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- [00:01]
IBM Representative
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- [00:29]
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- [01:09]
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- [01:37]
Edward Chancellor
Bloomberg Audio Studios Podcasts, Radio News Marantalks
- [01:43]
Marian Somerset Webb
Money Listeners Are you a Bloomberg subscriber? If you're not, here's why you should be. You'll get ad free episodes of this podcast and access to my marantalks Money newsletter as well as access to John's award winning newsletter Money Distilled. And you'll get access to subscriber only events such as the one we'll be hosting on March 17th. See the link in the Show Notes below to sign up to that. And of course you will get unlimited access to bloomberg.com and the Bloomberg app, including exclusive stories and premium market tools. Subscribe now@bloomberg.com podcastoffer onwards. Welcome to MarineTalks Money, the podcast in which people who know the markets explain the markets. I am Marian Somerset Webb, Editor at Large for Bloomberg UK wealth and this week I am speaking with Edward Chancellor, investment strategist and financial historian. Now he is the author of the Price, which I'm sure all of you will have read by now. And if you haven't, now is the time to go get it and start reading. He recently collaborated with Jeremy Grantham on the book the Making of a Perma Bear the Perils of Long Term Investing in a Short Term World. We interviewed Jeremy a few weeks ago, so do go back and listen to that one as well. We thought this would be a good moment to have a financial historian on the show, someone to help us point the market moves we've seen in the first quarter of the year into context. Both the volatility around AI, but also more recently, obviously, the reaction to the escalating conflict in the Middle East. What does that mean for markets going forward? And more importantly from Eddie, what does it mean for the price of money? Edward Chancellor, welcome to Maren Talks Money.
- [03:14]
Edward Chancellor
Nice to see you again, Merrin.
- [03:16]
Marian Somerset Webb
Now, we've got quite a lot to talk about, actually. Originally, last week or a couple of weeks ago when we thought about having you back on, we thought we'll just talk about bubbles, we'll talk about AI, we'll talk about the great rotation in stock markets, et cetera. But there's quite a lot more to talk about now. But let's start where we originally planned to start, shall we? Let's start with before the conflict, new conflict in the Middle east started at the weekend. We were looking at marketing going, look, there is something going on here. We're seeing a shift out of AI adjacent stocks and into something that connects more to real assets. We talked about the shift from YOLO and FOMO to Halo. All these things. Do you read columns that John and I have written on those things? So I wonder if I could just ask you to give us your thoughts on that, what you think has been happening in the market over the last few months.
- [04:05]
Edward Chancellor
The story about the market's response to AI is as with every sort of boom or bubble period, there are feedback effects and one narrative runs for a while and then another narrative takes over. So I'd say at the beginning of this year I wrote a paper with Jeremy Grantham looking at AI from the perspective of previous technology booms. And it looked at the time that Oracle stock had come down sharply, core weave, which is one of these near cloud operators that stop was off sharply. Then the big hyperscaler. The market was responding negatively to the amount of money they were spending and their collapsing free cash flow. So you could say quite reasonably at the time that that things looked as if AI enthusiasm was waning. But then in the last couple of weeks we've seen really quite extraordinarily powerful viral AI stories or narratives going around. There was one note by someone called Matt Schumer, who's some Californian tech guy, which was a story of AI is coming for your job. It was a fairly conventional story, but immediately got 50 million views on one. But more interesting to my mind was the research that came out. A piece of research that came out I found called Citrini research towards the end of last week. And that was mooting the idea that if AI were really to realize its potential, there would be collapse in all white collar jobs, followed by the mother of all recessions. And that actually is definitely worth reading as a story of what would happen if AI were actually to achieve what the likes of Sam Altman at OpenAI claim that it will achieve. I personally don't think it will get there, but. And we can discuss that.
- [06:10]
Marian Somerset Webb
Why don't we discuss that right away so we know, so we can set this bit up. The idea being that if AI can really do what its intense believers believe it can and effectively take over pretty much all white collar jobs, massively improve productivity, then that again gives us a huge level of unemployment and a recession as a result. So the productivity revolution destroys itself.
- [06:33]
Edward Chancellor
No, but Marianne, it's further than that. Is that, and this is a point goes back to Schumpeter's theory of the business cycle, that a Great Depression is created when a new technology comes along, interrupts established profit lines, and then the debt built upon that profit or cash flow collapses. So in fact, the Citrini research is really a. Is a sort of Schumpeterian dark picture. And I'm very well expressed. So why do I think I humble I who can't code to save their life, think it's not.
- [07:10]
Marian Somerset Webb
You don't need to code anymore, Edward. This is no longer a problem.
- [07:14]
Edward Chancellor
So why do I think that it's.
- [07:16]
Sonesta Hotels Representative
It's.
- [07:16]
Edward Chancellor
We're not going to see the Citrine research scenario played out. And I think this goes back. I was thinking it goes back to every. Every bubble, if you think about. It's always a. There's a core of truth to every bubble, that something is revolution, something's going to change the world, and then there is an element of reality that is being overlooked. So the market, if you will, chases the narrative and it chases the narrative uncritically and it doesn't examine the niggling elements of reality. I'm afraid that is the nature of a bubble. So you call it group think, or you can call it sort of people's resistance to dissonant information, cognitive dissonance. Call it what you will. So what is the Germ or what's the reality that the AI enthusiasts seem to be overlooking? Well, that's namely that as far as I can understand, bear in mind that I'm picking this up at secondhand. But if you listen to the AI, certain of the AI specialists, and I'm thinking of Turing Award winners such as Jan Lecun who left Meta last year, fellow called Richard Sutton, also another Turing Award winner, and then I listened, and I recommend that your listeners look listen to it too. The Faraday lecture given at the Royal Society last week by someone called Michael Wooldridge, who's Professor of AI and Computing at Oxford. And all of them really say the same thing, that the large language model is not a model that is actually engaged in reasoning. It's not engaged in seeking the truth, it's not engaged in logical processing. It uses, and this is where I get a bit fuzzy, it uses really a sort of probabilistic framework, guessing, so to speak, what comes next. And it does an incredible good job a lot of the time. But it also produces these pesky hallucinations. It makes mistakes and it doesn't correct those mistakes. It can't so far, as far as I can see, it's not learning from having made a mistake. Now, people like LeCun, Sutton, Wooldridge, they all say that this flaw is inherent to the large Language model architecture. So far, the advances with the LLMs have come from using more and more compute, more energy and scaling everything. And that's led to advances. But there are to my mind, quite compelling argument that we're reaching the limits of scaling. And that's just, that's not me saying it. The person who was saying that towards the end of last year was Ilya Sutskeva, who was one of the founders of the LLM models. So think about this way. If these machines are not really reasoning and not really intelligent, and whose tendency to create errors or hallucinations are built into the model, how far can you go with that technology?
- [10:54]
Marian Somerset Webb
Okay, so the key point here is that AI is the new wind. Nice to have around the edges, makes a good story, but won't actually change our world.
- [11:04]
Edward Chancellor
It's difficult to know where to draw line. And the other thing I'd say, Marian, is this and that. I've been doing quite. I'm writing a new chapter from my old book, Devil Take the the History of Speculation. So I'm going over the whole Internet bubble and TMT bubble of the late 1990s and one thing what I find interesting there is that of course there's a huge amount of hype around the Internet from the mid-1990s onwards. And if you look back, actually that hype was justified. I think as we get into the modern era of technology like the Internet. Think of the Internet, these companies lay down hundreds of thousands of miles of fiber optic cable. Now the businesses that did it, Global Crossing and other companies, they all went bust and there was massive overcapacity. I don't know, 95% overcapacity. But yes, then you had the infrastructure for YouTube and video and video conferencing and whatever. That's what's happening now. I'd say you and I like to see things from the point of view of investors rather than society at large. So my view is if the benefits are delivered for consumers or society at large, there's no need or requirement for any individual investor to provide the capital with the expectation of lots. So that's my caveat to the bubbles being necessary. I don't think there is, let's say, a necessity to partaking them. In fact, actually I was mentioning earlier to you the Sandy Nan's book Engines that Move Markets, which is really a tremendously good book which I would recommend to anyone who's interested in the inception of how markets respond to new technologies. And it's really quite clear that in the early stages of these new technologies, when there is, so to speak, the bubble enthusiasm that investors don't make money, there tends to be over investment, excessive competition and then eventually you get a fallout and a shakeout and then you get dominant companies appearing at that later stage and those dominant companies often make pretty good investments. You think of AT&T dominating telephone and we think obviously more recently of the likes of Facebook and Google. But Google and Facebook were not on offer in the late 1990s. Frankly, when a new technology comes along, the investor, almost invariably in the past, would have done better just to stay in bed for 10 years and get out of bed and say, hey, what is this thing? What is this railroad? I'm going to buy some stock, it's just better to hold back. I was thinking that Warren Buffett and Charlie Munger, they used to say about technology that they had a tray saying too difficult. And really when one looks at the outcome for AI, given these uncertainties that I mentioned earlier about what its capacities might be and also given the huge amount of investment that a number of extremely well funded companies are engaged in and the probably quite realistic prospect that the services they offer won't be particularly differentiated and therefore will probably earn their Marginal cost which might not even pay back on the capital they've invested. Then why not stay out? Why not, why not go for a halo trade instead?
- [14:55]
Marian Somerset Webb
Is that where we are now or where we were, let's say on Friday on the idea of investing in AI and AI related stocks or not? Which stage of this bubble?
- [15:06]
Edward Chancellor
This is definitely a different bubble or inception of new technology than the ones we've seen in the past because a lot of it is being driven in the private markets. We've never. Last week or a couple of weeks ago, OpenAI raised, I put in inverted commas, 110 billion.
- [15:26]
Marian Somerset Webb
Why are we having inverted commas?
- [15:27]
Edward Chancellor
We're having inverted commas because first of all there was 50 billion coming from Amazon, of which 35 billion was contingent on OpenAI. OpenAI achieving artificial general intelligence. I've told you there are a lot of people who seem to know quite a lot about, about AI who say you're not going to get there. Okay, so that, that's an inverted comment. The other thing is that you know that, that Open this is the world's largest vendor financing operation because Nvidia was putting up, I can't remember how much, 35 billion, whatever. And, and, and OpenAI was committing to using Amazon Web Services and buying 3 gigabytes or whatever or gigawatts of Nvidia compute. Now, if you remember back in the late 1990s, the likes of Cisco and the other telecoms operators, Nortel Telecoms equipment suppliers, Nortel and Lucent, they were all heavily engaged in vendor financing. Now the vendor finance I was reading yesterday, the vendor financing of these companies, which we thought, we all thought was an outrage when it was revealed, if you remember, actually total 15 billion. It's small change to compare.
- [16:49]
Marian Somerset Webb
15 billion is small change.
- [16:50]
Edward Chancellor
I'm just saying that OpenAI alone seems to be in its last funding. Roughly 80% of it, roughly 80 odd billion was a sort of vendor financing operation.
- [17:08]
Marian Somerset Webb
But wouldn't we love to see the valuations of these companies that are still private tested at an ipo?
- [17:14]
Edward Chancellor
This is, I mean, okay, that's the other thing is that I should have said that Amazon, the 35 billion was to OpenAI was contingent on either achieving AGI or IPO. These are big companies. I think OpenAI is funding different figures, but I think around 730 billion, but some say higher of the valuation. So the question then, what happens when, if and when the likes of anthropic and OpenAI and SpaceX, if they all come to the market and throw in a Couple of other businesses and you're getting 3 trillion of new market cap coming to the markets. Whether another scenario, another sort of Citrini type scenario, is you actually have a sell off as these companies come and push into the public market. But on the other hand, I was thinking that with the world, and particularly US markets so dominated by passive investment, they say roughly 60% of the US market, stock market is passive. Nowadays, of course, the passive investors, the passive funds just open up their arms. There's nothing you can't sell them. In some ways perhaps that some of the thinking is to build up to these huge trillion dollar valuations and then pass them into the market and get.
- [18:38]
Marian Somerset Webb
Yeah, so once they get to that size, the IPO automatically works.
- [18:42]
Edward Chancellor
I mean, that's something to think about. And again, my view from an individual investor's perspective is that you're already picking up AI exposure. According to JP Morgan, last year roughly 45, 47% of the US market had exposure to AI. It would go up considerably, probably to 55 or 60% if these AI companies were actually to achieve their IPOs. I think my view is that the individual investor has other things to think about because there are other opportunities in the world and frankly, the passive blind capital of the index funds will absorb the AI. For better or for worse.
- [19:34]
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- [20:03]
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- [21:04]
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- [21:46]
Marian Somerset Webb
Let's move on to talking about what's happened over the weekend and when we've talked about AI in the past, I'm interested that it's your view of the limiting factor of the future of AI is in fact that the models themselves that are inherently flawed so won't do what the biggest optimists think they will do. But the other limiting factor on AI has always been energy use, right? And that's been discussed a lot. And now we're finding that there are massive constraints on energy globally, which I think most people knew before, but those who hadn't recognized before the energy fragility of our world are of course learning that now. And you can see that fear reflected in markets. For example, the fairly massive fall in the Korean market this week is about the fact that it's very heavily dominated by memory chip companies, two big companies, and that the majority of their energy is imported. And that now becomes a major constraining factor on their manufacturing. So we now see this constraint across the board and that's going to have quite an impact. Brings us back to Halo, of course,
- [22:45]
Edward Chancellor
on the energy usage of AI. That's a political concern. But before the Iran war broke out, so the US Electricity prices have been going up strongly. That's causing political ructions. And the question is, will the American populace put up with much higher domestic electricity costs and the AI rollout the data centers? And the answer is probably not. And last week President Trump said that the data centers are going to have to start generating their own electricity. That should be a good thing, I think, and particularly if it encourages the development of small scale nuclear and other alternative sources of energy. We've heavily underinvested in conventional energy and if you will, overinvested in the unreliable alternative energy. And therefore there's a bit of fragility in the system. And when that fragility then gets exposed by a war in the Gulf.
- [24:01]
Marian Somerset Webb
It's interesting, there have been two responses, haven't there, to the war in the Gulf when it comes to energy. One response in the UK is, oh, my goodness, I wish that we were doing more to exploit our own fossil fuel energy resources. And the other response says we'll be needing more wind and solar to deal with this.
- [24:16]
Edward Chancellor
I got an email from my nephew last night to that effect. We need energy security and the answer is, yes, we do. But the unfortunate fact, and again goes back to the bubble. The important salient facts being missing from the bubble board is that not going to get energy security from wind and turbines. And we, in fact Britain is dependent on importing ever larger amounts of electricity from the continent, often from gas turbine power stations. I agree with President Trump. I think we need to utilize our own fossil fuel resources if we're going to have energy security, at least given current technology.
- [25:00]
Marian Somerset Webb
Okay, now what does all this mean, do you think, for the interest rate cycle? So before the war in Iran, there was much discussion about easing cycles across the board. We were expecting to see, some people were expecting to see rates come down fairly significantly in the uk that now seems at risk.
- [25:17]
Edward Chancellor
So let's get back to the AI discussion. Citrini. Citrini research says, you know, that you're going to unleash the mother of all depressions and that'll be a deflationary depression, and that would be a deflationary depression that was resistant to central bank impetus. So under that scenario, if AI were to realize its promise, then you might say perhaps interest rate inflation is coming down, deflation will replace it and interest rates would come down. That's a sort of theoretical position. I think if we have energy and commodity inflation, then you would expect interest rates to rise on the back of. In the old days, they never referred to inflation as a consumer price. They always referred to it as commodity price inflation. So I think if one is going to get higher energy prices and higher commodity prices, then one would expect the interest rate cycle to pick up. And the only thing I would say there is thrust of my book, the Price of Time that I was always saying, no one knows how to predict interest rates. I like to say the only thing we know is that interest rates run on very long Cycles, I'm talking about long term interest rates, bond yields and we had a good 40 year downward trend from 1982 to 2022 and we're now in the fourth year of the uptrend. So my view has always been, regardless of what anyone tells you is we are on the uptrend of interest rates for decades and there will be oscillations around it and those oscillations are inherently unpredictable.
- [27:11]
Marian Somerset Webb
Okay, I'm feeling stagflation in UK public debt crisis.
- [27:14]
Edward Chancellor
I've been of that view and instantly you and I are both sort of gold bugs, correct?
- [27:22]
Marian Somerset Webb
Afraid so. Actually no, I'm not afraid so. I'm thrilled to say I'm a gold bug. This is our time, Eddie.
- [27:27]
Edward Chancellor
I actually, I sort of wake up every morning, I think all these different scenarios of the world. I think actually yes, gold fits. Take the Citrini model, everything collapses and government finances would collapse at the same time. Then you'd want gold for that. Take the inflation model, take the inflation and commodity, you'd want the gold for that. Government debt crisis, you want the gold for that. And so I do think, and I wrote a piece towards the end of last year saying that we are in a new paradigm for gold and I think that for asset allocation going forward, people have just got to wake up and have, have gold as the sort of a sizable gold position as the anchor for their portfolio. And when I say sizable, I'm talking somewhere in the range of 10 to 25% of the portfolio. Our friend Russell Napier has 50% which is fine.
- [28:31]
Marian Somerset Webb
And does that mean that sovereign bonds no longer have a place in a portfolio?
- [28:35]
Edward Chancellor
I think some place, but a much smaller one. I mean if you think about the 60, 40 being 60% equities, 40% bonds being the traditional portfolio, I think you can keep to the 40 non equities. We go even higher, 50 non equities. And then whatever isn't your gold position for your sovereign. And then of course you're not obliged to buy sovereign bonds of near bankrupt stakes like France or Britain. So you can actually buy sovereign bonds elsewhere. And then you can also choose to get inflation protected bonds. I think the long term, I suppose my long term concern with the bonds is that we are heading towards a sovereign bond crisis among the advanced economies. And even if you own the inflation protected bonds, there's no guarantee that you know, that when government is cut, slashing pensions, slashing other forms of discretionary expenditure, they don't turn on the rentiers and say, you know, you should take A cut too. I think, as I said, I'm very wary and I. Over the last few years I've been cutting down my inflation protected bond exposure.
- [29:56]
Marian Somerset Webb
Yeah. And you say we're heading towards debt crisis in various developed economies. Do you feel that getting closer? We've been discussing this public debt problem for some time now. We both, I think pretty much everyone now sees that countries such as the UK really do have a very severe debt problem and no ability or apparently no incentive to attempt to cut spending to deal with that sovereign debt problem. So how close is it and what might make it go away?
- [30:23]
Edward Chancellor
I think it would appear much closer in France than Britain. Not just because France tax take is, is much higher than in Britain and therefore there's less room to raise it. Political paralysis in France would appear stronger and then you've got the Eurozone problem. The fact is we're now already in a position and you can see that interest rates in Europe are too high for France and too low for the periphery. So you've got strong house price inflation in Portugal weather. And so I think that. I think probably we'll see also we have to see what the outcome of the French elections are. But the. I think the crisis first comes to France. Yeah.
- [31:13]
Marian Somerset Webb
Let's go back to the equity part of the portfolio. We talked about how much you should have in gold and being slightly wary of the bond element of your portfolio. In fact, while I'm just on that, I wanted to ask you about one of the things that you've talked about when we've been discussing this kind of thing before is the cracks in the system and how super low interest rates get into all the crack and you don't see where the problems are until significantly later. I was wondering if you were worried about private credit as the source of one of our future crises and everyone
- [31:39]
Edward Chancellor
else now seems to be worried too. The private credit story as far as I see it is that it was engendered by the ultra low interest rates. We had this period where bank deposits were yielding nothing and there were these variety of different ways in which you could achieve higher returns. And private credit grew and private credit grew to fund private equity in large part. And the. And the private equity took over life insurers in order to have us to have a ready market to buy their. The private credit issue to fund the LBOs. And yes, I think that, I think something like 80% of private credit is what they call sponsor backed or related to private equity. We know that up to the end of the private equity boom Debt multiples were rising. In short, it wouldn't surprise you to know that I would not be. And I've never been advocating private credit exposure. And with regards to the thesis of price of time, it was always that there would be a crisis eventually coming out from the interest rates, these ultra low interest rates getting into all the cracks. The only surprise, I mean it's a big surprise to my mind is that, you know, it's taken quite a long time for these cracks to open up. But there we are.
- [33:05]
Marian Somerset Webb
Yeah, yeah. Everything will take longer than you think, this kind of thing, doesn't it? Let's go back briefly then to the equity part of a portfolio. Here we are. Tricky times with that 50% of your portfolio that you're holding in equities one way or another. How do you manage that today?
- [33:20]
Edward Chancellor
Total? The other idea of the price of time was with interest rates very low and a huge amount of, so to speak, financialization, private credit, that one. And with money going into these ethereal assets. Can I use inverted commas again like crypto?
- [33:39]
Marian Somerset Webb
Yes, you can. We can see you, you're on video. You can keep using them.
- [33:42]
Edward Chancellor
One wanted, one wanted investment had to get real. And I, I told in the 1930s, in 1920s, during the hyperinflations of Germans talked about the deflucht in die Sacht Wurten, the flight into things of real value. So I was always in favor of, I have for a while been in favor of commodities, traditional energy companies. And in particular there's another theme to that which you'll be aware of the whole sort of capital cycle story of underinvestment, huge boom in both in energy investment and mining up to about 2013, 2014 and then this, this 1012 year famine. And so I think so for me that has been a core part, it's a core part of my portfolios for recent years. And it's done almost, it's done slightly too well. It's sort of a bit worried about it. And then you, like you, I'm Japan bug and I just, I just, I just, I like the story in Japan and it took what it took 30, 30 years for the bubble of the late 19 of the late 1980s to wear off in Japan. And we're now a few years into the recovery of Japanese equities and the equity's not expensive and they're restructuring and so I have pretty big holdings in Japan and I like emerging markets too. I've been in the last couple of years, probably most new money I've invested largely in emerging again, emerging not attractive 15 years ago. But things change. And I think again we're a few years into an emerging who knows it go up and down, but a few years into an emerging cycle. And go back to what I was saying earlier about energy is I don't trust economies that have hugely uncompetitive energy costs. And so I know that UK equities are cheap and I know that European equities are cheap. And I'm just like our friend andy Lees at MacroStrategy. I think that economy is the transformation of energy. And if you push energy costs out beyond control, it's not the only thing. But if energy costs are too high, you cripple an economy. So I'm just where I actually like to look at a chart and say who has the lowest energy costs and just invest there. Not just invest there, but think okay then which one?
- [36:26]
Marian Somerset Webb
Think through it.
- [36:27]
Edward Chancellor
And emerging has, needless to say, very low energy costs.
- [36:30]
Marian Somerset Webb
Interesting. It slightly brings us full circle, doesn't it? Edward, thank you so much. That was really interesting. We loved having you with us today.
- [36:39]
Edward Chancellor
Thank you Marin.
- [36:40]
Marian Somerset Webb
Thanks for listening to this week's Marin Talks Money. If you like our show, rate, review and subscribe. Wherever you listen to podcasts and keep sending questions or comments to marinmoneyloomburg.net you can also follow me and John on Twitter OR X. I'm MarinesW and John is JohnStepek. This episode was hosted by me, Marin Sumset Web. It was produced by Sama Saadi and Moses Andam. Special thanks to Edward Chancellor of course and sound designed by Blake Maples and Kelly Garry.
- [37:04]
Edward Chancellor
Foreign.
- [37:14]
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- [37:19]
Edward Chancellor
Well, almost.
- [37:20]
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- [38:09]
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