Ruffer Review 2021

Navigating The Great The information Acceleration Andrew van Biljon Alexander Chartres Ruffer PAGE 94 PAGE 56 IT’S ALWAYS PRETTIER Review TO THINK SO, IN LOVE AND IN BUSINESS. Bethany McLean 2021 PAGE 8

Jurassic risk “It will take bravery, imagination, and an uncomfortable portfolio journey to get through the drama.” Henry Maxey PAGE 16

In God we trust Thinking beyond Water scarcity All others pay cash the summit The other liquidity crisis Duncan MacInnes Felicity Hall “The risks do not decrease as PAGE 34 you become more experienced. PAGE 52 If anything, the opposite is true.” Hermione Davies

PAGE 114 ruffer.co.uk Accusations of fraud simmered, and City lawyers sharpened their quills… the swindle was foiled.”

Rory McIvor

PAGE 102 This little quiz from Simon Drew (simondrew.co.uk) is for entertainment purposes only. It contains no hidden investment advice and it is not a solicitation to buy or sell securities that rhyme with any of the bands listed here. Answers can be found inside the back cover. PAGE 4 The Ruffer Review 2021

Foreword 6 Contents Jonathan Ruffer

DON’T LEAN ON ME

A bias to belief 8 Bethany McLean

Jurassic risk 16 and the chomping of the traditional balanced portfolio Henry Maxey

In God we trust 34 All others pay cash Duncan MacInnes

Water scarcity 52 The other liquidity crisis Felicity Hall PAGE 5

CHANGING REGIMES

The Great Acceleration 56 Alexander Chartres

JOURNEYS IN INVESTING

From Sifnos to Ruffer 88 Alex Grispos

Navigating

information 94 Andrew van Biljon The deflation machine 66 A second coming? Jamie Dannhauser The Cazique The conman 102 Rory McIvor

A market miscellany 80 Charalee Hoelzl and Jasmine Yeo

Book corner 110

Last word 120 Clemmie Vaughan PAGE 6 The Ruffer Review 2021

Foreword

JONATHAN RUFFER Chairman PAGE 7

THIS YEAR’S RUFFER REVIEW features the supremely fraudulent Gregor MacGregor, a man who invented an El Dorado and got the British to invest in the dream. How did he do it? We have two of his bond certificates hanging on the walls of our office in London, and it is noticeable that the quality of the printing is exceptional. It’s a basic lesson in investment – the more comfortable one feels with an investment idea, the more danger there is likely to be. And there’s no shortage of comfort and danger to go around. After the tumult of the past year, even the rhymes of history seem too faint to send out a signal. But central to our investment thesis is the certainty that it is possible to discern the future, something I am proud of when I read the gallimaufry of thought expressed in this Review: from Jamie Dannhauser on deflation, to Bethany McLean and Duncan MacInnes on what can be trusted, to Felicity Hall on water scarcity and Alexander Chartres’s take on the changing world order. Adding more meat than gravy, Henry Maxey’s piece is an authoritative overview of the looming threats to traditional balanced portfolios. Under Henry’s investment leadership, Ruffer has now survived its third market crisis – the halving of the stockmarket in 2000 to 2002, the 2008 crash, and that of March 2020. In a world that seems to lack solid ground, we’re aiming to build portfolios that will both endure and advance – as an aspiration, that’s noble; as a promise, it’s not one to trust. Bias to belief A BIAS TO BELIEF IN A CONVENTIONAL WORLDVIEW, THE VISIONARY AND THE FRAUDSTER OCCUPY OPPOSITE ENDS OF A SPECTRUM. One is all greed and perfidy, devoid of reality; the other is honest, trustworthy to a T, even altruistic. But history shows that many visionaries have traces of the fraudster, and many fraudsters have traces of the visionary. These often-transformational characters live where the supposed ends of the spectrum meet in a circle. What you see depends on where you sit or, maybe, the point in time at which you are looking.

“INCANDESCENTLY INTELLIGENT.” People who knew Jeff Skilling, the former CEO of Enron, who ended up serving 12 years in jail for his role in the fraud that ended with Enron’s spectacular bankruptcy in 2001, used to describe him in those terms. We all know intelligent people. But the ones whose intelligence can light up the room? They’re the uncommon ones. Skilling had another, more prosaic, strategy, or maybe it wasn’t so much a strategy as just the way he was. The greatest compliment he could give you was that you got it. The worst insult, of course, was that you didn’t get it. Everyone, but everyone, wanted to be included in the group who got BETHANY MCLEAN it. Those who got it were the cool kids, it Journalist, and co-author seemed, and the need to belong was powerful of several books on business gone wrong – particularly among those who had everything else. PAGE 9

A BIAS TO BELIEF

IN A CONVENTIONAL WORLDVIEW, THE VISIONARY AND THE FRAUDSTER OCCUPY OPPOSITE ENDS OF A SPECTRUM. One is all greed and perfidy, devoid of reality; the other is honest, trustworthy to a T, even altruistic. But history shows that many visionaries have traces of the fraudster, and many fraudsters have traces of the visionary. These often-transformational characters live where the supposed ends of the spectrum meet in a circle. What you see depends on where you sit or, maybe, the point in time at which you are looking.

In late 2019, almost two decades after the A willingness to thread the needle of fall of Enron, I read a Wall Street Journal the literal truth in order to further one’s piece about WeWork CEO Adam Neumann. ambitions. “For startup investors, the 6-foot-5 Mr And yet, in a 2009 piece, Wired magazine Neumann has always had the qualities described one famous entrepreneur this they crave… He is intensely ambitious and way. He was “leveraging profits from one a masterful storyteller with a magnetic invention to finance the next, announcing a personality who can inspire and sell.” Nothing product well before it’s completed, dodging in that description spoke to his ability to run a and defending intellectual-property real business. I thought, it’s been two decades, disputes, missing a big deadline, working but nothingBias has changed. tohis developmentbelief staff feverishly, unveiling a prototype in a splashy and impressive event, BEYOND THE GREY and still needing more time before it was Before I encountered Jeff Skilling, I’d thought actually available to end users — in select of the business world as being populated markets, of course.” mainly by men who existed in varying shades The subject was no modern fraudster. It of grey, both clothing and personality-wise. was Thomas Edison, who also announced he Wasn’t business by the book, bland and, well, had come up with a long-lasting incandescent business-like? And if business was primarily bulb (and filed a patent for it) before he’d an analytical exercise, meaning that either actually pulled it off. the numbers were solid or they weren’t, then For every one of these figures who goes charlatans never should have a down in history as a fraud, there are others competitive advantage. who leave the world-changing legacy they In the ensuing years, I’ve written about (and their investors) wanted, from Edison and seen dozens of ultra-charismatic – yes, to Walt Disney to Steve Jobs to (maybe) that enable your rise may also cause your There are intersecting and overlapping even incandescent – leaders who also led Elon Musk. crash. “His combination of entrepreneurial reasons as to why the business world is biased their enterprises to doom. From Aubrey If you’re going to do great things, perhaps vision, personal charisma and brash risk- towards belief. McClendon, the former CEO of Chesapeake, you can’t allow yourself to get bogged down taking helped the company surpass $2 billion When I first became a journalist, one of to Mike Pearson, the former CEO of Valeant in the negatives, the risks, the might-go- in annual revenue, and made it the country’s the things that struck me was how hard it to Elizabeth Holmes of Theranos and more. wrongs, or you’ll never try. But the very traits most valuable startup,” wrote the Journal was to find the negative side of a story. For an The stories they spun made believers out of about WeWork’s Neumann. “Now many of the endeavour that is innately competitive, there’s everyone who came close to their webs, and same qualities that helped fuel his company’s an odd veneer of clubby politeness. It’s rare the collapses were spectacular. breakneck growth in the private market are to have one CEO criticise another, or for an So it’s tempting to say there should be a The same qualities that helped piling up as potential liabilities…” investor to speak their doubts about a leader, pretty simple rule when you encounter that at least not on the record. There’s always visionary leader, that person whose presence fuel his company’s breakneck FINDING THE NEGATIVES negative information, but it tends to circulate scares away all sceptical thought: run! Well- At the end of Ernest Hemingway’s The Sun in a small and often closed loop. known short-seller Jim Chanos talks about growth in the private market Also Rises, when Brett is mourning the For instance, there was lots of scepticism pattern recognition, and some of the patterns relationship that might have been, Jake says about Enron in the short selling community, are crystal clear. An outsized belief in oneself. are piling up as potential to her, “Isn’t it pretty to think so?” Well, yes. and among debt investors. That’s because An inability to hear no. A desire to change the It’s always prettier to think so, in love and the former talked to each other, and the world that can border on the grandiose. liabilities…” in business. latter saw private placement documents The Ruffer Review 2021

In late 2019, almost two decades after the A willingness to thread the needle of fall of Enron, I read a Wall Street Journal the literal truth in order to further one’s piece about WeWork CEO Adam Neumann. ambitions. “For startup investors, the 6-foot-5 Mr And yet, in a 2009 piece, Wired magazine Neumann has always had the qualities described one famous entrepreneur this they crave… He is intensely ambitious and way. He was “leveraging profits from one a masterful storyteller with a magnetic invention to finance the next, announcing a personality who can inspire and sell.” Nothing product well before it’s completed, dodging in that description spoke to his ability to run a and defending intellectual-property real business. I thought, it’s been two decades, disputes, missing a big deadline, working but nothing has changed. his development staff feverishly, unveiling a prototype in a splashy and impressive event, BEYOND THE GREY and still needing more time before it was Before I encountered Jeff Skilling, I’d thought actually available to end users — in select of the business world as being populated markets, of course.” mainly by men who existed in varying shades The subject was no modern fraudster. It of grey, both clothing and personality-wise. was Thomas Edison, who also announced he Wasn’t business by the book, bland and, well, had come up with a long-lasting incandescent business-like? And if business was primarily bulb (and filed a patent for it) before he’d an analytical exercise, meaning that either actually pulled it off. the numbers were solid or they weren’t, then For every one of these figures who goes charlatans never should have a down in history as a fraud, there are others competitive advantage. who leave the world-changing legacy they In the ensuing years, I’ve written about (and their investors) wanted, from Edison and seen dozens of ultra-charismatic – yes, to Walt Disney to Steve Jobs to (maybe) that enable your rise may also cause your There are intersecting and overlapping even incandescent – leaders who also led Elon Musk. crash. “His combination of entrepreneurial reasons as to why the business world is biased their enterprises to doom. From Aubrey If you’re going to do great things, perhaps vision, personal charisma and brash risk- towards belief. McClendon, the former CEO of Chesapeake, you can’t allow yourself to get bogged down taking helped the company surpass $2 billion When I first became a journalist, one of to Mike Pearson, the former CEO of Valeant in the negatives, the risks, the might-go- in annual revenue, and made it the country’s the things that struck me was how hard it to Elizabeth Holmes of Theranos and more. wrongs, or you’ll never try. But the very traits most valuable startup,” wrote the Journal was to find the negative side of a story. For an The stories they spun made believers out of about WeWork’s Neumann. “Now many of the endeavour that is innately competitive, there’s everyone who came close to their webs, and same qualities that helped fuel his company’s an odd veneer of clubby politeness. It’s rare the collapses were spectacular. breakneck growth in the private market are to have one CEO criticise another, or for an So it’s tempting to say there should be a The same qualities that helped piling up as potential liabilities…” investor to speak their doubts about a leader, pretty simple rule when you encounter that at least not on the record. There’s always visionary leader, that person whose presence fuel his company’s breakneck FINDING THE NEGATIVES negative information, but it tends to circulate scares away all sceptical thought: run! Well- At the end of Ernest Hemingway’s The Sun in a small and often closed loop. known short-seller Jim Chanos talks about growth in the private market Also Rises, when Brett is mourning the For instance, there was lots of scepticism pattern recognition, and some of the patterns relationship that might have been, Jake says about Enron in the short selling community, are crystal clear. An outsized belief in oneself. are piling up as potential to her, “Isn’t it pretty to think so?” Well, yes. and among debt investors. That’s because An inability to hear no. A desire to change the It’s always prettier to think so, in love and the former talked to each other, and the world that can border on the grandiose. liabilities…” in business. latter saw private placement documents PAGE 12 The Ruffer Review 2021 A bias to belief

that illuminated some of Enron’s financial a US federal grand jury for rigging bids. He to be Netflix – or Enron? How do you know shenanigans. But that information never It’s hard to know for sure until died in a single-vehicle car crash the next when these characteristics are productive, made it into the public domain, the domain day. Chesapeake went bankrupt. But this rather than pernicious? of equity investors. The same was true of there’s the 20/20 vision that analyst knew that McClendon’s salesmanship, It’s hard to know for sure until there’s the Theranos. Other blood-testing companies combined with that deep gut desire to get 20/20 vision that only comes with hindsight. were sceptical, as was much of the medical only comes with hindsight.” rich, would have swayed the day, and his But there might be some clues along the community. But they didn’t raise the alarm firm would have overcome its analytical way. One is respect for execution, for the loudly. Politeness prevailed, at least in public. reservations and bought shares on emotion. actual work. A source described Jeff Skilling The purported gatekeepers usually don’t to me as a designer of ditches, not a digger raise the alarm either. You might think, as CONFIRMATION of ditches. This person went on to say, and I once did,Bias that accountants would account, to belief perhaps this was the real clue, that Skilling AND BELONGING lawyers would be sticklers for the letter and management. The person who joins a board Once we’re in, it’s hard to get out. That’s not only valued other designers of ditches. He had the spirit of the law, and bankers wouldn’t because they think a company is a fraud, just because of the financial commitment. no respect for the diggers. lend money to those who are going to lose or because they distrust management, is It’s also because of the phenomenon of That couldn’t be more different than it. But no, in practice, it doesn’t work that pretty rare! confirmation bias. It’s highly unpleasant Edison. The myth is that he was an way. Arthur Anderson went down with And yet, board members are supposed to to admit you’ve made a mistake. It’s much independent genius. He was not. He had Enron. Ernst & Young didn’t look too closely be able to hold the possibility in their mind more satisfying, at least in the short term, to a team of men, called his ‘muckers’, who at WireCard’s multi-billion dollar cash hole. that, even as it’s all going swimmingly and extrapolate from the available information relentlessly dug the ditches. Edison didn’t Banks raised the funds cash-haemorrhaging the stock is soaring and the leaders are being that which you want to hear, and dismiss that conjure the design for his light bulb out Chesapeake needed to stay in business, and admired, everything they’re hearing could be which contradicts your prior beliefs. of thin air. Rather, “he had teams of sold the risk to others. Short-term fees seem a lie. “The test of a first rate intelligence is the We also don’t want to be excommunicated experimenters rigorously testing sample after to outweigh the long-term losses. ability to hold two opposed ideas in the mind from the group of those who get it. “It sample to figure out what material worked Jamie Dimon, the CEO who steered at the same time and still retain the ability to would be so terrible to see that other man’s best for the filament,” as a 2020 essay in the JPMorgan Chase to survival during the function,” wrote F Scott Fitzgerald. face—that genial, confidential, delightfully magazine Ponderwall put it. Even more, the financial crisis, was personally a big Few of us have that kind of intelligence. sophisticated face—turn suddenly cold and essay notes that Edison failed frequently. supporter of Neumann, and his bank was Investors, from the biggest to the smallest, contemptuous, to know that you had been Edison viewed figuring out what didn’t work a major lender to WeWork. Neumann was want to believe too. After all, we all want to tried for the Inner Ring and rejected,” wrote as a necessary precondition to ultimate young and cool, and the big New York banks get rich and the way we do that is through C S Lewis in his memorable essay, The Inner success. Refusing to acknowledge failure, and were (and are) terrified of being left behind success: a stock going up, a private company Ring, which remains the best explanation of making failure part of the process, are two in the money bonanza that is modern Silicon going public, a merger. why it is we go along with others – and why very different things. Valley. We all get suckered because on some When I was working on my book Saudi those who seemingly have everything are level we’re willing to be suckered. America, which is about the lack of cash even more afraid than the rest of us to WHERE VISION IS OVER-RATED flow in the fracking industry, I spoke with be cast out. Maybe another clue is that the productive THE PULL OF THE TIDE an analyst at an investment firm. He was megalomaniac should be trying to solve A company’s board of directors isn’t one of many who were sceptical about ON DESIGNERS AND DIGGERS a giant, difficult, real world problem – influenced by money so much as it is held Chesapeake during its glory days. When So, if ultra-charismatic leaders with big one where the idea itself represents a hostage to an even more intense version discussing Chesapeake’s CEO, Aubrey dreams and a tinge (or more) of megalomania breakthrough. If they aren’t – if their of that polite clubbiness that pervades the McClendon, he told me, “I never let [him] all create a reality distortion field, how do you idea is something straightforward, even business world, the bias towards belief is in here for a meeting, because I know we tell which one is the visionary, and which one mundane, something requiring great hands- reinforced by the very act of joining a board. would have bought a ton of stock, and it is the fraudster? How do you know if Enron’s on execution – maybe you don’t need the Most people are willing to serve in that role wouldn’t have ended well.” He was right: it broadband business, which had Netflix’s core visionary in the first place. Think about because they admire the company, or the didn’t end well. McClendon was indicted by idea before Netflix was even born, is going WeWork through that lens. All the company The Ruffer Review 2021 A bias to belief PAGE 13

that illuminated some of Enron’s financial a US federal grand jury for rigging bids. He to be Netflix – or Enron? How do you know shenanigans. But that information never It’s hard to know for sure until died in a single-vehicle car crash the next when these characteristics are productive, made it into the public domain, the domain day. Chesapeake went bankrupt. But this rather than pernicious? of equity investors. The same was true of there’s the 20/20 vision that analyst knew that McClendon’s salesmanship, It’s hard to know for sure until there’s the Theranos. Other blood-testing companies combined with that deep gut desire to get 20/20 vision that only comes with hindsight. were sceptical, as was much of the medical only comes with hindsight.” rich, would have swayed the day, and his But there might be some clues along the community. But they didn’t raise the alarm firm would have overcome its analytical way. One is respect for execution, for the loudly. Politeness prevailed, at least in public. reservations and bought shares on emotion. actual work. A source described Jeff Skilling The purported gatekeepers usually don’t to me as a designer of ditches, not a digger raise the alarm either. You might think, as CONFIRMATION of ditches. This person went on to say, and I once did, that accountants would account, AND BELONGING perhaps this was the real clue, that Skilling lawyers would be sticklers for the letter and management. The person who joins a board Once we’re in, it’s hard to get out. That’s not only valued other designers of ditches. He had the spirit of the law, and bankers wouldn’t because they think a company is a fraud, just because of the financial commitment. no respect for the diggers. lend money to those who are going to lose or because they distrust management, is It’s also because of the phenomenon of That couldn’t be more different than it. But no, in practice, it doesn’t work that pretty rare! confirmation bias. It’s highly unpleasant Edison. The myth is that he was an way. Arthur Anderson went down with And yet, board members are supposed to to admit you’ve made a mistake. It’s much independent genius. He was not. He had Enron. Ernst & Young didn’t look too closely be able to hold the possibility in their mind more satisfying, at least in the short term, to a team of men, called his ‘muckers’, who at WireCard’s multi-billion dollar cash hole. that, even as it’s all going swimmingly and extrapolate from the available information relentlessly dug the ditches. Edison didn’t Banks raised the funds cash-haemorrhaging the stock is soaring and the leaders are being that which you want to hear, and dismiss that conjure the design for his light bulb out Chesapeake needed to stay in business, and admired, everything they’re hearing could be which contradicts your prior beliefs. of thin air. Rather, “he had teams of sold the risk to others. Short-term fees seem a lie. “The test of a first rate intelligence is the We also don’t want to be excommunicated experimenters rigorously testing sample after to outweigh the long-term losses. ability to hold two opposed ideas in the mind from the group of those who get it. “It sample to figure out what material worked Jamie Dimon, the CEO who steered at the same time and still retain the ability to would be so terrible to see that other man’s best for the filament,” as a 2020 essay in the JPMorgan Chase to survival during the function,” wrote F Scott Fitzgerald. face—that genial, confidential, delightfully magazine Ponderwall put it. Even more, the financial crisis, was personally a big Few of us have that kind of intelligence. sophisticated face—turn suddenly cold and essay notes that Edison failed frequently. supporter of Neumann, and his bank was Investors, from the biggest to the smallest, contemptuous, to know that you had been Edison viewed figuring out what didn’t work a major lender to WeWork. Neumann was want to believe too. After all, we all want to tried for the Inner Ring and rejected,” wrote as a necessary precondition to ultimate young and cool, and the big New York banks get rich and the way we do that is through C S Lewis in his memorable essay, The Inner success. Refusing to acknowledge failure, and were (and are) terrified of being left behind success: a stock going up, a private company Ring, which remains the best explanation of making failure part of the process, are two in the money bonanza that is modern Silicon going public, a merger. why it is we go along with others – and why very different things. Valley. We all get suckered because on some When I was working on my book Saudi those who seemingly have everything are level we’re willing to be suckered. America, which is about the lack of cash even more afraid than the rest of us to WHERE VISION IS OVER-RATED flow in the fracking industry, I spoke with be cast out. Maybe another clue is that the productive THE PULL OF THE TIDE an analyst at an investment firm. He was megalomaniac should be trying to solve A company’s board of directors isn’t one of many who were sceptical about ON DESIGNERS AND DIGGERS a giant, difficult, real world problem – influenced by money so much as it is held Chesapeake during its glory days. When So, if ultra-charismatic leaders with big one where the idea itself represents a hostage to an even more intense version discussing Chesapeake’s CEO, Aubrey dreams and a tinge (or more) of megalomania breakthrough. If they aren’t – if their of that polite clubbiness that pervades the McClendon, he told me, “I never let [him] all create a reality distortion field, how do you idea is something straightforward, even business world, the bias towards belief is in here for a meeting, because I know we tell which one is the visionary, and which one mundane, something requiring great hands- reinforced by the very act of joining a board. would have bought a ton of stock, and it is the fraudster? How do you know if Enron’s on execution – maybe you don’t need the Most people are willing to serve in that role wouldn’t have ended well.” He was right: it broadband business, which had Netflix’s core visionary in the first place. Think about because they admire the company, or the didn’t end well. McClendon was indicted by idea before Netflix was even born, is going WeWork through that lens. All the company PAGE 14 The Ruffer Review 2021

was doing was sub-leasing office space, and only the outcome dictates the reality. In losing a ton of money while doing it. Do you the modern world, that reality might be need someone who, like Neumann, wanted determined by just one thing: investors’ belief. to “elevate the world’s consciousness”? Or do If Enron hadn’t lost investors’ faith, and you need a nitty-gritty money-minded real had been able to maintain access to capital, estate maven who could crunch the numbers Skilling might have made it to the other side. and negotiate good deals – that grey, boring Enron Broadband would be Netflix, Enron businessperson, in other words? Energy Services would be making the green Of course, for everything that looks like world efficient, and Enron’s trading operation a rule, there’s an exception – like Elizabeth – well, it might not be making the world a Holmes.Bias She was unquestionably trying toto do better belief place, but it would be making a something grand, something world-changing. lot of money. So maybe the corollary question is this: apart This is why I’d never bet against Elon from the leader’s charisma, do they have Musk. He uses his position to enrich himself; any of the skills that make them equipped to the flags glow red. His merger of Solar City succeed? Building a machine that can run and Tesla allowed, among other things, Musk hundreds of blood-based tests from a single to have Tesla pay back the personal loans droplet, a finger prick of blood, is a feat that he’d made to Solar City. But that deal also eluded engineers and medical professionals accomplished something else. A bankruptcy for decades. That’s different from founding of Solar City would have dented Musk’s Facebook, or even Apple. The former requires myth. It would have made it more difficult for skill, real knowledge. The other, at its core, believers to believe, and might have made it Sometimes I wonder if there’s requires an idea. more difficult for Musk to keep raising capital. a Schrödinger’s cat-like aspect If ideas are the province of visionaries, There’s no question in my mind that, if you execution is the province of realists. froze Musk at a moment in time, maybe even to success in business.” A few final clues might be if the visionary now, an aggressive prosecutor could find has their hands on the levers of the financial evidence of fraud. But if he can keep statements, or stands to benefit by feigning raising billions? success via an inflated stock price or other By the time the history books are written, forms of self-dealing. Incentive compensation Musk’s companies will be very alive cats. encourages the leader to succeed. But if If I could wave a magic wand, I’d change success is a matter of perception, of stock the twisted incentives that bias people price, then the appearance may be more towards short-term gain. But I’m not sure important than the reality. Why do you need how much I’d meddle with our willingness real success if the faked kind pays just to believe. After all, without it, we might as well? still lack the real incandescence of Edison’s light bulb. OPENING THE BOX Sometimes I wonder if there’s a Schrödinger’s cat-like aspect to success in business. You may see an alive cat or a dead one, a visionary or a fraudster. Both are possibilities and The Ruffer Review 2021

was doing was sub-leasing office space, and only the outcome dictates the reality. In losing a ton of money while doing it. Do you the modern world, that reality might be need someone who, like Neumann, wanted determined by just one thing: investors’ belief. to “elevate the world’s consciousness”? Or do If Enron hadn’t lost investors’ faith, and you need a nitty-gritty money-minded real had been able to maintain access to capital, estate maven who could crunch the numbers Skilling might have made it to the other side. and negotiate good deals – that grey, boring Enron Broadband would be Netflix, Enron businessperson, in other words? Energy Services would be making the green Of course, for everything that looks like world efficient, and Enron’s trading operation a rule, there’s an exception – like Elizabeth – well, it might not be making the world a Holmes. She was unquestionably trying to do better place, but it would be making a something grand, something world-changing. lot of money. So maybe the corollary question is this: apart This is why I’d never bet against Elon from the leader’s charisma, do they have Musk. He uses his position to enrich himself; any of the skills that make them equipped to the flags glow red. His merger of Solar City succeed? Building a machine that can run and Tesla allowed, among other things, Musk hundreds of blood-based tests from a single to have Tesla pay back the personal loans droplet, a finger prick of blood, is a feat that he’d made to Solar City. But that deal also eluded engineers and medical professionals accomplished something else. A bankruptcy for decades. That’s different from founding of Solar City would have dented Musk’s Facebook, or even Apple. The former requires myth. It would have made it more difficult for skill, real knowledge. The other, at its core, believers to believe, and might have made it Sometimes I wonder if there’s requires an idea. more difficult for Musk to keep raising capital. a Schrödinger’s cat-like aspect If ideas are the province of visionaries, There’s no question in my mind that, if you execution is the province of realists. froze Musk at a moment in time, maybe even to success in business.” A few final clues might be if the visionary now, an aggressive prosecutor could find has their hands on the levers of the financial evidence of fraud. But if he can keep statements, or stands to benefit by feigning raising billions? success via an inflated stock price or other By the time the history books are written, forms of self-dealing. Incentive compensation Musk’s companies will be very alive cats. encourages the leader to succeed. But if If I could wave a magic wand, I’d change success is a matter of perception, of stock the twisted incentives that bias people price, then the appearance may be more towards short-term gain. But I’m not sure important than the reality. Why do you need how much I’d meddle with our willingness real success if the faked kind pays just to believe. After all, without it, we might as well? still lack the real incandescence of Edison’s light bulb. OPENING THE BOX Sometimes I wonder if there’s a Schrödinger’s cat-like aspect to success in business. You may see an alive cat or a dead one, a visionary or a fraudster. Both are possibilities and The Ruffer Review 2021 PAGE 16

A GREAT FEAR STALKS THE LAND OF ASSET MANAGEMENT – the return of inflation. And, with it, the death of an investing paradigm: the dominance of a traditional balanced portfolio of 60% equities, 40% bonds. These 60:40 portfolios have been structured to provide a good level of long-term returns, but with a smooth ride. Jurassic risk They have been a successful construct, as Figure 1 shows. HENRY MAXEY Today, with bond yields now so low AND THE CHOMPING OF THE Chief Investment Officer and inflation fears creeping in, investors TRADITIONAL BALANCED are confronting the obvious concern. It is PORTFOLIO

Figure 1 NOMINAL AND REAL RETURNS FROM A 60:40 PORTFOLIO IN THE US SINCE 1979

THE DEATH OF INFLATION HAS BEEN GREATLY

Its return – perhaps as 1970s-style T-Rex 100 EXAGGERATED. US nominal returns rebased or 2020s genetically-mutated velociraptor – will first scare, US real returns rebased then maim, then ruin the traditional balanced portfolios that have served investors well for a generation. Investors need to prepare for a world of greater inflation volatility. And with it a 10 Jurassic risk – bonds and equities falling in tandem.

0.1 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 Figure 1: Global Financial Data, Ruffer. Based on a logarithmic scale The Ruffer Review 2021 PAGE 17

Figure 1 NOMINAL AND REAL RETURNS FROM A 60:40 PORTFOLIO IN THE US SINCE 1979

THE DEATH OF INFLATION HAS BEEN GREATLY

0.1 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 Figure 1: Global Financial Data, Ruffer. Based on a logarithmic scale low interest rates. low interest very on capitalised being is shareholders to return What’s more, that return. of stakeholders’ proportion historically-high a receiving from benefiting are Shareholders too. role of equities the should re-examine jolly, you’re you if really And, are? feeling they suggest characteristics statistical historical their which assets diversifying low-risk, the still bonds are short, In understood.” alone let appreciated, not fully yet are they profound as as are consequences unintended the And targets. return its to achieve morerisk ever take when time it must at a diversifiers portfolio of acute shortage an now faces industry the Consequently,convexity.the negative offset to materially bonds onto Treasury rely able being without assets of risk portfolios to now build investors forced has pandemic to the response policy unprecedented “The Management: Asset Peters of River One Eric quote from this in up well summed they’re extinct. So too, apparently, So inflation. extinct. they’re well, because, amicrosecond more than T-Rex. doesn’t for thought linger But the a of facing terror the imagine We all can 40 years. past for the us surrounded havethat forces disinflationary structural of the because prospect unrealistic an such felt has itself inflation year’s Review, this later in covers Yet,it. Dannhauser Jamie as fear should rightly clients for their allocation asset atraditional too). running Anyone portfolio risk-parity your (and eviscerate 60:40 your eat portfolio will that beast lower margins). in (resulting income and of wealth redistribution towards tilted economy is likely, political seems the as if, tested further be will They inflation. of higher era an in probablywould tested be PAGE 18 PAGE As we saw in the 1970s, inflation is the is 1970s, the inflation wesaw in As The Ruffer Review 2021 Review Ruffer The 1 Both of these supports of these Both

the road to cheer us on our way. on our us to road cheer the lining are bankers central and to inflation, roadthe on now firmly for we are some time: policy macro of bias inflationary the change will This bailouts. the gets that Wall Street It no longer is just future. the role in this to play expected be will they consequences, inflationary adverse any without Street Main blows for able to soften are policymakers generation’. next economy for the the ‘greening and Theory Monetary Modern of to acombination traction its losing is generation’ next for the books the ‘Balancing unemployment. in evident remain covid of effects scarring the while particularly at austerity, efforts post-2008 their repeat able to be to unlikely are Governments crossed. definitively was regimes policy bailout. behind’ the ‘no – one left of monetary-financing expression for afull-throated allowed has no one’s (“it was fault”) crisis of the nature the fact, In playbook. the followed – has demand nominal support to policy fiscal and of monetary cooperation to it –the response The policy crisis. covid-19and that gave us – change regime precipitate the would crisis afinancial Iargued results. catastrophic likely, quite have some would and actually butpossible, is not just of inflation rebirth about why the ahypothesis palaeontology: to was story Park the what Jurassic inflation to was Review year’s Ruffer last My in piece THE PLAYBOOKENTER period of below-average inflation, we will let will we of below-average inflation, period a words: after not-so-many conclusion in The review. policy monetary its published Reserve US Federal the August, Last STOKING TO FIGHTING FROM In short, austerity is out. If fiscal fiscal out. If is austerity short, In 2020,In Rubicon of the macro

1 The stock market is expensively rated. But, if today’s interest rates and credit spreads are here to stay, then it is possible to argue the market is fairly valued.

2 Global Economics Analyst (7 November 2020) Jurassic risk and the chomping of the traditional balanced portfolio balanced traditional ofthe chomping the and risk Jurassic Chairman of the US Federal Reserve, October 1979 October Reserve, US Federal of the Chairman Paul Volcker, periodof prosperity.” believe have the stage been will set for anew long of and malaise caution... Should we succeed, I greatlyitself extend will and exaggerate the sense distortions and generated uncertainty by inflation economic stability? Should we fail, Ifear the environment of price stability without impairing Do we have and the wit the wisdom to restore an want to get back to full employment. to get to back full want and we issue, an is inflation we don’t think economy hot because the run wewill simply: Or, met. is employmentour more mandate the upside, to ensure to overshoot inflation biasing back to back inflation. biasing also are forces structural and political the as just tack have changed they And credibility. inflation-stoking their to establish want policymakers where point the now reached credibility. have We inflation-fighting their establish to efforts have made strenuous Fed’s the as such Paul Volckerpolicymakers decades. over recent experience Japan’s fear all They ones. deflation-beating their in are they than capabilities fighting inflation- their in more confident are They inflation. than more deflation fear have come to economies, developed the in Beginning in the 1980s, monetary 1980s, monetary the in Beginning banks central other most The Fed, and in 2021,in of 6% US GDP growth forecasting are Sachs even if you had correctly predicted that that predicted you correctly had if even today. are So, to they where decline decade multi- their began they before period year 16% 9% two- to around around –over this intent. of that credibility the reflecting to begin markets for the 1979. years Itof intent October took two in statement inflation-fighting He made his will strike. Weloose. don’t just predator when the know theis now on beast We inflationary the know WAY? ITS ON CHOMP FIRST THE IS rate hike as coming only in 2025. in only coming as rate hike As if to illustrate the point, Goldman Goldman point, the to illustrate if As Interest rates first had to rise – from – rise had to first rates Interest Paul Volcker’sConsider experience. 2 while modelling the first interest- first the modelling while low interest rates. low interest very on capitalised being is shareholders to return What’s more, that return. of stakeholders’ proportion historically-high a receiving from benefiting are Shareholders too. role of equities the should re-examine jolly, you’re you if really And, are? feeling they suggest characteristics statistical historical their which assets diversifying low-risk, the still bonds are short, In understood.” alone let appreciated, not fully yet are they profound as as are consequences unintended the And targets. return its to achieve morerisk ever take when time it must at a diversifiers portfolio of acute shortage an now faces industry the Consequently,convexity.the negative offset to materially bonds onto Treasury rely able being without assets of risk portfolios to now build investors forced has pandemic to the response policy unprecedented “The Management: Asset Peters of River One Eric quote from this in up well summed they’re extinct. So too, apparently, So inflation. extinct. they’re well, because, amicrosecond more than T-Rex. doesn’t for thought linger But the a of facing terror the imagine We all can 40 years. past for the us surrounded havethat forces disinflationary structural of the because prospect unrealistic an such felt has itself inflation year’s Review, this later in covers Yet,it. Dannhauser Jamie as fear should rightly clients for their allocation asset atraditional too). running Anyone portfolio risk-parity your (and eviscerate 60:40 your eat portfolio will that beast lower margins). in (resulting income and of wealth redistribution towards tilted economy is likely, political seems the as if, tested further be will They inflation. of higher era an in probablywould tested be As we saw in the 1970s, inflation is the is 1970s, the inflation wesaw in As The Ruffer Review 2021 Review Ruffer The 1 Both of these supports of these Both

period of below-average inflation, we will let will we of below-average inflation, period a words: after not-so-many conclusion in The review. policy monetary its published Reserve US Federal the August, Last STOKING TO FIGHTING FROM way. on our us to road cheer the lining are bankers central and to inflation, roadthe on now firmly for we are some time: policy macro of bias inflationary the change will This bailouts. the gets that Wall Street It no longer is just future. the role in this to play expected be will they consequences, inflationary adverse any without Street Main blows for able to soften are policymakers generation’. next economy for the the ‘greening and Theory Monetary Modern of to acombination traction its losing is generation’ next for the books the ‘Balancing unemployment. in evident remain covid of effects scarring the while particularly at austerity, efforts post-2008 their repeat able to be to unlikely are Governments crossed. definitively was regimes policy bailout. behind’ the ‘no – one left of monetary-financing expression for afull-throated allowed has no one’s (“it was fault”) crisis of the nature the fact, In playbook. the followed – has demand nominal support to policy fiscal and of monetary cooperation to it –the response The policy crisis. covid-19and that gave us – change regime precipitate the would crisis afinancial Iargued results. catastrophic likely, quite have some would and actually butpossible, is not just of inflation rebirth about why the ahypothesis palaeontology: to was story Park the what Jurassic inflation to was Review year’s Ruffer last My in piece THE PLAYBOOKENTER In short, austerity is out. If fiscal fiscal out. If is austerity short, In 2020,In Rubicon of the macro

1 The stock market is expensively rated. But, if today’s interest rates and credit spreads are here to stay, then it is possible to argue the market is fairly valued.

Volcker was serious, a long-bond investment THE TRANSMISSION MECHANISM wouldn’t have started working for two years. Ever since we started talking about the Japan’s deflation problem is real and serious; How long will it take to build the inflation- inflationary endgame at Ruffer, the most stoking credibility of policymakers in this common question we’ve been asked has but, in my view, political constraints, rather reverse Volcker manoeuvre? Could it be two been: how will inflation be generated? Or, years, and further falls in yields, before the as the investment geeks put it: what is the than a lack of policy instruments, explain why Fed’s inflation overshooting framework is transmission mechanism? credible? The answer will depend on two inter- Everyone can understand the argument its deflation has persisted for as long as it has. related things. First, political will: whether that inflation is the more palatable form of both the monetary and fiscal authorities have default for an indebted government. Thus, I do not view the Japanese experience as the courage to run the economy hot. Second, But most struggle to foresee how inflation the transmission mechanism: what, exactly, could actually be generated, given the evidence against the general conclusion that US will bring inflation about? structural headwinds to inflation and the dominance of monetary policy in the macro policymakers have the tools they need to prevent, POLITICAL WILL IS NEEDED policy mix. Volcker’s experience shows that, when a “It’s one thing wanting inflation; I want and, if necessary, to cure a deflationary recession regime is deep-rooted, it takes courage and to be 6 foot 2 inches tall” was the retort. “It’s political savvy to pull off a regime change. another getting it; I’m 5 foot, 8 inches”. in the United States.” Central banks today certainly seem Of course, inflation can always be committed to running the economy hot, but generated in a fiat-money system if there Ben Bernanke, November 2002 the heat is likely to be generated by the fiscal is the political will to do so. The issue is policy in the monetary-fiscal combination. how it can be generated So, if the politics of prudence gets in the way in a healthy fashion. As of the political will to reflate economies – as Nick Carn of Carn Macro it could in the frugal northern economies in Advisors puts it, if your the EU, or with Rishi Sunak’s “sacred duty” home central heating to balance the books in the UK – then we breaks down, it’s not could end up with more of a stop-start cycle. particularly reassuring This is what has happened in Japan. The when the heating engineer fiscally austere Japanese Ministry of Finance arrives with a jerrycan of by the operators. This leads to a focus on is an incredibly powerful bureaucracy, petrol and a flaming rag conventional explanations for inflation – for ideologically-wedded to balancing the books. and says, “Don’t worry, we example, the monetarist view that changes the country’s bonds and an inflation caused As such, it has a bias to being fiscally tight, can get this place warmed in the quantity, velocity, or, even, impulse of by currency weakness. A confidence crisis even surreptitiously so, when monetary up in no time.” money supply cause inflation. like this occurs suddenly, rather than in a policy has been loose. The result of this The transmission What history shows is that inflation is predictable, mechanistic manner. Think bureaucratic reticence is that inflation in mechanism matters when often a collective behavioural phenomenon – tipping points. Japan has been unable to sustain itself much it comes to policymaking. with all the non-linear dynamics that implies. Takeaway: the causal explanation of above 1% for any length of time. Yet the language here is If we think of it in this way, we may be inflation may not be obvious until after the So if politics in the West prevents sustained unhelpful: it conjures drawn to the lesser-discussed fiscal theory of event, so it’s not helpful to tie an investment fiscal cooperation with monetary policy, then it up mechanical images inflation. This holds that a loss of confidence strategy to a transmission mechanism. It’s an will be hard to raise the level of inflation much. of inputs and outputs, in a government’s ability to service and investor’s conviction on the inevitability of Stop-start stimulus will be the result. which can be controlled repay its debt results in a repudiation of the outcome that matters most. with the Wassenaar Agreement. Wassenaar the with Wassenaar? Wassenaar, obviously. what’s So a It’s areverse What’s aRaanessaw? THE RAANESSAW b First genetically-mutated velociraptor for the 2020s? to the repressor? What about the 1970s T-Rex? Orcould beanew it the 60:40 Should we portfolio. fear the Raanessaw? Will we beFed considering of will inflationary yet beast isAnd worth it whateat sort FOUR THE MEET restored so that the stimulus didn’t just get didn’t just stimulus the that so restored wages and profitability corporate between link the He wanted of Abenomics. part as this exactly Japan to attempted instigate bonuses. and wages to increase together working labour organised and industries major involve would governments, This reverse? in emerge, just consensus same the see wecould it possible is capitalism, to stakeholder ground giving seemingly capitalism shareholder and issue, political 1970s. of the spiral wage-price the ending with credited been has agreement the Europe, in elsewhere pacts later social tone the for it set As more people again. byemploying employers to respond needed and rises, wage ever-greater demanding employed. to stop the Unions and needed by employers be shared should inflation rampant of taming burden employment, the to sustain 1980s that, early the in emerged had Aconsensus unions. labour and employers’ organisations between agreement aground-breaking it was signed, it was where of suburb Hague The quiet the after PAGE 22 PAGE In 1982,In Europe’s Volcker moment came In 2013, Prime Minister Shinzō Abe of Abe Shinzō Minister 2013, Prime In ahot Today, inequality income with east The Ruffer Review 2021 Review Ruffer The 3 Named Named imminent inflationary threat. inflationary imminent margins. profit their undermines which aspiral create won’t unilaterally employees more, they bypaying capitalism of idea stakeholder to the lean-in may companies while And, wage-setting. in more broadly themselves to impose inclined not but are higher wages minimum push may 1970s. the Governments in did they than now influence less have far The unions West. the in spiral awage-price kickstart to hard it be would think Japan, Istill as mindset deflationary thesame suffer target. inflation 2% oomph the enough to reach with spiral wage-price a start to difficult made it very has muted.mindset Japan’s deflationary been has growth wage real rise, Japan did in wages nominal Although system. financial the and profits corporate higher in ‘stuck’ FED THE REPRESSOR beast Second government debt to a rate below the level of debtgovernment level of to arate below the on rate paid interest the by repressing achieved? 50%. this How was below down UK’s was the 25% and to around 1970s, US debt-to-GDP fallen had the ratio at early 250%. the stood UK’s By ratio the 120% at nearly of GDP,debt running while World Second The US ended the War with So the Raanessaw doesn’t seem like an an doesn’t like seem Raanessaw the So world of the doesn’t rest yet the While A lot of the heavy lifting was done was lifting A lot heavy of the

3 Not to be confused with the Wassenaar Arrangement

4 US Bureau of Labor Statistics Jurassic risk and the chomping of the traditional balanced portfolio balanced traditional ofthe chomping the and risk Jurassic meanwhile, averaged 5.9% averaged period. over that meanwhile, 1951. Inflation, February in Fed Accord Treasury- the level until at that remained and 2.5%in at June fixed 1941 US long was bonds on ratetheinterest of example, Forinflation. Does this period hold key? the period this Does the about 1970s. think tendthey to inflation, about story. people think of most the When part is only period post-war the inflationary, more be might future how the imagining we’re if So, prices. consumer higher stimulate not to enough is alone rate repression inflation. price butconsumer not inflation, price asset stimulated has Fed. This by the guidance forward and easing quantitative of acombination through managed heavily have been 1940s, they the in were they as fixed formally rate have not been overnight the beyond rates interest Although years. 12 past for of negative the most have been rates interest US overnight Real 2008. since music. mood the already was inflation because effective was repression rather, financial inflation; drove repression financial that therefore, say, to It difficult is controlled. were rates interest while elevated remained inflation war. Background bythe impacted still was supply and demand, created reconstruction The necessary repression. for financial flatlined. debt levels US gross result, a As it. after years the in balance toback near war, fell the during enormous been having government’s the deficit, that is period levels. debt-to-GDP to more manageable ratio the reducing thereby debt, nominal than faster GDP grew nominal meant which negative, deeply were rates interest real aresult, As In our current environment, interest interest environment, current our In place taken has repression A similar perfect was context The post-war about this things attractive ofOne the 4

through higher asset prices. asset higher through economy real to the stimulus monetary transmit will markets asset hoping that than rather directly, demand to drive needed is baton policy). pass This monetary from accommodation (with policy to fiscal passed has stimulus policy world. apost-covid in likely alot now less looks This mix. stimulus the in policy monetary abandons policy fiscal unless US the in attempted seriously be will rates interest nominal Idon’tReview, negative believe to thrive. continue would 60:40 the portfolio then rates, interest nominal negative with by experimenting to harder push Fed the were fact, In portfolio. 60:40 traditional –to the a threat than –rather asupport been has 2008 since repression Financial RATES INTEREST NEGATIVE Box 1 Why? Because the baton the of Because Why? year’s last in Iargued As with the Wassenaar Agreement. Wassenaar the with Wassenaar? Wassenaar, obviously. what’s So a It’s areverse What’s aRaanessaw? THE RAANESSAW b First genetically-mutated velociraptor for the 2020s? to the repressor? What about the 1970s T-Rex? Orcould beanew it the 60:40 Should we portfolio. fear the Raanessaw? Will we beFed considering of will inflationary yet beast isAnd worth it whateat sort FOUR THE MEET restored so that the stimulus didn’t just get didn’t just stimulus the that so restored wages and profitability corporate between link the He wanted of Abenomics. part as this exactly Japan to attempted instigate bonuses. and wages to increase together working labour organised and industries major involve would governments, This reverse? in emerge, just consensus same the see wecould it possible is capitalism, to stakeholder ground giving seemingly capitalism shareholder and issue, political 1970s. of the spiral wage-price the ending with credited been has agreement the Europe, in elsewhere pacts later social tone the for it set As more people again. byemploying employers to respond needed and rises, wage ever-greater demanding employed. to stop the Unions and needed by employers be shared should inflation rampant of taming burden employment, the to sustain 1980s that, early the in emerged had Aconsensus unions. labour and employers’ organisations between agreement aground-breaking it was signed, it was where of suburb Hague The quiet the after In 1982,In Europe’s Volcker moment came In 2013, Prime Minister Shinzō Abe of Abe Shinzō Minister 2013, Prime In ahot Today, inequality income with east The Ruffer Review 2021 Review Ruffer The 3 Named Named government debt to a rate below the level of debtgovernment level of to arate below the on rate paid interest the by repressing achieved? 50%. this How was below down UK’s was the 25% and to around 1970s, US debt-to-GDP fallen had the ratio at early 250%. the stood UK’s By ratio the 120% at nearly of GDP,debt running while World Second The US ended the War with FED THE REPRESSOR beast Second threat. inflationary imminent margins. profit their undermines which aspiral create won’t unilaterally employees more, they bypaying capitalism of idea stakeholder to the lean-in may companies while And, wage-setting. in more broadly themselves to impose inclined not but are higher wages minimum push may 1970s. the Governments in did they than now influence less have far The unions West. the in spiral awage-price kickstart to hard it be would think Japan, Istill as mindset deflationary thesame suffer target. inflation 2% oomph the enough to reach with spiral wage-price a start to difficult made it very has muted.mindset Japan’s deflationary been has growth wage real rise, Japan did in wages nominal Although system. financial the and profits corporate higher in ‘stuck’ A lot of the heavy lifting was done was lifting A lot heavy of the an doesn’t like seem Raanessaw the So world of the doesn’t rest yet the While

3 Not to be confused with the Wassenaar Arrangement

Third beast prone, 1970s- style? It’s unlikely; the oil biased). That combined with policymakers That has started changing in the post- THE 1970S T-REX shocks were very extreme cost-push events. who will both cheer inflation on and who 2008 world of extremely low, sometimes The inflationary cycle of the 1970s is largely That said, we need to consider the emerging have promised to let the economy run hotter negative, interest rates. Faced with a safe associated with the supply-side shock from macro context. If these supply-side changes for longer. All against a backdrop of financial pathway to retirement that is torturously oil prices allied to the labour market frictions are allied to macro policy, which assumes markets that have wired themselves to the slow, savers have been forced to take of high union power. Fiscal largesse, blind both an unchanged disinflationary backdrop proposition that low interest rates are here substantially more risk to find return. to actual output gaps, provided the fuel of and a greater degree of slack in the economy to stay. For some, particularly the young, this excess demand. than actually exists, then we could have the has incubated a ‘speculate to accumulate’ Lesser appreciated is that, in the US, this set-up for a very similar policy mistake to mentality. And one of the popular Fourth beast cycle had its origins in the 1960s. President that made in the 1960s. Stick a high voltage speculations has been on digital currencies. A NEW, GENETICALLY-MUTATED Lyndon Johnson’s government overestimated across a copper wire and it will get hot; stick Irrespective of the merits of these digital VELOCIRAPTOR the amount of slack in the economy – and the same voltage across a thinner wire and it assets, their emergence has led a generation While the 1960s and 1970s provide the sought to utilise it. Beginning with the will get hotter. of young people (and quite a few older ones textbook roadmap for inflation in the Kennedy-Johnson tax cuts in 1964, the US The US Federal Reserve, for example, too) to consider some of the existential developed economies, we need to think began stimulating growth with fiscal policy has been explicit in its view that monetary questions about money. Even if it is simply more creatively about what unique genetic while pressuring the Fed to keep monetary policy should remain accommodative until to justify a speculation, they have had to mutations the next inflation might have. One policy loose. The result was a series of unemployment is back to, or below, the low consider characteristics such as: fiat money’s avenue that interests me is the idea of a run inflationary waves in the 1960s which were levels of 2019. The Fed assumes inflation potentially unlimited supply; how much on fiat currencies. amplified by the events of the 1970s. will not be an issue between now and then, money is being ‘printed’ to bail out the latest In developed economies, we are used There are some parallels with today. Take because it wasn’t previously. So much so, in victim(s); how inflation typically eats away at to relative stability in foreign-currency the supply side, the capacity of the economy fact, that it has adjusted its monetary policy money’s purchasing power; how a real asset exchange markets because of the credibility to produce goods and services. This has framework to include the idea of inflation like gold can – and did – act as a monetary of the institutions that manage the economy. undoubtedly been damaged by the covid make-up, or inflation overshooting – the anchor; and how new technology offers the This means most people haven’t spent a lot crisis. Unusually, in the West it has been Fed will allow inflation to remain higher for potential of ‘money over IP’. of time asking themselves, “what is money?” the dominant service sector which has been a period to compensate for a past period in or “is my money safe?” hardest hit (think, hotels and restaurants which it ran lower than the 2% target. that will struggle to reopen). The crisis has And fiscal policy is now active alongside also reminded business leaders that there are monetary policy. This is direct stimulation benefits in having some redundancy (think, of demand. It does not rely on transmission holding a little more just-in-case inventory). via the financial markets, as it has since Covid-19 compounds two other structural 2008. Stimulus via monetary policy alone supply side shocks that are covered by my has tended to get trapped in financial colleague Alexander Chartres elsewhere in markets – with share buybacks and financial this Review: supply chains shifting as US- engineering, rather than new factories China relations deteriorate; and the attempt and higher real wages. Monetary-fiscal to price in some of the cost of environmental, coordination is stimulus via Main Street, not social, and governance externalities into the Wall Street. It stimulates consumer price costs of business. inflation rather than asset price inflation. Collectively, these shocks will act against Adding it all up… we have demand the structural disinflationary trends that stimulus (which is more directly have prevailed in recent decades. But will inflationary) hitting a post-covid economy they make the Western economies inflation- (which is structurally more inflationary The Ruffer Review 2021 Jurassic risk and the chomping of the traditional balanced portfolio PAGE 25

Large numbers of people outside finance DRAWING ON THE FOUR BEASTS are interested in what money is and, more Box 2 shows an example sequence of events AN EXAMPLE SEQUENCE importantly, what its failings are. They are from here, drawing on the thoughts set out OF EVENTS also getting equipped with tech tools that so far. allow them to move out of fiat and into The key point to take away is that it alternatives such as gold or bitcoin. The is inflation volatility, not necessarily Dramatic covid policy stimulus into supply website of the mobile bank Revolut yells out: sustained higher inflation, which ignites side shocks gives us an initial burst of inflation 1 “Go from cash to crypto, in seconds.” the psychological tinder. We might only and growth in the second and third In the nineteenth century, once people need 1960s inflation volatility to get 1970s quarters of 2021. Central banks are willing to look through this got the hang of the signals that indicated inflation rates. 2 and, if required, stop long-term interest rates banks might be in trouble, they would seek This would give us a kind of inflation from rising too much. Fiscal policymakers, to withdraw their bank deposits on the back unexpected by the conventional analysis. feeling the need to appear prudent, use it of the rumour, rather than waiting for the It is one which favours the intuition of This negative fiscal impulse quickly takes the as an opportunity to reduce some of the facts. The banking panic run of 1893 was a our Chairman, Jonathan Ruffer: the heat out of the economy. Inflation and growth 3 fiscal stimulus. spectacular example of this learned ‘panic transmission mechanism is something to fall sharply again at the end of 2021 or early 5 early’ behaviour. marvel at in hindsight, rather than seeking in 2022, and the secular stagnation headlines So the psychological tinder of confidence to time with foresight. reappear: ‘Inflation only transitory.’ Fiscal policymakers are compelled to return in fiat money is drying, and the technology By putting the focus on inflation volatility, 4 to stimulus, which they now feel is an effective providing alternatives is becoming available this also accommodates the possibility that tool alongside accommodative monetary policy. to everyone. This greases the wheels of the still-powerful disinflationary forces in Central banks continue to signal their approval. another route to inflation: a sharp fall in the world will continue to make sustained Chatter around Modern Monetary Theory and run on the currency, something we inflation hard to come by. The overall effect is much higher inflation and grows louder. normally only associate with emerging growth volatility, which central bank policy 5 market economies. As with fiscally-driven FIRST FRIGHT, THEN MAIMING, prevents from being priced into much inflation, this too would have tipping point THEN DEATH steeper yield curves. characteristics. Investors’ generic fear for portfolios today is Could this happen today? Potentially, that bond prices can’t rise much more and Suddenly, on the back of another wave of yes, but I doubt the tinder is dry enough yet. so they won’t be a good hedge in portfolios. 6 stimulus and a pick-up in inflation, there is run I think further development is needed on This is overly simplistic. on a major G7 currency. Domestic depositors and three axes – First, it ignores the possibility of negative investors seek to escape the financial repression nominal interest rates, something we Inflation in that economy moves decisively of low rates and resurgent inflation. • A sharp pick-up in actual inflation, which see as unlikely but not impossible. More higher, justifying the pre-emptive move by 7 central banks seek to look through. important, it ignores the key question: what depositors and investors. Perhaps, more • Sustained use of fiscal policy and drives the bond-equity correlation, and what interesting, what happens if – given today’s 6 continued academic endorsement for it. conditions will turn it positive again? Put technologies – society itself is able to function simply: when will bonds stop providing an better with higher levels of inflation than it has • A further acceptance of, and widening offset to equities in a portfolio? in the past? Would this make over-indebted access to, digital assets (the things On the Jurassic theme, true to Hollywood governments more tolerant of inflation? The Seeing this, depositors in other G7 countries, depositors would run to) by institutional form, it seems most likely that we get some losers would be the older generation of savers 8 are primed for exactly the same behaviour investors, regulators, and commentators. inflation frights before the final demise of and pensioners. But perhaps this too is more in their own currencies. The pattern All of these feel like very live dynamics for the 60:40 portfolio. By inflation fright, I tolerated because this is also the generation becomes contagious. brookings.edu/wp-content uploads/2020/11/furman-summers-fiscal-r econsideration-discussion-draft.pdf the next 12 months. mean inflation volatility, which 5 federalreservehistory.org/essays/banking-panics-of-the-gilded-age 6 For a recent example of such an endorsement, see this piece by prominent US economists: which has accumulated the wealth. The Ruffer Review 2021 Box 2

implies inflation rising sharply, scaring inflation rise (and vice versa). Equities are Figure 3 people, and then disappearing back into the likely to do the reverse. So bonds remain TERM PREMIA – ACMTP10 INDEX undergrowth. The conditions for starting this an offset, but bond prices are probably in 2021 are perfect thanks to the vaccine-led beginning to trend downwards. The 60:40 reopening of the world economy, supported portfolio has both dampened return and 4 by enormous monetary and fiscal stimulus. dampened volatility. No doubt, as soon as it looks like the world is The second phase will be maiming. reflating, policymakers will seek to remove This moment comes when the bond-equity 3 their extraordinary fiscal support measures. correlation switches back to being positive. This will quickly puncture any inflationary The purpose of bonds in a portfolio is lost. exuberance – and down inflation will go again. Phase three will be death. The deadly 2 For 60:40 portfolios, the first of three chomp arrives when inflation drives interest phases will be fright. Inflation volatility rates higher and this causes a de-rating of 1 rises. Bond prices no longer trend higher, equities (investors are willing to pay less for but they do remain negatively correlated the same level of future earnings). Bond and with equities. In this phase, bond prices are equity prices, being positively correlated, 0 likely to fall as nominal growth and expected both trend lower together.

-1 1961 1965 1969 1973 1978 1982 1986 1990 1994 1998 2003 2007 2011 2015 2019

Figure 2 THE BOND-EQUITY CORRELATION worrying pre-emptively about booms. On The negative correlation between bond prices the need for collateral, this simply means THE US BOND-EQUITY CORRELATION SINCE 1902 and equity prices has been a key driver of the that, when asset prices fall, the demand success of 60:40 portfolios. With bond prices for collateral rises (usually as margin in rising as equities are falling, portfolios enjoy a derivatives exposures) and therefore demand 0.7 smoother journey. Yet, as Figure 2 illustrates, for ‘risk free’ government bonds also rises. 0.5 the bond-equity correlation shows different The existence of this negative correlation, patterns over time. and the expectation that it would remain 0.3 In our research on the bond-equity in place, has shaped the bond markets. The 0.1 correlation, we have identified three main term premium – the extra yield you get factors behind the shift in correlation from as compensation for the uncertainty that -0.1 positive to negative since 1997: the spectre comes with lending for longer periods – has -0.3 of deflationary busts; the central banking progressively fallen. This premium is now

-0.5 paradigm in a low-growth world; and the considered to be negative, as Figure 3 shows. counter-cyclical need for high-quality, risk-free Paying a premium, rather than receiving one, -0.7 collateral in modern financial markets. The for owning longer-duration bonds can only US -0.9 second of those, on the central bank paradigm, be logical if the following holds: the 1902 1911 1919 1927 1936 1944 1952 1961 1969 1977 1986 1994 2002 2011 2019 has been shaped by a fear of repeating the drawbacks of uncertainty must be more experience of Japan: very low or negative than outweighed by the benefits to the inflation is a terrible thing, so monetary policy portfolio’s risk-return character that come

Figure 2: Global Financial Data, Ruffer Figure 3: Adrian, Crump, and Moench model, via Bloomberg is biased towards avoiding busts rather than from owning the long bonds. The Ruffer Review 2021 Jurassic risk and the chomping of the traditional balanced portfolio PAGE 29

-1 1961 1965 1969 1973 1978 1982 1986 1990 1994 1998 2003 2007 2011 2015 2019

This introduces a reflexive dynamic into Figure 4 bond yields. Disinflation has both caused US EQUITY TRAILING PRICE-EARNINGS RATIO (PE) AND CORE INFLATION yields to fall and the bond-equity correlation to turn negative. In turn, this caused the term premium to become a term discount, Trailing PE because of the added attractiveness of bonds 35 in a portfolio. This has been a double-headed 30 force for bonds; the trend has been self- reinforcing and will be hard to break. Late 1990s (TMT bubble) 25 Higher inflation volatility is unlikely to be enough to break this trend, especially 20 when the Fed is expected to look through any initial move above its 2% inflation 15 target. What will be required is a belief that the underlying level of inflation has risen 10 sufficiently and sustainably, so that central R2 = 0.55 R2 = 0.50 bankers once again begin to fear inflation 5 more than deflation. This might involve a Core CPI 0 sustained move upwards in the inflationary -2 0 2 4 6 8 10 12 14 trend (as in the US 1960s example) or a sudden jump to a much higher level of inflation (say, Figure 4 comes from Gerard Minack accompanying a currency crisis). at Minack Advisors. It shows the level of When the double-headed trend for bonds inflation (measured by core CPI) against THE DRAMA UNFOLDS low risk) will inadvertently make it does reverse, it will work just as powerfully the multiples investors place on equity The dramatic events of 2020 have tipped even harder for investors to avoid the in the opposite direction. Bond prices will earnings in the US. For equities, the best us into a new, more-inflationary, regime. Jurassic catastrophe. “Rest assured, both trend lower and be positively correlated level of inflation is around 2%. If inflation The demise of the 60:40 portfolio may not ma’am, the security cordon is impenetrable. with equities. At this point, bonds will be were to rise above 4%, then there is a high be imminent; the full drama may take There’s absolutely no way for the dinosaurs about as useful to portfolios as a chocolate probability that the equity market would years to play out. Rather than using the to get out…” teapot is to tea at the Ritz. The 60:40 de-rate. Given the high starting multiple time to escape, I suspect most investors It will take bravery, imagination, and portfolio is better off being a 60:0 portfolio. (the orange dot), this could be a very will just extend their stay in traditional an uncomfortable portfolio journey to get painful process. balanced portfolios. through the drama. WHAT ABOUT EQUITIES? Jonathan Ruffer calls this environment As with the visitors at Jurassic Park who In the scenes immediately ahead of If it takes a sustained shift in the level of the ‘airless valley’. Both equities and bonds know the velociraptors have broken loose, us, inflation volatility will rise in 2021 as inflation to break the negative bond-equity would be trending lower and their prices but who can’t emotionally connect with the economies reopen. Some of the inflation correlation, then the accompanying rise in would be positively correlated. The 0:0 danger until they see stampeding crowds, prints this year could be startling, elevated nominal interest rates may also cause a de- portfolio (cash) would outperform traditional it will take some portfolio bloodshed to by the recovery and the low base for year- rating of equity markets. This is the Jurassic 60:40 portfolios. When it comes, this cause panic. Perhaps we had a glimpse of on-year comparisons. It is unlikely that risk – equity and bond prices fall together. environment will destroy wealth on a level the future in March 2020 when traditional high levels of inflation will be sustained. In The most damaging phase for investors is not seen in a generation.7 portfolio diversification failed. the new macro policy regime, fiscal policy likely to come after the reversal of the bond- After decades of investing in financial Regulation focused on protecting is the accelerator and monetary policy will equity correlation, when inflation moves markets for wealth creation, wealth investors (using, for example, backward- (eventually) be the brake. So it is the fiscal

sustainably above the Fed’s target. preservation will be the priority. 7 Between 1972 and 1974, the average 60:40 portfolio in UK lost 70% of its real value Figure 4: Minack Advisers. Operational earnings from 1988, mont hly data 1955. This chart shows two lines of best fit. R² a t 0.55 excludes the TMT bubble. looking risk measures that present bonds as impulse – positive or negative – that will be The Ruffer Review 2021 Jurassic risk and the chomping of the traditional balanced portfolio PAGE 31

output gaps, not on the growing fragility authorities’ efforts to undermine the value I believe inflation, when of confidence in fiat money. of their savings? It matters not whether They see the firelighter of their policy this is actually the correct assessment. If it emerges in earnest, as sitting in the Arctic: the conditions the crowd takes a tech-enabled exit to other are cold and icy (even if some supply-side perceived stores of value, in that very instant will be a tipping-point pressures are warming the landscape a the objective truth will have changed.8 little). To worry about wildfires in this The firelighter will have teleported from phenomenon…” context seems perverse. the Arctic to the African savannah, and – Thanks to Volcker, policymakers also whoosh – we have inflation. have a prevailing confidence that inflation In physics, this is would be called a phase can be controlled if it does end up burning transition: certain properties of the medium a little too brightly. change, often discontinuously, as a result of From this, a paradox emerges. a change in external conditions. Policymakers may observe an objective truth

that the inflationary potential of the system THE CHALLENGE BEFORE US the primary driver of inflation and growth, an eventual ‘jump to inflation’ via a run is low at a given point in time. It is our job at Ruffer to create portfolios while central banks (initially at least) on the currency. Yet the inflation volatility they encourage for clients that are resilient to the different will look through inflation overshooting If, on the other hand, the economy is more and tolerate – shaped by their confidence pathways to the inflationary endgame but their targets. inflation-prone than expected, we are more in that objective truth – may alter the that don’t rely on precision timing. Having played second fiddle to monetary likely to see the underlying level of inflation subjective beliefs of the spectating public. Our approach thrived in the Spielberg policy for the past 40 years, fiscal rise steadily as inflation volatility persists. Armed with partial truths and partial drama of 2020. We are prepared for the policymakers are out of practice. Hence, Here, the level of inflation rises through 2% information, and powered by social media, sequels, and to dodge the chomps coming we can probably expect the sort of stop-go inflation targets and keeps rising above 4%. the collective action of the public may reveal for the 60:40 portfolios. driving of an old Land Rover going off-road, This could also happen quite quickly, and the greater truth about money and inflation: where the driver is scared both of driving too currency weakness may well be a part of this it is a confidence game. fast and of stalling the vehicle in a muddy story too, just not the abrupt weakness of a What happens if enough of the crowd ditch. This is the bumpy journey towards a currency crisis. This would look more like start to believe that sharp bursts of inflation policy regime which looks more like Modern the 1960s-1970s playbook. (even if not sustained) are proof of the Monetary Theory or helicopter money – Of course, different economies will have the explicit and enduring coordination of different characteristics, and may have monetary and fiscal policy. wildly different experiences. In particular, As inflation volatility rises, we will the US, with the dollar as the world’s reserve discover how inflation-prone economies currency, will matter enormously to what are. This will be the first test of structural happens globally. disinflationary forces clashing against more recent supply side shocks. THE CONFIDENCE GAME If the structural disinflationary forces I believe inflation, when it emerges in still dominate, then inflation volatility will earnest, will be a tipping-point phenomenon remain high while the underlying level – of the genetically-mutated variety – of inflation will rise only slowly. In this rather than a more linear input-output scenario, I think it is currencies that become mechanical phenomenon. Policymakers the confidence in expectation that matters, rather than itself; this is unlikely to be captured surv eys. brittle – there is a higher likelihood of will be focused on labour markets and 8 I doubt this drying of the psychological tinder will be picked up by survey measures inflation expectations. believe it is The Ruffer Review 2021 Jurassic risk and the chomping of the traditional balanced portfolio PAGE 33

THE SHAPE OF TRUST IS CHANGING. Technology and bad actors have chipped away at long-standing hierarchies of trust. A new trust architecture is growing in its place – emerging organically, dominated by technology platforms, where people place faith in strangers, and in computer code. The nature of trust has shifted before. What is really different today? And what might it mean for money – a system that has rightly been called both “portable power”

DUNCAN MACINNES and “trust inscribed”? Here we present eight Investment Director voices on the theme of trust and money. Which voices to listen to? What to believe? PAGE 35

In God we trust All others pay cash

DUNCAN MACINNES and “trust inscribed”? Here we present eight Investment Director voices on the theme of trust and money. Which voices to listen to? What to believe? PAGE 36 The Ruffer Review 2021 In God we trust – all others pay cash

“It is a slow process which we call either ideological subversion or active measures. What it means is to change the perception of reality of every American

to such extent that THE VOICE OF despite the abundance DESTABILISED PERCEPTIONS of information, no-one is able In his 2016 film HyperNormalisation, – government, academia, the professions, to come to sensible conclusions Adam Curtis features Russian politician religion, and the media – are crumbling, Vladislav Surkov. An adviser to President undermined by visible scandals – from in the interests of Vladimir Putin, Surkov stated his goal is to Deepwater Horizon to bankers rigging undermine people’s perception of the world, LIBOR, #MeToo to Abu Ghraib. so they never know what is really happening. Before the rise of the internet, who was In Curtis’s words, Surkov wanted to turn saying something, and who they were defending themselves, their families, politics into a “bewildering, constantly representing, influenced both what we heard changing piece of theatre”. Every group and how we interpreted it. Today, social their community could be sponsored and supported – from media platforms have democratised access to neo-Nazi skinheads to liberal human rights an audience of billions. Here, your impact is or their country.” groups. The key thing for Surkov was that determined by the virality and sensationalism he made it known that this was what he was of your content, rather than its veracity. doing, so that “nobody was sure what is real Of course, fake news is not new, nor is or what is fake.” misinformation in politics – in ancient Rome, Yuri Bezmenov, KGB defector. This is a world of destabilised perception. Octavian spread rumours about his rival The concept of truth becomes more Mark Anthony via commissioned poems ephemeral. and slogans printed on silver coins. What’s Trust structures anchored around ‘the new is how cheap and easy it has become to establishment’ and those with credentials misinform people, and on a large scale. The Ruffer Review 2021 In God we trust – all others pay cash PAGE 37

“It is a slow process which we call either ideological subversion or active measures. What it means is to change the perception of reality of every American

to such extent that THE VOICE OF despite the abundance DESTABILISED PERCEPTIONS of information, no-one is able In his 2016 film HyperNormalisation, – government, academia, the professions, to come to sensible conclusions Adam Curtis features Russian politician religion, and the media – are crumbling, Vladislav Surkov. An adviser to President undermined by visible scandals – from in the interests of Vladimir Putin, Surkov stated his goal is to Deepwater Horizon to bankers rigging undermine people’s perception of the world, LIBOR, #MeToo to Abu Ghraib. so they never know what is really happening. Before the rise of the internet, who was In Curtis’s words, Surkov wanted to turn saying something, and who they were defending themselves, their families, politics into a “bewildering, constantly representing, influenced both what we heard changing piece of theatre”. Every group and how we interpreted it. Today, social their community could be sponsored and supported – from media platforms have democratised access to neo-Nazi skinheads to liberal human rights an audience of billions. Here, your impact is or their country.” groups. The key thing for Surkov was that determined by the virality and sensationalism he made it known that this was what he was of your content, rather than its veracity. doing, so that “nobody was sure what is real Of course, fake news is not new, nor is or what is fake.” misinformation in politics – in ancient Rome, Yuri Bezmenov, KGB defector. This is a world of destabilised perception. Octavian spread rumours about his rival The concept of truth becomes more Mark Anthony via commissioned poems ephemeral. and slogans printed on silver coins. What’s Trust structures anchored around ‘the new is how cheap and easy it has become to establishment’ and those with credentials misinform people, and on a large scale. PAGE 38 The Ruffer Review 2021 In God Wewe trustTrust – – all all others other pay cash

WITH SO MUCH PROPAGANDA, IT IS HARD TO A ONE-WAY CONVERSATION CALM DOWN Can we at least, please, agree on the facts? Or do you have your facts, and I have mine? Take a look at this survey. A big company polled people across nearly two dozen countries, not long ago. You’ll have ENOUGH TO to trust me on the source, and on this result – 81% of people find it hard to know who or what to trust, due to contradictory information. Which links to a paradox: a world that has grown interdependent, globalised, and interconnected; yet also LISTEN.” more individualised, full of personally-curated experiences. My Twitter feed is unique to me – to foster engagement, keep me scrolling, scrolling, scrolling. Your feed is unique too, but within your own filter bubble. We’re in different echo chambers – and we can’t hear each other. Family, history, morality, truth – do you and I agree on what these words mean? If we don’t, we have no collective consensus on key cultural foundations. If we all have our own NAOMI WOLF truthiness, what does it mean for our collective expressions of trust, like the money we use? The Ruffer Review 2021 In God Wewe trustTrust – – all all others other pay cash PAGE 39

WITH SO MUCH PROPAGANDA, IT IS HARD TO A ONE-WAY CONVERSATION CALM DOWN Can we at least, please, agree on the facts? Or do you have your facts, and I have mine? Take a look at this survey. A big company polled people across nearly two dozen countries, not long ago. You’ll have ENOUGH TO to trust me on the source, and on this result – 81% of people find it hard to know who or what to trust, due to contradictory information. Which links to a paradox: a world that has grown interdependent, globalised, and interconnected; yet also LISTEN.” more individualised, full of personally-curated experiences. My Twitter feed is unique to me – to foster engagement, keep me scrolling, scrolling, scrolling. Your feed is unique too, but within your own filter bubble. We’re in different echo chambers – and we can’t hear each other. Family, history, morality, truth – do you and I agree on what these words mean? If we don’t, we have no collective consensus on key cultural foundations. If we all have our own NAOMI WOLF truthiness, what does it mean for our collective expressions of trust, like the money we use? PAGE 40 The Ruffer Review 2021 In God we trust – all others pay cash

ENTER THE ALGORITHMS

We trust Google’s search bar with all Getting into cars with strangers, via our secrets and desires. Smart speakers, Uber and Lyft. Or arranging to sleep in a “THESE LARGE including Amazon’s Alexa, sit in nearly 200 stranger’s house – as around two million million homes1 around the world listening, people do every evening – via Airbnb. CORPORATIONS recording, and learning from us. Wikipedia These are remarkable exercises of trust. is a remarkable source of reference, yet it is Collectively, we have sleepwalked into (AND GOVERNMENTS) free to be edited by anyone and verified by outsourcing important parts of our lives nothing more than the collective wisdom of to lines of code. Why? Expediency and NOW HAVE NEW TOOLS the anonymous crowd. convenience. We trust the algorithms, but Meanwhile, the ‘sharing economy’ enables few of us have any real conception of how AND STEALTH METHODS people to do what was once unthinkable. these digital systems work. TO QUIETLY MODEL OUR PERSONALITY, OUR VULNERABILITIES AND EFFECTIVELY NUDGE AND SHAPE OUR IDEAS, DESIRES AND DREAMS.”

ZEYNEP TUFECKI 1 Canalys/Strategy Analytics, estimate (December 2019) The Ruffer Review 2021 In God we trust – all others pay cash PAGE 41

ENTER THE ALGORITHMS

ZEYNEP TUFECKI 1 Canalys/Strategy Analytics, estimate (December 2019) PAGE 42 The Ruffer Review 2021 In God we trust – all others pay cash

THE FIVE CHARACTERISTICS OF MONEY

DIVISIBLE Can be scaled for transactions large and small

DURABLE A store of value; so spending can be deferred “Myth and unquestioned

RECOGNISABLE Must be easily verified by people who don’t belief is important in trust each other

PORTABLE Easy to move monetary matters. How

SCARCE To avoid debasement or dilution in value many of us have literal direct assurance of the existence of most items

ANYTHING CAN we regard as constituting BE MONEY our wealth?”

Jorge Luis Borges called money “a panoply What constitutes money has changed of possible futures”. Dostoevsky called it dramatically over centuries. Seashells, “minted freedom”, Niall Ferguson described salt, beads, stone and silver have all acted money as “trust inscribed” and “portable as money at different times and places. power”. But what is it? In American prisons, currency has changed Milton Friedman Money is a token of distilled labour; from cigarettes to noodle cups, as smoking we receive it in return for our efforts and has declined. can spend it in the future. This requires All money is to some extent a virtual delayed gratification and implicit trust that construct. Money can be anything so money will retain its value. Money is also a long as it is recognised as a unit of technology allowing us to exchange goods economic value within the system in and services with third parties whom we which you are transacting. have no basis for trusting. The Ruffer Review 2021 In God we trust – all others pay cash PAGE 43

THE FIVE CHARACTERISTICS OF MONEY

DIVISIBLE Can be scaled for transactions large and small

DURABLE A store of value; so spending can be deferred “Myth and unquestioned

RECOGNISABLE Must be easily verified by people who don’t belief is important in trust each other

PORTABLE Easy to move monetary matters. How

SCARCE To avoid debasement or dilution in value many of us have literal direct assurance of the existence of most items

ANYTHING CAN we regard as constituting BE MONEY our wealth?”

Jorge Luis Borges called money “a panoply What constitutes money has changed of possible futures”. Dostoevsky called it dramatically over centuries. Seashells, “minted freedom”, Niall Ferguson described salt, beads, stone and silver have all acted money as “trust inscribed” and “portable as money at different times and places. power”. But what is it? In American prisons, currency has changed Milton Friedman Money is a token of distilled labour; from cigarettes to noodle cups, as smoking we receive it in return for our efforts and has declined. can spend it in the future. This requires All money is to some extent a virtual delayed gratification and implicit trust that construct. Money can be anything so money will retain its value. Money is also a long as it is recognised as a unit of technology allowing us to exchange goods economic value within the system in and services with third parties whom we which you are transacting. have no basis for trusting. PAGE 44 The Ruffer Review 2021 In God we trust – all others pay cash

FROM GOLD TO DIGITS

Over centuries, the world settled on gold The severing of this link transformed as a dominant form of money. This was an the world from a gold-backed monetary organic, free-market decision. No central body system to a system based on faith in the ordained it: independent economic actors authority and durability of the issuing gravitated towards gold as the medium they government. Since then, we have operated trusted most to hold value and to be accepted a ‘pure fiat’ monetary system, no longer by others. bounded by scarcity. However, gold has weaknesses as a Fast forward to today and the value of monetary medium: it is expensive and money rests on a collective belief in its value risky to transport, and not easy to divide. and a faith in the authority and durability of So the technology of paper (fiat) money was the issuing government. invented; originally, the paper was fully Money has become even further de- backed and redeemable in gold. materialised and intangible as it has Most developed nations operated digitised. More than 90% of total money is currencies tethered to gold until the 1930s, not money in any physical sense. Modern with this gold standard, for the most part, money is nothing more than an entry in broken only in times of war. It wasn’t until a ledger, a digital footprint. Numbers on 1971 that all the world’s currencies became your bank balance or pension statement, completely detached from gold when the electronic records of debits and credits. US President Richard Nixon ended the When we say we spend money, what we are convertibility of the dollar. really doing is trusting someone else to make JOHN MAYNARD KEYNES, 1924. and keep entries on digital registers. The Ruffer Review 2021 In God we trust – all others pay cash PAGE 45

FROM GOLD TO DIGITS

Over centuries, the world settled on gold The severing of this link transformed as a dominant form of money. This was an the world from a gold-backed monetary organic, free-market decision. No central body system to a system based on faith in the ordained it: independent economic actors authority and durability of the issuing gravitated towards gold as the medium they government. Since then, we have operated trusted most to hold value and to be accepted a ‘pure fiat’ monetary system, no longer by others. bounded by scarcity. However, gold has weaknesses as a Fast forward to today and the value of monetary medium: it is expensive and money rests on a collective belief in its value risky to transport, and not easy to divide. and a faith in the authority and durability of So the technology of paper (fiat) money was the issuing government. invented; originally, the paper was fully Money has become even further de- backed and redeemable in gold. materialised and intangible as it has Most developed nations operated digitised. More than 90% of total money is currencies tethered to gold until the 1930s, not money in any physical sense. Modern with this gold standard, for the most part, money is nothing more than an entry in broken only in times of war. It wasn’t until a ledger, a digital footprint. Numbers on 1971 that all the world’s currencies became your bank balance or pension statement, completely detached from gold when the electronic records of debits and credits. US President Richard Nixon ended the When we say we spend money, what we are convertibility of the dollar. really doing is trusting someone else to make JOHN MAYNARD KEYNES, 1924. and keep entries on digital registers. PAGE 46 The Ruffer Review 2021 In God we trust – all others pay cash The US government has A WARNING OF WEAKNESS a technology,

Never-ending deficit spending, quantitative called a printing easing, ballooning burdens of debt and the increasing likelihood of outright monetary financing or Modern Monetary Theory – press or today governments and central banks are pushing their credibility to the limit. The Cantillon effect observes that the its electronic creation of money is different from the creation of wealth, but how different it is depends on how far away you are from the money creation. equivalent That Printing money stokes the fires of populism, inequality and inflation. The Romans shaved silver from their allows it to coins to fund foreign campaigns and soldiers’ pensions. To meet war reparations, the German Reichsmark was printed in such quantities it produce as in effect became worthless. In our day, those in Egypt, Argentina, Russia, Turkey, Syria and Venezuela have learned that economic, social many US dollars and political factors can wreak monetary chaos. Perhaps the surprise is that trust in our monetary system remains robust. We may as it wishes at have grown too familiar and too comfortable to conceive of calamity. Or, with many asset prices near all-time no cost highs, could we be suffering from a collective optical illusion? Rather than see asset prices booming, maybe it is simply that the BEN BERNANKE denominator – fiat currency – is diminishing. Former Chairman of the US Federal Reserve The Ruffer Review 2021 In God we trust – all others pay cash PAGE 47 The US government has A WARNING OF WEAKNESS a technology,

Never-ending deficit spending, quantitative called a printing easing, ballooning burdens of debt and the increasing likelihood of outright monetary financing or Modern Monetary Theory – press or today governments and central banks are pushing their credibility to the limit. The Cantillon effect observes that the its electronic creation of money is different from the creation of wealth, but how different it is depends on how far away you are from the money creation. equivalent That Printing money stokes the fires of populism, inequality and inflation. The Romans shaved silver from their allows it to coins to fund foreign campaigns and soldiers’ pensions. To meet war reparations, the German Reichsmark was printed in such quantities it produce as in effect became worthless. In our day, those in Egypt, Argentina, Russia, Turkey, Syria and Venezuela have learned that economic, social many US dollars and political factors can wreak monetary chaos. Perhaps the surprise is that trust in our monetary system remains robust. We may as it wishes at have grown too familiar and too comfortable to conceive of calamity. Or, with many asset prices near all-time no cost highs, could we be suffering from a collective optical illusion? Rather than see asset prices booming, maybe it is simply that the BEN BERNANKE denominator – fiat currency – is diminishing. Former Chairman of the US Federal Reserve PAGE 48 The Ruffer Review 2021 In God we trust – all others pay cash

1010101010101010101010101010101010101010101010101 01010 Bitcoin is a 010101010101010101010101 non-sovereign,01010 hard-cap 0101010101010101010101010101010 01010101010101010 supply,0101010 global,1010101010 immutable, decentralised, 101010 digital,10101010101 1010101010101010101010101010101010101010101010101 010101010101 store of value. 1010101010101010101010101010 It is an 10101010101010101010 insurance 01010101010101010101 010101010101policy against 01010101010101010101010101 the monetary 010101010101010 and fiscal 0101010101010101 1010101010101010101010101010101010101010101010101 01 policy mistakes of 010 central banks 010101010 IS THIS NEW 1010101010101010101010101010101010101010101010101 MONEY’S MOMENT? 010101010101010101 around the world.01010101010

1010101010101010101010101010101010101010101 An asset with a wild reputation, bitcoin sits at the intersection of populism, inflation, trust, and money. It was born in a storm, created during the trust- 010101010101010101010101010101010101010101010101010 shattering events of the global financial crisis in 2008. Bitcoin and its distributed ledger technology represent the invention of digital Travis 010101010101010101010101010101010 scarcity. At its core, this removes the need for trust in economic transactions, because the network itself provides verification. Rather than requiring the user 10101010 Kling 1010101010101010101010101010101010 to place faith in the issuer, this new monetary asset creates reliability from a combination of mathematics, cryptography, and the collective incentives of crowds 010101010101010101010101010101010101010101 – verified and supported by a powerful computer network. What is this asset worth? Bitcoins are valuable because of the inviolable trust- 0101010101010101010101010101010101010101010101 machine that mints them like digital gold. Its price could soar if it gains widespread adoption as a store of value. Or its price could collapse, for any of a large number of 1010101010101010101010 reasons, sending bitcoin the way of the Angolan kwanza or the Yugoslavian dinar. The Ruffer Review 2021 In God we trust – all others pay cash PAGE 49

1010101010101010101010101010101010101010101 An asset with a wild reputation, bitcoin sits at the intersection of populism, inflation, trust, and money. It was born in a storm, created during the trust- 010101010101010101010101010101010101010101010101010 shattering events of the global financial crisis in 2008. Bitcoin and its distributed ledger technology represent the invention of digital Travis 010101010101010101010101010101010 scarcity. At its core, this removes the need for trust in economic transactions, because the network itself provides verification. Rather than requiring the user 10101010 Kling 1010101010101010101010101010101010 to place faith in the issuer, this new monetary asset creates reliability from a combination of mathematics, cryptography, and the collective incentives of crowds 010101010101010101010101010101010101010101 – verified and supported by a powerful computer network. What is this asset worth? Bitcoins are valuable because of the inviolable trust- 0101010101010101010101010101010101010101010101 machine that mints them like digital gold. Its price could soar if it gains widespread adoption as a store of value. Or its price could collapse, for any of a large number of 1010101010101010101010 reasons, sending bitcoin the way of the Angolan kwanza or the Yugoslavian dinar. PAGE 50 The Ruffer Review 2021 In God we trust – all others pay cash

PUTTING A NUMBER ON TRUST

A concluding question – how should investors think about this? In financial terms, trust is a risk premium. The less we trust, the more we should expect a higher return or a larger discount to compensate us for the risk. Investors today seem complacent about trust. They are therefore embedding Joseph Stiglitz a low or zero trust premium in their valuation models. What investment portfolios need to be braced for is a sudden, jarring, re-appraisal – a collective awakening to money’s fragility. Money has become untethered from scarcity, productivity, and economic value. Through centralisation and digitisation, it can be created at will by people with an incentive to do so. Money faces the same degradation of trust as other traditional institutions. In a landscape of shifting trust, there may be much less of a role for money backed only by promises. WATER SCARCITY A LOW-WATER MARK AND CLIMATE CHANGE Only 3% of water in the world is freshwater. Disruption to weather patterns and an Of that, two thirds is locked in ice. The increase in extreme events have played majority of the remaining 1% is subterranean, havoc with the water cycle. If climate difficult to access and hard to replenish.1 change is a shark, then water resources are The tiny fraction of water that we can access the teeth. The freshwater crisis is alarming should be enough to sustain a growing not only because of our dependence on population. Yet our starting point for water water, but also because of the speed at security is worrisome: 2.2 billion people which the crisis is approaching. still lack access to drinking water that is managed safely.2 Covid-19 has exposed years of underinvestment in water and sanitation. Only around 60% of people have facilities WATER 3 to wash their hands at home. This makes simple virus prevention measures impossible. The United Nations’ sixth Sustainable Development Goal calls for “the availability SCARCITY and sustainable management of water and THE OTHER LIQUIDITY CRISIS sanitation for all”, yet in July 2020 the UN itself said that the pursuit of this goal is “alarmingly off track”. Water, in many ways, is a proxy for life itself. Civilisations have sprung from fertile river valleys and along the trading routes of the seas. For NASA, when searching for extra-terrestrial life, the guiding principle has been to ‘follow the water’.

WHAT IS WATER SCARCITY? Quite simply, it is when available freshwater supplies fail to meet demand. But water scarcity is not confined to regions of low annual rainfall. It can arise from poor infrastructure or mismanagement. As populations soar, freshwater supplies are failing to keep pace. Almost half of the human race now live in water-scarce regions. FELICITY HALL Investment Associate 1 US Geological Survey (November 2019) 2 Sustainable Development Goals Report 2020 3 Ibid PAGE 53

WATER SCARCITY A LOW-WATER MARK AND CLIMATE CHANGE Only 3% of water in the world is freshwater. Disruption to weather patterns and an Of that, two thirds is locked in ice. The increase in extreme events have played majority of the remaining 1% is subterranean, havoc with the water cycle. If climate difficult to access and hard to replenish.1 change is a shark, then water resources are The tiny fraction of water that we can access the teeth. The freshwater crisis is alarming should be enough to sustain a growing not only because of our dependence on population. Yet our starting point for water water, but also because of the speed at security is worrisome: 2.2 billion people which the crisis is approaching. still lack access to drinking water that is managed safely.2 Covid-19 has exposed years of underinvestment in water and sanitation. Only around 60% of people have facilities WATER 3 to wash their hands at home. This makes simple virus prevention measures impossible. The United Nations’ sixth Sustainable Development Goal calls for “the availability SCARCITY and sustainable management of water and THE OTHER LIQUIDITY CRISIS sanitation for all”, yet in July 2020 the UN itself said that the pursuit of this goal is “alarmingly off track”. Water, in many ways, is a proxy for life itself. Civilisations have sprung from fertile river valleys and along the trading routes of the seas. For NASA, when searching for extra-terrestrial life, the guiding principle has been to ‘follow the water’.

DAY ZERO Day zero is the first day the taps run dry. It has already dawned on several cities, most famously Cape Town in early 2018. Water was restricted to 60 litres per person per day in the South African city, around one sixth of what the average American uses every day at home.7 The crisis exposed the delusion that our drinking water supply is unlimited. Cape Town is not the only city to have come so close to disaster: São Paulo in SOLUTIONS CONSEQUENCE 2015, Barcelona in 2008, and the Indian city LEGAL AND PUBLIC POLICY For many, the fundamental problem of water MIGRATION of Shimla in 2018 have all faced the ticking In the driest regions in the world, freshwater scarcity lies not so much in the available clock of day zero.8 supplies have already reached the point volume of freshwater but in its management. of exhaustion. It is estimated that water This means that legal and policy-based tools scarcity could displace 700 million are a crucial part of the solution. These tools people by 2030.5 must ensure that human rights are protected Five years of drought in the Central and water-sharing agreements are fair and American dry corridor forced farmers into enforced both sub-nationally and across CONSEQUENCE the US in search of work. In Syria, the civil SOLUTIONS borders: 60% of global freshwater flow CONFLICT war was pre-dated by the harshest national TECHNOLOGIES AND comes from basins which cross 6 9 Competition for water has been a source drought on record between 2006 and 2011. ECONOMIC TOOLS national borders. of human conflict throughout history. Water scarcity led to widespread crop failure Improvements in efficiency and the use of We may have exchanged the water mills and consecutive poor harvests, driving rural new technologies can help minimise demand of old for the Three Gorges Dam, but the families into cities to seek employment. The while maximising supply. The Goreangab relationship between mankind and water strain on food resources and infrastructure waste treatment plant in Namibia offers an remains unchanged. As water becomes led to outbreaks of violence. example of how water reuse technology has scarcer, conflict seems inevitable. Of the 500 eased the scarcity crisis for one of the most THE WAY FORWARD? The answer most probably lies in employing water-related conflicts since 1900, half have arid countries in the world. Established a combination of approaches. Focus solely occurred in the last 10 years.4 in the 1960s to recycle wastewater, the on efficiency, and the livelihood of remote In Kashmir and Delhi, recent droughts plant now supplies around a quarter of farmers growing alfalfa in the desert is have sparked violent demonstrations the freshwater required by Namibia’s untenable. Put too high a price on water, against the government, and similar stories capital, Windhoek. Other new technologies and you risk exacerbating inequality and are unfolding in Iran and Iraq. In Yemen, are emerging, from the desalination of hindering emerging economies. water is not so much a cause but a casualty seawater to new sensors for detecting leaks, The value of water, unlike gold, does of conflict in the ongoing civil war, with all of which should help us use and reuse not depend on its scarcity. Its value lies in essential water sources targeted as a tactic water more efficiently. Economic tools, its necessity. for weakening the opposition. Trouble is such as thoughtfully constructed pricing also brewing with the Grand Ethiopian mechanisms and the reduction of harmful Renaissance Dam (GERD) on the Nile, where subsidies, can ensure that the true value and

in 2020, Egypt threatened military action. 4 Wallace-Wells (2019), The Uninhabitable Earth 5 Sustainable Development Goals Report 2020 6 Cook et al (2016), Journal of Geophysical Research: Atmospheres 7 US Environmental Protection Agency 8 Wallace-Wells (2019), The Uninhabitable Earth 9 Sustainable Development Goals Report 2020 scarcity of water is reflected in its price. THE CORONAVIRUS CRISIS HAS ACCELERATED PRE-EXISTING TECTONIC SHIFTS THAT ARE CHANGING WORLD ORDER. Four interlinked areas deserve the attention of long-term investors: greater geopolitical instability; the digital revolution; domestic political changes in the advanced economies; and the rise of environmental, social and governance (ESG) considerations. Together, these make for a more volatile and inflation-prone regime, one that is less favourable to capital. In short, we’re moving from a world where profit trumped politics, to one where THE GREAT politics trump profit.

THE OSTRICH EFFECT DESCRIBES A ACCELERATION REFUSAL TO ENGAGE WITH NEGATIVE INFORMATION. Pre-pandemic, much of the investment world was in denial about the reality of Cold War II and the geopolitical regime change it entails. Little wonder. Several decades of Great Power peace supercharged globalisation and the integration of cheap Chinese workers with the world economy. Both have been key drivers of the falling inflation, interest rates and volatility which have underwritten a Golden Age for capital. But unfettered Sino-Western entanglement only made sense if history had died with the first Cold War. It hadn’t, and a new East-West schism guarantees at least a partial unravelling of ALEXANDER CHARTRES this profitable settlement. Investment Director With covid-19 fallout sending US-China relations to their lowest ebb since formal ties were established in 1979, a fundamental change in world order is now harder to ignore. Trade tensions quickly became a footnote as the tech war escalated, morphing into outright hostility and nakedly ideological competition. PAGE 57

THE CORONAVIRUS CRISIS HAS ACCELERATED PRE-EXISTING TECTONIC SHIFTS THAT ARE CHANGING WORLD ORDER. Four interlinked areas deserve the attention of long-term investors: greater geopolitical instability; the digital revolution; domestic political changes in the advanced economies; and the rise of environmental, social and governance (ESG) considerations. Together, these make for a more volatile and inflation-prone regime, one that is less favourable to capital. In short, we’re moving from a world where profit trumped politics, to one where THE GREAT politics trump profit.

Rhetoric and reality began to elide. US this idea, with Xi Jinping declaring that “the domestic economy – runs alongside efforts and mass migration alongside wars over firms have been encouraged to de-couple pandemic once again proves the supremacy to expand its sphere of influence using the water and other resources. Geopolitics and their supply chains from China, especially of the socialist system with Chinese Belt and Road Initiative and its newly-minted economics become less stable. Compounded those involving advanced technology. Or characteristics.” South and East Asian regional trade deal with existing weather super-cycles such as La consider the pressure on Thrift, America’s Seen from Zhongnanhai – China’s White (RCEP). Meanwhile, the Sino-EU trade deal – Niña, the disruption will put more emphasis largest public-pension scheme, not to use House – America’s botched pandemic purposefully consummated just before Biden on security of supply, not simply the cost of investment benchmarks incorporating response, civil unrest and turbulent election beds in – aims to keep the West divided, and supply. Again, higher prices are likely. Chinese or Russian stocks. Or the ban on fallout provide further evidence of inexorable politics subservient to profits. US entities holding shares in Chinese firms US decline whilst affirming China’s gradual Geo-economic blocs with different trade, A, B, C, D, E, S, G… linked to the People’s Liberation Army. These restoration to the pinnacle of world order as regulatory and currency ecosystems centred In recent years, growing climate are merely amuse-bouches for greater capital ‘first under heaven’. on China, America and the EU – where consciousness has brought a greater focus conflict to come. President Xi has already used covid-19 enthusiasm for ‘strategic autonomy’ has on environmental, social and governance Von Clausewitz’s oft-misunderstood chaos as cover to advance China’s interests grown in parallel to US-China tensions – will considerations within the investment and formulation that “war is simply the in its near-abroad, from Hong Kong to the be a defining feature of the new landscape. business communities. Known by the continuation of policy… with other means” Himalayas. Lenin once opined that “you So will a more interventionist industrial abbreviation ESG, these criteria aim to reflects an eternal truth about conflict: it is probe with bayonets: if you find mush, you policy in the West, as it tries to re-build its consider the wider impact of companies, a dial, not a switch. This is truer today than push. If you find steel, you withdraw.” To date, domestic production capacity. looking beyond profitability. Considering ever before thanks to the proliferation of Xi has found only mush in his periphery, So the impetus for further de-coupling greenhouse gas emissions, for example, or capital markets, cyberspace and globalised and perceived US weakness may encourage is clear. It will become harder to run supply the treatment of workers. businesses. These novel battlefields place Beijing to test the new administration sooner chains through strategic adversaries. Investors like to talk figuratively about investors in the firing line. So the historic rather than later. Separate China and non-China supply chains the ‘investable universe’ of ideas. The reality, challenge of a twenty-first century Cold War On Taiwan, for example, the 40-year- will increase the cost of doing business. of course, is that there’s only one investable – and the return of Great Power politics more old status quo is crumbling fast and Xi has Market access will become more restrictive. planet open to us, so long-term stewardship broadly – is that there are well over 50 shades said that reunification issues “cannot be And the more decisive the schism, the lower of capital must ensure that economic activity of grey between (hot) war and peace. passed on from generation to generation.” the bar to Chinese adventurism. is sustainable. Markets should take him at his word. Taken together, tectonic geopolitical shifts For investors (including Ruffer), ESG BAYONETS AND MUSH Beyond the obvious risk of direct conflict will drive greater volatility, higher inflation criteria are invaluable when considering extra So where next? In Joe Biden, there’s a new between the world’s two largest economies, and will privilege politics over profit. dimensions of risk and opportunity. But they sheriff in town. The style has already changed the global economy is extraordinarily materially, of course – less tweeting from dependent on Taiwan for the most advanced BLACK SWANS, GRAY RHINOS the hip – but the substance is unlikely to. semiconductors. Any crisis there or over In the zoological pantheon of market Democrats’ traditionally tougher line on other disputed territories in the South China dangers, coronavirus was less a black swan human rights and deep Sino-scepticism Sea threatens the significant proportion – something impossible to predict – and across the political spectrum will limit room of global maritime trade sailing through it more a ‘gray rhino’. Coined by Michele for manoeuvre. Indeed, Biden may be able to whilst potentially catalysing broader-based Wucker, gray rhinos are “highly obvious, exert more sustained pressure by refocusing economic de-coupling. highly probable, but still neglected” risks. on US alliances. Think of a black swan crossed with the For Beijing’s perspective, recall first that BALKANISATION ADVANCES elephant in the room. the 2008 financial crisis emboldened China’s Cratered relations have accelerated China’s Climate change is a classic gray rhino. elite. It was the moment that many no longer efforts to wean itself off American tech, A warmer world promises more frequent and assumed convergence with a Western model dollars and foreign oil. Beijing’s renewed extreme weather events. With that comes was inevitable. The events of 2020 reinforced push on ‘dual circulation’ – a more autarkic crop failures, commodity price volatility The Ruffer Review 2021 The Great Acceleration PAGE 59

are also inherently more subjective than ‘politicisation of everything’. The investment pure financial metrics: one man’s terrorist world is no exception. Beyond its considerable is another’s freedom fighter, yet both would practical benefits, ESG will prove sticky both recognise a profit. because it helps satisfy the deep human quest Consequently, the greater long-term for meaning, and because it can be used to significance for markets of ESG measures establish political preferences. Operating in may be to accelerate the dominance of politics concert with indexation and passive tracker over profit. funds – both financial superpowers of the Take carbon border-adjustment taxes. twenty-first century – ESG judgement will be In theory, these are designed to adjust a force to be reckoned with. for the climate impact of goods – so that, All told, the growing focus on for example, a lower-emission domestic environmental risk and ESG issues will producer of steel is not disadvantaged against compound the effects of Cold War II steel imported from a high-emission mill and create huge new opportunities. But, overseas. In practice, these taxes can also be a relative to the benign settlement of recent disguised form of protectionism for domestic decades, investors and businesses face industry. This may be politically, socially or more constrained choice over where to environmentally desirable, but costs are going deploy capital. Expect increasing costs, new up whatever happens. dimensions of risk, and the privileging of the At the same time, geopolitical tension political over the profitable. will draw more attention to the social and governance factors, the S and the G of ESG. THE SECOND MACHINE AGE Relative to carbon emissions, say, investors The relentless march of technology is another have focused little on China’s human rights defining feature of our time. If the Industrial abuses, in Xinjiang and elsewhere. Running Revolution kick-started the first machine age, long supply chains through dubious regimes digital technology has birthed the second. will become harder to justify, bringing Andrew McAfee and Erik Brynjolfsson of reputational and financial risk. This will the Massachusetts Institute of Technology If the Industrial further encourage the post-credit crunch observe that the digital revolution is doing trend of de-globalisation in favour of for mankind’s mental capacity what James Revolution kick-started regionalisation. Watt’s steam revolution did for our physical In time, governance considerations may capacity: side-lining it. the first machine age, come to include national security objectives. And, as with the first machine age, we can Stressed about the lack of truly independent expect similarly dramatic political, economic digital technology has non-executive directors on the board of a and social dislocation this time. Western firm? Try investing in the corporate By supercharging global digitisation, birthed the second.” outriders of a one-party dictatorship. covid-19 just laid even more of the world economy at the feet of the tech titans, THE POLITICISATION accelerating our advance into the age of data- OF EVERYTHING driven ‘surveillance capitalism’. Geopolitics aside, the West is undergoing Networks create positive feedback loops: a broader cultural revolution towards the the bigger the network, the more useful it is, The Ruffer Review 2021 PAGE 61

which draws more users, and so on. In this Digital mastery is central to Cold War II accepted – and expected – in terms of state way, the digital era brings a winner-takes-all then, and will help decide the victor. But involvement in everyday life has widened effect, favouring fewer, larger companies. digitisation also poses a viral threat not considerably. Post-covid, saying ‘no’ to The tendency is towards monopoly. unlike covid-19: a cyber Pearl Harbor switching on the printing presses and turning “With the rise of digital – a crippling attack on critical national on the spending taps will be far harder. BIG TECH, BIGGER QUESTIONS infrastructure that could make pandemic A more inflation-prone fiscal dominance has Digital technology’s naturally disruptive money, how the world shutdowns look benign. This is another gray replaced monetarist orthodoxy. It is here and monopolistic tendencies will encourage pays is firmly in play.” rhino, and it is surely only a matter of time to stay. greater government intervention in the before such an attack occurs. Appetite for more activist government economy: ‘anti-trust’ counter-monopoly Computer viruses embody one of the had been growing for some years anyway. measures are set to be a hardy perennial. core features of (most) digital goods and Recent decades may have been a Golden Politicians are also stirring because of Big and big data. China has a natural advantage services: infinite replication at virtually nil Age for capital on account of globalisation, Tech’s colossal political power, exemplified by in the data economy. Sitting atop the world’s cost. This winner-takes-all dynamic creates technology and laissez-faire economic policy, Twitter’s de-platforming of Trump. In China, greatest natural information mine – a 1.4 extraordinary abundance – but also widens but the gains accruing to China and the the humbling of Alibaba founder Jack Ma sent billion-strong population without a privacy the jaws between the ‘have yachts’ and the Western economic elite have come in part its own pointed message: nothing is bigger tradition – it aims to be for data what ‘have nots’. They are contributing to what Joel at the expense of Western working classes. than the Chinese Communist Party. But Saudi Arabia is for oil. Since big data is a Kotkin has called ‘neo-feudalism’: a twenty- Median wages, for example, have been governments the world over are in a bind. competitive advantage, however, states – or first century version of the Middle Ages with stagnant since the 1970s despite significant On the one hand, they need to stop the geo-economic blocs – will guard it jealously. a handful of (tech) barons and a superfluity gains in productivity. digital revolution fatally undermining Unsurprisingly, who gets to set the global of serfs. In both the last UK and US general political and social order as well as hobbling (or regional) standards on data and Bringing these themes together, the elections, the working class vote was a economic competition. On the other, they technology is a key axis of twenty-first digital revolution is exacerbating geopolitical decisive demographic, from the Northern also need to harness the power of Big Tech to century realpolitik. instability and bloc formation, breeding gray ‘Red Wall’ of England to the US rust belt. This compete geopolitically. As in every previous And sitting at the intersection of rhinos and, through disruption and wealth influence is likely to increase demands for era, superiority in next-generation technology digitisation, economic blocs and realpolitik inequality, fuelling demand for more economic protectionism, not reduce it, and and industry are essential foundations for is control of money itself. King dollar still active government. send the pendulum back from capital towards global supremacy. Quantum computing, reigns supreme in the realm of conventional labour. This will probably include higher advanced semiconductors and space currencies, but China hopes its novel BIG GOVERNMENT’S minimum wages and increased capital taxes. weapons are just a few of the battlegrounds. digital yuan – the DCEP (Digital Currency BIG COMEBACK And, in a digital world, demands for All have the potential to be world-altering Electronic Payment) - will help establish The pandemic itself has also accelerated the economic protection are likely to expand technologies: in 2019, for example, Google a financial sphere of influence free from return of more interventionist governments from blue collar to white. “Beware the Greeks claimed that its Sycamore quantum processor dependence on the greenback. It marks in the West. Covid-19-induced shutdowns even when bearing gifts” wrote Virgil in the had performed in 200 seconds a calculation China’s attempt to revolutionise global pushed government deficit spending to levels Aeneid – perhaps today’s professional classes which a modern supercomputer would take finance in its favour. Is it only a matter last seen in the Second World War. Powers need an updated warning: beware the geeks 10,000 years to complete. Not to be outdone, of time before US tech titans provide the assumed by government in wartime (or crisis) bearing gifts. If you can do your job remotely, China claimed in late 2020 to possess a foundation for a rival to the DCEP? Like the tend to be relinquished grudgingly, if ever. so can someone else. For many in the service quantum computer which performed, in guns of Singapore, those focused on threats Financial repression - where interest rates sector, working from home is a Trojan horse, just over three minutes, what would have to dollar hegemony may have been looking are forcibly held beneath the level of inflation concealing the kind of disruption the working taken the fastest conventional computer 600 the wrong way, towards conventional rather - and increased state intervention remained classes experienced with the offshoring of million years to achieve. than digital currencies. With the rise of hallmarks of the UK long after 1945. Expect manufacturing 40 years ago. The ultimate prize lies in the combining digital money, how the world pays is firmly a similar lingering for the decade ahead. More immediately, the pandemic has of advanced processing, artificial intelligence in play. More broadly, the Overton window of what is widened the already considerable gap The Ruffer Review 2021 The Great Acceleration PAGE 63

between beneficiaries of the new knowledge a changing world is now dangerous. Instead, Lastly, emergent economic-regulatory economy, and those whose fortunes are tied adopt a fox-like mentality: range across change. blocs centred on the US, China and probably to the old, leading to a ‘K-shaped’ recovery. The central challenge is that the multi- the EU will shrink the available market for This is a risk. Wealth is ultimately built decade ‘everything trade’ driven by falling some global companies in high technology and secured on stable political foundations, inflation, interest rates and volatility has also and will make it generally harder to access themselves established in a broader culture. made conventional protections extremely Eastern growth with Western stocks. The challenge of extreme wealth inequality expensive – and that’s before you consider the National or bloc champions stand to benefit, to those stable foundations is as old as risk of inflation returning. both from reduced global competition and civilisation. Plutarch supposedly mused that Instead, anything which can protect from more activist states championing “an imbalance between rich and poor is the investors from the ravages of deeper financial their cause. oldest and most fatal ailment of all republics.” repression are worth considering: inflation- Wucker – who we met earlier – cites wealth protected bonds, real assets including gold A NEW MAXIM NEEDED inequality as another gray rhino of our time. and precious metals, perhaps a hard digital For a generation of investors, a guiding The political classes will conclude that the currency, too. All are ‘short’ positions on principle has been “Don’t fight the Fed” – ‘K’ is not OK, and investors should expect paper currency – in plain English, assets in other words, go with the direction set by measures to narrow the gap. whose values increase in line with the the world’s major central banks. In the new, The domestic political settlement authorities’ efforts to steal your savings more-politicised era before us, central banks within Western economies is thus under by stealth. and commercial banking systems will be considerable pressure. Assumptions in favour If the authorities succeed in engineering increasingly co-opted by governments. of globalisation, de-regulation and laissez- higher nominal economic growth – the “Don’t fight the government” may become faire policies are reversing, whilst geopolitical only plausible way to address both the debt the new maxim. and environmental instability encourage and the inequality issues – commodities, The 2008 financial crisis and the 2020 governments to bring critical capacities closer infrastructure, cyclical and value stocks covid crisis delivered a ‘one-two’ blow to to home. should perform strongly. So should the post-Cold War I order. That profitable As a result, a new age of government emerging markets. regime rested in large part on ‘end of activism is upon us. From fiscal splurges Desire for diversification may also history’ assumptions, from geopolitics funded by magic money trees to rebooted make Chinese assets look irresistible, and human nature to inflation. But history industrial policy, and higher corporate and particularly if they march to a different hadn’t ended at all. It was just sleeping. The capital taxes. It will not be so kind to the beat as Cold War II drives further de- covid punch accelerated the return of great owners and managers of capital. coupling. But geopolitical roadblocks power competition, the rise of ESG, the and ESG restrictions are likely to digital revolution, domestic political shifts, THE HEDGEHOG AND THE FOX make investing in China harder the growth of debt, and the return of fiscal For investors, the key to success in this – and riskier – not easier. That dominance. In turn, this has accelerated new era is resilience through genuine said, every challenge brings a regime change for world order and markets. diversification. What may have diversified commensurate opportunity. Our New World Disorder will be portfolios within a particular regime, may Cold War II is creating winners characterised by greater volatility, higher well not diversify them across others. every day, including economic inflation and deeper financial repression. Archilochus’s “fox [knew] many things, spill-over beneficiaries This world privileges politics over profit, and but the hedgehog one big thing.” That one such as Vietnam, Mexico favours the nimble, forward-looking fox over big thing? Knowledge of what has worked so and India. Japan looks the backward-looking hedgehog who only well in capital’s Golden Age. But relying on interesting from almost knows ‘one big thing’ from an era the hedgehog’s single back-tested strategy in every angle. that is ending. The Ruffer Review 2021 PAGE 65

THE COVID CRISIS HAS BROUGHT THE INFLATIONARY ENDGAME INTO VIEW. A belief that the current disinflationary regime would eventually break down has informed the Ruffer portfolio for many years. Regime breakdown’s most obvious consequences – inflation and institutional upheaval – are the dangers we fear most for our clients. What has always been uncertain is when the inflationary endgame would come into view. JAMIE DANNHAUSER Before the pandemic, it was possible that Economist the next economic downturn would be a run-of-the-mill recession and that central bankers, despite already-low interest rates, would have enough ammo to engineer a politically acceptable recovery. PAGE 67

CONVENTIONAL WISDOM SAYS THE PANDEMIC HAS GIVEN DEFLATIONARY FORCES A NEW LEASE OF LIFE. Forecasters expect inflation to remain low for several years. Investors believe that central bankers will do all they can to ward off the deflationary bogeyman. THE CONVENTIONAL WISDOM IS WRONG. We are in the final throes of the inflation-targeting regime that emerged from the ashes of monetary chaos in the 1970s. Central bankers are changing the way they achieve their goals. Far from reinvigorating the deflation machine, the coronavirus crisis will be its undoing.

Figure 1 CHINA’S URBAN POPULATION (M) VERSUS OECD WORKING-AGE POPULATION, 1969-2019

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I don’t know what the best 500

policy solution is, but I know 400 we can’t just keep doing what we’ve been 300 200

doing. As soon as there’s a risk that hits, 100

everybody flees and the Federal Reserve 0 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015 2019 has to step in and bail out that market, China's urban population OECD working age (15-64) population

and that’s crazy.” Amongst central bankers, there is an There is some truth in these arguments; Neel Kashkari, current president of the Minneapolis Fed accepted narrative. The decline in inflation but this diagnosis is incomplete. It ignores and voting member of the FOMC was primarily a function of improved the far more potent disinflationary forces monetary policy credibility. The elevation at work. Those forces emanate from the of price stability within central banks’ supply side – slow-moving structural mandates, and the shift to operationally developments that have increased the world The pandemic has removed that key independent monetary policy, helped to economy’s speed limit. They fall broadly source of uncertainty. anchor inflation expectations. As wage into three categories – the demographic, Our long-held expectation of painful and price setters came to expect inflation the technological and the political. These wealth destruction triggered by a shift a lethal pandemic – about as exogenous a near central banks’ targets, actual inflation forces have created a powerful, mutually to a more volatile and inflationary macro tail risk as one can conceive. The second was dragged lower. By the 2000s, inflation reinforcing disinflationary dynamic. environment and the emergence of money- is that policymakers would be prepared expectations were well anchored. financed fiscal expansion (aka helicopter to deploy unprecedented stimulus during Since the global financial crisis (GFC), THE EASY MONEY ERA money) is now matched by our confidence the next recession. Any lingering fears that inflation expectations have dropped below The numerous demographic trends together that the inflationary endgame is at hand. conservative sound money orthodoxy 2%, one reason central banks have been fostered a massive expansion of the global might constrain policymakers have now unable to drive up inflation. In addition, effective labour force. This is the central IT’S WHAT YOU KNOW FOR been dispelled. aggregate demand has run persistently observation in Charles Goodhart and Manoj SURE THAT JUST AIN’T SO… To explain why the covid crisis has below the world’s supply capacity, Pradhan’s insightful new book, The Great The covid crisis has revealed two key made the demise of the deflation machine restraining inflationary pressures, Demographic Reversal: Ageing Societies, pieces of information. The first is what inevitable, I will recap the root cause of low despite the supposed damage from the Waning Inequality, and an Inflation known as the global savings glut 1 2 would kill off the post-2008 bull market: inflation over the last three decades. 1 Before the 2008/2009 financial crisis, this shortfall in global demand is linked to what has become 2 Based on their original 2017 analysis in BIS Working Paper No. 656 Figure 1: Datastream financial crisis. Revival. In recent decades, the ratio of The Ruffer Review 2021 The deflation machine – a second coming? PAGE 69

Figure 1 CHINA’S URBAN POPULATION (M) VERSUS OECD WORKING-AGE POPULATION, 1969-2019

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700

600

I don’t know what the best 500 policy solution is, but I know 400 we can’t just keep doing what we’ve been 300 200 doing. As soon as there’s a risk that hits, 100 everybody flees and the Federal Reserve 0 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015 2019 has to step in and bail out that market, China's urban population OECD working age (15-64) population and that’s crazy.” Amongst central bankers, there is an There is some truth in these arguments; Neel Kashkari, current president of the Minneapolis Fed accepted narrative. The decline in inflation but this diagnosis is incomplete. It ignores and voting member of the FOMC was primarily a function of improved the far more potent disinflationary forces monetary policy credibility. The elevation at work. Those forces emanate from the of price stability within central banks’ supply side – slow-moving structural mandates, and the shift to operationally developments that have increased the world The pandemic has removed that key independent monetary policy, helped to economy’s speed limit. They fall broadly source of uncertainty. anchor inflation expectations. As wage into three categories – the demographic, Our long-held expectation of painful and price setters came to expect inflation the technological and the political. These wealth destruction triggered by a shift a lethal pandemic – about as exogenous a near central banks’ targets, actual inflation forces have created a powerful, mutually to a more volatile and inflationary macro tail risk as one can conceive. The second was dragged lower. By the 2000s, inflation reinforcing disinflationary dynamic. environment and the emergence of money- is that policymakers would be prepared expectations were well anchored. financed fiscal expansion (aka helicopter to deploy unprecedented stimulus during Since the global financial crisis (GFC), THE EASY MONEY ERA money) is now matched by our confidence the next recession. Any lingering fears that inflation expectations have dropped below The numerous demographic trends together that the inflationary endgame is at hand. conservative sound money orthodoxy 2%, one reason central banks have been fostered a massive expansion of the global might constrain policymakers have now unable to drive up inflation. In addition, effective labour force. This is the central IT’S WHAT YOU KNOW FOR been dispelled. aggregate demand has run persistently observation in Charles Goodhart and Manoj SURE THAT JUST AIN’T SO… To explain why the covid crisis has below the world’s supply capacity, Pradhan’s insightful new book, The Great The covid crisis has revealed two key made the demise of the deflation machine restraining inflationary pressures, Demographic Reversal: Ageing Societies, pieces of information. The first is what inevitable, I will recap the root cause of low despite the supposed damage from the Waning Inequality, and an Inflation known as the global savings glut 1 2 would kill off the post-2008 bull market: inflation over the last three decades. 1 Before the 2008/2009 financial crisis, this shortfall in global demand is linked to what has become 2 Based on their original 2017 analysis in BIS Working Paper No. 656 Figure 1: Datastream financial crisis. Revival. In recent decades, the ratio of PAGE 70 The Ruffer Review 2021 The deflation machine – a second coming?

Figure 2 to the breakdown of the post-war economic not revolutionary, but it goes further 5 UNDERLYING RATE OF PER CAPITA GROWTH IN GLOBAL ECONOMY SINCE 1830 settlement. Over the last three decades, the than others have been prepared to go. central organising principle of economic The signalled strategic shift does not herald policy has been the maximisation of the end of the inflation targeting regime; 4.0% aggregate economic welfare. Other worthy indeed, to its authors, it is the best way to political goals have been subordinated to ensure the regime’s survival. But the review 3.5% that end. Without these supportive political may come to be seen as a watershed moment, foundations, demographic and technological a public expression of a radical but unnoticed 3.0% forces would still have been influential, but transition in how central bankers achieve far less dominant and long-lasting. their goals and what risks they will take. 2.5% For central bankers, two critical changes

2.0% JAY POWELL: REVOLUTIONARY have occurred since the GFC. Inflation has OR CONFORMIST? been stubbornly weak, despite historically 1.5% Since at least the early 1990s, politics, low interest rates. And the neutral interest technology and demographics have combined rate – the reference point against which 1.0% to raise the global economy’s speed limit. (real) interest rates must be set to determine They made possible rapid growth with low whether policy is boosting or retarding 0.5% inflation.4 But this presents a thorny analytical growth – has fallen materially. problem for central bankers who believe that This latter development means central 0% 1839 1849 1859 1869 1879 1889 1899 1909 1919 1929 1939 1949 1959 1969 1979 1989 1999 2009 2019 “inflation is always and everywhere a monetary bankers have far less ammo to combat phenomenon”. How can forces emanating economic downturns: they can’t push from the real economy be responsible for three market interest rates as far below neutral workers to non-workers, and to the capital economies, China most obviously. Global decades of inflation dynamics? as before. But it also has another pernicious stock, has increased significantly, as many per capita growth accelerated noticeably A generation of policymakers struggle to consequence. Because policy is less effective, who, for political and historical reasons had during the 1990s and 2000s and, despite accept this conclusion. We are all taught that firms and households come to expect that been shut out of the formal jobs market, the damage from the GFC, has remained only monetary forces, anchored to monetary inflation will run below the 2% target. joined the global workforce. elevated in recent years (Figure 2). policy, influence nominal variables, such as This drift down in inflation expectations Relevant technological developments fall That this happened in the context of low inflation. Equally, only real forces impact in turn reduces the slow-moving, trend into two broad buckets: those that made inflation suggests the underlying forces at macroeconomic aggregates, such as output component of inflation. possible our increasingly hyper-globalised work were some combination of increased and employment. Only in the short run can In response, they have landed on a world;3 and those, notably in information resource availability and faster innovation – the real economy drive inflation dynamics, strategy with two core elements. The first and communications technology (ICT), not lower inflation expectations or via the impact of monetary policy on is a clear bias towards too much monetary that have propelled productivity growth depressed demand. aggregate demand. at the economic frontier and fostered the Rapid globalisation has been a pervasive Since the GFC, central banking has emergence of superstar firms. feature of this period. It is no coincidence been in a state of flux. Under luminaries It might seem odd talking about rapid that its high-water mark coincided with such as Ben Bernanke, Mario Draghi and technological change when everyone else the political mainstream’s acceptance of Janet Yellen, the tools and goals of monetary appears focused on secular stagnation. But free-market economic orthodoxy. Positive policy have been progressively tweaked. these technological developments, viewed technological and demographic changes How the economy functions has been globally, have clearly translated into robust are the outward expression of the liberal, incrementally reimagined. productivity growth. It’s just that the main internationalist, technocratic world order; In this sense the Federal Reserve’s review forecasts 2018-2020. PPP-adjusted where possible. Ten-year movi ng average of per capita real growth 4 bis.org 5 federalreserve.gov beneficiaries have been the emerging but its foundation was the political reaction 3 Subramanian & Kessler (2013), Peterson Institute of International Economics Working Paper 13-6 Figure 2: Conference Board alternatives China GDP and ICT-adjus ted series, Maddison dataset before 1950, IMF of monetary policy strategy is evolutionary, The Ruffer Review 2021 The deflation machine – a second coming? PAGE 71

2.0% JAY POWELL: REVOLUTIONARY have occurred since the GFC. Inflation has OR CONFORMIST? been stubbornly weak, despite historically 1.5% Since at least the early 1990s, politics, low interest rates. And the neutral interest technology and demographics have combined rate – the reference point against which 1.0% to raise the global economy’s speed limit. (real) interest rates must be set to determine They made possible rapid growth with low whether policy is boosting or retarding 0.5% inflation.4 But this presents a thorny analytical growth – has fallen materially. problem for central bankers who believe that This latter development means central 0% 1839 1849 1859 1869 1879 1889 1899 1909 1919 1929 1939 1949 1959 1969 1979 1989 1999 2009 2019 “inflation is always and everywhere a monetary bankers have far less ammo to combat phenomenon”. How can forces emanating economic downturns: they can’t push from the real economy be responsible for three market interest rates as far below neutral workers to non-workers, and to the capital economies, China most obviously. Global decades of inflation dynamics? as before. But it also has another pernicious stock, has increased significantly, as many per capita growth accelerated noticeably A generation of policymakers struggle to consequence. Because policy is less effective, who, for political and historical reasons had during the 1990s and 2000s and, despite accept this conclusion. We are all taught that firms and households come to expect that been shut out of the formal jobs market, the damage from the GFC, has remained only monetary forces, anchored to monetary inflation will run below the 2% target. joined the global workforce. elevated in recent years (Figure 2). policy, influence nominal variables, such as This drift down in inflation expectations Relevant technological developments fall That this happened in the context of low inflation. Equally, only real forces impact in turn reduces the slow-moving, trend into two broad buckets: those that made inflation suggests the underlying forces at macroeconomic aggregates, such as output component of inflation. possible our increasingly hyper-globalised work were some combination of increased and employment. Only in the short run can In response, they have landed on a world;3 and those, notably in information resource availability and faster innovation – the real economy drive inflation dynamics, strategy with two core elements. The first and communications technology (ICT), not lower inflation expectations or via the impact of monetary policy on is a clear bias towards too much monetary that have propelled productivity growth depressed demand. aggregate demand. at the economic frontier and fostered the Rapid globalisation has been a pervasive Since the GFC, central banking has emergence of superstar firms. feature of this period. It is no coincidence been in a state of flux. Under luminaries It might seem odd talking about rapid that its high-water mark coincided with such as Ben Bernanke, Mario Draghi and technological change when everyone else the political mainstream’s acceptance of Janet Yellen, the tools and goals of monetary appears focused on secular stagnation. But free-market economic orthodoxy. Positive policy have been progressively tweaked. these technological developments, viewed technological and demographic changes How the economy functions has been globally, have clearly translated into robust are the outward expression of the liberal, incrementally reimagined. productivity growth. It’s just that the main internationalist, technocratic world order; In this sense the Federal Reserve’s review forecasts 2018-2020. PPP-adjusted where possible. Ten-year movi ng average of per capita real growth 4 bis.org 5 federalreserve.gov beneficiaries have been the emerging but its foundation was the political reaction 3 Subramanian & Kessler (2013), Peterson Institute of International Economics Working Paper 13-6 Figure 2: Conference Board alternatives China GDP and ICT-adjus ted series, Maddison dataset before 1950, IMF of monetary policy strategy is evolutionary, PAGE 72 The Ruffer Review 2021 The deflation machine – a second coming?

accommodation while the economy is While Powell’s Fed is not the first to chip The optimising, rational representative agent intelligence, machine learning and robotics. operating below normal: keeping interest away at this idea, the recent review formally that inhabits modern models is a figment No doubt there is some truth in these rates lower for longer than they would have consigns Friedman’s dictum to the dustbin of economists’ imagination. A bad model claims. But the belief in inevitable scientific done historically, and convincing financial of history. FOMC policy will not look to tells the wrong story. In this case, it is about advancement has always been dubious. markets of that intention. restrain the economy when unemployment the disappearance of the unemployment- Invention and discovery may be indifferent The second is a deliberate effort to drive drops below its normal non-inflationary inflation trade-off.7 to the politics of the day; but innovation, aggregate demand above potential and keep level, until there is clear evidence of technological diffusion and economy-wide it there, once the economy is back to normal, unacceptable price pressures. The key word SUPPLY-SIDE TAILWINDS productivity gains are not. Politics matters. so that inflation will run consistently above here is “unacceptable”. But wouldn’t this be NO MORE Technology and politics most obviously its target for some time. The explicit aim is already too late, if it takes another two to If the demise of the Phillips curve is more clash over how to control dominant superstar to re-anchor inflation expectations that have three years before monetary policy has its imagined than real, the shift in monetary firms. Whether they are agents of benign or drifted down since the GFC. full impact on inflation? policy strategy could be a fatal mistake. As malign economic change is hotly debated; The Fed does not believe so, because, we exit the covid recession, central banks but the politics is clear-cut. They are seen THE PHILLIPS CURVE IS DEAD, in its view, the Phillips Curve – the link are looking to run the economy hot because as corrupters of the political system, drivers LONG LIVE THE PHILLIPS CURVE between unemployment and inflation – they believe the background environment of inequality and havens for what Theresa To many economists, these changes will has all but disappeared. Since inflation is remains disinflationary. A stint of above- May called “citizens of nowhere”. They are in enhance price stability. But underneath so unresponsive to unemployment, it sees target inflation is considered low risk and the firing line of populists everywhere – and this strategic shift is a more radical policy little danger in letting the economy run hot; the benefits meaningful. soon of centrist politicians too. re-think. Milton Friedman observed that and there is the added benefit that a period We see the world differently. Those It is enticing to believe that we are about monetary policy operates “with long and of inflation above 2% will help re-anchor structural shifts, so beneficial for robust to enter a golden-age of productivity- variable lags”.6 So interest rates need to be inflation expectations. non-inflationary global growth, are now enhancing innovation. But this ignores both normalised before the economy is back to There’s only one, rather large, problem coming to an end and, in some cases, the inequality-driving winner-takes-all- full health and inflation is at target. with this argument. It misdiagnoses reversing. China cannot emerge again. dynamic at today’s technological frontier the disinflationary bias in our economic Eastern Europe can’t be liberated from the and the politics of rage that has dominated system. Empirically, the link between USSR a second time. The long upward march recent Western elections. The tech-optimists unemployment and inflation appears to have of female labour force participation looks may be right in the long run, but, to quote weakened tremendously. Declining inflation to be over. And the liberal world order is Keynes, “this long run is a misleading guide expectations, monetary forces, are required teetering on the brink. to current affairs… In the long run we are to explain our current economic predicament. Tectonic shifts in the political regime, the all dead.” But this gets things backwards. Supply- Sino-US battle over tech supremacy and the side developments, real forces, have been the balkanisation of finance all suggest that the THIS TIME REALLY main downward pressure on inflation. explosive growth of global supply chains is IS DIFFERENT These are the numerous overlapping over. In fact, the increased dynamism and The morphing improvements in the world’s productive efficiency made possible by globalisation of structural capacity mentioned earlier. may already have stalled.8 The covid crisis disinflationary Yet these supply-side developments are adds an important dynamic: the need to tailwinds into absent from Phillips curve models. sacrifice efficiency for increased robustness, inflationary To the extent that inflation expectations a shift from just-in-time production headwinds have a role, they are backward-looking: networks to just-in-case. pre-dates the households and firms extrapolate inflation Tech-optimists will argue this is all covid crisis. from the recent past. They amplify too Malthusian, that we are on the cusp The question

developments happening elsewhere. 6 Friedman (1968), American Economic Review 7 Nalewaik (2016), Finance & Economics Discussion Paper 2016-078 and Hooper et al (2019), Research in 74-1 8 Akcigit & Ates (2020), Slowing business dynamism and productivity growth in the United States of radical leaps forward in artificial is whether the The Ruffer Review 2021 The deflation machine – a second coming? PAGE 73

developments happening elsewhere. 6 Friedman (1968), American Economic Review 7 Nalewaik (2016), Finance & Economics Discussion Paper 2016-078 and Hooper et al (2019), Research in 74-1 8 Akcigit & Ates (2020), Slowing business dynamism and productivity growth in the United States of radical leaps forward in artificial is whether the PAGE 74 The Ruffer Review 2021 The deflation machine – a second coming?

Figure 3 1970s, may return. Because of the virus, nasty supply-driven downturn of 1974 than SHARE OF AGGREGATE CORPORATE BORROWING BY US FIRMS WITH CASH FLOW PROBLEMS, % this downturn has been catastrophic for to any in the era of inflation targeting. consumer service sectors. State-backed An important difference today is that emergency liquidity has kept this part of the Fed seems hell-bent on pursuing 30 the economy on life support. But much of its new run-it-hot strategy despite truly its operational capacity has been made unprecedented fiscal expansion (Figure 4).

25 redundant and may remain that way The US has never gone this far to support for far longer than firms’ financing will growth during peacetime, and the same is last (Figure 3). true of many developed economies. 20 Other sectors are booming. The obvious, but largely ignored, implication is that THE ‘NOBODY’S FAULT’ CRISIS

15 capital and labour resources need to be Calibrating stimulus is hard enough in reallocated on a significant scale. No doubt normal recessions. Since the pandemic took some of this will be temporary, but it hold no government has given much thought 10 could be some time before the virus threat to the dose they plan to administer: the dissipates. In any event, some behavioural guiding principle has been ‘as much as is changes triggered by the pandemic will financially and politically feasible’. 5 persist over the longer term. How much The longer one’s time horizon, the more office space in high-density urban centres the ‘right-tail’ inflationary scenario comes 0 will be left vacant? How much will the into play. The reason is simple – politics. 1992 1995 1997 2000 2002 2005 2007 2010 2012 2015 2017 2020 gradual shift from in-store to e-commerce This is the ‘nobody’s fault’ crisis. spending have been accelerated? To what pandemic accelerates, weakens or even stops broad-based across sectors, but highly extent will demand for residential space in this process. Most believe that the economic concentrated in services that depend on cities be undermined? The list goes on. damage is so substantial, and cyclical face-to-face social interaction; activity A useful historical analogue comes from disinflationary pressures so powerful, that it in other industries has quickly risen the various supply shocks of the 1970s, makes little difference whether these tectonic above its pre-recession level. Third, the especially the 1973 OPEC oil embargo. shifts are happening or not. Central bankers fiscal and regulatory response has been The dynamics today aren’t the same: will apply the usual medicine in an even unprecedented in scale and scope. Finally, the oil shock crimped the supply of a larger dose. Only, this time, they will keep the post-recession politics will be radically critical production input, while the going until inflation is above 2% and rising. different. Not since the emergence of mass pandemic’s impact is less acute Markets have got one thing right: participatory politics have two major but has done more widespread intellectually and politically, there is no economic crises happened so close damage to productive alternative. What markets fail to see is that together; and, because this downturn was capacity at the other end it opens the door to an inflationary future caused by covid, there will be no obvious of supply chains. Still, that might otherwise have remained some interest group to blame – it is the ‘nobody’s the recession of distance over the horizon. fault’ crisis. 2020 is more Why? Because this recession is unique. Investors cannot follow the old rulebook. similar to the First, it was triggered by a global health This was not a traditional aggregate demand emergency and will end through virus shock, and it does not follow that elevated progression and scientific advances, not unemployment will translate into low

economics. Second, the damage is not inflation. ‘Stagflation’, the great evil of the Figure 3: Absolute Strategy Research. Largest 3,000 US listed fi rms, interest coverage ratio of less than 1 The Ruffer Review 2021 The deflation machine – a second coming? PAGE 75

economics. Second, the damage is not inflation. ‘Stagflation’, the great evil of the Figure 3: Absolute Strategy Research. Largest 3,000 US listed fi rms, interest coverage ratio of less than 1 PAGE 76 The Ruffer Review 2021 The deflation machine – a second coming?

Figure 4 Strikingly, however, they occurred after 2020 DISCRETIONARY FISCAL STIMULUS BY COUNTRY, % OF GDP a prolonged period of falling inequality (Figure 5) and rapid gains in living standards. Western society was as equal 12.6 as it has ever been. Today’s fight is happening after several decades of rising inequality and stagnant real incomes for 9.8 9.5 the average household. 9.2 9.1 8.9 JUSTIFYING THE 7.3 POLITICALLY INEVITABLE 6.5 6.0 Politics shapes every economic 5.5 regime; and every economic 4.9 4.7 4.6 4.4 4.1 regime shapes financial market 3.8 3.7 dynamics. The covid crisis 2.8 2.8 is not the reason the post-1980 regime 2.0 1.9 of low inflation, robust growth and rapid 1.0 globalisation is breaking down; but it has accelerated the political dynamics unleashed US NZ UK CN AU BZ JP CH SW IT SP SD FR GE KO RS NO IN MX DM EM World after the GFC.

Every vested interest can claim, with some workers, for whom this crisis has been little justification, that they are not to blame and more than a social irritant. that they should not pay to clean-up the This will make it exceptionally hard to Figure 5 fiscal mess. unwind covid-related fiscal stimulus. SHARE OF US PERSONAL SECTOR WEALTH HELD BY TOP 1% OF HOUSEHOLDS Post-recession politics does not normally If the pandemic escalates once more, 50% work this way. Society generally has to suffer these forces will ensure a major expansion a hangover because of the party it enjoyed of stimulus measures. This is the quid during the boom. pro quo society demands for accepting 45% Post-covid, things will be different. Such lockdown’s constraints on personal political arguments will fail because this time freedom and social interaction. 40% nobody is to blame. Instead, the case for Big As in the 1970s, the over-arching political Government has been radically strengthened. battle will be about how to distribute Unprecedented stimulus has prevented an society’s resources: between rich and poor, 35% economic calamity, without creating the between workers and retirees, between inflationary disaster that sound-money homeowners and renters and between 30% conservatives feared. borrowers and asset owners. At the same time, a political gulf has The Sino-US dispute has a geopolitical opened up between the young and low- dimension, but it too is a zero-sum squabble 25% skilled, who have suffered their second over who gets what. Those battles 50 years World Inequality Database debilitating economic crisis in just over a ago were economically divisive, Fed distributional accounts 20%

decade, and the well-educated white-collar with pernicious inflationary consequences. Figure 4: Goldman Sachs Research. 2020 measures that increase s pending or lower taxes, excludes automatic stabilisers and gove rnment loan guarantees Figure 5: World Inequality Database, US Federal Reserve 1919 1929 1939 1949 1959 1969 1979 1989 1999 2009 2019 The Ruffer Review 2021 The deflation machine – a second coming? PAGE 77

decade, and the well-educated white-collar with pernicious inflationary consequences. Figure 4: Goldman Sachs Research. 2020 measures that increase s pending or lower taxes, excludes automatic stabilisers and gove rnment loan guarantees Figure 5: World Inequality Database, US Federal Reserve 1919 1929 1939 1949 1959 1969 1979 1989 1999 2009 2019 PAGE 78 The Ruffer Review 2021 The deflation machine – a second coming?

Structural disinflationary tailwinds to sacrifice themselves on the altar of 2% Financial markets – wired to the Politics shapes are morphing into persistent inflationary inflation. Expect them to accommodate inevitability of low inflation, depressed headwinds. Equally important, the political politicians’ strenuous efforts to return nominal interest rates and limited macro every economic revolt against liberal overreach is at boiling Main Street to full health, a move that in volatility – face significant upheaval. We point. Against this backdrop, the monetary their eyes comes with limited risks and have feared that upheaval for some time, but regime; and every accelerator is flat to the metal. All major valuable rewards. accepted that we could not predict exactly central banks have effectively committed But the dangers are considerable. when it would materialise. For some years, economic regime to keeping it that way for several years and The background environment is more this uncertainty has conditioned the to emptying the monetary arsenal fully if hostile to robust non-inflationary growth Ruffer portfolio, but the covid crisis has shapes financial economic conditions deteriorate. than for decades. This crisis has potentially changed how we must think. Inflationary What happens once the recession is profound consequences for spending upheaval is now a clear and present danger market dynamics” behind us? Soon after the GFC, the interests patterns and the economy’s productive to client portfolios.9 of central bankers and politicians diverged. capacity. And policy levers have been pulled Governments shifted quickly to austerity, harder than ever. leaving monetary policy as the only game in town. Central bankers had no option but to cut interest rates every time bad economic news arrived, something investors took note of. Such a divergence looks unlikely in the years ahead. Central bankers and governments have their eyes on the same prize: Main Street’s return to full health. Practically, intellectually and politically, they are bound together. Central bankers’ political survival will depend on their implicit collusion with their legislative overlords. Mainstream politicians, having donned populist colours, will conclude that their grip on power depends on Main Street’s recuperation. In the economic realm, monetary-fiscal co-ordination will become the new norm – in practice, helicopter money. This is why the Fed’s new strategy is so consequential: it provides the intellectual justification for the politically inevitable. Those at the top of institutions have always fought tenaciously to ensure their survival. Central bankers are no different. The demise of the dominant liberal paradigm threatens

their independence. None will be prepared 9 Additional sources and further reading available at ruffer.co.uk/2021-references The Ruffer Review 2021 The deflation machine – a second coming? PAGE 79

their independence. None will be prepared 9 Additional sources and further reading available at ruffer.co.uk/2021-references India’s demographic dividend

NUMBER OF PEOPLE BORN BETWEEN 1996 AND 2015

Gen Z (m) A market miscellany ndia hina

igeria

ndonesia

akistan

rail

angladesh allows citizens to file tax returns and access Ethiopia welfare benefits from an online platform, eico through fingerprints and iris scans.

hilippines Prime Minister Narendra Modi has set an

ongo agenda of deregulation and labour reform to

Egypt lay the foundations for India’s burgeoning

ussia industrial sector. This prioritises the

ietnam expansion of the country’s manufacturing

Tanania capability over an already well-established

Turkey services sector.

enya But where China led, India may not

ran follow. Some argue that manufacturing

apan and export-led growth is no longer a viable path for rapid economic development in a more digital and service-focused world. As Generation Z comes of age, identity conflict and social tensions will need to be managed, INDIA IS HOME TO ONE-FIFTH OF particularly if job creation fails to meet the ALL THE WORLD’S ‘GENERATION ZS’. demands of such a young population. Almost half a billion in total, more than in However, historically, a youthful CHARALEE HOELZL JASMINE YEO the US and China combined. population has been a driver of consumption Investment Manager Senior Investment Associate They are growing up in a rapidly – this is a persistent trend, and one which digitalising nation. The Indian government’s India is unlikely to break. biometric database, Aadhaar, already India will take its own path, and it will be

Source: United Nations, Ruffer, data to July 2019 captures over 90% of the population and carved out by Gen Z. PAGE 81

India’s demographic dividend

NUMBER OF PEOPLE BORN BETWEEN 1996 AND 2015

Gen Z (m) A market miscellany ndia hina

igeria

ndonesia

akistan

rail

angladesh allows citizens to file tax returns and access Ethiopia welfare benefits from an online platform, eico through fingerprints and iris scans.

hilippines Prime Minister Narendra Modi has set an

ongo agenda of deregulation and labour reform to

Egypt lay the foundations for India’s burgeoning

ussia industrial sector. This prioritises the

ietnam expansion of the country’s manufacturing

Tanania capability over an already well-established

Turkey services sector.

enya But where China led, India may not

ran follow. Some argue that manufacturing

Source: United Nations, Ruffer, data to July 2019 captures over 90% of the population and carved out by Gen Z. PAGE 82 The Ruffer Review 2021 A market miscellany

OECD UNIT LABOUR COST COMPETITIVENESS Made in China LABOUR COST COMPETITIVENESS IN GERMANY, THE US AND CHINA no more? 160 140 USA 120

GER 100

CN 60

hina S Germany

CHINA HAS BEEN A POWERFUL Compared with the late 1990s, China has lost DEFLATIONARY FORCE OVER THE its low-cost advantage. PAST 40 YEARS. One billion workers Several factors have contributed to entered the global labour market, driving this: rising transportation costs, the rapid down manufacturing costs and incentivising expansion of US oil production and the Sino- Western businesses to offshore production. US trade war. But this trend may be coming to an end. The narrowing gap between China and This chart shows the relative Western manufacturers may not spell the end competitiveness of labour costs in China, of the ‘Made in China’ era, but if China is no the US and Germany over the past 25 longer cheaper, then a once-powerful driver years, as measured by the OECD of disinflation may now push prices higher. competitiveness index. Labour costs have risen more rapidly in

Source: OECD, Ruffer, data to 2020 China than in either Germany or the US. The Ruffer Review 2021 A market miscellany PAGE 83

OECD UNIT LABOUR COST COMPETITIVENESS Made in China LABOUR COST COMPETITIVENESS IN GERMANY, THE US AND CHINA no more? 160 140 USA 120

GER 100

CN 60

hina S Germany

Source: OECD, Ruffer, data to 2020 China than in either Germany or the US. PAGE 84 The Ruffer Review 2021 A market miscellany

THE FEDERAL BALANCE SHEET: DEBT VERSUS TAX RECEIPTS IN THE UNITED STATES You can’t tax 250% 60%

PROJECTION your way out

50% 200% of this.

40%

150%

30%

100%

20%

THE COVID-19 PANDEMIC HIT PUBLIC another period of austerity, is politically 50% FINANCES LIKE A WAR. The columns unacceptable in today’s world. 10% on this chart reveal the enormous rise in The Second World War may hold public spending. some clues for today’s policymakers. A With interest rates close to zero, the debt combination of rapid post-war economic mountain may be tomorrow’s problem. growth plus a healthy dose of inflation 0% 0% But tomorrow always comes. saw deficits fall rapidly. In the 30 years 1975 1970 1950 1955 1940 1960 1965 1935 2015 1985 1930 1945 1980 1995 2010 1990 2025 2020 2035 2050 2030 2040 2005 2045 2000 So, how will governments reduce the debt immediately after 1945, nominal growth in burden to manageable levels? the US averaged 7.3%, made up of 3.5% real Austerity is one option. In Britain, GDP growth and 3.8% inflation. for example, government spending fell This time, such levels of economic growth FEDERAL DEBT AS % OF GDP FEDERAL GOVT TAX RECEIPTS AS % OF FEDERAL DEBT by 75% after the First World War. But are unlikely to be achieved. There is no unemployment soared and the country post-war rebuilding boom to come, no ‘peace suffered a deep depression. The medicine dividend’. Instead, it looks like inflation – worked, but it almost killed the patient. not growth, austerity or taxation – will have

THE FEDERAL BALANCE SHEET: DEBT VERSUS TAX RECEIPTS IN THE UNITED STATES You can’t tax 250% 60%

PROJECTION your way out

50% 200% of this.

40%

150%

30%

100%

20%

Source: US Congressional Budget Office, Federal Reserve Bank of S t Louis, Ruffer calculations, data as at September 2020 Significantly higher taxation, and to do the heavy lifting. disinflationary? cities Are 86 PAGE CIRCUIT OF A SEMICONDUCTOR CHIP, ASEMICONDUCTOR OF CIRCUIT INTEGRATED SILICON-BASED THE ON human and economic activity. economic and human to 2050. change of this 1950, projections and world’s the in since population urbanisation rate of the shows chart This to cities. more efficient. denser, and chips faster have made these semiconductors compound in advancements chip’s productivity. the improves This current. of electrical flow the improves ofnumber transistors ahigher and of diodes proximity closer Cities are a spatial concentration of concentration aspatial are Cities applied be also can principle The same technological acentury, half last the Over The Ruffer Review 2021 Review Ruffer The

LIVING IN CITIES. WORLD’S POPULATION WAS MORE THAN HALF THE HISTORY, IN TIME FIRST THE AT 2015, OF START THE FOR RISE. THE ON IS URBANISATION technology itself? technology of acceleration the as powerful as a trend century, the on power through urbanisation will Or distance? at effects, network of acity’s intensity the people to recreate idyll. rural the tofor fled leave, afford who could when those crises periodic effects. network fruitful and specialisation, greater workers’ skills, and jobs between matching about better brings city A denser production. in of scale improve economies Looking ahead, will technology enable technology will ahead, Looking by plagued have been cities For centuries, density population acity’s in Increases

Source: United Nations, data to 2020 A market miscellany A market PERCENTAGE OF WORLD POPULATION LIVING IN RURAL AND URBAN AREAS URBAN AND RURAL IN LIVING PERCENTAGE POPULATION WORLD OF BILLIONS OF PEOPLE 10 0 1 2 3 4 5 6 7 8 9

RURAL

URBAN

PROJECTION

The Ruffer Review 2021 A market miscellany PAGE 87

URBANISATION IS ON THE RISE. AT THE START OF 2015, FOR PERCENTAGE OF WORLD POPULATION LIVING IN RURAL AND URBAN AREAS THE FIRST TIME IN HISTORY, MORE THAN HALF THE WORLD’S POPULATION WAS 10 LIVING IN CITIES. PROJECTION

9 DOES PROJECTED AREA NEED MARKED?

8 Are cities 7 disinflationary? 6 5

4 BILLIONS PEOPLE OF

ON THE SILICON-BASED INTEGRATED Increases in a city’s population density 3 CIRCUIT OF A SEMICONDUCTOR CHIP, improve economies of scale in production. closer proximity of diodes and a higher A denser city brings about better matching number of transistors improves the flow between jobs and workers’ skills, greater 2 of electrical current. This improves the specialisation, and fruitful network effects. chip’s productivity. For centuries, cities have been plagued by Over the last half a century, technological periodic crises when those who could afford 1 advancements in compound semiconductors to leave, fled for the rural idyll. have made these chips denser, faster and Looking ahead, will technology enable more efficient. people to recreate the intensity of a city’s 0 The same principle can also be applied network effects, at distance? Or will to cities. This chart shows the rate of urbanisation power on through the century, urbanisation in the world’s population since a trend as powerful as the acceleration of 1950, and projections of this change to 2050. technology itself? Cities are a spatial concentration of RURAL URBAN human and economic activity. Source: United Nations, data to 2020 PAGE 88 The Ruffer Review 2021

“OUR FINDINGS SUGGEST that individual A FAMILY IN A NATION investors’ willingness to bear risk depends Between 1939 and 1949, Greece experienced on personal history.” So wrote economists a full decade of war. No sooner had the Ulrike Malmendier and Stefan Nagel, from Second World War ended than the Greek the National Bureau of Economic Research, Civil War began. This decimated productive after analysing 40 years of the Survey of infrastructure and output and triggered Consumer Finances – a detailed look at what hyperinflation. Americans do with their money, as noted by Amid this turmoil, my great grandfather, Morgan Housel in The Psychology of Money. Yannis Prezanis, was financially ruined. In My ‘personal history’ has greatly the early nineteenth century, his family had influenced my character as an investor, and moved to the mainland from the Aegean my willingness to bear risk. Brought up in island of Sifnos. Yannis became a very Athens in the 1980s, I have been shaped by wealthy stockbroker and fund manager but, the history of my family and my country, in the late 1940s, his wealth was destroyed. my training as an engineer, and an early This economic devastation shattered my professional mentor. family. Yannis’s children were thrown from riches to rags. My great uncle Agis, and my grandmother Aliki (who was central to my upbringing) had to turn to the support From Sifnos to Ruffer of relatives to survive. A JOURNEY IN INVESTING

“IN MY DAY, A LOT IN THE FINANCE FIELD WERE MORE LIKE ENGINEERS. They were so chastened by the Great Depression and all the wretched failure that they really tried to make everything super safe. And it was a very different plotting place. The people weren’t trying to be rich, they were trying to be safe.” Charlie Munger, February 2020

ALEX GRISPOS Research Director The Ruffer Review 2021 PAGE 89

ALEX GRISPOS Research Director PAGE 90 The Ruffer Review 2021 From Sifnos to Ruffer – a journey in investing

They exhibited resilience but the path they, we are bankrupt.” As a newly-independent and the next generation of my family, took nation, Greece had invested heavily in both was deliberately stable and secure. The infrastructure and the armed forces, all on spectre of irretrievable financial loss had borrowed capital. By mid-1893, more than become part of the family DNA. half of the Greek government budget was needed to service its debt. HISTORY IN BRIEF In 1932, another crisis came with the The historical evolution of Europe in the mismanagement of the fallout of the 1929 nineteenth and twentieth centuries, being a global stockmarket crash. In the words of continuum of wars, includes major economic Roderick Beaton in Greece: Biography of crises. For example, Spain, Portugal, and a Modern Nation, the country had “at first Germany have all defaulted on their debt. been let off relatively lightly” in 1929, as My country has faced more than its fair the great depression swept across the globe. share of economic turmoil – the threat of However, the Greek drachma continued to financial loss is arguably part of Greece’s DNA. be pegged to gold and to the British pound. where he or she will pay no taxes – “what Since the formation of modern Greece in It was this decision that became the trigger percentage of your income would you bid to 1828, the country has experienced a series for yet another Greek bankruptcy. When be the one that is born in the United States?” of booms and busts, creating and destroying Britain abruptly left the gold standard in His point is that few people are truly self- the fortunes of many families like mine. 1931, and the value of the pound plummeted, made; a person’s innate qualities are not to There have been at least half a dozen major Greece could no longer service its debt. be judged in isolation. The ovarian lottery crises in this period, and the Athens Stock Greece had invested heavily That was followed by the 1940s crisis that that decides the country we are born in is a Exchange has been forced to cease trading ruined my great grandfather’s fortune, then major factor in how our lives play out. on more than a dozen occasions. The causes in both infrastructure and the oil shock of the 1970s, when inflation It is most probable that if I had been have included financial panic, war, invasion, leapt above 25% (and Greek inflation born and raised in America rather than coups and natural disasters. the armed forces, all on remained above 10% for the next 20 years). Greece – with a different family background One of the earliest crises of modern Finally, in the most recent debt crisis, and different national history – I would be Greece, in 1843, has striking parallels with borrowed capital.” Greece’s real GDP fell by almost one third less cautious as an investor. And yet this the debt crisis that began in 2008 (and (between 2008 and 2016) while the Athens caution acts as a solid foundation for stock which remains unresolved today). Under Stock Exchange fell by 90% in a decade analysis. Why? Because most businesses go the rule of King Otto I, Greece was unable (between the third quarters of 2007 and 2017). through significant change over time; many to service its external debt. In desperation, successful enterprises fail, even in America. austerity was imposed. These measures were ON GREECE AND AMERICA To illustrate this, consider a study by deeply resented by citizens and yet still did Warren Buffett, reflecting on his success as Hendrik Bessembinder of the Arizona State not go far enough to tackle the crisis. The an investor, talks about winning an ‘ovarian University. Looking at 90 years’ worth of King was then forced by the Great Powers to lottery’. In his own eyes, Buffett won this data beginning in 1926, the study concludes submit to humiliating terms; a portion of the lottery by being born in the US instead of “in that, while the US stockmarket overall country’s future tax revenues would be paid some other country where my chances would has handily outperformed short-term directly to foreign agents. have been way different.” government paper (T-bills) in the long run, The next notable crisis, in the winter of Buffett asks us all to imagine two identical most individual stocks have not. Of the 1893, is famously marked by Prime Minister twins in the womb. A genie presents the nearly 26,000 stocks in the sample, fewer Charilaos Trikoupis standing up in the twins with a question. One of the twins will than half generated a positive buy-and- Greek parliament to announce: “Regretfully be born in the US, the other in Bangladesh, hold return over their lifetime that was The Ruffer Review 2021 From Sifnos to Ruffer – a journey in investing PAGE 91

They exhibited resilience but the path they, we are bankrupt.” As a newly-independent and the next generation of my family, took nation, Greece had invested heavily in both was deliberately stable and secure. The infrastructure and the armed forces, all on spectre of irretrievable financial loss had borrowed capital. By mid-1893, more than become part of the family DNA. half of the Greek government budget was needed to service its debt. HISTORY IN BRIEF In 1932, another crisis came with the The historical evolution of Europe in the mismanagement of the fallout of the 1929 nineteenth and twentieth centuries, being a global stockmarket crash. In the words of continuum of wars, includes major economic Roderick Beaton in Greece: Biography of crises. For example, Spain, Portugal, and a Modern Nation, the country had “at first Germany have all defaulted on their debt. been let off relatively lightly” in 1929, as My country has faced more than its fair the great depression swept across the globe. share of economic turmoil – the threat of However, the Greek drachma continued to financial loss is arguably part of Greece’s DNA. be pegged to gold and to the British pound. where he or she will pay no taxes – “what Since the formation of modern Greece in It was this decision that became the trigger percentage of your income would you bid to 1828, the country has experienced a series for yet another Greek bankruptcy. When be the one that is born in the United States?” of booms and busts, creating and destroying Britain abruptly left the gold standard in His point is that few people are truly self- the fortunes of many families like mine. 1931, and the value of the pound plummeted, made; a person’s innate qualities are not to There have been at least half a dozen major Greece could no longer service its debt. be judged in isolation. The ovarian lottery crises in this period, and the Athens Stock Greece had invested heavily That was followed by the 1940s crisis that that decides the country we are born in is a Exchange has been forced to cease trading ruined my great grandfather’s fortune, then major factor in how our lives play out. on more than a dozen occasions. The causes in both infrastructure and the oil shock of the 1970s, when inflation It is most probable that if I had been have included financial panic, war, invasion, leapt above 25% (and Greek inflation born and raised in America rather than coups and natural disasters. the armed forces, all on remained above 10% for the next 20 years). Greece – with a different family background One of the earliest crises of modern Finally, in the most recent debt crisis, and different national history – I would be Greece, in 1843, has striking parallels with borrowed capital.” Greece’s real GDP fell by almost one third less cautious as an investor. And yet this the debt crisis that began in 2008 (and (between 2008 and 2016) while the Athens caution acts as a solid foundation for stock which remains unresolved today). Under Stock Exchange fell by 90% in a decade analysis. Why? Because most businesses go the rule of King Otto I, Greece was unable (between the third quarters of 2007 and 2017). through significant change over time; many to service its external debt. In desperation, successful enterprises fail, even in America. austerity was imposed. These measures were ON GREECE AND AMERICA To illustrate this, consider a study by deeply resented by citizens and yet still did Warren Buffett, reflecting on his success as Hendrik Bessembinder of the Arizona State not go far enough to tackle the crisis. The an investor, talks about winning an ‘ovarian University. Looking at 90 years’ worth of King was then forced by the Great Powers to lottery’. In his own eyes, Buffett won this data beginning in 1926, the study concludes submit to humiliating terms; a portion of the lottery by being born in the US instead of “in that, while the US stockmarket overall country’s future tax revenues would be paid some other country where my chances would has handily outperformed short-term directly to foreign agents. have been way different.” government paper (T-bills) in the long run, The next notable crisis, in the winter of Buffett asks us all to imagine two identical most individual stocks have not. Of the 1893, is famously marked by Prime Minister twins in the womb. A genie presents the nearly 26,000 stocks in the sample, fewer Charilaos Trikoupis standing up in the twins with a question. One of the twins will than half generated a positive buy-and- Greek parliament to announce: “Regretfully be born in the US, the other in Bangladesh, hold return over their lifetime that was PAGE 92 The Ruffer Review 2021 From Sifnos to Ruffer – a journey in investing

greater than the one-month T-bill’s. The an investor, I believe great CEOs, typically My approach to survival in investing strong performance of the overall market I wanted to understand how with significant stakes in the businesses they is shaped by my engineering education. is attributable to the substantial returns run, can make a huge difference over the An engineer designs a bridge with an generated by relatively few stocks. the laws of physics are applied, long term. adequate cushion to withstand extreme Or consider work done by JPMorgan Asset to the real world, to make conditions. Benjamin Graham, the father Management (The Agony and the Ecstasy, COMPOUNDING CAPITAL AS AN of value investing, is known for the concept the Risks and Rewards of a Concentrated ENGINEER of a ‘margin of safety’, an engineering- Stock Position), on the distribution of things work.” I joined Ruffer in 2005 and it has been like concept that allows room for error or returns for the Russell 3000 index – a broad a harbour for developing my investment redundancy. For Graham, the purpose of collection of US public companies. The data craftsmanship: this involves applying the margin of safety is to make forecasting covers the period since 1980, a long boom private-equity principles to the public unnecessary. It is likely the right approach period for the economy. Yet, of all these markets; focusing on the intense analysis of for those seeking to protect and grow stocks, 40% lost at least 70% of their value businesses and on the pursuit of balance, of their capital in a world that is governed by and have never (or not yet) recovered. Even a measured approach. probabilities, not certainties. for utilities, often seen as among the safest As Warren Buffett’s business partner, equity investments, the failure rate is more Charlie Munger, notes, the first rule of A FINAL REFLECTION than one in ten. compounding is never to interrupt it The dramatic narratives of the shifts In a world that is inherently uncertain, unnecessarily. Many books are dedicated to in fortune, of both my family and my caution is warranted, and not just in Greece. how Warren Buffett built his fortune. The country, taught me early in life a lesson real key to his success is that he has survived from Heraclitus – everything changes and A CALLING long and has been investing successfully nothing stands still. On finishing school, I moved to the UK to for more than 70 years. In 2006, when I admire the intensity of exceptional study engineering. I wanted to understand Buffett announced a search for his eventual CEOs and entrepreneurs, the ones who how the laws of physics are applied, to the replacement, he said he needed someone are embracing change and are combining real world, to make things work. At the “genetically programmed to recognise and operational acumen with a focus on same time, I had long been fascinated by man, an American who had invested in avoid serious risks, including those never capital allocation. the financial markets. But how would my Vodafone in the early 1980s. I asked to before encountered.” We allocate capital when the risk reward family feel about me following in my great work for him, initially unpaid. He became is asymmetric, aiming for businesses with grandfather’s footsteps? I vividly recall my my ‘undervalued MBA’, and I worked under longevity, the long-term survivors. Having grandmother Aliki’s anxious questioning: his direction in London and St Petersburg, a capacity to suffer is an important part of “Why do you want to go into a profession that focusing on investing in early-stage the investment process. This is easy to talk caused our family so much despair?” companies. about, but hard to go through patiently. The answer to that now, more than two Investing is a craft and Harry was my The journey from Sifnos to Ruffer during decades later, might run something like mentor – he offered me the best practical the last 100 years is about investing in a this: having a passion is a gift. It gives you course of international investing via the measured, well-balanced manner: being a purpose. And the process of investing – direct lens of how business really works, tortoise-like, seeking to preserve and trying to understand people, analysing across various countries. Most importantly, steadily enhance capital, always applying the businesses and the markets, aiming to he taught me the significance of people in necessary cushion in building and managing allocate capital successfully – has felt like a business. Who to marry is probably the an investment portfolio. calling since my student years. most important decision in life, given the For my apprenticeship, I have Harry positive or negative compounding effect on Fitzgibbons to thank. Harry was a special your happiness over the years. Similarly, as The Ruffer Review 2021 From Sifnos to Ruffer – a journey in investing PAGE 93

greater than the one-month T-bill’s. The an investor, I believe great CEOs, typically My approach to survival in investing strong performance of the overall market I wanted to understand how with significant stakes in the businesses they is shaped by my engineering education. is attributable to the substantial returns run, can make a huge difference over the An engineer designs a bridge with an generated by relatively few stocks. the laws of physics are applied, long term. adequate cushion to withstand extreme Or consider work done by JPMorgan Asset to the real world, to make conditions. Benjamin Graham, the father Management (The Agony and the Ecstasy, COMPOUNDING CAPITAL AS AN of value investing, is known for the concept the Risks and Rewards of a Concentrated ENGINEER of a ‘margin of safety’, an engineering- Stock Position), on the distribution of things work.” I joined Ruffer in 2005 and it has been like concept that allows room for error or returns for the Russell 3000 index – a broad a harbour for developing my investment redundancy. For Graham, the purpose of collection of US public companies. The data craftsmanship: this involves applying the margin of safety is to make forecasting covers the period since 1980, a long boom private-equity principles to the public unnecessary. It is likely the right approach period for the economy. Yet, of all these markets; focusing on the intense analysis of for those seeking to protect and grow stocks, 40% lost at least 70% of their value businesses and on the pursuit of balance, of their capital in a world that is governed by and have never (or not yet) recovered. Even a measured approach. probabilities, not certainties. for utilities, often seen as among the safest As Warren Buffett’s business partner, equity investments, the failure rate is more Charlie Munger, notes, the first rule of A FINAL REFLECTION than one in ten. compounding is never to interrupt it The dramatic narratives of the shifts In a world that is inherently uncertain, unnecessarily. Many books are dedicated to in fortune, of both my family and my caution is warranted, and not just in Greece. how Warren Buffett built his fortune. The country, taught me early in life a lesson real key to his success is that he has survived from Heraclitus – everything changes and A CALLING long and has been investing successfully nothing stands still. On finishing school, I moved to the UK to for more than 70 years. In 2006, when I admire the intensity of exceptional study engineering. I wanted to understand Buffett announced a search for his eventual CEOs and entrepreneurs, the ones who how the laws of physics are applied, to the replacement, he said he needed someone are embracing change and are combining real world, to make things work. At the “genetically programmed to recognise and operational acumen with a focus on same time, I had long been fascinated by man, an American who had invested in avoid serious risks, including those never capital allocation. the financial markets. But how would my Vodafone in the early 1980s. I asked to before encountered.” We allocate capital when the risk reward family feel about me following in my great work for him, initially unpaid. He became is asymmetric, aiming for businesses with grandfather’s footsteps? I vividly recall my my ‘undervalued MBA’, and I worked under longevity, the long-term survivors. Having grandmother Aliki’s anxious questioning: his direction in London and St Petersburg, a capacity to suffer is an important part of “Why do you want to go into a profession that focusing on investing in early-stage the investment process. This is easy to talk caused our family so much despair?” companies. about, but hard to go through patiently. The answer to that now, more than two Investing is a craft and Harry was my The journey from Sifnos to Ruffer during decades later, might run something like mentor – he offered me the best practical the last 100 years is about investing in a this: having a passion is a gift. It gives you course of international investing via the measured, well-balanced manner: being a purpose. And the process of investing – direct lens of how business really works, tortoise-like, seeking to preserve and trying to understand people, analysing across various countries. Most importantly, steadily enhance capital, always applying the businesses and the markets, aiming to he taught me the significance of people in necessary cushion in building and managing allocate capital successfully – has felt like a business. Who to marry is probably the an investment portfolio. calling since my student years. most important decision in life, given the For my apprenticeship, I have Harry positive or negative compounding effect on Fitzgibbons to thank. Harry was a special your happiness over the years. Similarly, as IT’S EASY TO BE OVERWHELMED BY THE VOLUME OF INFORMATION AIMED AT US. Inundated by a daily torrent of Navigating headlines, images, messages and data, we can be left feeling unable to process it to a satisfying degree. For investors, navigating information is central to being effective. Insights from information information theory and gauge theory can help.

FEAR OF THE DARK IS, AT ITS CORE, A FEAR OF THE UNKNOWN. It may have been a longing for the unknown that drove Sam Winston, an artist, to embrace darkness for weeks on end. First, he covered his studio windows with canvas and holed up for a few days with no outside communication. Later, he would spend a month in the dark in a cottage in the Lake District. Winston’s art from the sessions was a series of overlapping pencil scribbles and drawings: captivating in their effect, monochrome in their appearance. His mental experience, however, was vividly kaleidoscopic. Science has long recorded a heightening in the other senses when one or more becomes impaired. Brain plasticity, the boffins call it. It left Winston extremely sensitive to touch, smell, taste and hearing – and appreciative of just how much our faculties are dulled by the rush of modern life. Time became difficult to track. It would slip in a way that became impossible to shake – a parallel timeline moving at two- thirds speed. ANDREW VAN BILJON After emerging from the darkness, Research Director All artwork used with permission © Sam Winston samwinston.com Winston found himself pining for it again. PAGE 95

WILL MAKE MINOR CHANGES TO LAYOUT WHEN FINAL TEXT ARRIVES.

IT’S EASY TO BE OVERWHELMED BY THE VOLUME OF INFORMATION AIMED AT US. Inundated by a daily torrent of Navigating headlines, images, messages and data, we can be left feeling unable to process it to a satisfying degree. For investors, navigating information is central to being effective. Insights from information information theory and gauge theory can help.

Shannon’s ideas touch us whenever we use a telephone or computer.”

of inquiry. Today, he is best known for APPLICATION DU JOUR his work on information theory and his For much of 2020, covid-19 case counts were seminal work The Mathematical Theory a dominant variable. of Communication,1 published in the late Government policies are set by them. 1940s during his time working at Bell Labs The media reports them. And people’s in America. behaviours, livelihoods and health depend Shannon’s ideas touch us whenever we on them. Case counts are widely compared use a telephone or computer. His key insight and contrasted between regions and was to change the conception of what countries. They are seen as a measure of information is and how it is transferred. relative success and failure. He realised that, when thinking about Yet, as the pandemic began to spread, it the engineering behind communication, became obvious that case count numbers semantics were not so important, but the were complex. The degree of testing being information content of a message was undertaken played a huge role in the vital. Shannon showed that, when sending numbers of cases reported – a country with information over a ‘noisy’ channel (one a substantial testing programme will find that introduces errors) it is always possible more cases than a similar country with to transmit virtually error-free, provided little testing. This was also true of changing the rate of transmission doesn’t exceed the testing rates through time. capacity of the channel. What about the quality of the Let’s bring that back to the befuddled information? Are the test types Twitter user, looking at both the rate of comparable and similarly reliable? What transmission, and the noisiness of the is the false positive and negative rate? Are Could there be an addictiveness to the are of no great use to us. The information channel. The rate of transmission (about two asymptomatic people being tested, as well as blackout, to the world of visions rather has no direct impact on our lives. billion tweets a month from the top 10% of those with symptoms? Are positive antibody than vision? Nevertheless, we reflexively try to analyse, users2) is extremely high in the daily media tests being counted? Is the presence of live The notion of unplugging has become compartmentalise and digest it, struggling flood. So too is the noise, as facts (are there versus dead virus being accounted for? popular in countless camping trips, silent against the flowing tide. Exhausted, we wash still such things?) are ‘interpreted’ by any Even in countries with similar disease retreats, and wilderness breaks. Frazzled up on the beach of forced withdrawal, only to number of media outlets, politicians, and so incidence and testing rates, genetic, cultural, urbanites seek to escape a constant barrage wade back in once we have recovered. on. Yet the channel capacity of our busy daily demographic and environmental factors may of news and social media. The issue is partly lives is rather restricted. Perhaps we should make a positive case far more dangerous and linked to the magnitude of information INFORMATION THEORY not therefore be surprised when the result is consequential in one place than another. before us. Equally important, though, is Claude Shannon was a genius of the ineffectual information transmission To make sound policy decisions,

information’s relevance, or ‘noisiness’. The twentieth century, the sort of person The mathematicalShannon (1949), & Weaver theory of communication 25 Twitter statsCooper all (2020), marketers need to know in 2020, hootsuite.com with little to gain, other than elevated governments need to be skilled at navigating vast majority of media washing over us daily whose intellect bridged multiple fields 1 2 stress levels. information. Navigating information PAGE 97

Shannon’s ideas touch us whenever we use a telephone or computer.”

MOVING TO FINANCE The bridge to the world of finance is not a long one at this point. Markets are distillers of information, representing clearing prices for securities given the current state of information. There are layers too. Information about a factory’s widget production affects the company’s revenue, which affects the share price, which conveys a kind of short-hand to investors. Noisiness has ready analogues as well, from uncertainty about the company’s operations, to varied and conflicting reports by analysts and the media, to volatility in the share price. The share-price-as-a-signal is a primary way that finance borrows from information theory: return is weighed against risk (proxied by volatility) in determining which assets are most attractive. The relationship of assets to each other is brought in to create the mean-variance framework – its usefulness. Again, Shannon can information.3 This is then scoured for a flawed but still dominant paradigm for The more unlikely a message help investors. In his reframing of the unusual and unlikely – but repetitive enough investment analysis and decision making. information problem, he realised it would be – patterns that are exploited to produce Some of the flaws arise because return is, the more information more useful to think of information content stellar returns on average. There is a beauty (especially prospectively) is a poor proxy probabilistically. That is, the more unlikely a in the notion that they have abstracted from for information and because the variance content it has.” message is, the more information content it the usual investment information channels of returns is an insufficient description of has. This sounds cryptic, but, if we consider – such as company earnings and central the noise and true risk facing investments. a message that makes us think “That’s bank announcements – and looked directly While information theory doesn’t obvious”, then that message can be said not at price movements. In a way, they have quite give us a cheat-sheet for choosing to contain much information. But a message dulled some of their investment senses to investments, it does provide a way to that makes us think “Wait, what?!” is likely evolve a hyper-tuned feel for prices, those think about how information is processed. as useful as the returns it can potentially to be far more informative and, before the shorthand distillations of information in The trend in investment in recent years generate. There is far too much low-quality fact, seen as more unlikely. finance. Indeed, some have postulated that has definitively been towards the more information being paid for. There are investors who have shown that Renaissance Technologies have somehow information, the better. Countless data sets a command of information quality can be ‘solved’ markets – surely a ludicrous notion? are created, sold and subscribed to, from THINKING PROBABILISTICALLY hugely valuable, most notably the hedge retail sales to surveys of manufacturers, to As the response to the pandemic has fund Renaissance Technologies. Various DEGREES OF FREEDOM satellite data showing occupancy rates of car shown us (see box on ‘Application du jour’), near-insiders have revealed enough over the When we talk about solving something, we parks. Yet what should by now be abundantly information quality depends in part on years to suggest that one ingredient in their implicitly mean with reference to degrees clear is that, when investing, quality trumps an understanding, even a curation, of the success has been an incredibly detailed, of freedom, or the idea that we pin down

quantity. An information source is only underlying data. This in turn determines 3 Zuckerman (2019), The Man Who Solved the Market comprehensive and clean set of market different aspects of a problem until a The Ruffer Review 2021 Data – manipulative power PAGE 99

quantity. An information source is only underlying data. This in turn determines 3 Zuckerman (2019), The Man Who Solved the Market comprehensive and clean set of market different aspects of a problem until a PAGE 100 The Ruffer Review 2021 Navigating information

solution is possible. Consider a rugby team. done is allow enough degrees of freedom to SOME PRACTICAL APPLICATION The coach needs to put each of the 15 players unify our approaches, without sacrificing What is an investor to take from this world in a position for a match. At first, there are tractability in any one case. The tension of physics, gauges and free energy? From 15 degrees of freedom, as each player can between finding a local solution and Shannon, it is to ensure our information be placed in any position. But as the coach understanding the global system is key. sources don’t introduce too much noise. progresses, the number of players and The application of gauge theories has led More is certainly not always better, lest our available positions declines, until 14 players to amazing progress in complex problems, processing capacity be overwhelmed and take up 14 positions. At this point, the coach such as understanding the brain. For lead to bad investment decisions. If our has no choice, no degrees of freedom – the example, researchers realised that, if we had information sources are set to reduce noise final player is placed in the only remaining an overarching theory for how neurons in to an appropriate level then unexpected position. The team is ‘solved’. While this the brain respond to external stimulus, then messages provide us with the most useful example is trivial, degrees of freedom we would be able to model anything from information: unusual price movements, or prove vital when considering higher- a single neuron to overall brain activity.5 relationships changing. order problems, such as investing across This would give us insight into how the From gauge theory and neuroscience, the thousands of markets, or working with brain works at every scale and inform our takeaway is that understanding the unifying quantum physics. understanding of phenomena such as action fabric of a system can yield powerful results. and perception. By design, Friston’s principle works on many GAUGE THEORY levels. Markets generally act to minimise A gauge or measure is an important means THE FREE ENERGY PRINCIPLE the surprise of new information, driven by of standardisation that gives us a language One emerging idea in this field – the the wants and needs of buyers and sellers. to convey information. When we shift free energy principle, developed by But, as individuals, we have a call to action, between gauges, such as travelling from a neuroscientist Karl Friston6 – offers utility either to update our views of the world or to country using the metric system to one using for our task at hand: navigating information. adjust our portfolios. With the right gauge to imperial, it’s useful to know how to translate The essence is that systems (and potentially, help us navigate, we can make vast strides our measure. This translation is a very basic people) attempt to minimise surprise. It in understanding markets, if not quite in form of what we might call a gauge theory, sounds simple, but the implications are not. solving them. and this becomes indispensable when People have a model or idea of what And, finally, what to take from the thinking about the weird world of the world is like. We constantly update artist Sam Winston? Is it time to turn out quantum physics. this, incrementally, according to what we the lights and meditate on the nature of In different areas of quantum enquiry, perceive. If we are met with something that darkness, to heighten our other investment various properties are useful when seeking doesn’t fit with our model, that counts as senses? Fund managers have certainly to make sense of the often-strange behaviour surprise; we minimise the effect by updating resorted to stranger things.8 of particles. These properties don’t always the model, and also through action. This is play nicely together, however. Sometimes, a complementary insight to Shannon’s on they become almost contradictory.4 Here, the unlikelihood of a message, but Friston introducing a gauge theory comes to the gives us a model by which systems (and rescue – by giving us some redundancy. people) cope with surprising information. By explaining how we should think about Free energy as a gauge theory looks to be a the relationship between properties, we promising way forward in complex fields, can continue to analyse the different areas having already proved useful in several without worrying about local differences areas – most recently in modelling the 7 and contradictions. In effect, what we have 4 Tong (2018), Gauge Theory 5 Sengupta et al (2016), Towards a neuronal gauge theory 6 Friston (2010), The free energy principle: a unified brain theory? 7 Friston et al, (2020), Dynamic causal modelling of covid-19 8 Additional sources and further reading available at ruffer.co.uk/2021-references covid epidemic. The Ruffer Review 2021 Navigating information PAGE 101

RORY MCIVOR Senior Associate

ONCE UPON A TIME, there lived a prince. the Continent, the government had borrowed A handsome man, a decorated soldier and a vast sums, with the national debt reaching swashbuckling adventurer. 230% of GDP by the late 1810s. On this debt, That, I’m afraid, is where the resemblance investors could expect a ‘risk free’ return of to gallant fairy-tale characters ends. around 5%.

kasike meaning ‘king or ‘prince of an indigenous tribe in the pre-Columbian era The Prince in this tale is one General Sir The end of the Napoleonic Wars delivered Gregor MacGregor. Or, as he came to style a regime change in financial markets. himself, His Highness Gregor, Cazique The City of London emerged as a safe of Poyais.1 MacGregor orchestrated one haven for European capital, supplanting of the most audacious scams in history – Amsterdam as the world’s most important marvellous in its ambition and catastrophic financial centre. in its consequences. Waterloo brought an end to the debt “There are few more impressive binge. With government borrowing A GREAT DEAL OF INTEREST retreating towards peacetime levels, the sights than a Scotsman on the make.” In the early years of the nineteenth century, government no longer needed to pay the British investors had enjoyed a period of high rates of interest to encourage investors 1 Cazique or cacique derives from the Taíno word — JM Barrie Image sources: Wellcome Collection. Attribution 4.0 International (CC BY 4.0) reliable returns. To finance its war efforts on to lend. PAGE 103 The Cazique The conman

RORY MCIVOR Senior Associate

In 1822, the Bank of England cut interest We'll a’ gang to Poyais thegither, He concluded: His Highness Gregor, the Cazique, rates by 1%, the first reduction in POYERS! intended to establish a new kingdom on the over a century. We'll a’ gang ower the seas thegither, I now bid you farewell for a while…I Mosquito Coast, over an area of shoreline shall again be enabled to return amongst extending across present day Nicaragua and A PERFECT MATRIMONY To fairer lands and brighter skies, you, and that then it will be my pleasing Honduras. The kingdom would be Peace brought prosperity and optimism. duty to hail you as affectionate friends, named Poyais. Investors’ confidence soared. As did their Nor sigh again for Hieland heather.” and yours to receive me as your faithful appetite for risk. Cazique and Father. UTOPIA An ocean away from the City, newly- The Cazique claimed to have discovered independent states in Latin America sought into the sea. He was eventually recovered, an Eden, a “delightful and most valuable to finance their fledgling nations by issuing barely conscious, by the Venezuelan navy. country” with “great salubrity of the air”, debt. The result was a perfect marriage In 1821, after a colourful career in the fertile soil, riverbeds bulging with “native between borrower and investor. Income- Americas, MacGregor returned to Britain. globules of pure gold”. The land would be “a hungry investors were keen to put their And he returned with a plan. constant fund of health and activity”. money to work. And where better to do so than in a continent brimming with natural THE VISION resources, now free from the shackles of By this time, London society was enthralled Spanish colonial rule? by Latin American affairs, especially the It was in this early period of financial newly formed state of Gran Colombia and its globalisation, and with the birth of new first president, Simón Bolívar. It helped then, markets for debt, that our Cazique, Gregor that MacGregor’s wife, Princess Josefa, MacGregor, spotted his opportunity. was a cousin of the great liberator himself, and the MacGregors quickly became COMETH THE MAN coveted adornments to London dining Born in Stirlingshire in 1786, Gregor tables. But a question remained – princess MacGregor claimed descent from Rob Roy. of where exactly? Formerly a soldier in the British army, MacGregor had answered that just a few MacGregor sailed to Caracas in 1810 to join months earlier, in a proclamation to the the Venezuelan revolutionary army. inhabitants of the territory of Poyais. It read: He was soon promoted to Brigadier- General and tasked with the defence and POYERS! expansion of his new homeland. MacGregor On the 29th April 1820, the King of the was generally commended for his service, Mosquito Shore and Nation, by a deed although several of his escapades resulted in executed at Cape Gracias a Dios, granted perilously close shaves. For instance, during to me and my heirs for ever, the Territory an attempt to seize Porto Belo, in modern- of Poyais. day Panama, the Scotsman’s forces were The Territory of Poyais shall be an ambushed in the night. MacGregor, awoken asylum only for the industrious and by the noise of gunfire in the town, threw his honest, none others shall be admitted bed clothes from the window onto the beach amongst us; and THOSE, I trust, you will below and jumped out after them. He then receive with open arms, as brothers and

scrambled to the water’s edge and plunged fellow citizens. Image sources: Wellcome Collection. Attribution 4.0 International (CC BY 4.0) The Ruffer Review 2021 The Cazique – the conman PAGE 105

scrambled to the water’s edge and plunged fellow citizens. Image sources: Wellcome Collection. Attribution 4.0 International (CC BY 4.0) PAGE 106 The Ruffer Review 2021

All that was required to uncover Poyais’s That they would become rich great wonders were willing settlers and an injection of capital. seemed beyond doubt. These MacGregor set about alerting potential investors and colonists to his scheme. first dollars were a taste of the He published an exhaustive guidebook, endorsed by Thomas Strangeways, the bounty that lay in wait in the Cazique’s supposed “Aide-de-camp and Captain of the 1st Native Poyer Regiment”. Cazique’s utopia.” The guidebook was a verbose, at times bizarre, exposition of the new territory. The narrative frequently descended just £200,000, a modest amount to raise in into technical discussions of subjects London’s sovereign debt markets in 1822. ranging from plant husbandry to means It was agreed with the respectable City of protection from the native quadrupeds banking firm of Sir John Perring, Shaw, (including Mexican cats, gibeonites and Berber & Co. that Poyais would underwrite nine-banded Armadillos). its bold project by means of long-term debt. Whilst lacking the candour of “Guinness This took the form of bonds with good is good for you”, it proved to be effective rates of annual interest, guaranteed by the marketing. revenues of the Poyais national government.

RICH BEYOND DOUBT A BLIND BET MacGregor capitalised on the unquestioning South American loans were a great trust people often grant those from their attraction for international investors at the own religious or ethnic group. This trick time. But news from Latin America was – known as an affinity crime – is used by scarce, and investors often could not tell conmen the world over. He persuaded almost which nations’ obligations were the better 300 Scots to make the inaugural passage to credits. Pricing was more a factor of size, the Poyais. Doctors, lawyers and blacksmiths interest rate on the bonds, and the prestige were furnished with the tools they would of the arranging firm than it was a reflection need to colonise the exotic and verdant of the investment’s true risk. land. Eager to arrive prepared, the settlers The loans appeared to represent fresh exchanged their gold and savings for Poyais opportunity. In this wave of financial dollars, which MacGregor had had printed at globalisation, investors feared missing out the Bank of Scotland’s press. on the latest fashion. MacGregor observed That the settlers would become rich the mania and, with it, his chance to seemed beyond doubt. These first dollars make a fortune. were a taste of the bounty that lay in wait in Stock prices are supposed to reflect all the Cazique’s utopia. the information available to the market. With the colonists taken care of, That’s the basis of the Efficient Market MacGregor set about financing the creation Hypothesis. Something can be overpriced or of the new settlements. His requirement was underpriced only when there is asymmetry The Ruffer Review 2021

of information – when one party knows The Poyais debt issue was a is typically borne by the investors who throw more than the other. caution to the wind in the hope of making The Poyais debt issue was a perfect case perfect case of information a quick buck. With Poyais, investors were of information asymmetry. Investors not the only victims. The settlers who had couldn’t know much about the country, asymmetry. Investors couldn’t voyaged to the Mosquito Coast found an because the land of Poyais existed only in inhospitable wasteland. Within months, MacGregor’s imagination. know much about the country, the hardy Scots were left destitute, disease- because the land of Poyais ridden and abandoned. Some escaped to LURING IN INVESTORS Belize, around 50 made it back to Britain. The scrip for the Poyais loan was offered existed only in MacGregor’s The majority died. for sale on Wednesday 23 October 1822, in MacGregor’s scheme was cunning and the amounts of £100, £200 and £500. The imagination.” deceitful like most financial skulduggery. discounted purchase price was 80, with the Tragically, it was also lethal. bonds issued below par, and payments made upon the unaccredited chargé d’affaires of an in instalments, to allow speculators to make unacknowledged republic?” THE BUBBLE BURST substantial profits. Unease turned to distrust and Poyais At their core, financial bubbles are A deposit of 15% secured the certificate, bonds were soon caught up in the hectic imbalances of information. with the remainder due in two instalments selling typical of financial panic. Nervous The Latin American bond bubble was on 17 January and 14 February 1823. The investors attempted to limit their losses; the no different. Investors were sold new and bonds were to mature in 30 years and the price of the scrip plummeted. Trust in the exciting propositions but had very little annual interest rate was 6%, secured on all ability of governments in the New World all information about them. There was no the revenues of the government of Poyais. but evaporated – the fictitious Poyais way to determine which investments could The walls of Ruffer’s London offices are was no exception. generate the greatest return – and which replete with reminders of when investments Without the steady stream of cash might be a racket. Investors owned Latin go bad. On one such wall hang two of these from the loan, the Poyais scheme quickly American debt not because of what it was very scrips – Poyais bonds. unravelled. Unpaid bills from MacGregor’s (they couldn’t know) but because they extensive advertising efforts stacked up, and believed in a story. FROM FASHION TO FRENZY reports of disquiet began to filter through MacGregor exploited this information Fashion is a powerful force in financial from the Mosquito Coast, where the settlers asymmetry. He tapped into investors’ markets. But, as Oscar Wilde observed, had just made landfall. willingness to take a risk on something they “fashion is a form of ugliness so intolerable Accusations of fraud simmered, and City knew little about. In the case of Poyais, the that we have to alter it every six months.” lawyers sharpened their quills. The Poyais financing of an imaginary country. The fashion for Poyais debt barely lasted swindle was foiled, MacGregor exposed Today, with a growing volume of six weeks. as a scoundrel. information at our fingertips, we can expect In the winter of 1822, sentiment began to more asymmetries, and more bubbles. The turn against investments in South America THE VICTIMS challenge for investors remains the same. after an outbreak of political disorder It was the prevailing financial weather of the It is to identify these imbalances and avoid across the continent. The Times of London early 1820s that allowed MacGregor’s grand ending up on the wrong side of them. warned investors against Poyais debt: “Why Poyais fabrication to get as far as it did. So long as there are bubbles – and with should they abandon the certainty of the Excitement about burgeoning new markets them, opportunities to make money fast British funds to dabble in others, the value led to speculation, and a bubble was born. – there will be conmen, like the Cazique,

of which, as it appears, so entirely depends Further reading: Sinclair (2014), The Land That Never Was: Sir Gregor MacGregor and the Most Audacious Fraud in History In the history of financial crime, the pain seeking to exploit them. The Ruffer Review 2021 The Cazique – the conman PAGE 109

Takes on three books, by three people at Ruffer. A mix of personal favourites and topical insight, with some utility for investors.

ENGAGE THE ENEMY MORE CLOSELY Correlli Barnett

PAGE 111

INTO THIN AIR Jon Krakauer

PAGE 114

THE SHOCK OF THE OLD David Edgerton

PAGE 117 Book Corner PAGE 111

ENGAGE THE ENEMY MORE CLOSELY Correlli Barnett

HODDER AND STOUGHTON

Looking under the stones

WHAT’S THE DIFFERENCE BETWEEN KNOWLEDGE AND WISDOM? Writing as an arrogant nearly-70 year old, my answer is ‘about 40 years’. And which is the more important for investment insight? The answer is that these two elements need to fuse in a chemical reaction to produce an effective investment strategy – covet wisdom, and you have time on your side; covet As he was headed back from the Dunkirk knowledge, and you have facts on your side. It beaches with stukas offering a fond farewell is, of course, the luck of the draw as to which - he worked out that, if Britain won the war, one is the winner on Wednesday. then he’d make a good amount of money, and, These thoughts make me think of the if it lost, then he wouldn’t be worrying too redoubtable historian Correlli Barnett. It much about his investments. is perhaps stretching a point to turn to the Barnett is always an interesting read – I blowing up of HMS Hood to get a handle on have recommended to a number of Rufferians Tesla. But the best investment call I’ve ever his Audit of War which I came across, cut- heard about was from an old stockbroker price, in Cape Town. It was utterly compelling with whom I worked in the early 1970s, who – unread (because unheard of) in the City, bought Marks and Spencer in June 1940. yet the cult-read of every ambitious civil PAGE 112 The Ruffer Review 2021

It is the ability to see those things which are going to matter that gives a cruelly unfair advantage to the wise practitioner.”

servant in the 1980s. It, too, is a book for this leading the German Grand Fleet into Scapa moment, explaining that the US injections Flow, began to prepare for the next war. It into Europe to help recapitalise its industry had, literally, ruled the world, but, in the via the Marshall Plan were not so used in the words of Lord Morley of Blackburn, “the UK, for fear of inflation – UK industry could British lion is not a centipede – it cannot put not cope with the extra demand. its foot down everywhere.” So the decision was made that, come the next conflict, THE CURRENCY OF ANSWERS the Pacific was a pond too far, and the Every decade, I re-read Engage the Enemy Mediterranean, despite its proximity More Closely, to remind myself how the and prestige, was essentially irrelevant to pivotal decisions in history are made British interests. Britain’s naval power would parenthetically, randomly, without any sense be needed to keep its interests in world that they are the forks in the road which trade afloat. determine which way history moves. Thrice wise! By 1941, the Royal Navy was What the book does, quite brilliantly, stretched thin, the United States came, in and without ever quite meaning to (therein the event, to control the Pacific against the lies its power), is to show that knowledge is Japanese, and the U-boat campaign came the currency of answers to questions which within a single battle of winning the war turn out not to matter. It is the ability to see against Britain. It seemed to make sense in those things which are going to matter that 1922 to snub Japan by not renewing the naval gives a cruelly unfair advantage to the wise treaty which had just expired; Mussolini’s practitioner. invasion of Abyssinia in 1935 caused the UK government to humiliate Mussolini, A LION NOT A CENTIPEDE and his newly-created modern navy. These Here is the nutshell overview of the narrative. random decisions, which offended the deep In 1918, Britain had the biggest navy in the policy settled at the end of the First World world, and, despite the ritual humiliation of War, resulted in a centipedic dispersal of the Book Corner PAGE 113

Navy’s strength. They left its Atlantic, African able-seaman should have to stoop on deck. and Arctic routes perilously exposed. The decisions today are as impossible to assess as they were then – and, of course, DECISIONS THAT APPEAR we have no more idea than they did as to UNIMPORTANT which ones are sound and fury, and which Naval Intelligence lacked the imagination, ones simply sound. Is China imploding a too, to see that the battleship was not the ne big worry? Or is it not imploding a greater plus ultra of maritime fighting power – it worry? Can England survive a break-up with was superseded by aircraft over the high Scotland, or is it a good thing? What about seas, and submarines beneath them. The the EU? decision, in 1918, to split the air force into Wisdom looks under the stones, and at the the RAF and the Royal Naval Air Force precedents. It wonders about the amalgam, meant that, when the RAF were bombing in Edward Wilson’s words, of “stone-age Germany, they had no time to repair a 300 emotions, medieval institutions and God- mile vacuum where no aerial cover could be like technology.” given to the convoys. The knowledgeable are boned up on the Barnett’s book is a thundering good set speeches of the central bankers, the read, of course – but the fascination is presidential addresses, the PMI figures (if in the unannounced significance of the you don’t know what they are, you might, in pivotal decisions. They almost never looked the twilight, be mistaken for wise). My money important – we signed away alliances with is on the dipsomaniac barrister F E Smith, the two powers which could have preserved whose arguments to Lord Justice Darling the strategic gameplan. The RAF bombed failed to impress. “Mr Smith, having listened Germany to show Uncle Joe Stalin that to your views, I am none the wiser.” “No, my we were doing what we could to help. The Lord, but better informed.” County-class cruisers sat high in the water, silhouetted against a skyline in battle, JONATHAN RUFFER because the Labour government, when the Chairman rules were laid down in 1929, thought that no

We have no more idea than they did as to which ones are sound and fury, and which ones simply sound.” PAGE 114 The Ruffer Review 2021

INTO THIN AIR Jon Krakauer

PAN MACMILLAN

Thinking beyond the summit

THE NEGLECTED LESSON Krakauer’s book is a brilliant, pulse-racing read. And it carries many neglected lessons. THERE ARE PLENTY OF EXCELLENT Perhaps the most powerful – the top of BOOKS ABOUT INVESTING. But the mountain is only halfway there. As Rob sometimes the best advice can be found in Hall, the leader of Krakauer’s expedition, put unlikely places. it: “Any bloody idiot can get up this hill. The Into Thin Air tells the story of an ill-fated trick is to get back down.” assault on Everest in 1996. The American High mountains are wonderful when the climber-writer Jon Krakauer was invited to sun shines and the summit seems within join a high-profile expedition, to describe the easy reach. But it only takes a small change growing commercialisation of the mountain. in the weather to obscure both the way His team (and two others) set out for the ahead and the way down. Crucially, the summit in perfect conditions. The mountain risks do not decrease as you become more was crowded: there were queues. 19 of the experienced. If anything, the opposite is group reached the top, but only 12 made it true. In Krakauer’s words: “To succeed you back down again. Of the six in Krakauer’s must be exceedingly driven, but if you’re party, just two survived. In all, a dozen too driven you are likely to die… When climbers perished that year – the worst presented with a chance to reach the planet’s death toll since Hillary and Tenzing first highest summit, people are surprisingly reached the peak in the 1950s. quick to abandon good judgement.” Book Corner PAGE 115

That is why Everest is so dangerous. The objective – getting both up and down safely parallel with the financial markets almost – matters more. For climbers, the moment of paints itself. The way up is fun; the way euphoria on reaching the top contains grave down can be lethal. And experience is no dangers. In Krakauer’s case, he had used guarantor of survival. This lesson is all the nearly all his oxygen; he barely had time to more important after a near 40-year bull take in the view. Yet others were determined market – many investors have only known to relish the moment, unfurling flags and a market that trends ever-higher, one that, snapping photographs, using up time they when it goes down, does so only briefly. could no longer afford. None imagined what was about to befall them. It sounds like a ENTER THE AMATEURS moment of market euphoria. For some time, Everest was for elite climbers In the inquest, people questioned how only. Then bottled oxygen and improved expert guides could have led inexperienced equipment allowed a broader range of people amateurs – each of whom had paid up to have a go. Things really changed in 1985 to $65,000 to be taken safely up Everest when Dick Bass, a wealthy Texan with – into such a disaster. The answer lay in limited climbing ability, was pretty much the question itself. Rob Hall, the most carried to the top by a renowned guide. knowledgeable guide on the mountain, was Suddenly, Everest was becoming nothing worried all along about overcrowding. Hall more than a top notch life experience. feared that his own ascent might be put This led to a rush of interest. But the at risk by the need to rescue some of the mountain had not been tamed. There was unqualified groups he saw setting off. He still a ‘death zone’ above 25,000 feet, where thought it “pretty unlikely” that they would the air holds one-third of the oxygen a get through the season without “something human needs. Lung collapse, hypothermia, bad” happening up there. frostbite and a host of other dangers are only No-one was more respected than Hall. an accident away. He ran “the tightest, safest operation on the mountain, bar none.” So what happened? EUPHORIC DANGERS Much of it came down to the commercial To re-present the analogy: the summit pressures of running a prestigious operation. is the short-term goal, but the long-term On this occasion, it led Hall to break his own

It sounds like a moment of market euphoria.” PAGE 116 The Ruffer Review 2021

One of the biggest factors in Hall’s success was also the simplest ”

rules. He always emphasised the importance counterintuitive, the best decision-maker of having a predetermined turn-around time isn’t necessarily the person with the most on summit day, even if the summit had not successes, but rather the one with the best been reached. He was emphatic enough that process and judgement… You have to avoid five of his clients turned themselves back the risk of ruin, and this requires solid when they realised they would not make it by discipline.” his deadline. But on this occasion, Hall was It is always tempting to trust to one’s still struggling to get some clients to the top lucky star – indeed, this is almost a textbook hours after the deadline had passed. definition of irrational exuberance. You His fears were not groundless. Clients might get lucky. Nine times out of ten, the tended to believe they were paying to get to thing you fear won’t happen. But the tenth the top – in effect, buying a summit. Guides time? Disaster. on previous expeditions had been sued when I myself once climbed not Everest, but their clients had not made it to the summit. Mont Blanc. It was a two day ascent. On And, since Hall had turned his whole group the second morning, we rose at 3.00am, back the previous season, failing to reach climbing a steep slope in darkness. Two the summit again would have hurt his hours from the top, it started to snow. Our reputation. There was another experienced guide insisted we had to turn back. No ifs, guide on the mountain with a large fee- no buts. The snow would cover our track, paying group – neither man wanted to fail making the descent impossible. while the other succeeded. Of course we were disappointed. We did not make the summit. We never saw dawn THE PERILS OF LUCK breaking over the Alpine chain. But we did In Krakauer’s account, one of the biggest live to tell the tale. factors in Hall’s success was also the simplest: luck. As one of the climbers said: HERMIONE DAVIES “Season after season, Rob had brilliant Investment Director weather on summit day. He’d never been caught by a storm.” Years of good luck had given him a sense of security that tempted him to take excessive risk. It is the kind of observation that an investment guru might make. As Howard Marks put it: “While it might seem Book Corner PAGE 117

THE SHOCK OF THE OLD David Edgerton

PROFILE BOOKS

New things, 0ld things

A NOSTALGIC FUTURE Technology is a particularly fine example. Since the eighteenth century, we have been taught to expect near constant change as a result of ever-improving science and technology. Each generation has reheated breathless futurology; our current age is no exception. The assumption of perpetual technological progress is employed to AT THE HEART of historical enquiry are support both utopian and dystopian visions two simple questions: ‘What has changed?’ of the future. The coming of artificial and ‘What has stayed the same?’ For intelligence is said to bring either a leisure- investors, concerned with the future value filled, post-scarcity future or the extinction of assets, these questions can be reframed: of the human race. ‘What will change?’ and ‘What will stay So our idea of the future is quite the same?’ old-fashioned. Physical space, nations, In uncertain times, we have a tendency to distances, manufacturing and objects, so construct neat and orderly narratives of the the argument goes, become less important. past to help us understand the present. But Replacing them is a world defined by ideas, these narratives can omit important details. brands and services that can be transmitted A more nuanced understanding of history instantaneously and at no cost between can help us identify what will change when increasingly identical parts of the world. everyone else expects continuity. Perhaps But the knowledge economy has existed for even more usefully, it can suggest what hundreds of years. We still live in a world might stay the same when everyone else in which huge amounts of raw materials are expects change. shipped around the globe, where nations and PAGE 118 The Ruffer Review 2021

national identity still matter. This future has supremacy. Institutions of the British never arrived, yet the vision is still with us. Empire – the merchant navy and the Indian railways, for instance – brought European CONTINUOUS INVENTION? technology to new places and put white David Edgerton’s book teaches us to be technicians in charge. Non-whites were sceptical. We tend to focus far too much judged, explicitly, to lack both inventive on novel things and the process of creating and technical ability; they were carefully novelty. Invention and innovation trump excluded. These arguments have been continuity and resilience. Yet many of the remarkably persistent. fundamentally transformative impacts The technological progress which of technology have been diffusions of emerged from East Asia in the 1980s drew technology to new regions, classes or uses accusations of imitation and plagiarism. – decades or centuries after their invention. The implication was that non-white nations Both the motor vehicle and the bicycle lacked some fundamental spark of ideation. remain transformative technologies. When we think about engineers, we think about A NOVEL PAST people building (or coding) new things. Yet In many ways, Edgerton prefigured a most engineers are engaged in maintaining modern turn in this book. It is easier to things that already exist. imagine today, 14 years after publication, There is a tendency amongst public that older technologies may have benefits, policy experts to associate innovation and and new technologies may have costs. In invention with economic success: Germany a world increasingly concerned with the and America were inventive nations in climate emergency and where governments the twentieth century and therefore grew are more willing to implement drastic quickly. Spending sizeable proportions of policies to deal with it, the idea that an GDP on research and development (3% old-fashioned technology might come rather than 1%) is encouraged; failure to do back into use is conceivable again. Think so causes hand-wringing. Yet it is not true to of the shifting significance of wind power. say that countries that innovate more, grow Fracking, invented in the 1940s, has also more. In 1900, Great Britain had a much re-emerged. higher output per head of population than In a world that has seen steel, coal, Italy. Throughout the twentieth century, cement and motor vehicle production reach Great Britain spent considerably more on new highs as China has risen to power, the research and development. Yet, by the 1980s, transformative power of old technologies both countries were shocked by il sorpasso – should not be underestimated. when Italy overtook Great Britain in output The inconvenient characteristics per head. of the material world – nationhood, manufacturing, physical distance – are fast IMPERIAL TECHNOLOGY reasserting themselves. Historically, technology has been considered as an indicator of civilisation, and has TOBY BARKLEM been used to fuel the narrative of western Business Development Director Answers can be found inside the back cover. Book Corner Book PAGE 119 PAGE 120 The Ruffer Review 2021

Last word

CLEMMIE VAUGHAN Chief Executive PAGE 121

IN EARLY 2020, we were among the many millions around the world forced into a massive experiment at short notice – shutting our offices, moving everything online, asking everyone to work from home. Much has gone well. We’ve been able to deliver good investment performance through another crisis. Our client service has adapted, and we’ve found opportunities to serve and communicate with clients in new ways. And this year’s Ruffer Review has been almost exclusively a working-from-home production – written, edited, designed and illustrated in attics, spare bedrooms and on kitchen tables, from Cardiff to Chicago. Our offices are not the only thing missing from this edition of the Ruffer Review. Another thing that’s absent is the strong dissenting voice. Last year, Stephanie Kelton provided that voice, making the case for Modern Monetary Theory. This year, our editorial team have taken a different path. This is not because we’ve entered an echo chamber, where Zoom conversations simply amplify – rather than challenge – our existing beliefs. Instead, it’s an editorial nod to our high level of conviction. Much that the team wrote about 12 months ago has started to play out in markets. The covid crisis has been the accelerator, bringing on, among other things, a shift in the role of governments in the economy, a shift that may define the decade from here. We’re strongly of the view that investors need to be prepared for the regime change in markets that’s now under way. Ruffer portfolios stand ready, seeking to deliver good all-weather returns, whatever this new era brings. PAGE 122 The Ruffer Review 2021

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SPOT THE BAND – PAGE 3

1 THE FOUR TOPS

2 THE BEATLES

3 THE MONKEES

4 THE ROLLING STONES

5 MUMFORD & SONS

6 STEREOPHONICS

7 ELECTRIC LIGHT ORCHESTRA

SPOT THE BRITISH PRIME MINISTER – PAGE 119

1 SIR ANTHONY EDEN

2 JOHN MAJOR

3 HAROLD MACMILLAN

4 MARGARET THATCHER

5 SIR ROBERT PEEL

6 THERESA MAY

7 BENJAMIN DISRAELI “Knowledge is the currency of answers to questions which turn out not to matter.” ruffer.co.uk/rufferreview 003 Jonathan Ruffer PAGE 112