#29 – The Plumber

James Aitken is an expert in the plumbing of the financial system.


In this interview, James Aitken took me on a world tour of the hotspots in global finance. You will learn why James is relaxed about the US; why the Japanese government will Make Japan Great Again and why this could have serious repercussions for global bond markets; and why China will likely muddle through, in spite of massive problems in its property sector.


James Aitken is an expert in financial plumbing and as he says in our conversation, nobody sets out with that intention. But he learned a lot about this while at AIG Financial Products and was able to use this knowledge when he moved to UBS to help his clients avoid the traps and to exploit the opportunities presented by sub-prime in the Global Financial Crisis. Today, financial plumbing is a much smaller part of his business; his clients which include some of the largest and most influential investors in the world, use him to get a thoughtful and considered view on global macro.

Some takeaways

Steve decided to do a world tour with James, starting in the US of course. They carried on heading west and only made it as far as China before they had to land the plane. Hopefully James will be back and they can carry on the tour next time. A few of James’ comments are summarised below and of course there is the full transcript, but it’s honestly best to hear all this from the horse’s mouth and listen to the podcast.  

The US

So much of the last two years has been characterised not by what has happened but by what has not. If you had predicted the interest rate trajectory at the start of 2022, you would have expected a much weaker economic and market environment with earnings misses and credit defaults. That hasn’t happened. James thinks that we have been trained to think of economic cycles as credit cycles but this time round it’s an income cycle not a credit cycle.

Corporate and personal balance sheets in the US are still in really good shape which has limited the impact of the rate hikes. And an environment with nominal GDP growth of c.5% is a positive one – companies can pay their interest bills and the best run companies can deliver decent earnings growth.

James’ emphasis on nominal GDP was a real differentiator for me.


James believes that Make Japan Great Again is an investment theme which is likely to be with us for a long time. Corporate reform is really important. Normalisation of rate in Japan is important as it will boost income on savings.  The likely upward moves in interest rates are going to potentially be a game changer for global government bond markets. Japan pushed rates down globally as its savings fled overseas – Japan is an anchor investor in many structured credit markets. In coming years much of that investment could be repatriated which has significant global ramifications.


Everything is about housing, with tax breaks etc. Commonwealth Bank, the largest mortgage provider has just increased its loan to value limit to 95%. James is Australian and is gobsmacked to see where houses are transacting. The Aussie banks are watching default rates etc but the big four are intent in protecting their market share. As a consequence, Australia’s inflation problem is home grown and is demand driven so the RBA will have to raise rates. Which may make for a tough 2024.


It’s about Xi Jinping. Marxists are horribly consistent and once they have made up their mind about something, they keep going. Steve was surprised that James seemed relatively sanguine about the property sector’s troubles. James feels that with nominal GDP still growing at c.5%, admittedly a lot lower than in the recent past, and with the authorities still willing to support the economy, albeit not to the extent of 2009 or 2016, that China is not blowing up.


James believes that Xi Jinping has not de-escalated Taiwan and the political situation there – currently very messy with the two opposition parties in on-off talks – warrants careful monitoring. If the election result were to favour reunification (which is far from the consensus), China could even acquire Taiwan peacefully. Investors should monitor the election in January very carefully.



For over twenty five years, James Aitken has advised many of the world’s most sophisticated investors. An Australian, James has worked in financial markets for thirty years, the last twenty two of which have been in London. His background was foreign exchange sales and trading, helping risk-seeking investors think through then position for global macroeconomic trends. In March 2002, James was hired for a similar role by AIG Trading, and one year later AIG Trading was taken over by AIG Financial Products.

Given James’ multi-asset skills, after that takeover he was one of the few AIG Trading employees retained by Joe Cassano, and over the next three years James kept his head down: continuing to work with risk-seeking investors across all assets classes but also learning everything he could about the plumbing of the global financial system.

In September 2006, James was hired by UBS on their hedge fund FX desk in London and tasked with building upon his existing relationships with buyside CEOs & CIOs. From that seat, James was permitted to advise and transact across all assets classes, and soon started advising people on how to short subprime, and how subprime would expose and jeopardize the plumbing of the global financial system. Via the powerful UBS network, James’ daily email – Notes from a Small Island – soon became required reading for investors and policy makers alike.

Throughout 2007 & 2008, James’ unique ability to understand then explain the plumbing not only helped his clients not lose money, but helped some of them make a fortune. Starting in late 2008 a number of these clients encouraged James to set up his own firm, which he did: his one-man firm Aitken Advisors LLP went live on June 1st, 2009.

James’ unique plumbing skills also provided valuable insights into the EMU debacle: whilst the consequences and inevitable turmoil of injecting sovereign default risk into peripheral Europe ought to have been obvious, as with subprime it was not well understood. Via word of mouth alone, James’ business grew rapidly.

As much as his reputation was built during periods of extreme market disruption, James always knew there were two sides to the distribution of macro outcomes: there is a tendency for macroeconomic or macro-financial advice to focus on what is going wrong, but it is important to keep an open mind on what could go right.

His global client base includes every type of investor: the world’s largest family offices, endowments and foundations; pension funds and insurance funds; mutual funds; long-only investors; the world’s largest credit and fixed income investors; sovereign wealth funds; HNWI; special situations; distressed debt; and hedge funds of every description. In addition, he continues to be sought out and to advise Western policy makers, particularly when it comes to unfinished financial regulatory reform.

If James had a motto it would be ‘I want to be less wrong’: in a world that is endlessly shouting at itself, James prefers to spend as much time as possible reading books and other material in the public domain that he believes important to his clients’ success, but which his clients may not have time to read.


You can find James at https://aitkenadvisors.com/

and on Twitter 


James’ bi-annual booklists are much admired by his clients, their colleagues, and their families. James has recommended 2700 books to clients since he started his advisory business. He kindly gave us an abbreviated list below.

In the conversation James discussed The Kennedy Tapes: Inside the White House during the Cuban Missile Crisis, a book which explains how the events of the Cuban Missile Crisis unfolded in the actual words of President John F. Kennedy and his top advisers. James’ explanation of why this is relevant is amazing – decision making under pressure is what every investor has to do and James thinks JFK gives a masterclass.


Steve had never met James, but listened to him on mutual friend Grant Williams’ podcast and thought he was brilliant. Steve got in touch and it turned out that James was a subscriber to Steve’s Substack! Eventually they managed to get a date in James’ busy diary and he came into Steve’s office and they had a really enjoyable discussion. Steve barely looked at his notes and had to finish as they ran out of time.


00:03 – Introduction to investing basics
07:09 – Transition into financial plumbing
24:40 – Understanding nominal GDP and bond yields
35:12 – Investing opportunities in Japan
44:25 – Australian housing market analysis
54:35 – Decoding Xi Jinping’s actions
01:02:41 – Risks in non-bank financial institutions


STEPHEN CLAPHAM: Hi, welcome to the Behind the Balance Sheet podcast where we meet leading investors and commentators and educate ourselves about the world of investing and the world. Our mission is to remove some of the mystique around investing and improve our understanding of what makes a successful investment or indeed an unsuccessful one. Our goal is to inform, educate and entertain. We hope you enjoy this and every episode.

Disclaimer: Behind the balance sheet and affiliates and podcast guests may own shares or have an economic interest in securities discussed in this podcast which is aired for your education and entertainment. Only nothing in this podcast should be construed as investment advice or relied upon for investment decisions. Always do your own research.

STEPHEN CLAPHAM: This episode is brought to you by Alphasense, the A I platform behind the world’s biggest decisions. Are you still leaving alpha on the table? The right financial intelligence platform can make or break your quarter. Alphasense is the number one rated financial research solution by G two with A I search technology and a library of premium content.

STEPHEN CLAPHAM: You can stay ahead of key macroeconomic trends and accelerate your investment research efforts A I capabilities like smart synonyms and sentiment analysis provide even deeper industry and company analysis from when to buy hold or sell investments to why Alphasense gives you the tools you need to provide better analysis for you and your clients visit Alpha Hyphen sense.com/fs today to beat formal and move faster than the market.

STEPHEN CLAPHAM: Regular listeners will know that our new supported charity is Duchenne UK. It’s an awful disease which affects kids. Duchenne. UK have held an annual cycle ride from London to Paris in 24 hours, which has raised £7.3 million since it was set up in 2011.

STEPHEN CLAPHAM: Apparently, it’s an amazing experience where people make new friends and wonderful memories, but most importantly, a real difference in helping to end Duchenne. I don’t look great in Lycra and no way am I attempting that? Especially in 24 hours. I thought it was a misprint, but the next one is 17th to 18th of May 2024.

STEPHEN CLAPHAM: And you can register for a place at Duchenne, UK.org/dash Duchenne, UK.org/dash James Aitken is known as an expert in the plumbing of the financial system.

STEPHEN CLAPHAM: Those skills acquired largely while working for a IG generated a unique client base for him in the global financial crisis and allowed him to set up Aitken advisors, his global macro consultancy, whose clients include some of the world’s largest and most influential investors in this interview. You’ll be relieved to hear James left his wrench at home. Instead, we went on a world tour.

STEPHEN CLAPHAM: Looking at some of the hotspots in global finance. You’ll learn why James is relaxed about the US. Spoiler involves nominal GDP growth. Why the Japanese government is likely to be successful in its program to Make Japan Great Again? And why that could have serious repercussions for global bond markets?

STEPHEN CLAPHAM: Why China will likely muddle through, inspire the massive problems in its property sector and why investors should be paying close, close attention to Taiwanese politics. James operates his global business from his home in Wimbledon and spends a lot of time reading and thinking about the world.

STEPHEN CLAPHAM: And boy is that evident in this discussion, my intern Ivan who’s looking to do P Pe At Oxford called it a master class in Economics. James also has a pithy phrase for every occasion. Learn why you need to beware of the stable variable.

STEPHEN CLAPHAM: Why people sleepwalk into events and how he changed tack from financial plumbing because you can’t always be the man with the hammer. James has a seriously thoughtful approach and you can’t fail to be a better investor after listening to him for an hour and a bit. I hope you enjoy this almost as much as I did James.

STEPHEN CLAPHAM: I’m so excited to talk to you. Thank you for coming on the podcast and just tell people a bit about yourself because you’re an expert in financial plumbing and nobody ever set out in life with that as an ambition I assume.

STEPHEN CLAPHAM: And so talk a bit about how you got there and maybe give us an example of the sorts of things you look at, maybe look at something like LD. I, because that was, that my listeners are equity people. So they don’t understand the complex stuff.

JAMES AITKEN: So I think they understand a lot of it very, very well. But, but Steve, it’s nice to see you and it’s nice to come here to Paddington and have a conversation with you and I’ve admired for a long time from a distance what you’ve been doing.

JAMES AITKEN: It’s terrific and it’s, it stands in stark contrast with all the hair on fire commentary that, that seems to prevail these days and pollute linkedin and, and social media platforms. And I, I think what you’re doing is commendable in the extreme. Thank you because you’re trying to educate people on what really matters. And I think that’s invaluable.

JAMES AITKEN: So it’s lovely that we can have this conversation and I know we’ve been back and forth for about 18 months and here we are. Yes. Ii, I think you’re right. No one sets out in life to be a financial plumber. If one ends up as a financial plumber, clearly one has failed at a whole range of things first. But there we are. But look, coming to the chase. I, I’ve always had a curiosity into how things work.

JAMES AITKEN: I don’t just mean financial system. I just mean everything from when I used to drive, my father mad when I used to try and take apart our train set and everything else and there we are. But so this curiosity, innate curiosity into how things work. And combined with a a huge passion for reading.

JAMES AITKEN: My, my kid name is a, is a book with legs. But look, I’m not going to take you or, or our listeners through my whole lamentable c side career. But I, no, come on how long we got, but look, I ended up working at a IG financial products and I turned up there thinking I knew a bit about how the world works and of course, I didn’t.

JAMES AITKEN: But the, the irony of working at a IG financial products is of course that the, the the entity got into a lot of trouble. But it was also an opportunity for me to quietly learn about how things actually worked because a IG financial products touched every part of the financial system.

JAMES AITKEN: And yes, it was hard to see it and it was just an opportunity that presented itself. You could not have made it up. And I went from a pretty simple macro type of person trying to figure out the direction of economies and interest rates and currencies into this deep, deep world of structured credit balance sheets and basically everything that happens every day across the financial system to keep the lights on.

JAMES AITKEN: So you’re right. It, it was just a complete fluke and I tried to make the most of that luck and look, and then you skip ahead a couple of years. I’m at UB si mean, it’s laughable. Really. I’m on a foreign exchange sales desk from September 2006 onwards. Stop. Stop.

STEPHEN CLAPHAM: What, what, what’s, what, why is there a sales person in foreign exchange? You just take orders?

JAMES AITKEN: Oh, come on. That’s so dispassionate you. You sound like an equity man.

STEPHEN CLAPHAM: So you’re predicting.

JAMES AITKEN: No, look, actually we we should, as they say in, in podcast, we should double tap on that for, for the benefit of your audience. It’s like foreign exchange sales or advisory in an investment bank today is very different to what it was.

JAMES AITKEN: And the essence of foreign exchange trading for many many decades was frankly information who’s doing what, who’s doing what, how much, where and why? What does it mean? Do I go with the flow?

JAMES AITKEN: Do I do I reverse, you know, all that kind of i it was information, information information and then it became progressively more sophisticated and you had teams of traders executing often very very large orders in currency markets. And you had a team of people managing the client relationships and depending on the client, it could be like short-term advice, trading the next five minutes.

JAMES AITKEN: This that and the other or what I like to think was more sophisticated structural forces at work, slower moving capital and unsurprisingly given the way I’m constructed, I worked with slower moving capital.

JAMES AITKEN: So I’m sitting on a foreign exchange desk, Steve at U BS in London working with frankly the most wonderful group of people. I mean, just as a sidebar, one of the great tragedies of 2008 is that U BS got into such trouble whilst there were so many world class people working in various parts of U BS.

JAMES AITKEN: It was a classic management failure. So I love working at UBS and I was advising Sovereign Wealth Fund CEOs and CIOs, macro hedge fund CEOS and CIOs, basically thoughtful discretionary risk seeking investors who are trying to understand the world from a top down macro perspective.

JAMES AITKEN: And it’s obviously a challenge when you try to connect with those people who are very no nonsense, they don’t suffer fools, but it’s something we’ll discuss later on. I know that the way to connect with those types of people is by being brutally honest because most people pander to them.

JAMES AITKEN: So there I was and I’m arriving on an institutional sales desk trying to print foreign exchange tickets and I end up giving endless presentations on subprime and structured credit and help people get short subprime and help them understand what was happening in the financial system.

JAMES AITKEN: So look, all I tried to do is make the very most of my luck. I I was in a privileged position of being able to articulate and explain just what was happening under the surface of the financial system because you’d seen another side of it.

JAMES AITKEN: Yeah, I had, yeah. And, and the other thing was I knew, I thought I knew a fair bit having worked at AIG financial products but being surrounded by extremely impressive people at U BS with expertise in repo and structured credit.

JAMES AITKEN: All these Fancy bits of the plumbing that embellished my understanding because I could say, hey, I think I know something but I can walk over there and, and, and test if I’m actually thinking about it the right way and then go to explain to investors around the world.

JAMES AITKEN: And from late 2006 onwards, some of the most important financial policy makers on earth, just what was happening. So look, I made the most of it. I I was educating people.

JAMES AITKEN: I soon became known as the plumbing guy, which is great and the upshot was during a very, very difficult time for the financial system, I was able to help a lot of people not lose money, which was important and I was able to help some people make an absolute fortune. And that was the start of what I do today.

JAMES AITKEN: And, and to be clear, obviously, I was working with a lot of risk seeking investors and macro traders and credit types and bond people and rates.

JAMES AITKEN: But I was also working with an awful lot of equity investors as well, who soon realized that there was, let’s just say, diplomatically, a large bid offer spread between what people running large financial institutions thought they knew about the financial system and what was actually happening. It was quite shocking, the repeated management failures. I mean, not just at a IG of course, but many other institutions.

JAMES AITKEN: So an extraordinary time, an extraordinary experience and look, you know what it’s like, you can’t always be the man with a hammer. If you’re gonna be useful for pe to people for a long, long time, like any business you have to evolve and adapt.

JAMES AITKEN: I’m very happy to be always known as the plumbing guy, but you can’t just be all about the plumbing all the time. So look, I guess we could summarize all of that as a IG financial products, baptism of fire, but tried to make the best of it.

STEPHEN CLAPHAM: And so you set up in Iran in 2009 with the benefit of the tail wind from the global financial crisis.

JAMES AITKEN: And yeah, and I, and I, by the time I’d plucked up the courage to resign from us, the world had changed. The bottom was in the fire brigade had arrived. Central banks are printing money fiscal policy at that time was all in asset prices are going up. I mean, who cares about balance sheets, collateral plumbing or it, it didn’t matter anymore and, and, and things were reflating and I thought.

JAMES AITKEN: Oh, what the hell have I done? I’ve tapped out of a, of a useful job. I’ve got two children with a third on the way. What have, what have I done here? And my clients were absolutely fantastic. They said, don’t worry about it because finally we’re able to pay you. Now you’re working on your own for everything you’ve done over the previous three years.

JAMES AITKEN: Get after it, you’re good. We’ve got you. And I’m like, wow, how good’s that? But then I got lucky again, cos along came the Greek crisis which was entirely contrived in November 2009 and Steve amongst many things, I studied at a IG financial products in 2005 was Greek sovereign exposures, peripheral debt exposures across Europe, all the derivatives that connected them together and so forth.

JAMES AITKEN: I’d studied all of that and I knew without getting too technical. I knew if for any reason the haircuts, if you will let alone the spreads on any peripheral sovereign credit in Europe went out in terms of spread or the haircuts increased. We would have another enormous systemic problem.

JAMES AITKEN: And Germany and the finance Minister at the time, Wolfgang schaeuble, everyone knew that Greece had been fudging the numbers for the best part of a decade, right? Everyone knew. And then the new Prime Minister came in Papandreou and said, look, sorry, ladies and gentlemen, our budget deficit is twice what we said.

JAMES AITKEN: And Wolfgang Schauble says right, for the sake of European unity, we must teach Greece a lesson. And that was the trigger for frankly 2.5 years of rolling crisis.

JAMES AITKEN: And once again, I was one of the few people able to say, look, I know this, it’s not actually about Greece, it’s about all of em mu and here’s what you need to look out for and my client base over that period without any website, any public profile tripled via word of mouth.

JAMES AITKEN: So that, so I was very lucky. Very lucky indeed. And then of course, if we go further down the road, Mr Draghi talks about Bumblebees in London and whatever it takes and then that’s the end of that.

JAMES AITKEN: So you have to go off and learn new skills to make yourself relevant to your clients. So there we are. So look again, if people want to call me the plumbing guy, that’s fantastic. It’s always gonna be something of immense importance to me.

JAMES AITKEN: I would say even today that too much of how our financial system functions is taken for granted. Now to be clear, that’s nothing to worry about. It functions by and large pretty well. But again, too much is taken for granted. The things that need to happen every day to keep the lights on, to settle transactions, to move money around, still require an enormous amount of human intervention and somehow it all works.

STEPHEN CLAPHAM: But the thing is people need people like you because when you’ve got Russia and Swift and what, what is it? And so all these things only matter when you get something, when something bad happens.

JAMES AITKEN: That’s it. It’s, I, I think that’s the essence of finance, isn’t it? Oh, don’t worry about that. Don’t worry about that. Don’t worry about it. Oh, my gosh. This is really important. People sort of sleepwalk into events. But yes, it, it’s constantly updating your prize.

JAMES AITKEN: But you, you remind me there’s an important point. It’s very generous of people to suggest. I’m a plumbing expert. I’m not sure there’s any such thing. If people think I’m a plumbing expert, it’s only because I have a relentless curiosity. Goes back to what we said at the top. A relentless curiosity into how things work.

JAMES AITKEN: Are we sure about that? Now walk me through this and I’m, I, I have around me, a network of, in some cases, retired friends of mine who had enormously important roles over years on repo desks or collateral management, all this stuff over the years. So I can check with them if I’m thinking about stuff the right way.

JAMES AITKEN: And I still have great friends deep within financial institutions who can help clear the fog if I’m asking questions about various regulatory reforms and this, that and the other.

JAMES AITKEN: So it’s an iterative process where you’re constantly updating your prior, you’re constantly asking questions just to make sure things you’re thinking about things the right way no different to investing, is it? Right? You’re constantly updating your prior, you’re never complacent just to check. Things are all right. But again, you’ve got this cottage industry these days.

JAMES AITKEN: I note that, whenever they’re discussing the plumbing of the financial system or how things works, it’s nearly always from the perspective of what’s going wrong, what’s gonna blow up. I’ll look at this, that and the other and most of it is just complete nonsense. It’s complete nonsense.

STEPHEN CLAPHAM: So, listen, let’s go around the world and talk about your views and where should we, should we start with America? Because I was interested your, your comment about, well, you know, we’ve got 7% nominal GDP. So everything’s gonna be ok because at that sort of rate of growth, you’re not going to have a huge number of credit defaults.

STEPHEN CLAPHAM: I was slightly upset about this because I was kind of thinking that, you know, interest rates going up, we’re going to see some real problems and, and I’ve been thinking, you know, what the next shoe to drop is like private equity because all that, all those companies with very, very high leverage.

JAMES AITKEN: Look, it’s, it’s the same when we think about this extraordinary tightening cycle that we’re on, I’m not sure it’s fully complete, but we’re on a tightening cycle. I’m, I’m with you, Steve, if, if we’ve been recording this in January 2022 and we’d figured out that by the end of 2023 the fed would have jammed up rates.

JAMES AITKEN: The Bank Of England, you know, we go down the list, they’ve all jammed up rates and we’d have a fed funds rate at, let’s say, five and a quarter percent, give or take, et cetera. And we go around the US quite frankly, based on our experiences over the last 20 years, we would have said, oh, something’s probably broken by then.

JAMES AITKEN: Something’s gone really wrong. The central banks are in retreat. You know, the usual Grand old Duke Of York, we March interest rates up to the top of the hill and then we March them down again and around and around. We go because that described most of the past 20 years and it, it’s no different to the conversation we had about the plumbing.

JAMES AITKEN: You’re constantly updating your prize questioning whether you’re thinking about things the right way because so much of the past two years I think have not been about what has happened. But frankly, what has not? Absolutely right. And that’s the essence of your question.

JAMES AITKEN: We would have penciled in rising defaults by now. Tighter financial conditions, much weaker earnings, lower stock price. You know, we could go down the usual list, credit crunch, consumption, crunch. It hasn’t really happened. And that’s, that’s for me been for 15 months saying, ok, what am I missing? What am I missing?

JAMES AITKEN: What am I missing? What am I missing? So let’s think a little bit about that using the US example. But I think a lot of what I’m about to discuss applies to other countries as well. We’ve all been trained brutally. So, in 2008, that economic cycles are credit cycles. Right. Ok. There’s definitely something to that.

JAMES AITKEN: What’s so different, I think, or one of the many things that are indifferent, different this time round it’s not a credit cycle yet. It’s an income cycle. Now we did something in COVID that we’d all been told was impossible. We did direct fiscal transfers to households and businesses, right? Furloughs.

JAMES AITKEN: Helicopter drops to household. We were told it was impossible. We did it everywhere and macroeconomics 101 tells you that the fiscal authority, the government borrows a lot of money, hands the money to households and businesses.

JAMES AITKEN: Well, obviously, it boosts disposable income for households and businesses. It improves their balance sheets. It allows them to dele and in the case of us, households, they were very early to realize that inflation was not transitory.

JAMES AITKEN: They termed out their 30 year mortgages at very low rates. And right now they’re feeling pretty clever. Same with corporations, corporations were smart enough to not look a gift horse in the mouth, the best ones all termed out their funding. So the point here is, there’s no denying that the feds tried to jack up rates and tighten monetary policy and slow aggregate demand.

JAMES AITKEN: But the pass through because household balance sheets and corporate balance sheets in the US in aggregate are still in really good shape and the labor market is tight. So incomes in aggregate are rising, the pass through from a notionally inflation busting fed with much higher rates is lower is a lot lower than we’ve seen in previous cycles because balance sheets are in great shape.

JAMES AITKEN: That’s I think the primary transition and I think it’s befuddled a lot of people. And of course, the simple other point which is related is that there are three important borrowers in any economy.

JAMES AITKEN: There’s two private sector, borrowers, households and corporations and then there’s one gigantic public sector borrower which is Uncle Sam or her Majesty’s his Majesty, I should say a Treasury et cetera, the debt management office and others we can mention.

JAMES AITKEN: So two types of borrowers in the economy, termed out their funding and improved their balance sheets. And unfortunately, the biggest borrower of the more government did not, we missed a massive opportunity particularly in this country. If the market is desperate for long duration bonds, let them have as many as they want.

JAMES AITKEN: That was the big, big miss in the US and especially here and we’re paying for that now. So unsurprisingly as the cycle rolls on and the US in particular has to borrow a fearful amount of money, the market clearing price on long duration US, government bonds is lower and the coupon that investors demand to underwrite that issuance is higher and that process is far from complete even though bonds have bounced a bit.

JAMES AITKEN: So look a couple of key points, household and corporate balance sheets and aggregate, particularly in the US great shape, Uncle Sam, bad shape.

JAMES AITKEN: And then we have a lot of borrowing for a long time to come. We have lost the price insensitive buyers of treasuries for 25 years. We haven’t had to worry about demand for government bonds. We had global sovereign wealth funds. We had reserve managers had central banks and not least the fed indiscriminate buyers of treasuries for a long, long time. They’re not there anymore.

JAMES AITKEN: I mean, they’re dabbling but they’re not there. So we were trying to find out who the next indiscriminate buyer of government bonds is in the US and elsewhere. And if the answer is households, well, when they look at government dysfunction, they’re probably going to demand a higher yield to come, but that’s all to be resolved over the next couple of years.

JAMES AITKEN: But on a broad macroeconomic point, I’ll just finish with this. The US has a particularly perilous fiscal situation. I think everyone knows that but to be running what’s called a full employment budget deficit of 7.5 to 8% is nuts and full employment budget deficit round about now when you’re at peak employment give or take and the economy’s doing well, tax revenue should be roofing it transfers should be declining.

JAMES AITKEN: Your budget deficit ought to be stabilizing and falling and the opposite is happening. And I can’t imagine that whoever wins the election next year in the, in the United States is going to be for fiscal austerity. That’s the problem. But then here’s the rub which ties everything together.

JAMES AITKEN: I keep saying macroeconomics 101. Because frankly, I don’t think too much of this is complicated. Macroeconomics. 101 would suggest that if any country anywhere is gonna run a very large budget deficit, guess what nominal GDP is gonna be high and we’ll come to that in a sec. Nominal GDP is gonna be high.

JAMES AITKEN: I say to my clients, I know everyone’s excited about landings and economic landings and so forth. But to my simplistic way of thinking, if you’re running a budget deficit, that big, there can be no landing because nominal GDP is still gonna be quite strong and then for investors and this is where people have struggled.

JAMES AITKEN: If nominal GDP is gonna be 5% let’s just pick a number in the United States. So it’s come down a little bit from the extraordinary third quarter. If nominal GDP is gonna be 5% bills get paid the economy as a whole is gonna be generating enough cash flow to service all its borrowings, the cycle can continue and frankly, in an environment of nominal GDP of around about 5% which is above what we saw in the US for 20 odd years.

JAMES AITKEN: And we can come to that if you, like, guess what, the best run businesses will continue to find a way to generate sustainable earnings, defend their modes and perhaps surprise markets with the resilience of their business, which is kind of what we’re seeing.

STEPHEN CLAPHAM: And if we’ve got NONO GDP continuing at 5% then the 10 year goes to 5% stays at 5%. Yeah. But a 30 year.

JAMES AITKEN: Pick a higher number. Yeah, but let’s, let’s think about that.

STEPHEN CLAPHAM: But that’s got quite a lot of ramifications, right? Because if, if you’re talking say 7% on the 30 a year, why should anybody take risk?

JAMES AITKEN: Let’s, well, let’s, let’s set aside for a moment, the obvious conundrum that we’re gonna face for many years to come, which is us in particular debt sustainability because the cost of the interest on all this borrowing from Uncle Sam is probably going to go up. So we know that, but let’s just set that aside for a moment because that may take years to reach some kind of final reckoning.

STEPHEN CLAPHAM: We’ll come back to that.

JAMES AITKEN: Yeah, we’ll come back to that. But, but your point about nominal GDP, let’s just, let’s just flesh that out a bit and we’ll go with the US example, but it applies in, in other countries as well. So from 1995 till about 2019 nominal GDP in the United States was about four, inflation was about two, which meant that you had real GDP of about two and obviously a colossal undershoot in 2008 as we all painfully remember.

JAMES AITKEN: But Steve, if you’ve got nominal GDP for a number of reasons tends to peak around 4%. It kind of makes sense that a 10 year Treasury runs out of steam at 4% or at least acts as a handbrake on growth. And there was a rule of thumb 4045 years ago. And I work with some of these people who used to be on the Salomon Brothers Bond trading desk in New York.

JAMES AITKEN: And they were working with this chap, John Merriweather and they had this famous, famous economist, Doctor Henry Kaufman, who’s still alive and his books are amazing and their rule of thumb, it’s not like a point estimate. It’s not day to day, but their rule of thumb is that through the cycle in the USA 10 year note 10 year bond, the yield ought to converge with nominal GDP, which is what you’re asking.

JAMES AITKEN: And I think it’s an important point. So we’ve, we’ve grown and learned and managed capital in a 25 year environment of lowish growth, lowish inflation where people have rationally focused on real GDP. But one of the lessons from the seventies and eighties is that when you have a bit more inflation, OK, it’s coming down, but it’s still too high.

JAMES AITKEN: What you actually should focus on is nominal GDP as a metaphor for aggregate demand. And the point is this, if we or any of our listeners said, oh, my gosh, 10 year Treasury is going to 5.5 6%. Most people would be inclined to pull out a tinfoil hat. T you know, hunker down. It’s gonna be dreadful for Starks, dreadful for this. That and the other, you know, here we go.

JAMES AITKEN: Well, like everything in finance. It depends, it depends. It’s like these rate hikes. It depends if you, you’re jamming up rates because you’re way behind the curved in floating inflation. That’s, that’s a shock. But if you’re jamming up rates to do the bare minimum of monetary tightening, which I think central banks have, that’s the thing altogether.

JAMES AITKEN: But the point is this, if us nominal GDP is still somewhere between five and 6% it is absolutely sensible for a nominal 10 year note to be somewhere between five and 6%. So the 3.5% we saw in a 10 year Treasury earlier this year was the wrong price.

JAMES AITKEN: The 5% that we saw in October give or take was more like it. And we’ve sort of got this battle underway in markets as to whether the fed’s done or the fiscal situation this, that and the other. So look, I think yields are going up, I think there’s incomplete business. There is a wrong number that we’re looking for.

JAMES AITKEN: There’s a wrong number out there for Central Bank policy. There’s a wrong number out there for real yields, which are very important and there’s a wrong number out there for bond yields at which people just say I’ve had enough. We haven’t found it yet, we still haven’t found it.

STEPHEN CLAPHAM: But if we’ve got a 10 year at that level and a 30 year.

JAMES AITKEN: Let’s say six or 6.5, some high number. So call it 6.5.

STEPHEN CLAPHAM: Then the good news is that stocks can carry on earnings can carry on. There’s not going to be problems in the, in with credit default. So everybody’s happy. But why should anybody take any risk?

JAMES AITKEN: The point there isn’t it is just finance 101. If the risk free rate, let’s say the overnight risk free rate fed funds is five and a quarter, there’s your hurdle rate for everything.

JAMES AITKEN: So if you’re thinking sensibly as an investor, you’re not gonna extend duration for another 50 basis points in a risky investment, that’s only gonna give you 5.75% if the overnight risk free rate is five and a quarter, which is your point. Cost of capital goes up and on and on.

JAMES AITKEN: We go, the best run businesses will figure out that we need to do better to incentivize people, to stick with us. And that’s part of this. I think it’s part of buybacks and everything else. But it’s a tricky one, isn’t it? Because people haven’t had to deal with it for a long, long time.

JAMES AITKEN: But at the risk of being simplistic and obviously I’d defer to your listeners on this. But at the risk of being simplistic, if we pencil in that, the world’s risk free rate, which is a 10 year us note is probably going to be higher on average for longer and let’s say 5.5%.

JAMES AITKEN: Then obviously, in the first instance, we need to be absolutely rock solid in our earnings forecasts and estimations, we need to be absolutely rock solid on understanding that particular business balance sheet, refinancing risks and everything else. And we need to be absolutely rock solid on what kind of free cash flow yield does this business generate?

JAMES AITKEN: So if it’s 5.5% is the new hurdle rate, then we probably ought to be hunting for reasonably valued businesses that generate a free cash flow yield comfortably above that. And as you and I know that’s a bit awkward because the sector of the market that offers, that is the one that people can’t really touch.

STEPHEN CLAPHAM: Yeah, I mean that it’s quite funny that you say that, but we we’ll come back to the what to look for in, in equities. I I’m curious about the the buyers of the, the bonds.

STEPHEN CLAPHAM: If you enjoy this podcast, you’re bound to enjoy our free newsletter on Substack. It’s a weekly email on interesting investing topics. Visit behind the balance sheet.com and hit the sign up button while you’re there. You might want to check out our brilliant online investor training school.

STEPHEN CLAPHAM: Hundreds of students have taken our flagship analyst academy course which teaches you everything you need to become a serious equity investor. And if you’re a professional investor, we run a forensic accounting course for institutional clients and soon a cohort based course for serious amateurs, email us at info at behind the balance sheet.com.

STEPHEN CLAPHAM: So one of the big buyers of the bonds has been the Chinese. They’re probably not going to be big buyers of the bonds going forward for other reasons. Other big bar has been the Japanese and I know you’ve got interesting views in Japan and I’m not sure if I’ve got enough money in Japan, but if the Japanese are going to be completely changing strategy and putting rates up, will Mrs West and Abby go into the equity market?

JAMES AITKEN: That’s the general idea of what they’re trying to do. It started under the late Prime Minister Abe and the thrust of it is Make Japan Great Again. And, and I tip my hat to a hardcore group of equity investors who figured out five years ago that there was a long-term structural Japan re rating afoot.

JAMES AITKEN: Japan is moving away from Japanese style shareholder capitalism. Notice, I didn’t say activism. I said capitalism. In other words, they didn’t give a hoot about the shareholders, you had all the Koetsu side bars and the cross holdings. It was terribly inefficient and Abe sought to rectify that.

JAMES AITKEN: And the current Prime Minister who is deeply unpopular Kishida San is trying to accelerate that to finish the task. It’s very impressive, but it’s one part of a broad Japanese strategy frankly, to Make Japan Great Again. And the thing that they’re most nervous about is Taiwan and maybe we’ll come to that later.

JAMES AITKEN: But that’s, that’s a complicated area, but look fair play to some of the world’s largest active equity managers for figuring out that not only was there deep value in Japan, which has been the case forever, but there was actually a catalyst for change. I mean, when was the last time we heard mbo and Japanese equities in a sentence?

JAMES AITKEN: We’ve had another big management buy out in Japan this morning, a management buy out in Japan, what the heck’s going on and goes back to our broad point about keeping an open mind whether about interest rates, about the fed, about plumbing. We have to keep an open mind here, we’re going to succeed. And of course, there’s more long term capital coming into Japanese equities.

JAMES AITKEN: Of course, the valuations are still compelling. Of course, there’s use of this to play out, but Make Japan Great Again is an investable theme that is likely to be with us for a long time.

JAMES AITKEN: And you’ve just actually just a si keep saying sidebar, but just a sidebar here, you know, people go on and on and on about Jeff Bezos and rightly so and they look at all his sayings and phrases as this giant visionary, which of course he is. But one of the things he likes to talk about is that people, all of us in markets in business tend to focus on what is changing and Amazon is built on the back of what is not changing.

JAMES AITKEN: And I think that’s good, good thinking for investors to keep in mind as well. We are caught up in the day to day. We’re arguing over the next 10 basis points in inflation. We’re arguing over this, that and the other, we get caught up in the noise and you have to fight really hard to think about what’s not changing here.

JAMES AITKEN: And in the case of Japan, there is this run, I don’t know the words runway, but there’s something happening in Japan that no matter. Well, I say in no matter what’s happening in other parts of the world, Japan is now determined to finish this job of making Japan great again.

JAMES AITKEN: So it’s not just the shareholder activism or a more shareholder friendly environment, which is obvious, I think to most people today that will attract more and more of the world’s sticky capital in parallel with that. You’ve got a Central Bank that is poorly understood. People know that they’re liberating Japanese government bonds that’s happening we can see that.

JAMES AITKEN: And of course, Steve, as all your listeners know if the world’s lowest yield curve has suddenly been liberated. And Bank Of Japan, J GB purchases held down global bond yields everywhere. Then the spillovers from higher J GB yields are likely to be, be frowned and add to the pressure on us treasuries and everything else.

JAMES AITKEN: But there’s a missing ingredient here. The market knows that it’s absurd for the Bank Of Japan to have still negative interest rate policy when you have inflation ticking up again as we saw earlier earlier today in Tokyo. So the market knows that the Bank Of Japan is gonna do away with negative interest rate policy.

JAMES AITKEN: And a lot of people say, yeah, big deal minus 10 to 0. Who cares? Well, it’s a lot bigger than that because what they’re actually planning it sound, can you believe policy rate normalization and Japan in a sentence, you know, that’s what’s happening. They’re gonna take rates not from minus 10 to 0 but to a much, much higher number.

JAMES AITKEN: And I don’t think people are prepared for that. Now, of course, the doomsayers would say, oh my gosh, Japanese interest rates going up really bad for JG BS, usual tinfoil hat stuff. It depends. We all know that Japan is a nation of savers. What does it do for Japanese household income?

JAMES AITKEN: If instead of getting zero on all their cash balances, they start to get a nonzero number right, there’s a whole lot of things happening here. But then to get to your important point which is global capital flows. Japan has been the anchor investor in credit and bond markets worldwide, but us credit markets in particular. So not just treasuries, which is well known, right?

JAMES AITKEN: Cl os structured credit, high yield investment grade, they are the anchor tenant if you will of all those markets. Now, I want to be very clear. I’m not saying for a second that for example, Norinchukin, which is Japan’s Central Bank for agricultural co-operatives.

JAMES AITKEN: I’m not saying that they’re about to redeem all the C OS that they own in the United States and which to be fair. They’ve never lost a cent on I’m not saying they’re just saying, hey, you know, we’re out when they own 70 billion of triple AC Os. It’s not that, but the incentives are changing at the margin.

JAMES AITKEN: And if we get to the point where the non chuks and other gigantic pools of Japanese savings actually feel it makes more sense to put the marginal yen we have into yen credit or longer term JG BS, then it’s a marginal yen that’s not going into us credit and other markets around the world. Now, that’s not instantaneous. But again, it’s a process that is starting now.

STEPHEN CLAPHAM: But I mean, this could be a staggering effect because the end is what 150 so they can only lose money. I mean, they’ve they’ve made a lot of money out of the currency because the offers are worth a lot more yen. And that the yen is very, very cheap.

STEPHEN CLAPHAM: So, if you were, if you were the treasurer of one of these banks, you’d be saying, well, hang on a second and get more interest than my yen at home. And I’ve got, I don’t have the FX risk. So, I mean, you’d be bound to repatriate a huge amount of money, wouldn’t you? And that could be a huge, huge headwind for credit markets everywhere.

JAMES AITKEN: Yeah. And, and it could be, and it should be, but the timing of it is uncertain.

JAMES AITKEN: The last thing that Japanese investors want to do is rock the boat. But if we extrapolate this to a sort of a negative outcome, look, we all know that Japan has an awful lot of JG BS.

JAMES AITKEN: There’s a lot of domestic holders of JG BS. If J GB yields go up, everyone says it’s really bad. It’s bad for the Bank Of Japan. It’s bad for Japan Post Bank. You know, it’s bad because of the losses on the balance sheet, right? Ok. Fine.

JAMES AITKEN: People forget one important thing which is Japan’s net international investment position.

JAMES AITKEN: If the whole, this is a big, if it’s a hypothetical. But if the losses on domestic assets are big enough because J GB yields go up a lot. Well, the way to address that is to sell your foreign assets to fill the hole.

JAMES AITKEN: And, you know, that’s something that’s on my mind before you think of the organic incentives of putting more money to work at home rather than expensively Overseas when you’re factoring currency hedging and everything else. But the whole point here is this, something really important is happening in Japan? Really important. And again, equity, let’s call them the equity vigilantes figured it out a long time ago.

JAMES AITKEN: Some of the biggest private equity profits on earth have been generated in Japan. Oh, really? Yeah. And they don’t like to advertise that, but one or two of them got in there very early and have done phenomenally well, out of these restructuring transactions with the full blessing of the Japanese government.

STEPHEN CLAPHAM: Of course, they’ve been able to buy assets cheaply. So that’s, I mean, it seems obvious that we, what we should be doing is we should be paying a lot more attention to Japan. It’s going to become a lot more important equity market could be really good market if they, you know, these reforms take hold.

STEPHEN CLAPHAM: I mean, I, I wasn’t even aware of them. And so what was it last year? This year? I went to Polar Capital Dinner yesterday and I sat listening to the Japanese guy and he came out with these reforms and thought, well, why, why did I not know this?

JAMES AITKEN: But but look, I think, I think to be fair, we’ve all been able to eyeball all sorts of Japanese listed businesses for 20 maybe 30 years, the net cash businesses you go down there and just been sitting there and it’s been a, one of the world’s biggest value traps until Abe said I’m gonna fix this.

JAMES AITKEN: And now Kushida is saying we will finish the job. So you finally got a catalyst for change where all of the Japanese government bipartisan regulators and everything else and even the Tokyo Stock Exchange and I’m paraphrasing a little saying, if you don’t do something to improve your shareholder returns, we’re gonna d list you.

JAMES AITKEN: Well, there’s an incentive. So finally, we’ve got a catalyst and that’s different. And there’s this phrase I like to use as, as some of my clients who are probably listening. No, which is beware, the stable variable, right? So let’s think about the past 20 years.

JAMES AITKEN: Us, house prices cannot go down really well, if you build a whole financial ecosystem on that assumption and it turns out they can go down. We got a problem. There can be no inflation really. Well, look at the past 2 to 3 years. Guess what? Oh, we cannot do direct fiscal transfers to households and businesses. Really?

JAMES AITKEN: Oh, Japanese interest rates can never go up. Are we sure about that? So these things are changing and again, the challenge for all of us amidst these changes is to be proportionate and to be sensible because there’ll be any number of people saying this might break this, you know, that phrase people use.

JAMES AITKEN: Oh, something will break. What does that mean? You know, that’s just a cop out. But we need to keep these changes, in perspective.

JAMES AITKEN: Some people will say, oh, it’s bad. Well, I, I prefer to say it’s different and if we have the skills to evaluate these great assets and we’re comfortable with those valuations, we should own them. Simple as that.

STEPHEN CLAPHAM: Ok. Well, let’s fly down from Japan to Australia.

STEPHEN CLAPHAM: Who is the bank? Is it Commonwealth Bank that they are? Now, it’s a big one. They’re now allowing people to borrow 95% of a property’s value. I mean, what, what planet are these people on?

JAMES AITKEN: Well, I, I, I’m not sure and I’m one of them. I’m not borrowing a 95% LTV. I’ll just clarify that. But look, a lot of people view Australia as some kind of levied commodity play and there’s lots of reasons for thinking that it isn’t, it’s a levied house.

JAMES AITKEN: Everything is about housing, the incentives have been building for a long, long time. There’s the tax incentive of negative gearing on investment property, you can deduct the interest on debt. So is it surprising that a lot of people’s first home in inverted commerce is actually not one they live in. It’s one they rent out.

JAMES AITKEN: So they get on the property lander by buying an investment property, which strikes me as a bit arse about but there we are. But you know, as Munger always says, show me the incentive, I’ll show the outcome if you have long running tax incentives in Australia that incentivize you to build a property portfolio, you will do that and, and, and don’t care about the consequences.

JAMES AITKEN: I will do that. So we have residential construction, we have housing, we have household wealth, we have everything part and upon geared to housing in Australia. And it’s been that way for a long time.

JAMES AITKEN: And I’ve been home as I, even after almost 25 years in London, I, I’ve been home four times this year and I am gobsmacked to see where houses are transacting houses. I know, well, I grew up around to see what people are doing with property in Australia, the cost of living everything. It’s, it, it, it’s a high pressure economy, but here’s the rub and I’ll answer your question on CB A.

JAMES AITKEN: You would think Steve that the way to manage mortgage risk is by constantly monitoring defaults, prepayments this that and the other household incomes and to be fair, the Australian banks do that as well. But we have a mortgage market dominated by four institutions and the way they manage Morgan risk and I mortgage risk. And I say this tongue in cheek is by ensuring that they never lose market share.

JAMES AITKEN: It’s what’s going on seriously. It’s about market share when you’ve got four banks and CB A has the biggest mortgage book by far now to be fair. I know people at CB A, they have some really competent people there. They have amazing data on their securitized. You know, they really pay close attention and their assumptions about defaults and everything else are actually really tough.

JAMES AITKEN: But that doesn’t mean it’s all going to be puppy dogs and rainbows, but they do actually scrutinize their mortgage book carefully, but it goes back to the incentive. What’s the point of raising interest rates of your Central Bank? You are trying to slow aggregate demand to bring inflation down. And in Australia, aggregate demand is not coming down, aggregate, not anecdotal aggregate.

JAMES AITKEN: And if an Australian borrower now sees the biggest mortgage provider in the country once again offering 95% LTV with some kind of teaser rate, then the median Australian borrower is not going to reduce consumption and aggregate demand is going to stay high. And unlike the rest of the world, Australia’s inflation problem now is home grown.

JAMES AITKEN: It’s not about Ukraine, it’s not about the Middle East, it’s nothing, it’s home grown because it’s obvious, at least to the very fine lady now running the reserve bank, she’s just new to the job, Michelle Bullock.

JAMES AITKEN: She said it this week and she mentioned that it’s now homegrown and there’s a demand component and that means she’s going to be raising interest rates even more as she should. I’ve been trying to tell my clients that all year that the RB A is gonna have to go a lot higher and people really don’t want to hear it especially back home. So it’s a very difficult 12 months ahead for Australia.

JAMES AITKEN: But again, to be consistent if interest rates are going up in Australia, which they have to because underlying aggregate demand is stronger than people thought that is not automatically the end of the world. It’s difficult. It’s challenging.

JAMES AITKEN: We will see discretionary businesses in Australia are likely to have ongoing earnings. Misses to the surprise of nobody. But again, to be consistent if I’m saying that the RB A has to raise rates because aggregate demand is stronger. The cycle continues, the cycle continues until eventually the RB A overdoes it.

JAMES AITKEN: But to put some numbers on it for our listeners, the fed has a real fed funds rate of 2.25% give or take. The ECB has a real depot rate. So the deposit rate adjusted for inflation of 1.6% and even the mighty Bank Of England has a real bank rate of 60 basis points give or take in Australia, the real RB A cash rate which is their policy rate is still minus 100.

JAMES AITKEN: It is way too loose, way, too loose. Is it any wonder, Steve that the Australian housing miracle continues to churn along that my countrymen are out there consuming like there’s no tomorrow when the real policy rate is still minus 100. But it’s absurd. It is absolutely absurd.

STEPHEN CLAPHAM: But it will implode at some point.

JAMES AITKEN: Well, you worry about it, but II, I don’t know how we define implode, but let’s invert it. Right. If we were trying to cook up some kind of economic or financial crisis in Australia, we’d probably seek to do it a couple of ways. Firstly, yes, obviously the cost of refinancing, a owner occupied house or an investment property portfolio just becomes too tough.

JAMES AITKEN: The unemployment rate goes up. So household cash flow goes down, defaults rise, everyone hunkers down simultaneously. That’s the first instance. So we know it has something to do with interest rates just getting too high.

JAMES AITKEN: But in the second instance, the reason Australia has muddled through for so long is because the lingering benefits of a positive terms of trade shock. In other words, China says, we’ll have everything you got, we’ll have everything you got. Dig it out, give it to us, we’ll take it all forever.

JAMES AITKEN: And what that means in simplistic terms is that if our terms of trade is rising on all our exports, etcetera, then aggregate national income is going to be rising as well, which will trickle down to households through businesses and everything else, which is basically what you’ve seen.

JAMES AITKEN: So if people say Australia is going to implode, there’s two things that need to happen. I would argue the first interest rates get too high. Households and borrowers can’t cope.

JAMES AITKEN: And in the second instance, we have to have a negative terms of trade shock and to be frank, when you think about the energy transition, a Chinese economy that’s still muddling through, you know, the odds of a negative terms of trade shock where prices of iron ore, thermal coal, we go down the list, they all collapse seems to be fairly low probability for. Now. What is it?

STEPHEN CLAPHAM: I mean, China doesn’t look in great shape, the Chinese property sector. It looks a bit dodgy, doesn’t it?

JAMES AITKEN: Yeah, let’s, let’s see if we can frame this because look, you know, putting the plumbing hat back on, I’ve spent so many hours, days and weeks, 10 years ago trying to understand Chinese plumbing and you know what? It didn’t matter, it just didn’t matter.

JAMES AITKEN: So yeah, there’s complex moving parts, there’s this, that and the other, there’s blobs of liquidity that get moved around and when there’s all of that, but it didn’t matter. And the reason it didn’t matter, Steve is because there’s one fundamental in China and it’s called Xi Jinping.

JAMES AITKEN: What he says happens. So let’s think about the Chinese property situation. Six years ago, Xi Jinping announced a deleveraging campaign and the essence of that was to make his financial system fit for purpose because it isn’t.

JAMES AITKEN: Everyone knew that we all thought of Chinese property as the world’s greatest sustained malinvestment because it was, it was and most people like there is no way. And frankly, I was partial this, I’m thinking to myself, this guy is trying to deflate Chinese property. Is he out of his mind?

JAMES AITKEN: And that was six years ago and he is, and he’s got it wrong from time to time, but he is far from finished this campaign to make his economy and especially his financial system fit for purpose. You’re seeing more and more headlines around country garden and all these other things. Although this week they’ve provided support to 50 favorite Chinese property developers.

JAMES AITKEN: So they’re sort of, you know, Mick, they’re getting a bit uncomfortable about what’s happening and understandably so because you can’t expect above trend Chinese economic growth if the property market’s stumbling, given all the revenue and associated spin off of that. But the point here is that I am told time and time again to the effect.

JAMES AITKEN: Where’s the effect of Xi Jinping’s screwing it up, especially from commodity companies I work with, oh, this is terrible. My aluminum mortar book has fallen apart. Copper’s doing this. It’s like, oh, this guy has no idea what he’s doing. I’m like, dude, it’s Xi Xinping.

JAMES AITKEN: The thing you need to know about Marxists is that they’re horribly consistent. Once they make up their minds about something they keep going, they keep going. And at the sixth plenum, which is to be a little bit cheeky. The big Communist Party barbecue held in November every year at the sixth plenum in November 2021 Xi Jinping told his comrades and it was not reported in English only in Mandarin to his comrades.

JAMES AITKEN: And he gave a long, long speech in which he quoted Mao. And I’m like, ok, whenever he quotes Mao, that’s a big deal, right? And, and by the way, the time to listen to the Communist Party Of China is when the system is talking to itself, not when it’s talking to Bloomberg or Reuters or the ft or the economists that’s irrelevant because it’s spin in propaganda.

JAMES AITKEN: But when the Communist Party is talking to itself, you pay attention, that’s the number one rule when you think about China. So November 2021 he’s quoting Mao and he said as Comrade Mao reminds us, stop dot dot And he was talking about us and other things, sometimes you have to ruin a nation internally in order to renew it.

JAMES AITKEN: And that is exactly what he’s doing now. Leaving aside the geopolitics, which is very difficult just for a sec.

JAMES AITKEN: My point here is that it seems to me too much of the Western analysis of what’s happening in China. Both good and bad is done through the prism of our experiences, which is silly because if we’re going to understand it somehow we need to think like him and he’s not going to spoon feed us.

JAMES AITKEN: In fact, given the system they have, he wants to misinform us. He wants to not report statistics that are not going his way about the economy. But here’s the rub there seems to be this kind of bipolar discussion around China for many people in the West.

JAMES AITKEN: Either a China’s gonna take over the world or B it’s having a Lehman moment. Whereas in reality, it’s c somewhere in between muddle through lower trend rate of growth, but it’s not blowing up, it’s not blowing up again. Nominal GDP in China right now is probably around 4.5 5. Now, that’s low compared to where it’s been.

JAMES AITKEN: But if we’re consistent, it’s really hard to have an old fashioned financial crisis if nominal GDP is still going around five. And, and frankly, in the past week or two, the Chinese authorities collectively have demonstrated more willingness than at any time this year to support the economy. Now.

JAMES AITKEN: It’s nothing like what they did in 09, nothing like what they did in 2016. It’s much more measured and proportionate, which is good because he still hasn’t finished making his financial system fit for purpose. He’s deleveraging now. The big. So what for investors?

JAMES AITKEN: Well, it’s really hard because in the recent past and frankly, it on and off for 18 months, there’s been all sorts of bargains in Chinese listed equities and if people want to have a swing at those, they can, I mean, there’s some great, great, great Chinese businesses. There’s no denying that, particularly when we think of these tech juggernauts.

JAMES AITKEN: But then there’s an overlay that complicates things for everyone I work with and that’s the geo geostrategic side of it. And the geopolitics, it’s really hard. And you, as I’ve reminded people, my clients for five years now, you could be the world’s greatest analyst of an Alibaba AJ D A 10 cent.

JAMES AITKEN: You know, we can go. Now, this, that’s great. You could get earnings to the dot You could understand the balance sheet. You could even go. No, no, you couldn’t do that.

JAMES AITKEN: I know, I know that’s, yeah, you could get comfortable with a Cayman’s prospectus, you know, all that kind of stuff, you could get comfortable, but you’re missing the point because there is one super senior investor. His name is Xi Jinping. He doesn’t care about you. He doesn’t care about your fund. He doesn’t care about your NAV. He doesn’t care. All of these things are pawns in his game.

JAMES AITKEN: And when you, it surprises me that amidst the discussion of valuations of various Chinese businesses, nobody sort of discusses the Communist Party representation at the highest levels of all these companies. And I know this sounds harsh, but I have many reasons for believing it. Every Chinese business is now a state owned enterprise.

STEPHEN CLAPHAM: It’s funny because there are a few well regarded, highly respected investors starting to buy Alibaba in the last round of 13 apps. And I was thinking because we got the election in Taiwan in January and kind of that seems a big existential. So kind of risk.

JAMES AITKEN: It does and look to be fair. There will be a number of people listening to us saying, oh, you know, you’ve gone a bit Trumpy and this that and the other. No, I’m just describing the world we’re in.

JAMES AITKEN: Yeah, it, it’s, it’s a serious, serious situation and let’s think about that. Let’s just segue a little bit into Taiwan. So we had an APEC summit, a leaders summit in San Francisco where on the surface it looks like she and Biden and many others tried to hug it out and de escalate it.

JAMES AITKEN: Good. That is good news. If we’re finding a way to talk to each other and most critically of all resume military conversations that have been in abeyance for 2 to 3 years, that’s not good.

JAMES AITKEN: That’s not good. So we’re now talking to each other at Senior M Good. So we have back channels where we can deescalated and understand each other and we didn’t have them until recently. That’s an improvement. But the spin coming out of it was that there’s a deescalated on all sorts of things.

JAMES AITKEN: China’s Taiwan’s on the back burner. Everything’s just gonna simmer down and you may have seen over the past three weeks, there was a lot of excitement about Taiwan because the two main opposition parties appeared to be forming a coalition against the incumbent government.

JAMES AITKEN: So the incumbent government or the, the, the, the likely winner of the election in January 24 is not pro independence per se, right? Or not, not against re it’s hard to define it, but let’s just say they’re not in Xi Jinping’s good books.

JAMES AITKEN: But the two opposition parties getting together was a huge, caused a huge amount of excitement because if they could figure out a deal, they would very likely win and be much more pro Beijing. Now we’ve seen this morning that that coalition has fallen apart in one of the most farcical political moments that could only possibly happen in Taiwan.

JAMES AITKEN: Absolute farce that’s not going to please Xi Jinping. And there’s ample evidence that Xi Jinping sought to put this coalition together, right? These two opposition parties, coalition pro Beijing. And then here’s the rub what the press missed from this APEC meeting, which bothered me a lot is that Xi Jinping actually upped the stakes on Taiwan. He didn’t deescalated if you read everything that was discussed.

JAMES AITKEN: He did not de escalate. Although people are desperate to believe it, he actually upped the ante by saying to Biden on the record that you must agree if that you must abide by any peaceful reunification of Taiwan. In other words, if our preferred candidates win, you just need to let them give it back to us. Now, that’s a big problem.

JAMES AITKEN: Cos I don’t think in an election year, a presidential election year, an enfeebled president which unfortunately he is is able to stand there if Xi Jinping by some way, is able to get Taiwan back peacefully. So markets are very badly misunderstanding what’s going on on the surface. It looks like things are settling down.

JAMES AITKEN: But when you do a bit of digging Xi Jinping has upped the stakes. And the working assumption seem to be that if my, if I can smash together this opposition party, a coalition win a democratic election, then there’s nothing that all these democratic democracies in the West can do if the people of Taiwan have voted.

JAMES AITKEN: But now if the election is status quo, the current vice president wins in January, I think Xi Jinping is going to be pretty cheesed off. And the reason I flagged that and it’s not, wasn’t reported around APEC the incursions that are going on every day right now, even today into Taiwan airspace, sea space and everything else off the charts. We’ve never seen anything like it.

JAMES AITKEN: And that bothers me and look to be fair. It’s very difficult for those of us in markets and very difficult for investors to adequately handicap geopolitical risk. It’s really, it’s really hard to do. And I’m not suggesting for a moment that anyone listening incorporate Taiwan nervousness into a portfolio. Oh, I’ve got to do this in the Taiwan dollar its MC.

JAMES AITKEN: This, I’m not saying that I’m just saying we need to keep it firmly in mind. We need to investigate we need to read because this is not a de deescalation’s an escalation. So we January, is there January is where it gets a bit lively and he, my strong suspicion would be that Xi Jinping will be seriously displeased.

JAMES AITKEN: If it’s a status quo election to go back to.

STEPHEN CLAPHAM: Where we started, we, we don’t really have time to go all the way around the world but the just going back to where we started, we, we were saying interest rates can be higher and I just wondered what your views were because everywhere I look, there’s just a lot of leverage.

STEPHEN CLAPHAM: So, you know, whether it’s the basis trade and you, you send you something that there was that, I don’t know, it was a central banker said there was 500 billion of trade supported by $10 billion of hedge fund capital. I was listening to, Patrick o’s podcast and he had this guy on that was, I think Walleye Capital of Walleye Capital based in Minneapolis.

STEPHEN CLAPHAM: And he was talking about what a good business, multi strategy hedge funds were. And they, you know, we didn’t, don’t, you know, we reduce the risk right down and then we juice it up with 10 times leverage. I mean, I, I just, I just don’t get this, I mean, all this leverage everywhere. If money costs more, these guys can’t make money doing that, can they?

JAMES AITKEN: Well, well, they can because they are and, and the bets are enormous. And what we’re talking about is in, in this specific instance, we’re talking about sophisticated, highly leveraged relative value, fixed income folk taking advantage of the discretionary between Treasury futures and an underlying Treasury bond that you can deliver into the futures contract.

JAMES AITKEN: So we try to harvest 6 to 7 basis points, give or take. And if you’re gonna generate superior returns out of a 6 to 7 basis point, let’s call it anomaly or opportunity. Then of course, you’re gonna have to use a lot of leverage. It’s a trade that people have done for decades.

JAMES AITKEN: It’s just that in the, it, it, it caused a bit of problem in March 2020 it’s grown in size. But of course, given what happened in March 2020 if these guys are going to put on the risk again, then they’ve had to go through the internal compliance meat grinder. They’ve had to go through all sorts of checks and balances to put the trade on.

JAMES AITKEN: But so much of financial regulation is not pre-emptive. It’s financial archaeology, it’s solving for the previous crisis saying, oh, this is what happened. Must not let that happen again. Ok. That’s cool. The good news. Just to extend this conversation, the good news is for the regulated banking system, particularly the biggest banks.

JAMES AITKEN: It’s almost impossible to replicate Lehman. Although credit Suisse had a jolly good go at it. Right. It’s almost impossible to replicate le so we’ve got more capital, a little bit less leverage on the regulated banks. There’s more regulation pending from the fed on, on liquidity buffers and everything else.

JAMES AITKEN: So we’ve got more liquidity loss absorbing capital dot dot dot Great news. But as you know, Steve and as our listeners know, risk is never extinguished in finance, it just gets moved around and the risks that once would have been held on regulated bank balance sheets, guess what? It’s now all across non bank financial institutions.

JAMES AITKEN: Now. Frankly, I’m less worried about hedge funds that are doing this basis trade than I am. I mean, if some of them get unfortunately chinned, that’s life. I’m less worried about this basis trade that regulators are in a, in a, in a tizzy about than I am about all this other long duration of liquid stuff, private credit, private debt, private equity and w and most of all the people that have allocated to it.

JAMES AITKEN: There’s nothing wrong with private debt, privates in general. There’s nothing wrong with taking illiquidity risk, but of course, so keen were people to keep up with the game in 2020 2021. They thought they were harvesting the famous illiquidity premium, right? Buying cheaply being compensated adequately for taking long duration liquid exposure.

JAMES AITKEN: But they didn’t, they were so keen to play that they paid an illiquidity discount and the attraction was not their liquid asset, you know, you know, I was going to go with this, the attraction was that this stuff, all of it was apparently non Mark to market or it could only ever go up now for about 18 months.

JAMES AITKEN: That was true. It was true. Everything went up including some absolute garbage businesses because it could right. If interest rates are gonna be zero forever who caress about operating earnings, we just sit and wait for it’s party on all those parabolic charts.

JAMES AITKEN: But then if interest rates go up and all these are liquid businesses still can’t generate positive free cash flow and everything else, then they, they’re zeros and that’s the reckoning that’s ahead of us.

JAMES AITKEN: But the, the attraction I fear of so much of this liquid exposure was Z was the fact that it was no Mark to market risk zero vol and Steve, if you and I could stuff our portfolio with a whole bunch of stuff that we’re confident is zero volatility, then obviously it reduces our overall portfolio volatility.

JAMES AITKEN: So we look really clever and over the next year or two, we’re gonna see the other side of that now to be clear, it’s rational for people to say, oh jeez, you know what does a recession which will come at some point? What does a recession mean for all this private or liquid stuff? Well, guess what? It’s probably gonna be challenged? Oh, what does it mean for the people who manage these private XYZ portfolios?

JAMES AITKEN: Well, you know, it might be a few headline risks. But the real problem is actually not the managers. The real problem is the people that hurled money into these strategies. The end investor that thought I, I must do this.

JAMES AITKEN: And as of now, in late 2023 in a difficult world, there’s all these large asset allocators all around the world who are really starting to chafe with their liquid exposure and there’s not much they can do about it. And, you know, we didn’t talk about it but LD, I was an early example of how people got liquidity and operational risk. Completely wrong, hopelessly wrong.

JAMES AITKEN: And I don’t think any of us should be surprised if we start to see more of that sort of stuff with asset allocators, some of the world’s biggest pension funds. I’m thinking of California in course, start to get into a bit of trouble with their liquid exposure. In fact, we’d be more surprised if they didn’t.

STEPHEN CLAPHAM: Well, I think it’s guaranteed the, the Californian investment in the Blackstone.

JAMES AITKEN: The regions, the regions got, it seemed to get a great deal, but there was, it seemed, I’ll just say diplomatically, there seemed to be an awful lot more to it than the headline.

STEPHEN CLAPHAM: It’s the classic one. Now, on your website, you say you have gifted 2700 books. Now, I hope you’ve got an Amazon Affiliates account because that, that’s a big thing. What’s the big, what’s the most popular one. What’s the one you’ve most given away? And, and why do you give away so many books?

JAMES AITKEN: I’ve always liked books. I’ve always liked reading. And as you and I know from working with some immensely impressive investors over a long period of time, the most precious asset in their portfolio is not a stock or a bond or Amazon or NVIDIA or whatever.

JAMES AITKEN: It’s time, it’s time, time to think, time to read, time to reflect. And one of the beauties of your podcast is it helps people do exactly that. And in a world that’s shouting at itself all day long, most of my clients and yet they’ve got diversity inclusion training.

JAMES AITKEN: They’ve got compliance training, they’ve gotta do marketing and they’ve got to do this, that and the other, ok, you know, that’s part of the territory, it goes with the job, but they’ve got less and less time to be still to think and to reflect.

JAMES AITKEN: And you’re never gonna outperform if you’re always on the back foot, reacting to a text or reacting to a colleague on the trading desk saying boss, have you seen this? You, you’re never gonna outperform. And I thought when I started the business, what might I be able to do differently from a branding perspective and also to encourage my clients as best I could to just stop and decouple and to think hence the books.

JAMES AITKEN: So I sent my first book list 13 years ago and it really resonated with my clients. I sent my last one out about a month and a half ago and I’ve still 95% process. So, if there’s any clients listening, you, I’m getting there.

JAMES AITKEN: But it’s now closer to 3000 books and I compile a list every year and you, you know what, it’s like, people say, oh, I’m reading this, that and the other I thought, well, I’m going to be a bit more forceful than that. I’m actually going to send my client’s books.

JAMES AITKEN: They choose, I send them a whole array of books on not just finance and economics. In fact, especially not finance and economics, but all sorts of things, history, geography, music, sport, whatever, just to encourage them to read. And it’s been a huge success.

JAMES AITKEN: I, I don’t know why more people don’t do it. I suppose it’s a cost cos it is a cost, but that’s ok. So it’s two fold for me, it’s encouraging my clients to have the courage to step back to read and to think and also to thank them, thank them for supporting me for almost 15 years. But if we’re trying to be less wrong, which is another one of those phrases I like to use.

JAMES AITKEN: If we’re trying to be less wrong, we have to be able to decouple and to unplug and it’s the hardest thing, Steve for our mutual friends to do, managing these large portfolios just to create that space. It’s a constant battle.

JAMES AITKEN: Arguably it’s a first world problem when you’re managing many, many billions of dollars or tens of billions of dollars in. Oh, gosh, you have to do another marketing pitch. Well, you’re not going to get much sympathy but it’s an important point. So, the books are an important part of that. I tried to read all the time.

JAMES AITKEN: How many books do you read? A year? It, it’s, well, last year it was 74 and this year it’s, it’s 60 so far. But look, it, it, it’s, it’s great to keep score. But the point here for, for listeners is not to say, oh, you should feel bad if you read three or four books a year.

JAMES AITKEN: It’s not that at all, it’s not the quantity or volume of books that you read. It’s what you take away from them and you should never be afraid. And this just happens to me frequently. I, a book is recommended to me or I read about it and I say, oh, ok.

JAMES AITKEN: Yep. Ok. I’m just not feeling it. I give every book 100 pages and if I’m not getting it or feeling it, I have 100 pages. There’s done. Life’s Too Short, but it’s the cheapest education we can buy. I absolutely agree.

JAMES AITKEN: You know, five, the number of unbelievable books I’ve read that cost me 5 to 10 quid or 5 to $10 on Amazon or Abby books or whatever, just incredibly insightful books I read in large part of the function of some of the people I connect with around the world. I spend a lot of time reading about intelligence analysis, not output per se on various geopolitical issues. Although that’s important.

JAMES AITKEN: But some of the best books I’ve read are on intelligence analysis. I mean, for example, I did not know that JFK who died 60 I should say was assassinated 60 years ago. This week, I did not know he recorded all his deliberations in the White House over the Cuban missile crisis.

JAMES AITKEN: There are transcripts and a book was published years ago and we think, or there’s this tendency to think of JFK as a bit of a philander philanderer. Well, to say the least he was and a bit of a naughty boy and his father was a, you know, corrupt as heck. That’s, that’s all true. But to see this young man under enormous pressure, he was 45 years old.

JAMES AITKEN: We forget that 45 years old with all these inputs. Some of them like Curtis LeMay who wanted to bomb the entire world to pieces, you know, listening to all of this and the thing you take away from these tapes. And of course, he was badly scarred by the, the bay of pigs invasion, right?

JAMES AITKEN: So he learned from that and he improved, which is impressive. But the transcripts of Kennedy dealing with the Cuban missile crisis are absolutely extraordinary. There is a man under pressure because if he makes a mistake, the world ends and with his brother and other key advisors, the thing you take away is how far ahead of all of them.

JAMES AITKEN: He was in understanding Khrushchev’s incentives and in understanding that Khrushchev knew instantly, he had massively overstepped and finding a way eventually when everyone’s saying bomb the crap out of this, that and the other finding a way eventually to give Khrushchev a way to back down. It’s extraordinary.

JAMES AITKEN: And you think, how do I apply that to understanding the world today or understanding the pressure that our leaders are under? So I spend a lot of time reading books like that. Graham Allison, oh, you know, is will there be war with China this that and the other thys trap and so forth and oh Graham Allison’s a doom Mger on China. No.

JAMES AITKEN: One of Graham Allison’s earliest books was on the Cuban missile crisis and decision making under pressure and frankly decision making under pressure is what all of us in finance do every day. So just things like that actually come to think of it. Would it be useful for you and your listeners if I put together a short list? That’d be fantastic.

STEPHEN CLAPHAM: Would it be useful? We stick it on the web page? Yeah.

JAMES AITKEN: Yeah. Yeah. Why don’t, why don’t we do that? Very happy to do it. So look, books are absolutely essential to what I do. I read because I can, I read because I must and whether it be to educate clients or to help me be less wrong. There’s no excuse.

STEPHEN CLAPHAM: Listen, it’s been really, I really, really enjoyed talking to you and it’s funny because we never met before. So this is the first time we’ve had a conversation and I, you know, II, I would laugh because I, I haven’t asked you the question. You know, you, you, you’ve got a brilliant turn of phrase and you said the two best answers are, it depends. And I don’t know.

STEPHEN CLAPHAM: And he said, you said, if in doubt, don’t listen to me and I was gonna ask you, how do you have any clients left? But it’s obvious, it’s obvious why you’ve got a brilliant client roster. I am incredibly grateful to you for allowing me to have this conversation. And I know you get asked. Did you go on a lot of podcasts? I feel privileged to be one of the three. You’ve come on. Well, thank you.

JAMES AITKEN: Well, it’s my pleasure, Stephen. Thank you for your time this morning. It’s great to meet you as well and keep up the great work. We all appreciate it. Thank you. Cheers. And that’s a wrap.

STEPHEN CLAPHAM: While anyone who’s produced a book list of 2700 books was always gonna be well read. But wow, James’s expertise in China, Japan and Taiwan seemed really remarkable to me, if you’re an institutional investor, you better get in touch with Aitken advisors. As I don’t see how you can afford not to have his notes from a small island in your inbox.

STEPHEN CLAPHAM: And how happy am I James used to work with John Clemo and Andy Lee at U BS. Back in the day, I really enjoyed Cleo’s emails. And finally I got the chance to meet James. I just want to say thank you to all you listeners. I’m so enjoying doing this podcast and having the opportunity to talk to people like James. This is such a fun project for me. I hope you enjoy it half as much as I do.