic view on this entire space. What has you so excited? Why have you devoted your time and attention, which we talked about at the beginning, you’re allocating meaningfully for some larger goal. What is it about this ecosystem that has attracted you and so many other talented people, and do you anticipate staying in it a long time?
[00:38:11] Sam: There are a bunch of things leading to that. First of all, just huge, huge demand in this space and not enough supply. And I need that on many levels. I’ve met that historically in terms of buying versus selling crypto currencies. It’s still today the case that one thing you can look at for instance, is, I don’t know, on FTX, which is the crypto exchange I started, we have a [bought] borrow lending book, where there’s market forces determining the interest rates of the various assets. And right now, if you want to borrow a Bitcoin, which you can use to short sell, you’re paying a little bit less than a percent a year in interest. Then there’s $700 million of open interest there. If you want to borrow a dollar, which you could use to get long crypto, you’re paying 10% a year, and there is $2 billion of open interest.
So this is still the case today that there’s more demand to buy cryptocurrency than there is supply of dollars in the space to buy cryptocurrency. But I also mean this in terms of infrastructure, there’s huge demands being placed on all the infrastructure in crypto and not enough supply of great infrastructure. And that ratios off by a sort of a comical amount, especially rewind a few years, exchanges were crashing daily because they couldn’t handle the load, risk engines were incinerating a million dollars a day of customer funds because they couldn’t margin call on time. It was a total fucking mess because it was massive, massive interest, demand, excitement, capital volume in the crypto industry. And it just hadn’t had time to mature enough for the infrastructure to catch up with that. So one part of this is just like business opportunity. It seems like there’s a lot of demand for a new business here and someone’s got to do it.
And it didn’t seem like the existing players were going to get their act together. Another piece of this is, you pointed this out, when I first tried to do a crypto trade, the hardest part of the crypto trade was the wire transfer. And I think that’s super instructive for me. I think what it sort of made me think was, wow, the existing financial infrastructure we have has some issues.
[00:40:10] Patrick: Sucks.
[00:40:12] Sam: Somehow, despite the fact that this space seems like a total shit show, it still is actually easier to use than a bank. And there’s obvious ways to make this space a lot more efficient. And so it just sort of felt like, yeah, boy, payments must be real bad. And when you sort of start to dig into it, it’s like, yeah, they are. We often don’t notice it, but we’re bleeding 3% of our GDP each year to payments. Every time you go to a supermarket and buy a banana, you’re paying 3% to a credit card company to cover up the fact payments don’t really work. You’re trying to wire money to Nigeria, you’re losing tens of percents. And I think that there’s just substantial opportunities to start fresh, the natively digital and natively online approach. The nice thing about decentralized lectures is that it allows international cooperation, it allows cooperation between companies on sending value between each other. There’s a lot of economic opportunity in crypto rails. And when you look at the potential of something like DeFi, here’s one cool thing you can do with DeFi. You could put social networks on chain.
What does that mean? It means you build a protocol on chain for sending encrypted messages. Maybe they’re DMs, maybe they’re public, depending on whatever setting you choose. Every social network could draw from that same protocol, that same set of messages. What that means is that if you tweet, someone else can like it on Facebook, because they’re both accessing that same underlying set of messages and that same underlying protocol, that’s extremely valuable. It solves this network issue where no one wants to use a social media company and tell all their friends are using it. So it makes them interoperable with each other. And it also allows cool approaches to censorship, have a permissionless underlying protocol layer, and then anyone can build their own user interface on top of that and can make their own decisions about whether to censor it.
And if you’re sort of upset with the censorship level on some platform, you can start your own and you already have access to all the messages that are floating through there. So I think that sort of like is another example, a pretty cool application of blockchain tech, which I think could actually be better than the existing products, but would take a lot of work to build out…
…[00:47:25] Patrick: How do you think about the centralized nature of most regulation historically that it’s far easier to regulate, say, bank charters and a limited number of them, than a decentralized ledger and the decentralized ledger provides so many of the interesting properties. There’s this weird tension here between what you can regulate, whether it’s the exchanges or the wallets, or whatever it might be, what the right point is, that seem to naturally have to then centralize versus the benefits of a decentralized ledger. How do you square this circle in terms of innovation?
[00:47:56] Sam: I have some thoughts, but I don’t know what the answer will ultimately be. And I do think that’s something that regulators are very much struggling with and trying to figure out how to approach, what could you do there? Well, here’s one example. I think a reasonable thing to do is to try to find strategic parts of the ecosystem, to put the bulk of the regulation in. And as an example, I think centralized exchanges and anyone who’s running a fiat to cryptocurrency conversion business is a really good place to start looking for, at the very least, anti-money laundering, anti-financial crimes regulation, and also market integrity regulation and things like that. I think with stablecoins, I don’t know what the perfect approach is. Here’s something which I think would be a substantial step forward from where we are. On the regulatory side without endangering the product would be a registration regime based around reporting and transparency, where you have to say exactly what assets you’re holding.
And there have to be QI audits confirming that, and you have to have policies around redemptions and honoring those, and maybe some blacklist for addresses known to be associated with financial crimes. Maybe the assets have to be held in a US bank account, some sort of regime like that, which I think would address a lot of the consumer protection and financial crimes worries that exist with some regulararies, with stablecoins, while still allowing the space to thrive. And I think that I almost explicit what we want to say. I don’t know what the perfect thing is. I sort of think that’s a really hard question and it depends on how the space develops over time, and rather than shooting for the perfect here, I think the right thing to do is take steps in the right direction. Start to build out frameworks that protect consumers, that prevent financial crimes without killing the industry, start with that, take steps forward.
And then yeah, in three years, maybe there’s going to be a second round of things. With a regime like that with stablecoins, that addresses most of the large points of concerns while allowing USD stablecoins to thrive, which I think is really valuable from the economic efficiency perspective for the crypto ecosystem. Also, frankly, for like dollar dominant. There are going to be stablecoins in the world. And if you ban USD stablecoins, then it’s going to be Euro coins or be CNY stablecoins. It’s not a question of whether there will be stablecoins. It’s a question of which country they come from and which currency they’re backed by.
7. Investor perspectives on pre-crisis Asia – Michael Fritzell
Claire Barnes’s book Asia’s Investment Prophets is a historical document.
It was written in 1994 and published in 1995, just before the Asian Financial Crisis. Since it’s now out of print, it’s difficult to find and costs US$189 on Amazon. So to spare you from buying the book, I thought I should give you a summary of the key insights I absorbed from the book.
The book is an Asia 1990s version of The Market Wizards. It features 16 interviews with famous fund managers at the time, as well as a profile of an insurance company operating in Hong Kong at the time (I left this part out of my review below as I thought it didn’t add much value).
What makes the book special in my view is not just the historical perspective, but also the fact that it was written right before the Asian Financial Crisis in 1997. Some cautious investors saw the crisis coming and hedged themselves appropriately. Others bought into the hype.
I also tried to track down every investor featured in the book by Bloomberg, Google and other public sources to see where they are today. Some investors remain successful even today. And many of those who suffered excessive drawdowns didn’t live to see another day.
This is the story of 16 investment prophets on the cusp of one of the greatest financial crises the world has ever seen.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. Of all the companies mentioned, we currently have a vested interest in Apple and Facebook. Holdings are subject to change at any time.
