Speaker 1: Bloomberg Audio Studios, podcasts, radio news. This is Masters in
Speaker 1: Business with Barry Ritholts on Bloomberg Radio.
Speaker 2: This week on the podcast Another Banger, Bill Bernstein, neurologist,
Speaker 2: investor author, What a perfect time to talk to the
Speaker 2: author of the Birth of Plenty, and of course a
Speaker 2: splendid exchange about how trade has made us all so
Speaker 2: much wealthier. Really, a person who dives deep into the
Speaker 2: subject matter, understands it better than anybody else and could
Speaker 2: put it into great historical context. I thought this conversation
Speaker 2: was fascinating, and I think you will also with no
Speaker 2: further ado, my discussion with Bill Bernstein of Efficient Frontier Advisors.
Speaker 2: So you have such a fascinating career, I want to
Speaker 2: get into some of the details before we start talking
Speaker 2: about markets and investing. You practice neurology for twenty years.
Speaker 2: That's kind of unusual to say I've had enough of that.
Speaker 2: Let me start managing assets. Tell us about that transition.
Speaker 3: Well, first of all, it kept me off the streets,
Speaker 3: and secondly, I'm easily bored, so I do move from
Speaker 3: thing to thing. And it occurred to me all about
Speaker 3: forty years ago that I live in a country that
Speaker 3: doesn't have a functioning social safety net, and so I
Speaker 3: was going to have to invest and save on my
Speaker 3: own account to accomplish that. And I approached it the
Speaker 3: way I thought anyone with scientific training would do, which
Speaker 3: is I consulted the peer review literature. I read the
Speaker 3: basic texts, I collected data, I built models, and by
Speaker 3: the time I had done all that, I realized I
Speaker 3: had something that was useful to other small investors, and
Speaker 3: so I began to write things up. And I just
Speaker 3: that when you're writing about investing, one of the key
Speaker 3: subjects that you have to nail down is the history
Speaker 3: of finance. If you don't know the history, you're dead
Speaker 3: in the water. You know. Can you spell long term
Speaker 3: capital management?
Speaker 1: Uh?
Speaker 2: Just LTCM? Yeah, exactly, need to spell it.
Speaker 3: Yeah, I mean, if you know, you can, you know,
Speaker 3: solve differential equations as easily as most people brush teeth.
Speaker 3: But if you don't know the history, you're going to
Speaker 3: have your head handed to you, which is what happened
Speaker 3: to them. So I discovered that I enjoyed writing history,
Speaker 3: and so that's how I segued into into writing history.
Speaker 2: And footnote Roger Lowenstein's When Genius Failed is so instructive,
Speaker 2: not just because of the things you're referring to, failing
Speaker 2: to learn from history, the danger of leverage and you know,
Speaker 2: tiny inefficiencies, but it was also a cautionary tale that
Speaker 2: was ignored a few years later led right to the
Speaker 2: Great Financial Crisis, the same mistakes.
Speaker 3: Yeah, there's a historian by the name of Robert Kaplan
Speaker 3: who said that all of history is half geography and
Speaker 3: half Shakespeare. And when I heard that, it resonated. I
Speaker 3: realized that investing is the same way. It's half mathematics
Speaker 3: and half Shakespeare, and you have to manage. You have
Speaker 3: to master both of them. If you can't master both,
Speaker 3: you're dead in the water.
Speaker 2: Literally. My next question, you describe you describe it as
Speaker 2: half mathematics, half Shakespeare. Some people would call that art
Speaker 2: and science. But tell us why you need both compounding
Speaker 2: and exponential mathematics and the Bard to be successful as
Speaker 2: an investor.
Speaker 3: Well, it gets to what I call the prom queen
Speaker 3: theory of life, which is the different.
Speaker 2: Wait, the prom queen theory of life.
Speaker 3: Indeed, if you're the prom queen, then the most important
Speaker 3: thing in the world is how you dress and how
Speaker 3: you look, and that's how you judge other people. Brains,
Speaker 3: athletic ability, political ability don't matter.
Speaker 1: Well.
Speaker 3: Financiers are exactly the same way. If the peak of
Speaker 3: your skill set is your quantitative ability, that is how
Speaker 3: you judge other people. And if other people can't understand
Speaker 3: your models, then they're stupid, all right, getting you have
Speaker 3: to you know, the conceit of finance is that basically
Speaker 3: the math is all there is to it, and that
Speaker 3: you don't have a limbic system. They deny the existence
Speaker 3: of their emotions and their psychology, and that's what gets
Speaker 3: them into trouble. They don't understand the history and now
Speaker 3: how that feeds into mass fear and mass greed and
Speaker 3: mass illusions, which is why I wrote that particular book.
Speaker 2: Kind of reminds me of the Richard Feinemann quote imagine
Speaker 2: how much harder physics would be if electrons had feelings?
Speaker 3: Exactly?
Speaker 2: Yeah, so interesting. So since we mentioned Shakespeare, I have
Speaker 2: to ask the obvious question, what writers and investors have
Speaker 2: influenced how you invest and how you write?
Speaker 3: Oh, dear well, Jim Grant of course would be at
Speaker 3: the top of anyone's list, and then the person who's
Speaker 3: right at the top of that list was the was
Speaker 3: a Scottish guy who lived almost two hundred years ago.
Speaker 3: Charles Mackay who wrote Extraordinary Popular Delusions and The Madness
Speaker 3: of Crowds are actually memoirs of Extraordinary popular Delusions and
Speaker 3: the Madness of crowds, and he described all of the
Speaker 3: things that we've been seeing, you know, over the past
Speaker 3: couple of decades, more than two hundred years ago.
Speaker 2: So those are two well known names. Jim Grant is
Speaker 2: really best known as a macro analyst and a fixed
Speaker 2: income investor. How has Grant influenced how you look at
Speaker 2: the world of investing?
Speaker 3: Well, he's also a historian. You know, he's written several
Speaker 3: historically deep books, particularly about Bernard Baruk, but he certainly
Speaker 3: you know, describes the historical episodes of manias and panics.
Speaker 3: I guess the other one would be John Kenneth Galbraith,
Speaker 3: whose history of nineteen twenty nine crash was non non prole.
Speaker 3: I mean, it was just absolutely superb. You know, it's
Speaker 3: one of those books that you just can't help but
Speaker 3: you know, snickering out loud, you know, with every paragraph.
Speaker 2: And he has probably coined more quotes and phrases that
Speaker 2: other people unknowingly steal and don't credit him because they're
Speaker 2: just the essence of truth and wisdom.
Speaker 3: Yeah, especially you know, whenever anybody talks about innovation in finance,
Speaker 3: he describes it as reinventing the wheel, only in slightly
Speaker 3: more unstable form.
Speaker 2: That's pretty that's pretty amusing. We briefly talked about if
Speaker 2: it's in the headlines, if it's above the fold in
Speaker 2: the paper, it's already in price. So you're a proponent
Speaker 2: of modern portfolio theory and the efficient market hypothesis. How efficient?
Speaker 2: How much do market prices truly reflect future discounted cash flow?
Speaker 3: Well? Samuelson once wrote, I think in a private letter
Speaker 3: that the markets were micro efficient but macro inefficient. And
Speaker 3: what he meant by that by micro efficiency was that,
Speaker 3: as the both of us know, it is brutally hard
Speaker 3: and getting harder by the day to pick stocks in
Speaker 3: time the market. If you don't know that, you're in
Speaker 3: big trouble. But the markets are also can be macro inefficient.
Speaker 3: So the overall markets can overshoot in one direction or
Speaker 3: the other. It's very hard to almost impossible, to figure
Speaker 3: out exactly when that's going to happen. You can look
Speaker 3: at a market as abulian and frothy, and you can
Speaker 3: say I know what's going to happen, I just can't
Speaker 3: tell you when. So that to me is the best
Speaker 3: explanation or the best description of macro and micro efficiency
Speaker 3: there is. But you know, I mean, my message to
Speaker 3: anybody who's is twenty years old or twenty five years
Speaker 3: old and just coming out of their education and think
Speaker 3: they're going to be the next Warren Buffett, the bad
Speaker 3: news is you're trading against Warren Buffett.
Speaker 2: That's right, that's right. I have been told that markets
Speaker 2: can stay irrational longer than you can stay solvent.
Speaker 3: Yeah, that's an apocryphal quote from right from Canes yet.
Speaker 2: Right, but not really. I don't believe he ever said that. No,
Speaker 2: he certainly never wrote it.
Speaker 3: No, he never said it or wrote it.
Speaker 2: So, speaking of apocryphal times, you have said investors should
Speaker 2: build their portfolios for the worst two percent of market
Speaker 2: conditions rather than normal times. Tell us why you believe that,
Speaker 2: and how do we go about accomplishing that?
Speaker 3: Well, that's that directly falls out of Charlie Munger's dictum,
Speaker 3: which is that, yes, compounding is magic, but the first
Speaker 3: rule of compounding is never to interrupt it unnecessarily, and
Speaker 3: you're most liable to interrupt, compounding to panic and sell
Speaker 3: during the worst two percent of times. So you design
Speaker 3: your portfolio for the worst two percent of times, which
Speaker 3: means that it should be more conservative then you think
Speaker 3: it should be the other ninety eight percent of the time.
Speaker 3: And it's a suboptimal allocation to have less stocks. A
Speaker 3: suboptimal But what I like to say, is it a
Speaker 3: suboptimal allocation you can execute is better than an optimal
Speaker 3: one you can't execute.
Speaker 2: No doubt about that. You mentioned someone twenty twenty five.
Speaker 2: There are a number of people who have said, and
Speaker 2: I've been swayed in this direction. Hey, when you're twenty
Speaker 2: twenty five years old and you don't need this money
Speaker 2: for thirty forty fifty years, do you really need bonds
Speaker 2: to offset the volatility of equities. Shouldn't you be one
Speaker 2: hundred percent equities at that age?
Speaker 3: Theoretically yes, Practically no, because there are a few sentient
Speaker 3: beings in this quadrant of the galaxy that can tolerate
Speaker 3: one hundred percent stocks.
Speaker 2: Huh really really interesting. So you mentioned half math, half Shakespeare.
Speaker 2: Let's talk about the math side. So when you started
Speaker 2: looking at investing and bringing a scientific rigor to the process.
Speaker 2: You created your own set of asset class databases. This
Speaker 2: is before CRISP and other widely available databases. Tell us
Speaker 2: how you want about doing this?
Speaker 3: Oh no, no, I stole it from them.
Speaker 2: Oh you did?
Speaker 3: Yeah? I mean I went out and spent full disclosure.
Speaker 3: Yeah yeah, no, I mean, I mean what did I do?
Speaker 3: I went out. I did what anybody would do in
Speaker 3: that situation, which I spent ninety five dollars which seemed
Speaker 3: like a king's ransom at the time, for the Ibbitson yearbook.
Speaker 3: And I transcribed all you know, nine hundred and eighty
Speaker 3: five data points into a spreadsheet which I had just
Speaker 3: learned how to use, you know, sometime around nineteen ninety.
Speaker 3: And then that was the start of my models. And
Speaker 3: the other people provided me with data. Ken Fisher, bless
Speaker 3: his soul, supplied me with a fair amount of data,
Speaker 3: and I, you know, impersonated a professional investor at certain
Speaker 3: large banks and was able to get data sits from
Speaker 3: them as as well.
Speaker 2: By the way, I find Ken Fisher to be one
Speaker 2: of the more fascinating people in finance, because not only
Speaker 2: did he bring a writer's perspective. I think he was
Speaker 2: the longest running Forbes columnist at like forty three years,
Speaker 2: some crazy number, writing a monthly column for them. But
Speaker 2: he was both an investor and a very accomplished business
Speaker 2: person in terms of like he was early in direct mail,
Speaker 2: he was early in the Internet, he was early in
Speaker 2: just as running a business, just throwing stuff against the wall,
Speaker 2: seeing what stuck, and just ab testing, iterating on a
Speaker 2: continual basis, long before Google started doing that online. He
Speaker 2: was one of the early people who developed here's what
Speaker 2: financial asset management marketing should look like.
Speaker 3: Yeah, and he did all those things, and he's also
Speaker 3: a superb writer and observer. I think you interviewed him
Speaker 3: a couple of times, Yeah, once or twice, maybe once
Speaker 3: memorably and well there was that sure, And you know,
Speaker 3: he said something on one of your interviews that that
Speaker 3: stuck with me, you know, for the past twenty years,
Speaker 3: which is that he pays close attention to the headlines
Speaker 3: because he knows that if something is above the fold,
Speaker 3: it's already been impounded into prices and can be safely ignored.
Speaker 2: That's exactly right. I thought you were going in a
Speaker 2: different direction the first time quick digression. The first time
Speaker 2: I interviewed him right in the studio. He was kind
Speaker 2: enough to do an interview with me in the first
Speaker 2: year of the podcast, which was, you know, admittedly pretty terrible.
Speaker 2: I was very rough around the edges, and it was
Speaker 2: very formal and rigorous and tell us about small cap
Speaker 2: and tell us about emerging market value. And it was
Speaker 2: really on the you know, just kind of straight down
Speaker 2: the line and really boring. And afterwards we're having a
Speaker 2: conversation as the new firm going pretty good, we're a
Speaker 2: few hundred million dollars, blah blah blah. You know, we
Speaker 2: come in second very often on some of these big households.
Speaker 2: And he said to me, wait till you're five years
Speaker 2: old and a billion dollars in assets under management, and
Speaker 2: the world will open up to you, because no one
Speaker 2: with real money wants to give, you know, a small
Speaker 2: firm with no history a big chunk of cash. And
Speaker 2: we just started talking about how the business ran and
Speaker 2: how he delegated authority and how he built stuff. And
Speaker 2: I'm sitting there listening to them, listening to him, and
Speaker 2: saying to myself, idiot, this is the conversation, not the
Speaker 2: small cap nonsense. You just spent an hour chatting about
Speaker 2: And when he finished schooling me, I said, can you
Speaker 2: come back one day and we'll discuss that because this
Speaker 2: is fascinating and he goes, sure, anytime. So a year
Speaker 2: later we came back and had the conversation we should
Speaker 2: have had. He has always impressed with me with how
Speaker 2: insightful and unique his perspective is. I mean, we're all
Speaker 2: a little neurodivergent. He has his issues, I have mine,
Speaker 2: but I just find him to be an absolutely fascinating guy.
Speaker 3: I mean, if we can get into just a little
Speaker 3: bit of neurophysiology here, there's something called the well.
Speaker 2: You happen to be a neurologist, so let's have at it.
Speaker 3: There's something called the default mode network, which is a
Speaker 3: part of your brain that becomes electrically active when you're
Speaker 3: at rest and which turns itself off when you're doing
Speaker 3: any focused task. And it turns out you can locate
Speaker 3: it anatomically on imaging studies, and people who have well
Speaker 3: developed anatomically well developed default mode networks tend to be
Speaker 3: very good at reading other people and have good emotional intelligence.
Speaker 3: The opposite of that is in people who are on
Speaker 3: the spectrum who have small default mode networks and are
Speaker 3: not good at reading other.
Speaker 2: People, and so he kind of blunt by the way,
Speaker 2: the firm is done fine. They've recovered from his stumble.
Speaker 2: I don't know if it was even pre pandemic. And
Speaker 2: I thought he kind of got slagged by a lot
Speaker 2: of people unfairly. The guy has been a public figure
Speaker 2: for forty five years. He's been at least writing in
Speaker 2: public for all that time. You know, sometimes stuff happens,
Speaker 2: and in a sort of social media gotcha environment.
Speaker 3: To say nothing of being a spectacularly effective environmentalist.
Speaker 2: So on our last interview with him, we talked about
Speaker 2: all the trees and woods that he has purchased and
Speaker 2: put into permanent conservation. He's done giant studies on sequoias
Speaker 2: and redwoods. I think he's one of the leading experts
Speaker 2: in a specific type of tree known in the Pacific Northwest.
Speaker 2: He's really like a wildly fascinating guy, and I hope
Speaker 2: people don't judge him for that. I mean, I don't
Speaker 2: know what to call it. That politically incorrect snafu. I
Speaker 2: think he meant it in any other way, and it,
Speaker 2: you know, they kind of had to reel him in
Speaker 2: a bit. But the farm is doing fine. His farm
Speaker 2: is doing fine. And there was like about a five
Speaker 2: billion dollar outflow. But when you're one hundred and five
Speaker 2: or one hundred and ten billion dollars, all right, you
Speaker 2: got to dance with who brought you there? He built
Speaker 2: it up to that. But I find him to be
Speaker 2: really an interesting guy.
Speaker 3: Yeah, and he has the address here on Lexington, so
Speaker 3: he knows where to send the chocolates.
Speaker 2: I think I'm going to begin with a quote that
Speaker 2: I stole from Bill to start a chapter of my
Speaker 2: new book. To the extent you succeed in finance, you
Speaker 2: succeed by suppressing the limbic system, your system one, the
Speaker 2: very fast moving emotional system. If you cannot suppress that,
Speaker 2: you are going to die poor. I love that quote.
Speaker 2: Is it an exaggeration or is it accurate?
Speaker 3: No, it's it's extremely accurate. Let me tell you a
Speaker 3: personal story. I have a good friend who is a
Speaker 3: wealthy person, and that has enabled this person to have
Speaker 3: a career in public service, and she's done very very well.
Speaker 3: And one day, after I'd known her for many, many years,
Speaker 3: she told me that her sister was poor. All right?
Speaker 3: Or did not have a lot of money. And I said,
Speaker 3: I don't understand this. Was she disinherited? Did she make
Speaker 3: the family angry? And she looked at me straight in
Speaker 3: the eye and she said no, she was afraid of stocks.
Speaker 3: Really yeah, And so that's the difference. If you can
Speaker 3: suppress that fear, you will do very well, and if
Speaker 3: you can't suppress the fear, then you probably will die poor.
Speaker 2: So it's so fascinating you said that you must have
Speaker 2: a similar situation. I live in liberal New York. You
Speaker 2: live in liberal Oregon, right, But we have clients that
Speaker 2: are on the left and the right. And so anytime
Speaker 2: you put out a commentary on current affairs, not only
Speaker 2: because you don't want to offend half your clients, but
Speaker 2: because it's a good analytical strategy to try and go
Speaker 2: down the middle. Be objective and fact based. But whatever
Speaker 2: your personal bias is, keep it, keep it out of it.
Speaker 2: And I wrote something up about what are the best
Speaker 2: and worst case scenarios about the tariffs, And we'll talk
Speaker 2: a ton later about tariffs. But the fascinating thing is
Speaker 2: when you look at history, and you look at a
Speaker 2: chart of everything that's happened, go back one hundred years,
Speaker 2: go back to nineteen twenty six. There's always a reason
Speaker 2: to sell stocks year in, year out. There's always some
Speaker 2: spectacularly crazy news that says this is gonna be terrible.
Speaker 2: I want to sell. And if you're selling in response
Speaker 2: to headlines, you know, and you're gonna wait for the
Speaker 2: dust to clear by that it's too late. You've missed
Speaker 2: most of the recovery. How do we deal with that
Speaker 2: never ending threat that persists? This time is different since
Speaker 2: and carent affairs the headlines today? Does it feel like
Speaker 2: the tariffs are different? Or is this no different than
Speaker 2: the Great Financial Crisis, the pandemic, the dot com implosion,
Speaker 2: go down the list to say nothing of the Kennedy
Speaker 2: assassination nine to eleven, Like there are endless reasons to
Speaker 2: be panicked about what's going on in the world.
Speaker 3: Yes, this time certainly was different. Never before in American
Speaker 3: history has a colossally incompetent American president tried to creator
Speaker 3: the economy. And that's it's very different.
Speaker 2: Do you think that was his purpose? Is he like, hey,
Speaker 2: we cause the recession rates come down and that's good
Speaker 2: for real estate?
Speaker 3: Or I think we've talked about this one. The Rosetta
Speaker 3: Stone of Donald Trump is a call in show he
Speaker 3: did with Howard Stern along with his daughter and his
Speaker 3: son Junior, And Howard looked at him and said, quick,
Speaker 3: multiply six times seventeen. All right. None of the three
Speaker 3: of them could do itred two. Well, that's the whole point.
Speaker 3: And you know, Don Junior laughed, he thought it was funny.
Speaker 3: Ivankas said, oh no, you don't have to be able
Speaker 3: to do math.
Speaker 2: To do real estate or investing for that math.
Speaker 3: But the most interesting response was Donald's. He said, no,
Speaker 3: it's one hundred and twelve, and he argued with Howard
Speaker 3: Stern about whether it was one hundred and two or
Speaker 3: one hundred and twelve.
Speaker 2: Six times ten is sixty six times seven is forty two,
Speaker 2: sixteen forty two. I mean that's how I do math
Speaker 2: in my head. I don't know how you do it.
Speaker 3: Yeah, yeah, there's yeah, that's one way to do it.
Speaker 3: Or you might know that three times seventeen is fifty one, okay,
Speaker 3: and you could double it, double it exactly. And so
Speaker 3: this is a math problem that you know, a reasonably
Speaker 3: bright middle school student can handle. None of the three
Speaker 3: Trumps could do it, okay, and so this is the
Speaker 3: guy who's now directing our economy. So that's different. All right, Well,
Speaker 3: how different was that from nine to eleven? All right,
Speaker 3: nine to eleven was sure different.
Speaker 2: I mean, arguably, Jeorge H. W. Bush is in the
Speaker 2: sharpest tool in the in the box. Barack Obama had
Speaker 2: no national experience whatsoever, had no idea how really the
Speaker 2: national apparatus worked. You could do this on both sides
Speaker 2: to some degree. You're saying this time really.
Speaker 3: Oh yeah, yeah, yeah, this is this is this, this
Speaker 3: is completely there were there were adults in the room
Speaker 3: during the Bush presidency, and there were adults in the
Speaker 3: room during the first Trump presidency. They're all gone now.
Speaker 2: And yet the market continued to go higher during the
Speaker 2: first Trump presidency regardless of who was president.
Speaker 3: Because they took him literally but not seriously.
Speaker 2: Other way around, Yeah, seriously but not literally. Yeah, this
Speaker 2: time I think we should be taking him literally but
Speaker 2: not seriously.
Speaker 3: Yeah. Yeah, that's right, got it reversed exactly.
Speaker 2: Yeah, the great So we talked earlier about the efficient
Speaker 2: market hypothesis. So to be fair to the president, he's
Speaker 2: been talking about Tariff's whole adult life. He says, Tariff
Speaker 2: is the most beautiful word in the dictionary. He says,
Speaker 2: I'm tariff man. Why were the markets so surprised by
Speaker 2: Liberation Day when here's a guy who has told you,
Speaker 2: I'm going to implement big, beautiful tariffs in my second term.
Speaker 2: Why did the market have to adjust revenue and earnings
Speaker 2: expectations down substantially after April second if the market's so efficient.
Speaker 3: Well, I think that the reason why is because he
Speaker 3: didn't do ninety percent of the other things he said
Speaker 3: he was going to do. He was going to repeal
Speaker 3: Obamacare and give us a big, beautiful healthcare system. He
Speaker 3: was going to redo our infrastructure. He was going to
Speaker 3: establish peace in the Ukraine on day one.
Speaker 2: And I think that his breaking and the price of eggs, yeah.
Speaker 3: Exactly, And I think that his I think that his
Speaker 3: promise on tariff's just got put in the bin with
Speaker 3: the rest of the stuff. He obviously wasn't going to
Speaker 3: do it and didn't do.
Speaker 2: But I think people did take him seriously. They did expect,
Speaker 2: you know, the sort of muscular US foreign policy and
Speaker 2: take tough you know, a tough stance with the Middle East,
Speaker 2: a tough stance with the Russia Ukraine War, and he's
Speaker 2: going to bring prices down. That's why I believe most
Speaker 2: of his non hardcore supporters voted him. I think a
Speaker 2: lot of people were kind of surprised by what he's done.
Speaker 2: Are you suggesting that we should not be long term
Speaker 2: investors and step aside or do we just have to
Speaker 2: ride this out?
Speaker 1: No?
Speaker 3: I think that it's this time is different in the
Speaker 3: same way that all the other times were were different.
Speaker 3: I mean, you know October nineteenth, you know nineteen eighty seven, Boy,
Speaker 3: that was sure different. We've never seen that before and
Speaker 3: we've never seen it since. And the smart thing to
Speaker 3: do on October twentieth of nineteen eighty seven was to
Speaker 3: buy stocks.
Speaker 1: Right.
Speaker 2: So when you say so, not that you had time
Speaker 2: like I was hoping, we would be down. I don't
Speaker 2: get excited about down eight to ten percent, but down
Speaker 2: twenty percent, you've got my attention. I want to start
Speaker 2: legging into more equities. We never quite got there on
Speaker 2: the SMP, right, I think, well we down eighteen percent,
Speaker 2: seventeen percent.
Speaker 3: Yeah, And it's the same thing with you know late
Speaker 3: March of twenty twenty, Boy, that was fast.
Speaker 2: Thirty four percent seventeen days. So if you were looking
Speaker 2: for down twenty You got it. You just only had
Speaker 2: a day or two to react.
Speaker 3: Yeah, I don't, you know. I try to stay away
Speaker 3: from correction ten percent bear market twenty percent. To me,
Speaker 3: that's numerology.
Speaker 2: There's no difference one hundred you and I know, you know,
Speaker 2: I find the base ten like what you have ten
Speaker 2: fingers and ten toes. So twenty percent is a bear market.
Speaker 2: There's just no data that supports that.
Speaker 3: No, there's no difference between the market being down nineteen
Speaker 3: percent and down being down twenty one percent. It behaves
Speaker 3: the same way in both cases.
Speaker 2: Arguably. If so, maybe I should make our rebalance BA
Speaker 2: instead of being down twenty percent, maybe it's down sixteen percent.
Speaker 2: So you get executed and then add a second one
Speaker 2: down twenty four percent.
Speaker 3: Yeah, until you get to you know, March of nine,
Speaker 3: and there you've rebalanced. You've thrown all your cash in
Speaker 3: three different times.
Speaker 2: And but you know, if you've thrown away your cash,
Speaker 2: it kind of works out. The really the really strange
Speaker 2: thing about bear markets, and I'm my frame of reference
Speaker 2: is not just twenty to twenty thirteen, but the Dow
Speaker 2: kisses one thousand in nineteen sixty six and it doesn't
Speaker 2: get over and on a permanent basis till nineteen eighty two.
Speaker 2: And if you just continued to dollar cost average for
Speaker 2: those sixteen years, or from twenty to twenty thirteen, when
Speaker 2: the market finally got over all its previous highs, that's
Speaker 2: when you start to make a ton of money because
Speaker 2: that next cyclical I'm sorry, that next secular move. Those
Speaker 2: bad buys you've made over the past ten years, suddenly
Speaker 2: they start flower.
Speaker 3: Yeah, there's this academic parlor game we're both aware of,
Speaker 3: which is the argument is do stocks get riskier with
Speaker 3: a longer time horizon? And the correct academic answer is yes,
Speaker 3: they do. But the assumption there is that you're a
Speaker 3: buy and hold investor, all right, But there are other
Speaker 3: kinds of investors besides buy and hold investors. If you
Speaker 3: are a periodic savory, you're a young person who's putting
Speaker 3: money away, then stocks are really not all that risky
Speaker 3: for the reason you just gave. On the other hand,
Speaker 3: if you're a retiree and you have no more human
Speaker 3: capital left than stocks are three mile Island dangerous? You are?
Speaker 2: You know, you have to explain what that means to a.
Speaker 3: Young Yeah, there was a nuclear There was a nuclear
Speaker 3: accident which was sort of the junior early version of
Speaker 3: Chernobyl at three Mile Island outside Harrisburg, Pennsylvania. There was
Speaker 3: a movie that was that was parody of all Yeah, yeah,
Speaker 3: the China syndrome. That's right, uh and and and so
Speaker 3: the point being that if you're an older person, stocks
Speaker 3: are are risky. And you could say, if you're you know,
Speaker 3: like me, you don't have a lot of human capital left, well,
Speaker 3: five out of six times, uh, stocks have higher returns
Speaker 3: in bonds. So even in retirement, I should have plenty
Speaker 3: of stocks. And that's like saying that when you play
Speaker 3: Russian roulette five out of six times you win.
Speaker 2: I guess five out of six times. But that said
Speaker 2: that that six time is a doozy, isn't it exactly?
Speaker 3: It's it's it's all about asymmetric consequences. It's if you're
Speaker 3: if you're invested too heavily in bonds and you should
Speaker 3: have been invested in stocks, well you don't get to
Speaker 3: fly first class, you don't get to buy the beamer.
Speaker 1: Uh.
Speaker 3: But on the other hand, if you invest too heavily
Speaker 3: in stocks and you're wrong, then you're bunking with your kids.
Speaker 2: Right, if you're an older investor and you don't have
Speaker 2: that time horizon, right. Yeah, someone someone said to me,
Speaker 2: can you really look through the next four years if
Speaker 2: you're not retiring for ten or twenty years, or if
Speaker 2: your kids five twenty nine, they're not going to school
Speaker 2: for ten fifteen years. That's the easy question. The challenge
Speaker 2: is what happens if you're retiring in twenty five, twenty six,
Speaker 2: twenty seven, right in the next three years. You know,
Speaker 2: that sequence of returns problem is really thorny. I think
Speaker 2: it was Bill Sharp said, it's one of the most
Speaker 2: difficult problems in all of finance. How much do you
Speaker 2: draw down each year? We all use four percent as
Speaker 2: an average, but how much do you draw down each
Speaker 2: year if your first couple of years of retirement is
Speaker 2: down five, down, ten, down, twenty percent?
Speaker 3: Yeah, there's this one or wonderful little bit of quantitative
Speaker 3: work done by Mike Kitsis. And wait, foul about you
Speaker 3: know the reversel glide slope, which is you actually raise
Speaker 3: your equity allocation the further into retirement you get, and
Speaker 3: that just if you think about it logically, it just
Speaker 3: falls right out of that your first your first five
Speaker 3: ten years of retirement, you want to be fairly conservative
Speaker 3: just for that reason. And then when you're eight years
Speaker 3: old and you know you'll be pushing up the daisies
Speaker 3: in five or ten years, then you can be more
Speaker 3: aggressive because you don't need that much of a liability
Speaker 3: match in portfolio at that age.
Speaker 2: Huh really really interesting. So you wrote a short book
Speaker 2: called Deep Risk talking about different types of risk. Explain
Speaker 2: what is deep risk? What is shallow risk?
Speaker 3: Well, shallow risk is the way we normally think about risk.
Speaker 3: There's this theoretical finance dogma that risk is the same
Speaker 3: as variance or standard deviation. And the problem with that
Speaker 3: is that's only true in the short term short term volatility,
Speaker 3: and short term volatility is not of any real importance
Speaker 3: to the long term investor. The real risk of long
Speaker 3: term investing is not having enough assets to pay for
Speaker 3: your living expenses five, ten, fifteen, twenty thirty years from now.
Speaker 3: So what are the things? What are the what are
Speaker 3: the events that can that can impair that? Big ones? Inflation? Inflation?
Speaker 3: Hyper inflation in particularly is extremely common. It is almost
Speaker 3: the rule rather than the exception. Really, sure, you look,
Speaker 3: all you have to do is ask yourself, what unit
Speaker 3: of currency that would buy yourself something in the year
Speaker 3: nineteen hundred can still buy yourself something today? Well, the
Speaker 3: US dollar can still buy yourself something, okay, can buy
Speaker 3: you something. A Japanese yen sure can and it can't.
Speaker 3: An English pound can, and a Swiss franc maybe can
Speaker 3: buy you a candy bar if you find the right
Speaker 3: store in Geneva or more likely burn and so you
Speaker 3: know those, you know, they're the case of the yen
Speaker 3: and the French franc and the German lera are much
Speaker 3: more common than the US dollar and the Swiss frank
Speaker 3: and the English pound.
Speaker 2: Those German deutsch Mark, Italian lera.
Speaker 3: Exactly exactly, Yeah, I mean you start with, you know,
Speaker 3: a reich mark in the year nineteen twenty and you
Speaker 3: know by nineteen twenty three, late nineteen twenty three, you
Speaker 3: were down to one trillionth of its personal purchasing power.
Speaker 3: That's hyper inflation. So that's the rule. So that's the
Speaker 3: most common thing that you have to worry about, and
Speaker 3: that is, relatively speaking, the easiest one to defend against. Now,
Speaker 3: there are other three other things that can well.
Speaker 2: Wait before you go to the other three things. How
Speaker 2: do you defend against that.
Speaker 3: Well. First of all, in the US, we have these
Speaker 3: marvelous instruments called tips, and all you have to do
Speaker 3: is worry about, you know, the Department of Labor rejiggering
Speaker 3: the inflation adjustment, which is something to worry about. But
Speaker 3: of all the worries you can have, that's a relatively
Speaker 3: small one.
Speaker 2: We went through that with Michael Boskin already rejiggered how
Speaker 2: we calculate, right, of course, the living adjustments. Rather than
Speaker 2: debating this like adults politically, they just made some I'm
Speaker 2: not a big fan of substitution or hedonic adjustment. When
Speaker 2: when steak gets too pricey and you substitute chicken, that
Speaker 2: just means I've been priced out of steak. Not that
Speaker 2: this is.
Speaker 3: The equivalent, Yeah, exactly, I mean it is. It is
Speaker 3: a problem. But of all of the asset classes that
Speaker 3: protect you with the greatest charity against the decrement in
Speaker 3: your future consumption, loss of your future consumption, tips do
Speaker 3: it better than anything else I can think of. All.
Speaker 2: Right, stock, really interesting stocks.
Speaker 3: Do a relatively good job of it. You know. Elroy
Speaker 3: Dimson likes to point out that stocks are an inflation
Speaker 3: head simply because of their high returns, but they're also
Speaker 3: a claim when real assets. You know, companies own real estate,
Speaker 3: they own equipment, they have human capital, and those retain
Speaker 3: real value.
Speaker 2: Plus stocks are their revenue and profits are in dollars,
Speaker 2: so at least in the US, so if there's inflation,
Speaker 2: the cost of their goods go up and their total dollars,
Speaker 2: maybe their profits get squeezed, but everything seems to rise
Speaker 2: in an inflationary environment on the equity side, right.
Speaker 3: Right, And then there's certain kinds of stocks that are
Speaker 3: especially good at protecting you inst inflation. Value stocks do
Speaker 3: why because they tend to be overly leveraged, and with inflation,
Speaker 3: their debts tend to get inflated away and so that
Speaker 3: flows to their bottom line. So if you look, for example,
Speaker 3: at the period that we just talked about from sixty
Speaker 3: six to eighty two, value stocks actually perform the market
Speaker 3: by an inflation by a very good margin. And then finally,
Speaker 3: there are commodities producers in an inflation environment, the petroleum stocks,
Speaker 3: gold stocks, base metal producers are all going to do
Speaker 3: fairly well, at least relatively well to the market. And
Speaker 3: then finally, you know, on the bond side, for God's sakes,
Speaker 3: keep your maturity short. As we found out in twenty.
Speaker 2: Two, I noticed when you talked about real assets, you
Speaker 2: did not discuss real property. How does real property do
Speaker 2: as an inflation hedge over time?
Speaker 3: It's pretty good. But what I like to say about
Speaker 3: real estate is that it's not an investment. It's a job.
Speaker 2: Yeah.
Speaker 3: If you, if you, if you, if you enjoy dealing
Speaker 3: with drug addle tenants and fixing toilets, then be my guest.
Speaker 2: Okay, I wasn't. I wasn't thinking of rental properties. I
Speaker 2: was thinking of the various roots and offices and paying
Speaker 2: a professional to manage it. So you're not getting the
Speaker 2: two am call that the toilet is overflow.
Speaker 3: Yeah, but then by the time you're investing in public reads,
Speaker 3: you're back in the stock market again.
Speaker 2: Right, So there's no difference. Really really really really interesting.
Speaker 2: I was kind of fascinated by a data point you
Speaker 2: shared talking about old Master paintings. Imagine if you bought
Speaker 2: a Rembrandt for one hundred bucks, and three hundred and
Speaker 2: fifty years later you sold it for ten million dollars
Speaker 2: the return was a little over three percent a year.
Speaker 2: That that's astonishing. All these paintings look like they've appreciated
Speaker 2: so much. Tell us about the math behind these paintings
Speaker 2: that go for ten twenty thirty million dollars.
Speaker 3: Well, it's really it's really not about finance or math.
Speaker 3: What it's about is human neuropsychology. We are particularly bad
Speaker 3: at exponential calculations. And you know, it's the old thing
Speaker 3: that even the the they knew back in the in
Speaker 3: the Far East, that you know, the emperor asks the
Speaker 3: artisan or the farmer what he wants. We'll put one
Speaker 3: grain of rice on the first square in the of
Speaker 3: the chessboard. And by the time you get, of course
Speaker 3: to the to the square, but by the time you
Speaker 3: get to the sixty fourth square, he's the wealthiest person
Speaker 3: on the planet. Human beings are not good at that.
Speaker 3: And that's all that. That's a demonstration of. Now, if
Speaker 3: you want to get into the academic finance of it,
Speaker 3: it's that art has value in investment, has investment value,
Speaker 3: but it also has a complementary value, which is a
Speaker 3: syesthetic return. And Bill Bommel did the research on this,
Speaker 3: the late Bill Bommel. Then Yu did the research on
Speaker 3: this and figured out out that art had a much
Speaker 3: lower return than stocks or bonds simply because of its
Speaker 3: esthetic return.
Speaker 2: Makes a lot of sense. And that's before we get
Speaker 2: to the whole survivorship bias that you only see the
Speaker 2: most famous paintings in the world and their price tag.
Speaker 2: The tens of thousands of other paintings that aren't auctioned
Speaker 2: off each year, we don't see their returns.
Speaker 3: So to say nothing of the maintenance and insurance and
Speaker 3: security costs of keeping the art as well.
Speaker 2: No doubt, no doubt about that. It's funny because you
Speaker 2: have this whole group of investing books and then you
Speaker 2: also have this separate group of really fascinating historical books
Speaker 2: about markets and the economy and global trade. Let's start
Speaker 2: with the splendid exchange. It's so perfect for the moment
Speaker 2: we're in. What is the history of trade and how
Speaker 2: has it helped raise everybody standard of living?
Speaker 3: Well, it just gets down to Adam Smith's concept of specialization.
Speaker 3: Nations specialize, and nations have and people have an intrinsic
Speaker 3: tendency too, as he put it, truck and barter. They
Speaker 3: want to trade one thing for another. So you know,
Speaker 3: the one of the great luxury commodities of the seventeenth
Speaker 3: century was the pineapple. If you look at the coats
Speaker 3: of arms of all these European aristocrats, about third or
Speaker 3: a quarter of them have a pineapple on them. Why
Speaker 3: because they came from the New World. They were incredibly
Speaker 3: precious and they were delicious. Everybody in Europe wanted a
Speaker 3: pineapple because they don't grow pineapples in Europe. And so
Speaker 3: different nations have different geographical and intellectual and technological endowments.
Speaker 3: And it's if you improve everybody's standard of living by
Speaker 3: trading among nations the things that other nations aren't good at.
Speaker 2: That seems fair. And we all specialize and we all
Speaker 2: do different things. It makes sense as the US developed
Speaker 2: computer technology and software that we're not going to make
Speaker 2: furniture or fabrics or sneakers or those sorts of things.
Speaker 2: But at what point does globalization go too far? At
Speaker 2: what point have we hollowed out the middle class by
Speaker 2: outsourcing manufacturing to China and other low cost countries.
Speaker 3: That's a really good question, and it was highlighted by
Speaker 3: a series of patients. Again, it was highlighted by a
Speaker 3: series of papers by an economist named David Otter auto
Speaker 3: R And his colleagues, and it showed just how badly
Speaker 3: communities that were affected by Chinese competition were hollowed hollowed out. Now,
Speaker 3: the problem with free trade is that its harms are
Speaker 3: concentrated and obvious, as David Order found out, but its
Speaker 3: benefits are diffuse. So a world in which we have
Speaker 3: to make our own shirts and our own furniture is
Speaker 3: a world in which the other three hundred and fifty
Speaker 3: million Americans who don't make those things are taxed very heavily.
Speaker 3: So instead of paying fifteen dollars for a shirt, you're
Speaker 3: paying thirty five dollars for a shirt. Instead of paying,
Speaker 3: you know, two and a half dollars for a head
Speaker 3: of lettuce, you've got to pay seven dollars for ahead
Speaker 3: of lettuce. And so that's a world in which everyone
Speaker 3: else is impoverished, but in which those costs are much
Speaker 3: harder to see than the out of work auto worker
Speaker 3: or out of work furniture manufacturer.
Speaker 2: So we certainly have problems in the United States. There's
Speaker 2: wealth inequality, there's income inequality. I think the worst of
Speaker 2: the pandemic inflation is behind us, but we have these
Speaker 2: real problems with which a lot of people are blaming
Speaker 2: on trade and globalization. What's wrong with that thesis.
Speaker 3: The analogy I like to use is Churchill's comment about democracy,
Speaker 3: which is it's the worst form of government that's ever
Speaker 3: been tried, except for all the others that have been
Speaker 3: tried from time to time. I think that's close to
Speaker 3: the exact route. And so the alternative to free trade
Speaker 3: is protectionism, and protectionism, as we found out during the thirties,
Speaker 3: is a disaster in multiple dimensions. What happens when you
Speaker 3: raise tariffs is what we're seeing now, is in the
Speaker 3: first place, prices go up. You know, automakers, automakers have
Speaker 3: to pay more for their steel. You know, people who
Speaker 3: are making agricultural products and processing food have to pay
Speaker 3: more for their imported basic inputs, and so domestic prices
Speaker 3: go up. You get inflation, and we're already starting to
Speaker 3: see the expectation of inflation going up. I think the
Speaker 3: media and expectation is now six point seven percent in
Speaker 3: survey data. And once you see the expectation of inflation
Speaker 3: going up, then inflation goes up, because that's how inflation
Speaker 3: is driven. Then you see retaliation, which we're already seeing
Speaker 3: in spectacular fashion, and you see trade wars. But that
Speaker 3: is not even the worst costs cost of protectionism, because
Speaker 3: what happens with that is that it inflames international relations.
Speaker 3: And it was apparent to people in nineteen forty five
Speaker 3: that one of the causes of the Second World War
Speaker 3: was the protectionism of the nineteen thirties, and that gave
Speaker 3: rise to the new world order that we put in place.
Speaker 3: Basically in nineteen forty five, you know, with the what
Speaker 3: came in what became the World Trade Organization, the IMF
Speaker 3: and Breton Woods, and they said, never, never again, this
Speaker 3: is never going to happen again. Why did the Japanese
Speaker 3: attack Pearl Harbor r It was because we embargoed oil,
Speaker 3: all right, and they knew what would happen if we
Speaker 3: cut off their oil supplies. And I fear the same
Speaker 3: thing would happen today. Imagine, for example, an inverted naval
Speaker 3: encounter in the Straits of Taiwan between US and Japanese
Speaker 3: naval vessels. The difference between a peaceful and a non
Speaker 3: peaceful outcome may very well be the state of mind
Speaker 3: of the policymakers on both sides, whose emotions have been
Speaker 3: inflamed by the trade RUCKUS.
Speaker 2: Huh really interesting. So PAX Americana eighty years of growth
Speaker 2: and economic success, much of which accrued to the benefit
Speaker 2: of the US. Are you implying that that is now
Speaker 2: at risk?
Speaker 3: Yes. Absolutely. There is a man, very fairly well known
Speaker 3: economists by the name of Albert Hirshman, who has a
Speaker 3: fascinating biography. He was Jewish, he was raised in Berlin.
Speaker 3: Not only was he Jewish, but he was also a socialist.
Speaker 3: So he fled the Nazi persecution, fought in the French
Speaker 3: army against the Germans, then wound up in Marseille, spiriting
Speaker 3: people like Hannah Arendt out of Marseille into the United
Speaker 3: into the United States. And he saw quite clearly that
Speaker 3: World War II was enlarged part triggered by the trade
Speaker 3: frictions of that period. For example, you know, one of
Speaker 3: the things that inflamed the Germans so much was because
Speaker 3: they couldn't pay their way out of the World War
Speaker 3: One reparations, because they couldn't export.
Speaker 2: And Lord quad Amat's book goes into great detail about that.
Speaker 3: Yeah, and so he wrote about that in nineteen forty five,
Speaker 3: and he says, we have to establish a world order
Speaker 3: in which that doesn't happen again.
Speaker 2: Huh. So here's the best case scenario. And I want
Speaker 2: to talk a little bit about this because splendid Exchange
Speaker 2: and Birth of plenty are sort of two sides of
Speaker 2: the same coin. Best case scenario, this is just a
Speaker 2: negotiating tactic. We're going to cut all these side deals
Speaker 2: and all this brew Haha, Hey, you took him literally,
Speaker 2: we should have taken him seriously. Is there a way
Speaker 2: out that doesn't destroy the post World War two order
Speaker 2: that has accrued so much wealth to the United States?
Speaker 3: It is possible. I don't think at this point it
Speaker 3: is probable. I think that so much damage has been done.
Speaker 3: I don't think that any any foreign power is ever
Speaker 3: going to trust us again. You know, Donald Trump renegotiates
Speaker 3: andn after we get the USMCA.
Speaker 2: His new treaty in Trump one, in Trump one.
Speaker 3: And then he repudiates that. And you know, let's say
Speaker 3: that the Democrat gets elected into in twenty twenty eight.
Speaker 3: Let's assume that you know that he not only he
Speaker 3: or she not only gets the presidency but also gets
Speaker 3: a democratically dominated Congress. The other nations of the world
Speaker 3: are going to look at us and say, yeah, but
Speaker 3: we don't know who's going to be elected in twenty
Speaker 3: thirty two or twenty thirty six. We can't trust these
Speaker 3: people ever.
Speaker 2: Again, that sounds like a worst case scenario.
Speaker 3: I think that's the most I don't think that's the
Speaker 3: worst case scenario. I can think of worst case scenarios
Speaker 3: than that which I've just I described previous to that
Speaker 3: in front of geopolitics, But I think that's the most
Speaker 3: probable scenario. I don't think that anyone is ever going
Speaker 3: to trust the United States again.
Speaker 2: So I'm an optimist because I was fortunate to be
Speaker 2: born when I was where I was, into the family
Speaker 2: I was. I know that shapes how I see the world.
Speaker 2: I'm kind of hopeful that the twenty twenty six Congress
Speaker 2: changes hands, the tariff power is retaken back by Congress,
Speaker 2: which is within their authority to do, and that whoever
Speaker 2: gets elected in twenty eight, regardless of which side of
Speaker 2: the aisle, just does a global goodwill tour and kind
Speaker 2: of rolls back the past four years. Am I being
Speaker 2: pollyannish about this? Am I too sanguine about the potential
Speaker 2: to repair the worst damage that you're suggesting?
Speaker 3: Well, you and I are engaging in a forecasting exercise.
Speaker 3: Which is well beyond computational impass Human beings, as Philip
Speaker 3: Tatlock described, don't forecast very well, even even the best experts.
Speaker 3: My judgment, my forecast would be that your scenario is
Speaker 3: possible but less probable than mine. But I wouldn't be surprised,
Speaker 3: and I would hope that you're right. But if you
Speaker 3: want a worst case scenario, which I think is as
Speaker 3: probable as yours, the current ructions trashing the treasury market,
Speaker 3: I see rates rising, and I see us falling into
Speaker 3: a debt spiral, and away we go.
Speaker 2: So Ben Hunt of Epsilon Theory wrote a piece a
Speaker 2: week or two ago called the car Crash of Pak's
Speaker 2: Americana and lays out that exact case. Nobody wants to
Speaker 2: buy our treasuries, so how do we finance our debt?
Speaker 2: The dollar, our exorbitant privilege, The dollar as the world's
Speaker 2: reserve currency, is replaced with a basket of euro, yen, wan,
Speaker 2: things like that, and people just start to realize how
Speaker 2: good they had it and frittered it away on a
Speaker 2: very ill advised policy that the last time we tried
Speaker 2: it in nineteen thirty, Smooth Hawley didn't work out well. Either.
Speaker 2: So if that's the case, why would I want to
Speaker 2: own a dollar denominated US assets? Isn't that an argument
Speaker 2: for head for the hills?
Speaker 3: Why? Indeed, and that is certainly an argument for international diversification.
Speaker 3: To invest in countries whose economies are run by adults.
Speaker 2: So once you buy it, the exchange rate no longer matters.
Speaker 2: If you're purchasing Europe, and if you're purchasing Japan or
Speaker 2: in or wherever, and there is inflation in the US
Speaker 2: and there is a decrease in the value of the dollar,
Speaker 2: it doesn't matter after you've made the purchase.
Speaker 3: Yeah, there will be damage on a global scale no
Speaker 3: matter where you invest, but you will mitigate the damage
Speaker 3: by investing abroad. That's the argument for international diversification. It
Speaker 3: hasn't had a lot of fans the past fifteen years,
Speaker 3: but it's coming back into fashion.
Speaker 2: So yeah, No, you've definitely seen this year to date overseas,
Speaker 2: especially Europe and even some of the emerging markets start
Speaker 2: to do much better than they have. What's fascinating about
Speaker 2: splendid exchange is you trace the rise of trade and
Speaker 2: the benefits of an interrelated economy back to the plague,
Speaker 2: the Black Death tell us how the plague led to
Speaker 2: changing up trading patterns.
Speaker 3: Well, it's a fairly well established economic historical subject, which
Speaker 3: is that what the plague did is it overvalued labor.
Speaker 3: A third half of the population of Europe disappeared, and
Speaker 3: so that greatly empowered workers. It drove prosperity, and it
Speaker 3: also probably you know, a century a century and a
Speaker 3: half later, drove the voyages of discovery to the Indies.
Speaker 3: What were people looking for in the Indies. Well, they
Speaker 3: were looking for this really important economic commodity, which was nutmeg,
Speaker 3: mace and clothes, which were great luxuries, and it's what
Speaker 3: made Portugal wealthy early on, and then drove the wealth
Speaker 3: of the Dutch and then finally the English.
Speaker 2: Huh, that's really interesting. So one of the things you
Speaker 2: wrote in Exploded Exchange is trade almost always benefits the
Speaker 2: nations that engage in it, but only averaged over the
Speaker 2: entire national economy. There's always a minority that is hurt
Speaker 2: by evolving trade patterns, and they always call for protection.
Speaker 2: That was very pressing in observation. Is that coming true
Speaker 2: now in what you see for the people who are
Speaker 2: demanding protection from international trade and globalization in the current administration.
Speaker 3: Yeah, when when trade opens up, then someone is hurt.
Speaker 3: If you're making furniture in the United States and people
Speaker 3: in China can make it more cheaply then you can,
Speaker 3: then you're going to be hurt as a furniture maker.
Speaker 3: On the other hand, if you're a consumer of furniture
Speaker 3: and there are you know, thousands and thousand times more
Speaker 3: consumers of furniture than there are makers furniture, then you
Speaker 3: benefit greatly from that. But trade always produces losers and winners.
Speaker 3: Now is part of the fun of writing Splendid Exchange
Speaker 3: was identifying who the losers were three and four hundred
Speaker 3: years ago, and two hundred years ago, and one hundred
Speaker 3: years ago, four hundred years ago, the big losers with
Speaker 3: trade were the people who grew sugar on the island
Speaker 3: of Madeira, which was a sugar producing eye and from
Speaker 3: about the fifteenth century or actually the fourteenth century on,
Speaker 3: and they made a lot of money until people started
Speaker 3: growing sugar in the Caribbean and in Brazil and Madeir
Speaker 3: and sugar producers got clobbered. And did they demand and
Speaker 3: get protection, Yes, they did because they were losers in
Speaker 3: the system. And in the nineteenth century the big losers,
Speaker 3: and they drove a protection as you still see today,
Speaker 3: were European farmers, and was all the fault of Henry Bessemer,
Speaker 3: who learns how to produce or develops a process for
Speaker 3: producing high quality steel which goes into steel rails, which
Speaker 3: enables the grain exporters of the American Midwest and of
Speaker 3: Argentina and of the Ukraine to export vast quantities of
Speaker 3: cheap grain, which bankrupted European farmers who demanded and got protection,
Speaker 3: and they have protection even to this day because of that.
Speaker 2: And then let's talk about the birth of plenty. What
Speaker 2: is the relationship of trade to all the abundance that
Speaker 2: we seem to be enjoying, or at least up until recently.
Speaker 3: Well, yeah, it's the same basic thing. It's the ability
Speaker 3: to purchase things more cheaply than would be available to
Speaker 3: be available to you from domestic producers. It's that simple.
Speaker 3: The birth of plenty was really, really though about the
Speaker 3: four basic preconditions for strong economic growth, which are property
Speaker 3: rights and capital markets and scientific rationalism and modern transport
Speaker 3: and communications systems. And so it's not until you see
Speaker 3: those four things come together that you see the sort
Speaker 3: of modern economic growth that's really only been present for
Speaker 3: the past two hundred years. It really wasn't until relatively
Speaker 3: early in the nineteenth century that this idea that the
Speaker 3: economy grew per capita GDP grew at one or two
Speaker 3: percent per year became a reality. Before eighteen hundred, per
Speaker 3: capita GDP growth was zero.
Speaker 2: Wow, that's amazing. So before we get to our speed round,
Speaker 2: let's talk about your next book. What are you writing now?
Speaker 2: What are you working on?
Speaker 3: I'm still working on it, and whether or not I
Speaker 3: get a publisher for it is open to question. I'm
Speaker 3: interested in two basic subjects. One is the radius of
Speaker 3: trust and societal radius of trust that feeds into the
Speaker 3: strength of institution's rule of law property rights. Why did
Speaker 3: modern prosperity or prosperity of the modern sort arise in
Speaker 3: Northern Europe and England, and in Scandinavia and in Germany
Speaker 3: Weltz because those societies have high radiuses of trust. You
Speaker 3: tend to trust strangers, and the origins of that are
Speaker 3: just extremely, extremely interesting, having to do with prohibitions on
Speaker 3: cousin marriage. It's way too complicated to get into. And
Speaker 3: then the other subject that I'd love to write about
Speaker 3: is something that I call the paradox of religion, which
Speaker 3: is that it is very well established that religiosity is
Speaker 3: beneficial to the individual. People who are religious live longer,
Speaker 3: they are healthier psychologically, they have better social connections, They're
Speaker 3: healthier and happier in every way you'd want to measure.
Speaker 3: On the other hand, when you look at the national level,
Speaker 3: religiosity is inversely correlated with the health of a society.
Speaker 3: So you know, obviously the most religious places on Earth, Somalia,
Speaker 3: the Indian subcontinent, you know, sub Saharan Africa, are also
Speaker 3: the poorest nations on Earth. The richest nations on Earth
Speaker 3: are the ones that are the least religious. What I
Speaker 3: like to talk about is what I call the Somalia
Speaker 3: Sweden scale of religiosity. And there's a concept in economics
Speaker 3: called the paradox of thrift which we're all familiar with,
Speaker 3: which is thrift is good for the individual, it's bad
Speaker 3: for the society. And what you see with religion is
Speaker 3: that it's the same way. Religion is good for the individual,
Speaker 3: but religion is bad for the society overall for obvious reasons.
Speaker 3: You get religious conflict.
Speaker 2: Well, well, let's break that down my savings, my thrift
Speaker 2: is your laws sales, So that's pretty easy to into it.
Speaker 2: Why would my improved psychology and happiness and whatever you,
Speaker 2: as a religious person, end up making the whole country
Speaker 2: more poor less wealthy if everybody's.
Speaker 3: Religious, because because it accentuates religious difference, religious and personal differences.
Speaker 3: If you are deeply religious, you tend to be more
Speaker 3: distrustful of people of different religions. So the societal radius
Speaker 3: of trust is highest in the least religious societies because
Speaker 3: there's less reason for personal conflict.
Speaker 2: And tell us about what is this radius of trust
Speaker 2: you keep referring to give us a little flesh that
Speaker 2: out if you would.
Speaker 3: Well, the best example I can think of, sort of
Speaker 3: the most pungent example is what Jared Diamond talks about
Speaker 3: in his field work in New Guinea, which is that
Speaker 3: when two New Guinea highlanders from different valleys meet, the
Speaker 3: first thing they do is they try and figure out
Speaker 3: how they're related. Okay, do you know this person you
Speaker 3: that person, this person your call that Jewish geography judar. Yes,
Speaker 3: and so you figure that out, and the first person
Speaker 3: figures out, oh my god, this person on the other
Speaker 3: side of me doesn't know anything about me, turns around
Speaker 3: and runs like hell because he knows if the other
Speaker 3: person figures that out, he's going to try and kill him. Okay,
Speaker 3: So this is a society where where people are so
Speaker 3: mistrustful of people from different tribes that murder is often
Speaker 3: the result. All right. Now, in Western societies, you get
Speaker 3: at it by what's called the trust question, which is,
Speaker 3: and it's a very very very common question in sociological surveys,
Speaker 3: which is, do you generally believe that other people can
Speaker 3: be trusted or do you endorse the statement that you
Speaker 3: can be too careful about who you trust? And you
Speaker 3: can measure societal radius of trust that way. And a
Speaker 3: society in which people say, yes, most people can be
Speaker 3: trusted and very few people say you can't be too
Speaker 3: trusting of people, those tend to be much wealthier places. Okay.
Speaker 3: Those are the places where you leave your wallet on
Speaker 3: the sidewalk by mistake and it gets returned to you.
Speaker 2: Sure, Japan is notorious for that sort of thing exactly.
Speaker 2: So let me ask you an odd question. Can both
Speaker 2: of those things be true at once?
Speaker 1: Can you?
Speaker 2: Hey, we're social primates. This is how we evolved and adapted,
Speaker 2: and so we want to cooperate, but maybe we need
Speaker 2: to be a little less gullible about people selling us
Speaker 2: crappy financial products. Are those two things compatible?
Speaker 3: Yeah, I mean there certainly are exceptions. No matter how
Speaker 3: trusting you are, you have to be very suspicious of
Speaker 3: the people who calls you from a non identified phone number.
Speaker 2: Really interesting, even if you're.
Speaker 3: A trusting Midwesterner from Peoria, you still have to have
Speaker 3: your guard up.
Speaker 2: So I only have you for a short period of time,
Speaker 2: and you've done the favorite question so many times, I
Speaker 2: feel like they're redundant. So rather than go through all
Speaker 2: of those, I just want to ask you, tell us
Speaker 2: what you're reading now, what are some of your favorite books?
Speaker 2: And what's keeping you occupied right here and now?
Speaker 3: Well, the person I think who I've read more of
Speaker 3: in the past year than anyone else is a man
Speaker 3: by the name of Robin Gunbar who is an evolutionary
Speaker 3: psychologist and an evolutionary biologist at Oxford. And what he
Speaker 3: did was he figured out that the size of primate
Speaker 3: social groups was directly related to the size that basically,
Speaker 3: the size of their brains the size of their neocortexes.
Speaker 2: Meaning the more the larger your evolutionary brain has developed
Speaker 2: the biggest circle of friends you could keep clear in
Speaker 2: your head. We're talking primates up to and including humans.
Speaker 3: Is that right, Well, yeah, up to and including humans.
Speaker 2: Now.
Speaker 3: Dunbar's number for human beings who have the largest neocortex
Speaker 3: is the largest brain sizes, if you will, it is
Speaker 3: about one hundred and fifty all right, And so you
Speaker 3: and I can keep about one hundred and fifty people
Speaker 3: straight and be able to read them and be able
Speaker 3: to interact with them and have a good social and
Speaker 3: trusting social relationship with them. And that's the natural size
Speaker 3: of a human band. So for example, when you look
Speaker 3: at church congregations, when a church congregation gets to be
Speaker 3: beyond one hundred and fifty, say towards two hundred, towards
Speaker 3: two hundred or two hundred and fifty people, it splits
Speaker 3: because the group can't cohere, it can't keep itself, it
Speaker 3: can't keep itself together. What is the basic military unit
Speaker 3: that you see around the world in all militaries, Well,
Speaker 3: it's the company. Okay, that's one hundred and twenty, one
Speaker 3: hundred and forty soldiers. That's dune Bars number. And chimpanzees
Speaker 3: have a Dunbar's number because they have smaller brains of
Speaker 3: about fifty that's the size of a chimpanzee tribe or
Speaker 3: a chimpanzee clan. Lemmurs have very small brains. You can't
Speaker 3: keep more than two lemurs together. Really, Yeah, And so
Speaker 3: Dunbar has immersed himself of the world of how we
Speaker 3: keep our social interactions straight, how we juggle them all,
Speaker 3: and how we're able to do it. And it turns out,
Speaker 3: for example, that there are some people who have great
Speaker 3: emotional intelligence who can who probably have Dunbar's number of
Speaker 3: two hundred or two hundred and fifty or three hundred.
Speaker 3: That was probably Bill Clinton. You know, Bill Clinton had
Speaker 3: this ability to read people. When what was said of
Speaker 3: Bill Clinton that you know, when you were talking with him,
Speaker 3: it wasn't just he was taught. He was talking only
Speaker 3: to you. You were the only person in the room, right,
Speaker 3: And that's a person with a high Dunbar's number, also
Speaker 3: with a very high with a very large size to
Speaker 3: full mode network, which we talked about earlier, which is
Speaker 3: the part of your bane that maintains your social intelligence.
Speaker 3: So Dunbar has a series of books out. One is
Speaker 3: called Friends, which I can't recommend highly enough. And then
Speaker 3: the other is called The Evolution of Religion, which has
Speaker 3: to do with with religious groups and how religious groups
Speaker 3: go here, and how it has to do with his
Speaker 3: with his number. Both absolutely, both books are just complete
Speaker 3: and total brain candy feasts.
Speaker 2: Really all right, I'm going to put those on my
Speaker 2: list for sure.
Speaker 3: And and then and then of course the person who
Speaker 3: I you know that the other two people who I
Speaker 3: read read repeatedly, over and over again are Joe Henrik,
Speaker 3: who's the head of theoretical biology at Harvard. He's the
Speaker 3: guy who wrote the weird book you know, w E
Speaker 3: I R D. Oh sure, w I W E I
Speaker 3: R D. Western educated, industrialized, rich and democratic, And it
Speaker 3: turns out that most human societies are not weird, most
Speaker 3: human societies, you're true additional societies, and that we in
Speaker 3: Western societies are the weird ones.
Speaker 2: Huh.
Speaker 3: And and he's also the one who's written about how
Speaker 3: radius of trust evolved, uh, you know, through the prohibitions
Speaker 3: against cousin marriage. It's the Hendrick hypothesis, which is just
Speaker 3: a fascinating hypothesis. So those are the kinds of people
Speaker 3: I enjoy reading.
Speaker 2: Hut.
Speaker 3: And then and then fiction Nick Harkaway, Uh, I don't
Speaker 3: know the name. He's the pseudonym of of Jean Le Carrey.
Speaker 3: Jehan La Carey, of course is also a pseudonym.
Speaker 2: Uh.
Speaker 3: And he's taken up the Smiley series and he it's
Speaker 3: hard to make you don't want to read it, because
Speaker 3: who wants to read a book by the son of
Speaker 3: a great novelist. He's better than his.
Speaker 2: Father, no kidding? Yeah, wow, that wrote book.
Speaker 3: Carlo's choice, which is you won't be able to.
Speaker 2: Put down Carlos joints.
Speaker 3: Kay. If you know, if you're a Smiley fan, you
Speaker 3: know who carl is k A r l A all right,
Speaker 3: Russian spy.
Speaker 2: Huh sounds like fun. Bill, Thank you for being so
Speaker 2: generous with your time. We have been speaking to Bill Bernstein,
Speaker 2: author of so many fascinating books, The Intelligent Investor, Four
Speaker 2: Pillars of Investor.
Speaker 1: On and on.
Speaker 2: His most recent book is on the Delusions of Crowds.
Speaker 2: If you enjoy this conversation, well, be sure and check
Speaker 2: out any of the previous five hundred or so we've
Speaker 2: done over the past ten years. You can find those
Speaker 2: that Bloomberg, iTunes, Spotify, YouTube. Be sure and check out
Speaker 2: my new book, How Not to Invest The ideas, numbers,
Speaker 2: and behaviors that destroy wealth and how to avoid them.
Speaker 2: I would be remiss if I did not thank the
Speaker 2: crack team that puts these conversations together each week. John
Speaker 2: Wasserman is my audio engineer. Anna Luke is my producer.
Speaker 2: Sean Russo is my head of research. I'm Barry Richolts.
Speaker 2: You're listening to Masters in Business on Bloomberg Radio.