Yves here. Storied short seller Jim Chanos is being more polite than we have been about crypto. We have pointed out that its main uses are tax evasion, crime, and speculation, none of which are socially productive. As private currencies (think frequent flier miles), they will have only limited acceptance in real economy transactions, as we have seen. And crypto owners have found they need many of the services provided by regulated financial services players, which the crypto firms have been developing in a piecemeal fashion, with few or no fraud protections, and less efficiently that traditional money players (which means higher costs and/or lower service and reliability). Chanos below directly confirms our earlier take on costs and it’s even worse than we surmised. Crypto is so high cost that has turned off institutional investors, making it a retail enterprise. The hope is EFTs will force costs down….but what you’ll see is big gaps between the NAV (which will be based on actual crypto trading) and the ETF price.
By Lynn Parramore, Senior Research Analyst at the Institute for New Economic Thinking. Originally published at the Institute for New Economic Thinking website
Last week, Sam Bankman-Fried was convicted on seven counts of fraud and conspiracy following the spectacular collapse of his cryptocurrency exchange FTX. He now takes his place alongside history’s most notorious conmen. Famed short seller Jim Chanos, who exposed the Enron fraud, has been called the “Darth Vader of Wall Street,” probably because he spends a lot of time looking at the dark side of finance. His specialty is sussing out hype, malfeasance, inflated prices, and what he calls the “flimflammery” rampant not only in finance but in our political systems and society. Chanos has a passion for studying the great money scams and fraudsters, teaching courses on the history of financial fraud at the University of Wisconsin-Madison and Yale University, his alma mater. The longtime crypto critic who called cryptocurrency a “predatory junkyard” — and was bashed by enthusiasts as “willfully ignorant” and “lacking in humility” — followed the trial with his students, who he says are now a little less eager to jump into the crypto-verse after graduating.
Chanos spoke to the Institute for New Economic Thinking about crypto, AI, China, Tesla, and other items on his mind.
Lynn Parramore: Things generally appear pretty unsettling right now. We have two wars, both of which the U.S. is deeply involved in, inflation, climate change, rapid technological change, massive political infighting in both parties, fraud seemingly around every corner, and global unrest. What’s your overall take on the situation? Could you sell the whole world short?
Jim Chanos: Ha! I wouldn’t go that far, but as you know, I’ve been calling this in the financial sphere the “golden age of fraud.” A lot of these things now are intersecting in very unnerving ways. Take our political dialogue – we have the ostensible front-runner of the GOP on trial for fraud —
LP: — and ahead in the polls.
JC: Yes, apparently. The world does seem to be spinning a bit faster. There are always things going wrong as long as there has been a human condition, but from my perspective, it seems that with all the advances in technology to make us smarter, somehow we’re getting dumber. That’s worrisome on a short-term and a long-term basis. We believe things that are too good to be true. Or wacky conspiracy theories. It’s not good for civilization and the body politic, in my view.
LP: Do you think our technologies are dumbing us down?
JC: They’re putting us in echo chambers, right? A journalist friend pointed out that we’ve removed the reasonably intelligent editing function from the discourse, where a set of eyes with experience and judgment is going to look at a story or set of events and say, wait a minute, let’s ask the right questions before we publish something inflammatory. Maybe we ought to step back and say, does this make sense? Should we talk to another source? Now, anything and everything goes out there onto the digital wall and sticks. It’s frightening how fast stuff goes around. With the advent of AI and deep fakes, it’s disturbing what can happen technologically to get people to believe things that they shouldn’t believe. Imagine if Stalin or Hitler had use of AI or deep fakes. The ability of those types of totalitarian governments to control people would have been off the charts.
Recent high-profile prosecutions notwithstanding, our willingness to accept fraud, deceit, and lies in our everyday lives and shrug about it is also unnerving. It keeps lowering the bar for what we find acceptable in society, financially or otherwise.
LP: Speaking of high-profile prosecutions, we have Sam Bankman-Fried convicted in what some are calling possibly the biggest financial fraud in American history, and yet crypto mania is still going. Bitcoin has been going up recently, BlackRock is going ahead with its Bitcoin ETF, and buyers are looking to snap up FTX. Why are so many crypto enthusiasts undaunted? Why is Wall Street still so eager?
JC: You have to understand that the crypto ecosystem is well-suited for the dark side of finance for a lot of reasons. It’s perfect for facilitating money laundering and illicit transactions. But also, there’s the nature of the unregulated domiciles for a lot of this activity where someone can go to basically defraud customers, whether it’s NFTs or ICOs [Initial Coin Offerings] or all the various types of digital flimflammery out there – it’s perfect. The last iteration that you just touched upon is the hope by aspects of Wall Street that crypto gets institutionalized because the one thing that Bitcoin really has — and we’ve pointed this out to our clients — is ridiculous levels of transaction fees associated with it. So Coinbase, for example, which is one of our shorts, charges customers over 4% per round trip trade to transact in a so-called currency.
LP: Why would people be willing to pay that?
JC: Well, exactly. They think the asset price is going to go up. It’s like a Nasdaq stock, not a currency. So they’ll pay, and Wall Street wants the fees. The cost structure in crypto is quite high and so the fees are really high. You need retail investors because institutions aren’t going to be paying 4% per round trip to buy and sell Bitcoin. Mom and Pop are, so Wall Street needs to keep the public interested in the crypto space. The paradox, of course, is that if BlackRock and Vanguard and whoever do get ETFs, it’s actually going to force fees down, not up, because ETF fees will be a fraction of the cost of what Coinbase or Binance charge. It’s like mutual fund fees and stock trading fees: they’ve all converged to zero.
LP: Same Bankman-Fried was always talking about wanting to give his fortune away, and FTX’s charitable arm was donating money and promoting crypto as a way to help the poor in West Africa. You teach courses on the history of financial fraud, and I recall that one of the items you highlight as a red flag for spotting a company up to no good is an uptick in philanthropic activity. Is this a prime example?
JC: One of the models I teach in my class is a checklist derived from Marianne Jennings’ The Seven Signs of Ethical Collapse. The seventh box on the checklist is “Goodness in some areas atones for evil in others.” Often, fraudulent companies or individuals are tremendously charitable or perceived to be so. Enron, for example, was notoriously generous to charities in Houston, where their headquarters was located. It’s interesting — I think the FTX/Sam Bankman-Fried entity checked every one of Jennings’ seven boxes.
LP: Pretty impressive!
JC: Yes! Not all frauds check all seven boxes, but they did. We’ve been covering the trial in my class this fall in Wisconsin in real-time. We thought that the moment he lost the jury was when Caroline Ellison testified that they were all driving luxury cars paid for by FTX or Alameda, and Sam Bankman-Fried pulled them into a meeting and said they had to get rid of them and get Toyota Corollas. Those are the moments when the jury not only sees credibility but intent, which you have to prove in a fraud trial. The whole schlubby, messy, I-sleep-on-a-bean-bag-chair image was contrived. Those kinds of things matter in criminal trials because at the end of the day, most of the time it boils down to whether the jury believes the defendant or not. It seems that the whole façade of FTX and Alameda was just that – a façade. They were losing money, not making money, and they were hiding it. I thought the evidence presented at trial was overwhelming.
LP: Are your Wisconsin students still excited about crypto?
JC: They were much more enthusiastic in 2021, 2020, 2019. There’s a lot less enthusiasm now in terms of students going to work for a crypto startup or whatever. I had a number of them in 2020 and 2021 who said they were going to work in the digital currency or blockchain space. I don’t hear that as much anymore.
LP: How about your Yale students?
JC: The last two springs, they’ve been skeptical. During the spring semester of 2022, Bankman-Fried’s now-infamous interview with Bloomberg dropped about an hour before my class started. I ran to the audiovisual department to see if I could get the interview up on our screen because to me it was such a bombshell. This was where Bankman-Fried basically called the crypto ecosystem a giant Ponzi scheme. I told the class it was very rare to get an industry leader telling you that his industry is a Ponzi scheme. That was seven months before the collapse.
LP: Are crypto and blockchain good for anything useful?
JC: There is a historical pattern to this. Alternative currencies, alternative forms of payment, and alternative banking systems have generally followed financial cycles like fraud. When everybody is making money and asset prices are going up, people find it easier to float these things and people will buy into them and finance them. I teach about a great fraudster named John Law, who brought forth the scheme that resulted in the Mississippi Bubble in Paris in 1719. Law was also one of the great economic thinkers, the fellow in the early 1700s who understood that money is that by which things are exchanged, not for which things are exchanged.
LP: It has no intrinsic value.
JC: Right. It has value in what it will buy in goods and services. Law understood the utility theory of money before some of the other economists did 50 or 60s years later. He had another interesting observation, however. He was a big proponent of fiat currencies and pushed his scheme to various kings and dukes throughout Europe. He understood the drawbacks to fiat currency, like debasement and inflation, but he understood an important thing, which is that in times of fear and uncertainty, a state-backed currency had certain advantages because it could adjudicate contracts and adjudicate fraud. He talked a little bit about the idea that the state could make banks solvent — it was the first thinking about how the state could be the lender of last resort before that concept truly got fleshed out a hundred years later. That’s what people forget about with crypto. Again, it came in at the end of a bull market or during a bull market, and what have we seen in the collapses? People have lost everything. There’s no deposit insurance. Lots of small investors lost everything they put up. One of the advantages of holding fiat currency in the system is that you have deposit insurance. If there is fraud, you can get your deposit back up to $250,000. That doesn’t exist in the crypto space and that’s for a reason. It was always the elephant in the room that nobody wanted to talk about that. Some people were sold on the idea that it was a replacement for the dollar, that the dollar is going to go down the tubes and you want to have a store of value. They thought it was great for that.
LP: Like gold.
JC: Yes, like gold. But they forgot that if it’s at FTX and it goes “poof!” there’s no recourse. There’s no FDIC.
LP: Kind of ironic when you think about how much of the excitement about crypto was that it was supposed to be a “trustless system” with so much transparency, etc.
JC: Yeah. How’d that work out? You could see that entity 45672xyz took all your money. Great. Even if you find out who that is, what recourse do you have?
LP: Let’s talk about artificial intelligence. Do you see any winners and losers emerging? You’ve mentioned data centers as having some issues as old technology becomes obsolete because of AI.
JC: Legacy data centers, yes. There are certain industries like that where you can already point to problems. But I think more broadly, we don’t have an idea yet. I keep pointing out to people that despite the groundbreaking technology of the internet, global growth has been lower subsequent to the internet than right before it. Growth in the 10 years prior to the advent of the internet, 1989-1999, was higher than in 1999-2009. While the internet created a lot of businesses and wealth, it also destroyed a lot — creative destruction. Businesses we took for granted are no longer with us because of the digitization of products. I suspect AI will be similar. It will be beneficial to some businesses and people and it will be a real problem for others. We’ll have to see how that shakes out.
When the AI hype got going in the spring, the IBM CEO said something to the effect of, well, we’re looking at all of our employees to see if AI will make any of them redundant. I joked that they better hope their customers don’t say the same thing. You know? IBM is consulting! You have to think through all the iterations. It’s moving so fast, it’s hard for us to do that. Obviously, the guys who are making the chips, NVIDIA, and others, are beneficiaries right now, but how this all plays out in five or ten years, I don’t think anybody knows.
LP: What are your thoughts on ChaptGPT? There are concerns about its accuracy, biases, and other issues.
JC: For the time being, it’s only as good as the input. I’ve dealt with that with algorithmic trading on Wall Street where the machines look for patterns, information, press releases, and so on, and try to come up with trading strategies around that. The reality is that if the companies themselves are lying or playing games, the algorithms are just going to pick up on the lie, at least until they get smart enough to figure out that the liars are going to underperform. So it’s a work in progress. It’s only as good as what it can go out and get in the public domain. Will that improve? Yeah, I’m sure it will. What will be the implications? I don’t think we know yet.
LP: You’ve been bearish on China since 2010, and you’ve said recently that you think China is going to have to move away from its current economic model –
JC: The treadmill to hell.
LP: Right. You’ve said they’re going to have to transition to a consumption or consumer-based model. Historically, these types of transitions don’t happen without wrenching effects. How might this unfold for China and the global economy if it does transition?
JC: Since 2010, China has had, I think by our count, three public attempts to hit the brakes on this developmental model which is based on real estate, debt, and infrastructure investment. In each case, the economy – not reported, but in reality – hit stall speed and began to drop, and they panicked and took their foot off the break and hit the accelerator again. That’s the real problem. It took Japan 20 years to deal with this, from 1990 it was 20 years of no growth, low growth. It was working through the debt bubble and the debt hangover and all the investment that you didn’t need. The Asian Tigers kind of took their medicine all at once in the ‘90s but paid the price in a couple of very steep recessions in the late ‘90s and early 2000s in order to wean themselves off that model.
Under Xi Jinping, you have the additional issue of a relatively pure Communist leader who is dealing with this kind of capitalist model that’s out of control. How he deals with it six or seven years into his second term is going to be interesting. Does he have the stomach to just stay the course in a real change to the model? Or does he let it keep going until the inevitable bubble bursts? I don’t know. I think that’s the biggest question, but China is still very much wedded to this developmental model, and that’s what’s so amazing. So 13 years later, after we and others raised the alarm bells on this debt-driven real estate model, investment is still 43%, 44% of GDP. I think it was 46% of GDP when I first started looking at China, so it hasn’t changed in any significant amount. The nature of some of the investment has changed, but China is still a giant construction zone 13 years later.
LP: Let’s talk about Tesla. What do you see as its biggest current challenges?
JC: It’s basically a car company — at this point, an established car company. It’s better than we thought it would be six or seven years ago, but it’s a car company. Yet in the stock market, it’s the hopes-and-dreams company. If you talk to Tesla fans who own the stock, they’ll tell you it’s not a car company, but an AI company, an alternative energy company, a robotics company. Take your pick. Musk had been very successful in selling the image as a futurist, right? I’m going to Mars! I’m going to build tunnels under every city! There’s this H.G. Wellsian kind of guy who has sold this image of the future to a whole new generation of investors who have looked at Tesla and SpaceX and said, ok, he’s built rockets and an EV that’s popular, so I’m going to value it more than the entire automobile business combined. But when you look at the actual numbers, which is what we do, it’s a car company. His margins are car company margins, his returns are car company returns. That’s the dichotomy: the challenge of running a real global auto company vs. the hype of going to Mars or selling you a robot to do your household chores.
LP: And there are some issues with the cars themselves.
JC: Yeah. There are definitely issues with how truly green they are. Some of his competitors are finding out that a lot of people wanted a Tesla, but they didn’t want an EV. That’s to his benefit, but if you listened to GM or Ford two years ago, their entire product line was going to be electric by the end of this decade. Now they’re starting to waffle on that promise: “Maybe we’ll have internal combustion engines and EVs side by side because the other companies just aren’t seeing the demand.”
LP: In the wake of the recent auto strikes, Ford and GM are going to be paying much higher wages. Does that increase Tesla’s advantage?
JC: Yeah, until the UAW figures him out. It’s so odd because one of the last factories he built was in the costliest venue, in Germany. He built a big factory in Berlin. Labor is expensive there. It’s interesting, if you actually look at employment cost per vehicle, the good news is that based on the latest UAW contract, the hourly salary or wages per Tesla employee is about half the UAW, but this is the paradox: he has many more employees per vehicle produced than the American companies do. The American companies are actually more automated than Tesla. So the labor cost per vehicle isn’t much different. Over time, as labor costs for the U.S. companies got higher, they put in more automation, and Musk still has a lot of stuff being done by hand.
LP: You’ve been active on X (formerly known as Twitter). What’s your experience of it since Musk took over? Do you see it declining?
JC: My alter ego I post on what’s called #FinTwit which is financial people, so I try, with the occasional snarky post aside, to focus on companies, things we see in the markets. But I’m getting more bots, more imposters. All of this has gotten worse since he’s owned it. I’m not the only one saying that. We talked at the beginning about the echo chamber, and I think all these social media venues are problematic for that because as opposed to the free-flowing of ideas and listening to the other side, you get people who just go down the rabbit hole into their little silo. Things are getting worse. That’s a problem. Look, it’s his baby, he can do what he wants with it. He owns the company, but I don’t think the experience has gotten better. It’s gotten worse.