Stanley Druckenmiller | May 2023 | Keynote at USC Marshall

Keynote Speech by Mr. Stan Drockemiller

In this keynote speech, Mr. Stan Drockemiller discusses the issue of generational inequity and the looming financial crisis that will affect future generations.

The Demographic Problem

• After World War II, there was a baby boom which peaked in 1957 at 3.7 birth rate.

• The Baby Boomers are all turning 65 right when the birth rate is declining.

• There is a huge growth in surplus of older Americans who are receiving entitlements but you don't have the younger workers creating enough revenue to pay for them.

• In 25 years spending on seniors will grow to 70 percent of all taxes.

Fiscal Recklessness

• The fiscal recklessness of the last decade has been like pouring gasoline on a fire given what his thoughts were about the looming financial crisis.

• Entitlement programs will be compounding away and they're going to squeeze everything else out in terms of private and public investment.

Call to Action

• If nothing changes pensions tomorrow will be a fraction of what they are today and the government won't be able to pay half of your health care bill.

• Unfortunately, if you believe you will have as comfortable as Retirement as current seniors like me and Sheldon think again.

• Long before you retire, the horrible consequences of remaining on the path we have foolishly stuck with will be borne by you and your children.

Final Thoughts

• Mr. Stan Drockemiller became terrified of some kind of financial crisis in the 2025-2035 period.

• He wanted to energize young people because it was young people that were suffering in his opinion the brunt of what he considered great generational inequity.

• The situation looks so dire he just got to give it another shot and what better place to start at USC.

The US Federal Debt and Fiscal Gap

In this section, the speaker discusses the level of indebtedness in the US, which is comparable to that of the country during World War II. He also talks about how the federal debt has grown from 15 trillion to 31 trillion since he first talked about it at USC.

The Assumption of No Future Social Security or Medicare Payment

• The current federal debt assumes that the government will never make another social security or medicare payment.

• This assumption is unrealistic and makes the actual debt much higher than what is reported.

Missed Opportunities to Reduce Fiscal Gap

• Over the last ten years, there have been missed opportunities to reduce the fiscal gap ahead of a demographic storm.

• Despite having a booming economy with high inflation nominal growth and windfall capital gains taxes, we ran a deficit over a trillion dollars.

• This trend is expected to continue without radical policy changes.

The Fiscal Gap and Its Implications

• The fiscal gap measures how much taxes need to be raised today to maintain current safety net payments in the future.

• As of now, this measure is 7.7% of GDP, which means we would need a 40% permanent tax increase or a 35% cut in spending today forever.

• Waiting only makes the problem worse as interest rates keep building up.

Entitlements and France's Example

In this section, the speaker talks about entitlement programs in America and compares them with France's social welfare state.

Entitlement Programs in America

• Both Democrats and Republicans agree that entitlement programs should not be touched despite their unsustainability.

• Waiting only makes things worse as interest rates start compounding.

France's Example

• France, a social welfare state, has a fiscal gap that is less than a third of the US.

• The country has just been through huge political upheaval because its leader wants to do the right thing for the next generation.

The Nightmare of Future Economic Growth

In this section, the speaker discusses how the interest rate bill will increase from 8% to 27% by 2050, which will negatively impact future economic growth, investment, productivity and taxpayers.

Interest Rate Bill Increase

• The interest rate bill goes from 8% of outlays now to 27% in 2050.

• By 2040, healthcare spend plus Social Security plus interest will be 68% of tax revenues on the CBO chart. By 2052, spending for seniors and interests alone will be 117% of revenues.

False Pretense of Cutting Entitlements

• It's time that we let go of the false pretense that cutting entitlements is a choice. Either we cut them today or we will have to cut them much more tomorrow.

Irresponsible Behavior by the FED

In this section, the speaker talks about how around fifteen years ago, the FED started courting asset bubbles and embarked on QE2 despite promising it would be a temporary measure.

QE2 and Asset Bubbles

• Around ten years ago Ben Bernanke embarked on QE2 another round of rapid expansion of the fed's balance sheet.

• The chairman feared appeared like the 1930s and wanted to buy insurance to avoid deflation by not only keeping policy rates at zero but also by reducing long-term interest rates he assured everyone this would be a temporary measure.

• Despite several periods of strong growth with high inflation, the FED never felt the need to meaningfully reduce its balance sheet. The balance sheet of the FED today stands at just below 9 trillion or 10 times as large as before the financial crisis.

Central Banks and Asset Prices

• As I have repeatedly said central banks should be in the business of balancing rather than fueling asset prices or risky Behavior.

• This asymmetric fed response is what feeds a lack of serious structure.

The Everything Bubble

In this section, the speaker discusses how the FED's policies have enabled risk behavior from investors, banks, and governments that has driven unprecedented asset bubbles in both breadth and magnitude.

Unprecedented Asset Bubbles

• The FED's policies have driven unprecedented asset bubbles in both breadth and magnitude.

• Congress spent another three trillion bringing their cover total to 5 trillion with the FED financing over 60 percent of all issuance. Pals fed acted as a great enabler for fiscal accesses.

• In the last year they have now raised rates 500 basis points in one year better late than never well I guess still at the first kinds of trouble a month ago Silicon Valley Bank what do they do in four days Dan did all the QT progress they had made in six months.

The Need for Fiscal Responsibility

In this section, the speaker discusses the need for fiscal responsibility and criticizes current policies that prioritize short-term spending over long-term investments.

Criticizing Current Policies

• The speaker suggests that current policies lack foresight and prioritize short-term spending over long-term investments.

• He warns that delaying action on the fiscal gap threatens American exceptionalism and risks emboldening autocracies in China and Russia.

• The speaker argues that a lack of sufficient investment due to irresponsible spending could lead to existential crises like climate change.

Q&A Session

This section covers a Q&A session where the speaker answers questions about his thoughts on U.S. exceptionalism, reserve currency status, and his investment portfolio.

Thoughts on U.S. Exceptionalism

• The moderator asks the speaker to connect his challenging of U.S. exceptionalism to his current investment portfolio.

• The speaker responds by saying he is short on the dollar due to concerns about our country's behavior compared to France's responsible actions towards climate change.

Reserve Currency Status

• The moderator asks if the speaker is less clear about the dollar as the reserve currency of the world going forward.

• The speaker explains that he believes we are coming to an end of a process where 13 trillion dollars came into our country partly because our tech companies were dominating foreign investors.

Investment Portfolio

• The speaker shares that he is thinking about how challenging U.S. exceptionalism affects his investment portfolio but does not trade frequently based on this.

• He also explains that the dollar thesis is simple and he is short on the dollar due to a number of reasons, including our higher inflation rate compared to Brazil.

The Current Macro Play

In this section, the speaker talks about the current macro play and how it affects his investment strategy going forward.

The Pound Collapse and Broader Thesis

• In Britain, there was a collapse in the pound that was nothing like ours.

• The speaker believes that this event is part of a broader thesis.

• This event will continually affect his investment strategy going forward.

Economic Forecasting

• The speaker tries to come up with economic forecasts for the future.

• He has had some misses but has been better than random at it.

• His process involves looking at a lot of history and trying to equate it with what's going on now.

• However, he has never seen a roadmap like this before.

Making Money in Chaos

• The speaker makes his money in chaos.

• He has always made more money in equity bear markets than bull markets because that's when macro goes crazy.

• He would be salivating over opportunities if he wasn't so worried about the country.

Opportunities Setting Up

In this section, the speaker talks about opportunities setting up and how they relate to his investment strategy.

Time Period for Opportunities

• The speaker has been talking about 2025 to 2035 for better than 15 years.

• We are getting into the time period he mentioned earlier.

Deficit Estimate for 2050

• According to CBO estimates, by 2050 with a four percent interest rate, there will be an 11 deficit.

• If we have an 11 deficit, we will not be the reserve currency.

Multi-Polar World

• The speaker believes that we are chipping away into some kind of multi-polar world as opposed to just this dominating.

• He can feel it intuitively.

Playing Big

In this section, the speaker talks about his investment strategy and how he places his bets in today's world.

Position Sizing

• The speaker waits for fat pitches and then plays really big.

• If he's wrong, he constantly reevaluates.

• One of the great things about playing big is that you don't get lazy about believing your own ideas.

Thesis on Dollar

• The thesis the speaker has on the dollar is not a fat pitch.

• He has seen a lot of fat pitches in his career, but this thing is so complicated that he just wants to stay alive financially until the chaos comes because it's coming given our behavior.

Fattest Pitch That Worked Out Well

In this section, the speaker talks about one of his biggest wins in investing.

German Economy Boom

• When the Wall came down in Germany, the Deutsche Mark got killed for two days because people thought that osmark would pollute it.

• However, based on his knowledge of German culture and history, the speaker knew that their economy was going to boom.

• He knew exactly what the Bundesbank would do; they would keep raising.

Two Investment Mistakes and the Current Economic Situation

In this section, the speaker talks about two investment mistakes he made in the past and how they affected him. He also discusses his concerns about the current economic situation.

Housing-Driven Economy and Tech Boom

• The speaker talks about how a housing-driven economy couldn't hold over time, leading to a decline in the US economy while Germany's economy was going up.

• The speaker shares that he missed out on the tech boom in mid-99 but bought into it later and made a fortune in tech stocks. However, he acted emotionally when he saw others making more money than him and lost three billion dollars in four months.

Concerns About Current Economic Situation

• The speaker shares that anecdotal information from his clients convinced him that the economy was going to tank, so he put 350 percent of his fund in 10-year equivalents. He was down 18% at one point but ended up making 42% in the fourth quarter.

• The speaker expresses concern about asset bubbles and their potential negative impact on economic outcomes. He recommends reading "The Price of Time" by Edward Chancellor for more information on asset bubbles throughout history.

• The speaker is worried that there are still unknown risks associated with the current economic situation, as there were before the 2007 financial crisis. He believes that giving free money for a long period of time can lead people to do stupid things.

Questions from Audience Members

In this section, audience members ask questions related to investing and current events.

Ray Dalio's Missive About War with China

• An audience member asks the speaker if he has read Ray Dalio's missive about war with China, especially over Taiwan. The speaker does not provide a response.

California's Economic Situation

• An audience member asks the speaker if California is leading or behind in terms of economic growth. The speaker does not provide a response.

China, Taiwan, and California

In this section, the speaker shares his views on China's relationship with Taiwan and the Chinese economy. He also discusses the current state of politics in California.

Mitigating Factors for China Taking Taiwan

• The speaker believes that mutual self-destruction is a mitigating factor in China taking Taiwan.

• There is a great national sentiment in China to take Taiwan, but the speaker does not see it happening in the next three to five years.

• If economic trouble arises in China, it becomes more likely that they will take Taiwan.

Thoughts on California Politics

• The speaker thinks that California is "screwed" politically and wonders why they keep re-electing certain officials.

• The speaker expresses disappointment with the current political climate and hopes for better options than Biden or Trump.

Financial Issues with Signature Fidel First Republic Silicon

In this section, the speaker discusses financial issues related to several institutions.

Concerns about Mega Financial Institutions

• The speaker has never seen asset issues pop up as quickly as they have recently.

• If something isn't done soon, there may only be five or ten mega financial institutions left which could have ramifications in the markets.

• Hundreds of banks would have no capital if their assets were marked to market.

Worries About Loan Losses

• Bank runs are usually caused by loan losses or credit issues rather than balance sheet problems.

• Dodd-Frank changed risk-weighted assets to treasuries, which didn't count against capital. The speaker worries that the median bank in the US has only 43% capital.

Predicting Financial Crises and the Importance of Humility

In this section, the speaker discusses his predictions for financial crises and the importance of humility in investing.

Predicting Financial Crises

• The speaker believes that there are more dead bodies out there that haven't revealed themselves yet.

• He notes that political leaders are cavalierly dismissing the possibility of a crisis, despite the fact that we just experienced the biggest asset bubble in 500 years.

• The speaker argues that it's not enough to say we have a problem with inflation and then add 500 basis points in a year and expect everything to be fine.

• He suggests that it's possible this won't be as bad as 2008/2009, but he thinks it's risky to assume that.

The Importance of Humility

• The speaker emphasizes the importance of having an open mind and being willing to change your position if conditions change.

• He admits that he's not as good of an investor as he was when he was younger because he has scars from past losses.

• The speaker believes that having humility is key to successful investing.

Generative AI and Its Potential Impact

In this section, the speaker discusses generative AI and its potential impact on macroeconomics, productivity, and security prices.

Generative AI

• The speaker believes that generative AI has the potential to be even more transformative than the internet.

• He notes its implications for disinflation, productivity, and security prices.

• The speaker thinks it could be incredibly disruptive but also create opportunities for young investors.

• He hasn't decided whether model builders or application level will benefit most from generative AI.

The Future of Global Leadership

In this section, the speaker discusses the future of global leadership and who might take over if the US or China is not leading.

Potential Leaders in a Multi-Polar World

• If neither the US nor China leads, it could be a multi-polar world.

• Saudi Arabia's MBS is trying to create a dominant Middle East block with Egypt and Iran.

• Europe already has the Euro and could become a leader.

• It is unclear who will lead, but the speaker hopes it will be the United States.

Economic Indicators

In this section, the speaker talks about economic indicators and what they are predicting for the future.

Treasury Market as an Indicator

• The treasury market has been distorted over the past cycle but is now back to being a good indicator.

• The most inverted yield curve in history suggests an upcoming recession.

• Short-term bonds yielding 5% are a good place to park money as long as you're willing to move it into risk if there's a hard landing.

Risks of Concentrating Money in Institutional Banks

• There are risks associated with people pulling their money out of regional banks and concentrating them in significant institutional banks. No further details were provided.

The Future of Banks

In this section, the speaker discusses his concerns about the future of banks and how they will make money.

Concerns About Regional Banks

• The speaker is worried about how regional banks will make money.

• He believes that the problem with these banks is not that they will go under, but rather that they won't be able to make any money.

• The speaker mentions First Republic as an example of a bank that was so bad it had to be taken over by JP Morgan.

Actions for Newly Minted MBAs

• A student asks what actions newly minted MBAs can take to help prevent a banking crisis.

• The speaker suggests using political voice to push for changes in entitlement programs.

• He encourages young people to get involved in this issue and use their voices to effect change.

Entitlement Programs and Shorting the Dollar

In this section, the speaker answers questions about entitlement programs and investing strategies.

Cutting Entitlement Programs

• A question is asked about cutting entitlement programs while still providing for those who need them.

• The speaker suggests means testing entitlement programs and getting rid of cost-of-living adjustments (COLAs).

Investing Strategies

• A question is asked about shorting the dollar against a basket of currencies or a particular currency.

• The speaker does not provide a direct answer but mentions danger signals in the market, such as seven stocks accounting for 85% of gains in the S&P this year.

The VIX and Bank Collapses

In this section, the speaker discusses the VIX and recent bank collapses.

The VIX

• The speaker believes that the recent increase in liquidity from the FED is responsible for the current level of the VIX.

• He mentions that seven stocks account for 85% of gains in the S&P this year.

Recent Bank Collapses

• A question is asked about recent bank collapses.

• The speaker does not provide a direct answer but mentions that there are danger signals in the market.

Means Testing Social Security

In this section, the speaker discusses means testing for social security and eliminating cola increases.

Starting with Means Testing

• The speaker suggests starting with means testing for social security.

• He mentions that he and Sheldon don't need it, but he is eligible.

• The speaker acknowledges that means testing would be terrible for those who rely on social security.

Eliminating Cola Increases

• The first step in reforming social security should be to eliminate cola increases.

• The speaker believes that new grads would do anything for $5,000 a month.

Outlook on Inflation and Currencies

In this section, the speaker talks about his outlook on inflation and the currencies he currently holds.

Currencies Held

• The speaker currently holds gold, euros, Mexican pesos, Brazilian currency, and Australian dollars.

• He mentions that his big ones right now are the euro and two Latin American currencies.

Outlook on Inflation

• When asked about his outlook on inflation, the speaker admits that it's complicated.

• He predicts that inflation will come down to 2.5% or 3% over the next year or so before going back up to 5% or 6% due to a hard landing.

• The speaker is unsure if there will be deflation after a hard landing or if there will be high inflation of around 8%.

Commodities and AI Productivity Increases

In this section, the speaker talks about commodities and how AI productivity increases could help mitigate risks.

Commodities Held

• The speaker is long oil but has lost money in the last four weeks.

• He believes that if the reopening thing works, oil could go up to 100.

• The speaker is also long gold and copper.

AI Productivity Increases

• The speaker believes that AI productivity increases could be huge in mitigating risks.

• He admits to wrestling with the AI rollout because of the high cost involved.

The Importance of Passion in Life

In this section, the speaker talks about how wealth has affected his life and how he thinks graduates should think about money. He emphasizes the importance of finding one's passion in life and doing something that brings joy.

Wealth and Happiness

• The speaker is a happy person, not because of the amount of money he has, but because having earned success has given him happiness.

• He worries about screwing up his children with inheriting too much money because they won't enjoy earned success.

• Giving away money through philanthropy gives him joy and enables him to do things he wouldn't be able to do otherwise.

Finding Your Passion

• The speaker advises young graduates to find their passion in life, which may not necessarily be finance just because they are business graduates.

• In this industry, if you don't love what you're doing, you're going to lose because every time you buy something somebody else is selling it.

• Money does not guarantee happiness; doing something that you're passionate about does.

Conclusion

This section marks the end of the keynote recording.