Ep 82: Whitney Baker's Masterclass on Macro Investing & the State of the Economy

0:00In my view, the Fed has been a huge contributor to inequality already. and by virtue of juicing the assets that wealthy people own by definition. And so that's created a lot of the populist backlash that we've seen politically, not just in the US, but around the world.

0:22Our friend Whitney Baker is one of the great global macro minds of the world. She understands the financial markets better than almost anyone I know. She worked at a couple of the most important, biggest hedge funds in the world. at her level, this is really an interesting game. You have to understand history, economics, politics, all sorts of things about finance, and you're mapping out why things are happening in the world. And it sounds like it's esoteric. It sounds like it's touching finance, but really a lot of what happens in history, a lot of what's happening now in our economy, a lot of what we've experienced in our lives are driven by these forces behind the scenes that Whitney studies for a living.

0:55How do we get to where we are today? What's happening with inflation? Will AI save us? Let's talk to Whitney. Excited to have my friend Whitney Baker here with us today. Whitney's the CIO and founder of Totem Macro. Thank you for having me, Joe. Whitney, let's tell us about your background first. So you're one of the great macro financial thinkers in the world. We're going to get into what that means. But you studied economics at the University of Glasgow, right? I did. And where'd you grow up and how'd you become interested in finance? So I'm Canadian. I grew up in Toronto. I moved to a small town a couple hours north of there.

1:24And, you know, it was like a very small provincial place. It was a little bit tumultuous for me. And so I had this almost a compulsion to just figure out the environment and how the world worked. And that's really what got me into investing. It's not so much investing for the sake of investing. It's more it's a medium to test and understand the world around you and the big forces. What are the forces? What's driving things? How do things actually work and why? You're talking to a macro person. And so the forces are really the flows that drive economies, money and credit flows, borrowing cycles, how those things translate into asset valuations and what's discounted.

2:02So from my perspective, you know, we've had a very long period of almost unconstrained balance sheet growth the world over, right? Debt, money, asset prices, spending associated with that. And the question is just how sustainable that is and the constraints that we're sort of buckling up against. And I think that's the interesting thing right now. We're going to come back to that. early in your career, you worked as Bridgewater's head of emerging markets, right? And you were actually Soros before that as well, right? Yeah, that's right. And a lot of people say Soros, he's like the evil guy funding the bad DAs, but actually like a lot of people we admire the most actually like Stan Drucker-Miller and Scott Best-Sent and many other great minds worked there.

2:38It sounds like it was a great job to learn a lot. Absolutely. Yeah. I mean, they both were for different reasons, but like you're saying, I happen to land at Soros first and at Bridgewater or later, and I have experienced just great mentorship under both Scott Bessett and Greg Jensen at Bridgewater. I consider myself super lucky to have learned a lot from those guys. And the things that I learned really complemented each other well. The Soros idea of reflexivity and directional momentum and having concentrated bets in high wind trades. What's reflexivity mean for our listeners? It's just the idea that a certain cause will create an effect, and that will then create another cause that kind of works in a circular way.

3:18So you can think about anything like a virtuous cycle or a vicious cycle as having some degree of self-reinforcing reflexivity. So you learned those lessons, things around that at Soros and Bridgewater obviously is famous for its radical transparency. Was that something that you're taking with you? Yeah. Well, okay. So Bridgewater, when people ask me what the most important thing I learned at Bridgewater is, it's not investing specific. This is just, I think, the most important thing of all things, which is, you know, I think a lot of people live their lives kind of afraid of the truth. Whatever the truth is, it constrains them.

3:53It creates sort of fears and things that they want to push against. And Bridgewater had completely the opposite mentality, which is, you know, you have weaknesses, we have weaknesses. There are just certain dynamics in play. And it's better if we understand what all of those things are. So let's be transparent. Let's get them on the table. Let's figure out, you know, if you're not good at scheduling, we'll partner you with somebody who is. And I mean, at the end of the day, if you can evaluate your strengths and weaknesses in an unbiased way and kind of disabuse yourself of this shadow government that's driving most of your behavior, you know, then you can solve problems and you can create growth and progress.

4:32And I think it takes some discomfort, but that's... It's fascinating that the biggest insight from the biggest hedge fund in the world was not even the macro stuff, but this understanding of yourself and how to think and how to approach truth. Yeah, it's truth itself is the takeaway, whether that's truth in yourself and how you invest in the biases you have and how to get rid of those, or whether that's like the economy and the markets work a certain way and it's not magic fairy dust. It's things that we can go and understand and test systematically and make sure we're right and that we're not just investing based on what we believe or we want to believe is true.

5:04Um, so that, you know, kind of relentless loyalty to the truth is something that I think, anyway, in my experience, like behooves you to, to incorporate into all aspects of growth and, and work and investing. And so based on this, based on these truths, you understand about yourself now, hopefully too, why did you launch Totem in 2018? You're launching it as an advisory and as a fund, obviously now, like what caused you to do this? So, um, really, I think probably it's, it's not that complicated. It's the same thing that would drive any, you know, tech founder or somebody with a particular set of goals and, and really a like drive to get to those goals quickly to not work in a bureaucracy or not work in an existing company where you have to trade off some of your goals with some other people's goals.

5:50Um, totem, you know, from my perspective, I have always seen the market as a good, um, uh, sort of like testing mechanism of all of your views of how things work. It's just an ongoing laboratory. And we happen to do a lot of our work in these extreme phenomenon, trying to understand the extremes of human behavior as reflected in macro and in markets, and really trying to make sure we can hone our understanding of that, getting up that curve even incrementally and incrementally and want to spend as much of our time solving those puzzles as we can without worrying about other misallocations of resource.

6:28Focusing on part you want to focus on, which you're in charge. So, you know, in my opinion, macro is like the, it's like one of the highest levels of investment. Like you said, you're seeking the truth. You're trying to understand the forces behind the biggest things in the world that are happening in all of global finance, trying to measure where things are at an extreme in your case and take advantage of it. At a basic level, what is macro investing? And what are strengths and weaknesses as a strategy? At the basic level, macro investing is just trying to, firstly, it's unconstrained. You can trade all assets in all countries, long and short.

6:56You can trade Bitcoin, you can trade Turkey. You can trade whatever you want. Trade Rwanda. But the commonality across, there's lots of different ways to execute macro. And the commonality is what you're trying to do is figure out what the macro scenario looks like ahead and how that is different versus what markets are pricing in. And you say macro scenario ahead. This is how the economy is going to do ahead. That's how the financial markets are going to do ahead. What does that mean? Yeah. So it's any number of things. So different currency dynamics, growth, inflation outcomes, how that all translates to where we are in the cycle and how assets are reflective of that.

7:31There's a few different, you know, at the high level, there's a few different things that matter. Any asset, any market, any economy, all of it is just transactions that add up to that thing, right? So as like any individual human's behavior, if there's a bunch of humans in a company, their behavior adds up to the performance of that company. You can think about that, therefore, like any market, any macro outcome as being a reflection of those same sorts of dynamics, transactions that add up to the high level. All of those transactions are financed with something. So our particular lens in terms of looking at macro is understanding which flows of money, which flows of credit are coming from where and into what.

8:12What are people spending that money and credit on and how sustainable is that? And therefore, what are the prices that that creates? It's not just true in economies. It's true in financial markets. Where are the flows coming from that are going into U.S. stocks? How sustainable are they? What's motivating those flows? Can we figure out when they're going to stop? And when they stop, what happens? Because if they're setting the marginal price, if that flow stops, some marginal weakness is going to happen as that price starts to reconnect. I think to outsiders, this stuff sounds like wizardry. It's really interesting, right?

8:44Because you think about it, you have to understand history. We'll talk later. You go back and you go back very far and explain different things. You have to understand economics. You have to understand politics. You have to know how banks work, how central banks work, how normal banks work. You have to understand how markets themselves work in different ways. Are people in macro just like really smart? Like you have to know all this stuff. You have to know all of the high level stuff. But the thing that I like about macro is that, you know, if you're investing in particular companies or stocks, you got to like, there's like 30, 40 stories in your head at every level of the P &L that you're trying to remember about those investments.

9:18You don't have to worry about this. You just don't have to worry about that. And from my perspective, all that stuff, you don't have to worry about it because it's idiosyncratic. And then when you consider markets or economies at large, all of those idiosyncratic things diversify out and net out at the high level. So you're just saying, look, I mean, it's hard to predict what a particular stock is going to do because that particular stock is driven by a bunch of idiosyncratic things, their growth profile, their sector and so on and their strategy. But if you look at a diversified basket of stocks like the US market or any other global equity market, the vast majority of what drives the variability in those prices is some combination of growth, inflation, discount rates and equity risk premium or the multiples that people will pay.

10:03And that is all just a function of these flows that I'm talking about. So it's a sort of scientific way of figuring those things out. I want to get into specifics so people don't understand examples here. But before I do that, you know, I did some macro with Peter Thiel when I was younger and I really enjoyed macro trading. Some people I admired were people like Paul Tudor Jones and Stan Drucker-Miller, who I got to know. And Stan, of course, returned over 30 % annualized over 30 years on a very large amount of money. So a lot of people think that investing is random or luck or doesn't make any sense.

10:30Like here's a guy who's a legend who just did this consistently without losing money for 30 years. So clearly it can be done. Are there people like that you've interacted with that you really admire in the macro world who shaped your thinking? Yeah. I mean, well, the most important, the most formative were my CIOs at Soros, Scott Besant, who's worked under Stan for a long time, and Greg Jensen as co-CIO at Bridgewater. And like I say, they were instrumental in different ways. And I think to some degree, I always wonder if I just happened to land in the right place to learn from those two guys, or whether there was something sort of pulling me in that direction in the sense that we think about things a similar way and have similar frameworks for investing.

11:14And so when you have a similar sort of base level of parameter, you can then learn a lot and interface really well on all the particulars and refine your expertise that way. But those two guys in my career have been, you know, huge, hugely impactful mentors and teachers for me. And before I asked you a little bit more about macro specific, I also curious, so you're an emerging markets expert. You ran emerging markets, I think, at Bridgewater. And so it's already really hard to do all this stuff. You also must have to learn a little bit more about like 20 emerging market countries as well. Is that you spent a lot of time doing this?

11:46Yeah, I spent all my time doing this. Do you have to fly there or do you just have to read or what? It's a good mix, I think. On the one hand, we're a reasonably systematic strategy in the sense that we think about things systematically. Money and credit flows drives spending, drives prices. Can we go figure out which money and credit flows matter, which players matter, what they're doing and why? And yeah, you maybe want to go talk to those players. Maybe you want to talk to the central bank or you want to talk to the heads of banks that are doing a bunch of lending that's going into a particular place.

12:16But by and large, you want to understand there's a lot of universality in what drives economies and drives markets. It's this basic idea that there's a business cycle. It's driven by credit creation. When the economy gets too hot, you hike. It turns credit creation down. It creates slowdowns. Like this set of linkages, they operate differently and different linkages matter more in different places. But the financial piping and the flows that run through those pipes are the same everywhere. So yes, you do need subject matter expertise when it comes to India or Turkey or Poland or wherever you're investing.

12:51but what you're looking for is not random. You're not just gathering all the things you could possibly know about that place. You are understanding how those features of your framework and that architecture that you need to understand how they look. How they're impacting them and how they're creating different extremes. So let's get into specifics. You were just, you were just teaching some of the business leaders in Austin at lunch with me, some of these things. I think you started in the 1970s there. She didn't want to go too far back. Like what's, like what's, you probably, we could go to the 19th century.

13:19Yeah, stop me if I start quoting Nietzsche or something like that. You could go way farther. I have lots of books from the 18th and 19th century here, which I like to read, and it probably do inform us. But let's give the picture since the last 50 years. What's going on and why would you start there? Right. Let's go back to 1970. So there's a few, two very important changes that happened in that year, right? Up until that point, by and large, the world had been operating. There's these alternating centers of power and all these things change, right? Which countries are in control, which markets are deep and all that stuff, where the flows go.

13:50But the same thing remained the case for hundreds of years, which was that the supply of money was a constraint on the supply of credit and the supply of money was tied to gold. So it's very, everyone knows this. It's we've been in a weird experiment for essentially 70 years of, this is really the only time that we've had any currency, a global currency, a general. It's called a fiat currency. It's a fiat currency, right? Where there's no hard and fast tether to how much supply of that can exist. And so what that's meant is that we started from a position in 1970 where actually, you know, the prior 20, 30 years, we built up a lot of debt in the wars.

14:29We had come off the gold standard in the wars to finance that during World War I and II, lots of inflation, lots of debt accumulation, and then 20 years working that through. So 1970, everything is clean again, right? It's like, okay, balance sheets are clean, not a lot of debt. Assets had been enjoying a technological boom like we've just had throughout the 60s. U.S. stocks, U.S. exceptionalism characterized that decade as well. And ultimately, it was very similar to today. Like in 1968, you had this very late cycle fiscal stimulus. So we're in a boom. There's a bubble. There's a tech-driven cycle.

15:05And all of a sudden, there's a bunch of fiscal spending and deficits are rising Vietnam as well. And so Nixon had a choice, right? And it's the same choice everybody faces. It's, am I going to cut spending and piss some people off? Or am I going to find a new way to finance the spending? Do I de-peg from gold and do that and start borrowing abroad? And basically, that's the choice that the US made at that time was that we are going to start spending above our means and financing that with either money or credit essentially sourced from abroad. And so what that meant was that, as I said, like the supply of credit globally used to be tethered by this fixed amount and that just went away.

15:43So we had this explosion in global debt and global spending associated with that borrowing, people borrowing to buy cars or borrowing to buy houses or whatever it was. And we've gotten to this point where we have the highest debt to GDP globally in the US, pretty much everywhere, secularly that the world has ever seen, including those worlds. Right now we've gotten that point. So it's untethered and there's a crazy waves of inflation and et cetera in the 70s. Right. And it didn't get under more control in the 80s or were you just expanding it? Yeah, okay. So the issue was, again, you're unleashing a bunch of demand through these financial channels.

16:17And okay, initially there was a lot of inflation. When you're running hot like we are today and you're financing a huge fiscal deficit like we are today with printed money like we are today, you get into this self-reinforcing inflationary cycle like we had in the 70s. And that's bad because it generates a real erosion of wealth, real losses of purchasing power. And throughout that whole decade, the Fed was constantly behind it and didn't tighten because that would have created problems for the fiscal side. And because it's not popular. You say problems for the fiscal side, if you raise interest rates, if you're in debt and you raise interest rates too high, then your debt servicing costs a lot of money and it's troublesome.

16:50It's a combination of, yeah, your debt servicing goes up, so your fiscal deficit goes down. And that's very true today because the debt stock is so large, right? It's so large and it's all short term. But problems would it cost back then? Why didn't they raise more back then? So back then it was just simply they thought they got the situation under control. And then they were very and then by that time they'd impose some degree of economic pain on people in order to choke off the inflation. And they reacted very quickly and tried to ease up again. Got it. So he just went too early. They didn't have someone who's strong enough to impose enough pain to actually solve the problem until Paul Volcker.

17:21Right. And then and then bear in mind, you know, the dollars depreciating during this time and all of OPEC are saying, well, we had to deal with you, which was that you were going to pay us in dollars that were tethered to gold. But then you went and you violated that. And now there's this inflation and the dollar's falling. And like, why do we want to sell you our actual real stuff for your dollars, which are just, you know, something you can print in your basement? And so those guys do the second oil embargo. And you have this combination of inherent, you know, still an economy operating above capacity, entrenched inflation, which only temporarily went away because of that gross lowdown.

17:57And then another oil shock on top of that. So you get the second wave of inflation later in the decade. And then ultimately, you know, stocks are like reeling from this because the essentially money supply is tightening to try to choke this off. Stocks, as I say, had a bubble and a tech driven boom in the late 60s. They trough at like eight times earnings in the early 80s after Volcker jacks up the rates. Way down eventually. Way down. Negative real returns to pretty much every asset you could have held in dollar and the dollar was falling. So this is the danger of allowing inflation to become very entrenched by overly relying on printing.

18:32particularly when your currency is falling, because then essentially you're giving new money to people who are foreigners who are selling your currency and creating additional. So we have this mess, Volker cuts it off, and then we still have this fiat currency and we should be inflationary, but I guess there's lots of disinflationary forces as well from globalization. So yeah, here's the second thing that happened in 1971. And again, I don't think this was like a grand plan. I just think it was his combination of his foreign and domestic policy. Nixon de-recognized Taiwan and recognized the PRC, so he recognized China.

19:03So that set in motion globalization, all of the trade deals we saw since then, the wave of essentially bringing 3 billion people into the global labor market that depressed wages and provided a bunch of cheap outsourced supply for things. So yes, you have Western demand, like debt funded consumption booming, and you have all of the manufacturing of the stuff they're demanding being sent to China and other emerging markets that were cheaper. And so supply is increasing one-to-one with the growth and demand. So you don't really get the inflationary problem because these two things are offsetting.

19:37So globalization is just massive disinflationary force, basically. Yeah. And tech to some degree as well, although globalization was more impactful in the early part of this story. Tech became impactful, particularly in the 2000s and 2010s. We like to think we're very impactful in the tech world. You are. You are. You are. Increasingly more so because it's that nonlinear, tech development that's been going on. But no, so that was the issue. I mean, you basically had this perfect virtue, coming back to the reflexivity point, this perfect virtuous cycle where you could spend as much as you want.

20:11The foreigners kept buying our bonds. So there was no lack of support for the dollar, even though we're doing all this printing. And there's a lot of supply of all of these goods that we're buying. So the prices continue to basically fall from the 80s onwards. And so you just had rates falling and inflation falling and all assets rallying. We get to the 90s and a lot of people don't realize this. There was a lot of macro forces behind the tech bubble, of course. I think you started in 94. What happened then? Okay. So what drives a bubble, right? So a bubble is financial assets essentially going up faster than the economy.

20:44So you get things like re-rating and equities, the PEs are going up or the market caps at the economy-wide level are going up much faster than GDP. The thing that causes that is always an economically inappropriate amount of central bank printing. And what started in the 90s was, this was really the first time any foreign banks had been materially involved in US debt purchases. So what we had, coming back to the China story, China had been going through its own infrastructure boom in the early 90s, led by Deng Xiaoping. They're trying to liberalize, become a little bit more capitalist. They do all this infrastructure build out.

21:21They became very reliant on debt, just like today. But at that point, they were pegged to the dollar still. The dollar, the renminbi was very expensive. And so their ability to keep expanding their debt pile was constrained by their own monetary base, which just means that they had uncompetitive currency and it was creating problems for liquidity. And so that tightening created a domestic crisis, banking crisis, unwind of this whole investment boom and so on, big NPL upswing. And what they responded to that with was a DPEG. So they devalued the currency by about a third. They re-pegged to the dollar at very cheap levels.

21:59This is around 1994. And by consequence of the economic crisis, the current account deficit went into this huge surplus. This is even before WTO accession. And so what happened was the PBOC was forced to buy huge amounts of U.S. bonds. It was People's Bank of China. Sorry, People's Bank of China, the central bank. It's maintaining this peg. And the only way to do that is to buy U.S. bonds. And so they're doing that and taking those bonds off the hands of U.S. investors who previously held them. Bear in mind, under Clinton, there wasn't a lot of deficit spending. So not a lot of supply, lots of new demand for bonds.

22:33Chinese come in, take it out of the private market. All of a sudden, people who are sitting there with 10 or 20 year bonds previously now just have cash. And they're thinking, well, what's another long duration asset I can buy? And so that is how you start the kindling for the dotcom bubble. That money basically works out through credit instruments and then into stocks and sort of riskier and riskier things, pushing up the prices of those things. And then retail starts to notice, oh, man, the tech stocks are going up. We're going to buy some of those. And so, you know, you start the bubble with the central bank printing, which creates this rally, and then everybody kind of piles on to that.