Chinese Economic Data Is Distorted

Welcome to our weekly mailbag edition of The Bleeding Edge. All week, you submitted your questions about the biggest trends in technology. Today, I’ll do my best to answer them.

If you have a question you’d like answered next week, be sure you submit it right here.

The Facebook cabal revealed…

First up is a question about Facebook’s new digital asset, Libra…

You mentioned recently that Libra itself will have a more open governance, but its wallet Calibra will be closed and require [Anti-Money Laundering (AML) and Know Your Customer (KYC) regulation]. However, since you need some openness of code in order to achieve the usability goals stated on the whitepaper, will it be possible for developers to create Libra wallets independent from Calibra and then enable transactions out of Facebook’s control and without AML/KYC?

– Mateus G.

Thanks for the question, Mateus.

As regular readers will remember, Facebook’s Libra will be a “stablecoin.” It will be backed by a basket of fiat currencies. Libra will be governed by the Libra Foundation – a group of 27 companies and Facebook – in an open and transparent way.

At least, that is the plan. We have yet to see if the Libra Foundation will operate truly independently or be under the strong guidance of Facebook… I would bet on the latter.

But the digital wallet to house Libra, Calibra, is a different story.

This is a closed proprietary technology. And it will eventually be used to offer financial services like loan issuances and investment products. We can be certain that Facebook will keep very tight control of Calibra.

We, however, expect that Libra, as a digital asset, will be fully fungible. In other words, users will be able to convert Libra into another digital asset like bitcoin or convert assets back into U.S. dollars, yen, pounds, euros, and so forth.

That means that other digital wallets should be able to hold Libra, and there will be digital asset exchanges that will be able to trade Libra as well. It is a little early to have specifics on how the industry ecosystem will build out.

But the mere presence of Coinbase and Xapo (two of the largest cryptocurrency exchanges and on-/off-ramps in the world) on the Libra Foundation suggests that Libra will exist outside of Facebook’s network and Calibra wallet.

We have to appreciate the chutzpah demonstrated by Facebook. It is launching a global central bank (Libra and its “association”) that it will control. Literally, this will be a global reserve currency, effectively controlled by one corporation (or a group of corporations – let’s call it a cabal), that is more transferable, more fungible, more secure, and more divisible than any fiat currency on earth.

How do we think governments will respond?

Why I don’t recommend Chinese companies…

Next up is a question about the outlook of the Chinese economy.

Hi, Jeff. Your take on China is very different from Steve Sjuggerud’s. He’s been focused on China for years. He believes that the Chinese economy is strong, and China doesn’t really need us. Maybe you could check that out. I love your newsletters.

– Nick G.

Thanks for being a reader, Nick. I’ve known Steve for a long time. I really respect him. I was a reader of his before I ever became a research analyst myself. But on the point of China, we agree to disagree.

I do agree that China has been an economic powerhouse on all accounts. There is no debate about that. Very often, what appear to be opposing views can boil down to timeframes and perspectives.

For example, I can still be bullish over a two-year timeframe on a favorite stock but be bearish on that same stock over the next two months. One is an investing approach, while the other is a trading approach.

The current trade negotiations between China and the U.S. are having a material impact on China’s economy – in the short term this year. During 2018, the Shanghai stock market dropped more than 30%. And just this February, China’s exports plummeted more than 20% – driven by the decrease in trade with the U.S.

The strategy by the Trump administration is working precisely as expected. China will be forced to come to the table to negotiate a better, fairer trade agreement. Over a 5- or 10-year timeframe, China’s domestic economy could certainly absorb these kinds of material impacts to its economy, but over a short timeframe like the last year, the immediate impact is very meaningful and painful to China’s economy.

But I’d like to take this opportunity to address another question I get frequently. Why don’t I recommend investing in Chinese companies?

The answer is simple: The amount of misinformation about the Chinese economy makes it nearly impossible to get reliable information. Virtually every piece of information from the country is either partially or wholly distorted, usually for political reasons.

We don’t know the real GDP numbers for China, for instance. GDP growth numbers for provinces can help highly placed party officials progress further up the ladder. So the local figures are typically “smoothed out.”

And at the national level, the GDP numbers are reworked further to hit politicized targets determined by party officials.

That’s just one example. But we also don’t know the extent of bad loans issued by Chinese banks. This information is kept secret, too. The same goes for most Chinese financial assets.

And almost every Chinese company has two sets of books. Can I trust the numbers? Definitely not. Is the stock I am buying actually representing a direct equity ownership in the underlying company? Oftentimes, the answer is no.

It is worth mentioning that I spent more than a year of my life with my boots on the ground doing business in China. I’ve established and sat on the board of several subsidiary companies in China and done business at the highest levels.

I have immense respect for the economic powerhouse that China has become during the last 20 years. But I will say this… Business is conducted in ways that are not consistent with the rules and regulations that we consider to be normal in the West.

When I research and analyze companies for their investment potential, I’m not just looking for fantastic investment returns. I’m also looking for companies that have limited downside potential. Great growth potential with limited risk is how I continue to make my subscribers returns that outpace the stock markets and the best hedge funds year after year.

If I can’t trust the numbers in the company filings, I just can’t make investment recommendations to my subscribers… That’s why I steer clear of Chinese stocks.

The power of early stage investments…

Let’s close on a great question about gaining access to early stage private companies.

Hi, Jeff, I’ve been a subscriber to several of your publications for a number of years, and I really love your work and have done well with your recommendations. I have a question… I don’t know where to get started in the world of investing in private companies. How would you recommend an accredited investor get started in the early stages of these companies such as you yourself have done? 

– Rob M.

Thanks for the question, Rob. And thanks for being a subscriber.

This is a great question. As you likely know, I can’t give personalized investment advice.

But finding ways for everyday investors to access early stage tech companies when the upside is highest has been an intense area of focus for me. And over the years, I have been trying to find a way to bring that kind of investment research to my subscribers.

Broadly, there are three major categories of investing in private companies:

• • Investing in later stage private technology companies through secondary markets (only for accredited investors)

• • Investing in early stage private technology companies (only for accredited investors)

• • Investing in early stage private technology companies through crowdfunding (often referred to as Regulation CF) or Regulation A+ deals (open to all investors)

Secondary markets are a unique – and not widely known – segment of the investment market. It’s a world where investors can buy and sell shares of private venture-capital-backed companies outside the stock exchanges. While they have been around since the early 1980s, they have been mostly inaccessible to the everyday investor. In fact, most investors today do not even know that these markets exist.

Secondary markets exist to provide liquidity in shares of private companies to investors and employees while at the same time providing new investors access to these incredible companies well before they go public or are acquired by larger companies. But unless investors are willing to purchase $1 million or more allotments, it is nearly impossible to get access to shares directly.

The most common method is to invest in a special purpose vehicle (SPV) that is composed of shares in the company. Investors buy into the SPV and have a pro rata ownership depending on how much they invested. There is basically no liquidity. Investors are in until the company is acquired, goes public, or goes out of business.

Early stage investing for accredited investors is the riskiest kind of investing we can imagine. For the average investor, 90% of deals will go to zero. This requires deep expertise to make smart decisions in this space.

Reg CF and Reg A+ deals on average tend to be the early stage deals that were not able to raise capital from venture capital firms. In other words, they are the lowest-quality deals of them all. There are exceptions, but this kind of investing is even more treacherous than early stage investing for accredited investors.

I would just urge caution for any accredited investors looking to gain access to secondary market shares.

Without understanding the core business, the fundamentals of the investments, or whether the valuation makes sense, investing in a private company can be extremely risky. Making decisions in private technology companies requires performing analysis with limited information. Understanding the technology, the industry, the people, and the money behind these firms is critical.

If readers are interested in a research product focused on investments available only to accredited investors, please write in and let me know. I’m still exploring if this is something that we might be able to offer. You can reach me here.

But I do have some good news.

I’ve uncovered a way for everyday investors to gain access to early stage technology companies without having to buy pre-IPO shares.

It’s taken a very long time – about five years – to get the system just right. But I’ve done it.

In my more than 30 years researching and writing about technology investments and being an investor in technology, this could be the most important breakthrough I’ve uncovered to date. For “Main Street” investors looking to gain access to early stage tech companies and see explosive returns quickly, this is the best way I know how.

I hope all readers can join me on July 24 at 8 p.m. ET. I’ll reveal all the details then. Save your spot right here.

That’s all the time we have for this week’s mailbag. Did you have a question you’d like me to answer? Submit it right here, and I’ll try my best to get to it next week.

Regards,

Jeff Brown
Editor, The Bleeding Edge