Financial History as Superpower: Sir Niall Ferguson on Markets, Mistakes, and Making Big Calls

Financial History as Superpower: Sir Niall Ferguson on Markets, Mistakes, and Making Big Calls

Cold OPEN: “"Knowing financial history I
think is a superpower. I think it's actually probably more valuable to an
investor than knowing economics..."

Justin Thomson

Welcome to The Angle from T. Rowe Price, a podcast for
curious investors. Just a reminder that outside of the U.S., this podcast is
for investment professionals only.

I'm Justin Thomson, head of the T. Rowe Price Investment
Institute. My guest today is Sir Niall Ferguson. Sir Niall is an acclaimed
historian, author, and public intellectual, renowned for his deep insights into
economics, finance, and global history. He is currently the Milbank Family
Senior Fellow at the Hoover Institution at Stanford University, and has held
prestigious academic positions at Harvard, Oxford, and the London School of
Economics. Sir Niall is the author of numerous influential books, including
"The Ascent of Money," “Empire,” and “Doom: The Politics of
Catastrophe.” His work has been widely recognized for its ability to connect
the past to today’s most pressing issues. We’re thrilled to have him join us
for a conversation on history, finance, and the forces shaping our world.

Sir Niall Ferguson, welcome to The Angle.

Sir Niall Ferguson

Great to be with you Justin.

Justin Thomson

So Niall, you have made great pains to say that you are a
financial historian, and not an accomplished investor, but for the purpose of
this we are going to assume you are a master investor. As we discuss what the
patterns of history can tell us about the future of financial markets. So,
there's a theoretical question or questions to be asked here. Why is studying
history and particularly the history of financial markets so crucial to making
smarter investment decisions?

Sir Niall Ferguson

Well, Justin, it's true that I am not a great investor.
Don't don't claim to be, nor am I an economist. I'm a financial historian by
training, which means I belong to an endangered species in academia because
there are very few jobs in this field. History departments don't like you
because you're into economics and economics departments don't like you because
you're into history. And so most of my students are kind of, struggling to make
their way. The benefit of being an endangered species is that you know stuff
that most people don't know. And knowing financial history I think is a
superpower. I think it's actually probably more valuable to an investor than
knowing economics, a discipline that grows increasingly remote from the real
world as it becomes more mathematical and, and spends less time thinking about
money and and about markets.

So financial history is all about money and markets. It's
about taking long runs of data, not just the last ten years, but the last
hundred years, the last 200 years, and trying to do some pattern recognition.
That's really a lot of my career. Understanding the history of the bond market
in the 19th century was something I spent a lot of time doing when I was a
young scholar. And once you've got 200 years worth of data, you will see that
the world is characterized; A by financial evolution - that's to say the
financial system evolves, it changes structurally. B; by punctuated equilibria.
Shocks occur of all kinds, from plagues to wars, to financial crises, and these
are very unevenly distributed and extremely hard to predict. Understanding that
character of financial history, if you like, its bumpiness, its lack of smooth
lines, I think is a very important basis for being a good investor. I wish I
were a better one, but I think that's a matter of temperament more than it's a
matter of knowledge.

Justin Thomson

When you look at history or the history of financial
markets, what do you believe are the constants?

Sir Niall Ferguson

I think the constant is this evolutionary process where
things don't stand still. The institutional arrangements of, say, banking
evolve. The other constant is that investors, sophisticated and unsophisticated
investors alike, when they are enthused about an asset class, will tend to get
overenthusiastic, particularly if they can speculate on margin. The more
leverage, the more excitement, the more likely there is, to be an accident. So
those are the two things that are a pretty constant, and you'll encounter those
throughout the ages. What's interesting about history is that even quite
distant events make sense, and so we can understand a financial crisis even in
medieval Venice, because it has the same familiar characteristics in which
investors become overenthusiastic, miscalculate risk, and then there's a blow
up. These things are perennial, even, although, of course, the setting, the
technology and all, the all the rest of it changes.

Justin Thomson

I'm often asked about how you handicap geopolitical risk. I,
I have no idea how to handicap geopolitical risk, but can you help our
listeners with a framework to think about pricing geopolitical risk into asset
markets?

Sir Niall Ferguson

I think it's possible to have a more rigorous framework than
most have. That is to say, we can have, some sense of the probability of peace
in Ukraine. A return of conflict in the Middle East. A Taiwan crisis in the Far
East. We can, we can attach rough probabilities to those scenarios by combining
historical pattern recognition with good human intelligence. If there's a
Taiwan crisis, then markets will really be very heavily impacted. I think that
the probability that there's a showdown of some kind of or Taiwan is better
than 50% over the next three years. But I arrive at these estimates, these
rough probabilities, by combining my historical knowledge of what the stakes
are, who the players are, how the how the players think with the best
intelligence that I can gather about, about the decision makers.

Justin Thomson

You've given a great segway back to previous podcasts we've
run, which were about behavioral finance. Annie Duke - retired professional
poker player - who wrote a book, “Thinking in Bets”, encourages us to
think in probabilities. And that's great because you can; you're never wrong.
You're just you're just subject to the lower probability event, which I think
is the best. I think that is a good way for investors to frame things to think
in probabilities, and to be explicit about those probabilities. I think that's
a really good way of thinking about it. I also think in terms of developing as
an investor, intellectual honesty and owning up to your mistakes, or at least
being the wrong side of probabilities, is crucial for anyone's development.
What prediction or historical interpretation have you got most wrong?

Sir Niall Ferguson

It's very important to acknowledge when you're wrong. Many
public intellectuals and, and, academics are bad at this, because there's not
much accountability in the press, or in academia. Now, I, I was very wrong
about something back in; I think it was 2010. I signed a letter. I didn't write
the letter, but I cosigned a letter which was critical of, of, quantitative
easing and implied that it would be inflationary. And I remember as I signed it
thinking, I'm not even sure I believe this. So, I signed it more out of peer
group pressure than real conviction. But it was quite wrong. So, I learned an
important thing from that, which is, if you're going to make a prediction; A:
write it yourself, and, B: have really high confidence. Never put your name to
a prediction that you have low confidence in. The downside’s just too great.

More recently. So to cut a long story short, it was in the
wake of, of that kind of mistake where I'd called the financial crisis pretty
well in the “Ascent of Money”, but then I didn't call the aftermath
particularly well, that I decided to set up Greenmantle and bring some other
minds to bear on the problem. So, I hired some of my best students and said,
let's do applied history, but we'll do it together. I think one rarely can know
everything. In fact, you can't. And it's important to make, these sorts of
calls in some kind of group, preferably a group that does not all think alike.
So, I hire people who disagree with me, and I encourage them, to, to push back.
And that's worked well for us.

We've had a run of pretty good big calls, but I'll remember
2019 for many years to come because we made two terrible calls that year. One
was, on Argentina, and the other was on Britain. In both cases, it was an
election, and we were just wrong. We were wrong about the Argentine primary,
which Mauricio Macri lost handily. And I greatly underrated my Oxford
contemporary, Boris Johnson's likelihood of winning a thumping majority in the
UK election that year. And that is important because calling elections requires
you to be as dispassionate as making any investment call. You can't allow
yourself to be too emotionally engaged. And I think I was, in some measure,
emotionally engaged in both those cases. I really kind of wanted Macri to win.
I really didn't want the Peronist’s to win. That made me underestimate their
chances. And my kind of skepticism about Brexit and my, I generally, somewhat
low opinion of of of Boris, led me to underestimate his enormous appeal to
voters, many of whom had never voted Tory before. So those political mistakes
came from just allowing my biases into the process. I learnt from that.

Justin Thomson

Interesting. You introduced the idea of biases. I mean, to
go back to quantitative easing, you may have got the outcome wrong, but your
thought process may have been right. I mean, the logical conclusion of that
degree of monetary stimulus would be that it would be inflationary. So, you
know, that's that separating the outcome from your thought process.

Sir Niall Ferguson

I think what was wrong about that, letter, though it's been
a while since I looked at it. Was that it, it somewhat vaguely foresaw adverse
unintended consequences of, of, quantitative easing, without being terribly
specific, but implying that at least one of them, was inflationary. Now, the
work that I subsequently did on the history of central bank balance sheets
taught me something very valuable, which is that in the event of a crisis or a
shock, for centuries, central bank balance sheets have expanded to offset the
shock. And that's just part of what they're supposed to do. It's , it's
actually a correct policy response. And looking at the expansion of the Fed
balance sheet and thinking it would be inflationary was just a very basic
confusion, of, of monetary base with the things that matter more; A: broad
money supply; B: velocity. And there had been all kinds of reasons why, in the
wake of the financial crisis, there was a real risk of monetary contraction,
with bank failures. What the Fed did, I think, as, as has often been said,
worked better in practice than it did in theory. But the thing that mattered
was that it works. And if anything, when one looks back on that period after
2010, the striking thing was that it took a while for the economy fully to come
out of, the doldrums that, that, that, were the aftermath of, of the financial
crisis. You’ll remember at that time, Ken Rogoff and Carmen Reinhart just
published a very important book – “This Time is Different”. And one of the
takeaways of that great work of financial history was that you can have quite a
hangover from a financial crisis, and indeed we did. So, the thing to worry
about in 2010 wasn't the unintended inflationary consequences of QE. The thing
to worry about was, that despite QE, despite the Fed's quite successful efforts
to offset the effects of the banking crisis, they would still be a prolonged
hangover in the economy because of scarring, of, of, of households. I think
that, with the benefit of hindsight, was what I got wrong.

Justin Thomson

Okay. It's always good to own up to things you got wrong and
work through the process.

Sir Niall Ferguson

Well, we do it every year at Greenmantle. Every year we go
through every predictive statement that we have made in the course of the year,
and we assess whether they were true or false, or not proven. Because, of
course, some things that you predict aren't yet clearly right or wrong by the
end of the year. So we do that every year. Unsparingly. Trying to be completely
honest with ourselves, as well as being honest for the clients. And I think
it's a very important exercise. It's also kind of important to confront your
bad calls, and to make sure that you're batting at least 66%, because the
minute we're only 50%, right, we might as well give up and just send all the
clients a coin and tell them to toss that for the future.

Justin Thomson

What is the right number for being right in your business?

Sir Niall Ferguson

Look, I would have said if you'd asked me that a few years
ago. As long as we had 66% to 75% of the time, right. Would never be 100%
right. But as long as most of our calls, you know, two thirds to three quarters
are right, we're doing our job. I now think of it differently. What I've come
to realize, Justin, is that every year there's one big thing, and you can be
right about all the small things, but if you get the big thing wrong all that
rightness is kind of for the birds.

Let me illustrate this. In 2020, in January of that year, in
the middle of January, we told our clients with high confidence this is the
biggest pandemic since the Spanish influenza of 1918/19; it’s going to be
hugely disruptive and buckle up. And that was very early, and I think it was
very right. So that was a big call. Everything else that year was sort of
really of much less importance. You had to get that right. And I think each
year there's something like that.

The following year, the call at the beginning of the year
was; the Biden people are making an inflation mistake, and this is going to get
very messy. That was something that was very against the currents. Very few
people saw that. In fact, you was supposed to not say that because this was the
age of modern monetary theory and, all that kind of stuff. And so, very few
people said there's an inflation problem coming, and I remember feeling very
nervous about it for the reason that I mentioned earlier. I'd been wrong in
2010. So I remember thinking, oh, we’re going to make this inflation call again
and be wrong. But, but, my colleagues persuaded me that there was a fiscal and
monetary blunder being made. And so that was a good important call that year.

And then the big call in 2022, right at the beginning was,
Putin's going for an all-out invasion, for real. That that, was a really
important call, which we gave 80% probability to at a time when a lot of people
thought it was all a bluff. So what I've learned is that each year there's some
big call, and you just have to get that right, and, the rest, will be a
rounding error.

Justin Thomson

The trick is to actually know which identify in the moment,
which are the big calls and which are the less relevant one. And I guess
without putting words in your mouth, that's where the historians eye gives you
the edge.

Sir Niall Ferguson

Yeah, I think so, because ultimately what you're doing,
given that not everything belongs in the realm of the normal distribution.
There's lots of uncertainty around the incidence of pandemics, or major wars.
So in a way, you're using a kind of rough pattern recognition to get a sense of
whether there really is going to be a war. And I think the only way to acquire
that skill is just to have read a lot of history. You know, the feeling I got
when I saw a paragraph, it was actually an email saying, strange outbreak of
bronchitis in Wuhan. And it just reminded me of the first paragraph announcing
a major pandemic, that had also begun in, in, in China in the 19th century.
That sense of, that sense of that's how it begins. It begins with a little
paragraph about somewhere you haven't thought much about.

I mean, I think, in 2023, the big call was that there was
going to be a crisis in the Middle East. And here I give great credit to J.
Menz, who, was our Middle East director at that time. He said, I can't tell if
it's Hamas or Hezbollah, but one of them is going to blow up the negotiations
that are going on between Israel and Saudi Arabia, and I just, I don't know
which one it is, but the Iranians are going to have one of them do it. So that
was the 2023 call. And 2024 was all about Trump. You just had to have
conviction about, about, the U.S. election, and I always did.

Justin Thomson

Okay, I'm going to I'm going to move this into the future,
because 2026 is the 250th anniversary of the U.S. Republic. What is, what is
the center of conversation? What is the big call in 2026?

Sir Niall Ferguson

Well, you're kind of steering me towards it's being about
the United States, which it may well be, because after all, it is still the
number one economy, and it does still feel as if what happens there has
ramifications that are global. My sense is that there's a political call to be
made on the 250th, which is just about the midterm elections. Do the
Republicans lose the House of Representatives? And if they do, what are the
consequences for the Trump administration? In other words, is it a normal second
term after all? And is the president a lame duck for the two years that remain?
I think that's probably the main call.

The subordinate call will be, does, does this AI boom
finally run out of legs, or has it got further to go? I, I think it probably
has further to go, but that's, that's the other big call that one has to, to
make. It's plausible, I think that the capex can go on increasing, because the
hyperscalers just have so much free cash flow. And those, as they begin to
borrow balance sheets are so darn strong. They're weaker brethren, clearly,
that don't have those strengths. And might be that the market starts to look
even more askance at those weaker brethren, but that ought not to suffice to,
to cause this boom to roll over. So, I suspect 2026 will be one of these years
in which the political news flow will be kind of bad. But the markets news flow
will be okay. Those are, those are the obvious things to think about.

What about the, the thing that will kind of surprise us? I
think it's the view of others, is that the, that China is preparing for a
Taiwan event, it's not yet ready. It has to happen while Trump's president
because Trump, the Chinese see as somebody who could do a deal on Taiwan. The
market tends to think about this in two binary ways. Either they're invading
Taiwan or they're not. But I don't think that's the right way to think about
it. I think invasions very unlikely. That's a very difficult thing to do, even
for a super experienced military. Even blockade, it’s quite risky. You could
end up in a naval conflagration, but you could see ways in which the Chinese in
the next three years push the envelope, say, trying to restrict Taiwan's trade,
claiming that China can enforce customs on Taiwan. Grey type, grey-area type
moves. And I think the goal of Chinese policy is a peaceful victory where they
don't have to fight, where they simply assert their sovereignty. So that's how
to think about this. The Taiwan contingency isn't likely to be an invasion or
even a blockade. It's likely to be a kind of grey zone in which the Chinese
assert their power in various ways.

Justin Thomson

I'm interested in this term U.S exceptionalism because it's
become a journalistic heuristic. But one, one  fact that, historical fact,
that you can't contest or is the least contentious is the dominance of U.S
equities as an asset class. Not just among other equity markets, but all asset
classes. But for you, what defines U.S. exceptionalism?

Sir Niall Ferguson

Well, this is indeed, an annoying turn of phrase, because
it's, it's used, in this promiscuous way by people who haven't thought at all
deeply about the long run; sure in the last ten years, or maybe since the
financial crisis, U.S equities have performed exceptionally well. And, the U.S.
economy has performed exceptionally well, particularly compared with Europe.
But that hardly merits a term like exceptionalism. Normally, when historians
use that term, that they're implying that there's something unique about the
country. The United States has been exceptional for 249 years. But, but, in
what ways exceptional?

What's interesting about this is that if you take a 100-year
view or even longer 150-year view, it is true that U.S. equities have performed
better than everywhere else they they have. I mean, that's partly because the
competition suffered much heavier damage in the world wars than the U.S. did.
And so, if you take 100 year view, the U.S is like an obvious, an obvious
winner, for an equity investor. But, if you just break it down into decades,
there are decades when U.S. equities were exceptional for their awfulness. I
mean, 1930s was a time when you absolutely didn't want to be exposed to U.S.
equities. And so are the 1970s. So, I think if we're talking about
exceptionalism, we should be quite clear that over 100 years, 150 years, sure.
It's been a, it's been a fantastic buy and hold strategy. But you have to
remember the decades when American equity performance is exceptionally bad, and
there is nothing written anywhere that I'm aware of that says it can't happen
again.

Justin Thomson

Sounds like your objection to the word exceptionalism is, is
the equivalent to my objection to the word unprecedented, which is overused,
become so overused.

Sir Niall Ferguson

Absolutely. It's also a little bit like the word, literally,
where young people will say, I'm literally on fire. When people say
unprecedented, what they actually mean is, I don't know any history.

Justin Thomson

That's how I read it. Well, this has been literally an
unprecedented conversation. And, I think.

Sir Niall Ferguson

True, we've never had this conversation before.

Justin Thomson

So, you've written 16 books. You're currently in the middle
of the second volume of the Kissinger biography. You've said this is going to
be your 17th and last, which for someone with your energy I find hard to
believe, but what would; give us a hint of what's next?

Sir Niall Ferguson

Well, the Kissinger books are really, really, a huge magnum
opus because I'm trying to write a biography in a novel way, in the sense that
I am trying to go deeper in the researches than I think is conventional in the
biography, and that's why it's taken so long. It's going to be a book, I hope,
worth reading, by, this audience, as well as many others because you you kind
of are navigating the 1970s with, the ultimate player who's kind of in every
game. And I'm fascinated by what I'm learning about the way the U.S. government
really works and the interaction of politics, geopolitics, and economics, which
the 1970s is a really, really fascinating case study in.

What do I do after that? Well, I think I've written enough
books. I also have a sense that the book is a, it's a fading form in a world of
emojis and artificial intelligence. And it would be sort of a bit futile to
write yet another if the goal is to change the world, in at least some way. And
so I'm more interested for the rest of my life, however long that is, in
working on new institutions. I think founding is the most fulfilling thing one
can do, aside from being a parent. I founded several companies, and now I've
founded a university in Austin, the University of Austin, and I'm deeply
committed to growing those institutions, making sure, in particular, that the
University of Austin contributes to the reform of higher education that is so
urgently needed. And so that's where I'd like to put my energies, into the
institutions, rather than writing another book.

Justin Thomson

This has been a fun conversation. I'm not sure it's been
unprecedented because you do this all the time, but I thank you so much for the
insight.

Sir Niall Ferguson

Thank you Justin. It's been real fun and unprecedented,
literally.

Justin Thomson

And thank you for listening to The Angle. We look forward to
your company on future episodes. You can find more information about this and
other topics on our website. Please rate and subscribe wherever you get your
podcasts.

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