China | Economics & Growth | US
This is an edited transcript of our podcast with Douglas Greenig on 17 November 2023. Dr Douglas Greenig is the CEO, CIO, and founder of Florin Court Capital, a systematic, trend-following asset manager uniquely broad in its focus on over 500 markets. Doug has over 25 years of experience in portfolio management and trading. Prior to founding Florin Court, Doug started in markets on Goldman Sachs’ bond arbitrage proprietary desk through the late ‘90s after being hired as an Assistant by Fischer Black. Following this, Doug headed Agency Mortgage Trading at RBS Greenwich Capital, worked as a quantitative portfolio manager at Fortress Investment Group, and then as Chief Risk Officer at London quant firm AHL. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.
Introduction
Henry Occleston: Welcome to Macro Hive Conversations With Bilal Hafeez. I’m Henry Occleston and I’ll be your host today. Macro Hive helps educate investors and provide investment insights for all markets, from equities to bonds to FX. For our latest views, visit macrohive.com. Before I start my conversation, I have three requests. First, please make sure to subscribe to this podcast show on Apple, Spotify, or wherever it is you listen to podcasts. Leave some nice feedback and let your friends know about the show.
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Now, onto this episode’s guest, Dr. Douglas Greenig. Doug is the CEO, CIO, and founder of Florin Court Capital, a systematic trend following Asset Manager uniquely broad in its focus on over 500 markets. Doug has over 25 years of experience in portfolio managing and trading, all starting when he was hired to Goldman Sachs by famed economist Fisher Black as his assistant. Doug headed agency mortgage trading at RBS Greenwich Capital, worked as a quantitative portfolio manager at Fortress Investment Group, and then as Chief Risk Officer at London Quant firm, AHL.
Our conversation today focuses on macro uncertainties and risks that lie ahead as we enter a more multipolar world. Now, onto our conversation!
My warmest welcome to you, Doug. It’s great to have you on the podcast today. Now, before we get into the main part of our conversation, I’d like to understand a little bit more about your origin story. It’d be useful if you could just tell us a little bit more about your background, what you studied at university, was it inevitable that you’d end up in finance, and perhaps just some of the highlights of your career so far?
Greenig’s Origin Story
Douglas Greenig: Well, thank you. Thank you very much for having me. Well, I don’t think there was any inevitability about my ending up in finance. I went to Princeton University as an undergraduate and I studied economics. I drifted into economics from the liberal arts, but as I got into economics, I went to a more and more quantitative side of the subject. By the time I was writing my senior thesis, I was actually doing some reasonably cutting edge things. This was back in the 1980s, a different era altogether. I did work on the generalised method of moments and real business cycle theory. These were the cutting edge topics actually in macro. We were trying to reinvent macroeconomics, you see, based on micro foundations, the idea of an optimising representative agent and so forth. It was from a mathematical standpoint and statistical standpoint, some pretty sophisticated stuff, but I don’t think it was all that successful, because actually it’s the heterogeneity of agents and an economy.
It’s not a second order effect. It’s a first order effect, and so a lot of the math that we ended up doing was based on rather unrealistic assumptions of uniformity, of preferences, and so forth. That’s how I got into economics. Following that, I decided, well, maybe I should just do mathematics because I enjoyed it so much. I went and got my master’s in PhD from the University of California, Berkeley, and what a wonderful math department we had in those days. This is now the late 1980s, early ’90s. There were so many fantastic mathematicians, multiple field medalists in my department, and it was just wonderful doing the work I did. It was in differential topology, branch of pure mathematics, and had a very great time. What I did, however, so I worked part-time at Barra in Berkeley, California, and it allowed me to live the high life for a graduate student.
I wasn’t living in the graduate student housing down by the train tracks in Albany with these trains rumbling by and shaking the house and stuff. Instead, I was able to live in San Francisco with a lovely view because of this work I was doing. I was earning a decent living. When I came out of graduate school and got my degree, I had a choice to make, would I stay in academia or would I go into finance? I decided to go into finance. I got an amazing job offer. Fisher Black hired me to be his assistant at Goldman Sachs. He actually did it on the strength of that senior thesis I wrote that I mentioned earlier. Actually, a lot of that stuff was featured in Fisher’s last book called Exploring General Equilibrium. He discovered my work, which had been done when I was an undergraduate. That’s why he hired me.
I was at Goldman Sachs and then went on to the proprietary trading desk, the bond arbitrage desk. I was there up through the late ’90s, and then I went on to Greenwich Capital, where I headed the mortgage arbitrage desk, and then I eventually headed mortgage trading with a wonderful firm. Subsequently, I was at Fortress Investments, and then I went to a quant firm in London, AHL. That was a very, very interesting experience. As you know in finance, you have all these different segments and specialties. It was my chance to really have a careful look at the so-called CTA business and it was a terrific experience in a very good firm. After that, I founded Florin Court Capital.
Trend Following: What Is It? What Drives Performance?
Henry Occleston: That’s really interesting. Thank you so much for giving us the background on that. Florin Court Capital, its focus is systematic trading, particularly trend following. There’s a lot of focus in particular on the niche and alternative markets. Could you tell us a little bit more about what exactly trend following entails? What drives its performance in particularly uncertain environments? And how you apply those systematic strategies to what are no doubt a little bit more illiquid markets?
Douglas Greenig: Okay. Trend following is a very interesting thing and it really helped me to come into it with the finance background that I had. I was asking myself very interesting, very incisive, if you will, questions about why it works, what drives it. Trend followers trade the interplay of directional movement and volatility. It’s not just the trend, it’s also volatility. The basic idea, and I think I’m one of the first people to articulate this because I saw it and I haven’t really heard it much elsewhere, the basic idea was found in the work of Minsky. Hyman Minsky was an economist and he studied bubbles and crashes. You can find a nice exposition in Kindleberger’s book, Manias, Panics, and Crashes. Essentially, the idea, and he thinks of this more on a big macro scale, is you have these huge trends, these bubbles, and eventually, there’s a period of distress, where there’s enhanced volatility, and then the bubble becomes discredited, a new idea emerges.
But I think this has more general applicability. Themes take over in a market, trends emerge, then there’s a burst of volatility around the time narratives are changing. Narrative changes are often, not always, but often accompanied by a burst of volatility. What CTAs do, they ride trends and then they do this thing called volatility scaling. When you volatility scale, you’re adjusting the size of your positions to react rather quickly to market volatility. Imagine you have a nice trend, up or down, let’s say up, and you’re long some asset. At some point, the volatility starts to jump. It goes through what Minsky or Kindleberger would start to call distress that’s consistent with a narrative change. Well, now, you’re cutting the risk. Bubble doubles, you cut the risk in half. The basic rule is that the position size, I should say, the position size is cut in half in order to maintain the risk at a relatively constant level.
Volatility jumps, position is cut in half. That allows you effectively to take a profit. If the trend reverses, you lose a little bit at the beginning, assuming the position size has been cut, and then you pick up the new trend on the way down. The importance of that volatility scaling is quite high. In fact, if you take it out and make volatility, you’re scaling very non-reactive. You’re going to lose a large part of your sharp ratio. Volatility scaling is key to what CTAs and trend followers do. The idea is you’re writing trends up and down and getting smaller in position size when there are bursts of volatility. That tends to help you because, as I said, trend reversals are usually accompanied by a burst of volatility.
Trend Following vs Herd Mentality
Henry Occleston: That’s really interesting and I thank you so much for that. The first question is, I suppose the market, I presume, is not particularly good in general at calling those when the trend starts to turn, when it’s the second order of Europe, you’re seeing that in the volatility, is that what really separates the trend following strategy from just herd mentality riding the bubble, getting caught in the worst part of it?
Douglas Greenig: Well, you make a good point. If you apply this strategy to one market, you’re likely to be disappointed. The signal just isn’t that strong. You have an edge but it’s not a big one, and that’s why diversification becomes so important. If you look at the basic trend models that we use and other people use, and apply it to 1, 2, 5, 10 markets selected at random, you’d say, “Why would anyone ever do this?” The sharp ratio isn’t acceptable. But as you add more markets, creating more independent bets, you end up in a situation where that slight edge gets bigger, and bigger, and bigger. Part of the reason we have been more successful than a standard CTA is we’re trading about 500 alternative markets that are not that correlated with each other.
Colombian interest rates, French electricity, methanol in China, yellow maize in South Africa, Malaysian palm oil, crossover credit default swaps in Europe, how related are these markets? Not very much. If you build up a portfolio with 500 things like this, that small edge starts to become a big edge. You become more like, forgive me, the casino, as opposed to just one table at the casino. Because we have all these markets, because the pairwise correlations are low, we end up having a level of diversification that is, in our view, several times higher than an ordinary CTA, and our results bear that out. You see about what you would expect on the basis of that.
Henry Occleston: That’s really interesting. I suppose it’s a lot of operational work in getting into those little markets and understanding them, and not being in places that you don’t fully understand, I’d imagine.
Douglas Greenig: Yeah, that absolutely is the case. It’s quite labour-intensive. I have a very experienced team doing this who’ve been doing it for years. It’s not the prettiest thing. There’s part of me that would just like to do some badass mathematics and stuff like this, but the truth of the matter is the models we have, they’re hard to improve a lot. Markets are non-stationary. The past doesn’t repeat perfectly, you know what I’m saying. But finding a new market where it’s pretty uncorrelated with things, where there’s not a huge amount of systematic participation, not a huge amount of that, that’s generally more additive than tweaking your models a little bit. In a way, the back test is slightly better, but doesn’t necessarily do better in the future.
For us, the priority is very much getting new alternative markets in. We add about 50 every year and we’re now trading about 500, just under 500 markets. They’re everything from methanol, as I mentioned, jujube, so I think it’s a fruit, peanut kernels in China. There’s a lot of stuff in there and most of them are reasonably orthogonal to the other things we trade.
Henry Occleston: That’s incredible scale. I suppose, we’ll get onto some of the macro risks that you see ahead. As a quick top down view, is this macro environment working particularly well for systematic trading and what makes it particularly apt for it, I suppose, or for the trend following?
Douglas Greenig: Well, broadly speaking, I think this will be a very good macro environment, but that doesn’t mean it’s good every month or every quarter, because you can have volatility with some whipsaws and reversals that may be tough for trend following. But the basic question is do you think we’re in a non-stationary environment? Do you think prices are going to be in a very different place months, quarters, years ahead? I think we’re in an environment where the rate of change is almost dizzying. We can talk more about it. But basically, we were in this kind of Pax Americana after World War II, the post-war American century. America was so dominant, economically, militarily, and broadly enforced a certain piece and certain norms. Fossil fuels were plentiful and relatively cheap. At the time, it felt more permanent than it really was. Now we see that the pillars of that order are breaking down.
Certainly, the U.S. does not have a particularly stable financial position. Yesterday, there was an awfully bad long bond auction, and people are extremely concerned about the national debt in the U.S., which is either about 33 or 4 trillion, if you count it in total, or if you consider the privately held part, it’s a slightly smaller number. I think, what, 26 or 27, somewhere in there. Either way, it’s a big number and it looks set to take off further. That’s a concern. You have countries around the world that actually are a lot stronger militarily and economically than they used to be. This is not necessarily a bad thing, but it’s a different world with economic as well as strategic multi-polarity. It’s a world that’s more complex.
We have the energy transition. There’s a wonderful book, I want to totally recommend it to everybody, Vaclav Smil, S-M-I-L, How the World Really Works. It’s a terrific book about energy. The reality is energy and how a society generates energy is so key to its development. Relative to a couple of hundred years ago, humanity, the primary energy supply is several times more per capita, and most of that came from fossil fuels. Weaning ourselves off of fossil fuels, decarbonizing, is so difficult, as Dr. Smil documents. It’s hard. The four pillars of modernity, as he calls it, was cement and concrete, steel, plastics, and nitrogen fertiliser. They’re all very fossil fuel intensive. As we were talking about before we even started, the green transition is going to prove to be resource intensive. You need various metals and materials to produce batteries for electric vehicles.
The environment that I’m describing is, one, where things are changing. We’re going to try to decarbonize but it’s going to be a tough process. We need to do it, we absolutely do. Don’t dismiss climate change. The climate is changing and de-carbonisation will be difficult. We’re moving into multi-polarity. The debt position of the advanced economies, the fiscal position, it’s very, very tenuous, very delicate. It’s not particularly stable, so this is an environment where things are going to move. I like being long volatility, because trend following is basically a long volatility strategy.
Is the US Truly in Decline?
Henry Occleston: Absolutely. No, thanks. That segues very nicely onto, as I said, some of the points we’ve been discussing. I suppose one of the big themes, as you mentioned, is the reversal of the post-war globalisation and the pullback of the U.S. from playing global policemen. I suppose some of the questions, from my side at least, is how do you know or is the U.S. truly in decline? Is it inevitable and is the U.S. ready for it, I suppose?
Douglas Greenig: Certainly. I don’t want to pretend to know all these answers. I mean, these are hard questions and a lot of people are thinking hard about them. My angle would be this, there has very, very seldom been, if ever, one big hegemon for the world. Even in the glory days of Rome, they didn’t conquer Persia. At various points in time, the Chinese have been among the largest powers. Usually, there were a bunch of big powers. The situation where the US found itself at the end of World War II and then after the Cold War was the peak of the U.S. in the early 1990s. Certainly, that’s when Francis Fukuyama wrote his famous book about the end of history, that we have it all figured out now and the future will look just like us. It struck me as a very hubristic point of view.
Yeah. There’s almost no question that the relative U.S. dominance is gradually coming to an end and it would be absurd if it didn’t. Technology is spreading all over the world. The Chinese are doing remarkable things. They have outstanding universities, incredibly hardworking people and students. I mean, think of this, 90% of all Chinese families have private tutoring for their kids, and in various international comparisons of secondary school students, they’re always right near the top or at the top already and they get private tutoring. They have a very rigorous and, shall I say, incorruptible admission system based on exam. An important person in China will have more luck getting their kids into an Ivy League school in the U.S. than getting around the system. I believe it’s called [foreign language], but perhaps I mispronounce it, than getting around the merit-based system in China. China is certainly, despite some cyclical issues with real estate, an incredibly important country coming up. Many people in the American business community are dismissive. They shouldn’t be.
Henry Occleston: No, I definitely agree and we’ll come on to China shortly. I think especially when you mentioned how things seem more permanent than they were, I think history is definitely a very, very good thing to look back on where you see these kinds of things never last particularly long and end of history, as you mentioned, was very premature. It was interesting, you mentioned Rome. I suppose one of the things about the fall of Rome was it lasted a lot longer than, I suppose, it maybe should have. Do you think there’s lags for the U.S. decline to be a lot slower than, I suppose, some are discussing, and it may be dragging out for decades, if not a little longer?
Douglas Greenig: The U.S. has some wonderful strengths. A lot of times, when I think about my country, there’s some real pride. The educational institutions in the U.S. are amazing. The U.S. remains an incredibly powerful military power, probably the single most powerful one. Although, again, the mission statement for the U.S. military strikes me as quite a lot. It’s consistent with this role as a global hegemon that has emerged over time. But I think the U.S., it’s going to be bipolar with China. I probably shouldn’t use the term bipolar, but there’re going to be two centers of power. The U.S. will be one and China will be one, and hopefully, there’ll be a constructive albeit competitive relationship between the two. I don’t think the interests are necessarily so much across purposes, but who is the person that’s written extensively about this? An old colleague, Stephen Roach. He has a very nice book out about China and the U.S.
Henry Occleston: Oh, thank you for that. We will, just for all our listeners, we’ll stick links to all the books you mentioned and we’ll have a little bit more discussion around books as well a little bit later on. It’s interesting, when you’re talking about the changing and the shift from the uni-polarity, are we talking more about the ascendancy of China but also the challenges facing the western model? Are there, I suppose, internal questions that need to be asked, I guess, as to why the current political structures not able to handle the challenges ahead in the west? And then where do you see them?
Douglas Greenig: Well, we need to ask ourselves more questions, important questions. Because if we go back to Francis Fukuyama and his book, The Last Man and the End of History, there was a triumphal tone that we had basically figured things out and that there was no alternative model to be considered. And then in more recent years, he’s been trying to figure out why things didn’t work out so well. I believe he introduced the concept of vetocracy. We have to think about our institutions. Imagine we’re people on a bus and we want to go somewhere, it’s not a great thing if the person driving the bus is not accountable to the passengers at all. That can lead to some pretty bad outcomes. They go where they want and the passengers are dragged along. But on the other hand, if you have an ongoing melee, where people are constant fighting over the wheel all the time, the bus could easily crash.
There needs to be a method of organising things where there’s accountability representation but an emphasis on governance over longer timescales. Think about all the times we’ve stopped and started the Keystone Pipeline. Think about the healthcare system in the U.S. I’m not advocating one thing in particular, but we had an attempt with Obamacare that Trump partially reversed. Everything is lurching one way, then the other, then the other way. The level of consistency in our policy is very low, and that’s because politicians live in a state of great insecurity about their jobs. They’re essentially worrying always about the next election. Daniel Ellsberg, he was the fellow who published and got into a great deal of trouble, the Pentagon Papers way back when, which revealed important facts about how the U.S. government was approaching the Vietnam War and the fact that, to a large extent, the American public was not hearing that behind the scenes discourse among policymakers.
Well, Daniel Ellsberg had this idea of the stalemate machine. He argued that it’s very difficult for America to get out of conflicts because no one wants to take the L before an election. No one wants to explain to the public why it didn’t work out and there’s always an election coming up very soon, and so that it leads the U.S. into these very difficult situations. For example, we stayed for a very long time in Afghanistan. I think it was actually Trump who negotiated effectively the departure in Doha. When Biden executed on the very departure Trump had previously negotiated, he was blamed. Everybody said, “Look at this mess. How can we be leaving? Why are you doing this?” He actually dropped in the polls notably. Now, again, I’m not taking a stance on what we should or shouldn’t have done, but I’m pointing out that the timescales over which the people consider these things and politicians address these things, they’re too short.
You have a whole range of problems that are typical of what we’re facing in the U.S., and in Britain, and in Germany, a lot of public debt, a lot of populism, short-termism, the polarisation, and the idea that the political process is not about choosing the right person to govern you, but about choosing a person based on the sensations they elicit, the sense of affinity with your group. Somehow we have to become a little more long-term and I’m not sure how to do it, but it would be a wonderful thing if we were able to think more about how we can make our political system more focused on good governance and less on name-calling and short-term nonsense.
Populism: A Symptom of a Bigger Problem?
Henry Occleston: This is a very good point and especially, I think, we’ve seen it come to the fore in terms of the short-termism versus long-termism, because a lot of political analysts are looking at the situation in Russia and Ukraine and seeing it partly as terrible misstep by Russia on a political scale, but also them seeing it as a more of a long-standing, they can outlast basically whatever coalition or elected officials in the West. We have seen a lot of rise of populism. That was going to lead onto my… You did mention Trump. I suppose an interesting question I would have is as we go into an election year next year, we’re seeing populism pretty much across the board in the west rising, in your view, I suppose taking Trump for example, the election of Trump, say, or Trump two, would that accelerate the process you are talking about or is that just a symptom of the long-standing process as it works, if you know what I mean?
Douglas Greenig: Well, I don’t know. I don’t know. What I would say is this, we should try to gracefully manage the transition from being the single hegemon to being a really important global power that doesn’t necessarily try to do everything everywhere. It’s just logical. I’m not certain that we can afford the situation. Take a look at where we are right now. We’re running deficits of about 8% of GDP, give or take. Forgive me if it’s seven and a half, but it’s in the ballpark of eight. If you look at what the Congressional Budget Office predicts about that ratio, it rises pretty sharply over the next few years, but it isn’t quite right because you need to take into account where interest rates have moved. I would encourage people to take a look at the Penn Wharton Budget Model. It’s a model very similar to the CBO model, but you can play with it.
They put out a very nice report this year where they showed what happens under different assumptions. If you take the CBO assumptions and bump interest rates up by 100 bits, which by the way, isn’t crazy at all, the thing takes off like a rocket, the debt to GDP ratio. In fact, they pointed out that there’s a great quote in there. They said, “Outside of tight academic and DC modelling circles, people do not realise that you can’t even run these budgetary models without making a strange assumption.” The assumption is right beyond the horizon. Somehow we find God and engage in austerity. Somehow the light strikes us and we say, “Whoa, we’ve had it with these deficits, we’re going to do something.” “You have to put that in,” the authors were saying, because if you don’t, by backward induction, everything just unravels, because markets ought to anticipate the unsustainability and eventual collapse, if you will, of the budgetary arithmetic.
It’s very much worthwhile taking a look at their website, the Penn Wharton Budget Model. When you look at that and you say, “Okay, we’ve got some budget problems,” then you go back to the CBO and you say, “What were you assuming about defence? Oh no, they’re assuming that we spend less.” They’re assuming that we gradually take down defence to what is it about, two and a half percent of GDP, roughly something like that 10 years out. And then I’m thinking, wait a minute, if we resist the move to multi-polarity and start projecting our strength as, for example, neoconservatives would encourage us to do, that’s going to take more spending than what’s in there. In military circles, it appears that there’s kind of a consensus that we’re not as strong as we ought to be, that we’re not as strong in the U.S. as we were in the 1990s, that we’re not actually very ready for the mission that has been defined.
I think that this forces you to the conclusion that Americans need to think very hard, policymakers, about what the mission is. What’s our place in the world? My hope is that transition can be done gracefully. Different people across the political spectrum have different views about to what extent America should be the global policemen and present everywhere and doing everything. We also need to think about what we can actually afford.
Will the US Head for Higher Tax?
Henry Occleston: That’s a very interesting question. I think Bilal, on one of the recent podcasts, he was actually speaking with Barry Eichengreen. One of the comments he made was it being partly on the deficit side around lack of revenues for the U.S. It’s a low tax, especially when you compare to the rest of the western world, far lower tax than a lot of us. Could we be going into a high tax future, I suppose, in the U.S.? Or is the U.S. ready for that? You mentioned about austerity, but on the other side, I suppose, of the equation, is there any prospect for that, do you think?
Douglas Greenig: That’s another great question. You’re asking some really good questions. I wish I had all the answers to this stuff. This relates, again, to the short-termism versus long-termism. The U.S. needs to clean up its debts, sort out the issues with entitlements, and build a lot of infrastructure, and might need to spend more on the military. I don’t know. It depends on what your view of the mission is. In my view, I would be happy with spending a bit less. But another way of squaring the circle would be higher taxes, but it’s very politically unpopular. Americans, as a group, don’t feel like they’re getting much value from the taxes they pay. People in Europe and in England, I can say that because I’m a British citizen as well and I spend a lot of time there, they at least feel that they get some stuff. The average American often wonders what they’re getting, because they certainly don’t have assorted healthcare system and they recognise…I mean, a very few people know the math, but they recognise their spending perhaps between 800 billion and a trillion bucks a year on a military that has something like 800 bases around the world. That’s a lot of bases. I’m told the Chinese have won in Djibouti, but I’m not sure. I’m not an expert on military strategy or anything, so if I misstate something, please forgive me. I don’t know. It’s going to be hard, politically, to raise your hand and raise taxes. There are very large parts of the country that just won’t tolerate it. Most of the red states, that would be politically suicidal, but it is a way of approaching this even if it does come at the cost of growth. High taxes are just not great for growth. I mean, if Europe is the model we want to follow, we need to be careful, because the lack of dynamism in some European economies and slow productivity growth is a matter of great concern to many economists. But my answer is, yeah, it probably means more taxes in the end.
China-US Bipolarism
Henry Occleston: It is a very interesting point as you mentioned China, that I think as far as I’m in agreement without a Google letter, it’s one in Djibouti and there was a talk recently of one in Oman, which has interestingly got the Americans quite concerned, it seems for, as you say, two versus 800. But it’ll be interesting to know your thoughts in terms of do you think it becomes a bipolar world or is it more a sort of regionalism? It seems, it feels at least in the last two years, there’s been more regional wars we’re seeing in the Middle East, Ukraine. Is there a risk that we fall into that situation where globalisation does pair back on the back of that?
Douglas Greenig: I’m not certain and I don’t know if I see it as a positive or negative. Certainly, wars are a negative, but the emergence of regional powers that matter is not necessarily a negative. It just depends on how people behave. I suppose the American dominance imposed a order and that probably the scenario you describe involves more conflict. They’re just more people doing their own thing, countries doing their own thing that it’s going to necessarily lead to more conflict. It’s probably true. I’m not very certain whether we get the bipolarity or whether you get a true multi-polarity. I know that there are plenty of thinkers out there that say that they’re going to end up being five, or six, or seven poles in this dispensation. I don’t know.
Just from the standpoint of what I do for a living, all of this stuff makes me like being a long volatility. I think the years of my childhood in the United States, growing up in the late ’60s and the ’70s and so forth, the world looks so different and so much less stable. But I suppose if you go back further in time, it didn’t look like the Pax Americana at many points in history. The world’s a very complicated, unstable place.
Henry Occleston: It’s a very good point. It’s interesting, you mentioned around being long vol and comfort you have with that. It does sound like, increasingly, a good position to be. Back to the working in the niche markets and, as you say, things like Malaysian palm oil, et cetera, how does that look, from a functional perspective, if you were to see the kind of more regionalism or even the bipolarity breakout? Is it more just more legwork and things like that or are those more fundamental operational risks on that side?
Douglas Greenig: Well, the first thing is that probably some of the correlations will break down. There’ll be more independent movement of things in a world that’s more fragmented. I mean, linguistically, the way that sentence was constructed seems to make sense. Even if I’m lacking in specifics, it certainly requires more legwork. It already does. We’re very, very active in Chinese commodity markets. They’re amazing big liquid markets, but it’s not trivial for outsiders and offshore money to be involved with those markets. We think we’re good and responsible participants there in the way we do things and it’s certainly a meaningful part of our portfolio, but it wasn’t easy. In a sense, that’s what people pay us for. They pay us for doing that legwork and getting into operationally challenging markets, managing risk well, and just having the process be very tight and buttoned down and careful, where we’re thinking about all of the different risks that can occur.
I mean, what happens if the regulator says, “I can’t trade it tomorrow,” how do I deal with that, that kind of thing. You think about all these things and you plan for these contingencies, and you’d never do anything that would put the fund in a really threatening position. I think this is a world where there are going to be a lot of opportunities for the kind of stuff that we do, but I have to say, on a personal level, I find this much change slightly unsettling. I don’t know about you, but you look at things and these certitudes that I had as a young person have dissolved into a measured scepticism about some of the conventional wisdom.
Nuclear Energy and the Green Transition
Henry Occleston: I definitely agree. I mean, I went to uni just as the financial crisis. It’s been a crisis after crisis it seems. I mean, one of the things, I think, that’s definitely taken a lot more airtime surely, and you didn’t touch on it, was energy transition. It will be interesting to get your thoughts on that a little bit more because I know you were talking about energy intensity falling and the difficulties of that. I suppose the counter to that or the question I would have is where does, I suppose, nuclear come into that? But also on the scarcity of resources and things like you mentioned lithium for lithium batteries, do you remember early 2000s, people talking about it was running out of oil? But in that regard, demand created its own supply in that it incentivized people to, I guess, look harder. Is there a chance we could be in that kind of thing and these…
Douglas Greenig: Of course, but you need to know when you actually got lucky. I know that my late mother, years ago, used to send me these emails. They were like chain emails that went around and they almost seemed slightly conspiratorial. The claim was that there was all of this oil locked in shale in the U.S. She was sending me this stuff a long time ago, the 1980s or something, and I was a little bit sceptical. I didn’t look into it properly. My attitude was, if it’s really there, people are going to go get it. Mom quit reading these things that your friends send you and forwarding them to me. But guess what, God bless her, she was right. These people were right. The Mogollon Rim and the Eagle Ford, and people knew about these shale deposits for a long time. It was just the question of developing the technology to go after it.
But I don’t know that the same thing is true for lithium, nickel, copper, and it takes a long time. Back to my point, people knew about this for 15, 20 years before it was actually exploited, if my memory is correct about when mom sent me these emails. But clearly, not a lot was happening at the time, so you need to be mindful. I mean, a person who’s spoken very intelligently and clearly about this is Robert Friedland, I think, at Ivanhoe Mining. It’s very worthwhile listening to him on these subjects. But the basic story is this, in the digital world, things can move very fast. Maybe the constraint is something like Moore’s Law. But when it comes to stuff like batteries and electric vehicles, and stuff that will hurt you if you drop on your foot, like matter, molecules, things move a lot slower.
We don’t have great replacements at scale for those four pillars of modernity that Smil identified in his book. Concrete, steel, plastics, nitrogen fertilisers. We don’t have great replacements at scale, cost-effective replacements. That’s just true. When you talk about, okay, you want to do vehicle electrification, the western governments have, by and large, dropped the ball on climate change. We need to be going after it in a really intelligent way. Instead, governments just passed mandates and hope somehow people are going to achieve it. Well, if you have a lot of electric vehicles, then you’re going to need batteries for them. If you need batteries for them, you need the materials for batteries. That’s the part nobody figured out. When you map it out, it’s going to be very hard to deliver that, and by the way, very energy intensive as you try. Likewise, you need electrical grids that are capable of handling mass vehicle electrification. Our electric grids in many developed countries are decades and decades and decades old. Of course, again, I’m not the super expert on the subject, but you can find them.
They don’t store energy, and so there’s not a lot to do with these extra electrons, because many forms of renewable energy don’t produce a smooth flow of electrons. Instead, you get bursts based on, for example, wind, and then it goes lower and so on. There’s a lot of work we need to do for the energy transition. It’s going to be very energy-intensive, materials-intensive. It’s going to drive, we think, probably some very big trends. The people who argue for a commodity supercycle over the years, they’re probably right over the very long term. You also asked about nuclear. I would say a lot of the very smart people say that the right answer for energy, whether you’re saying is it fossil fuels, is it sustainable? Various forms of green and renewable energy, is it nuclear? The answer a lot of the well-informed people say is all of the above with an emphasis on decarbonisation, with an emphasis on that, but perhaps there are issues with nuclear that I don’t appreciate as a non-expert.
Henry Occleston: Absolutely. I mean, myself included. You made a very interesting point around electricity grids, and it, I suppose, in my head if is there a second mover advantage on those economies that have perhaps less electrified? As you mentioned, the raw materials being incredibly important for this, is the, I suppose, one of the off missed discussion points is, I suppose, the role of or the position of Africa within this very energy or very resource-rich, a lot of, I suppose, second mover advantage possibilities, how do you see that in the midst of the U.S, China growth story, et cetera?
Douglas Greenig: Well, to my understanding, China has reached out in various ways to the African countries and other countries, especially resource-rich countries, saying, “What can we do for you in return for access to resources?” That’s great forward-thinking by China. The popularity of China among young people in Africa is so high. They appreciate that long-term thinking and that investment, and I think it’s a great thing. It is unfortunate, I think, that the U.S. hasn’t done more, because Africa definitely needs some assistance with development. Everyone agrees. I hope Africa develops in a spectacular way, and there may be, just as you say, some great advantage to the fact that you’re starting without an installed infrastructure that you’re patching up, because one is hopeful that this next century will be a great one for Africa because they certainly have not had an easy time with the colonialism of the past and issues that have extended into the present. One would think that the continent and the many countries there have great potential. Let’s hope that that potential is at least partially realised. There’s a real opportunity for a lot of people to live better.
What Are the Big Global Risks Right Now?
Henry Occleston: No, absolutely. I was just going to ask, we’ve obviously touched on a lot of risk scenarios and tail risks across the global macro space, are there any other things, not necessarily keeping you up at night, but topics that you see as underappreciated on the risk scale of, I suppose, the same context of global risks?
Douglas Greenig: Well, one thing that may be underappreciated is the fact that the U.S. military capabilities are not what they were, and in addition, the staying power of the U.S., given ever greater short-termism in the political space, may not be what it was. I think people should not be confident that the Pax Americana will hold. One doesn’t want disorder in the world and I hope that the world is a reasonably orderly in good place, but I’m not sure the U.S. can call the shots the way we once did. Actually, senior policymakers in Washington, many of them realise this. What I’m saying is not rocket science, it’s just reality. But I think there are people in the investing public who are not necessarily sensitive to this. One thing that I heard, from someone who is very well-connected, is that if there’s a tussle over Taiwan, the war gaming that the Pentagon has done and the consultants have done do not suggest that the U.S. can be confident about the outcome in a struggle over Taiwan.
Hopefully, there will be no struggle, things can be worked out in a smooth manner. But I wonder how many people know this, because when I heard this, I was a little surprised in the sense that I had not appreciated how capable [China is within a few hundred miles of its shore. It’s very capable at certain things. Likewise, tensions are exploding in the Middle East, and there are various actors in the region who are not perhaps as weak as people think, and so everybody needs to be pretty careful about what they do. I’m very hopeful we don’t discover who’s weak and isn’t weak, and things can be managed. But I’m just saying this notion that many people in the states have, that we’re really pretty omnipotent and can oppose our will. By the way, we didn’t have that notion at the end of the Vietnam War. We didn’t. But that notion came back particularly after the 1990s with, effectively, the triumph, if you will, in the Cold War, where the Soviet Union just went away as an important adversary.
Book Recommendations
Henry Occleston: It’s a very important point. It’s also quite interesting, I suppose. I think there is a risk, obviously, with Russia being almost playing the same role again as the adversary and honestly looking quite weak over the last year or so in its goals, that we do get into that, I suppose, complacency again, even when it’s perhaps even less merited in the ’90s. But definitely a lot to think about on that front. Thank you very much for that. We’d like to ask, and I know you’ve touched on a lot of the books that have influenced you through your life or just things that are very interesting you find, and we will have links, as I mentioned, below, but I just wanted to ask if there’s any beyond Kindleberger, and Fisher, and Smil, and Roach, and Friedland, if there are any other books that you would really recommend or that really influenced you through your career?
Douglas Greenig: Oh, there’ve been a lot. I read a great deal. I would say that it was a terrific book about China I read a few years ago called When China Rules the World. It actually had a very nice discussion of the history of the western world as well as a point of comparison. Martin Jacque wrote it. That was a very, very interesting book to read. I’ve also been influenced somewhat by the realism school in international relations. I think one of the tricks to finding the truth, there’s no general formula, but you need to be willing to accept or seriously consider ideas that make you uncomfortable. It’s like the issue of how do you become a good person. It starts by considering you’re considering the fact that you might be wrong, that you might be acting not so well in a given situation. The person who looks in the mirror and wonders about the correctness of their own actions, that person has the potential.
Likewise, when it comes to ideas, the assumptions you make, the basic ideas you’ve inherited from your environment, you should be questioning them. By the way, this is also very good in the world of investing and trading. You have all these ideas that everyone believes. What if they’re wrong? Challenging them. In the realism school of international relations, a lot of the ideas make you rather uncomfortable. For example, the Thucydides’s Trap, Graham Allison. The notion there is that when you have an existing strong power and then an up and coming power, the existing strong power might very well choose to go after them before it becomes too late.
Graham Allison looked at, I think it was 18 cases. In 16 of the 18, the great power just attacks at some point. It was some sobering ratio like that. Graham Allison and John Mearsheimer, who was one of the leading thinkers in the realism school, who very much predicted the Ukraine conflict ahead of time and how it would turn out years ago. So there’s so much great reading to do. I just wish I had more time, because I got a job, man, and I have to focus on work. But there is a bit of a connection, because we want to make sure that we cast our net very widely with respect to these markets, that places where there’s the potential for dislocations and instability, we’re involved. Having some understanding of the world, as I try to build this at a very, very diversified programme, is relevant.
The outlook actually really is quite interesting, particularly the next two years, for interest rates and stuff. I forgot to tie that off. I talked about the debt sustainability equation and how we’re in a bad spot, and there are essentially three ways to sort out our bad finances. One way is by somehow magically having a high growth rate. That really fixes things. The second way is by running a primary surplus. The third way is by having very low real interest rates, because the key ingredients in the debt sustainability equation are debt to GDP now, the real interest rate, the real growth rate, and the primary surplus. Those are your ingredients. One of the only things we can do to stabilise things is to push real interest rates down.
I think we’re probably going to return in due course to a friendlier interest rate environment and financial repression, because if you don’t, the budgetary math in the U.S. becomes unmanageable. I don’t really imagine the U.S. actually having surpluses. Remember I was mentioning that in the Penn Wharton Budget Model, somewhere past the horizon, we miraculously discover austerity. No, we won’t. I don’t buy it, and I don’t think the growth rate is what it is for structural reasons. The only variable left is real interest rate, real yields, and you have to push that down. I think we will see an eventual return to bond buying by the Fed, but I don’t know when.
Henry Occleston: That also is a very, very interesting point to finish on, because I think from speaking to a lot of clients, from speaking to a lot of investors out very contrary to the, I suppose, received wisdom, which is this was a brief period of very, very low interest rates and now we’re going into the pre-financial crisis, going back to basically higher interest rates that we once had, I suppose. Thank you. Thank you so much for taking the time out of your day to talk to us today. It was honestly an excellent discussion and I really enjoyed it. Could have gone off twice as long, but we truly are in very interesting times. It’s always hugely useful to hear from people such as yourselves with so many great insights. Best of luck to you and for the rest of the year, and hope it’s fruitful. Please take care.
Douglas Greenig: Hey, thank you so much. I enjoyed it. I enjoyed it.
Henry Occleston: Thanks for listening to the episode. Please subscribe to the podcast [00:57:00] show on Apple, Spotify, or wherever it is that you listen to podcasts. Leave a five-star rating, a nice comment, and please let others know all about the show. We’d be really grateful. Finally, sign up to our free newsletter at macrohive.com. We’ll be back soon, tune in then.