Future Current

Photo courtesy of Renee Blodgett

Peter Thiel is the founder and president of Clarium Capital Management LLC, a global macro hedge fund managing $2 billion in assets and which has returned 240% since its inception in October 2002. In 2005, Clarium was honored by both MarHedge and Absolute Return as the global macro fund of the year. At the 2007 Singularity Summit hosted by the Singularity Institute for Artificial Intelligence, he observed that over the past three decades, financial markets experienced the largest and most violent series of booms and busts in history. Nothing in the orthodox literature predicted the market gyrations of the recent past. One distinct possibility is that the epochal shift the market senses but cannot identify is the arrival of the singularity as the transformational technological event of our time.

The following transcript of Peter Thiel’s 2007 Singularity Summit presentation “Financial Markets and the Singularity” has not been approved by the author. An audio version of the talk is available at the Singularity Institute website.

Financial Markets and the Singularity

I thought I would dispense with the powerpoint presentations and the detailed slides to share a few thoughts I’ve had on investing in a world where the possibility of a Singularity exists. It’s sort of a different perspective from some of the discussions people have had. There are two levels one can think about investing. One is as a venture capitalist, investing in early stage companies. The basic rule there, and for investing in general, is that you want to do something that is fundamentally true and that nobody else sees. That’s how your do really well.

Artificial intelligence, or near-artificial intelligence, or quasi artificial intelligence, this is so out of fashion today that it is perhaps the only thing thematically that I think makes sense on a venture capital side to do - to try to identify things that are promising in this sort of direction. I think the venture capital end of it is fairly straightforward. There are all sorts of details you can discuss, but I want to focus instead on a very different element of it, which is the big picture. How do you invest in the world as a whole? What is going to happen to the world’s stock market or the world’s larger financial markets in a world where this possibility of a Singularity, or something like this, exists? How will the world’s markets be different from a Singularity-type world from a world where such a thing would never happen or not even be possible?

I suppose the basic intuition that I have about it is very simply, this is a world in which there is a possibility of things going extraordinarily well or extraordinarily badly, where both the good things and the bad things are bigger than people think. If you have a bell curve distribution of possible futures for the world, the tails on that bell curve are much fatter than people think. There is far more that can happen at the far edges. This would lead to a very different behavior in markets from a normal bell curve of distributions where nothing that interesting or extraordinary is going to happen. In particular, the Singularity will either be very successful, in which case we are going to have the biggest boom ever, or it is going to blow up the whole world and there will be nothing left to invest in whatsoever. This leads to an interesting investment dynamic.

I will start parenthetically by saying that the second category is one that’s rather difficult to invest in. If you are somebody who is predicting the end of the world, even if you are right, I think you will still not make a lot of money. Even if you put all of your money into gold coins in a silver chest and hide it in some forgotten corner of the planet, when the world does come to an end there will be nothing left to buy or to sell, and probably well before then some humans or robots will have come along and taken your gold away from you. The bad versions of the Singularity are things that one cannot invest in, at all. They are not investable. So there are all these possibilities that one cannot even think about. In some sense, if you believe in something like this, you have no choice but to bet on it, as an investor. The best investments will be the ones that represent the most aggressive bets on it: you have no choice at all, ultimately. The challenge is that maybe the things you will choose aren’t exactly right. You thought the Singularity was going to happen here, and it turns out you made a small mistake, there were catastrophic approximations leading to things that are very disappointing.

What would you expect to see happening in a world where the Singularity is near? The alternative to a good Singularity is the apocalypse, and we don’t really know where it is going to happen. You would expect the world to be full of massive manias, booms, and busts on a scale unprecedented in all of history. Interestingly, if you actually look at the world’s financial markets over the last 25-30 years, that is exactly what they have manifested. It is one of things that I think is very striking. All of the conventional theories say that markets should be getting more smooth and efficient as there is more and more information out there. Somehow everything smoothes out, the volatility gets suppressed, and stocks should move up like 6% a year in a smooth, monotonic function. Instead, we’ve seen bigger booms, busts, bubbles than ever before.

I want to suggest to you that one of the ways to think about a lot of these incredible booms that we have seen is that they represent different bets on the Singularity, or on various things that are proxies for it, like globalization. If you have a Singularity there is presumably going to be one entity, or one company, or one technology that is going to basically take over the whole world. It will basically be worth more than everything else put together. You have had this series of bets on what that is going to be, over the last 25, 30 years. If you actually were to do a chart of the booms and busts in the history of the modern world, the amplitudes of the booms and busts have gotten much bigger. So, if you are like a doctor looking at this graph and it starts oscillating really wildly in the last quarter century and you’ve said, “Nothing interesting is going on in this world,” you are probably not the person I’d want to have treating me.

Let me run through a few of these by way of illustration. The first of these hyperbooms took place in Japan in the late 1980’s. I think it is no coincidence that Japan in the ’80s was conceived as being on the cutting edge of technology. There was all the 5th generation AI stuff that Japan was pushing and you had all these textbooks about how Japan Inc. was going to run the whole world. By the peak in 1989, the Japanese stock market was worth more than all the other stock markets in the world put together. The emperor’s palace in downtown Tokyo was assessed as being worth more than the entire state of California. People said that the entire future of the world was going to be based in Tokyo, and this is where it’s going to happen. People took out 100 year-long mortgages that their great-grandchildren would pay off for a 400 square-foot hole in the wall condominium. And then, of course, it turned out that it was not quite like that, and you had a massive, extraordinary bust.

We saw the same thing in the mid ’90s. There was an emerging markets boom. Some of the busts have also been extraordinarily big. In the financial derivative context, the long-term capital blow up in 1998, the mathematicians who had priced these financial derivatives estimated that something like the scale of the move on these markets was something that would happen only in one trillion times the history of the universe. The conventional postmortem on long-term capital is that the mathematicians were just wrong and hadn’t done a good job programming their computers. Obviously, the math must be wrong. But I think there is sort of an interesting question there. What if the math was actually right, and in fact we just had an extraordinary bust?

In ‘98 when long-term capital blew up and Russia went bankrupt, where basically you had a country with 10,000 nuclear bombs, everybody’s bank account went to zero, and in case you still had any money left in your bank account the currency also went to zero. Normally, emerging market banking crises, either the banks go bust or the currency goes bust. In ‘98 in Russia, they did both. So, zero times zero definitely equals zero. Of course, in that context you bring to bear every kind of resource you can because a country where everyone is going to starve to death with 10,000 nuclear weapons doesn’t seem like a good outcome for the Singularity. Then all of a sudden, within 18 months, we had the hyperboom in Silicon Valley, where it was going to be the internet.

Having lived through the hyperboom and the last few months of insanity, I’ve often thought I could write a whole book on it. It still seems like yesterday. There are aspects of it, of course, that seem like a strangely different time. There was obviously something real about it. The conventional postmortem on the internet boom was that in March 2000 the delusion and insanity had reached its peak and people were completely crazy. I can tell you all sorts of anecdotes that one could see as confirming that thesis. However, let’s ask the opposite question. What if March 2000 in some sense represented not a peak of insanity but a peak of clarity, and that at the peak of the boom people could actually see the furthest, and what they could see was that in the long-run, in the next 20 years, 30 years, the entire old economy was going to be doomed and that all sorts of businesses and ways of doing business were no longer going to work? Therefore, and this is the tricky part, you had to bet on this one way that was going to be the way out. And that was the internet.

It turned out that perhaps online companies selling pet food by buying Super Bowl advertisements offline were not really the technology that was going to be the decisive set of breakthroughs that was going to lead to the Singularity. Again, we had this pattern of catastrophic approximations, but basically a picture that was very much correct. The bust in ‘02, ‘03 was quite extraordinary. There are a number of different ways to describe it financially. An interesting one is Japanese government bond yields got to 0.43% on a ten-year bond yield in 2003, which was the lowest bond yield in the history of the world. Again, we have multi-trillion dollar markets that go to massive extremes one way or the other, and then basically in the last three years, we have a whole series of new booms.

You have a choice, which one do you believe? Which one is going to be the Singularity? Is it going to happen in China, which is basically at this point looks like it is accelerating on every front, and has probably the most extraordinary evaluations of any emerging market in the history of the world? Is it going to happen through finance, where there has been these enormous amounts of financial engineering? A lot of very smart computer people have tried to apply computer technology to Wall Street, to repricing things, doing financial engineering to fundamentally change the valuations of things. You have all these quantitative trading strategies. Are the computers going to figure out how to allocate all the money perfectly? If you can figure out how to get computers to allocate money better than humans, maybe the place to bet on the Singularity is on finance itself, which is Wall Street.

Even something like the real estate bubble, which seems to have nothing whatsoever to do with the Singularity I think has been centered in these places that are going to be at the center of the new future world. London and Manhattan, if you believe in the finance version. Shanghai, if you believe in the China version. Of course, we have a Web 2.0 boom, and the question whether these things are booms or bubbles to some extent comes down to, Is this how the Singularity is going to happen? The macro-thesis I want to suggest is, even though it is likely that most of these massive moves are going to be fake, there’s something wrong with them - Japan, in fact, was fake in the late ’80s. There was a lot that was not quite right with the internet boom in the late ’90s - it can’t be the case that every single one of them will be fake. One of them is going to be real, or the world is going to come to an end.

I come back to this point that as an investor, you probably have to try to figure out which ones are real and try to invest in those. You don’t want to fade these things. This has certainly not been a good environment for investors who are merely sane. I think this is a recurrent motif of the last 20 years. All the classic funds that were trying to figure out what does a normally overvalued market look like, they all blew up in ‘99, 2000. What looked really overvalued went much further. The reason these bubbles go much further is because people see no alternative. They are implicitly betting on something like the Singularity, whether they know it or not. There may be some indirect ways to do this.

Perhaps the smartest investor in the world is Warren Buffet. You could ask, How is he betting on the Singularity? Obviously, that is what you should do if you’re a smart investor. He’s doing it in a very interesting way. He used to be focused on value stocks or selling thing like regional companies in long-term gradual decline, nothing that seemed to have much to do with the Singularity. But the entire Buffett portfolio in the past ten, fifteen years has shifted towards selling insurance and catastrophic reinsurance products. If you think about it, we’re going to ensure against a nuclear bomb going off, I think there are basically four different things that can happen. Scenario number one is, nothing happens, you just get the premium. That’s pretty good. The second scenario, you have a mild disaster like 9-11, but it actually helps the insurance companies because people expect the future premia to go up. And, in fact, perversely after September 11th, all the insurance stocks went up dramatically in value. Scenario three, you have an even bigger catastrophe like, say, a single nuclear bomb going off. In which case, maybe the rules get changed, the government bails you out, something like that happens. Scenario four, you have maybe 10,000 nuclear bombs go off, in which case you’re in trouble, but there may not be anyone around to collect.

I would definitely not underestimate someone like Buffett. I think that he has probably thought this through at least to the level that I have described just now. One thing that is of course very tricky is that we don’t know what the probabilities for these different things are. If you have a situation where in a successful Singularity a stock is worth $100, but there is only a one in ten chance of it happening, then you might say that the Fair Market Value is $10. But then the alternative is one where everybody’s dead. So, how much do you pay for the stock? Do you pay $10? Do you pay $20? I would say you pay an indeterminate amount somewhere between $10 and $100. You could make an argument that you should pay $50, or something like that. The inverse is that these insurance policies, maybe they’re priced correctly, maybe they’re priced incorrectly, we don’t have any idea what the probabilities really are. But we are living in this very strange world where this seems to be a very big part of a fabric of what is going on.

It is very difficult to know where one necessarily goes from there, but the point that I would stress is, probably the best thing to try to focus on are these sort of incipient booms that people have not yet realized. My guess is that we will see a whole series of booms, bubbles, and busts for the next ten, twenty years as we are getting closer to this. It’s not at all clear that it will be any of the ones we’ve seen. If you look at the historical info, we had Japan, the internet, we now have financial engineering on Wall Street, we have emerging markets, even the boom in the late i960’s, it was outer space. It was basically thought that the Singularity was going to be driven by whoever controlled outer space. Maybe we’ll have a combination of all of those. If I had to bet, I think it will probably be something completely different that people are not expecting at all. That makes it quite difficult to figure out. I would say that as a baseline, it’s going to happen and it will be none of the above.

I do think that there is this very big frame out there. There is something about the world we’re living in. It is too easy to dismiss people who are screaming in Hyde Park, predicting the end of the world, and stuff like that. The people who have predicted the end of the world have been wrong for too long. We cannot measure whether they are right or wrong, because they only have to be right once. There is a cartoon that we have given to some of our investors that shows somebody saying, “In the end of the world we predict disasters and catastrophes, but in the run-up to the end of the world, we predict extraordinary opportunities to make lots of money.” It’s not clear which of the two is going to happen, and I think it will be a very exciting thing to try to sort through this in the next 20 years. It’s going to be a very exciting time. Buffett may be doing it best, but there are some things that you could do that may be a little bit riskier but better than the Buffet selling catastrophic insurance strategy. Thanks a lot.

This entry was posted on Wednesday, November 14th, 2007 at 5:21 pm and is filed under Singularity Summit, Financial Markets. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.