Jay:  This week’s show guest is Erik Townsend, a retired software entrepreneur turned hedge-fund manager. Throughout his career, Erik has capitalized on his ability to understand complex systems and anticipate paradigm shifts far in advance of the mainstream. Erik is a fellow podcaster and is the host of Macro Voices, a weekly financial podcast which targets financial professionals, high net worth individuals, and other investors who desire financial content at a level of sophistication and complexity above what the retail-investment-focused podcasts on the internet currently offer. Let’s get on to the show.

Hi, Erik. How are you doing? Thank you so much for joining us. We’re extremely grateful for your time and excited to hear your thoughts on the world and investing. So thank you for joining us.

Erik:  It’s my pleasure. Thanks for inviting me.

Jay:  Absolutely. We have a very global audience that’s tuning in from around the world. For the select few that have not heard for you — because I think you’re pretty prolific and you do a lot of good work out there, so I think most people in investing have heard of you — but for the minority that hasn’t, maybe you could give us a bit of background, how you got started, how you became an investor.

Erik:  Sure. I’m not a Wall Street guy originally. I was a software entrepreneur. I ran a software company in the ’90s, and it was very clear to me by the late ’90s that we were in a bubble in technology, so I sold my software company, not because of wanted to be retired at the age of 33 but because I could tell it was a good time to liquidate my assets there and to move on.

So suddenly I found myself wondering at the age of 33, “Okay, what’s next in life?”

What I wanted to do, what my very strong inclination was, was to reinvent myself as a full-time private investor. I had always been fascinated by financial markets. I had been a retail investor previously. I grew up watching Wall Street Week with Louis Rukeyser, and that’s what I thought I wanted to do.

And the single worst advice that I have ever received in my life was from a lawyer who was the M&A lawyer who handled my software company acquisition. He said, “Look, Erik, I’ve seen this so many times before. You’ve got a smart guy like yourself, but you’re a software guy, and you feel really confident because you’ve made millions of dollars selling your company, and that’s great, but you’re not a finance guy. You don’t know all about finance and investing. You are not qualified to run the amount of money that you now have. You need the help of professionals.”

Well, that was the worst advice that anybody has ever been given, as far as I’m concerned.

One thing he was right about is that I was not qualified to run my own money at that point. I didn’t know enough about it. The correct solution to that probably should have been to learn all about it and not take any risks of significance until I knew a lot more than I did.

Instead, I trusted his advice, which was to allow the world’s most prestigious investment bank to run my money for me and to allow their Private Wealth Management Department to manage my money. It only took them about six or even years to lose half of my net worth. So suddenly, I wasn’t quite as set for life as I thought I was when I retired from the software business.

In part out of necessity, because I no longer had the assets that I once did, and in part because it’s what I’d always wanted to do, I reinvented myself around the end of 2006, beginning of 2007, as a full-time private investor, and it’s the best thing I ever did. Retirement sucked.

Believe it or not, I lived on a mega-yacht in the Caribbean, an 87-foot motor yacht. Worst chapter of my life by far. It looks amazing from a distance. It looks incredible. It’s not. And as much as it probably sounds crazy to hear that, I’m sure that living on a yacht in the Caribbean sounds amazing to you too. Talk to somebody who has actually done it, and I’m not the only one who’s had a very, very disappointing experience with it.

Anyway, I started out in 2006 or 2007 to reinvent myself as a private investor, and I was amazed at how rewarding it was because I didn’t know… I knew the Graham and Dodd-style of analyze a balance sheet and figure out what’s a good company to buy stock in, and frankly, it sounded really boring to me. I didn’t think I would like that. And I don’t. I didn’t know there was this whole world called macro investing which has to do with learning about all of the things that are going on in the world and the actions of different nations and how those translate to currency exchange rates between countries and interest rate differentials and so forth.

So when I learned that it’s possible to discover all kinds of fascinating things about the world like, why is it that when there’s an earthquake in Chile that means the price of copper is probably about the go up? You can learn about all these fascinating things and make money from knowing these things. Wow, I didn’t think that was possible.

So it was a discovery for me that this idea of global macro investing is a way to do this that really resonated with my personality, and that’s how I got involved with it.

Initially, I was living there in Hong Kong full-time, living in Mid-Levels, being a private investor, hanging out in my apartment with a beautiful view of Victoria Bay and trading and learning more and more about it. And some friends of mine in Hong Kong said, “You’re doing all the work of running a hedge fund. Why don’t you turn it into a hedge fund?”

I thought, “Me? I’m a software guy. I’m not a finance guy. I can’t do that.”

They said, “Dude, you’re doing all of the work. We’ve met private investors before, the guy with the iPhone at the golf course. Erik, you’re sitting in front of nine computer monitors for 14 hours a day. That’s not private investor. That’s hedge fund investor not getting paid for it.”

I said, “Oh, really? Okay.”

It took me a few years to really take that advice to heart because, frankly, I had not had a good experience with “the world’s most prestigious investment bank.” I didn’t think that this whole finance business is something that I, frankly, wanted to be involved with. Eventually, I warmed up to the idea and launched a fund in 2013, and I’ve been having a blast ever since.

Jay:  That’s awesome. That’s a great introduction that you gave, by the way. What a fascinating story that you have personally. It’s kind of rare to find people that are successful investors that weren’t doing it from day one, and it’s cool that you came from being a very successful software entrepreneur, retired, to going back into investing. I find that fascinating.

You launched a fund. You talked about macro a bit. Obviously, you’re a macro guy, but how did you find that path? There are many ways to make money in the market, and it seems like different people go down different paths at some point in their lives, and it can range from value investing to momentum trading or macro. So how did you find yourself to become a macro guy?

Erik:  Well, the single most important rule that I know in the world of investing is what I call the Schwager doctrine, and I name it after Jack Schwager who you’ve also interviewed. Jack has been the most outspoken in saying, “Look, there is no right or wrong way to trade. The right way is what resonates with your personality.”

And as I said, if you take something like balance sheet analysis and figuring out expense ratios and so forth, it’s possible to make money that way. I could never do it because it would drive me crazy. You’ve got to figure out where your passion is, and I don’t think anybody can be really successful in investing unless you’re doing it for the passion because you love doing it, and you love waking up every day just excited to do some more of it. If you’re doing it as a job that you have to do in order to make money to get by, I don’t think you’ll ever be successful at it.

The Schwager doctrine is to figure out what resonates with your personality, and that is where I started, and I recommend reading Jack Schwager’s books, the Market Wizards books. There are four of them which are interviews with the most famous and successful investors and traders in the history of the world. The reason to do that if you’re new at this is not to learn how to invest from them but to figure out which of those guys resonate with your personality, which is the one that you want to for your role model.

When I read the books, it was the macro guys. It was people like Jim Rogers, in particular. Jim was a huge inspiration in my life. He was the guy, when I read the Market Wizards books, I’m like “Yeah, I want to be like this guy. Think about what makes the world work. Thank about what the interactions are between governments and trends and society and what it’s going to mean.”

One of the things that that led me to — because I’m a very big-picture thinker — it led me to thinking about where do I start with really understanding the big picture of finance and economics and so forth. A guy named Nikolai Kondratiev in Russia started writing about the long-wave business cycle. Now a lot of people, when they hear the phrase business cycle, they think about the boom-bust cycle where each cycle is about five to seven years. Thank of those as the little waves on the ocean. Those little waves are on the surface of much larger swells, and those larger swells of a long-wave business cycle, which run about 80 years.

I first read about Kondratiev, and I thought it was so fascinating that history comes in these rhythmic patterns that run about every 80 years or so. Kondratiev never really figured out why it was 80 years. It was Neil Howe who modernized Kondratiev’s work and wrote a book called The Fourth Turning, which was a huge influence on me.

Basially, what Howe says is that although history doesn’t repeat, it definitely rhymes, and it comes in these rhythmic seasons. And if you think about seasons of the year, there are four of them. They last for three months each. Well, these seasons in the long-wave cycle are about 20 to 25 years in length, and they each have characteristics, just as you know what summer is like and what winter is like and what autumn is like and what spring is like. A Kondratieff winter, or a fourth turning as Howe calls it, has certain characteristics.

Basically, each one of these, Howe numbers them as first, second, third, and fourth turnings. The second turnings are the big periods of cultural and spiritual awakening where society tends to change. The last one that we had was the 1960s and ’70s when we had free love and Woodstock and the women’s movement and radical changes in the attitudes that people had socially, a liberalization socially.

The fourth turnings are the crisis periods when things go very badly, and major systems and institutions get replaced. If we go back to the Spanish and Indian wars, it was a fourth turning. The next one after that was the American Revolution. The next one after that was the Civil War in the United States. The next one after that was the Great Depression and World War II, and the next one after that is the one that we’re in right now which began in 2008 with the great financial crisis and which will continue until about 2030.

So my biggest theme that I follow is we’re in a fourth turning. We’re in Kondratiev winter, which means that major things, things that are thought to be just cast in concrete, never going to change… If you go back 100 years ago, the pound sterling is the world’s reserve currency. Great Britain is the world’s hegemonic military power. Nothing will ever be bigger. Nothing will ever be stronger. That’s just the way it is. Nobody questions it.

Well, of course, you go through the last fourth turning with World War II, now all of sudden the US dollar is the world’s global reserve currency, and the United States is the world’s great hegemonic military power that everybody assumes will never be challenged.

And as we come into the second half of this fourth turning, that’s the magnitude of things that tend to change. Now, I’m not necessarily predicting that those particular things change, but the point is something that is taken for granted like “The US dollar is the word’s reserve currency” or “The center of everything is the United States, the military power, the financial center in New York, the daddy of them all that’s in charge of the world is the United States.”

Things on that level are the kinds of things that change in fourth turning.

Where does Asia play into this? I think this is Asia’s century. I think we’re coming into a period in history where it is very possible that the major powers in the world change, and I think that Asia is in a good place to be where the power moves to. It moved from England to the United States, and I think that Asia may be next. And that doesn’t mean that it’s going to happen overnight, but over the next hundred years, I think you’re going to see major shifts.

The concept of long-wave business cycles informs everything that I do on a high level, and from there, I break it down into more specific themes and investment strategies.

Jay:  That’s a great overview of your investing framework.

From what you’ve just spoken about, it sounds like if one were to be astute and more observant, one could tell that, like you said, we’re coming up on the end of this long-wave business cycle, and it sounds like there could be some very dramatic shifts that are just around the corner in the next, say, ten to 15 years, one of which you just mentioned — it’s Asia’s century, this thematic that, of course, people are aware of. People hear about China all the time in the news — the second largest economy, soon to be first at some point, the rising middle class and all the stuff that’s happening over there. But I think that the magnitude of this huge shift that’s happening in the background, I think that a lot of people aren’t aware of that, as aware as you are and maybe some of the more educated investors are.

What are some of the other possible big changes that we might see, Erik, in the next 12 to 15 years?

Erik:  One of them is definitely that our attitudes about energy have to change. There is an idea that I call “peak cheap oil,” and sometimes people roll their eyes and say, “What are you talking about peak oil? Oil is cheap right now. We’ve got too much of it.”

It’s absolutely true that we’ve got too much of it, but this is a short-term thing as a result of the financial crisis. In the United States, we had this easy money policy from the Federal Reserve that led to overinvestment in the shale patch in the United States. So we do have too much oil. Oil is super cheap right now, and that’s an opportunity because oil is not going to stay super cheap.

The days of “drill a hole in the ground and oil comes out” are over. All of the oil resources where you can simply drill a shallow oil well and oil comes gushing out have been used up. It doesn’t exist anymore.

Right now, the hot thing is shale oil where you drill a hole and the ground and then you turn the drill bit and drill sideways, horizontal oil wells, and then you inject into it a very, very high-pressure hydraulic fluid that’s full of sand that cracks and breaks the rock, and then the sand gets wedged in the cracks and holds them open, and that allows the oil to flow.

The point is we’re not ever going to run out of oil. That’s nonsense. What we are going to do is have to rely on more and more human innovation and fancy technology in order to produce oil. And oil is absolutely the backbone of the economy.

People sometimes think, “Wait a minute. Electric vehicles are going to change all that.” Electricity is not a source of energy. Electricity is a transmission mechanism. You’ve got to get the energy from someplace. So either we’re going to continue to burn fossil fuels in order to generate electricity, or we’re going to have a very, very different attitude about nuclear energy, which would be a radical change from the attitudes that exist now.

So how does that all play out? Do we go all nuclear and not need as much oil? I don’t know, but it’s going to be a major change from what we have right now.

Eventually, more and more complex and expensive technology will be required to produce oil. Oil will become more expensive, and alternatives will become more and more important, even more so than they are today.

Another really theme is the International Monetary System, which was put in place at the end of the last fourth turning at the Bretton Woods Conference in 1944 which designates the US dollar as the international trade currency and is also the defacto favored reserved asset for central banks, which is essentially like the piggy bank or the savings account of an entire country. It’s all US Treasury bonds is what they hold as their piggy-bank assets for all the nations around the world.

Things of that magnitude are likely to change. China and Russia right now both have expressed extreme frustration that the United States continues to have this monopoly on the world’s reserve currency status. They would like very much, through a process that a scholar in Russia called Sergei Glazyev has called de-dollarization. They would like to persuade the rest of the world to dump the US dollar, and they’ve actually just introduced a new crude oil contract, which is not trading yet, but which will be both denominated in yuan and convertible into gold. And so the idea is to bypass the US dollar for the international sale of oil. They’re trying to do things to displace that.

That would have profound, profound implications because the US gets, essentially, a free license to borrow and spend as much money as it wants to. Normally, if a country is over-indebted, it pays a very, very harsh price for that. But as the world’s reserve currency issuer, the United States is almost forced to run massive current account deficits, trade deficits, in order to supply the world with a supply of dollars necessary to run the global economy.

If the US dollar was no longer needed internationally in that capacity, all of a sudden, there would be a massive crisis in the US treasury market. All of the international buyers wouldn’t be there anymore.

So there are a lot of people in the world that would like to displace the US dollar’s hegemony over the global financial system. How does that play out?

One of the possibilities is a government-backed cryptocurrency. This is something where I think people in the West are so complacent and so lost. They think of China as a third-world country. It’s a bunch of peasants bent over in a field picking rice or something. That’s China. Of course, that used to be true. 50 or 100 years ago, that was true. But right now, China has absolutely no shortage of fantastically talented software engineering capabilities, and the People’s Bank of China is hiring blockchain engineers right now to design the digital RMB.

Okay, what do they have in mind for this digital RMB? Are they going to use the popularity of a cryptocurrency, combine it with being state-backed, maybe even combine it with being gold-backed at some point and use it to assert it as a competitor to the US dollar as the world’s global reserve currency? They’re not saying that’s their strategy yet, but as I look at it, I scratch my head and say, “Hmm, what are they up to?”

There is a lot of things that are going on with the general international monetary system and the desire of other countries not to let the US continue to monopolize it. So this de-dollarization theme is very important.

And the other thing, I’m sure if your viewers have seen an interview with Jim Rogers, the reason that Jim moved his whole family to Singapore was because he could see what was coming, and he felt so strongly that he wanted his two newborn daughters to grow up speaking fluent Chinese.

He told me much more recently that he didn’t know when we moved to Singapore in 2007 that what they speak in Singapore is not exactly perfect Putonghua. They speak bad English, Singlish, and bad Chinese. But his daughters, they speak fluent Mandarin. It was very important to him to bring his children up in an environment — because he could see what’s coming for the world.

So this idea that it’s Asia’s century, I think is really important. That doesn’t mean that right now this instant Asia takes over. The last century was the United States’ century. Look at what we went through between World War I and a Great Depression, stock market crash in 1929, World War II… There are a lot of bad times that go into having your century, so it doesn’t mean that it’s all roses for Asia, but I think that eventually Asia is going to be in a much stronger position at the end of this century than when it started it.

Jay:  Absolutely. Erik, you talk about this de-dollarization theme a lot on your program, Macro Voices, which is a great, great podcast. We’ll get into that a little bit later on this interview.

Can you quickly explain the significance of what you just mentioned, the oil contract that is in yuan that might be convertible to gold? Just give us a quick primer without, obviously, going too far down the history rabbit hole. But the significance of that and with the petrodollar and how that was the institution for a while and now how this is pretty radical, and it’s going to change the way that that can be traded with China.

Erik:  I’ll try not to go too deep. You’re right, I have a bad habit of doing that. An economist named Robert Triffin started writing in the 1950’s and ’60s about what became known as Triffin’s paradox. He said, how do you decide which country’s currency is going to be the world’s reserve currency? Well, you pick the best credit, the strongest credit. Clearly in 1944 when the United States was a creditor nation with no external debts, and the Great War had been fought entirely overseas, it had never been fought on US shores, most of Europe is lying in ruin, clearly the US dollar had to be the world’s reserve currency.

What is the result of gaining this status of being the world’s reserve currency? Well, it basically gives the issuing country, it creates such a demand for their currency offshore that it almost forces the issuing country to borrow and spend beyond their means because what the issuing country has to do is basically print up a whole bunch of money in order to make it available to the rest of the world, and that allows the government to do all kinds of things.

Now, if a country that was not the reserve currency issuer did that, they would see the yields on their treasury bonds go through the roof as a result of default risk.

If you’ve got all this artificial demand externally, it essentially let the US go into debt for free. The finance minister of France, Valéry Giscard the’Estaing, said in the 1960s that the US gets, essentially, an exorbitant privilege it doesn’t deserve, which is the ability to go into debt for free.

What Triffin said is this paradox starts with how do you get to be the reserve currency? You’ve got to be the best, strongest credit. Having that status just encourages you to become the worst credit, to borrow and spend to the point where your currency is no longer nearly as strong as it was when you started.

And he predicted that the US would eventually have to lose its reserve currency status.

Now a lot of people thought that was going to happen when, in 1971, President Nixon was effectively forced to close the gold window, to default on the Bretton Woods Conference, which promised the rest of the world that US dollars would always be convertible into gold at a fixed conversion price of $35 per ounce.

Well, when the rest of the world figured out that the US dollar was not really worth the gold that backed it, they started turning in their dollars and wanting the gold, and it was very clear that the US was going to have a run on its gold reserves. So President Nixon slams the gold window, and a lot of people assumed, “This is it. The US loses its reserve currency status.”

At the time, the Secretary of State of the United States, Henry Kissinger, was a very astute, shrewd man who understood exactly what was at stake. He went and met with Saudi Arabia and basically made them a deal they couldn’t refuse. He said, “Look, you guys are in a very fortunate position. The royal family is very, very wealthy because you’re in power right now. It would really be bad for you if that was overthrown somehow.” And by the way, our CIA has a bit of a history of overthrowing leaders of countries. “On the other hand, if you cut a deal with me right now and make a promise that you’re going to only sell your oil in dollars, regardless of whether it’s to the United States or to China or to Russia, it doesn’t matter who, only price it in dollars, and number two, whatever profits you make, you’re going to reinvest that in US Treasury Bonds, the safest investment on earth.”

Of course, Kissinger was smart enough to know that treasury bonds were about to be anything be the safest investment on earth unless he could talk the Saudis into this. But they knew they didn’t have a choice. They knew that they had to do what he wanted, and so the petrodollar system was born.

Basically, the petro-dollar system means that the oil-producing nations, particularly Saudi Arabia, price and sell their oil in dollars. That means there has to be this huge international demand for all the other countries around the world to have dollars to pay for their oil exports. It allows the US dollar to continue to be the world’s reserve currency even after Nixon defaulted on the gold convertibility upon which it was based. That’s what’s kept it going for the last 45 years.

One of the reasons is that the US was the biggest importer of crude oil. It was in a position of “Hey, we’re the biggest customer. We can throw our weight around and get what we want.

Well, all of a sudden, the US is absolutely not the biggest importer. China is as big an importer of crude oil and probably will soon be a bigger importer of crude oil. It’s not what it used to be.

So if you were to change the world in a way that the Saudis and everybody else sold their oil in a currency other than US dollars, there would not be a need for all the countries around the world to have US dollars to pay for their oil, and that means that all of a sudden, the things that have kept the US dollar’s hegemony over the global system and have allowed the US to borrow and spend beyond its means without really paying any penalty in the sense of default risk in the bond market, those things could all change. And that’s a really big deal.

I just interviewed Luke Gromen recently on my show. He thinks that this new oil contract, on the surface of it, it looks like it was just designed to be a contract that nobody other than China would use because it allows you to pay for your oil in yuan. Well, nobody but China has yuan to spend on oil, so why would this matter?

Gromen thinks there is a lot more to it than that. He thinks that China is trying to create a mechanism that basically allows any country in the world to bypass the dollar going through the yuan market and to effectively take this exorbitant privilege that the United States has had and transfer it to China. And it’s a fascinating concept.

This contract is not trading yet. What really remains to be seen is when it starts trading. Is it like some esoteric thing that gets ten contracts a day traded, or does it suddenly capture market share and dramatically take over what the Brent contract currently commands in terms of the market share that is transacted through it? We don’t know yet, but it sure looks, in a lot of ways, like that was designed with the intention of stripping the United States of the benefits that it has. And frankly, I don’t think the United States government gets it anymore.

Henry Kissinger understood this stuff inside-out and backwards. He designed it. He knew what he was doing. I don’t think that President Trump understands all of these mechanics as well as Kissinger did. And I think that the United States takes a lot for granted. They assume “We’re the biggest. We’re the strongest. We’re the mightiest. Nobody would dare to ever question us.”

I think that militarily that’s still true. Economically, I think it’s changing, and I think it could change in a big way, and it could be one of those things that sneaks up on you, and I think the United States may be in for a rude awakening.

Now, that certainly does not mean that I’m predicting that happens tomorrow or next week or next year. Over the next 12 years, the best of this fourth turning, I wouldn’t be surprised if it was no longer just commonly accepted that the US dollar is the world’s reserve currency and always will be. I think that’s likely to change.

Jay:  Absolutely. That was an excellent overview, Erik. I think if you ever get bored of the hedge fund industry—

Erik:  I was supposed to not be long-winded with that one.

Jay:  Sorry about that. You could definitely become a history professor. You brought up a lot of thought-provoking points there that I think the audience is going to go back and research after we’re done. Thank you for that explanation.

Going back to China now and the theme of this being Asia’s century, so to speak, a lot of investors have rushed in over the last decade, 15 years, in and out, some have come in too early and gotten burned, some have just not done their homework or didn’t really know what was going on, and then you see a lot of even companies trying to break into and penetrate the Chinese market without having a good, on-the-ground partner. They think they can just steamroll in and set up shop and take over, and then they’re out of business in two to three years, and they leave the country with their tail between their legs.

So from an investor’s standpoint, I do understand that there are very specific nuances with the Asian markets and China particularly, but from what you’re saying, it sounds like it’s a pretty good bet, so to speak, on a longer-term basis. What do you make of investing in Asia and China? What a your big-picture thoughts and any cautions that an investor might consider before diving in?

Erik:  Yeah, really, really big cautions. I suggest going back about 90 years. Look at the roaring ’20s in the United States when there was some economic prosperity after World War I. Everybody was feeling great. A lot of very fast-moving activity in the economy. Everybody thought nothing could ever break. There was the famous quote about how stocks had reached a permanently high plateau and could never come down again, and then we got the stock market crash of 1929.

I’m not necessarily predicting that China is going to have a crash akin to 1929, but the ingredients are there for it. There is a very famous hedge fund manager in Texas called Kyle Bass who has been staking his entire career on this idea that this massive, massive credit expansion that has occurred since 2009 in China is going to blow up in China’s face. It’s going to force the PPOC to have to dramatically devalue the yuan in order to recapitalize the banking system and that that could send a wave of deflation around the world that induces the next global financial crisis.

Kyle thinks that that’s overdue to happen. Now that doesn’t mean he’s right. He’s been thinking that was a few years now, and it hasn’t happened yet, but I think there are plenty of reasons to consider that where we are in this story right now, the best time to come in with new money to invest in any market is right after a crash when there is blood in the streets, that 2009 moment when everybody is afraid to invest because it seems like the sky is falling. That is not the environment that we have now.

My advice to anyone coming into this, first thing is to understand the difference between investing and trading. Investing is building a portfolio that you’re going to buy and hold for a long period to grow your wealth and that you don’t want to be coming into buying and holding assets for a long period… These things come in waves. If we’re kind of surfing on top of the wave, maybe you don’t want to be bringing new money to work in a market that may be headed for a down trough sometime soon in the next few years here.

From a trading standpoint though in particular, trading being shorter time frame — how do I put trades on to make money in the next several months or perhaps as long as the next few years? — I think that what you want to do is realize there are times for different strategies. If we were at the bottom of a cycle, if this was 2009 and everything is dirt cheap, value investing, the Warren Buffet style of investing, that’s what you’d want to learn about because it’s the way to look for the bargains and buy the things that are just so distressed that they can only go up.

Nothing is cheap in this market. Now, there may be some things that are still going to go up, but nothing is cheap.

So if you look, Michael Covel wrote a book about trend following. Trend following is a directionally neutral strategy. It’s not saying “I’m going to bet on things going up.” It’s saying, “I’m going to bet on things either going up or going down, based on what the market is actually telling me about what’s happening.”

If you look at a strategy like trend following, another one would be option writing… In option writing, you’re not betting on what’s going to happen; you’re betting on what’s not going to happen because you’re selling the options to someone else who is buying them because they think they know what is going to happen. If you look at strategies that are not associated with an assumption that a bull market is going to exist, I think you’re much better off.

If you’re investing for the longer term, there is a strategy called long-short equity, which a lot of hedge funds use. The idea there is to say “I’m not going to just pick the best companies and buy their stock hoping it goes up. I’m going to pick the best companies with half of my money, buy their stock, and I’m going to look for the worst, and I’m going to use the other half of my money to short their stock, to bet that the price is going to go down.”

That way, if you have an up year in the stock market, your long positions are going to outperform your shorts. If you have a down year, your shorts are going to outperform your longs, but hopefully you still make money either way in an up or a down market.

So there are strategies that work in both up and down markets. This is a time, if you’re coming into this, to learn about those kinds of strategies, not about the strategies like value investing that work best when you’re coming in at the bottom of a cycle.

Jay:  Right. It sounds like, from everything that we’ve been talking about thus far, and you go over a lot of these same concepts on your podcast with a number of extraordinary guests and brilliant investors, but essentially the markets, at least in the US, by many metrics, almost every single metric, are extremely overvalued because they’re extremely rich at this point. It does make sense to, if you are invested there, to take some chips off of that table and perhaps look over into Asia. What would be some simple… Asset allocation might not really be your thing, but what would be some simple ways that investors that are listening and maybe some of these things that you’ve said have resonated with them and they’re like “Okay, maybe I should rotate out of US equities or fixed income and look into Asia,” are there any things that are on your radar that you might recommend?

Erik:  Yeah, what I would be careful of in Asia is anything that’s associated with credit and the massive expansion of credit that has occurred. Kyle Bass has a very good point about this credit expansion.

If you look at things like banking shareS, they are going to be really hurt if the credit collapse that Kyle Bass predicts occurs. On the other hand, if you look at technological innovation, technology entrepreneurship, small companies that are doing exciting things with technology…

Recently I’ve been riding these electric unicycles. I don’t know if you’re family with these products.

Jay:  I’ve seen them, yeah.

Erik:  They’re outlawed in Hong Kong, unfortunately.

Jay:  I saw one in Singapore not too long ago, maybe a month or two ago when I was down there.

Erik:  So little inventions like this could only come out of China. They’re really cool. They’re not very expensive, and they’re super fun. Apparently, in a lot of Chinese cities, they are the thing as far as… And I guess a lot of your viewers have no idea what we’re talking about, so if you go to YouTube and put in “Airwheel,” Airwheel is not the best brand of electric unicycle, but they do have the best videos, and you’ll see these things. It’s basically a little electric wheel with a battery on top of it, and it’s a gyroscope that balances it, and you stand on it with two little pedals, and you ride it around the city. Mine goes up to 45 kilometers per hour, although I would be scared to ever go that fast. And it’s got a handle on it. You pick it up and take it on the subway or the bus with you. It’s really cool.

That kind of innovation coming out of Asia is awesome. I would be looking at companies that are doing cool, innovative technology things as opposed to exposure to the Chinese banking system, in particular Chinese credit markets. I’d be really careful there.

Jay:  Erik, you mentioned earlier, we talked briefly about cryptocurrencies. We hear all these things about Bitcoin and cryptocurrencies. To me, it’s like religion. I don’t own any, for the record, and I can’t really take a view because I don’t know that much about it. But hearing different people argue about it, it’s like either religion or politics. People have strong opinions on it. What are your views? I’m particularly interested because you do have a technology background, so I’m sure you know a lot more about the technology than most.

Erik:  What I would say is what if you had met the Wright brothers in 1906 and had the opportunity to invest with them? Wouldn’t that be the ultimate of getting in on the ground floor? Well, guess what? The Wright brothers never made any money on aviation. It was other people who did.

And unfortunately — I’ve predicted this for a long time — as a technology guy, I love Bitcoin. I think it is so cool I just can’t stand it. I would never pay a penny to buy one of these things, and the reason is simply that I cannot imagine governments allowing it to continue. What Bitcoin was designed to do was to create a money system that is completely anonymous and completely immune from government overreach. It’s impossible for the government to seize your account or track your transactions or know who you are or tax you or any of those things. It’s a Libertarian pipedream. It is a governmental nightmare, and I think that what will happen, unfortunately, is governments will steal all of the wonderful innovations from the first generation of cryptocurrencies — like Bitcoin and Ethereum.

The blockchain is absolute brilliance from a software engineering standpoint. That is going to be used for a long time to come. Unfortunately, I think that the way it will be used is Bitcoin will be outlawed. China has been the first major nation to take governmental action to do that, something I’ve predicted for years now, and I think it will be outlawed around the world. The excuse that will be given is that it’s the tool of terrorists, and there is actually some truth to that, that people who are putting up ransom attacks, stealing intellectual property, and this hack that happened to Equifax, which is a big credit rating agency, it’s “Pay us so many Bitcoins.”

They will use stories like that out of context to say, “Bitcoin is the tool of criminals and terrorists. No good person other than a criminal or a terrorist would ever want to have them, and therefore, we’re outlawing them.”

What they’ll do then is the governments will steal all of the technical innovation, and they will invent a new digital currency. By the way, the People’s Bank of China appears to already be doing this right now. They’re hiring blockchain engineers to design the digital RMB. I predict — and I have no idea what the digital RMB is conceived to be — but I predict that eventually we will have a government-backed cryptocurrency which is the opposite, the antithesis of Bitcoin.

Everything will be traceable. The government will be able to know exactly who has any penny of wealth on the planet, who they got it from, when they got it, how long they’ve had it, where the last guy got it from. They’ll be able to seize accounts. They’ll be able to tax accounts. They’ll be able to do anything that they want. And they will use the technology innovations that the creators of Bitcoin invented in order to basically do the exact opposite of what the Bitcoin designers set out to do.

It’s a very sad story, in my opinion. I don’t agree with the view that that’s for the better good. I think that governments tend to interfere too much in our lives. But if I look, in the investment business, you’ve got to be really, really careful to separate your own views about what should happen from an objective analysis of what’s most likely to happen.

What’s most likely to happen, I think, is governments will continue to abuse our human rights and control things in a way that give all of the power to the governments. And the way you do that is you outlaw Bitcoin and Ethereum, and you provide a government-sponsored cryptocurrency which has exactly the opposite set of features. And I hope that I’m proven wrong. I’ve never wanted to be wrong about anything as much as that, but you can see it’s already happening with China.

The Chinese government is doing two things at the same time — outlawing Bitcoin and hiring blockchain engineers to make their own cryptocurrency. Read the handwriting on the wall, I guess is my message.

Jay:  Absolutely. You mentioned a very good point there, Erik, about independent thinking, and I think that, as an investor, it’s something that all of us struggle with and finding your conviction level based on your experience and your research and your trading experience and just really trying to separate, like you said, what is independent thinking versus your biases that you might be carrying into the trade from your previous life experiences.

As someone who has a diverse background and educated yourself on investing, what is some advice you could give to some of our viewers that are serious about wanting to learn how to invest, maybe started off as a private investor very much like yourself, and then hopefully scale up to see some of the success that you have?

Erik:  It all starts with the Schwager doctrine. You’ve got to figure out what style of investing resonates with your personality, and you’ve got to find passion for it. There is no reason to ever put a trade on unless you have edge, and you know what that edge is, and you’re not going to find that edge until you have enough passion to work really hard at this. It’s not something you can dabble with in your spare time. So I would certainly say that’s probably the first thing.

A lot of people, very understandably, think this might be an interesting hobby that they’ll dabble with for a few hours here and there. My strong advice to that part of the audience is don’t do it. Try golf or ping pong. Something else. Don’t do it.

If you want to pursue this, you’ve got to figure out what’s that style of investing that I’m going to feel so passionate about that it doesn’t feel like work to me, that I just can’t wait to pick up the next book and read all about it. And it’s very much a question of your personality. The best way I know to figure that out is to read all four of Jack Schwager’s Market Wizards books. Even if you don’t understand what they’re talking about — some of the strategies are very complex hedge fund strategies, statistical arbitrage and so forth — it doesn’t matter. You don’t have to know what is actually being discussed. What you want to be reading it for, at least on the first read is “Okay, this guy’s whole strategy is about math, and he likes to model things with algorithms. And this other guy, Jim Rogers, for example, doesn’t care about charts. He doesn’t care about any kind of technical analysis. It’s all about understanding what’s going on in the world.” Which one of those resonates with your personality better?

Start at a high level, and eventually, you find who were the characters in their Market Wizards books that become your role models. And then you start to learn more about those people and how they do their things and how those strategies work. It’s a lot of reading. You’ve got to have a lot of dedication and commitment to it, and it’s, again, why I argue you can’t be successful unless you find something that you really enjoy.

Jay:  Absolutely. One of the other things that I think that, in recent years, that I’ve used as a great resource is podcasts such as your own. You have one of the best investing podcasts out there called Macro Voices, which I’ve learned so much from. So thank you, Erik, for starting that and for your commitment and your dedication to bringing some fabulous guests, some of the smartest investors that you hear and read about, and you actually get to pick their brain, so to speak.

Can you tell us a little bit about that project? Why did you decide to get started on that? Who is the target audience of that? It’s all for free. You provide so much free content. What’s your motivation to do that?

Erik:  Well, I got started in podcasting after I took a big trip around the world, trying to figure out where the best place to live is. I was interviewed on another financial podcast about that trip, and it was kind of fun. I got a lot of interest and people sending me emails and wanting to follow my newsletter that I was writing at the time. I don’t have a newsletter anymore. I just do the podcast these days.

That got me involved appearing on that podcast as a regular sort of columnist. What I encountered was there is a mindset, which is we’ve got to design these things for the retail investor, for the person who has no real professional experience. And I kept being told, “Erik, you can’t talk about future spreads. You can’t talk about butterfly option combinations. You’ve got to keep it simple — stocks are going up; stocks are going down.”

I found too that a lot of the guests that were interviewed, they’re used to being asked by the producers — whether it’s a financial television show, a podcast, or whatever — to basically dumb it down to a retail level. And it was not so interesting for me to take a person that I really, really wanted to talk to, that I would not get the opportunity to talk to, and ask them questions that were not interesting because I was trying to dumb it down to retail.

And I thought, “What if I created the first and only podcast that was intentionally designed to say, look, we’re not trying to get the biggest number of listeners. We don’t care about that. What I’m going to do is I’m going to ask these guests the questions that I, as a professional fund manager, want to ask them. I know that that’s going to be fairly sophisticated content that is not going to make sense to a lot of people, and I’m okay with that. This will be the only podcast in the world which is targeting professional finance and only the very, very sophisticated retail investors who have been doing it for long enough that they really know a lot about it.”

And I assumed it would have a very small audience following. What’s really amazed me is the opposite has been true. We’ve got a huge retail following. We get emails all the time from people saying, “Look, I don’t understand half of what you’re talking about, but that’s why I like this show. If I listen to the other show, and I totally get it and I understand it, I don’t really learn from it. Every time I listen to Macro Voices, you talk about something and I’m like ‘What the hell is he talking about?’ And I spend the next three hours on Wikipedia figuring it out, and I learn something, and it’s fascinating.”

So it’s really surprised me that we’ve gained a much bigger audience than I expected to. And the strategy is basically to get all the people that I can think of that I want to talk to and ask questions of and try to give them interviews that are on a more professional, sophisticated level targeting the more sophisticated investor market.

And to my surprise, we’ve got a really fantastic following that’s developed in the last couple of years.

Jay:  I only listen to a handful on a regular basis, and it’s definitely one of them. I really like how current you are when you are. Every episode before you bring on the guest, you do a macro and markets overview, which actually helps me a lot in my own personal investing and just trying to keep tabs on the gush of information that’s out there. Again, thank you, Erik.

Is there anything that you are working on, in addition to the podcast, obviously, that excites you right now, or just more of the same, putting out solid content and obviously running your fund?

Erik:  Between running the fund and producing the podcast, it’s about all the bandwidth that I’ve got. But I’m really loving it. I’d encourage people to come to MacroVoice.com or just put Macro Voices into the iTunes store. You can subscribe for free there. We publish every Thursday evening, and it’s a little over an hour long each time. There is, as you said, a market wrap, and then there is a feature guest interview which is about 45 minutes with some of the smartest people in finance. And it’s mostly macro-economics-focused interviews. So come and check us out.

As far as other projects, not a whole lot else going on. The fund and the podcast keep me pretty busy.

Jay:  And the markets, I’m sure. Erik, thank you so much for your time and your generosity and the insights that you shared. It’s going to be very well received by our audience. A lot of thought-provoking nuggets that you dropped there for our audience, so that’s great.

Finally, where can people find you, follow you, and learn a little bit more about yourself or Macro Voices?

Erik:  Well, I’m trying to join the younger generation and do the Twitter thing, so I’ve been active on Twitter lately. You can follow me @ErikSTownsend on Twitter and MacroVoices.com or just put Macro Voices in. Definitely, the best way to follow me is to listen to the podcast every Thursday night, and that gives you both what I’m thinking about the markets every single week as well as a fascinating interview with a featured guest.

Jay:  Fantastic. Thanks so much again, Erik. We really appreciate it.

Erik:  It’s my pleasure. Thanks for having me on, Jay.

Jay:  Alright. Take care.