Druckenmiller On Emerging
Markets, Investing, And The China Issue
Druckenmiller
is Chairman and Chief Executive Officer of Duquesne Family Office. He founded
Duquesne Capital Management in 1981, which he ran until he closed the firm in
2010. Previously, he was a Managing Director at Soros Fund Management, where he
served as Lead Portfolio Manager of the Quantum Fund and Chief Investment
Officer of Soros
Interview with
Stan Druckenmiller
Hugo
Scott-Gall: What are the
risks of investing in China that are not well understood in your view?
Stan
Druckenmiller: The growth in
credit at a time when GDP growth is slowing is a problem for China. And I think
this is the 2009-11 stimulus coming back to bite. I understand that it had to
be done to fund entrepreneurs and the private sector, but it’s easier said than
done if you’re channelling funds through local government investment vehicles.
I’m a believer in markets. A few men sitting around a table and deciding how to
allocate capital goes against everything I’ve ever believed. Not only are they
not great at capital allocation, such an exercise also needs to deal with a
lack of property rights and corruption. In essence, the frantic stimulus
China put together at the end of 2008 sowed the seeds of slower growth in the
future by crowding out more productive investments. And now, the system’s
building enough leverage and misallocation of resources to warrant risks of a
financial crisis, but the timing of that is still uncertain in my mind. What
we’ve seen in China since 2009 is similar to what happened in the US in 2005,
in terms of credit growth outpacing economic growth.
I think ageing
demographics is a bigger issue in China than people think. And the problems it
creates should be become evident as early as 2016.
You also need
to keep in mind that for China to grow and evolve further, it will need to
compete with a more innovative Korea and now a more competitive Japan. I don’t
think China can do that with where its exchange rate is today. I think
productivity is a key concern too. And I think that could be one of the
reasons why the US has been so supportive of Abenomics.
People mention lack of infrastructure as a constraint. But when I go over
there, it looks like they have a lot of infrastructure. It seems ahead of the
population, not behind. I see expensive apartments in empty cities that 300 mn
rural Chinese are expected to migrate to. That looks very unbalanced to
me. Nobody’s ever had investment to GDP at 47%. Japan and Korea peaked at
36%-38%, so as a result I think capacity is way ahead of demand in some areas
in China.
Hugo
Scott-Gall: If China slows
its fixed asset investment, will that have a knock on effect for its
commodities demand and thus commodity prices?
Stan
Druckenmiller: When I
started in 1976, I was taught by my mentor that when cash flow rises equities
go up. But commodities are driven by the cost of extraction 90% of the time,
and over the long run, technology makes extraction cheaper, pushing the cost
curve down and with it commodity prices. But that hasn’t always worked, if I’d
followed that advice over the past few decades, I’d be in trouble.
About five
years ago, I bought into the peak oil thesis. But then, along comes shale oil
and shale technology, reminding me of what my old mentor said 35 years ago. Now
I’ve come to think that the oil price is not as vulnerable to China slowing
down as it is to ongoing shale supply growth. I regard the ramp up in
investment by China as a 10-year aberration, making the last two years more
normal and more representative than the previous decade.
I do think China is serious about rebalancing, which means infrastructure
investment is going to slow. And obviously, there's been a huge ramp-up in
supply around the world in response to the 2009-11 stimulus, which in my view
is a massive misread by the suppliers of these commodities. So that’s not good
for commodity prices. And then you have innovation. Can technology progress in
iron ore and copper, the way it has with shale energy? My guess is it will.
If you look at
food, there’s now technology that allows seeds to be drought-proof and disease
proof. Yes, there is a demand-supply argument for food prices rising, but the
impact of technology on food supply is greater than you think. On the other
hand, we are using up more and more good arable land to build cities in China
and there is a water problem in China too.
Hugo Scott-Gall: Do you think we underestimate the
role of innovation in resolving these global constraints?
Stan
Druckenmiller: Even with all
the progress we have made in technology in the recent past, I think we are only
scratching the surface in terms of innovation. We haven’t seen half of the
practical applications of big new technologies yet. And the cost of these
technologies will come down too, whether it’s robotics or driverless cars. That
has to provide a productivity boost.
But there is a
downside to technology-driven productivity surges too. There is improved
efficiency, but at the cost of fewer jobs. I think the impact of technology on
manufacturing jobs is easy to overlook because of the huge surge in services
jobs. But we’re now at a point where the impact of technology is hitting the
services sectors too. And not everyone understands this. I recently brought up
the possibility of driverless auto technology resulting in zero jobs for truck
drivers within the next 20 years and there were gasps of disbelief from the
audience of investors. When I mentioned it to a high-tech company CEO from
Silicon Valley a few days later, his response was exactly the opposite. The
point is that the problem with a tech-driven productivity surge is that the
benefits of that are going to accrue to a smaller, narrower group. Already,
computer engineers have benefitted from computing and the internet a lot more
than the broader population.
You could draw
similar conclusions on the impact of technology and automation on investing. I
believe that good investors are successful not because of their IQ, but
because they have an investing discipline. But, what is more disciplined than a
machine? A well-researched machine can make many average investors redundant,
leaving behind only the really good human investors with exceptional intuition
and skill. And what happens when machines really take over investing? Do the
markets get really efficient? Or will there be competing systems trying to
outdo each other? All of this is depressing because there won’t much left to do
for humans once machines start doing more and more.
If machines do
everything well, including allocating capital and resources efficiently, can
that be deflationary, can that eliminate poverty? I don’t know. It’s hard to be
very optimistic if you look at how humans have behaved historically. All in
all, I don’t think robots and greater automation can bring about a utopian
world as I imagined it would as a kid 50 years ago.
Hugo
Scott-Gall: If you combine
the prospect of fewer jobs with an ageing population, it doesn’t look very good
for many economies...
Stan
Druckenmiller: Apart from India, most of the other
major economies have worsening demographics to worry about. It’s a big problem
for the US too, especially given that relative to many other economies,
including Japan, its fiscal gap is much wider. All in all, I don’t think robots
and greater automation can bring about a utopian world as I imagined it would
as a kid 50 years ago.
You can look at the US debt stock in a few different ways. The official
estimate of the total debt may be US$11 tn, but if you include what the Fed has
bought (which you should), then the number if closer to US$16 tn. But a better
measure of US debt would include some of the off balance sheet items. Laurence
Kotlikoff, who is one of the top economists in his field of generational
accounting, estimates the present value of US debt including what has been
promised to senior citizens, adjusted for the projected tax revenues and the
fiscal gap, to be about US$211 tn. That’s staggering.
The US needs to
resolve its debt problem politically, otherwise it is headed towards default. I
believe the estimates suggest that the US needs to raise all taxes by about 64%
in order to be able to support its older population. That’s raising payroll,
capital, dividends and income taxes by 64%. The other option is to cut all
government spending by 40%. Neither one is a viable option and a combination is
not easy either. In 20 years, those numbers will become even tougher. The US
will need to raise taxes by 75% or cut spending by 46%.
There has been
vigourous debate on the veracity of Rogoff and Reinhart’s research on the
consequences of countries exceeding 90% debt-to-GDP. But it doesn’t take away
from the fact that historically, such levels of indebtedness has resulted in
extreme implications. Countries tend to go into a full-blown monetisation
or a default or inflation on average 23 years after they cross the 90%
threshold according to their research. So these debt levels are less relevant
for you and me today, but will be extremely crucial for our children. If we
continue to borrow and spend like we do now, this can become a serious problem
in 15 years.
If machines do
everything well, including allocating capital and resources efficiently, can
that be deflationary, can that eliminate poverty? I don’t know.
I understood
the need for QE1 because the US economy faced a potential meltdown then. But
further easing brings problems of its own, that only come to light in
hindsight. All that easing and prolonged negative real interest rates have gone
beyond resolving the core issues the economy faced and has led to
re-leveraging. I’m not worried about inflation as much as misallocation of
investment.
Another
consequence of today’s monetary policy is that the US government is not getting
any price signals. In any other society, at some point in the next 15-20 years,
the markets will give a price signal and the politicians will need to respond.
But currently, there is no such impetus for politicians to act. What adds to
the problem is that young Americans don't vote. Old people not only vote, but
also have incredibly powerful lobbying groups behind them. Entitlements in 1960
were 28% of government outlays, today it is 67%. And the baby boomers have only
now begun to retire. Another debate is that this is a huge reason to accelerate
immigration, but current policy is moving in the opposite direction. But even
with immigration, the US needs to fix this pay-as-you-go system or the
consequences could be quite drastic.
Hugo
Scott-Gall: Do you think
investing is becoming harder now with more government intervention and
regulation interfering with market price signals?
Stan
Druckenmiller: It has become
harder for me, because the importance of my skills is receding. Part of my
advantage, is that my strength is economic forecasting, but that only works
in free markets, when markets are smarter than people. That’s how I
started. I watched the stock market, how equities reacted to change in levels
of economic activity and I could understand how price signals worked and how to
forecast them. Today, all these price signals are compromised and I’m
seriously questioning whether I have any competitive advantage left.
Ten years ago,
if the stock market had done what it has just done now, I could practically
guarantee you that growth was going to accelerate. Now, it's a possibility, but
I would rather say that the market is rigged and people are chasing these
assets, without growth necessarily backing confidence. It's not predicting
anything the way it used to and that really makes me reconsider my ability to
generate superior returns. If the most important price in the most important
economy in the world is being rigged, and everything else is priced off it, what
am I supposed to read into other price movements?
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