Trump's Potential Treasury Secretary on Macro Strategy ft. Scott Bessent

0:00Hi, everyone. I'm Raoul Pal, the CEO and co-founder of Real Vision. Here at Real Vision, we're committed to give you the best knowledge, tools, and network to help you succeed in your financial future. If you're enjoying this podcast, please take a moment to give it a five-star rating. It truly helps us continue to bring top-tier content. Thank you so much.

0:28Scott, welcome to Real Vision. Good. Thanks for having me, Ash. I have to tell you, we're so excited to have you with us today. I got a message from our CEO and co-founder, Raul Powell, this morning saying, oh my God, how did you manage to book Scott? He is a true legend in the hedge fund space, words I know that he doesn't use lightly. This conversation, we're just excited to have it with you. We're going to talk about markets, of course, everything that's happening on the macro front. But first, we also want to talk about your career and all the wisdom you've gained over your decades as an investor.

0:59You've had a storied career in the space. Tell us a little bit about how you got started. What first interested you in markets? Sure. So I don't know if it's wisdom. I think a lot of it is probably scars and some unfortunate muscle memory. I tell my team, we try not to make the same mistakes, but we will always make new mistakes. Yeah, so I was fortunate enough to identify and get into the hedge fund business really in its infancy. I got to Yale. I was very interested in both writing and computer science. And I did a summer internship with George Soros' original partner, Jim Rogers. And it occurred to me that investing, especially in this nascent hedge fund fashion, for me, was a wonderful combination of you created a narrative.

2:03And then could you apply some kind of quantitative techniques to it to turn it into an investment? So I began with that summer internship with Jim Rogers, and they had a few training courses in between then and walked in the door at Soros Fund Management in 1988 as a sub-advisor. And then in 1991, Stan Druckenmiller asked me to join the team. And I think what is interesting, you know, in macro, there are a lot of different models. You know, there's the, you know, if you think about kind of the lineage, there is the Caxton Commodities Port model. There is a lot of fixed income RV models, Revan Howard, Chris Rokos, which obviously turned into much more directional.

3:08And then there's what I would call the Soros-Duquesne model, which all of us actually began as equity research people. And we have a saying, the micro drives the macro. and we never thought we were better at constructing what are non-farm payrolls going to be? Is core PCE going to round up, round down? We spoke to a lot of companies in the real economy, observed what was going on, and then constructed a mental model of the macro environment. And I think for all of us, it then turned into something bigger. And I could tell you is if I look back at my career, other than this year so far, I've made the most money in foreign exchange and followed by equities, followed by fixed income, followed by commodities.

4:13And I would say a lot of my success in foreign exchange has been thinking like a corporate. But what would make a cash-rich corporation move money in and out of a country across national boundaries? What would make you not want to hold a currency? What would make you be inclined to not repatriate earnings? So I was very fortunate. I had some great mentors. I would say Stan Druckenmiller, maybe the greatest money manager of all time, never a down year, and incredible human being, wonderful thinker, amazing trader. and for one of the richest people in the world is still at his desk, loves every morning, by six, loves the game, is, I can't remember how old he is now, but still as engaged as ever.

5:18So I think that I was very fortunate not only to have people who gave me great training, but who had a great love of the game. It's a Michael Jordan idea. I think Michael Jordan might have been the first NBA player to actually have a clause in his contract that he could go and play pickup basketball because he loved basketball so much. And I think that there's a group of us who, you know, we, I think we all think we would maybe intellectually, emotionally, maybe even physically atrophy if we weren't somehow engaged in the markets every day. Ever wanted to explore the world of online trading but haven't dared try?

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6:49Plus 500 gives you an unlimited risk-free demo account with charts and analytics tools for you to practice on. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit us.plus500.com to learn more. Trading and futures involves the risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus. Well, Scott, you were present at the creation, so to speak, of this industry. Some of the names you mentioned, absolute legends in the space. Stan Druckenmiller has been on Real Vision, so has Jim Rogers many times. You mentioned the idea of the models that you use.

7:29Let's unpack a little bit about that. Talk about those three models that you mentioned, how you came to land on the one that you use, and how you apply it in your investing framework. Sure. So I have a saying. We study history, we observe the present, and we try to imagine the future. So I actually taught economic history and market structure at Yale. And one of my sayings is never say never and never say always. And that's been very, very helpful in some of the bigger wins in my career and keeping me out of trouble. But the way we go about our business is we observe what's going on and we're looking for anomalies or systems that are either accelerating or could break down.

8:35And so, you know, I would say every Monday I come in and I have a lot of theories. I am very loathe to say, and I dislike people in the social sciences who try to compare social sciences to hard sciences, because I think that's like the certainty is where we all get in a lot of trouble. And but I do think that there is a process one can follow. So we have a theory. Then can we gather enough data and prove it empirically? And then how do we want to frame that? What's our theory of the case? Is our framing correctly? Are we looking at this the right way? And then so step one is theory. Step two, can we prove it and come up with framing?

9:35And then step three is we go back to the street. Unlike most people, we don't begin our process with something from the city, from Wall Street. but we do use it as the final check. So we may have this elaborate theory and it may turn out when we go to the street, everybody else is in agreement with us. The positioning is high. We may think we split an atom and somebody has been thinking of this for three or six months. It may show an option skew that it's already priced in. And we're very happy to put our work up on the shelf and come back to it. So I would say a lot of what we do is we compile the research and then we don't trade.

10:36And Ash, to your question, I would say that a lot of this process, it results in being patient, which I'm 61 now. And I think my job with my team and even myself is to still be Dr. No. That idea is not unimportant, but it's not undiscovered or it's not really a big idea. You know, like what are we playing for here? What do we know that others don't know? What is our, we try to have an inferential edge because in the market today, you can't really get a data edge. You probably don't want an information edge. But in terms of your framing, how are you thinking about it maybe in a different way than everyone else?

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12:16Talk a little bit about that story, since it's one that is just so ingrained in the annals of hedge fund history. Yeah. So, you know, again, it, you know, I think that we had a framing advantage on this is we had the belief and we were able to, you know, my small contribution was backing it up with data. Stan Druckenmiller correctly analyzed the risk reward in terms of the ERM at that point was a series of quarters that currencies had to stay in. and the government's central banks as always tend to think in very linear fashions. So if there was a 2.5 % quarter on either side of the British pound versus the Deutschmark, they could, if the British pound was very weak, it would go to the top of the quarter up 2.5%.

13:27If it excuse me, if it's very strong, go to the top of the quarter and up two and a half percent if it's very weak, two and a half percent below the central level. So there's five percent range there. And, you know, what Stan correctly identified was we could push the Bank of England up against the bottom of the band and they had to buy an unlimited amount of sterling. My small contribution, and I think this goes back to framing, is...

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15:03We believed that the market didn't understand how fragile the British economy was or how geared the British economy was to short-term rates. So Margaret Thatcher had come in in the 80s and made the UK a homeowning society. UK mortgages, unlike long-term US mortgages, floated with the overnight rate. So Bank of England raised rates on Wednesday. On Friday, you, Mr. and Mrs. homeowner, got a notice that your mortgage had gone up. So we were of the belief that as the Bank of England can't raise the rate to supply the currency, They were actually destroying the British housing market, which was the most important component of the British economy.

15:56And that proved true. And I can't remember which day it was leading up until what we like to call White Wednesday and the emancipation of the British economy, the British people. that there was a point where the UK government raised rates or the Bank of England and the Chancellor raised rates and the pound went down. And I think that's when the UK just stayed. And if we were to go back, you just ended up with, structure was flawed at the beginning. A lot of times these flawed structures always take longer to break down than you think. And there's this at the end where the UK government wisely stopped supporting the pound.

16:56I mean, it was a loss for the UK treasury. It was a loss for the Bank of England. But it could have been much bigger if they had continued trying to support the failed policy. You know, Stan Druckenmiller talked about this with Kirill Sokolov on Real Vision. That's on YouTube if you guys would like to go check it out. But boy, I think two things about that, Scott, that really are true milestones. The first is this view, as you described there, that markets have the power to impact sovereigns in a way that sovereigns can no longer control, that large industrialized nations like the United Kingdom.

17:38Simply, they just get away from it. They just can't hold on to the policy that they want. And second, perhaps a truly enormous moment in finance where a hedge fund had the ability to apply these real world market forces in a way that contradicted the narrative of the Bank of England, indeed of the British government. Just an astonishing moment for people in the hedge fund space. Yeah, well, look, I think it was really just a power acceleration. It was never going to work, it just brought forward the moment. And, you know, Ash, obviously, it wasn't a single hedge fund. It was, you know, a wave of market forces.

18:19It was a wave of banks piling on. And the other thing, too, is it was a wave of corporates trying to get out. is, you know, because at the same time, Italy devalued a few months later. They did not leave the ERM. It's the exchange rate mechanism that was in place. Yes, yes. So they didn't leave the bands. They recalibrated within the bands because they had probably come in at the wrong, or they had obviously come in at the wrong rate. So, you know, again, you were trying to create this unified currency where capital is very mobile, but economies are structured very differently. And there was also in the U.S., if I think back to the 80s, there's the energy bust.

19:19there was a record number of u-hauls that went from texas to ohio and you know kind of vice versa right now is you know so there's complete mobility of labor there was a central government that could smooth over and like you know this doesn't didn't exist so uh back back to systems that accelerate, systems that break down. It was a flawed system. And then as the economies diverged, it became more apparent. Scott, I know you say you played a small role, but this was a huge bet for the firm at the time. And everything that I know of Mr. Druckenmiller, he did not make that move without the extensive data that you provided.

20:08Yeah, but again, it was the asymmetry of the risk-reward. If we look back over some of the great trades or investments of all time, it's really the asymmetric nature. If we go back to John Paulson's famous subprime trade, he has structured it with a CDS portfolio. So investors knew, I can't remember what the negative carry was. I'm going to say it's 5%. It was 5 % per annum. It was a five-year fund. You could lose 25%. And that if the housing market cracked, which it did, then you could make 250, 350%. So, Ash, I think what you're getting at is how do you identify asymmetries? and they don't come along often and you've got to have an open mind.

21:15That goes back to never say never and never say always. If you go back, I remember during the housing trade or leading into the GFC, there was a mantra in the US. The U.S. housing market has never had a down national year. California's been down, Arizona's been down, New York. But in general, it had never happened before. Well, we had never had a national banking system. We had never had a CDO machine being spun out like Wall Street had before. We had never had such a high level of subprime loans. So, you know, it's always very interesting to me, like, you know, that's kind of, you know, red meat for us when someone said, oh, this could never happen, this has never happened, this will never happen.

22:16Or to say, well, you know, it's always okay. You know, we could talk a little about, you know, the developed market debt. A little later, maybe we'll talk about developed market debt. Well, you know, it's always okay. the U.S. is a reserve currency, nothing can go wrong, or China has complete control of their economy, there's no way that they could have an economic meltdown.

22:48This idea, this notion of asymmetry, the idea that you have disproportionate reward per unit of risk is, I think, a fascinating one, and one that I'd love to explore in the context of what you're doing right now at your work at KeySquare Group to talk a little bit about the current macro picture, what you see. You touched on some of those points with China, with the United States, with debt levels for sovereigns in aggregate around the world. Let's just talk about it. As you see the picture right now, what are some of those assumptions that people are saying are always baked in, things that are never going to happen, that you see those potential asymmetric reward opportunities on.

23:26Yep. And actually, if it's all right, I'll just go back to 2016, 2017, because a lot of the asymmetry, sometimes the institutions can set you up for asymmetry, as the Bank of England did, as the Bundesbank did, as with the Abenomics, the Bank of Japan, and the prime minister's office did, but other times it becomes behavioral. And if I think back to 2016, the world was shocked that Brexit happened. And so that happened, there was a week-long meltdown in markets and bond yields. And somehow the UK not being the EU was going to destroy the financial markets. So on Brexit night, I was at a macro, big macro conference in Villa d 'Este with everyone.

24:36You've probably interviewed a lot of the people. And the next morning, the room was in a complete panic. and there were only three of us who thought everything would be okay and one myself sir richard dearlove who was former head of mi6 and ian hercieli neal ferguson's wife who has seen you know so many the crazy things happen in her life and you know in in her world that you know I think she thought, so what compared to her life story? And then, you know, a week, two weeks later, things settled down and the world didn't end. Fast forward to November of 16, and I wasn't sure Donald Trump was going to win, but I thought he could win.

25:32And I thought the market wasn't pricing that in. And then it was announced he had one, and the market crashed that night. And the S &Ps went limit down. And I was sitting there thinking, this could be the most pro-business president for 100 years. I'm not sure why this is happening. So we were able to accumulate a very large position in that. Move forward to the French elections in April, May of 2017. And this is where it becomes behavior, is if you're a fund manager, you got Brexit wrong, you got Trump wrong. You're not taking any chances that Marine Le Pen is going to be the president of the Republic of France.

26:29And the French, one of the things the French are very good at is polling. So there was very robust polling that showed that Emmanuel Macron was going to win against Marine Le Pen. The French have a blackout period. I can't remember. It's one, two weeks before the election. So you went into this blackout period that just turned into like a little shop of horrors for everybody's imagination that, oh, the polls are wrong. Just like with Trump, there are reluctant Le Pen voters who are lying to the pollsters. So I remember it like it was yesterday. I think the French vote on Sunday, the Friday before the election, the euro was at 105 versus the dollar, the 90 puts.

27:28So the euro was going to move 15 big figures in a month had never been so big. The skew was out of the park. the 110, 112.5, 115 calls nobody wanted except for us. And again, I couldn't have 99 % confidence that Macron was going to win, but the market was paying me to take the risk. Then even on the night when he won, the euro only went from 105 to 107 and a half, 108, so we could buy a lot more euros. So, you know, a lot of it is behavioral. So, you know, you ask a good question now is I think we're at a very interesting point now in macro because the opportunity set is very rich And a portion of it is government policy, but a big portion is how are people interpreting the behavior around the government policies?

28:37There is a substantial decoupling going on between the U.S. and China. I think that to a lot of people, it's unimaginable. And we don't know where this is going. I would say I am less worried about a kinetic war than most people, or a kinetic war over Taiwan. But I am much more worried about the global economy, the U.S. economy, that the U.S. economy or the U.S. government is dependent on external financing. So you try to imagine a state of the world one year, two years, three years out on where are we with the U.S. and China? Would China have done a big devaluation? have they flooded the market?

29:41As we're seeing, they've gone from wanting to be the sweatshop of the world to the machine tool shop of the world. And now they are exporting. They moved up the value chain. And if you think, if they're moving up the value chain for these products, what's the business model for Korea at that point if there's a big overlap with a giant manufacturer that's exporting deflation. What's the business model for Germany if that happens? So, you know, I think with China, I think the U.S., China, it just gets very, very difficult for people to imagine how ugly this could get in the decoupling. And I think it would probably accelerate under Trump.

30:38I don't have any particular information. We could see what some of his advisors are saying. But you're also seeing it under Biden. And I think the Biden administration has been firmer on a lot of the export bans than I would have expected. I think that they are quite tentative right now. Blinken was in China. Secretary of State Blinken was in China this week. He put down a red line for the Chinese government over supporting Ukraine. The Chinese told him to get lost. So my sense is that the U.S. will not enforce the red line before the election, but that after the election, anything's possible in terms of what kind of sanctions the Biden administration might put on China.

31:33So, you know, there's really, if we think about going into November 5th, this thing could really accelerate. What are some of the gauges that you're looking at on your screen to understand those stresses in China, to understand this potential decoupling? Because this is a significant, not only global financial, but geopolitical story that you're looking at. So we're looking at all the Chinese trade balances, their trade with the developed world versus what's now called the global south. What is being exported, repackaged and sent? You know, what are the sanctioning that the U.S. continues to do on technology?

32:29What is happening with the Chinese central bank? Interest rates in China had been quite low. The bond market reflected the deflation that's going on. Now it looks like they're trying to steepen the yield curve for some reason. So we're looking at internal stress, external indicators, and then fund flows. And again, if I go back and I think like a corporate, one thing Trump administration has done or did, the Biden administration has done. If you are a U.S. corporate or you are a G20 corporate, would you ever build a factory in China now? So there can be portfolio inflows and outflows. Bridgewater came out and said they're bullish on Chinese equities.

33:27And sure, Chinese equities could bounce. But in terms of foreign direct investment, what would make a long-term investor put money in China right now? If you think about the Chinese currency, it really exists in two different equilibria. One is it may actually be cheap. They've done a big internal devaluation. They've pushed down the cost of labor. They've deflated some of the assets. They are experiencing deflation, disinflation that's turned into deflation. So the currency could be cheap on a normal, if you're looking at normal equilibrium. But what is the equilibrium for not getting your money back?

34:23and clearly the Chinese, the signals that Xi Jinping is sending and the signals that the U.S. is encouraging people to think about is, is there a 5%, 10%, 20 % chance that if you have RMB that your assets will be frozen or that you have the equivalent in Chinese equities of a day like you had in Russian equities when everything went to zero. Those are some truly material tail risks. And it's interesting to hear you talk about FDI CapEx as a metric of what people might want to do if they did not have the ability to have liquidity in a market where you can enter and exit the position quickly. Yeah.

35:14And look, China, especially China venture capital, China private equity was the flavor du jour or the flavor of the decade for 10 years. Now, I think a lot of U.S. institutions are finding themselves in a very uncomfortable position now. And these private equity funds and these venture capital funds, there's a robust secondary market for those. And some of these funds are trading at 40, 50, 60, maybe even one at a 70 % discount to stated NAV. People just want out. So let's talk a little bit here about some things that you touched on earlier and that you brought into the China discussion. Debt here in the United States and also your view about what Secretary Yandel and Chair Powell are doing at the moment in terms of their view of the macroeconomic outlook for the United States, the yield curve, inflation and growth.