In Conversation with Citadel's Ken Griffin - Bloomberg New Economy Forum 2023

Please welcome to the stage, founder and CEO of Citadel, Ken Griffin, and Editorial Director of Bloomberg New Economy, Eric Schatzker.

Good morning, everyone. Ken, welcome back to the New Economy Forum.

It's great to be here.

It's great to have you here. I'm going to begin with the word on everybody's lips, not only here in Singapore, but everywhere in business and finance across the globe. Geopolitics. But the way I want to phrase this to you is perhaps a little bit different, or at least in search of something different than what we've heard from your fellow speakers thus far. You and I and everyone here grew up during an aberrant period in world history. There were no major wars. And we enjoyed the benefits of peace, multilateral cooperation, scientific collaboration, the economic efficiencies of globalization and fully flowing capital, a massive reduction in poverty, moderate inflation, and a mostly relentless upward trend in asset prices.

Is that era over?

I sure hope not, because it's been a really good era for us. But regretfully, the peace dividend is clearly at the end of the road. No matter what one may dream to be reality, reality is there's two wars in the world right here, right now, one of which is in Europe. So there's no doubt that the NATO countries are going to have to increase defense budgets over the years ahead. That's going to come at a point in time where governments around the world are already struggling with the sizes of their deficits. And then when it comes to globalization, I mean, we're in Singapore. We are at one of the global nexuses in the world of trade, of finance. Many of us in this room have been tremendous beneficiaries of globalization.

And it hasn't been great for everybody, to be clear. But for the world as a whole, it's pulled a billion people out of poverty. But now we're talking about deglobalization. We're talking about re-architecting supply chains. And some of this is rooted in the behavior that we saw in the pandemic. We saw countries hoarding personal safety equipment. We saw the tension around the distribution of vaccines around the world. Countries are much more sensitive to what do we want to have created domestically so that we're not reliant upon global trade. And then take that into the general geopolitical trends right here, right now. The war in Ukraine has resulted in Europe losing access to natural gas from Russia for all intents and purposes.

Europe's struggling to deal with how does it maintain its economy, having lost its cheap source of energy. So there's many trends at play right now that are pushing us towards deglobalization. And with that is almost certainly a trend towards higher baseline inflation. Over what period? It could be for decades.

And the implications of higher inflation might be obvious to some, but I think we'd all like to hear it from Ken Griffin.

Well, it depends on where this baseline effect lands. If we're looking at a 2% or 3% baseline effect, in some sense, the central bank will have a much easier job in the United States. The struggle over the last 20 years has actually been to hit a 2% target. And there's a variety of reasons that you want a low level of background inflation. It helps to lubricate the wheels of commerce. And that number the Fed has committed to as being 2%, they're going to fight pretty hard to keep that as the target for a litany of good reasons. But it also means that we're likely to see higher real rates, and we're likely to see higher nominal rates, and that will have a real implication on the cost of funding our enormous deficit.

The U.S. has $33 trillion of debt outstanding. We didn't plan for an era with higher nominal and higher real rates when we went on the spending spree that created a $33 trillion deficit.

You have been warning about the unsustainability of U.S. debt. And America, to be clear, is not the only developed country that has a heavy debt load for quite a long time. You would know better when you started to talk about this than I do. But up to now, Ken, it appears that nobody in the U.S. government, at the very least, Republican or Democrat, has taken those warnings to heart. And when I say nobody, of course, there are other people in government who say the same things, but the government itself hasn't done anything about it. Is this moment in time, when we've seen 10-year Treasury yields hit 5%—they've backed off slightly, but in that neighborhood—is this the moment when everybody wakes up to the, as you would put it, unsustainable realities of...

Of deficits and debt?

So first of all, I think there's an awakening taking place, but it's going to take time. it's going to take time. And nothing like mortgages at 7% and 8% to push the body politic to start to wake up to the consequences of the scale of the deficit we're currently running. There's no doubt that a big part of the move in the tenure this year has been driven by the realization we're in a full growth economy, full employment economy, and we're going to run almost a $2 trillion deficit this year. Like in some sense, you're supposed to save in this moment in time for the rainy day, and yet we're spending at the government level like a drunken sailor. And the challenge with this is actually a variety of different challenges.

Number one is, when you're spending too much on your credit card, like, you feel really good in the here and now, but in the back of your mind, there's that gnawing feeling that this isn't gonna end well. And I think that's part of why the American consumer is just not as happy as you'd expect them to be. They're seeing the impact of inflation, they're seeing the impact of a dysfunctional set of regulatory policies, and they know in the back of their mind that we can't sustain this level of government spending. The amount of economic malaise right now in America, relative to where unemployment is—almost 10 million open jobs—is a stunning phenomenon. And I think the American people just understand deep down that something's not quite right.

Do you think the risk-free status of Treasury debt is at all in question?

Well, one thing to remember is that the United States has the ability to always print dollars. Europe does not. So, in the European Union, you just can't print euros as a member country. That's why Greece had its back against the wall. They just couldn't print euros. That forced a restructuring to take place. Now, to be clear, the minute we start to print dollars to deal with the possibility of default, our economy is in a deep tailspin. So, it's a theoretical possibility that we can go there, but the economic consequences would be devastating. Big picture, though, there's no IMF for America. If the United States came off the rails with respect to its debt and its ability to service its debt, the effect on the global economy, not just the U.S. economy, would be stunning.

There is no IMF for America.

The consensus so far among your fellow speakers is that the world is unstable, that power—the distribution of global power—hasn't been this diffuse since the turn of the 20th century. And because of that, the risks to the global economy are as great as they've been in decades.

Do you agree? Well, actually, I'm going to go back to the last point for just a moment. Talking about the deficit in America is something every business leader should do. So, in other words, while we're all talking about geopolitics, we should be talking about the deficit? We should. We should. We need to put America's fiscal house in order. And until Washington hears it from enough people, we're just going to keep using the credit card until the day comes where no one's willing to pay for it. If we can't have that conversation, who's going to have it?

I don't want to go too far—so much further—down that rabbit hole. But up until now, nobody's—what's to say that that somebody will end up holding the Treasury Department's feet to the fire? Hasn't happened yet. So, I was actually with—or maybe not since the days of the bond vigilantes—a number of the senior members of the House just a week ago.

In the top three conversations, the deficit was on every single person's lips. They're starting to get the message. They get it from the family that can't buy its first home. They're getting the message. But we need to keep pushing that message as the business community, as the financial community, to the American people, who are the American voters, who will start to demand that we put our house in order.

So allow me for a moment to go back to geopolitics, because interest rate risk is something that you can predict up to a point. Geopolitical risk is much harder to model. How, as arguably the world's most successful risk manager—you have to be the world's most successful risk manager to run the world's most successful hedge fund—do you manage geopolitical risk? "Well, I wish that statement were actually true." I hate it when he attacks the premise of my question.

And one of the things that we spend a lot of time on is to try to be a great risk manager. But there is a real art to risk management. And unfortunately, it's not until you have the benefit of hindsight that you actually know how well you were as a risk manager. So, just first and foremost, everybody who's in the business of managing money—we're all learning to be better risk managers, but you can't take that for granted. You don't—that's like a God-given right, just because you've made money, you're a good risk manager. Now, we look—in our risk management, we look at a variety of historical scenarios and how that impacts our portfolio. And then we're always—when there are events on the horizon, there are events that are being talked about amongst geopolitical analysts, we will start to run stress tests.

If that happens, what do we think it means for our portfolio? So, before the war in Ukraine started, obviously we could see the amassing of the troops on the border. What happens if a war breaks out? And we're thinking about, how do we reshape the portfolio in light of that possibility? Right now, front and center is, if we head into recession in the United States sometime next year, what's that mean for our portfolio? So, you can think about all the different scenarios that people talk about in the media amongst the analyst community. And then you start to think about what scenarios, how will that affect asset prices, and how will our portfolio holistically perform if that unfolds?

So, what kinds of those, again, are known knowns? The possibility of a recession in the United States is a known known. It may not happen, but it's certainly within the field of view. What about the left-tail outcomes? Certainly, the kinds that you encounter in geopolitics are harder.

I mean, one of the known knowns is where most people lose their firms. I mean, just managing the known knowns—Silicon Valley Bank. I mean, really? You lost a depository with 200-and-some billion dollars of deposits because you couldn't measure your interest rate risk? That is the basic core function of a bank, is asset-liability management and the management of interest rate risk. They didn't go out of business because of an esoteric derivatives portfolio. They went out of business because they borrowed short through the deposit base and put the money into 10-year bonds. So, never underestimate the importance of just block-and-tackle basic risk management.

Okay. The root of almost all financial crises is an asset-liability mismatch, usually amplified by a considerable amount of leverage.

Yes, no, mostly true. That is the root of most crises in the banking system.

What about in the financial system, beyond banking?

So the question is, is the capital that's been deployed capital of a nature that can absorb the loss? That's the question. So when people think about their equity allocation, they do realize they could have a 15, 20, 30% drawdown. That's part of their mental model when they make that allocation. It's when capital's deployed in a strategy where the capital doesn't have the ability to absorb the loss that you see real shocks rip through the system. Whether it's the banking system—highly levered, they're funded with deposits and money market issuance—they don't have the ability to absorb loss.

The reason why I'm glad you brought it up and the reason I want to go a little further on this topic is because there's a lot of leverage in the industry of which Citadel is a part, the multi-manager hedge fund industry. And again, going back to the need for risk management, you guys have done it well up until now, may continue to do it well in the future. Not every hedge fund is as good. One of your peers, a firm called Schoenfeld, recently required a bailout by another one of your peers. What if, Ken, that does become a problem? What if there is a significant amount of asset-liability mismatch in the multi-manager hedge fund industry and things begin to go pear-shaped?

Well, let's think about the choice of words here and it'll say everything: "Schoenfeld bailout." I think they're up for the year. I literally think their P&L is up for the year. When you refer to an industry as being in distress when the investors have still made money, that's a pretty good industry. That's a pretty good industry. And I really think that drives home the point that hedge funds almost never meet their demise in bankruptcy or receivership like Silicon Valley Bank. They meet their demise because they have mediocre performance for a period of time and investors seek to withdraw their capital. Now, Schoenfeld's had a period here of weaker performance. It happens to great firms. It happens to poor firms.

You can't draw a conclusion based on 18 months, in my opinion. They've had some withdrawals, and they're raising new money. Like, this is just the nature of how capital flows through a system. And it'll be up to them to prove to their current and future investors that they can deliver. But if "bailout" is the word that we're using for a firm that's up modestly, that's a pretty good place to be from an industry perspective.

I'll rephrase the question. Do you worry at all about the amount of leverage in the multi-manager hedge fund industry?

I worry more about the correlation of holdings between the firms. So if I own a given stock, there's a higher average that that stock is also owned by other multi-strategy managers. And that means that if one of us is forced to liquidate that position for whatever reason, that that will have cross effects across our holdings. We saw this in the stat arb community back in 2007, the infamous quant quake. The stat arb community, generally speaking, has a variety of alphas based, many of them based on academic research, many of them understood from very just clear historical correlation patterns. And it's not surprising that if one firm finds itself facing an exogenous shock and they start to liquidate risk, that creates losses for competitors. But losses against your equity capital base aren't, aren't going to put you out of business in almost any scenario with this type of cross-holding phenomena, that the losses relative to your equity capital base just are not expectationally

going to be that large. They're going to be painful, don't get me wrong. I hate losing money. But we're going to get through those moments, by and large.

You and the rest of your industry. In other words, if I interpret what you're saying to me correctly, you don't see a systemic level of risk there.

I definitely don't think the word 'systemic' applies. I think, could you see the multi-manager hedge funds take a joint 10%, 15%, 20% hit to their equity? It's possible. It's possible. That's painful, but not systemic.

Ken, last year we spoke at length about U.S.-China relations. You said, and I quote you directly:

Just to give you a—you know, go back to the pandemic, go back to the first few weeks of the pandemic, and you saw a number of multi-strategy hedge fund managers down somewhere between 4% and 8%. So you saw this play out. Like, we actually have a real-life study of what that starts to look like in a moment of panic.

Well, not just because of what was happening in hedge funds, but that situation did require an unprecedented liquidity injection from the Fed and central banks around the world. That is—we don't want to go back there. Well, so let's be clear.

We needed a liquidity injection to the system because people became unemployed overnight. You sent home tens of millions of Americans from work. And I was—I was in the White House. We needed to get checks into the hands of American families that have no savings. I mean, can you imagine being a waitress and literally it's like, 'We're going to put the "Closed" sign on the restaurant, and I don't know when we open back up.' So the move by the Trump administration to get those checks into the hands of the American people—and we saw various permutations of this around the world—was unprecedented and necessary.

I was getting into China because I think we need to talk about it. And I was about to quote you directly. This is from last year. Ken said, 'Structurally, the trade war with China is a huge loss for humanity.' And we also talked about the U.S.-led restrictions on Chinese access to advanced semiconductors. And you warned about a bifurcation of the global tech stack and the possibility that it could inspire President Xi to perhaps attack Taiwan. And I bring this up because since then, the evidence has mounted that China is using these chips for military and intelligence purposes as part of a campaign to challenge the United States internationally, undermine U.S. security, and weaken U.S. democracy.

And Christopher Wray, the FBI director, put it this way: 'No country represents a broader, more severe threat to our ideas, our innovation, our economic security than China.' So I'm curious, given the 12 months have passed and we now know some of these things, if your thoughts, your opinion on the value of trading with, investing in, maybe even trusting China with our technology has changed at all.

Well, so this comes down to competing interests. Do we want a world of cleaner energy? China leads in EVs. China leads in solar. China is one of the few countries making a huge investment in nuclear again. And we desperately need nuclear in the West. We need a way to have baseload power that's cost-effective and clean. So it's a series of trade-offs. And when we chose to deprive China of access to semiconductors, I made the point—I don't know if it was here or in other forums—we're just going to inspire them to double down on their research and development. "No, you said it here. I remember." All right. And Huawei did just that. They cracked the code of how to create a competitive 5G phone that competes with all the best of the West.

And they did it, frankly, in a blink of an eye. So it's going to be hard to just sever. If we could just snap our fingers and sever our relationship with China, do you think we really come out ahead? That's the question. And I think they have 1.4 billion people who are going to prove to us that we were wrong. They graduate far more STEM graduates every year. The Australians recently, at one of their top think tanks, did an analysis of the 44 most important developing technologies in the world. China leads in 37. So, in spite of what—so I believe the U.S. strategy needs to be: how do we become better at being a competitor? How do we improve K-12 education? How do we improve our university education to focus more on STEM degrees?

How do we strengthen American business and American innovation to beat the Chinese on a global stage?

And it's okay to continue selling China, you know, three-nanometer lithography equipment.

So I think that's a really interesting debate. If it's, 'We're going to withhold but not put our house in order,' that's a huge mistake, because once they catch us, they're going to lap us. So if we're going to go there, it should be tied to a set of domestic policies around creating long-term American competitiveness. And we haven't done the second part of the equation.

The battleground is no longer just in technology. Recently, the United States imposed some—a very small number of—restrictions on the flow of capital to Chinese venture capital and specifically startups that are engaged in military research. What if capital becomes a tool of economic statecraft? What if? Yes. I mean, it has been for—it's been that way for a very long time. But in these terms, if countries start to prevent, to a much greater degree, the flow of capital to places like China, for example.

Well, I mean, look at the history of Europe for several hundred years. The country that had the gold was the country that had the military, was the country that won the war. This is not new in the history of humanity. And our national security comes down to our economic vibrancy. And that sometimes seems to be lost in Washington. If we want to have a very strong national defense and national security posture, give me a really strong economy as a baseline starting point.

The rise of artificial intelligence is both exciting and, to many people, terrifying. Citadel has been experimenting with and incorporating AI into its businesses for years. What have you learned?

So machine learning was first developed in roughly the 1990s, and Google pulled this body of knowledge out of almost the dustbins of academia and applied it in a massive way to improve search optimization. And when they open-sourced that body of knowledge as TensorFlow, it changed the world. Because the power of machine learning was lost upon us in the 1990s because we didn't have the computational power to fit a modern neural network. And Google made the unprecedented investment to build enough computational power to solve a really important machine learning problem, which was search optimization. The rest of us have been in the wake of that great success ever since. At Citadel, we looked at TensorFlow literally within a day or two of the announcement.

And a small group of my colleagues said, 'We're going to see what we can do with this.' And we had a follow-up meeting about two or three weeks later. I said, 'Well, what are our initial thoughts?' It was already in production. We were already using that branch of technology to impact how we priced and traded securities. And it was that groundbreaking that I had colleagues that literally worked like practically 24 hours a day for 10 days in a row to make it happen. They were just that excited about it. Now, generative AI is the next new thing in machine learning. And part of the reason I think it captivates humans so much is it produces written words. It produces images that we can see and understand and appreciate.

In contrast to what we did 10 years ago, where you would just get a vector of numbers—it would just be gobbledygook to the human eye. But when you produce written word, you produce an image, that's something that you go, 'Wow.' This branch of machine learning will have real impact on Hollywood, on creating content, on managing call centers, on helping to summarize research, on helping to automate routine and repetitive tasks. It's going to be a big impact on the economy, and it will help to spur the next cycle of investment in technology, even if that technology only makes ancillary use of this new set of tools. I think that's an important point to make. This will be another wake-up call for corporate America to focus on how to create productivity gains.

Any lessons from Citadel's experience? With respect to generative AI, I think we're in the early innings. I mean, there are clear wins. We already use Microsoft's Copilot tools. It increases our productivity of our developers by roughly 10%. When you've got about 1,500 software engineers, that's like 150 people show up for work every day, and they don't demand benefits. And that's really important because that gives us the ability to take on a whole variety of new projects that we just didn't have the resources for six or 12 months ago. So we're seeing clear productivity gains there. We see it in the manipulation of data that was done by people, like tagging data, a variety of low-level tasks.

And we like to automate those jobs. At Citadel, it's very important that our value proposition to our employees is about a career. So every chance we have to eliminate jobs, we take that. We want to create careers for people that come to Citadel.

I have to spend a couple of minutes on this topic. The United States is 12 months away from an election, arguably a very consequential election. Who are you rooting for? Well, right now there's a debate taking place. Yes. Lately, you've been saying approving things about Nikki Haley, in particular, her foreign policy position. What should we read into that? Look, I hope she has a great night tonight.

I really do. And if she does? If she does, I think that could be a galvanizing moment for her campaign. Can she beat Trump in a primary? We'll find out.

We will find out, but I'm interested in your opinion.

It's going to come down to how does the American public incorporate the legal morass that former President Trump's enmeshed in. There's no doubt a huge portion of this legal morass is the politicization of our judiciary. There's no doubt. You believe that? He's being politically persecuted? 100%. That the charges against him are flimsy? I think a number of these charges are really flimsy. Which ones? How much time do we have here today?

There aren't that many charges.

No, I think it's somewhere like 90 at this point. Which case in particular do you think is most suspect? Well, okay, let's go to Georgia for a moment. And I'm really curious to see where this lands. But when you argue there's this great conspiracy to deprive the American people of a democracy, and then you allow people to agree to testify on behalf of the government, and the ramifications for the crime that they committed as part of this great conspiracy to destroy democracy in America is borderline community service.

The sweetheart deal, effectively, that the government has struck with these defendants who have pleaded guilty is enough to make that case, point... You know, it feels pretty flimsy at that point in time. Okay. What about the insurrection case? Jack Smith's prosecution?

Well, we'll see what he has in the way of facts there.

Okay. I mean, one of the questions is, what did Trump know and believe? That is most definitely one of the most important questions.

All right. And so President Biden was very happy to tell millions of Americans that he was going to forgive their student loans. The DOJ, the government told him, 'You can't do this.' It didn't stop him from making that statement.

It did ultimately stop it from happening.

And to be clear, President Biden is President of the United States of America.

If the election were held today, knowing what you know about both Joe Biden and Donald Trump, who is, of course, leading the polls as the potential Republican nominee, who would you vote for? What are my write-in choices? You're choosing between Joe Biden and Donald Trump.

Well, I mean, I'll be right to the point. It's 12 months further out. What is each of these individuals' state of mental health?

This is an excellent question, one that, of course, I can't answer.

It's an important question because we're in two wars right now in the world. The United States is on the periphery but instrumental to supporting Ukraine right now. And if Ukraine falls, the next border is NATO. Oh, I think I— All right. So we get the picture. Sound mind will be really important when it comes time to pick who is going to be president. So as I say, if it were today, who would you pick? I'm going to wait for 12 months. I'm going to see where people's mental capacity is. And let's be clear, there's another talking point that I've been on nonstop: I would love to see two candidates from each party who are each 20 years younger.

Like, that's the heartbreaking part of the story. Well, as you point out, the Republican debate that is happening more or less right now, Donald Trump isn't participating. Nikki Haley is, Ron DeSantis is, other potential nominees for the Republican Party are. We'll see how they do. Ken, it's always a pleasure. Thank you for joining us at the Bloomberg New Economy Forum.