IU.com: Let’s turn north. What about
Russia? Is the Russian economic boom real, or will it eventually wither and die?
Friedman: Russia is
Russia. It is a country that exists because it has a single functioning entity: the security service, meaning the KGB or now the FSB. This has been true since the 19th century.
Russia is so diverse and diffuse that it has to have the security service or it has nothing.
For investors, the thing to understand is that the security service is the economy. If you look at how a company like Gazprom exists, it exists because it is deeply integrated into the FSB, which is in turn deeply integrated into the oligarchs.
The Russians have corporations, but regarding them as Western corporations is a massive mistake. To do business in Russia, you have to grasp the … the stunning idea that
Russia is different. Where Western investors get in trouble overseas is when they fail to understand that they are not investing at home.
Russia, politics and investments are mixed. If you don’t want to get involved in politics, don’t get involved in Russian investments. If you do want to get involved, understand that you are getting involved in the politics of the security agencies.
When Russian business is done, making money is an issue. But it’s very rarely the only issue.
IU.com: But Russian stocks have been booming. Practically, what does the fact that the security service runs
Russia mean for investors?
Friedman: [It means] economic growth is not
Russia’s biggest concern. It will sometimes grow at a slower pace … to achieve political goals. If an investor goes in just wanting growth, he may find that his interests are not aligned with the government.
The Russians are playing a more complex game than, say, the Chinese, who just pursue growth. That complexity makes investing there more difficult. You always have to remember that the period that investors remember as the most exciting in Russian history—the 1990s—is regarded by the Russians as an unmitigated disaster, and a road map as to what never to do again.
IU.com: Speaking of China, you’re actually one of the few people who have expressed skepticism about the growth in
Friedman: There are many people expressing skepticism, but mostly they are domestic Chinese, and they do so by investing outside of
We are seeing a surge of public and private investment coming out of
China, filling many voids in the Western world. But ask yourself the old insider rule: If China were such a great investment, why would anyone in China be investing outside of
If you listen to the central committee and politburo, they’re deeply concerned about the economy. They’re particularly concerned about the rapid growth rate, because unlike in the West where growth tends to parallel profitability, it doesn’t in
China. The profit margins on their exports are extremely low and sometimes negative. An extremely rapid growth rate is sometimes suicidal. That’s why the government is always trying to slow down the growth rate. But they can’t slow it down too much because all of the indebtedness is driving companies to raise cash to pay back debt.
IU.com: So all that growth is not necessarily a good thing …
Friedman: That’s the micro problem. The macro problem is bigger. According to the Chinese government, there are 1.3 billion Chinese, and 600 million live in households whose income is below $1,000 per year. Another 440 million live in households earning between $1,000 and $2,000 per year. That means slightly more than 1 billion Chinese have a standard of living equivalent to sub-Saharan
There are 60 million Chinese with household incomes over $20,000 per year, the global standard for the middle class. Out of 1.3 billion Chinese, the “surging” Chinese middle class is 60 million. That’s the size of France, which is impressive, but looking at the whole country,
China is extraordinarily poor.
The Chinese factories produce things that cannot be consumed in
China. Therefore, they are completely hostage to the American and European markets. The possibility of them refloating the yuan is zero. China’s biggest customer is Wal-Mart, but Wal-Mart also has the option of buying in Pakistan or
China doesn’t have another option of where to sell its products. Withdrawing their investment in American government paper would be an interesting way for the Chinese to cut their own throat.
China had a serious recession, it would be plunged into economic chaos. If you make $1,000 per year and you lose your job, it’s not your 401(k) you’re worried about. The Chinese government is desperately worried about unemployment because they are afraid of the alternative. And so, they keep their uneconomic factories going, despite the debt.
Aside from all that, the Chinese are in great shape.