Stanley Druckenmiller On China's Future And Investing In The New Normal

Tyler Durden's picture

From Goldman Sachs

Stan Druckenmiller is Chairman and Chief Executive Officer of Duquesne Family Office. He founded Duquesne Capital Management in 1981, which he ran until he closed the firm in 2010. Previously, he was a Managing Director at Soros Fund Management, where he served as Lead Portfolio Manager of the Quantum Fund and Chief Investment Officer of Soros

Interview with Stan Druckenmiller

Hugo Scott-Gall: What are the risks of investing in China that are not well understood in your view?

Stan Druckenmiller: The growth in credit at a time when GDP growth is slowing is a problem for China. And I think this is the 2009-11 stimulus coming back to bite. I understand that it had to be done to fund entrepreneurs and the private sector, but it’s easier said than done if you’re channelling funds through local government investment vehicles. I’m a believer in markets. A few men sitting around a table and deciding how to allocate capital goes against everything I’ve ever believed. Not only are they not great at capital allocation, such an exercise also needs to deal with a lack of property rights and corruption. In essence, the frantic stimulus China put together at the end of 2008 sowed the seeds of slower growth in the future by crowding out more productive investments. And now, the system’s building enough leverage and misallocation of resources to warrant risks of a financial crisis, but the timing of that is still uncertain in my mind. What we’ve seen in China since 2009 is similar to what happened in the US in 2005, in terms of credit growth outpacing economic growth.

I think ageing demographics is a bigger issue in China than people think. And the problems it creates should be become evident as early as 2016.

You also need to keep in mind that for China to grow and evolve further, it will need to compete with a more innovative Korea and now a more competitive Japan. I don’t think China can do that with where its exchange rate is today. I think productivity is a key concern too. And I think that could be one of the reasons why the US has been so supportive of Abenomics.

People mention lack of infrastructure as a constraint. But when I go over there, it looks like they have a lot of infrastructure. It seems ahead of the population, not behind. I see expensive apartments in empty cities that 300 mn rural Chinese are expected to migrate to.  That looks very unbalanced to me. Nobody’s ever had investment to GDP at 47%. Japan and Korea peaked at 36%-38%, so as a result I think capacity is way ahead of demand in some areas in China.

Hugo Scott-Gall: If China slows its fixed asset investment, will that have a knock on effect for its commodities demand and thus commodity prices?

Stan Druckenmiller: When I started in 1976, I was taught by my mentor that when cash flow rises equities go up. But commodities are driven by the cost of extraction 90% of the time, and over the long run, technology makes extraction cheaper, pushing the cost curve down and with it commodity prices. But that hasn’t always worked, if I’d followed that advice over the past few decades, I’d be in trouble.

About five years ago, I bought into the peak oil thesis. But then, along comes shale oil and shale technology, reminding me of what my old mentor said 35 years ago. Now I’ve come to think that the oil price is not as vulnerable to China slowing down as it is to ongoing shale supply growth. I regard the ramp up in investment by China as a 10-year aberration, making the last two years more normal and more representative than the previous decade.

I do think China is serious about rebalancing, which means infrastructure investment is going to slow. And obviously, there's been a huge ramp-up in supply around the world in response to the 2009-11 stimulus, which in my view is a massive misread by the suppliers of these commodities. So that’s not good for commodity prices. And then you have innovation. Can technology progress in iron ore and copper, the way it has with shale energy? My guess is it will.

If you look at food, there’s now technology that allows seeds to be drought-proof and disease proof. Yes, there is a demand-supply argument for food prices rising, but the impact of technology on food supply is greater than you think. On the other hand, we are using up more and more good arable land to build cities in China and there is a water problem in China too.

Hugo Scott-Gall: Do you think we underestimate the role of innovation in resolving these global constraints?

Stan Druckenmiller: Even with all the progress we have made in technology in the recent past, I think we are only scratching the surface in terms of innovation. We haven’t seen half of the practical applications of big new technologies yet. And the cost of these technologies will come down too, whether it’s robotics or driverless cars. That has to provide a productivity boost.

But there is a downside to technology-driven productivity surges too. There is improved efficiency, but at the cost of fewer jobs. I think the impact of technology on manufacturing jobs is easy to overlook because of the huge surge in services jobs. But we’re now at a point where the impact of technology is hitting the services sectors too. And not everyone understands this. I recently brought up the possibility of driverless auto technology resulting in zero jobs for truck drivers within the next 20 years and there were gasps of disbelief from the audience of investors. When I mentioned it to a high-tech company CEO from Silicon Valley a few days later, his response was exactly the opposite. The point is that the problem with a tech-driven productivity surge is that the benefits of that are going to accrue to a smaller, narrower group. Already, computer engineers have benefitted from computing and the internet a lot more than the broader population.

You could draw similar conclusions on the impact of technology and automation on investing. I believe that good investors are successful not  because of their IQ, but because they have an investing discipline. But, what is more disciplined than a machine? A well-researched machine can make many average investors redundant, leaving behind only the really good human investors with exceptional intuition and skill. And what happens when machines really take over investing? Do the markets get really efficient? Or will there be competing systems trying to outdo each other? All of this is depressing because there won’t much left to do for humans once machines start doing more and more.

If machines do everything well, including allocating capital and resources efficiently, can that be deflationary, can that eliminate poverty? I don’t know. It’s hard to be very optimistic if you look at how humans have behaved historically. All in all, I don’t think robots and greater automation can bring about a utopian world as I imagined it would as a kid 50 years ago.

Hugo Scott-Gall: If you combine the prospect of fewer jobs with an ageing population, it doesn’t look very good for many economies...

Stan Druckenmiller: Apart from India, most of the other major economies have worsening demographics to worry about. It’s a big problem for the US too, especially given that relative to many other economies, including Japan, its fiscal gap is much wider. All in all, I don’t think robots and greater automation can bring about a utopian world as I imagined it would as a kid 50 years ago.

You can look at the US debt stock in a few different ways. The official estimate of the total debt may be US$11 tn, but if you include what the Fed has bought (which you should), then the number if closer to US$16 tn. But a better measure of US debt would include some of the off balance sheet items. Laurence Kotlikoff, who is one of the top economists in his field of generational accounting, estimates the present value of US debt including what has been promised to senior citizens, adjusted for the projected tax revenues and the fiscal gap, to be about US$211 tn. That’s staggering.

The US needs to resolve its debt problem politically, otherwise it is headed towards default. I believe the estimates suggest that the US needs to raise all taxes by about 64% in order to be able to support its older population. That’s raising payroll, capital, dividends and income taxes by 64%. The other option is to cut all government spending by 40%. Neither one is a viable option and a combination is not easy either. In 20 years, those numbers will become even tougher. The US will need to raise taxes by 75% or cut spending by 46%.

There has been vigourous debate on the veracity of Rogoff and Reinhart’s research on the consequences of countries exceeding 90% debt-to-GDP. But it doesn’t take away from the fact that historically, such levels of indebtedness has resulted in extreme implications.  Countries tend to go into a full-blown monetisation or a default or inflation on average 23 years after they cross the 90% threshold according to their research. So these debt levels are less relevant for you and me today, but will be extremely crucial for our children. If we continue to borrow and spend like we do now, this can become a serious problem in 15 years.

If machines do everything well, including allocating capital and resources efficiently, can that be deflationary, can that eliminate poverty? I don’t  know.

I understood the need for QE1 because the US economy faced a potential meltdown then. But further easing brings problems of its own, that only come to light in hindsight. All that easing and prolonged negative real interest rates have gone beyond resolving the core issues the economy faced and has led to re-leveraging. I’m not worried about inflation as much as misallocation of investment.

Another consequence of today’s monetary policy is that the US government is not getting any price signals. In any other society, at some point in the next 15-20 years, the markets will give a price signal and the politicians will need to respond. But currently, there is no such impetus for politicians to act. What adds to the problem is that young Americans don't vote. Old people not only vote, but also have incredibly powerful lobbying groups behind them. Entitlements in 1960 were 28% of government outlays, today it is 67%. And the baby boomers have only now begun to retire. Another debate is that this is a huge reason to accelerate immigration, but current policy is moving in the opposite direction. But even with immigration, the US needs to fix this pay-as-you-go system or the consequences could be quite drastic.

Hugo Scott-Gall: Do you think investing is becoming harder now with more government intervention and regulation interfering with market price signals?

Stan Druckenmiller: It has become harder for me, because the importance of my skills is receding. Part of my advantage, is that my strength is economic forecasting, but that only works in free markets, when markets are smarter than people. That’s how I started. I watched the stock market, how equities reacted to change in levels of economic activity and I could understand how price signals worked and how to forecast them. Today, all these price signals are compromised and I’m seriously questioning whether I have any competitive advantage left.

Ten years ago, if the stock market had done what it has just done now, I could practically guarantee you that growth was going to accelerate. Now, it's a possibility, but I would rather say that the market is rigged and people are chasing these assets, without growth necessarily backing confidence. It's not predicting anything the way it used to and that really makes me reconsider my ability to generate superior returns. If the most important price in the most important economy in the world is being rigged, and everything else is priced off it, what am I supposed to read into other price movements?

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Colonel Klink's picture

Proper conclusion.  If it's being manipulated then old paradigms would cease to function.  Now it's all inside information and knowledge of what the plan is in advance.  Even if it's 15 milliseconds.

Having enough cash or being on the inside is all that matters anymore.  And our CONgress critters are free to join the rigged casino.  Isn't there something out there like CONgress shall write no law which doesn't apply to them.

"We" have the best representation money can buy.

knukles's picture

Stanley just hit the ball out of the park with his observation about trying to function as an asset manager in a world of rigged markets.
It is painful, demoralizing and just plain madness!
Which is one reason I personally have taken a very longer term tack that; all the problems created and burst forth so to speak over the last 10 to 15 years have not been addressed y and large let alone solved.  In fact, most of them are worse...
Given that bottom line, dealing with fixed, manipulated, jury-rigged markets in which I'm at the bottom of the food chain, I'll say thank you very much and stick with lower risk financial assets, higher up the capital structure with real assets (real estate, precious metals, commodities, et al) as an inflation and disaster hedge, if you will.
Why do anything else if a reasonable effort, intellectual grounded is not effective in this environment?
I plan for the worst, pray for the best.

But well said, Stanley.  Ever so honest and humble.


PS  Lemme tell y'all sumptin', that the investment business was (about 108 1/2 lifetimes ago) difficult enough in periods when not everything was overtly rigged, when sound economic and financial forecasting could add alpha.  Was hard then!

Colonel Klink's picture

Yep I'm low on that totem pole too.  I took my marbles and went home to my gulch.   Been enjoying a frugal life for the past 4 years and don't miss the rat race.  Been all on my own dime.  I'm beholden to no one.  Happily starving the system 1 person at a time.

I don't just talk the talk, I walk the walk.  Vote with your dollars.  My money is on gold and silver.  Paper since 71 is a scam.  Nothing is more permanent that something temporary in the government.

greatbeard's picture

>> I don't just talk the talk, I walk the walk.

We have much in common.  I got a snoot full a few years ago and cashed out.  Sold everything in the city, closed my business (actually gave it to my last two employees who wanted to continue the fight) and moved to a little hobby farm.  It's all on my dime.  I made a decision I'd rather spend my stash than risk losing it, so I live off of my principal.  I bailed about 15 years before I thought I would, and 15  years before I as ready, but it was the best decision I've ever made.  I am appalled at what the system has become.

Colonel Klink's picture

Not only do I live off principal, I live by principle.  It's the only way I can fight the system.  My vote doesn't count for shit.  I've never been counted in the "unemployed" number.

Stopped my productive capacity for the economy by 42.  Just a "smidge" earlier than I had planned.

Remington IV's picture

Obama's food stamps or welfare checks don't entice you ???

stocktivity's picture

Correct Stanley - to make a long story short, It's all Bullshit!!!

Yen Cross's picture

 Evangelist - Misogynist > ectraordinaire

   Drukenpuke made money watching charts for "PRICE ACTION"!  I watch charts 24-7-365 and I make Fiat.

   If it smells like SKUNK, It's a SKUNK!

Colonel Klink's picture

Still a proper conclusion.  Wasn't passing judgement on the writer.

Sounds like he's upset because he doesn't get the smoke signals from the tribe.  And without those, you're taken to the cleaners by the HFT club.

Yen Cross's picture

  Be well.  Sgt. Shultz .

Colonel Klink's picture

Thanks YC.  I read a lot of your posts.   Du auch.

Just for the record, neither of those red are mine.

Yen Cross's picture

    We aren't getting any younger Colonel Klink.   Thanks for your kind comment.

lolmao500's picture

Personally, I'm investing in a new Chinese civil war.

eatthebanksters's picture

I would not count out a problem much closer to home....

Yen Cross's picture

 I don't dispute your (train of thought) however , the problem originated from home.

Colonel Klink's picture

I don't think problems will hit us (US) until after Japan has their little event, flowing through the EU, and then to the States.

While we may be the cleanest dirty shirt, the hamper is starting to stink.

Yen Cross's picture

   Japan will "not" default.( Abe PUT) There's going to be a lot of "speculative" traders heads on a stake next Wednesday.

ToNYC's picture

Japan's Martingale Strategy. What's not to like Mrs. Watanabe crack-ho?

Yen Cross's picture

  "Japan's Martingale Strategy"  I'm being rational.

Colonel Klink's picture

Japan's Massengill Strategy

Fixed it for you guys.

short screwed's picture

Stanley, you're over thinking! Just BTFD! What could possibly go wrong?

lolmao500's picture

Egypt Brotherhood backs Syria jihad, denounces Shi'ites
Egypt's ruling Muslim Brotherhood blamed Shi'ites for creating religious strife throughout Islam's history, as the movement joined a call by Sunni clerics for jihad against the Syrian government and its Shi'ite allies.

This is gonna end SO WELL... I mean, what's not to like about a middle-east wide war between a dozen countries??? Especially countries with oil???

What's next, Pakistan with their nukes are gonna enter the melee??

Seems like the middle-east is about to have their own version of a world war... The first two were in Europe, the third one will be in the middle-east...

short screwed's picture

I agree. These are some interesting times in the Mid East . I'm interested in seeing what the Russians do in Syria. If the west tries to impose a no fly zone, do the Russians continue to supply SA missles to Assad? Does the West then try to stop the flow of arms to Syrian govt?

lolmao500's picture

Well so far they are still going to deliver the S300.

AllWorkedUp's picture

They have to. Syria is their lone ace in the hole. Where else do they? Where else in the M.E. do they have ports or bases?

AllWorkedUp's picture

Oh no, it won't just be a regional war. McCain, Graham and Obummer will drag our dumbasses into any conflict on the globe. It's the American way you know. Besides there's some scandals going on here at home and Obummer needs to deflect attention from the US police state.

kito's picture

In 20 years, those numbers will become even tougher.... Oh for ducks sake.....I have to deal with gloom and doom reality for another 20 years??!!!!..... Somebody get me a noose.....

Colonel Klink's picture

Not sure it's going to take 20 years but I'll get you a noose anyways. ;)

kito's picture

Red pill pill!!!!

Colonel Klink's picture

There isn't but one, truth.

Yen Cross's picture

 Kito , we discussed the 97 usd/jpy level (first week of June) I told you all hell would break loose. I was correct.

   Kito, now I'm telling you to stay away from the trade, or get LONG.  I could give two shits less, what people think. I study charts and momentum/velocity. Get long usd/jpy or stay under the PORCH.

kito's picture

Thanks yen....duly noted....what a world....what a world...

are we there yet's picture

20 years a problem? It's official with me, you are now an extreme optimist.

Stanley Lord's picture

I don't know if I trust listening to Stanley or not. He says he believed in Peak Oil but also said, technology always brings the price of commodities down, so I guess he went against what he was taught.

I don't have Stanleys money but I did not fall for Peak Oil, Hubert King's science for Peak Oil was junk. I am surprised Stanley fell for that.

The best work on oil has been done by Vaclav Smil in his book Oil, he said it is real simple, American troops in the Middle East leads to high oil prices.

Hohum's picture


Are you following the marginal cost of a barrel of oil lately or are you off in your dream world?

candyman's picture

Stan is a pro, always respectful when I called him.

dognamedabu's picture

Im guessing you are a client. Im sure he great guy. He of course would have great salemanship qualities. Sincerity and trust cannot be manufactured.

candyman's picture

My comments go back many, many years ago, he always picked up the phone, introduced himself and listned to my ideas. Old school. Try to do that today. This is even before he left Soros.

dognamedabu's picture

Idk. Try doing that today would be the best job. People who care about people will always take the time to listen and learn. People arent any different from 30 years ago. Same great guy then would be great guy now except not wearing plaid.

ToNYC's picture

Creative Destruction that feeds our technological evolution absolutely depends on the natural signals of an alert economic population of non-cooperative players, but the academic Platonic central banking monopoly has poisoned the commonwealth with ZIRP GMO money, so good it's free for banks to charge you 29.99%

Yen Cross's picture

  We have a "New-Bee"...

Billy Shears's picture

The original intention of "the machine" was to produce wealth to reduce drudgery and the collective burden of existence but this was/is unacceptable TPTB so they then turned the capacity of "the machine" to producing the implements of destruction (i.e. war) thereby collapsing the progress of history into a continuous loop of warfare and poverty with the ruling class safely ensconced. Right out of Orwell.

Non Passaran's picture

Why was that unacceptable to TPTB?

PubliusTacitus's picture

I see expensive apartments in empty cities that 300 mn rural Chinese are expected to migrate to.  That looks very unbalanced to me. Nobody’s ever had investment to GDP at 47%. Japan and Korea peaked at 36%-38%, so as a result I think capacity is way ahead of demand in some areas in China.


Classic Krugman/Keynesianism.


WOW! SEE?! LOOK AT MY 7.8% (Command economy) GDP, etc.!


electricgorilla's picture

Once upon a time when the market was less complex and had fewer variables to understand, big money was made in arbitrage/spread type positions and markets. Now with the FED crowding that space and controlling interest rates, it's forcing everyone to become a trader. Market profits have always been from small arbitrage like advantages. The FED in the fixed markets has crowded out the big money trying to make arbitrage/spread like profits. In the equity space, once again, HFT has crowded out anyone trying to make arbitrage/spread like profits. The market is now the wild west and if you want to make returns you have to jump into a sea of complexity and moving variables.

pitz's picture

Computer Engineers benefitted?  Hardly.  Salaries are still a fraction, in real terms, that they were even 15 years ago in the tech industry.   Software engineers, computer engineers, have performed dismally on the labour front compared to bankers and public servants.  Having failed generally to reap the rewards of their knowledge and skills.