Druckenmiller on How AI is Dominating His Long Portfolio
Transcript
Sonali: [Applause] Okay, now I actually want to start with you, not with the presidential elections. We’ll get there, but I do want to start with you on the U.S. debt limit because this is something where we’re out of the clear on the surface, but you have been very, very clear. You’ve recently revived a presentation you did 10 years ago with students at USC, and you’ve told them that the economic storm that’s brewing from U.S. spending is worse than you had imagined. I also want to bring up on the screen some of the charts that you showed them, kind of the pace of entitlement spending in the United States. I want to ask you: what are the consequences now that we’re kind of past the initial pains in Washington? What is the country and the economy and investors—what are they ignoring?
Druckenmiller: Thanks, Sonali. Nice to be here. Um, I don’t think the entitlement situation is something you should be trading on in the next three to six months. What I’ve been focused on, actually for over a decade, is the long-term picture and the long-term implications. So the last thing you should do is run out of this conference after I say something about entitlements and think there’s a trade to be made on it. That’s not the situation.
Okay, I need to go back a little bit. But way back in the ’90s, somebody sent me a paper outlining how the birth rate in the ’50s was so high and it had shrunk, and that we’re going to have this demographic storm hit sometime in the 2020s. And you could pretty much map it because the demographics are public information. This was on top of the fact that since Medicare and Medicaid joined Social Security as entitlements in the ’60s, the seniors’ share of government spending had already grown dramatically—say from 30 to 58 percent of outlays during that time.
And I was concerned way back then that sometime in the 2020s—sort of like the “pig in the python”—when the Baby Boomers became seniors, already with them being a high percentage of government spending, your growth of seniors would be dramatic. And by the time I was looking at it, the birth rate for the current generation was below two. So you’re going to have this huge increase in seniors at the same time that you had a reduction in workers. In the way our system works, you take the taxes of current workers to pay for seniors.
It really looked bad to me in around 2011 or 2012, so much so that I thought I’d go out and see if I could move the needle on this issue. I was really successful: the only thing Donald Trump and Hillary Clinton agreed on was that you shouldn’t touch entitlements. In other words, nobody listened to me. It was a tough situation then, and looking out, it was really scary.
But when you just use the term “worse than I ever imagined,” what I didn’t know is that for the next 10 years, we were just going to have a proliferation of government debt even outside of entitlements. And then when COVID hit, it was just sort of the cherry on top. It’s hard to believe, looking back during those 10 years with interest rates near zero, you had two big economic booms. One going into 2018 under Donald Trump—supposedly a Republican, supposedly with the party that cared a lot about spending—and with three and a half percent unemployment, we had something unprecedented: we had a trillion-dollar deficit. Usually, when the economy is roaring, tax revenues go up and the deficit shrinks.
We then had a post-COVID boom in 2021, which was also accompanied by wild increases in tech and in tech stock prices, so much so that we had capital gains 600 billion dollars above the average capital gains for a year. We sold 100 billion in spectrum sales. We had 10 percent nominal growth because of inflation. So you might ask yourself: since the last tech boom in ‘99 under a Democratic administration, by the way, we had a surplus—how big was the surplus with all these anomalies in ‘21? Again, I’ve led my own question: we had over a trillion-dollar deficit. We didn’t even get to less than five percent of GDP.
So what I was worried about 10 years ago, you now have an enormous amount of debt on top of it. The zero interest rates kind of suppressed what I would say is the concern about this. Obviously, with a lot of debt you’re not paying any interest on, who cares? But now, once the inflation hit, interest rates are going to go up. So the punchline—I’m rambling on here more than I wanted to—the punchline is: if you take the current situation and you ask yourself… why should I actually say something else? The debt went from, say, 15 trillion to 31 trillion over that time.
And this is important because most people don’t understand it: that debt assumes there’ll never be another Medicare or Social Security payment made. 200 trillion is the present value, as you’ve calculated for the students—not me, credible people, Larry Kotlikoff and others. So if you assume we’re never going to have another Social Security or Medicare repayment, the debt is 31 trillion. But if you did your accounting like any corporation and you assume those payments are going to be made, the present value is probably around 200 trillion dollars.
So, you know, I should also say that the big topic is “U.S. exceptionalism at risk.” Is it? Yeah, I think it is. America is an amazing country with an amazing system. And if you look at the innovation in this country—just look at what’s happened since 1980—we led in the PC revolution, we led the development of the internet, we led the development of cloud, we led the development of mobile… maybe it’s not good that we led in crypto, who knows… and we’re obviously leading in generative AI. So we’ve been the leader throughout. But we’ve also been the reserve currency, and we’ve been eating so much seed corn presently that I worry about the future.
If you were to take—economists have this, only economists come up with this term—it’s called “fiscal gap.” What is fiscal gap? That’s how much you would have to raise taxes today to guarantee the benefits you’ve promised seniors in the future. It’s 7.7 percent of GDP. What does 7.7 percent of GDP mean? To actually pay for the entitlements we promised in the future, you’d have to raise all taxes 40 percent today forever, or cut all spending 36 percent today forever.
So what I’m looking at here is, this stuff is borrowing from the future. You’re going to crowd out private investments, you’re going to crowd out the kind of investment that made us a leader on all those kind of things. But again, this is a long-term worry. But the statement by both parties that entitlements are off the table—it’s like 70 percent of the federal budget and rising, and now that interest rates have come up, it’s a fantasy. In fact, it’s a lie. We are definitely going to cut entitlements. It’s just a matter of whether we’re going to cut them today or in the future, and the longer we wait, the more it piles up.
A year or two ago, or right now, the interest expense is about one or two percent of GDP; it’s about six percent of outlays. The CBO’s estimate, not mine: interest expense is 27 percent of outlays by 2050. And just entitlements and interest expense—just those two things alone: no defense, no running the government, no money for the disadvantaged—will be 117 percent of taxes by 2050, and it’ll be more than all taxes by 2040. But again, for investors in the room, this is just stuff to worry about in the long term. I like to think in the long term, but for trading, it doesn’t impact your original question. The way you put it to the students, it’s the tsunami that is 10 foot out on the horizon.
Sonali: But you know, the other thing here is, I think it’s pretty safe to say you’ve been pretty critical of fiscal and monetary policy. The question here—and I want to put one more chart on the history of bubbles that you showed the students as well—because the question I have for you there is: do you believe that there are still many shoes to drop as the central bank stays tight?
Druckenmiller: That’s my central case. I deal in the world of risk-reward. There’s a 500-year history of asset bubbles, well-documented in a book that you had some issues with, The Price of Time. And basically, it documents—and I had already known this about the last hundred years, but it’s going out for 500 years—every time you’ve had a significant asset bubble, economic trouble is way ahead.
But yeah, when you had 11 years of free money, people do stupid things. All you have to do is look it up. Talk about how the stupidest is somebody paid 80 billion dollars for Dogecoin, which was invented as a joke. I mean, that can only happen in the world of free money. It also suppressed people worrying about the kind of stuff I just talked about two or three minutes ago, because you keep rates at zero.
But the fact that this was arguably the most disruptive economic period we’ve had since the late 1800s, and there were no bankruptcies—apparently they’ve started in the last few weeks—tells me there’s a lot of stuff under the hood. When you go from this kind of environment, the biggest broadest asset bubble ever, and then you jack rates up 500 basis points in a year, I think the probabilities would suggest that Silicon Valley Bank, Bed Bath & Beyond… they’re probably the tip of the iceberg. Nothing’s guaranteed. I’ve been wrong a lot, I’ve been right a few times. But yeah, our central case is there’s more shoes to drop, particularly in addition to the asset markets.
Sonali: Economically, what are you most worried about? We’ll definitely get to the opportunity on the “fat pitches” that you see on the horizon, but before we even get there, what starts to sink?
Druckenmiller: I could see corporate profits down 20 to 30 percent. Normally I would say 40 or 50 in a hard landing, but this recession is so anticipated, I don’t think a lot of corporations are going to be caught with their pants down, which is how you normally lose a lot of money—as you’re not prepared for something that happens.
Commercial real estate… and you know, I’m not informing anybody in this room with something they don’t know, but office is a problem. It would have been a problem anyway, but the change of lifestyle and COVID makes it an even bigger problem. Financing rates going up… I get a problem. I’m worried about credit tightening the next six to nine months.
Obviously, the banks are going into an economic period that, if in fact we get a recession, their balance sheets are already impaired. Not from where they usually lose money, which is loans, but from the fact that the Fed convinced them that they’re going to keep rates at zero until ‘24. So they bought a bunch of Treasuries yielding one or two percent, and now they’re carrying them at five. So their balance sheets are impaired. But if we get in a recession, then the real losses come, which is stuff like credit cards, commercial real estate… that kind of stuff. So those would be my worries. You asked me my worries; that’s different than my predictions.
Sonali: Well, the predictions you’ve been talking about… I’m so tired of being a bear and being labeled a bear. But to the bearish point of view, we haven’t seen it. We have not seen that hard landing yet. And there’s going to be many people after you today that are predicting a soft landing. And so, to the extent you still believe that a hard landing is ahead of us, when does it come? What does it look like? Do we see it anymore?
Druckenmiller: Yeah. A lot of people, because we haven’t had an economic decline start yet, have changed their forecast from a hard landing to a soft landing, and a lot of others have changed it from soft landing to “no landing.” I haven’t changed mine at all. The fact that it hasn’t happened yet doesn’t change the probability, if it does happen, of the depth of it.
I mean, basically 10 trillion dollars—5 trillion monetary, 5 trillion fiscal—was put in during COVID. What has happened is that created this giant, giant stock of liquidity. I think Jamie Dimon said a couple years ago there were two and a half trillion excess demand deposits. We’ve been working that liquidity off slowly. That liquidity shrink was interrupted when the Bank of Japan changed YCC; they went in and they bought 400 billion dollars’ worth of bonds to defend their bond market. Very odd situation: they raise rates, but then liquidity exploded on it.
And then obviously the debt ceiling. Secretary Yellen drew down the TGA—that’s basically the Treasury savings account—from 700 billion to practically nothing last week. That also ended up in non-issuance of government debt. So that was a big boost of liquidity. All that is set to change now. Actually, the TGA is going to go the other way; she’s already stated she wants to build it back up to normal levels. So you’re going to have probably about 800 billion in Treasuries issued between now and year-end.
The Fed will be continuing on with QT. You’ve got the student loan thing, which I think has kept consumption up; that’s all changing in September. They’re going to have to actually—God forbid—in the United States, somebody actually pays interest on a loan. So to me, the probabilities haven’t changed. It’s been pushed out relative to expectations, but in no way does the fact that it hasn’t started yet change the probability of whether it’s going to be hard or soft.
I would actually argue, since it’s taken so long, the Fed has ended up with a higher terminal rate, and in fact, inflation gets stickier the longer it stays in the system. That increases, not decreases, the probability of a hard landing. By the way, after the ‘87 crash, I was convinced we’re going to have a depression, so I’ve been wrong before. And if I’m wrong on this, I’ll adjust. But I have to weigh the probabilities and do what I do in my process, and right now, that’s where we are.
And when? I have been… I think September is the first time when I was sort of… afraid of a booming economy, inflation guide to… I’m more worried about growth than I am about inflation. And originally I was fourth quarter of ‘23. I temporarily maybe lost my mind, or maybe I was right when the Silicon Valley thing happened and got anecdotals and stuff that is traditionally a leading indicator, like trucks and retail. Moved that up to now. I think I’m probably wrong and I’m going to go back to the end of ‘23, but the real answer is: I don’t know.
Sonali: So, recession or no recession, though, one thing that’s interesting—and you included it—a lot of people are very encouraged by certain areas of the market, particularly the AI boom.
Druckenmiller: There’s always stuff to do. We had a hard landing in ‘74-‘75, and chemicals and oils and that stuff did great. I’m sorry, go ahead.
Sonali: Well, do you think that all of AI makes it through this recession? Or do you think that some areas of the market, particularly in AI, start to look like they’re in bubble territory?
Druckenmiller: Well, all of AI is not going to make it through, whether we have a recession or not, because they haven’t separated the wheat from the chaff yet. But I do believe, unlike crypto, I think AI is real. It’s probably… it could be as transformative as the internet. It’s a huge thing.
And I think I’ve argued publicly that if staples can go up in price in a recession, why can’t a company like Nvidia? If their orders and earnings go up 70 percent in a hard landing—which is what I think would probably happen—it’s not clear to me that Nvidia goes down despite the lofty valuation level. History has proved, if you have very good earnings in a recession and they’re sustainable—if they’re not, the market somehow figures it out—those stocks will do just fine. So, we have some longs, we have some shorts, and the AIs have sort of dominated the long portfolio for five or six months.
Sonali: How do you think about shorts in this market?
Druckenmiller: Our shorts have been fine this year, except my index shorts which have been a disaster. But we always short the same way: I just try and look at the current situation, and then I try and think of a situation 12 to 18 months from now based on my forecast. And if I think the security prices are going to be less, then I short them.
Frankly, I’m not sure I’ve ever made money… if I took back the last 40 years—I’m afraid to look. I’ve never had a down year, but I’m not sure I’ve made money in shorts. I like it, it’s fun, but you can get your head handed to you. And it’s a game that really only professionals should play, and the odds are against you. If you’re dead wrong on a long, you can lose 100 percent. If you’re dead wrong on a short, you can lose 10 times your money.
When I was at Soros, I shorted 200 million dollars’ worth of internet stocks in March of ‘99, and in three weeks covered them at a 600 million dollar loss. I lost 600 million dollars on a 200 million investment in three weeks. I was short 12 stocks; they all went bankrupt, every one of them. Don’t try that at home.
Sonali: Well, I mean, to that point, when you look at the AI kind of boom here, are there lessons to be learned from the .com bubble?
Druckenmiller: Yeah, there are lessons. There are definitely lessons to be learned: don’t get emotional, don’t get crazy. But I will say this about the AI: Nvidia bottomed in October in the low 100s. It’s true it’s at 380 or 390; it’s nosebleed territory. If this is a secular move, if this thing is real, you just don’t have 10-month moves. That’s not how it works.
Even the dot-com bubble lasted two, two and a half years for many of the “guts” of the internet. It lasted four years for the Ciscos and the Sun Micros. So, could Nvidia go down materially in the short term from any point? Yes. But I would be surprised, if I’m right on AI and the impact on it… I mean, it’s already making the top coders seven to eight times more productive than they were five months ago. If it’s as big as I think it is, Nvidia is something we’re going to want to own for at least two or three years, not for 10 months, and maybe longer.
Sonali: Certainly the topic du jour. There’s another thing that a lot of investors are talking about: it’s the promise of China. This idea—and you know, it’s time to get your global view here because so many people rely on you for the macro perspective—the view here is that the GDP in China will expand faster than the United States, and a lot of investors are kind of shaking off geopolitical tensions on the back of that theory. Do you see the same promise that the China bulls are seeing?
Druckenmiller: I do not. I was in love with China until about six or seven years ago. You go over there and the energy in Shanghai was like New York on crack. I mean, just fantastic energy. The entrepreneurs were exciting, they were into it. And then Xi Jinping did his thing.
If you look at China and the rise of China, I think it all sort of happened because you had this internal capitalist system with a bunch of people that act like crazy New Yorkers building new businesses in a dynamic economy. But he has proved he’s not a capitalist. He’s definitely not a monopolist—there’s only room for one monopolist in China in his mind, and that’s him. Anybody that gets their head stuck up… and I honestly think he either doesn’t understand why China grew and succeeded the way they did, or frankly, he doesn’t care because he’s more interested in staying in power.
But I would be looking out 10 or 15 years, I just don’t see it. Unless there’s a change in power there at the top, I think that’s going to be a very undynamic economy. It’s not so much a geopolitical concern. I will say this: if I’m right, it makes me more fearful of military action, because that’s when dictators become more dangerous—when they’ve got to divert attention from the immediate problem.
So what they’re doing now is very stimulative. We’re expecting a “sugar high” and some kind of robust growth there, maybe for six or nine months. But looking out, I do not look at them as a big challenge to the United States in terms of economic power and growth.
Sonali: There’s equally been a lot of investor questions about the future of Japan as well. How do you think about the opportunity set and how to invest?
Druckenmiller: Well, when I went to Soros, Japan set me off like a rocket ship because I shorted the Nikkei at the top, I had everything… and then I think every trade I made like five years later on, I’ve lost money in Japan. It’s been the biggest value trap in history.
But I will say right now—I haven’t checked this, but it’s by far been the deepest breadth and the best market this year. Our market’s up, I think you said 12 percent, but it’s like seven stocks and everything else is not even up. That’s not the case in Japan. The breadth is tremendous there. You have a couple things going on: they look like they’re solving deflation plus, so you’re getting nominal growth. They’ve also… it’s more than just talk; they’re really into the whole shareholder value thing.
And then you’ve got a guy running monetary policy and he sounds like Jerome Powell two years ago. I mean, inflation’s taking off there and he’s saying, “We haven’t quite achieved our goal yet,” even though he’s like doubled his goal that was stated. So you put all that together… for now, you have a dynamic market. But given my record trading Japan now for the last 15 years, you should do the opposite of what I’m saying mathematically.
Sonali: So we’re going to get there… you know, because the fiscal will overtake the monetary pretty soon as well, especially as we look forward to a 2024 election cycle in the United States. When you look at the wide range of Republican hopefuls who are either challenging or may challenge Donald Trump—Nikki Haley, Chris Christie, Mike Pence, Ron DeSantis, Tim Scott, Glenn Youngkin—who has your money and who has your vote?
Druckenmiller: I love Tim Scott. I’d like him to be the next president. Whether he has the name recognition, whether he’s too nice a guy for this fight, I don’t know. But I’m not really into dividers; I’d like to see the country united. I think from that party, he’s the one that could probably most accomplish that.
I’m kind of excited about Chris Christie taking on Donald Trump. The others kind of dance around the subject; they don’t even use his name. I think somebody needs to hit him in the mouth with the way he hits people in their mouth, and Chris Christie could be very good at that. I was very disappointed the way he handled the 2016 thing.
For those who don’t know it, on national television I said that Donald Trump had the economic understanding of a kindergartner of the U.S. economy—on national television with John Kasich. And then he came a year later and said I overestimated his economic standing. Just so you know… but anyway, I don’t think Chris Christie can win, but I’m excited that he’s getting in the race because I think he can maybe expose Donald Trump, and he really needs to be exposed.
Sonali: So what do you think about some of the other candidates, especially Ron DeSantis? You know, the way that he has approached corporations in Florida in particular—what do you think that means for him as he enters the race?
Druckenmiller: I actually think until recently he did a great job in Florida, if you look at the record. He’s very smart. Not that broad in terms of the people around him; he’d have to build that going in. But despite his intelligence, it seems like his calculus is to go after the Trump voters. I don’t think the Trump voters care about policy; I don’t think they can be moved. And by going after the Trump voters, he’s alienating the other 30 to 40 percent of the pie, particularly women and others that care a lot about the social issues. He’s not my favorite, but frankly, if he ran against Joe Biden, I’d vote for him enthusiastically.
Sonali: I wonder… you define yourself… is there anyone in the Democratic party that excites you?
Druckenmiller: Well, I’d love it if Gina Raimondo would run, but apparently we’re going to put an 80-year-old who’s going on 100 on the ticket. I don’t understand what the Democrats are doing. I voted for two Democrats out of the last five elections; I’m not like some partisan crazy person. But what are they doing?
So, you know, I don’t know. There doesn’t seem to be anybody other than Bobby Kennedy who’s willing to take him on. Bobby Kennedy is a little nuts, but mark my words, he’s going to scare this guy because when people go to the polls, particularly a year from now… because Joe Biden is a moving puck. I wouldn’t be surprised if Bobby Kennedy doesn’t get more support than any of us could imagine.
Sonali: You know, Democrat or Republican, the kind of trajectory you pointed at at the very beginning of this—higher spending no matter what scenario we’re in in the next couple of years in the United States—do you think investors will be facing much higher taxes eventually?
Druckenmiller: Yeah, the only way out of this is… I mean, given what I talked about earlier, taxes are going to be much higher in 20 years. If it’s a Republican president, can they hold out for a few more years? I assume so. But taxes are going up. It’s either that or, you know, 30 or 40 percent inflation, which I don’t think is going to happen.
Sonali: So before I let you go—I know you won’t perfectly answer me on this with a lot of specificity—you’ve been saying…
Druckenmiller: I know I haven’t given any perfect answers.
Sonali: Well, what is the “fat pitch”? You’ve been saying that you have been kind of cautious when it comes to markets. At what point do you start to get in and you start to have a conviction trade that is much bigger?
Druckenmiller: I think my record is as much knowing when not to play as when to play. And because I deal in five or six different asset classes, I’ve had the luxury: if there’s uncertainty in equities, usually that’s a good time for bonds and currencies. They’re doing crazy things when the world’s blowing up, so there’s a lot of volatility there.
And I would love to answer your question, but this is the most complicated, non-roadmap, unanalyzable situation I’ve ever seen in terms of having a lot of confidence in an economic prediction going forward. So I honestly—and I hate not to answer questions—I honestly don’t see a fat pitch right now.
What I do think is, given the change in liquidity, given everything I’ve outlined, some really fat pitches are going to emerge in, say, the next 8 to 24 months. And I don’t want to blow my cash and be in a horrible mental state, being down eight percent, making a big bet on something that I didn’t have amazing conviction on when I think the roadmap is going to be good.
So, you talked to me about this interview in January. I probably wouldn’t have accepted it if I knew that I was going to be as messed up in the head as I am right now in June. But I also thought it would be bad to cancel. [Laughter] So I don’t have a fat pitch, but I hope I’ve imparted something to your audience.
Sonali: Yeah, absolutely. We will ask you again in eight months, you said. Appreciate it.