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Sebastian Mallaby

VC, hedge funds, the Fed, and theories of history

Sebastian Mallaby is the Paul A. Volcker senior fellow for international economics at the Council on Foreign Relations (CFR). Mallaby contributes to a variety of publications, including Foreign Affairs, the Atlantic, the Washington Post, and the Financial Times, where he spent two years as a contributing editor. He’s the author of many of my favorite business books of all time including ⁠The Power Law⁠ on the history of Venture Capital, ⁠More Money Than God⁠ on the history of Hedge Funds, and ⁠The Man Who Knew: The Life and Times of Alan Greenspan⁠, which is one of my favorite biographies ever in any category.


(0:00:00) Intro

(0:00:57) Business journalism

(0:04:11) Journalists as investors

(0:06:24) Most misunderstood part of the economy

(0:07:34) EMH

(0:11:49) Private v public markets

(0:17:27) Liquidity premium

(0:20:13) New asset management models

(0:26:12) Investor specialization

(0:37:42) Firm culture vs outlier talent

(0:41:00) Sequoia and FTX

(0:44:40) Meme stocks

(0:45:56) VC vs hedge funds

(0:50:38) Decision making at the Fed

(0:57:22) Evolution of the Fed

(1:01:34) Powell

(1:05:39) The Fed’s political independence

(1:07:13) History, Marx, Carlyle



[00:00:11] Dan: Welcome. This is a conversation with Sebastian Mallaby, senior fellow in international economics at the Council on Foreign Relations. He's authored many of my favorite business books of all time, including The Power Law on the history of venture capital, More Money Than God on the history of hedge funds, and The Man Who Knew: The Life and Times of Alan Greenspan, which is one of my favorite biographies in any category ever.

What makes Sebastian's books and insights so unique is you can tell he's spent a ton of time with the biggest names that impact the global economy. You get the sense that he really understands what makes them tick. Insiders in the industries he writes about comment on the accuracy of his books, and it really comes out in this conversation. He's also a student of history, and there's a fun bit at the end where we get into Marxism and the great man theory of history. I hope you enjoy it.

All right. I'm here today with Sebastian Mallaby. Sebastian, welcome.

[00:00:56] Sebastian Mallaby: Great to be with you.

[00:00:57] Dan: Okay. First question. When the book The Power Law came out, I was really struck by how many VCs took to Twitter or another public forum to talk about-- The response I generally saw was something to the effect of, "Yes, if you want to read a book on venture capital, this is how it is." What do you think that you understand about business writing that others might miss where your writing gets praised actually by the practitioners?

[00:01:21] Sebastian: It's partly patience. I do spend five years or so on these projects, and so I take the time to really go native, get access as much as much as possible. If it requires me to accept that somebody doesn't want to see me, but I can circle back in a year, that's what I do. I end up having really spent quality time, two-hour interviews, recorded, where there's really time to go into a lot of depth with folks.

I also built an environment of trust. Most of the time I'm approaching somebody because I've gotten to know somebody else who knows them, and I'm being passed along, so it's a warm intro. Unlike most writers, I'm not worried about sharing pages I've written. What I say is, "Look, this is an independent project. I don't promise to change a single comma, but I do promise to listen to what you have to say. If you've got comments, tell me."

In my view, that makes the book better. It means that if there's an error, which is a real error, then I will correct it, and if it's a matter of judgment, I will make a judgment. In my view, that serves the reader, but of course, it also serves the source because they feel like I'm not a cowboy who's going to completely introduce what they're telling me, therefore, they talk more.

The frequent outcome of that sort of process is that I send people some pages. They say, "Listen, it's not wrong, but we feel, or I feel, that there was some angle you under-emphasized. Why don't we have another conversation, and I'll explain why?" So then I get another hour and a half of time with someone. That always deepens my understanding, and it makes for a better result. Now, it is time-consuming. You have to be willing to write a first draft, a second draft, a third draft, et cetera until you really feel that you've gotten it right, but I do feel it's the best way to proceed.

[00:03:23] Dan: Say, a talented young person said, "I want to be the next Sebastian Mallaby," is there any advice that you would give them specific to journalism?

[00:03:31] Sebastian: I guess it's probably the case that you have to get to these projects after you've had a bit of journalism under your belt. In my case, I'd been a full-time journalist at The Economist magazine, and then at the Washington Post, writing editorials and opinion columns before my book-writing career really began to take off. I think that was important because you build a foundation of knowledge, you build credibility, you get some name recognition, and that enables you to go out and get the good access that you need in order to have a shot at writing a good book.

[00:04:09] Dan: It's striking to me that both Alfred Winslow Jones, who you credit as starting the very first hedge fund, as well as Mike Moritz, who, of course, started Sequoia and was one of the very early stars of the industry, they both began their careers as journalists. What do you think is useful about journalism in a career as an investor?

[00:04:26] Sebastian: Actually, that's a great parallel, which I hadn't quite thought of, but you're completely right that Alfred Winslow Jones was a kind of a journalist. He wrote long essays in what, at the time, I think, were the more heavyweight versions of, I guess, Fortune, maybe Forbes. I think Fortune. He was on the borderline between a bit of journalism and academia. He had a PhD in sociology.

Michael Moritz was more a classic journalist, wrote for Time magazine, and so, because he was doing this work much later than Alfred Winslow Jones, it was more of a journalist in the recognizable modern sense, Michael Moritz. You're right that they both had that formation. I guess it's a natural thing for someone to do if they are very curious about the world and they want to go talk to people and discover stuff, and that's what investors do as well. I think that's the reason.

[00:05:21] Dan: Back when you were starting your career, did you have any business journalists that you looked up to or tried to emulate, or do you feel like you're trailblazing?

[00:05:29] Sebastian: I think Roger Lowenstein was influential in my development. He wrote the famous book When Genius Failed, about the hedge fund long-term capital management. He also wrote a bunch of other books. I really like his long biography of Warren Buffett, for example. He focused on telling it like it is, not rushing to judgment to condemn a business operator as a greedy capitalist, but more trying to understand what the intellectual process has been that went into investment decisions that then made a lot of money.

It was less about the kind of what you might call wealth porn and more about the geeky intellectual understanding. I related to that, and I guess that's what I've tried to do as well.

[00:06:21] Dan: To that end, what do you think is the most misunderstood part of the global economy by the general public?

[00:06:28] Sebastian: I would say that finance is right up there in the sense that it's routinely condemned in a, I think, rather knee-jerk fashion. The reality is that if we don't have central planning, which over history hasn't worked terribly well, you need decentralized planning. That means you need financiers to allocate capital intelligently. We have limited amounts of capital to allocate. There are also limited amounts of workers in the economy, capital goods in the economy. If you give somebody a bunch of capital, they're going to go off and hire some people and buy some capital goods and use up the non-financial resources as well.

If you want growth, if you want productivity, you have to give these resources to the smarter operators who are going to do something that's actually useful, useful being defined as producing goods that people will buy because they want them, they have utility. I think decentralized planning is at the center of what makes economies good. That is largely carried out by investors.

[00:07:31] Dan: It seems like people have very different views on the efficient market hypothesis. It's super debated, right? In academia, they'll tell you, "Hey, it's mostly true with a couple of nuances." In business, sometimes they'll say it's mostly not true, with a couple of nuances. Just from your perspective, what's the best way to understand it?

[00:07:49] Sebastian: I think, first, one should make a distinction and point out that the efficient market hypothesis I think was only ever intended to apply to public liquid markets. When you're talking about venture capital or private investments, it doesn't even apply there because arbitrage is the central idea that makes markets fairly efficient. In other words, you can look on your screen and see two bonds or two stocks and figure out whether one of them is mispriced relative to the other. If it is, you sell the overpriced one, buy the underpriced one. That trading is going to realign the prices to what is a sort of rational equilibrium.

You just can't do that with public companies whose price you don't get a quote on your screen and you can't go in and out of them quickly. Large amounts of modern capitalism have actually gravitated towards private markets, right? Private equity hardly existed in 1980. Now it's a huge chunk of corporate wealth. Public markets, on the other hand, have seen fewer listings over the last 20 years or so than they did before. It used to be typical if you had Amazon to-- If you were doing really well as a startup, you raise one round of capital and that takes you to the IPO and you IPO at a valuation of around $400, $500 million. That was the typical thing in the late '90s.

Obviously today there are lots of unicorns which have blasted past that half-a-billion mark and they show no sign of going public. Capitalism has gravitated towards private markets, which are by definition not efficient in the efficient market hypothesis sense. Now, in the public markets, you're right, there's a debate. I think the debate is in the end people who essentially agree but exaggerate the small amounts of disagreement. Efficient market hypothesis very few people believe it's perfectly efficient. If it is efficient, it's because of arbitrage that has happened by traders, and that arbitrage is profitable in the theory.

Even the hardcore EMH theory accepts that there are profitable arbitrage players in the market otherwise it wouldn't be efficient. I think, what one is talking about really is that, by the time you have a liquid public market and smart investors who have paid a lot of money to get the trades right have looked at all these public instruments and figured out whether they think they are overvalued or undervalued, you then have a price-setting competition between the buyers and the sellers that creates an equilibrium. If you are going to second-guess that fairly efficient price, you have to have some really deep specialized information to have an edge.

That edge, that development of deep specialized insights is what hedge funds exist for, right? They are highly, highly compensated, right? 20% of the upside if they get it right to try to do deeper research and come up with new ways of going about pricing public instruments. Therefore, they work incredibly hard at it. When they get it right, they make an absolute fortune. Again, going back to your earlier question, is this a social injustice? I think you have to just consider before you condemn it that one group in Connecticut could correct a pricing inefficiency that's global and that affects a trillion dollars in market capitalization.

I think it's more debatable than others do. Whether or not this is good for society, I would be inclined to be more sympathetic than critics would.

[00:11:46] Dan: If private markets are highly inefficient because there isn't liquidity, why don't we see more capital just pouring into private markets and more trading ending up happening between these in order to make it efficient if there's, in theory, so much return to be had there?

[00:12:03] Sebastian: It's a great question. Let's just start from a basic idea of efficiency in capital market intermediation. In a market economy, we have users of capital, typically a company that wants to go do something with the capital, and we have providers of capital, so that would be a pension fund or some other savings institution. Efficient intermediation would be when the financiers who match up the savers with the users of savings don't take too much of a big slice. You'd expect that over time there would be competition between systems intermediation, and the ones that are cheap and efficient would win, right?

Now, if you compare a public stock market with a private equity setup, the public stock market is much, much, much cheaper as an intermediator, right? If I'm a pension fund manager, I can go buy shares of blue chip companies in the stock market and the fee I pay for doing this is zero. I can hold those stocks for nothing, pretty much. You might pay a little bit for custodian stuff, but essentially it rounds to zero.

Whereas if I, on the other hand, want to access, I'm the pension fund again, I want to access private companies, I'm going to pay a private equity manager to go do this for me, and I'm going to pay them 2% of the capital I give them plus 20% of the profits that they make. Extremely expensive. Why on earth would capitalism gravitate from the cheap form of intermediation, public markets, to the expensive form, private equity? I've basically just rephrased your question thus far, right? The answer has to be that there is some incentive for both the savers of capital and the users of capital to go with that shift to private intermediation.

Now, I'll give you an example of a toxic incentive that is not good for the way capitalism functions, and I'll give you an example of a benign incentive, which probably is good. The toxic reason to shift over to private equity would be that it's not mark-to-market. Pension funds feel comforted if they give money to the private equity manager who locks it away for 10 years and doesn't keep giving them updates about whether it's up, down, or sideways, and particularly, therefore, they can't get a report one day that says, "Oops, there's been a market crash and you're suddenly down 25%," at which point you the pension fund manager might be fired for having given money to a bad private equity group, right?

Caution, job security concerns, a desire not to be measured is part of I think what drives pension funds to be happy to pay these very high fees to private equity managers. That's the toxic part. Just as an aside, I think this is a broad phenomenon in modern capitalism that people hate to be measured and they will accept all kinds of inefficiencies and stupidities in order to avoid being measured. We can come back to that if you like.

Now, the benign example, the benign theory of why we see this shift to apparently inefficient private equity is something different. It is that there are huge agency problems in stock market capitalism. You've got the shareholders, they don't really exercise that much influence over the board, the board, in turn, doesn't exercise that much influence over what the chief executive does, and so you get chief executives who can be not terribly good, the evaluation methods aren't very effective, and you've got these principal-agent splits that are super inefficient.

It's worth paying that 2% and 20% to private equity to get a private equity group that comes in, buys the whole company, and collapses the principal-agent splits. Now you have the owner, the private equity company, directly appointing the CEO and doing the board-like oversight, and they have 100% skin in the game, and they are damn well going to make sure it works properly, and so they're going to drive efficiencies into the company.

I think you can think of private equity, if you're being so sympathetic to it, over the last 20-30 years in the following way. You can say, look, management consultants are the people who prance around, coming up with supposedly new ideas about how you make companies efficient, but the people who really do proper management consulting with skin in the game, aligned incentives, which really drive them to do good management innovations, and by management I'm also thinking about optimizing your balance sheet, optimizing the data science you might use to do good marketing, it's a big range of things, but the groups that really do proper management consulting are actually the PE shops.

Where they're not marketing themselves and doing a PowerPoint projection, which they flipped over sideways to make them look fancy. They're not performing, they're actually doing. They're implementing new management ideas in the companies they own and making capitalism more efficient.

[00:17:24] Dan: The idea here on the second piece is that there's actually work being done. You're paying for that work to be done to optimize efficiencies. On the first one, this is really interesting. I think Cliff Asness actually came out with a paper at one point, or a post or something online, where he-- Typically, there's what's called the liquidity premium that you pay on an asset that's highly liquid. He calls it the illiquidity premium, which is the ability for private equity or the illiquid assets to get marked up for exactly that reason, because people don't like being measured.

I'm curious how big of an effect you think that actually has. On balance, do you think that illiquid assets actually are charged more than liquid assets in some cases, specifically to obscure being mark-to-market at any given point in time?

[00:18:10] Sebastian: I don't know how to directly measure that. I haven't seen anything that tells us how big that effect is. Anecdotally, I do hear that institutional money managers, it could be pensions, it could be insurance, it could be endowments, it could be family offices, that they do like the comfort of not having to wake up in the middle of the night worrying about where the markets are, which is irrational because they ought to be worried. It's their job to worry. As an allocator of capital, you should worry about the capital. It's lazy to lock it up for 10 years and say, "Oh, now I don't have to worry." That doesn't strike me as a good way to do your job.

It wouldn't be surprising if that is how people choose to do their jobs because-- Let me pick up the breadcrumb I dropped earlier. I've been looking for various reasons recently at the problems of getting artificial intelligence baked into healthcare. One of the problems is that any time you try to collect data on health and you have any data repository that can be used to train models, the suspicions around data collection in this sector are enormous.

You might think, "Well, it's because of privacy concerns and patients shouldn't have their data shared and all that stuff." Actually, what I'm told is quite a chunk of this aversion to using data in healthcare is that the healthcare providers don't want to be measured. They don't want there to be results saying, "Oh, your hospital uses the following protocol for this procedure." "Look, your survival rate for your patients is 25% lower than these other 7 hospitals that we measured," because that would suck if you're running the hospital and you're trying to get patients in the door. It's this desire to cover up competitively relevant data that I think is one of the big enemies of efficiency and equity in capitalism.

[00:20:09] Dan: Oh, that's super interesting. A question on both hedge funds and venture capital. I guess in the grand scheme of American business are relatively modern ideas, especially to what we think of as the modern corporation. I guess, would you expect new models of asset management to emerge that have a similar level of impact to private equity, hedge funds, or venture capital?

[00:20:30] Sebastian: I would. My theory of the case here is that as-- I'm a bit Marxian on this stuff.

[00:20:38] Dan: Okay.

[00:20:38] Sebastian: I think that what happens is technology changes. When you get technology changing, the superstructure has to change too. The superstructure includes financial mechanisms and corporate forms. If you just indulge me, if you don't mind, for a second in a little bit of history. Is that all right?

[00:20:58] Dan: Please. Yes, let's do it. Yes.

[00:21:00] Sebastian: All right. I'm going to start in 1840 or thereabouts, where the standard unit of the American economy was the one-man shop. I did say man, I'm afraid it was true in 1840. Probably a large language model these days would correct my language, but it was actually accurate to say man for 1840. All right. The reason is that in 1840, the Industrial Revolution hasn't happened and so there's no returns to scale. You don't have steam power to be able to make a big factory very efficient. You don't have the ability to transport what you produce on railroads around the country yet. There's no economies of scale. One-man shop is fine.

Then you have the Industrial Revolution and now it makes sense to have a big company, so they start to emerge. You need a way of financing the big company. First of all, the joint stock company is invented, where you issue shares and different investors can own pieces of them. You have limited liability as well to make it not too risky to own a chunk of a company when you're not actually managing it yourself. Somebody else might make a mistake. You don't want to be liable for that, so you need limited liability.

Then out of this comes the JP Morgan phase of trust-building because there's monopoly power that can be reaped if you have a JP Morgan-type of conglomerate building finance. Then that carries on for quite a long time in America. You've got the period of big corporations, big business, big government. That lasts roughly up to the 1970s when the Japanese start to be too competitive and we need a new way of doing things because otherwise, the Japanese will eat our lunch.

What we come up with is, oh, look, personal computers are just coming online and we can get rid of a bunch of paper-pushing middle managers in the corporation. To do that, we're going to have to have really, really aggressive CEOs who don't mind firing tons of people. Now we enter the period of hostile takeovers. We enter the period of private equity, KKR, Carlyle, these kinds of groups got started around 1980, give or take.

These private equity and takeover mechanisms, leveraged buyouts and so forth empower ruthless CEOs to be Neutron Jack, the Jack Welch story of the 1990s became the archetype of this thing, firing just reams and reams of middle management. These antiseptic words like de-layering, unbundling the corporation is how business gurus describe that. Then you come into 2000 or thereabouts, and much of that re-engineering of the American corporation has happened.

Now we've got a new thing going on, which is the internet, the arrival pretty soon afterwards of mobile and cloud, and the opportunities to create enormous amounts of wealth based on companies that exploit these new technologies. Now people realize that it's all about IP. Broadly defined, it's about intangible capital. There's a whole book, Capitalism without Capital, by two British authors, which talks about this. The point of Capitalism without Capital is we don't need so many capital goods anymore was their argument. It's all about business processes and intellectual property.

How do you create this intangible capital? It turns out that you have lots of parallel experiments going on in applied science where different startups try using the new platforms in new innovative ways. The way you finance that is with venture capital. That is the most effective way of creating wealth for some period between, let's say, 2005 and the COVID pandemic, roughly speaking. Venture capital had existed before, but it really took off and entered its prime for this technological reason that the internet, cloud, and mobile had created so many opportunities to do venture-style businesses that were going to create enormous amounts of wealth really fast.

My prediction is that as the substructure changes, to go back to Marx, the superstructure will change again. Maybe artificial intelligence is showing us a new phase already. You've got the hyperscalers dominating much of the action because AI turns out to be very capital-intensive in terms of both compute and in terms of the data you need and in terms of the high-priced human talent you need to bring in. Every single supposed startup, whether it's OpenAI partnering with Microsoft or Mistral or Anthropic or DeepMind back in the day being bought by Google, they've all basically formed alliances with behemoths. We have a new tech-based capital formation happening just in the last 18 months or so.

[00:26:08] Dan: Thank you for that. The history of everything is super interesting. I had a question about just how focused these firms would be. It seemed like during COVID, you had firms like Sequoia branching out to different geographies. You had Y Combinator creating growth funds, branching out from their traditional early stage. You had hedge funds coming down and playing in early-stage venture rounds. Then recently both of these things have started to retract. I think Y Combinator recently got out of the growth equity business, D1 Capital and other hedge funds have been criticized really heavily for their venture returns weighing down the core hedge fund returns.

I'm curious if you think in this changing world, where's the equilibrium here? Do you think we'll go back to more specialization or will it be required that these firms expand their scope and try new things?

[00:26:59] Sebastian: Good question. I think that there are some kinds of diversification, which I think are definitely a recipe for trouble. It's particularly not in the hedge fund or venture capital space. Just to address the broader point you're making, let's think about Lehman Brothers for a second, circa 2006 or 2005, when it was brewing the troubles that led to its bankruptcy in 2008. What was going wrong there? These guys hurled enormous amounts of toxic mortgage paper.

The reason I believe that they did this is that they couldn't decide if they were, A, maybe into the mortgage origination business, B, maybe into the mortgage securitization business. They had a lot of inventory of mortgage loans because they were going to package it up and securitize it and make money that way, or maybe they were doing prop trading and they actually wanted to hold these mortgages because it was a bet that they believed in.

Maybe there was some other theory that, at this point, I'm running out, but I think those investment banks were so diversified out of merely asset management into various kinds of transaction businesses and various kinds of relationship businesses that I think if you can't decide why you own the mortgage paper, you're not going to do a good job of deciding whether or not you should be owning it. I think that was the lesson of 2008, or one of them, as to why the broker-dealers, the investment banks proved to be such a disaster.

Now, you're asking a slightly more focused question, which is, within asset management-only companies, namely hedge funds, or venture capital, should you specialize? I do think that specialization is better. I'm less dogmatic or less hard on the point than I would be about Lehman Brothers because there are some synergies. We could frame this in the venture space as being the Benchmark versus Sequoia debate. I do write about this in my book The Power Law a bit.

The reason why Sequoia was determined to get into growth equity was that one day, I think, in 1994, Michael Moritz was sitting with Jerry Yang, the founder of Yahoo, who he had backed, in comes Masayoshi Son, less notorious then than he has become since, but already a sort of cowboy-type figure. Masa says, "I want to invest $100 million in Yahoo." This was at a time when nobody in the valley ever had seen $100 million check. It doesn't exist.

Jerry Yang said, "I don't need $100 million. I'm going to go public. We've already lined up Goldman Sachs to do the IPO, why do I need $100 million? Thank you, but no, thank you." Masa said, "If you don't take $100 million from me, I'm going to give it to your main rival, and they're going to outspend you on getting your search function or your directory on the home page of other apps. Think about it. Do you want my $100 million? I think you probably do."

Masa, waited while Moritz and Yang went off into some other room and had a little confab and they came out and said, "Okay we'll take the $100 million," because they believed that Masa was crazy enough to turn around and give it to AltaVista if they didn't. Mike Moritz swallows that, then he observes what happens, which is Sequoia, which did the series A investment in Yang, discovered Yang, made Yang into a media sensation by putting him on the cover of various business magazines, lined up the IPO, found the chief executive who would lead the company through that, did all of the work. They made less money on Yahoo than Masa did because Masa wrote so much of a bigger check.

Although Sequoia had a better multiple, in dollar terms they lost. Michael Moritz is somebody who does not care to lose. He's one of the most competitive people I've ever met. He said, "I'm not having this. I'm going to do my own growth equity operation at Sequoia." Right around the same time as that meeting with Masa, he became the leading partner along with Doug Leone at Sequoia. He was in a position to make company policy. What he did was insist that they should go into growth equity.

Then later when Masa came back with his vision fund, circa 2016-2017 or thereabouts, that's when Sequoia did an $8 billion growth fund, much bigger than before, precisely because they wanted to be able to provide follow-on capital to Sequoia Series A's companies without the danger that their own Series A companies would take money from Masa, whom Moritz hated. I'm not making this up. When I say hated, one of the things that Mike did, which he maybe shouldn't have done in my research was to give me some internal memos he'd written in which he compared Masayoshi Son to Kim Jong Un the dictator of North Korea.

[00:32:05] Sebastian: He had fairly strong feelings about him. It was all about not having Sequoia Series A companies hijacked. Now, if you look at the story of Series D, E, F companies that did take Masa's money, like WeWork, or indeed, Uber, it didn't turn out so well because Masa said to these entrepreneurs, "I want you to be bigger, faster, crazier, never mind about being careful." You get a WeWork phenomenon where masses of capital are destroyed. I think Sequoia was right to prefer to keep Masa at arm's length, not just in ego terms but actual return terms.

Now, Benchmark is the parallel story. They were a Series A shop just like Sequoia. They believed in generating high multiples on low, small-sized checks in Series A. They thought about doing growth and they decided not to. They stuck to their guns. Then lo and behold, who was the Series A investor in WeWork which Masa hijacked? It was Benchmark. Who was the Series A investor in Uber which got hijacked, actually not just by Masa but by a whole bunch of people including the Saudi sovereign wealth fund? It was Benchmark.

Benchmark did these Series A checks. They were good investments at the beginning and they became bad investments later, particularly WeWork, because they didn't have the Sequoia strategy of defending themselves with their own growth fund. I think that tells us that there is a case for some diversification. Growth investing is different to early-stage investing. You need a different team, you need to train that team and make sure that they're not just doing a Series A type of mentality. I think it's clear that it's doable. Sequoia got it wrong the first couple of times, but by the third growth fund it was generating very good returns.

Accel seems to be doing okay, as far as I know, with its growth fund. I think this is a doable thing. It makes sense for Series A VCs to go for it.

[00:34:08] Dan: Okay. In broad macro terms, in the grand sweep of history, we should expect asset management to continue to evolve like all of the history of business has. Some firms can do multi-strategy well. I'm curious about a case where a change of strategy went poorly. Specifically with John Doerr when he really focused the firm on climate tech in the mid-2000s. Do you view that as just an unlucky bet? Maybe Moritz made the good bet with growth equity and Doerr just made the bad bet with cleantech? Did he fall into a trap that investors like Moritz have a framework for avoiding?

[00:34:42] Sebastian: I think one of the big surprises, when I did the research for my book, was that I hadn't expected the dynamics within the partnership of the venture capital fund to be so important and so interesting. I think what went wrong with John Doerr when he did that climate bet is that Kleiner Perkins had evolved to a point where the other big hitters that had been around in the 1990s, most notably Vinod Khosla, had left and set up their own VC shops.

John Doerr was left behind at Kleiner Perkins with nobody of his stature who could challenge him. When he got it into his head that cleantech was the thing, he went in way too big and with far too few checks and balances and cautions that might have arisen if he'd been doing this 10 years earlier, because there would have been partners who had the standing to say, "Wait, John, let's do some cleantech, but not that much. Just be a bit careful," because there were people at the time who were arguing, "Look, it's going to take a very long time for these cleantech bets to pay off. You're essentially betting in a way on the outcome of the 2008 election."

I think that's part of what went wrong with cleantech. There was an assumption that whether it was McCain who got elected at one point, or Obama who got elected, they both said they were going to do something about pricing carbon, or at least capping and trading it. Some of the cleantech bets, in that period in '08, went in on this assumption that the politics was moving in the direction of making cleantech a winner. Then what happened is the financial crisis hit, so Obama prioritized financial reform and never got around to climate change reform.

Part of it was an over-leveraged political bet. Part of it was just, too hard in one sector and not acknowledging that it was going to be-- just the nature of the technologies were going to take a long time to pay off. I say, I think, if you look at Vinod Khosla's firm, he did climate bets, but he didn't blow the firm up over it. Whereas Kleiner Perkins really did. They went from being the top venture partnership in the world in 2001 to not even being in the top 10 a decade later.

I think that tells us, because venture capital is about subjective early-stage judgments, where there are no quantitative metrics that would guide you about what a good investment is, it's very subjective, you're making these bets on two-legged mammals who walk into your office with a dream, you need smart partners around the table on Monday morning to challenge your judgment. Particularly in venture capital, more than in other investment disciplines, the partnership glue is super important for smart decision-making. I think that's what explains why John Doerr blew up.

[00:37:39] Dan: In venture firms, how much of the success do you think is due to-- On the contrary, John Doerr was also the reason it was successful. How much of a firm success do you think is due to these outlier stars at the firm and just having 1 or 2 can carry you for 10 or 20 years versus an institution that you build where there's a culture and a thesis and a way of working together where you can maybe get by without the industry number 1 or 2 guy?

[00:38:07] Sebastian: I'm very, very strong believer in the team story. If you look at who were the individuals who topped the Midas List in venture, they are frequent, not always, but they are frequently from a partnership where somebody else from the partnership is pretty high up as well. That was certainly true for John Doerr when he was doing really well in the 1990s, doing the Amazon deal, the Google deal, and so forth. Vinod Khosla, his partner, was actually doing even better than him. In 2001, Khosla was number one and John Doerr was number three in the world. I think that's totally not a coincidence.

Equally, if you look at Sequoia partners, who are frequently very near the top, there's a whole bunch of Sequoia partners at any given time who are in the top 20 or whatever. I think that's because of the need for balance within the team. Benchmark is a durable, very successful partnership. It's famous for having equal economics between the partners, meaning that if there are 5, let's say, 50-year-olds, who have been doing it for 20 years and they bring in a 30-year-old partner who's new to it, they will give that 30-year-old the same returns, the same compensation exactly as the experienced people are getting.

I told this story to a friend of mine who runs a private equity shop and he practically stopped walking and had to sit down for a bit. He was so shocked. The idea that he as the founding partner of his private equity operation would share equal economics with somebody 20 years younger than him, he just couldn't get his head around it. I explained to him, "Look, it's because when you're doing PE, your counterpart is the CEO of some big company who's probably 50 years old. The fact that you're 50 is an advantage, you're relating to them. In venture, you're often dealing with somebody in their 30s or even late 20s or something who's the founder and being young can be a big advantage, so you should give equal economics-

[00:40:09] Dan: Oh, that's a good saying.

[00:40:09] Sebastian: -to the new partner who comes in. Again, I think this is why investing partnerships and the shape of the investing industry changes with the ebb and flow of who the founders are. If we went back to a period where most venture upside derived from deep tech companies where you need a PhD at least in material sciences or some deep thing like this, and therefore, by definition, the youngest you could be is 27 and probably you are more like 40, then you would see the average age of venture partners go up. The capital structures move with the technology, which drives the nature of the companies that are being formed.

[00:40:57] Dan: Yes. I hadn't heard that insight before. That's fascinating. Question on FTX and some more recent phenomenon. Sequoia had a glowing bio of Sam Bankman-Fried on their homepage where it talked about he's a great founder. It's just a one-pager on him. They caught a lot of negative press for it, but I'm actually wondering if you think this negative press was warranted, or in order for a firm to be successful, should we expect that they will be enthusiastic about some people that are right on the borderline of, for lack of a better word, too weird?

[00:41:29] Sebastian: I think weird people is fine. That's part of why venture capitalists make the big bucks, they have to manage weird people because weirdness goes with genius quite often. Actually, that's a scientific observation, not just an anecdote. I've read things about how if you look at members of Mensa, the high IQ club, people who test very, very high on IQ tests are more likely to have depression, autism, and other challenges.

I thought initially this is just because if you're that smart and you're 10, all the other 10-year-olds are really dull. While they're playing sports at break in the schoolyard, you're solving a chess problem at your desk, and therefore you don't socialize. No, it's more than that. The biochemistry of this thing is apparently that the links go deeper than just-- It's beyond just nurture.

I think if you are looking for power law returns from individuals who are often one tail of the distribution, you should expect to see some unusual characters and you should be willing to work with them. Your job as the VC is in a way to compensate for their idiosyncrasies, to protect them from making mistakes that might arise from those idiosyncrasies. Clearly, many founders don't have these idiosyncrasies, but some do and one should work with that.

I think with FTX, the fault that Sequoia had was not backing somebody with a fantastically exciting hairdo, who played video games whilst talking to Anna Wintour. The mistake was not to ask basic due diligence questions about, so when money is transferred from Alameda, the hedge fund to FTX, the trading platform, who signs that? Where's the paperwork? Basic things like that any investor in any financial operation should ask, they seem to fail to ask that. Why did they fail?

I think that's partly pandemic, that they did the due diligence in a Zoom call. I believe that one of the lessons from the pandemic is actually that being forced to get on a flight to the Bahamas, in FTX's case, means that you have four or five hours or whatever it is on the flight to think about what are you going to ask, what are the pitfalls, how will you ask it, how will you suss it out? You see the person face to face, and if they're playing a video game, you probably notice. I don't know.

I think not doing it over Zoom might have saved Sequoia. Then the other thing clearly going on is that crypto was just insanely hot at the time. Sequoia had stayed out of crypto until the last minute and they wanted badly to get some skin in the game. They thought FTX was, at least in the crypto world, the closest to a blue chip that you could be and so they rushed in too fast for that reason as well.

[00:44:37] Dan: Another big story in recent years is Reddit and meme stocks taking down Melvin Capital with the GameStop short squeeze. It's maybe one of the wildest stories actually ever in finance, if you think about it. Do you expect this to be a phenomenon that we'll continue to see going forward and impact how hedge funds or other asset managers allocate their capital, or do you think it was a blip on the radar and a one-time thing?

[00:44:58] Sebastian: I think on that one, I incline a bit towards the one-time thing theory. When people in finance do something that is deeply irrational like buy stocks because of some meme, they get burnt and normally they learn a lesson. I'm not discounting the importance of Reddit or of Robinhood, but I do think that people on these platforms are intelligent and they learn lessons. The other thing to keep in mind is that I didn't know that Reddit would have happened. If I'm getting my timing correct, this was in the period when everybody had a stimulus check to invest. I think-

[00:45:38] Dan: That's true, yes.

[00:45:39] Sebastian: -that was driving quite a lot of the froth at the time. People today on Reddit and on Robinhood may not have quite the same cavalier attitude with the money they've got.

[00:45:53] Dan: If a talented young relative came to you and said, "I've got my heart set on being an investor," and they're going to do a hedge fund or venture capital, let's say they're graduating today, which industry would you advise them to go into?

[00:46:06] Sebastian: I think it does depend on personality. There's a huge personality gap between hedge funds, just to generalize, and venture capital. In hedge funds, you can make your money by looking at data on a screen and figuring out some quantitative relationship that other people haven't spotted or even a machine learning deeper approach. You can make money by judgments around political decisions, whether that's in merger arbitrage or whether that's in macro trading around currencies. These are things which you can pretty much do it from your desk.

On the other hand, venture capital is a social sport. You have to be out there meeting entrepreneurs, out there interviewing the first five people. That entrepreneur you backed last week might want to hire onto their founding team, you're typically very involved in the early hiring, vetting. You're just in meetings the whole time. You're chasing people down. The securities you're trying to invest in are actually people with two legs who will run away if you're not good at relating to people personally.

I think venture capital is a game for extroverts and hedge funds is often a game for introverts. When Louis Bacon, the macro trader, did very well and bought himself a private island, people joked that it didn't make any difference because he was already so insular. I think I would advise the young relative based on the personality type and skillset that they had.

[00:47:38] Dan: What do you think is more irreplaceable, the elite VC firms or the elite hedge fund firms? Assuming Renaissance Technologies was wiped off the face of the Earth, it's very possible their trading strategy just wouldn't exist and that alpha just wouldn't be collected today. If you took Sequoia off the face of the Earth, I'm not sure you could make the argument that the same companies that are getting funded wouldn't find capital elsewhere. I'm curious how you think about that question of which is more impressive and which of the elite firms have more of a core differentiator in the two industries.

[00:48:10] Sebastian: I think what you said is correct, in other words, that inventing a new hedge fund insight really takes some feet of intellectual originality because the markets are pretty efficient, as we discussed, and so to do something that gives you an edge means that you've got an insight that other people haven't really come up with or they haven't figured out how to express that insight in terms of trading.

You have to innovate and so I think that is more impressive, whereas in venture capital, to a first approximation, everybody's doing the same thing. They're interviewing founders, doing due diligence on them, trying to do a 360, calling references, figuring out the shape of the market and the term, the total addressable market that they might be going over. That's the formula. No, there are exceptions in venture capital.

Part of what I was trying to do in my book by describing the history is that every now and again a venture capital partnership does come up with a new idea and creates a new branch of the discipline. Whether that's Y Combinator, having the idea for an incubator with batches twice a year, that was a new idea. Growth equity as practiced in the 2010s was invented by Tiger Global and Yuri Milner from TST, and I described that process as well.

Other innovations might include the prepared mind approach, which Accel invented in the 1980s, where you deliberately think about, okay, so which new technology platforms are coming down the pike? How do I prepare my mind and think about what business could be built on top of this new platform? What entrepreneur would be likely to have the right credentials and experience to build that business? Therefore, what do I do I expect to meet in the next six months in terms of the right entrepreneur to back.

That was just a new way of thinking about venture, less ad hoc, more deliberative, which now has been spread around the valley and I think most people understand it. It was an innovation at the time which gave Accel, I think, an edge, at least until that secret source leaked out. It's not that there's zero innovation, but I agree with your core point that hedge funds is all about innovation whereas venture capital is less clear.

[00:50:35] Dan: I want to shift gears a little bit over to your work on Alan Greenspan and the Federal Reserve. For folks listening, the Alan Greenspan biography is one of the best biographies I've ever read, period, so I highly recommend it.

My first question on this topic is let's say that a new Fed chairman emerged, so we're in a hypothetical here, and they understood exactly what needed to be implemented to guide the economy to have low unemployment, maximum productivity, et cetera, all the benchmarks that we look for in terms of outcomes, my question is, what would they run up against as the biggest bureaucratic blockers they would run into, especially if they're trying to implement something that is a little bit not historically typical, so maybe something other than the 2% inflation targeting? What is the bureaucracy within the Fed that they would face if they knew what the solution was?

[00:51:23] Sebastian: It's an interesting thought experiment. Of course, nobody knows the solution to these things because the whole nature of central banking is that you are trying to guide an economy which itself is unstable and is changing in shape and all that stuff we were talking about, about technological change and so on. You have experience from the past that might lead you to a view about how to do central banking, but it's a dynamic system, and therefore you have to be dynamically adjusting your model. Certainty is not really a possibility.

To go with your thought experiment, supposing you could know for sure what to do, what would you face in terms of constraints? You'd have to get the Fed system on your side. There's a federal open market committee that meets every six weeks or so, and they vote on interest rate-setting decisions, monetary policy decisions. The chairman is just one vote, and so the chair has to pull the other members of the committee along. That typically means that you need a bit of time to make your argument, persuade people.

It's a combination of one-on-one diplomacy with the other Fed governors of the central Federal Reserve Board. Also, the presidents of the regional reserve banks alternate with each other, but they get to vote on interest rate-setting decisions as well. You need to win these people over. In turn, to do that, you probably need to win their staff over because central banking is a very technical priesthood and the staff economists who have been in the trenches building the models and generating advice for the principles, those people are deep experts and they are properly respected, as they should be, for their technical chops. It would be essentially a challenge of persuasion to bring the system behind you.

It's not good enough in a 12-vote committee to win the vote 7 to 5 because if you did that, then you'd also be having to think about the reaction of the markets. Monetary policy doesn't work in a vacuum. The Fed sets the short-term interest rate and then investors out in the wide world, not only in the US, but globally, look at what you're doing, and then they make trades in the bond market, which determine longer-term interest rates, which affect what you really care about, which is the cost of borrowing for businesses, and therefore the growth rate and so on.

Even if you could persuade the entire Fed system that you knew what you were up to with some unexpected interest rate decision, if you couldn't persuade the financial markets and that's a lot of participants, that you were on the right course, they would look at this and say, "No, that doesn't make sense. We don't believe that's going to be sustainable. The Fed's going to have to reverse this decision at the next meeting, and therefore we're going to go in the opposite direction to what the Fed wanted." It's actually a highly democratic system in the sense that you have to persuade a lot of actors what you're doing. That's why Fed communications is a whole specialty in the central banking world in and of itself.

[00:54:39] Dan: This gets to my next question, and this one is similar to the earlier question I had for you on how much innovation we should expect in models for asset management. The challenges you listed give me the sense that innovation in the Fed is going to be very challenging, and there's got to be a lot of systemic and public opinion changes before an authoritarian Fed chairman could come in and just make a change to anything.

Just broadly speaking, how much innovation do you expect to see in terms of the Fed's strategy for stabilizing the economy in, say, the next 10 or 20 years, or should we expect it to be very slow-moving and to look very much similar in the future to how it does today?

[00:55:16] Sebastian: It's not static, as I said. It's dynamic because the conditions of the economy change and that forces a need for some change by the Fed. It tends to be evolutionary more than revolutionary because quick changes don't allow for the consensus building that is necessary. I think the great counterexample, which people like to cite, namely Paul Volcker being appointed to be Fed chair in 1979 and then a few months later shocking everybody with a change of inflation regime from-- Essentially, he invented monetary targeting. Didn't invent it, but he adopted it for the first time at the Fed. This brought about the big Volcker disinflation. It was a radical change of direction.

That's the most famous, commonly cited example of a turn-on-a-dime shift, a revolution, not an evolution. Even that example, when you look at it a bit closely, you realize there's some qualifiers. First of all, Volcker didn't actually do the big shocker as soon as he got into office. He had already been president of the New York Fed, and therefore effectively the number two or number three in the whole central bank system before he became the chair. He'd been part of the team making this argument for a while even before he became chair.

Then he became chair and didn't do anything radical at first. It was only after a few months when the US inflation data and also the currency started to go crazy, particularly the dollar was crashing against gold, that there was a sense of panic in the country that something radical was really, really needed. At that point, he had the political consensus in his favor if he went radical. That's what he did. He seized the wind. He went with the wind behind his back, but there had been this period of preparation beforehand, as I say. Even that revolution had more of a evolutionary character than people remember.

[00:57:19] Dan: Oh, interesting. Interesting. In what ways do you think the Fed has most evolved since Greenspan's time?

[00:57:25] Sebastian: A huge difference is in communication. It used to be that the Fed said almost nothing about its reasoning for its decisions, and sometimes actually didn't even communicate the decision. That's an amazing fact today, but they didn't tell the markets when they had decided to change rates. Indeed, when Volcker, I said before, he started to adopt monetarism in 1979, he gave up in 1982. He didn't tell the markets, he didn't tell the world that he'd given it up for a few months. Then he let it slip in some obscure speech where he said in passing, "Oh, we just reconsidered this thing a bit, and for the moment, we're backing off. We'll see how it goes." It was very, very soft peddled.

Greenspan, when he became chairman in 1987, continued this Volcker tradition of being pretty circumspect. When the Fed changed interest rates, it would instruct the trading desk at the New York Fed to buy and sell short-term securities to manipulate the short-term rate. It wouldn't announce that and people in the markets in New York would get calls from the Fed and they'd figure out what the Fed had decided, but there was no announcement.

Then I think in 1994, the Fed began to announce its decisions, and so there was guidance and communication. Then in the 2000s, Ben Bernanke became a governor, not the chairman yet, but just the governor, and he brought with him a whole university perspective on the value of forward guidance, of communicating more rather than less with the markets.

If you do that, then, flipping what I said earlier on its head, the markets do understand what your reasoning is, and they do trade bonds in a direction that will change the interest rate up or down on the long-term end of the curve in a way that is consistent with your policy because you've explained to the bond markets why interest rates should be higher, you've moved up your short-term rate, and then the long-term rate will follow because you've made the case on the whole. Bernanke was very big on forward guidance. He began to get his way before he was chair. Then he became the chair of the Fed in 2006, and very much entrenched this. Yellen continued that in her term.

It's actually, funnily enough, I think, been slightly dialed back by Jay Powell who believes, and I agree with him, by the way, that there was some merit in the Greenspanian situation because the problem with forward guidance is if you tell people in advance what you're going to do, then it's only credible if you stick to your view over several meetings, and that makes you slow to react to new information.

One of the reasons why we had this high inflation in 2022 was that the Fed had seen that inflation was for real by late 2021, but it took about four more months to actually start to raise interest rates because it was felt that a complete turn on a dime would shock the markets too much, would violate the implicit contract in forward guidance, which is that you give people warning. The Fed allowed four more months of inflation to kick in and the Ukraine war started in that period, and then the inflation, which would have happened anyway, just got even worse than it might have been if they had been freed of the self-imposed constraints from forward guidance.

I'll stop on this, but it's worth recalling that Greenspan, when he was chair, was perfectly willing to move interest rates not only without a warning but in between meetings. He wouldn't wait for six weeks to the next meeting. If he felt like one week after the last meeting interest rates should be up a quarter point, he would convene a conference call and move rates with no warning whatsoever. We're a long way from that today. In general, we communicate more and the markets expect that, but that's a very profound shift from where we used to be.

[01:01:31] Dan: What is your assessment of how Powell's done so far as Fed chairman? We're recording this on April 10th, 2024.

[01:01:38] Sebastian: I'm pretty sympathetic to Powell. I have my criticisms, but my criticisms come from a place which is steeped in my study of Greenspan, and which is actually out of consensus from where the Fed was when he was going into COVID and faced this big challenge of the supply shocks from COVID. Let me unpack that a little bit. I never believed in forward guidance to the extent that Bernanke did for the reasons I've explained. I think it just boxes you in too much. When Powell was chair, I think he'd absorbed that. He had served in the US Treasury in a senior position when Greenspan was the chair. He admired Greenspan.

I happen to know that he read my book and he absorbed some of what I said there. I think he's just a pragmatic-- He's a lawyer by background, not an economist. He's less steeped in that academic economics, monetary policy, I would call it dogma. He was less of a forward guidance believer than either Yellen or Bernanke who were both academic economists. He was ready to make a shift, but the consensus on his committee and in the financial markets were so powerfully in favor of the Bernanke-Yellen model that I don't really fault Powell for not moving towards a more agile data-driven approach straight away.

Equally, I have another critique, which is that I believe that central banks should be willing in some cases to raise interest rates because there's an asset bubble. It's not always appropriate to do that, but when the economy is operating at full employment and there's no deflation that you're worried about because if there's deflation, you shouldn't be raising interest rates more. You see a big asset bubble, which I think everybody saw in 2021 during the COVID everything bubble, then you should raise interest rates in response to the bubble.

I'm not seeing inflation in the data like the consumer price index, the PCE index. That's not showing me inflation yet, but I'm seeing huge inflation not in the price of eggs, but in the price of nest eggs, i.e. assets. I am raising interest rates to dampen that bubble because I know the bubbles tend to burst and that's very ugly. If they had had that reaction function, which I believe they should, in 2021, they would have raised interest rates sooner. They wouldn't have waited till March 2022. Those are my two criticisms, don't be too dialed in on forward guidance, be willing to raise interest rates in response to asset bubbles.

I'd say that, otherwise, what happened to Powell was that COVID was just a super uncertain environment. Trying to foresee when the next wave of COVID, Omicron, Delta, whatever, those names that used to trip off our tongues and now we're massively forgetting, but nobody knew how bad the next wave would be, if there would be another lockdown, if that would because a supply shock from China or from some other thing, how COVID shy workers would be about going back to work, how long COVID would affect things. Don't tell me anybody could predict that.

We know they couldn't because look at the way that auto companies just completely dialed back on semiconductor orders thinking that their whole business was toast. Then there was a massive semiconductor shortage and everyone was scrambling for semiconductors. That just is one metric that tells you that the private sector was certainly no better at predicting what was going to happen than the central bank was. I think the classic familiar critique of, "Oh, Powell, you didn't see the COVID inflation coming out," and nobody saw anything about COVID, it was totally unprecedented in how it would play out. I really don't fault Powell for that.

[01:05:36] Dan: Do you ever worry that the Fed will lose its political independence or do you sense that it already is?

[01:05:40] Sebastian: I do worry. I don't think it is already. Biden's team has been very explicit in acknowledging the central importance of Fed independence. If the financial markets got the idea that the Fed was moving interest rates around not in order to control inflation, but in order to please the incumbent in the White House, then the financial markets would conclude that inflation will be higher than it would be otherwise, and they would extract a penalty in the form of higher long-term interest rates to compensate themselves for higher inflation. It's really a dumb idea to compromise Fed independence. The Biden team totally gets that.

Janet Yellen, the treasury secretary, was the former Fed chair, so she knows this better than anybody and she's not going to be part of an economics team that compromises Fed independence. Now, Donald Trump is a different situation. When he was elected last time, I thought that his wacky insistence on very high growth and his total disregard for the value of institutions would combine to create a very dangerous situation in terms of Fed independence.

I was pleased and surprised that actually his Fed chair choice was good in the form of Jay Powell and that he tried to get one inappropriate person on the Fed committee, but she was blocked. Basically, the appointments have been okay under Trump 1. If he were to be reelected, who knows? Then I would worry again.

[01:07:10] Dan: Last question here. As I understand it, you studied history at Oxford. I'm just curious, generally, in terms of the broad sweep of business history, are there any historical periods or areas that you haven't covered in your professional work that you find especially interesting?

[01:07:24] Sebastian: When I was at Oxford, I was obsessed with the question of why there'd be no Marxism in Britain. I studied late 19th century, early 20th century European history in a comparative way, so comparing Russia and France and Germany, those experiences with the British one. I haven't later in my life as a writer really done anything that goes back beyond about 1950. Greenspan was born before then, and I talk about his early life. A little bit of the 1930s and '40s. Essentially, my work is focused on the post-Second World War period. As a undergraduate, I was fascinated by the period before that, 1870 to 1940 or so.

[01:08:09] Dan: Did that work influence your published writings at all?

[01:08:13] Sebastian: I think it influenced it mostly in the methods I developed of intellectual inquiry. I had to synthesize, organize, make sense of large amounts of unstructured information. I think the distinctive thing about history as a discipline, and this is why I slightly regret, that it's, certainly in the US, less of a popular major than it is in Britain, I would say, and then certainly was even more so when I was an undergraduate. I think history has the feature that it does not insist as the first move on imposing structure on reality.

Look, political science, which tries to turn a bunch of 50 elections in different democracies into data and then turn that data into insight, not against it by any means, but I do think there is something qualitative, valuable in history, which begins by the other way around. It studies the details, makes sense of the stories, including the human components in the stories. Then from that, it tries to generalize.

It doesn't invent the categories before it's done the analysis. Just to stretch the point a little bit here, if you'll indulge me, there's a strain of thinking in artificial intelligence where you want an AI to learn concepts. One approach to that is you train the AI in a very unstructured environment. You don't put your simulated agent in what looks like a modern city with lots of right angles and standardized shapes.

You put it in a more natural environment where no one tree is the same shape as the other tree and everything is undulating and irregular in shape. That's the feature of the natural world. Then you invite the AI to try to navigate that natural world, which is much harder than a right angular, physically built human world. The notion is that the AI will learn things from the irregularities. It'll have to invent its own set of categories, its own set of concepts. It will have to adapt those concepts as it explores the natural world further. It's a different approach to understanding reality, which I think has value.

One piece of evidence for my view would be the way that after 2008, the value and the standing of economic history went up a lot. There had been this big push in economics towards essentially turning it all into data and modeling it. The nature of any model is that you say, "okay, we've got eight recessions and we're going to analyze these eight and try to find the regular things that show up in each recession so that we can predict the next recession," but every recession is different. If you ignore that part of it, you ignore something quite important.

I think what was realized is that the turning points in economic history which really matter for everybody, for investors who are trying to preserve capital, but also for ordinary workers and people just going about their lives, the stuff that matters is the huge inflection points like the 2008 crisis. That's what affects people's lives. If you're just predicting is next year's growth going to be 3% or 3.4%, nobody noticed that in their everyday life. It doesn't matter.

If you're looking for the inflection, then you need history because you need to more deeply study turning points. It's going to be individuals that make a difference, by the way, in these studies. I'm going on about this, but let me-

[01:12:01] Dan: No, this is great.

[01:12:02] Sebastian: -go back to my studies of history and to Marxism as one approach to history. Of course, Marxist history is structural. It believes in a deterministic view of how technological change drives economic change, drives business forms, drives political stuff on top.

[01:12:23] Dan: Do you consider yourself a Marxist?

[01:12:25] Sebastian: I was definitely influenced in my early student life by this thing, and I moved way beyond that. Now I'm a sort of anti-Marxist, but for the following reason. I'm not anti, but I think Marxian analysis, that deterministic structural analysis is only part of what we need to do. The other part is precisely looking for the stuff that isn't structural because that will turn out to be super important. If you think about the big geopolitical calls that many analysts, myself included, maybe got wrong in the last 20, 30 years, it's usually when an individual is way out of sample in his or her behavior and does something radically unexpected.

If you analyzed objectively, was it in Putin's interest to invade Ukraine? Clearly, it was not. It was going to isolate him from the West. It was going to mean that NATO would be enlarged. It was going to mean that lots of Russian kids would get killed. It would mean that his entire technology sector would decamp to Dubai. It was a really dumb thing to do. If you analyze Putin in terms of the forces acting upon him and how he would act as a rational person, you would have got the prediction wrong. He did it based on his own view of czarist and the Russian imperial history and so forth and so on.

If you think about Xi Jinping, same thing. He broke with the rational expectations model of what a Chinese leader would do. If you look at Donald Trump, far more consequential in terms of the path of American history than Biden or Obama because he's so out of sample and radical in his personal choices about the ideas that he pushes. It's the radical, unpredictable individuals who matter in business entrepreneurship and who matter in geopolitics. This is what history can capture, and it's something that political science utterly cannot.

[01:14:23] Dan: Do you subscribe to the Thomas Carlyle, great man, theory of history? That's what you're saying here, but I'm curious if you're on it.

[01:14:28] Sebastian: Yes. I'm subscribing to both. I'm saying that of course you want to understand the structural stuff, the Marxist stuff, the demographics are super important and all that. Of course, I don't want to ignore that kind of thing, but I think if you want to find, again, the inflection points, the unexpected changes, individuals make a difference.

[01:14:49] Dan: Great. Sebastian, you've been very, very courteous with your time. Thank you so much for coming on today.

[01:14:54] Sebastian: I enjoyed the questions. Thank you, Dan.