Hugh Hendry says the world is brimming with risks right now, from Chinese deflation, to the strength of the US dollar, to unrealized losses in US Treasuries held by the bank. In the new episode of the podcast, we speak with the former manager of the Eclectica hedge fund, who now writes and operates under the Acid Capitalist branding. Hendry, who now resides in St. Bart's, says that the most important story in the world, and for as long as he's been in markets, has been the rise of China, which he sees as inflating asset values all around the world. Specifically, he sees a broken model, in which the country's GDP grows rapidly, but domestic investments and household income don't keep up. He warns of a risk of a yuan devaluation, as the country seeks to maintain its export drive which, he warns would create "Mad Max" deflation. He also talks about the "terrifying" drop in the Japanese yen, and the unusual situation by which the US is one of the world's growth leaders. This transcript has been lightly edited for clarity.
Key insights from the pod
:
Why it’s important to get “high” in the world of finance — 4:44
What Hugh has learned from his old investor letters — 8:19
The early signs of China's boom — 12:53
How China's growth is fueling world asset markets — 16:03
How China generates GDP without generating wealth — 28:08
What Hugh got wrong about China — 35:40
Why international diversification doesn't work — 37:49
Why global wealth goes to places like St. Barts and Dubai — 40:22
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Joe Weisenthal (00:20):
Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway (00:25):
And I'm Tracy Alloway.
Joe (00:27):
Tracy, you know, what's sort of giving me a little bit of anxiety these days, just...
Tracy (00:32):
I feel like that's a dangerous question to ask your coworker, but go on.
Joe (00:36):
It does seem, — right, It could be anything. It's not personal — it does seem like across many industries, EVs, etc., like Chinese firms, either because they're doing very well organizationally, technologically or whatever, or cost competitively, are like really killing it in a lot of industries. And as an American who, you know, wants a thriving US economy watching, say, like the day after Boeing is experiencing some new investigation, and then the next day seeing some headline about like Comac is like expanding its factories. It’s like what's going on here?
Tracy (01:14):
I know what you mean. I feel like EVs are sort of a microcosm for, I guess, a lot of anxiety over the Chinese economy. So first of all, the idea that China is sort of going to leapfrog America in one way or another in terms of technology, renewable technology, as we've sort of seen in solar panels.
But also the idea that to some extent China has a lot of policy levers to pull in a way that the US sometimes struggles with. So President Xi Jinping can go out and say ‘We want China to make massive investments in things like EVs or in things like semiconductors.’ And to some extent, the entire economy sort of turns that way and starts doing it.
Joe (01:55):
And just to be clear, I think it's good that more countries around the world are getting richer, more competitive and able to, so I don't see the world as some sort of zero-sum type thing. But if the US is embarking on this sort of renewed industrialization push, if we think it's valuable, if we think it's important that certain types of batteries and cars, etc., are manufactured here, which we seem to have prioritized, also chips, then the question is like, ‘Well, will any of this be competitive, globally cost competitive, effective, similar technology to what competitors overseas are doing?’
Tracy (02:33):
But also just to ease your anxiety a little bit, because that's what I'm here for, there are a lot of question marks around the direction of the Chinese economy at the moment. There's speculation over a yuan devaluation, interest rates are already pretty low. They're struggling to boost economic growth. So you have these sort of twin things happening at the same time.
Joe (02:52):
Totally. No, China unambiguously has its host of issues. That being said, you know, I do think that for as long as I've been paying attention to markets, economic stuff like that, one of the overriding questions is like ‘Well, when is the crash? When is the financial crisis?’ And it hasn't really happened. There's been some issues now, and obviously they sort of on purpose to some extent pricked the real estate bubble. But by and large, some sort of like big Chinese disaster, the likes of which many people have been expecting for a long time has not materialized.
Tracy (03:21):
I think this goes back to the command economy policy lever idea. And if you have those types of levers, you can kind of pull them and buy yourself time. And that's what we've seen over and over again. You do have these disasters that happen in the Chinese economy, like the three red lines proposition for real estate that led to a housing crash. But on the other hand, you have sort of measures that can offset some of that and, I guess extend and pretend for a while.
Joe (03:47):
Totally. Well, I am really excited about our guest. We've had him on the show once before, although now he's in studio with us, which is always a lot more fun. Someone who has been covering this story for years, I first discovered him probably in 2008 or 2009 watching his YouTube videos where he was in China looking at these gigantic, I think the term at the time was called Ghost Cities, where there were tons of skyscrapers and apartments, and at the time, no one was ever living in them. And it sort of raised all these questions about misallocation, all these questions.
Anyway, we are speaking The Acid Capitalist himself, former hedge fund manager, now all around cool guy who lives in St. Barts, but he graced us with his presence here in New York City. Hugh Hendry, thank you so much for coming back on Odd Lots.
Hugh Hendry (04:31):
It is an absolute pleasure. And, you know, for the folks at home, if you wanna see the future, you gotta get high.
Joe (04:37):
Why is that?
Tracy (04:40):
Let's just leave it there.
Joe (04:41):
No, no, let's not leave it there. Why do you need to get high to see the future?
Hugh (04:44):
Well, what does high mean? I mean, so what that means is I'm on a mission to try and give the indication that the science of finance should be left alone and we should actually embrace the art of the future. You know? That is a creative flow.
And you're not going to get there just by clocking up hours wearing a suit and staring at a spreadsheet, yeah? You gotta get a little bit kind of creative with it. And so I'm kind of trying to put out my career. I've got my book coming out later this summer, and it's a different path. There are many paths, yeah? We only get presented the path with the guy. You know, they're always guys, they're always guys, you know, and they got the ties and they don't see the future, but they get a lot of airtime.
Tracy (05:29):
For listeners who can't see Hugh right now, I can confirm that he is not in fact wearing a tie. But Hugh, here's something I want to ask. And I feel like you might have to answer to this. Have you ever stared at an Excel spreadsheet while on acid? What happens?
Hugh (05:45):
You certainly don't stare at spreadsheets. I've stared at walls. I mean, Saturday night there was a wall that really came alive. So I'll get back to you on that.
Tracy (05:57):
You should try it. See if, like, new patterns emerge.
Joe (05:59):
Or like do you realize something and the next time you go back and look at that spreadsheet, you see something there that wasn't there before?
Hugh (06:05):
I just don't look at the spreadsheet. Have someone else look. Someone has to look at the spreadsheet. So actually what I did was, I mean the wonderful Bloomberg and the graphics package, there was a function, forgive me, I can't remember the name now, but I would load like the S&P 500 and I'd have my designated kind of the images in terms of the moving averages and what have you. And I would assign maybe 10 seconds to each chart, because it was like 500, and I'd watch and I'd see patterns. And for me, I was becoming like a paranoid schizophrenic because the charts would create voices in my head and with those voices and the pattern recognition, and they were spread and concentrated on particular industries.
Joe (06:44):
Did you ever see the movie Pi?
Hugh (06:46):
Yeah.
Joe (6:48):
Have you seen that Tracy?
Tracy (6:49):
I haven’t, no.
Joe (6:49)
I've always wanted to do an episode on that, which is basically like, an old like Darren Aronofsky movie, or this guy is convinced, he kind of has like a psychic breakdown, but he's sort of convinced that he sees the entire pattern of the stock market and can predict it second to second through like numerology and kabbala and Jewish mysticism and all this stuff. It's a great movie.
Tracy (07:09):
When I have mental breakdowns, I just eat ice cream and can't get out of bed in the morning. But other people unlock the secrets of financial markets. They're much more productive.
Hugh (07:18):
Well, I got paranoid because I was risking other people's precious capital using these voices in my head. But the paranoia is a good thing. And that's when I had to call for the spreadsheet. So don't get me wrong, I listened to music and I was kind of separate from my team, but there was a fusion where I had like the CIA, I had an intelligence operation and I said, ‘I'm crazy. Challenge me. Let's see if we can find a synthesis.’
And so I'd take a position, I'd take a small risk position, but when we got, or if we could get confirmation, then we would build and we'd lean into it. So, you know, it's, I don't mean just to be a circus freak, you know, there's more to it.
Tracy (07:55):
So speaking of challenging yourself, one of the things you're doing right now on your Substack is you are publishing all the old letters from your hedge fund Eclectica. And I'm curious, what's the goal of doing that? Is it sort of self-reflection? Is it seeing how your investment theses have stacked up, you know, two decades or whatever it is later?
Hugh (08:19):
Yeah, I mean, it is the diary of a long period of my life. And for, I guess, you know, I take a different step perhaps from the rest of the community. And I gave everything, I mean, it became like a mousetrap. Like people liked it 'cause it was a little bit zany. And then the challenge each month is you gotta redesign the mousetrap. And so I was always late. It had to be the very last day before I could actually get the thing written.
But there's a lot that happened over that period. We're talking about the period from October, 2002 to October, 2017. And, you know, at leisure it comes at, you know, at my Substack, and you get to see it and it resonates. And I'm playing with language, and you can then, it's nice. It's like a game where you can actually, I'm trying to predict the future, and you can actually determine with your coffee if I got it right. What my hit ratio is. And it becomes kind of fun, I hope.
Joe (09:13):
What have you learned about yourself? I mean, when you go back and read those 2002 [letters], some of [them from] over 20 years now, are there things that you look back at your own thinking, you're like ‘Oh, this was, these ideas weren't fully formed’ or I things that you later changed your mind about or had new perspectives? What have you learned rereading your old hedge fund letters?
Hugh (09:33):
Heavens, yeah. What did I learn? I mean, I tell you what I'm most proud about, it was a form of deduction, which I had right at the beginning because right at the beginning, this is before the Zuckerbergs and, you know, the Amazons where you have a platform, it goes global and like you're the richest person on the earth, like Elon, etc.
And back then, the the highest return on intellectual capital was to be a hedge fund manager. You know, like 2 and 20, if not more. And so, by logical deduction, you’ve got to think you are up against the smartest minds on the planet. And of course, when you meet some of these guys and girls, you’re like, ‘Oh, maybe not,’ but, you know, it kind of stands up. And I kind of concluded that it actually didn't make any sense to try and outsmart the smartest people, yeah?
Like, you're gonna fail, okay. And so I reverse-engineered and I said ‘Why is it in this like musical chair game that we call the markets? Why is it that it's not enough to be super, super smart?’ Because let's face it, everyone out there and listening to this, everyone's got like a really high threshold level of intelligence.
And so that's why, you know, we come back into my Acid Capitalist brand. It sounds like cute and stuff. It actually had a function, you know, and, you know, when people would throw up their arms. So if we were to fast forward into horror story of late 2008 and Lehman goes bankrupt, etc., and you, we've all seen the movie, you know, The Big Short, I mean, I knew all those guys. I was the London operation of that. But you know, when the, the suit guys are throwing their hands up and they're saying ‘Who would've guessed that?’ Well, little old me. You know, I made 50% in the month of October
Tracy (11:30):
So one thing we wanted to talk to you about is obviously China. And I feel like going back and reading over some of your old notes directionally you got the China call right, but timing has sort of been an issue here. And maybe it goes back to those policy levers that we were talking about in the intro. But walk us through the China thesis in sort of the early, mid 2000s and how it panned out.
Hugh (11:56):
Yeah, I mean, I am the pig on the Chinese calendar. China has been the formative energy and force for my career and the career of all speculators in really over the last 40 years. The rise and rise of China has actually, I think, been responsible for what is now the preposterous rise and rise in asset prices.
And I'll try and explain that. But you know, back at the beginning when I was listening to the sheet, I was seeing the sheet music on my Bloomberg terminal, I was seeing the chart formations. What was I seeing? I was seeing the most ugly, old industrial businesses that no one had wanted to own for 20 years. Everyone was in services and drug stocks, etc. I was seeing the worst businesses and they were coming alive.
Joe (12:49):
What's the example of that when you say one of the worst businesses in there coming up?
Hugh (12:53):
Oh, they would be like smelters. I mean, just insanely ugly businesses. They had not earned an appropriate return on capital for the longest time, and they were coming alive. And so I used a lot of, like, you know, people on Twitter and stuff, on Bloomberg, they throw around charts and they look at a three-month chart. I mean, what is a three-month chart?
I'm greedy. Show me everything. So I'm looking at 40 years and I'm seeing things which just stopped falling. And then one of the other key determinants that I was using was, things go right. Stocks and risk positions, they go right relative to their peer group before they actually go right in absolute terms. And so you've gotta lean in there. And so I was beginning to see this immense relative performance.
I mean, let me give you an example with regard to like another like really dumb thing, which is gold. I know that inflames people. But, you know, gold had had, what? 25 horrid years. It peaked at 810 bucks in 1980, and it was like 270 bucks by the time the British Treasury got through selling it at the very, very bottom in 2002. Who were they selling it to? I was buying it. I got 15 years of this blessed thing we call speculation because my first calendar year, I made 50%.
I'm not gloating. What I'm meaning by that, is the failure rate in hedge funds, it's like a restaurant. Most restaurants fail, yeah? And the return to the survivors really high. And I got — heavens, there was times when I didn't think I was gonna make it, but I was absurdly long gold. And again, if you're like a wannabe new hedge fund manager, like I gotta tell you, iyou ain't gonna make it in your first year if you're not making money.
And you ain't gonna make it if you're like making 6% or 7% and trying to tell people your Sharpe ratio is really good. You're gonna make it if you find like and you concentrate and you take leverage in a rising asset class and it’s volatile, and you chase the dragon. And that was gold back then. And I'd got gold because gold did nothing, okay? But we'd had the Nasdaq crash, stock markets had collapsed, gold had done nothing.
And so when you look at the relative performance of the two, gold was saying, ‘Baby, I'm coming back.’ And. you know, so that, and that was good. Why? Why was all this happening? It was happening because back then China was the size today of the Turkish economy. Today it’s the size of the European economy. And the markets and my prices were telling me that this long journey was beginning to pick up pace and their desire, you know, they laid down more concrete, they used more steel, etc. in like 10 years than the US economy did in the 20th century. You know, it was big. And that's what I was seeing. And I was long it.
Joe (15:42):
I understand like, okay, you can point to specific commodities like obviously copper and some of these old industrial, you mentioned the smelters, coming alive with the industrialization and rise of the Chinese economy. Zoom out a little bit further. Because what you said is that China has been the biggest story in asset markets, period. And that the incredible rise in valuations and boom inasset prices, it all, in your view, sort of comebacks to China. How does that work?
Hugh (16:07):
Because it's a cheat charter. Sorry to say it, but, so you know, there's this thing, the Triffin dilemma. You know, they don't have an independent monetary policy. They've kind of caught onto the coattails of the mighty US dollar. They have a dirty float. They have a closed capital account now.
So economics, which is a dire, dire, dire subject, but economics at its heart is really the investigation in the study of how something in chaos kind of tries to return and find equilibrium and clear, yeah? And it can be the opposite. It's an equilibrium and it's gonna pull apart. And you know, that's like, what people like me were kind of watching that and the rise, they've done amazing things.
They've industrialized, yeah? And the reward in economics is you get richer for doing so. The benefits. And they've not done that. And it's kind of like the frog, like boiling the frog. We've warmed up the Chinese citizens, we brought them into these congregations. We've given them amazing factories. The rise in productivity from taking someone off a field and putting them in a semiconductor fab is insane, yeah?
And so they're getting paid like 10x what their grandparents got paid. And they're like, ‘Hey, you know, this feels good.’ The thing is they should be getting paid more. And really where it should be represented is in the exchange rate. The renminbi, forgive me, I call it the red cabbage, who wants to eat red cabbage? So back when we had the NAFTA agreement with Mexico and Canada, they devalued their currency to 6.3 and where's the currency today versus the dollar?
So you needed 6.3 red cabbage, and today you need like 7.3, which is to say you need more red cabbage. So they've got poorer. Now that doesn't make sense, right? And then you were talking about your anxiety. I’m here, I've got a pill, I've got a chill pill for you. Because again, right, so what we're seeing in EV, right? We saw it initially at the turn of this century — again, back to my, like my letters and stuff — biggest company in the world for a moment was Nokia. I mean, there’s kids like listening saying “Nokia? Who was Nokia?”, right?
Nokia used to make television and then it pivoted into mobile phones, right? And then Apple of course came by at the turn of the century, biggest company on Earth. And you had Ericsson and these guys control, you know, your network, your 5G, etc. Chinese came in and said ‘Wow, that's kind of dope. We want that.’ Okay. And now they own it. And that's why you had all that.
Joe (18:36):
I thought you were gonna give me a chill pill?
Hugh (18:38):
It's coming. It's coming. It's coming. It's coming. If you look at Ericsson and Nokia today, those prices fell 95%. And just they've just, they’ve stayed in the graveyard, okay? Then the Chinese came in, they said the same thing with solar. And now they've come in and they've said the same thing with EV. What are they doing? They're saying, ‘We don't need to make money.’ We allocate capital in America in the free world with the sharp jagged knife of ‘you gotta make it if you want to stay in the game.’ China doesn't. That's one of the implicit subsidies.
So where do we see that? Where do we get, I mean, maybe that's just cured, okay? But what China does, it's very good at creating GDP, but not wealth. So look at the stock market, right? The stock market's flat. Flat for 25 years and the currency is weakening. And that's the problem. And so what happens with their savings model, all of it, all of it, and again, to maintain those advantages, they have to push all of their capital into risk-free US Treasuries.
And unfortunately, only until the last two, three years, the US, we were fiscally conservative. We should have been running huge deficits, whereas ‘Oh no, you can't do that.’ We should have been running huge deficits. And the Chinese would've funded the rollout of the best, like fast trains, the best education, the best healthcare, the best cities, you know, ships that don't crash into bridges and bring it all tumbling down.
And instead, whenever we did something, we did a stupid tax cut. And right at the very end of this process, you know the Great Inflation Reduction Act, which is, ‘Hey, listen, we're gonna pay you money to bring great technology and make it in the United States,’ that's working. And so what's happening today, the fascination and the drama of today, is the fiscal policy is working, and the US is being transformed into the economic locomotive for the rest of the world.
Now, this dollar standard, yeah? The mighty dollar, it was not conceived on the basis that the US would be the chief. It wasn't conceived that the US would be at 5.5%, and the ramifications of that are coming through. The Japanese yen, incredibly, has lost 40%.
Tracy (20:54):
This is exactly what I wanted to ask you about, which is just to add to Joe's anxiety, but should we be panicking about a currency crisis right now?
Hugh (21:03):
Absolutely. So, like, again, heavens, we've got to go back to 1997, ‘98, and we had the Asian sovereign Tiger crisis. Countries like Thailand, they had too many debts denominated in dollars and they had to default. I mean, their currency fell 40%, like the yen. I mean, why no one's talking about [it]?
The move in the yen is terrifying. And through this period, really, what I want you to concentrate on, is at the end, it was like an 18-month period. And at the end, Taiwan — now Taiwan had no dollar borrowings. [It was] really tightly, like Singapore, [a] really well-managed economy. And right at the end, Taiwan devalued. And everyone's like, ‘What? What are you doing?’ And it's the Aesopian fable of the scorpion on the frog. The frog's like, ‘I ain't taking you,’ he's like, ‘No, no, no, you're, you're cool, you're cool.’ And they get halfway over, and the scorpion like zaps. He's like ‘Whoa!’
Joe (22:00):
What year are we talking about here?
Hugh (22:02):
We're talking about 1998. In Taiwan. And so the point is, why did Taiwan devalue?
Tracy (22:08):
In its nature.
Hugh (22:09):
That's what they do. They weren't going to leave a legacy of their neighbors having devalued by 40%. So the big elephant in the room, and you touched upon it in your intro, is what if the Chinese come around and go boom! And they devalue, right? That would be profound. I would call that Mad Max deflation.
Now, one of the incentives for them to do it is the quantitative easing in the United States. I actually think it was sabotage for the Chinese, because the very polite request was, listen, you gotta revalue, your currency should be rising. And why is that a good thing? Because 1.4 billion Chinese people will be richer vis-a-vis the rest of the world, and they'll buy our things.
I mean, the Dreamliners may have some problems just now, but they'll buy more, you know? We'll work it out. And the Chinese stubbornly refused to do that. And so if you can't revalue the external price, I think actually quantitative easing coming out of the states and elsewhere revalued the asset prices domestically in China.
And so now, did they prick the bubble? They've got the biggest damn bubble of all time, $60 trillion valuation. And what do you do with that? It's a lot easier if you devalue in dollars as opposed to the local currencies. So all the people feel like they're still the frogs in the jacuzzi.
Tracy (23:27):
Joe, I remember this from, do you remember Dick Bove? The banking analyst. But, but he used to write about QE as a currency war, as like an underappreciated currency war. And this would've been in like 2010, 2011. I still remember that.
Joe (23:42):
Yeah, yeah. So let's take it to today. And I guess there is still this anxiety out there of a Chinese devaluation. We have seen them basically purposefully prick their own real estate bubble. And there's been a lot less speculation. That seems like it's done.
They’re trying to, the bet is that they can sort of make up for that with a lot of exports in advanced technologies, vehicles being the one we talk a lot about these days. But that basically it can be an industrial exporting powerhouse. And of course, you know, people have always talked about Chinese exports, but I think the real growth driver was domestic investment. Now it feels like selling to the rest of the world. What happens here? Can it work? Can they make this pivot from a sort of inward investment, real estate-focused economy to one where exports really lift everyone up?
Hugh (24:33):
Uh, no. No. And it's back to your anxiety, right? The biggest industry in Europe is automobiles, yeah? And they're, I mean, listen to Elon. It's like the Chinese where they are, they wipe you out. You are gone, okay? So you think Europe's gonna sit there and go ‘Hey, we're open, we're friendly. Come and wipe us out,’ right? That avenue is over.
The proportion of exports to the Chinese economy, the proportion of exports to the global GDP, we are at levels where it's intolerable for the rest of the world to accept it. The bigger issue is, I would say, so here we are. I mean, I've been invested for like 35 years. And I'm saying to you, China going from the size of Turkey to Europe and the avalanche of money and liquidity is why every asset price in America is high.
And I think we're now at the, I call it the Obayashi Maru moment. If you remember from Star Trek, when it's a no-win scenario. There's just no win, because we got five and a half percent rates in the US. We've got a currency, which is rising, and the rest of the world's like, ‘I'm outta here, I'm checking out.’
And so the flow that is coming more and more into the US. Now, the Fed's sitting there and it's listening to, it's like the Bank of England in 1927, when they were like overpowered on the gold standard. And like ‘We are at four. And like, we're gonna be overthrown by the communists unless we can bring interest rates down.’ And so he went to the Fed and he said, ‘The only way we can bring rates down is if you cut,/ remember Benjamin Strong, the coup de whiskey? And he takes a cut.
And what happened? The US stock market like went to the moon. It bred instability. So the big drama this year is the Koreans, the Japanese, and I think the Chinese are saying, ‘You gotta, you actually gotta subjugate the domestic strength of the US economy, and you gotta bail us out.’ Now, if the Fed, that's a no-win. If the Fed does that, like buy 10,000 call strikes on the S&P, it's not gonna be there in two months. But that's where it's gonna head really rapidly.
Because that's what happened in, I get back again to 1998. Remember LTCM? So we had a sovereign crisis. The US economy in the third quarter of 1998, grew at 5.6%. And what did the Fed do? They cut rates. And people were like ‘You guys are clowns. Okay, I'm buying stocks.’ And stocks again, went to the moon.
We are at a point where, if the Fed, so I think the Fed actually, the Fed only ever cuts when something breaks. And the rest of the world is saying, ‘we're kind of at that point,’ okay? So if something breaks, the Fed's cutting, it’s going to subjugate the strength of the United States economy, like the interest of it. And asset prices will become intoxicatingly, at levels, you gotta remember, trees grow tall, but they don't grow to the sky. And we're getting close to the sky.
Tracy (27:27):
Why doesn't China try to boost domestic consumption if the rest of the world is like closed off to it? Why is it still so focused, it seems, on manufacturing, even though it's moving from, you know, manufacturing TVs or whatever to semiconductors.
Hugh (27:41):
Yeah. I mean, you know, I wish to remain polite, but it's not a democracy. You know, the civil liberties are, I mean, you know, I don't think that's a contentious thing. You don't really have much in the way of civil liberties. Again, the quid pro quo is look at your life. You're so much richer than your grandparents. And we just ask for a bit of tolerance. It’s like ‘Hmm.’ So you were saying, again, your anxiety about the Chinese and they're gonna overtake us. They took the wrong bet, right?
Because I was talking to someone like, ‘But what about the Chinese thousands upon thousands of PhDs?’ I'm like ‘Yeah. Like, I'm sorry. Again, forgive me, but if you just completed a PhD, my God, you just chose the wrong moment in history.’ Why? Because we got AI, we got the AI and the PhD thing, by and large is the left hemisphere of your brain. If you're listening to this now, the future, and if you want to be rewarded, again, you've got to be kind of like an Acid Capitalist. It's the right-hand side of the brain. All that PhD thing has been made redundant.
Joe (28:43):
But the AI companies all have to hire PhDs. So some of them get jobs.
Hugh (28:47):
No. Now they just, they invest in more AI, it’s become circular, like PhDs are not the future.
Tracy (28:51):
AI can invent itself.
Joe (28:51):
I talked to a founder this week by the way, Tracy, who says that all code will be written by AI in the future. Let's talk more about this idea. Okay, the Fed is not going to cut until something breaks. You think the thing that will break will not be like a domestic thing, but will be like on the international front. Walk us through like where we're at risk of breakage.
Tracy (29:28):
Yeah, because a year ago, the thing that was breaking was banks.
Joe (29:29):
Yeah it was banks. That was the fear.
Hugh (29:32):
Yeah. I mean, it ain't going away. Extend and pretend and all that thing. So, I mean, you know, not wishing to name and shame, but you know, an organization like Bank of America, you know, has, and like its peer group has an enormous Treasury portfolio, which it doesn't mark to market.
And that is an inducement by the US Treasury to ensure that people are there to buy the Treasuries, okay? And so they've got unmarked losses, right? Which are the same magnitude as their equity, okay? Now, and where we are just now is that we started this year and we were gonna get four, five, six interest rate cuts. And when you get that, the bonds normally kind of come off their lows and kind of rise in value and like their viability gets better.
That ain't happened. If anything, you know, the domestic economy's saying we need higher interest rates. Where's the 10-year today? Like it was four and a half. We were heading close to five before the weaker GDP statistics come out. So that's still there. There's fragility there. 4.42%. And look, when we get bank earnings, I mean, if we've got any banking analysts listening to this, can you do your job? Like, rather than blowing smoke up the CEO, can you say, ‘Hey, listen, can you tell me what is the size of your unmarked Treasury portfolio? What is the loss on it? What are you doing? What have you shifted the duration? Can you just talk to the street about it?’
No one asks, no one. Like bad news comes at you, really, really, it comes at you really, really slow. And then it stings you. Let's ask the questions. So that's there, that's out there.
Tracy (31:07):
Okay, just on the banks. So when we say that ‘Okay, if you marked the bonds to market, it would just blow a massive hole in banks equity.’ That is terrifying, on the one hand. But on the other hand, part of me is like, I find it hard to believe that the banking system is going to be ruined by investing in too many US Treasuries.
Hugh (31:31):
Okay. I mean, what? Is that blind faith? I mean, the numbers are like really big.
Tracy (31:36):
I guess it's blind relativism. It's like US Treasuries are the safest asset out there.
Hugh (31:44):
Until they're not.
Tracy (31:45):
Until they're not, this is true.
Hugh (31:46):
So I tell you, so what we're doing is we're flying high without a safety net, okay? So we've been there, we had the — again, I can't believe this is happening — the entire global banking universe went bankrupt in 2008. They were gone. Gone, right? But the US Treasury was at like 60% debt to GDP. And they stood in and they're like, ‘You know what? We got it. Alright, we're gonna, we've got these fun tokens and we're gonna issue lots of these fun tokens and you're gonna come back.’
Okay, what happens? And that was your safety net. Where's the safety net now? Like if they tried that maneuver again, people like me would be like ‘Get outta here. We're getting out of like, we're not owning these silly securities because you're tapped out.’ So the US Treasury now is not the safety net if there is folly, and if there's an incident in the financial sector, it's tapped out. It doesn't have the resources. So we're on our own. And that's scary.
And so again, that's why, you know, the next move for people is to consider, well, what if they cut? And, you know, I actually think it could get so bad that we will go back to the notion of zero interest rates. And I think that Treasuries, I mean, I've been so hideously bad. I've been owning LEAPS on the TLT, the long duration, now LEAPS, options. Like, you know, if I've got a million dollar portfolio, I've been spending like $50,000 and then topping it up as I lose money on them and just keeping a lot of time on it. So I've probably spent a tenth of my portfolio.
You know, I'm underwater, but I own that because I think we're at the end of the most incredible bull market in Treasuries, which again absolutely coincided with China. And who came in to preserve their currency and leave it undervalued? They had to put money into risk-free US Treasuries, and they bid it higher, okay? But the bull market in Treasuries, it was a double bottom in price terms between 1982 and 1984, if you put that into yield perspectives, the 10-year peaked at 16%. But in 1984, as the economy came back, and found vigor. People went, you know, the notion of recency bias?
So the recency bias was strong economy, inflation. And people sold the bonds again. So in 1984 yields peaked at 14%. And then that was it. You know, and of course they went to where they were. They went to like 40 basis points during the Covid. I think the end of this bull market is in the next 18 months. And I think the Treasuries, I don't think they'll yield 40 basis points, but I think they could get down to like, 1.2%, 1.5% yields and that, and then that's like, and then sell them and get out because we'll have to redraw and we'll have to examine and try and create a new monetary order.
Joe (34:39):
Exciting. I'm sure we'll have plenty of good episodes about that redrawing of the monetary order. Back to China. Didn't all those ghost cities that you toured and showed on YouTube end up getting filled? Because I feel like now, there's a hundred, what do they call it? Tier two and tier three cities that none of us know the names of that have like 10 million people, with glistening subway systems and whatever else. In your view, what, what happened to those cities?
Hugh (35:03):
Thank you for that because I was dead wrong. Dead wrong. Dead wrong. Okay. Dead, dead wrong. But can I tell you why? So I, like you, you get value investors, growth investors. I'm a time investor, would you believe? Okay? And I, it was only really very recently I came to understand the Chinese, like, what do you call it? Like your horoscope and like the pursuit and the investigation of heavenly bodies around the sun, right? Like Pisces and all that kind of stuff. We use the Earth's rotation around the sun. And I believe that takes a year.
Joe (35:40):
Oh, theirs is 12 years. Oh, that's a very interesting — I hadn't heard. That's a very good, like, metaphor...
Tracy (35:45):
No, you have heard that before because we talked about this exact thing with Hugh last time.
Hugh (35:50):
There you go.
Joe (25:51):
But that's a good one.
Hugh (35:51):
And then like, so when I was peak, peak bearish, I was 12 years out. Literally, it was 2011. I had launched a credit fund, I'd have made a billion bucks. A billion bucks. If I had been 12 years in the future. You know, so I was wrong. But I want to tell you my time piece was 12 years out. And the time is now.
Tracy (36:16):
When was the last time you were in China?
Hugh (36:18):
I ain't rushing to go back to China.
Tracy (36:19):
Yeah. Well I was kind of curious if you've been back recently and seen some of the changes
Hugh (36:24):
I've been invited by some funky people to go to Mongolia in August.
Tracy (36:28):
Oh. I would go.
Hugh (36:30):
August. But I think I'd rather be in Ibiza, but you know.
Joe (36:34):
Ibiza will always be there.
Hugh (36:35):
Yeah. So my last, I tell you in terms of, again, formative and with the investment letters, March, not the last time, but March, 2008, I took a slow train from Wuhan to Beijing, and it was quite grim.
Tracy (36:49):
Not the high speed train?
Hugh (36:50):
No, it was really quite, it was, I like traveling slow. It was really grim. I should have been buying the S&P. The S&P had fallen 65% in March, 2009. And instead I was in Wuhan, where was I in Wuhan? I was in the wet market where the, the whole Covid thing [happened]. I should have been buying the S&P.
Joe (37:12):
Just in general. I mean, I am struck by this fact that like, we hear all these different people and it's like diversification and international stocks and all this stuff and exotic things. In the end, we should have just all been buying the S&P and like gone and lived our lives, right?
Hugh (37:28):
Absolutely. And like, they're still peddling emerging markets. Like how many, how many years?
Joe (37:34):
Why does it that work? I'm curious, because there's been a ton of growth overseas. And this is always the thing. It's like there's a lot of growth everywhere. What has been the fatal flaw of the International Diversification/EM thesis that has been very popular and people are always repackaging and reselling?
Hugh (37:49):
Again, I think it's my accent. You're not hearing me. They are magnificent, these countries are magnificent at creating GDP growth, right? They're incredible, right? But it's GDP growth at the expense of wealth. So let me give you [an example], so let's say we've got a bridge that's gonna cost us a billion dollars. We're gonna link two communities and let's say it's in America and and it's in the Bay Area, and the average per capita income of the two cities is $150,000, right? And so, you're gonna cut like 15, 20 minutes in the daily commute of all those people, people with that level of wealth. Cutting time is good. It's productive, it's gonna add utility to their lives, okay? And it's going to, it's an NPV positive, it has net present value.
So the value of the billion that you spend, maybe it's 2 billion, okay? Now, if you join up two Chinese communities and the average per capita consumption is $8,000, if you're on $8,000, you ain't in a hurry. You ain't in a hurry, right? But you spend a billion and what happens is you've not created wealth. So ifyou actually had, if you were a corporation, you'd have to mark it, because let's say you're taking a token, it's a toll bridge, okay? And you do the DCF, you're gonna quickly work out that your NPV is like half a billion.
So you're in a half a billion deficit. The half a billion deficit doesn't get measured in GDP. You measure the billion. And so this is why the strategy doesn't work because sure, you get GDP, but where's the stock market, right? And where's the stock market in America? Because what do we do? We actually go ‘Hey, we're return on capital. Positive NPV. We're in it to win it.’ Right? And so we get less GDP, but you know, we get the best stocks and the best stock market. That's the fundamental flaw.
Tracy (39:40):
So one of the reasons we enjoy talking to you is because we get to live vicariously and pretend that we're talking macro on a beach in St. Barts instead of talking macro in an office in Midtown. And you've been in St. Bart's for many, many years now. And I'm curious, what changes have you seen over the years? And one of the reasons I ask is because I went to the Seychelles, which is on the other side of the world, but I guess it is a beach. And I went to the Seychelles last year. I was kind of surprised by like the number of Russians that I saw there, just so much Russian money. And coming from the US economy at a time when, you know, it was all about sanctions, all about European energy crisis, things like that, it was kind of surprising to me to see that level of wealth externally.
Hugh (40:22):
Well, I mean you know, the Paul McCartney, Wings, it’s Band On The Run. I mean, it's the Russians on the run. I mean, they're fleeing. Go to Dubai and it's the same thing. You know. From the beginning, when I was writing those letters, like, you wanna solve Russia? Because that's the time of the emergence of the oligarchs. I was like’You wanna solve Russia, you wanna bring freedom?’ I mean, it's not for us to solve Russia, it’s for them to solve it, right? But if we want to stop them impinging and being annoying, being noisy neighbors, the number one thing you do is you say to all the rich oligarchs ‘No visas, you can't come to St. Barts. You can't go to Seychells. You can't go skiing in the Swiss Alps or in America.’
‘Enjoy the motherland, okay? Talk to the boss when you sort it out. You know what? We'll look at your visa again.’ And that's so they can't come to, they can't come. I'm gonna say they can't come to St. Barts, but actually I'm thinking, my Christmas client actually is Russian, so some of them can get in. But Abramovich, he came in and he laid down $80 million in February, 2008, and put Saint Barthélemy on the map.
But, you know, that was like a huge investment. And you know, property prices are absurd. Really absurd. I just got divorced and I had to do a valuation on the portfolio. I mean, it's just, it's insane. Saint Barthélemy is kind of like Bobby Digital. Forgive me, I call Bitcoin Bobby Digital. It's gold's baby brother or something.
Joe (41:45):
What is, you know, one of the things, and we've talked about it a little bit on the show, is like the extreme concentration of ultra wealthy in places like Dubai, Miami, etc. What is driving? Is it, I mean, I sort of get it from the Russian perspective, wanting to get money out of the country, being on the run as you you put it. What do you think, like, what is the sort of anxiety among the ultrawealthy that they're, you know, that they congregate in cities like Dubai or elsewhere to sort of get away from messy countries, whether it's messy democratic countries or messy autocratic countries?
Hugh (42:18):
Yeah, I mean the Miami thing is the same thing. It's South America, you know, it's taking all of your wealth and really they're kind of robber barons. It's the confiscation of other people's money, the good folks' money, and getting it out of places like Venezuela. And it resides in Miami. That's Miami.
I'm an LA person because, I was gonna say, LA's a real place, which kind of is, I like LA, you know, but I mean, it's real in the sense that you've not got capital on the run. You've not got robber barons like they're in Dubai and the Seychelles. It only exists because the US Treasury and the administration are looking the other way. I don't know why they look the other way. I really don't because it's against the rules. It's like, look, you know, there's a war. We're kind of funding the Ukrainians against it, and we should be really tight. There should be no slippage. And yet we let them slip into Turkey, into Dubai, and into the Seychelles. I would like, again, you're staying in Russia. Call me when you're more polite to your neighbors.
Joe (43:20):
Hugh Hendry, always great to catch up, live vicariously a life that’s much more colorful, perhaps, than ours here in a midtown office. But thank you so much for coming back on Odd Lots
Hugh (43:30):
An absolute pleasure.
Joe (43:46):
That was a lot of fun, Tracy.
Tracy (43:47):
It's always fun talking to Hugh. One thing I was thinking, I kind of, do you think Bloomberg would let us expense the $25,000 that it costs for like a VIP package to the Acid Capitalist summer camp in St. Barts?
Joe (44:01):
Yeah. For sure, right? Yeah, I think so. There's no question.
Tracy (44:02):
I think it's worth it.
Joe (44:03):
Let's go. I don't necessarily feel chilled, or relaxed. I mean, the idea that like something is gonna happen in the Treasury market, yields are going to go back down to 1%, 2%. Doesn't make me relaxed.
Tracy (44:13):
No. Also, the ‘time to panic about the currency war’ line isn't exactly reassuring. The other thing I was thinking, I think the thing that will stand out to me is the idea about a lot of emerging markets being good at generating GDP growth, but not wealth. I feel like that encapsulates, certainly, a lot of the story around China right now. And the question over, why not boost domestic consumption versus manufacturing and sort of repeating the same thing you've been doing for decades now.
Joe (44:40):
No, I mean I think that is, it's just true, right? Like there's been incredible growth of some of these companies. I mean, even if you look, I was looking at the chart of BYD the other day, which like everyone knows now, is like this global behemoth, you know, arguably by some measures bigger than Tesla.
That stock is the same as where it was in 2020. But if you actually, if you go back to even 2010 or if you go back to 2009, it's only up like threefold since its peak in 2009. I mean, this is a company that was literally nothing. And now it's at the forefront of probably one of the biggest industries in the world. It's not amazing. You don't get paid very much to own these companies.
Tracy (45:19):
Less than Domino's Pizza, I suppose.
Joe (45:21):
Yeah, exactly.
Tracy (45:22):
But this is the other thing I was thinking about. So there are pros and cons to the command economy model, right? And the idea that you can pull all these policy levers because on the one hand, like yes, China can direct huge amounts of capital to whatever project it deems strategically important at any one period of time.
But on the other hand, you get misallocation of capital. And then you get the uncertainty that's sort of hanging over investors where they can't predict what China is gonna care about next. So going back to, you know, the real estate crash, the three red lines program, and then the crackdown on consumer internet companie, those are real expressions of the uncertainty of that particular aspect of the economy. Shall we leave it there?|
Joe (46:14):
Let's leave it there.
You can follow Hugh Hendry at
@hendry_hugh
.