Thematic Investing in an Age of Global Entropy | Marvin Barth

0:00Demetri Kofinas:What's up, everybody? My name is Demetri Kofinas, and you're listening to Hidden Forces, a podcast that inspires investors, entrepreneurs, and everyday citizens to challenge consensus narratives and learn how to think critically about the systems of power shaping our world. My guest in this episode is Marvin Barth, founder of Thematic Markets and former chief economist for international affairs at the US Treasury, who previously served at the Federal Reserve and Bank of International Settlements and has led global macro and FX strategy on both the sell side and buy side. Marvin and I spend the first hour of this conversation unpacking his thematic framework, including his concepts of localization, being as believing, and global entropy, and how these thematic frameworks can help us understand changes in growth, inflation expectations, interest rates, the underperformance of emerging markets, the limits of monetary policy, and the weakening of American soft and hard power.

1:00Demetri Kofinas:The second hour turns to geopolitics as we explore Marvin's three pillars of Western primacy, mythology, economic dominance, and military superiority, why he believes each of these have already peaked, and how rivals to America's post-World War II liberal order have used asymmetric methods of warfare to thwart the West's dominance and are now in a position to offer something radically different, a new sociopolitical and economic model that can rival Western capitalism and democracy. We also explore scenarios ranging from a rapid dissolution of the global system to the managed emergence of a new bipolar order with two sets of economic and political ideologies, supply networks, and technological standards.

1:44Demetri Kofinas:This includes a broad discussion about portfolio construction for this new regime, including the role of the dollar, and how the broad international adoption of stablecoins could prove to be one of the most consequential stories of the coming decade. If you want access to all of this conversation, go to hiddenforces.io slash subscribe and join our premium feed, which you can listen to on your mobile device using your favorite podcast app, just like you're listening to this episode right now. If you want to join in on the conversation and become a member of the Hidden Forces genius community, which includes Q &A calls with guests, discounted access to third-party research and analysis, and in-person events like our intimate dinners and weekend retreats.

2:28Demetri Kofinas:You can also do that on our subscriber page. If you still have questions, feel free to send an email to info at hiddenforces.io and I or someone from our team will get right back to you. Lastly, because this conversation deals with investing, nothing we say on this podcast can or should be viewed as financial advice. All opinions expressed by me and my guests are solely our own opinions and should not be relied upon as the basis for financial decisions. And with that, please enjoy this expansive and deeply thought-provoking conversation with my guest, Marvin Barth.

3:11Demetri Kofinas:Marvin Barth, welcome to Hidden Forces. Thank you, Dimitri. Pleasure to be here. I was almost going to say welcome back, but you haven't been on the show before, but you have been to one of our genius dinners in London, our most recent one. So you and I have had some time to get to know each other and for me to learn about your work and your approach and the way that you think, but the audience doesn't. So I'm excited to sit down with you today and apply your framework to the world. And there's a lot that we share in common, which is also kind of scary. I always worry a little bit when I talk to somebody that I agree with too much because then I worry that I'm going to get into a thought bubble.

3:46Demetri Kofinas:But before we get into any of this, Marvin, just tell me a little bit about you. What's your story? What's your background? How did you become interested in markets and geopolitics? Yeah. Well, first let me say thank you for inviting me to that dinner. That was a really great experience. I really enjoyed that. You bring together an amazing network of people that definitely do break outside of the thought bubble, I think. So I appreciate that. In terms of my background, I was raised in a military family, mostly grew up in the Central Valley of California. And I went to UC Berkeley and studied economics by accident.

4:25I wanted to study everything under the sun. And Berkeley had this really interesting undergraduate program that you could get a degree in economics with only four upper division courses. And so I was able to study everything else and basically do a liberal arts major, but graduate with this supposed degree in economics. And I'll spare you the long story about how I ended up pursuing a PhD, but it was another one of these sort of path-dependent things. And I got a PhD in economics, went to the Fed. I was, despite the fact that I had focused on domestic monetary policy, was put in the international division, covering emerging markets, thrown in the hot seat right in the middle of the Asian crisis back in the late 1990s, covering Southeast Asia.

5:19Moved on from there to look at global financial markets in a position where I was briefing the board on what were the international developments once a month. And it was just this great experience to not only be there, be the sort of first line of defense for that, but also like I was working with the most senior people in the Fed who had years more experience than me. So they were telling me about, oh yeah, you know, do you remember the dollar crisis of 1978? Things like this, you know? And I just sort of absorbed all this economic history from the people who were there dealing with the problem at the time.

6:01And what I would say was a big formative experience was being able to translate that myself. My first sort of job outside the Fed was I went to markets and I came to London, was working for Citi, and I had to come up with a global currency view. And I think this is really core to the way I think, trained as an economist, I think in sort of general equilibrium terms, right? So I think about how all the pieces fit together. That's just naturally the way I've thought. And being able to draw on all that I learned at the Fed, and they'd sent me away for a year to the Bank for International Settlement.

6:42So I got to see how other central banks and other institutions thought about the world as well, I was able to and forced to by my job sort of think about how everything fit together because I've always thought of foreign exchange as the market that clears all other markets. So the only way you can possibly understand what's going on with the dollar or things like that is you literally have to understand every other asset market and you have to understand the politics, the geopolitics, the technological trends. And that's really where I started to develop this sort of thematic basis. I later went back to Washington, worked at the U.S.

7:22Treasury where I was the chief economist for international affairs. And again, this was really thinking about the big picture geopolitics. It also gave me an experience of working at an explicitly political institution. So, you know, the Fed, especially under Alan Greenspan, was actually quite apolitical. And that's not the role of Treasury. Treasury is to advance the agenda of the president. So it's a very political organization. And to see how politics actually worked and sort of absorb that into my framework. And I've been back to markets and other forums on both the sell side and the buy side, but it's been continuously refining this general equilibrium view that there are major themes out there that ultimately drive the things we're seeing.

8:09And sometimes those themes go unobserved for a while. People don't recognize what's going on. Sometimes they make up names for them because they don't understand what's going on. I would differentiate that. That's a narrative, right? But it's really about looking through across all the pieces and figuring out what are the underlying dynamics that are driving the phenomenon that we are seeing, rather than focusing on the specific news event or what you might call the proximate cause of a move inside. So I suspect we'll put some meat on the bones in terms of what I'm talking about in our discussion, but I'd say that's where my philosophy comes from, if that helps explain it.

8:54Demetri Kofinas:Sure. Sure. And the way that you talk about, those are the themes that you're talking about there. And the way that you talk about themes is the way that I have often talked about forces. In fact, I have literally said, what are the underlying forces driving the epiphenomena that we experience in the world? Exactly. And you're not the only one either. By the way, Tim O 'Reilly, who had been on the show in the early days, has a similar way of talking about what he would describe as the vectors, the sort origin points from which the epiphenomena are impacted. And the deeper you go down the vector, the better you understand the underlying force.

9:28Demetri Kofinas:So your sub stack is called thematic markets. I think maybe the best place to start here, Marvin, in terms of helping people understand how you view the world is to understand what you mean exactly by taking a thematic approach to understanding markets. Can you explain that please? Yeah. So I think the easiest way to do that is to illustrate that with a specific example in terms of one of the themes that I think has been one of the crucial ones. And it's one where I've been quite different from most of the rest of markets for the last several years. and I would identify as crucial to my out of consensus calls being accurate.

10:12And that's this one about what I call localization. So, you know, there's a lot of people talk about deglobalization or things like that. And that's what I mean about a narrative. Deglobalization is, oh, well, we observe that trade is not growing with GDP in the same way that it was before or that there are barriers to trade going up or things like that. We're going to call that this deglobalization phenomenon. Localization is something very different. It is actually what's driving that process. And I think it's a very underappreciated and under-observed phenomenon. So to explain it, let me take you back for a second and explain a little bit of economic history.

10:53You know, David Ricardo, 200 years ago, pointed out that trade was beneficial because different countries had different comparative advantages in terms of their, you know, economic geography, what was there in terms of like pasture lands versus, you know, river networks for trade and things like that, and different skills of labor. And so we've known about the benefits of trade for at least 200 years. Why did we not have significant globalization until really it took off in the mid-1980s? There was a period in the Victorian age as well. But when we talk about globalization, it's really about the mid-1980s.

11:38It really starts to take off. And what that was all about, in my view, was not tariffs, because tariffs had been falling since the first GATT, a general agreement on trade and tariffs back in 1947. What it was was technology. You couldn't manage the complex supply chains you needed for these globalized supply chains unless you had the advent of personal computers and software that allowed multinational companies to coordinate and track and have extremely complex supply chains. And so that's what really drove globalization. It was technology.

12:16Demetri Kofinas:What about the counter argument that the first era of globalization that happened in the late 19th and early 20th century happened before the personal computer, before the microchip? Yeah. So the Victorian period is a great example of that. But then think about what you were talking about in terms of what was happening with global trade. Most of the trade that you were seeing was trade in commodities and finished products. You didn't have the type of globalization that we had post-1980, where you have all the different intricate intermediate parts going back and forth between each country to create a final product.

13:00I think that's the big difference, right? And of course, that's one of the reasons why, if you look at productivity per person, it's so much higher now than it was in that Victorian age of globalization, where you weren't fully able to take advantage of total specialization of labor. That was really about economic geography, taking advantage of economic geography, not the specialization of labor. And that, by the way, is a great transition, Dimitri, in terms of that's what starts to change, is that in the late 2000s and early 2010s, we start to get the advent of early artificial intelligence, increasing abilities, robotics, to the point where you can increasingly substitute capital for labor.

13:50Now, once that happens, there's no more reason why you need to trade with other nations other than that you don't have those resources in your country, right? So if the machines are doing all the intermediate steps, why wouldn't you just locate those machines where your rich customers are in rich countries, not dispersed across the world where they're subject to trade disruptions, or frankly, the fact that labor are all a lot less reliable than machines, to be perfectly frank.

14:23Demetri Kofinas:So if I'm understanding you correctly, localization is not just a function of growing geopolitical risks and the breakdown of the unipolar order or the rules-based liberal order, but it's also a function of technology and technological effects. I would say it is primarily a function of that. And I would say this is one of those, I can't think of a good example off the top of my head. I'm sure you probably have some good ones you'll think of, of how things happen because their time is right. I guess maybe a good example is the emancipation of women and women's rights. That didn't happen really until we got the technological advancement of birth control.

15:10It's not that those ideas hadn't existed before, It's that the technology enabled it.

15:15Demetri Kofinas:Well, I mean, also the same thing, you could say the same thing about the Civil War. I mean, the Civil War would not have happened if the North had not become industrialized. Yes, exactly. So this is exactly what I'm saying. So it's the technological break that is enabling localization that also actually facilitates, like, you know, we'll probably get to this in more depth, but I would say, you know, Donald Trump, to the extent that his push and what he's trying to do is going to be successful, is entirely a function of coming at the right time in terms of the ability to actually re-industrialize the US through localization.

15:57But the key point is that localization starts more than a decade ago. And you can see this in the change in global investment patterns, the change in import penetration, all of these things, the US fundamentally changes its economic model beginning in 2012. It steps up and accelerates in the first administration, then you hit COVID, really does it. And I would argue we're going to go through a third stage of acceleration right now because of the second Trump term.

16:30Demetri Kofinas:So I just want to throw in a caveat and maybe we can explore it later. I'm hesitant to give Trump much credit when it comes to localization, not because what he's doing isn't necessarily consistent with that, but also the economy of North Korea is localized. And I'd like to dig into this a bit later, because I do think this is a point of departure between the two of us. I do not see in Trump's policies a sensical approach to what you describe as localization or friend-shoring or near-shoring or on-shoring. I don't see a president or an executive branch or a White House that's doing an effective job incentivizing the rebuilding of American domestic manufacturing because it seems that it's...

17:19Demetri Kofinas:And my primary critique is that Trump's policy, besides being just focused on tariffs, because that seems to be the big one, it's also so erratic that I feel like it bears other costs that are ultimately counterproductive to that specific objective. But we'll have a chance to talk about that. Before we do, just do me a favor. What is the difference between a theme and a narrative? Okay. So if we take the localization example, I've given you an example of how this is happening. There is a technological cause that is driving this, right? De-globalization is a description of what's happening. That's a narrative.

17:55Or you might think about, I mean, one of my favorite examples is secular stagnation. I ask you, what is secular stagnation other than a way to describe that growth was lower than people expected, right? It's a narrative, but there's no causation behind it. It's just, oh, I don't know how to explain this, so I'm going to give it a name.

18:15Demetri Kofinas:So secular stagnation was Larry... Larry Summers. Larry Summers's phrase. And didn't it describe long run forces that were leading to underperformance of growth? Wasn't the idea that the causal forces were secular and not cyclical? So he related them to that. So he said, oh yeah, we've got demographic decline. We've got a lack of productivity growth. All of those things lead to this or are consistent with it. But he didn't have a clear causal framework as far as I could find. And in fact, I think there were very clear explanations for why something else was really driving what he was talking about.

18:59So obviously, demographics is part of the situation. But I think if you ignore the fact that China was pursuing and continues to pursue a policy of overinvestment to develop itself and to undermine its adversaries, that naturally brings down the return on capital in the rest of the world, then you're missing a key part of the story there, right?

19:30Demetri Kofinas:That seems like it would also be a good explanation, maybe even a better explanation for the narrative of the great moderation. Which one? I mean, specifically China's role, because what's interesting is what was not really discussed in the late 90s and I think more, and in the early 2000s where Greenspan raised his conundrum about long-term interest rates, not responding to the feds, raising the fed funds rate was this lack of a geopolitical framing. Although I suppose there was some talk about excess savings on the part of Chinese bringing down interest rates in the United States. But to your point, I'm simply trying to say that this explanatory framework is an interesting way of, I think, explaining what was at the time a huge narrative, which was the great moderation that central banks around the world were bringing interest rates down.

20:20Demetri Kofinas:And the way it was discussed to the layman, the layman was thinking, oh, it's because central banks are bringing interest rates down. And as opposed to there were other causal forces driving a lower cost of capital. And I think that's a critical point to understand why central banks have lost control of inflation at this point. Because they never had control of it to begin with. Exactly. And this, by the way, if we go back, I'm sorry to answer one of your previous questions. One of the things that's sort of a defining characteristic of my research is a great skepticism that economists know as much as they think they would know.

20:58I would argue very clearly economists do not understand inflation well and have continuously gotten it wrong and they're continuing to get it wrong.

21:09Demetri Kofinas:If a theme becomes a narrative, in other words, if the underlying structural drivers of the epiphenomenon become widely understood, what does that suggest about the remaining lifespan of that theme's relevancy? Well, I think this is why I focus on themes versus narratives, is that the theme is a causal mechanism. So, you know, there's always this issue of endogeneity, right? Or what, you know, I always have to laugh, what George Soros calls reflexivity. He acts like this is some sort of new concept that only he thought of. But obviously, when people become aware of it, it helps change the behavior.

21:52But just because you're aware of it doesn't change the underlying phenomenon itself, right? If technological change, if we now have increased capacity to build production chains in our own countries rather than having outsourced supply, and you still have to build all that capital to do that. If everyone all of a sudden today agreed with me and said, oh yeah, Marvin's really hit upon this. This is all about localization. That may change to some extent how it's priced in markets, right? But it's not going to change the phenomenon. We still have to go through that process, which means you're still going to have the demand for capital, which is going to still put pressure on real interest rates.

22:38Does that answer your question?

22:39Demetri Kofinas:It does. And so a few more questions about themes and the symptomology around themes before we get into the three pillars of Western power, which for me is the most interesting part of this conversation. So let's stick first with localization and discuss some of the symptoms that arise from localization, for example, like higher long-term rates or stickiness in inflation during the early stages of this cycle. And then let's get into some of the other themes that you've identified. So localization first, what knock-on effects does localization, which we have broadly been thinking of in Western societies as deglobalization, What's the primary symptomology of that in markets?

23:15Look, so there are some really important things that come out of this. So I mentioned that there were a lot of big calls I had in markets that were quite out of consensus that have turned out to be spectacularly right. So when I first started writing about localization, I was writing about it in terms of emerging markets. The first piece I wrote on this was called Rethinking Emerging Markets. And the key point was that if you look at the growth of emerging markets, most of it actually came from globalization. That is that you had Western companies coming in, not only bringing capital to build factories in these countries, but also more importantly, bringing technology and know-how, right?

24:00And so the interesting thing is that if you break down growth in emerging markets into sort of the three components of what's called the solo growth model of how economic growth happens, you can either add more workers, you can add more capital, or you can add more technological know-how or process know-how, so-called total factor productivity. If you look at the 1950s and 60s and most of the 70s, emerging markets actually had almost zero per capita income growth. All their aggregate growth was population growth because they weren't very good at adding capital and they had very little total factor productivity growth.

24:46Once globalization starts to happen, you have foreign capital coming in. And so capital is going up. And most importantly, total factor productivity shoots up because you're bringing all these Western techniques with you. Well, guess what? Since 2012, when I said was the sort of turning point in globalization for the US, emerging markets have consistently underperformed the West and especially underperformed the US, right? And if you look at their total factor productivity data, it's because they aren't having total factor productivity anymore, right? So this is a really big point. The second big point I'd think is that you built all this capital in other countries.

25:27You shifted all your factories out of the Midwest, out of Germany, out of northern England to emerging markets all over the world. Now you're trying to localize. Well, guess what? You have to rebuild capital again. That means you have to increase demand for capital. savings is relatively fixed. And in particular, this is where that demographic factor comes in. It's actually restraining savings. Well, real interest rates are the intersection of savings and investment. So if investment goes up and savings ain't, guess what has to happen to real interest rates? So one of my big calls was in the middle of the last decade.