Types of Wealth from the Perspective of Chinese Asset Investors


Time and time again, we have tried to emphasize the importance of seeing the world in a complex manner and now more than ever, in light of recent developments, it makes sense to pay attention to the many forms of wealth that exist and understand the complicated yet logical relationships between them.

We will pay especially close attention to the “paper wealth” dimension because the proverbial West has had to learn the hard way that no, money cannot buy anything. The problem with the West’s handling of the COVID-19 pandemic was most definitely not one of improper financing. On the contrary, wealthy entities such as the United States and European Union countries had all of the “fiat currency” in the world at their disposal and have manifested a clear desire to throw as much money as necessary at the problem. What they didn’t have was masks, medical equipment and other “real world” goods that all of a sudden became unavailable.

Money buys everything… until it doesn’t.

Until enough of a game-changer occurs for major supply chain disruptions to occur, to put it differently.

In our case, these disruptions involved exporters of much-needed medical equipment such as China and India deciding to disallow exports temporarily for national security reasons (in order to satisfy their internal needs) and once exports were eventually allowed, it was too late on the one hand (with the peak being close in many Western nations) and on the other hand, bottleneck issues emerged as soon as exports were back on the table (too much demand, not enough supply nor adequate enough scaling options).

The COVID-19 situation was enough to expose the many fundamental weaknesses of our economic status quo: supply chain complexity issues, inadequate resilience and, we might add, an improper understanding of what “wealth” truly means. In our increasingly complex economic and financial landscape, the basics tend to be buried under ever-increasing layers of complex products.

To illustrate this, let us assume that we have a Chinese factory that produces precisely what we have discussed: medical equipment. This can be considered let’s say a primary form of wealth: a company that has the ability to produce essential equipment.

Things are going reasonably well and it gets listed on a US exchange, with US investors buying shares because they believe in the business model of the company in question. There we have it, a new form of wealth is created on top of primary wealth, let’s call these shares a form of secondary wealth.

It does not end here, however. US investors are not content with simply buying and selling these shares in traditional fashion. As such, ultra-complex derivatives are created on top of these shares, through which “investors” essentially bet on a wide range of different outcomes, with options being the most obvious examples.

Once again, however… there’s more.

We also have hedging requirements, with even more sophisticated investors being interested in “insurance policies” that are created on top of tertiary wealth, insurance options through which they can hedge accordingly. We will, of course, call this quaternary wealth.

As can be seen and as crazy as it may seem, a LOT of let us call it “paper wealth” has been created on top of the “real world” Chinese factory we have mentioned and when times are good, all stakeholders seem content. The factory in question is chugging along nicely, shareholders are happy, derivatives speculators are also content with the wide range of options they have at their disposal and sophisticated hedging enthusiasts share their excitement.

Then a crisis such as the COVID-19 one comes along and all parties involved end up understanding all too well that there is a deep disconnect between primary wealth and the various other forms of wealth that exist. To put it differently, what would US shareholders have done when exports were disallowed in China so as to get much-needed equipment to the US? What about those who traded options associated with the shares in question or hedging enthusiasts?

The short answer is this: absolutely nothing.

The same principle is valid when it comes to other examples of primary wealth, anything from arable land to commodities.

This brings us to the elephant in the room in terms of questions: are those who have their net worth tied up exclusively in secondary wealth actually… well, wealthy? What about tertiary or quaternary wealth holders?

In our view, the key to tackling these questions lies in a meaningful understanding of “realized” as opposed to “unrealized” gains. Imagine that you are currently holding a trading position, for example longing Asset X. The position in question may currently be very profitable but until you close it and book profits, the numbers you see on the screen can be misleading. For example, Asset X can be only one crash away from wiping out all of your unrealized gains.

The same principle is valid when it comes to our discussion surrounding the many different forms of wealth. As such, the ChinaFund.com team would strongly recommend never forgetting the importance of also acquiring primary wealth every now and then, even if only in an effort to “book” profits or if you will, transition from “paper” wealth to “real world” wealth.

No matter what your investing or trading strategies may be and no matter which asset(s) you specialize in, it ultimately all boils down to one word time and time again: diversification. Therein lies the essence of the conclusion we are trying to articulate: please do not make the mistake of considering primary wealth too “old school” for your strategy because we can all but assure you that you will end up regretting the attitude in question down the road. By all means, take advantage of all the other forms of wealth that are available to the best of your ability but never underestimate the importance of “booking” profits in terms of primary wealth. The ChinaFund.com team will, of course, gladly provide assistance with just that.

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