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Viktor Shvets is Macquarie's head of global equity strategy and Asia-Pacific equity strategy.

We recently spoke with him about who, if anyone, can threaten the United States' status as the global economic superpower. 

This is part three of a series. Part one was a discussion on the populism that's sweeping the globe and the role technology has played and part two explored the biggest problem China faces.

This interview was lightly edited for clarity.

Jonathan Garber: What country do you think is the biggest threat to US economic power?

Viktor Shvets: In one of our recent reports, we asked whether China is on the wrong side of history. Let’s just quickly examine what one needs to be successful in five or ten years time?

If we look at the US, is it poor infrastructure or disappearance of supply chains that is holding it back? I don’t believe so. In other words, the US does not need bridges. It doesn't need roads. It doesn't need any of that. Accelerating Acela Express between Washington and Boston by 30 minutes, would that make any difference to productivity? The answer is no, to my mind. The only thing the US needs is to make sure accidents don't happen, so planes don't fall from the sky, to make sure disease doesn't spread, and to make sure that broadband penetration is much better, and the biological and energy footprint that the US generates shrinks over time. Yes, you need to maintain stuff, but that's about all.

The way I look at things, the 19th and 20th centuries were a period when capital was scarce. Capital had to be allocated, had to be rationed. That's why we used to have, and still have, a capital asset pricing model, DCF, and all the rest of it. The 19th and 20th centuries were also a period when most activities were highly capital-intensive: roads, bridges, machinery, etc. Finally, the 19th and 20th centuries were a period when labor input was very important, and you needed to extract maximum hours.

Now, the 21st century is the opposite of that. We're drowning in capital. We don't know what to do with it, although it is misallocated. We have more than enough capital. As I said, we have almost 10 times the value of financial instruments outstanding in the global economy compared to the underlying global GDP of $75 trillion. We have around $700 trillion, or possibly even more depending how you count derivatives, so we have plenty of capital. It's just staying in the cloud of the financial sector. The question is, how do you get it allocated? Capital is no longer a scarce resource. It hasn't been for a while. It's particularly evident in the banking sector, which operates in the cloud itself. That's why returns are coming down. The more capital you add to that cloud, the lower returns you get.

Number one, we have no problems with capital.

Number two, most activities we have today are not capital-intensive at all and deliver almost unlimited scalability. Like I said, look at what Amazon has done to Walmart. Look at how few people those companies, whether it's Google or Amazon, actually employ. It's almost unlimited scale, whereas the 19th and 20th centuries had limitations on scale. The new world is not capital-intensive at all and we have got plenty of capital and it has nowhere to go because we don't actually need bridges and roads, certainly not in developed and also not in quite a few emerging markets as well. 

Number three, the value of labor input is different. It's not about working hours anymore. It's not about working harder. It's about knowledge, brains, connectivity.

If you take those three things together, and say, "is China well-positioned going forward?" Well, Peter Thiel had a terrific phrase, what he called ‘zero to one’ and ‘one to n’. ‘Zero to one’ is brains. ‘One to n’ is your scalability. China is an example of a classic scaling nation. In other words, they take technology and they scale it massively. They scale supply and value chains and scale operations, but zero to one, they're not as good at this stage.

The US on the other hand is very good at zero to one. What the private sector in the US has done over the last several decades is that they shipped all the dirty stuff across to places like China, Thailand, Malaysia, Mexico, and that's where I think the current discussion is getting it wrong. Corporates in the US sent manufacturing, supply, and value chains away over the last 20 or 30 years.

It had several impacts. Number one, we have pollution in Beijing but not in Washington. The other impact, of course, is that American corporates have become very cash flow generative. They generate huge cash flows because all the investment and dirty stuff have been shipped away. Corporates ended up being very light and hence free cash flows went up, and that's why SPX or the S&P is trading at such high levels.

The US is now much better positioned in ‘zero to one’ rather than ‘one to n’, while China is very much positioned in ‘one to n‘. Gradually value is gravitating towards ‘zero to one’, not ‘one to 10’ or ‘one to n’. In other words, the most value is shifting towards the brains, not scalability. If that's the case, is China on the wrong side of history? The answer is maybe, "Yes, they probably are, unless they manage to restructure," and that's what we addressed in the report, regarding the topic of rebalancing and how can China rebalance and how it can move towards ‘zero to one’?

When people say that the US is finished, I think they're just operating in an industrial-era mentality, where you needed to have scalability, you needed to have supply and value chains. That is not the world over the next decade.

I think the US is actually much better positioned in the right areas. I think forcing people to relocate factories, whilst understandable from a political perspective, is harking back to an era that has no relevance to what's going to happen going forward.

Unless the US were to shoot itself in the foot, which is possible, I actually think the US is very well positioned for the coming decades, and what people will discover is that the value and supply chains that countries like China have nurtured and built up will deteriorate in value. In other words, we don't need those supply and value chains anymore.

A classic example, you mentioned robots, but the same can be argued about 3D printing. If General Electric can print the entire engine in one room, why do they need suppliers of blades, for example? If Adidas and Nike can build robotic factories in Germany or the US (by the way employing almost no incremental labor), do we need Vietnam when the marginal cost is going to be lower than employing people and constructing and shipping stuff around?

That's part of the reason why merchandise trade is not recovering. We don't need as much shipping anymore. We don't need as many moving parts in every product and neither do we need to manufacture products the same way as we would have done 25 or 50 years ago. The offshoring trend started in the 1980s and most of the US supply and value chains left the US, hence aggravating wealth and income inequalities whilst also causing some regional anomalies. But now it actually positions the US well for the next decade, whereas people who took away supply and value chains are probably facing declining values. By the way, nobody took supply chains away. It's the US corporates who made a rational judgment that that is the way to go forward.

That's also a reason US corporates have not been investing in non-residential private fixed asset investment. They could have borrowed as much as they wanted at zero for years. Why didn't they invest? The answer is, we don't need those investments anymore. That's not what drives you forward. On balance, therefore, I am not in the camp who would argue that the US will cede its dominance and I am not convinced that this coming century is going to be an Asia-Pacific century. Having said that, I do think that popular angst is legitimate, and whether it is the US, UK, eurozone, China or Japan, there is an urgent need to change current income distribution and welfare policies. In many ways, current welfare systems (with some subsequent modifications) were designed by Bismarck of Imperial Germany in the 1870s-80s. It was designed for an industrial age and not for the forthcoming age of unlimited scale.

SEE ALSO: The rise, fall, and comeback of the Chinese economy over the past 800 years

Join the conversation about this story »

NOW WATCH: Here's how to use one of the many apps to buy and trade bitcoin

Viktor Shvets is Macquarie's head of global equity strategy and Asia-Pacific equity strategy.

We recently spoke with him about who, if anyone, can threaten the United States' status as the global economic superpower. 

This is part three of a series. Part one was a discussion on the populism that's sweeping the globe and the role technology has played and part two explored the biggest problem China faces.

This interview was lightly edited for clarity.

Jonathan Garber: What country do you think is the biggest threat to US economic power?

Viktor Shvets: In one of our recent reports, we asked whether China is on the wrong side of history. Let’s just quickly examine what one needs to be successful in five or ten years time?

If we look at the US, is it poor infrastructure or disappearance of supply chains that is holding it back? I don’t believe so. In other words, the US does not need bridges. It doesn't need roads. It doesn't need any of that. Accelerating Acela Express between Washington and Boston by 30 minutes, would that make any difference to productivity? The answer is no, to my mind. The only thing the US needs is to make sure accidents don't happen, so planes don't fall from the sky, to make sure disease doesn't spread, and to make sure that broadband penetration is much better, and the biological and energy footprint that the US generates shrinks over time. Yes, you need to maintain stuff, but that's about all.

The way I look at things, the 19th and 20th centuries were a period when capital was scarce. Capital had to be allocated, had to be rationed. That's why we used to have, and still have, a capital asset pricing model, DCF, and all the rest of it. The 19th and 20th centuries were also a period when most activities were highly capital-intensive: roads, bridges, machinery, etc. Finally, the 19th and 20th centuries were a period when labor input was very important, and you needed to extract maximum hours.

Now, the 21st century is the opposite of that. We're drowning in capital. We don't know what to do with it, although it is misallocated. We have more than enough capital. As I said, we have almost 10 times the value of financial instruments outstanding in the global economy compared to the underlying global GDP of $75 trillion. We have around $700 trillion, or possibly even more depending how you count derivatives, so we have plenty of capital. It's just staying in the cloud of the financial sector. The question is, how do you get it allocated? Capital is no longer a scarce resource. It hasn't been for a while. It's particularly evident in the banking sector, which operates in the cloud itself. That's why returns are coming down. The more capital you add to that cloud, the lower returns you get.

Number one, we have no problems with capital.

Number two, most activities we have today are not capital-intensive at all and deliver almost unlimited scalability. Like I said, look at what Amazon has done to Walmart. Look at how few people those companies, whether it's Google or Amazon, actually employ. It's almost unlimited scale, whereas the 19th and 20th centuries had limitations on scale. The new world is not capital-intensive at all and we have got plenty of capital and it has nowhere to go because we don't actually need bridges and roads, certainly not in developed and also not in quite a few emerging markets as well. 

Number three, the value of labor input is different. It's not about working hours anymore. It's not about working harder. It's about knowledge, brains, connectivity.

If you take those three things together, and say, "is China well-positioned going forward?" Well, Peter Thiel had a terrific phrase, what he called ‘zero to one’ and ‘one to n’. ‘Zero to one’ is brains. ‘One to n’ is your scalability. China is an example of a classic scaling nation. In other words, they take technology and they scale it massively. They scale supply and value chains and scale operations, but zero to one, they're not as good at this stage.

The US on the other hand is very good at zero to one. What the private sector in the US has done over the last several decades is that they shipped all the dirty stuff across to places like China, Thailand, Malaysia, Mexico, and that's where I think the current discussion is getting it wrong. Corporates in the US sent manufacturing, supply, and value chains away over the last 20 or 30 years.

It had several impacts. Number one, we have pollution in Beijing but not in Washington. The other impact, of course, is that American corporates have become very cash flow generative. They generate huge cash flows because all the investment and dirty stuff have been shipped away. Corporates ended up being very light and hence free cash flows went up, and that's why SPX or the S&P is trading at such high levels.

The US is now much better positioned in ‘zero to one’ rather than ‘one to n’, while China is very much positioned in ‘one to n‘. Gradually value is gravitating towards ‘zero to one’, not ‘one to 10’ or ‘one to n’. In other words, the most value is shifting towards the brains, not scalability. If that's the case, is China on the wrong side of history? The answer is maybe, "Yes, they probably are, unless they manage to restructure," and that's what we addressed in the report, regarding the topic of rebalancing and how can China rebalance and how it can move towards ‘zero to one’?

When people say that the US is finished, I think they're just operating in an industrial-era mentality, where you needed to have scalability, you needed to have supply and value chains. That is not the world over the next decade.

I think the US is actually much better positioned in the right areas. I think forcing people to relocate factories, whilst understandable from a political perspective, is harking back to an era that has no relevance to what's going to happen going forward.

Unless the US were to shoot itself in the foot, which is possible, I actually think the US is very well positioned for the coming decades, and what people will discover is that the value and supply chains that countries like China have nurtured and built up will deteriorate in value. In other words, we don't need those supply and value chains anymore.

A classic example, you mentioned robots, but the same can be argued about 3D printing. If General Electric can print the entire engine in one room, why do they need suppliers of blades, for example? If Adidas and Nike can build robotic factories in Germany or the US (by the way employing almost no incremental labor), do we need Vietnam when the marginal cost is going to be lower than employing people and constructing and shipping stuff around?

That's part of the reason why merchandise trade is not recovering. We don't need as much shipping anymore. We don't need as many moving parts in every product and neither do we need to manufacture products the same way as we would have done 25 or 50 years ago. The offshoring trend started in the 1980s and most of the US supply and value chains left the US, hence aggravating wealth and income inequalities whilst also causing some regional anomalies. But now it actually positions the US well for the next decade, whereas people who took away supply and value chains are probably facing declining values. By the way, nobody took supply chains away. It's the US corporates who made a rational judgment that that is the way to go forward.

That's also a reason US corporates have not been investing in non-residential private fixed asset investment. They could have borrowed as much as they wanted at zero for years. Why didn't they invest? The answer is, we don't need those investments anymore. That's not what drives you forward. On balance, therefore, I am not in the camp who would argue that the US will cede its dominance and I am not convinced that this coming century is going to be an Asia-Pacific century. Having said that, I do think that popular angst is legitimate, and whether it is the US, UK, eurozone, China or Japan, there is an urgent need to change current income distribution and welfare policies. In many ways, current welfare systems (with some subsequent modifications) were designed by Bismarck of Imperial Germany in the 1870s-80s. It was designed for an industrial age and not for the forthcoming age of unlimited scale.

SEE ALSO: The rise, fall, and comeback of the Chinese economy over the past 800 years

Join the conversation about this story »

NOW WATCH: Here's how to use one of the many apps to buy and trade bitcoin

• The tax could come in a broader tax reform bill and would be used to help pay for a border wall
• However, American consumers and companies may end up actually paying the tax
• The tax might not improve the US trade deficit as other countries respond

On Thursday, President Donald Trump and his administration debuted a series of new economic talking points on trade.

Trump, in a speech to Republican lawmakers in Philadelphia called for a change in the tax code to reduce trade deficits.

"We’re working on a tax reform bill that will reduce our trade deficits, increase American exports and will generate revenue from Mexico that will pay for the wall if we decide to go that route," said Trump.

White House press secretary Sean Spicer then followed this up with comments suggesting that the Trump administration is considering a 20% tax on imports, starting with Mexico, that would help finance the building of a border wall between the US and Mexico.

"When you look at the plan that’s taking shape now, using comprehensive tax reform as a means to tax imports from countries that we have a trade deficit from, like Mexico," said Spicer. "If you tax that $50 billion at 20 percent of imports — which is by the way a practice that 160 other countries do — right now our country’s policy is to tax exports and let imports flow freely in, which is ridiculous."

While Spicer later clarified that this was one of many options being looked at to pay for the wall, the suggestion set off a firestorm of attention.

The only problem is that Trump's, and later Spicer's, comments paint the picture of an unfocused plan that could do more harm than good if implemented.

For one thing, not everyone is sure exactly what Spicer meant when he was describing his "border tax." Most economic observers took Spicer's language, especially citing the trade deficit, or the difference in imports from and exports to Mexico, and not just raw imports, to mean a border adjustment tax. This is an idea favored by many congressional GOP leaders, but one Trump had previously described as "too complicated."

According to the Washington Post, some Republican lawmakers assumed Trump and Spicer meant a border adjustment tax, but many GOP staffers were unclear on whether that was the case due to Trump and Spicer's vague language.

Spicer, however, did not clarify the comments in a later meeting with reporters and said that the tax was just one possible "option" for making Mexico pay for the wall.

For an economic perspective, let's assume Spicer was talking about a border adjustment tax or BAT.

Spicer's insistence that a border tax would mean that Mexico is "paying for the wall" is hardly correct. While barriers to exporting would certainly hurt the Mexican economy, the actual people footing the bill would be in the US.

Since a BAT is paid for by companies selling goods in the US, these companies would have to either eat the new tax (which is unlikely) or pass the cost onto consumers in the form of higher prices to protect profit margins. Thus, US consumers would end up paying higher prices to fund the tax, not Mexico.

Additionally, since a BAT is a tax on consumption in the US, it would be difficult to have it target one country, such as Mexico. This would imply Spicer was talking about a tariff, since those are more simple to make country-specific.

Republican lawmakers argue that the BAT would offset the price increase since the shift in the trade balance would cause the dollar to strengthen, improving the purchasing power of Americans and scaling back the effect on consumers. A stronger dollar, however, is also consistently the top complaint of S&P 500 companies when they report quarterly earnings, as it makes American-made goods and services less attractive to customers overseas.

The other problem with the GOP proposal is it allows companies to subtract the cost of labor and land, as well as input goods, from the amount that gets taxed.

Economic analysts have suggested that this may violate World Trade Organization standards as it not only incentivizes exports, as many countries' value added tax systems do, but also incentivizes domestic production. Additionally, retaliatory measures from other countries could spark a trade war.

Furthermore, economists seem to think this proposal would cause problems for the US economy.

Michael Gapen, chief economist at Barclays, said the border tax would decrease GDP and compared it to Japan's experience with a value-added tax. From Gapen's note to clients:

"We estimate that a 20% border tax could increase year-over-year rates of core inflation by 0.5-1.0 percentage points and reduce real GDP growth by 1.0-1.5 percentage points. Japan, which raised its VAT by 3pp in 2014, provides a useful case study for comparison. The response of inflation in Japan was consistent with what we would expect for the US. However, the decline in GDP growth was much larger at 4pp (to -1.1% y/y from 3.1% prior to the increase in the VAT), implying significant downside risk to our estimates."

Additionally, Ethan Harris, chief US economist at Bank of America Merril Lynch, noted a BAT may not even decrease the size of the trade imbalance.

"Imposing tariffs, border adjustment taxes, or other protectionist measures will only reduce gross trade flows, without necessarily reducing the US deficit because, as we mentioned above, trade deficits are related to the inter-temporal consumption decision of a country rather than to trade agreements," wrote Harris in a note to clients.

Put another way, countries that see the price of imports go up may simply choose to export elsewhere rather than to the US and also decide not to accept as many US exports. So the impact may be a wash in terms of trade deficits.

Not only that, but many industries that depend on imports have some out against the plan and Goldman Sachs estimated that American companies from Nike to Walmart to Restoration Hardware will see their businesses negatively effected by such a tax.

The fact of the matter is that it is not clear what Trump and Spicer want out of a border tax. Between the muddled messaging and the unclear implications of different policies, the Trump team has a ways to go before they've developed a fully formed trade policy to benefit Americans.

SEE ALSO: Trump press secretary says the administration is considering a 20% border tax on Mexican imports to help pay for the wall

Join the conversation about this story »

NOW WATCH: Here's how to use one of the many apps to buy and trade bitcoin

LONDON — Cryptocurrency bitcoin could be the new gold.

Gold has traditionally been seen as a "safe haven" asset by investors — when uncertainty and risk is high, gold seems like a safe bet. (For a good explanation of why people think this, read our interview with "Made in Chelsea" start-turned-gold miner Francis Boulle.)

Bitcoin, likewise, has attracted investor attention when uncertainty and risk is high. The currency spiked on Donald Trump's shock victory in the US election and bitcoin wallet provider Blockchain had a record month as a result.

"I think the world is starting to realise that, just like gold is a good hedge, bitcoin is a great hedge against the system because it’s outside the system," says Bobby Lee, the CEO and cofounder of BTCC, one of China's three biggest bitcoin exchanges.

"Gold is sort of the hedge against the system, the status quo. Our society is ingrained with the current monetary system of fiat money, where governments issue it, they can put out as much of it as they want. Today’s money system, in a very rude way, it’s no different to airline miles or hotel reward points."

Like gold, cryptocurrency is not controlled by any one central bank or country. The network is instead run by a distributed and dispersed network of computers who do the back office work required to run the system in return for bitcoins. However, the work to earn 1 bitcoin gets harder and harder, requiring more and more computing power.

"The philosophy of bitcoin is that it’s a limited digital asset," Lee says. "There’s only 21 million bitcoin. The smallest amount you can get is not one bitcoin, you can get fractions of bitcoin. But if you own 1 bitcoin or 0.1 bitcoin you’ll forever have that percentage of the world’s supply. No one can dilute you. In that sense it’s very attractive, it’s very unique."

'A much higher percentage of drug trades are done in US dollars'

However, one thing standing in the way of bitcoin becoming a mainstream investment product is its reputation. The cryptocurrency, originally championed by hacking cliques who flew close to anarchism, has an association with the "dark web" and shady forums where drugs, sex, and other illegal products and services are bought and sold.

Lee retorts: "Pay for drugs, hitmen, all the illegal illicit activities — sounds like you’re describing the US dollar. The US dollar is also associated with drugs, drug money, cartels. Sure bitcoin can be used for that, but it can also be used for a lot of good things. I think it's a meta-narrative that’s not factually based.

"I think it's a meta-narrative that’s not factually based. If you want to look at facts, a much higher percentage of drug trades are done in US dollars — both in the number of instances and in the raw amounts. It’s a matter of a narrative."

He turns to metaphor to support his point: "A knife can be used for good things — I’m using it to eat my breakfast — but it can be also used for potentially nefarious activities. It’s how you choose it. You can try to eliminate all knifes and guns but it doesn’t solve the problem of murder.

"Bitcoin — the question is about the causal relationship. Bitcoin itself does not cause drugs trades, just as the US dollar doesn’t. I think it’s more important we focus on the correct narrative — how bitcoin brings value to society. I’m not concerned. I think the truth will prevail. I truly bitcoin has great functionality and great features and it will be recognised for the value it brings to society, rather than any nefarious uses."

China currently dominates the global trade in bitcoin and the price has been hit in recent weeks by a government-led prove on bitcoin exchanges in the country. Lee is confident that the currency can overcome these issues and is confident about the outlook for 2017.

"Four years ago bitcoin was very much used as trading in China," he says. "Going forward, I think bitcoin is getting worldwide attention with demonetization events in India — they just cancelled 84% of their bank notes — and in Venezuela, with hyperinflation."

Join the conversation about this story »

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