The Great Rebalancing: Why Debt, Demographics, and Politics Will Crush Forward Returns | Sony Kapoor

In Episode 436 https://hiddenforces.io/podcasts/great-rebalancing-debt-demographics-and-politics-sony-kapoor of Hidden Forces, Demetri Kofinas speaks with economist, policy adviser, and investor Sony Kapoor https://substack.com/@geostrategy4tumultoustimes about why developed world demographics, debt, and political sclerosis will crush forward returns for investors who fail to rebalance their portfolios for the new investment paradigm. Kapoor and Kofinas spend the first hour of their conversation unpacking the thesis explored by Sony in two of his papers: "Winter Is Coming" and "The Case for a Great Rebalancing" in which he argues that global capital has been increasingly misallocated due to factors such as the growth of passive indexation, maladaptive benchmarking, and an excessive focus on short-term performance at the expense of long-term returns. They explore how demographic tailwinds in advanced economies have flipped into headwinds; whether AI driven productivity gains can realistically offset the drag of declining birth rates; why accommodative post GFC monetary and fiscal policies undermined political stability in developed countries; and what recent stresses—including dollar weakness, Treasury market liquidity scares, and an increased reliance on short-term debt financing—suggest about looming financial repression, fiscal dominance, and a rotation out of U. S. capital markets. The second hour is devoted to a conversation about investor incentives, market structure, investment opportunities in emerging markets, and how to construct a more diversified portfolio suitable for the world that is coming into being. Demetri and Sony discuss why political and currency risks may now be lower for a diversified emerging markets basket than for a similarly diversified portfolio of developed market assets. They discuss what a reweighting toward emerging markets could look like; why India stands out given its digital public rails and domestic-demand engine; how places like Indonesia, Brazil, and Nigeria fit into a rebalancing; and how to think about geopolitics, US policy risk, and portfolio construction in this new paradigm. Subscribe to our premium content—including our premium feed, episode transcripts, and Intelligence Reports—by visiting HiddenForces.io/subscribe https://hiddenforces.io/subscribe. If you'd like to join the conversation and become a member of the Hidden Forces Genius community—with benefits like Q&A calls with guests, exclusive research and analysis, in-person events, and dinners—you can also sign up on our subscriber page at HiddenForces.io/subscribe https://hiddenforces.io/subscribe. If you enjoyed today's episode of Hidden Forces, please support the show by: Subscribing on Apple Podcasts https://podcasts.apple.com/us/podcast/hidden-forces/id1205359334, YouTube https://www.youtube.com/channel/UC8URhgYos5fjHqFSO4RSIEg, Spotify https://open.spotify.com/show/0TK6u251zGSlMgJKH6cOaP, Stitcher https://www.stitcher.com/podcast/demetri-kofinas/hidden-forces, SoundCloud https://soundcloud.com/hiddenforces, CastBox https://castbox.fm/channel/2629539, or via our RSS Feed http://hiddenforces.libsyn.com/rss Writing us a review on Apple Podcasts https://podcasts.apple.com/us/podcast/hidden-forces/id1205359334 & Spotify https://open.spotify.com/show/0TK6u251zGSlMgJKH6cOaP Joining our mailing list at https://hiddenforces.io/newsletter/ Producer & Host: Demetri Kofinas Editor & Engineer: Stylianos Nicolaou Subscribe and support the podcast at https://hiddenforces.io https://hiddenforces.io/. Join the conversation on Facebook https://www.facebook.com/hiddenforcespod/, Instagram https://www.instagram.com/hiddenforcespod/, and Twitter https://twitter.com/hiddenforcespod at @hiddenforcespod Follow Demetri on Twitter at @Kofinas https://twitter.com/kofinas Episode Recorded on 08/18/2025

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Demetri Kofinas?

  What's up everybody? My name is Demetri Kofinas and you're listening to Hidden Forces, a podcast that inspires investors, entrepreneurs, and everyday citizens to challenge consensus narratives and learn how to think critically about the systems of power shaping our world. My guest in this episode of Hidden Forces is Sony Kapoor, an economist, policy advisor, and investor who began his career in leveraged finance and derivatives at Lehman Brothers and went on to advise roughly 20 governments, including Norway, Sweden, and Germany, as well as some of the world's largest sovereign wealth and pension funds. We spend the first hour of this conversation unpacking the theses explored by Sony in

• 0:43Demetri Kofinas?

  two of his papers, "Winter is Coming" and "The Case for a Great Rebalancing," in which he argues that global capital has been increasingly misallocated due to factors such as the growth of passive indexation, maladaptive benchmarking, and an excessive focus on short-term performance at the expense of long-term returns. We explore how demographic tailwinds in advanced economies have flipped into headwinds, whether AI-driven productivity gains can realistically offset the drag of declining birth rates, why accommodative post-GFC monetary and fiscal policies undermine political stability in developed countries, and what recent stresses, including dollar weakness, treasury market

• 1:24Demetri Kofinas?

  liquidity scares, and an increased reliance on short-term debt financing suggest about looming financial repression, fiscal dominance, and a rotation out of US capital markets. The second hour is devoted to a conversation about investor incentives, market structure, investment opportunities in emerging markets, and how to construct a more diversified portfolio suitable for the world that is coming into being. We discuss why political and currency risks may now be lower for a diversified emerging markets basket than for a similarly diversified portfolio of developed market assets. We discuss what a reweighting toward emerging markets could look like, why India stands

• 2:04Demetri Kofinas?

  out given its digital public rails and domestic demand engine, and how places like Indonesia, Brazil, and Nigeria fit into a rebalancing, and how to think about geopolitics, US policy risk, and portfolio construction in this new paradigm. If you want access to all of this conversation, go to hiddenforces.io/subscribe and join our premium feed, which you can listen to on your mobile device using your favorite podcast app, just like you're listening to this episode right now. If you want to join in on the conversation and become a member of the Hidden Forces Genius Community, which includes Q and A calls with guests, discounted access to third-party research and analysis,

• 2:46Demetri Kofinas?

  and in-person events like our intimate dinners and weekend retreats, you can also do that on our subscriber page. If you still have questions, feel free to send an email to [email protected] and I or someone from our team will get right back to you. Lastly, because this conversation deals with investing, nothing we say on this podcast can or should be viewed as financial advice. All opinions expressed by me and my guests are solely our own opinions and should not be relied upon as the basis for financial decisions. And with that, please enjoy this wide-ranging and in-depth conversation with my guest, Sony Kapoor.

• 3:32Demetri Kofinas?

  Sony Kapoor, welcome to Hidden Forces.

• 3:35Speaker 01

  Thank you for having me.

• 3:37Demetri Kofinas?

  It's great having you on. I was telling you, Sony, that I could swear that I first came across lectures of yours and interviews of yours back in 2011 or so, like in the years after the great financial crisis. Before we start today's conversation, which was precipitated by a paper that you published actually a while ago in 2016, and you followed it up on that paper with a different paper in 2024, where you explored many of the themes that you talked about in that paper. We're going to, we're going to talk about that because I think it's something that the audience will find very interesting. But before we get into the meat of today's conversation, just brush me up on your, your life, your story, your career arc, and why do I remember you from that period post 2008?

• 4:18Speaker 01

  Ooh, it's a hard one. Well, I've followed a rather unusual career trajectory. And you know, nowadays it's fashionable to call it a portfolio career. But I think I sort of accidentally stumbled upon a portfolio career before it became fashionable. And that was as far back as I think 23 odd years back, when having started life as an investment banker doing leverage finance and...

• 4:46Speaker 01

  Private equity for Lehman and then I traded derivatives. I sort of, you know, got pretty disillusioned rather quickly with what I saw inside the financial markets. And I decided that, you know, in general, I mean, the insight I think I got back then was what is well paid is often neither very interesting nor very important. And often some of the most important and interesting stuff is not very well paid. And sort of I, part by design, part by accident, have hit upon this portfolio career model since then, where I work for money for about one, two days a week.

• 5:31Speaker 01

  And then three, four days a week, I do pro bono and charity stuff. The important stuff, you know, and that has sort of taken me everywhere. So I've worked with governments, I've been advised to the Norwegian, the Swedish, the German governments, you know, about twenty governments in all. Um, I've worked with some of the largest sovereign wealth funds in the world. I've advised pension funds, but I've also worked with Christian Aid and Oxfam and charities. I've helped set up several main nonprofits. I sit on boards, I ran one of the most influential think tanks in the EU for about a decade or so called Redefine.

• 6:14Speaker 01

  And sort of I've been there, done that. And, you know, in, in a world of sort of super specialists we live in, most people's career as this sort of goes along, they focus more and more narrowly. And I think this has created both a need and a space for someone like me, who I think primarily out of just natural curiosity, my interests in life have just gotten. Broader and broader, the older I get. And perhaps one last point. So, you know, I went to one of the Indian Institute of Technology, these elite engineering institutions in India. And I started life, as you know, many of the folks do, as a rather cocksure,

• 6:59Speaker 01

  overconfident, you know, quite quantitatively sort of focused young man who hadn't seen the world and didn't appreciate the subtleties and the complexities and the nuances. And I had overtly deterministic view of the world. And perhaps, you know, if I'm honest, had you asked the twenty-year-old me, I might have sounded arrogant on things like arts and music and history and anthropology and cultural studies and, you know, these software issues. And the older I have gotten, I think perhaps the more wise, you know, I have gotten.

• 7:40Speaker 01

  Of course, I have still much to learn. The more I've seen of the world, the more humble I have got. The more I have known smart people, the less certain I am of things. And the more I appreciate, not the black and whites, which almost always are ridiculously inaccurate and lead to, you know, very false premises, but I appreciate the shades of grey and the nuances. And so much so that perhaps, you know, by some measure, I've gone the other extreme. While I had the competence to, you know, do all the quantitative stuff and look at equations and not have my eyes glaze over, but I don't like looking at equations anymore, you know,

• 8:21Speaker 01

  even in my work on climate, et cetera. I mean, there's only so much that a data-driven, you know, supposedly quantitative approach can deliver in a world that is only partly driven by numeric deterministic forces. And I think the biggest risk we face is in a world driven by an excessively data-driven quantitative approach.

• 8:50Speaker 01

  Dominated by, you know, the supposed promise of AI, et cetera, is to lose our connection with the real world, with our humanity, with the uncertainties and the shades of gray that actually define real life. So that kind of sums me up.

• 9:10Demetri Kofinas?

  Boy, you were just pulling on the heartstrings of our audience towards a crescendo right there. So you're going to fit right into this conversation. So let's get right into it. I mentioned that you published two papers that I read. One was Winter is Coming in 2016. You actually published this, I believe this was under NORFUND. You did it for NORFUND, a Norwegian investment fund?

• 9:30Speaker 01

  Yes, that's right. Yeah.

• 9:31Demetri Kofinas?

  What is NORFUND for those who don't know, including me?

• 9:34Speaker 01

  Yeah. So the backstory to that is that I was a strategy advisor to the Norwegian government for a while around the financial crisis. And one of the things I did was the then finance minister asked me to look at revisiting the investment strategy and the governance structure of the Norwegian Sovereign Wealth Fund, which I believe is the largest sovereign wealth fund in the world. It's now about 1.9 trillion dollars. And I made a number of recommendations and it's become, you know, one of those sort of hobby projects where I hate leaving unfinished tasks. So every few years I would sort of revisit that and check where, you know, things have been. So I published a report on the investment

• 10:17Speaker 01

  landscape that was covered by The Economist in the after 2013. And this was one of those revisitation. Then this time it was done under the rubric of NORFUND, which is the equivalent of the DFC in the US, the Development Finance Corporation, which invests US capital, or at least, you know, pre-Trump used to, into economically productive projects in emerging economies with a dual mandate of a financial return and a positive developmental impact. So they were sort of the sponsors of the study, but the main focus was on the broader investment landscape of the kind that the Norwegian Sovereign Wealth Fund inhabits.

• 10:58Demetri Kofinas?

  Got it. So that paper was titled "Winter is Coming." As I said, you published it in 2016. And then you published another paper recently called "The Case for a Great Rebalancing." That was in 2024. Let's talk about "Winter is Coming," and then we can discuss the other article when we look at how events in the last decade have validated or invalidated the thesis that you put forward in that 2016 paper. So what is that core thesis that you put forward in "Winter is Coming"? Can you tell us?

• 11:24Speaker 01

  The core thesis, I think, was that the capital allocation through the financial system globally had increasingly lost touch with real productive investment opportunities globally. And it was driven by a series of idiosyncrasies with which the financial system works, of which, you know, relative performance, index tracking, short-termism, et cetera, you know, are just a few, plus a fairly outdated worldview that still reflected,

• 12:06Speaker 01

  let's call them, the glory days of developed markets, you know, the times, particularly post-World War II decades, of significant gains in economic productivity, significant expansion of capital stock, robust growth rates that were part-driven by very favorable demographics, et cetera. And many of those forces that drove sort of that golden age in the relative rise of, you know, developed markets and recovery in post-World War II Europe had sort of run their course mostly by the end of the 90s. And so, you know, had

• 12:47Speaker 01

  markets tracked the real economy and productive potential, then there ought to have been a sort of great rebalancing that should have begun away from the excessive investment in rich economies towards the so-called emerging economies already at the turn of the century. So you know roughly around two thousands. But fueled by one development or the other, you know, was it the internet mania, it was the real estate bubble. Then, you know, rather counterintuitively, despite the fact that it was. The US that sort of, you know, inflicted the financial crisis in the rest of the world.

• 13:29Speaker 01

  It was the US that also led the recovery and that was partly because of the very robust. Fiscal and monetary response in the US. Which again, counterintuitively attracted even more capital. To the place that had, you know, through misallocation of capital at scale. Inflicted a financial crisis on the rest of the world and then every single time. It would seem that, you know, the economic case would finally lead to. The financial sector starting to change its allocation and focus. Something or the other would happen in the most recent examples, because there was another paper I. Published in the interim and that was called Winter Has Come.

• 14:13Speaker 01

  And I think that was just at the cusp of the Corona crisis breaking out, right? And I said, and if you remember, twenty nineteen was not a particularly good year. For financial markets, so that was in twenty nineteen. And I said, okay, now finally, you know, the rebalancing has begun, but of course, you know, in Corona. It was the rich markets that were able to drive the most robust fiscal and monetary policy response, you know, we saw new bouts. Of quantitative easing, which further inflamed the very same drivers of, you know, asset prices. That had made rich country financial markets, but in particular, American markets. Look attractive on a year by year financial return basis.

• 14:58Speaker 01

  And so, one way or the other, you know, so we've gotten further and further away. From what is an economically sensible, productively enhancing global allocation of capital. And in twenty twenty five, you know, mid twenty twenty five, we've never been further away from that equilibrium. As we are today, sort of at least in living memory, and my present thesis is, I think, as sort of Hemingway's rumored to have said, you know, when asked about going bankrupt, he said, first slowly and then suddenly. And I think we are at the cusp of first slowly

• 15:41Speaker 01

  and then a sudden rebalancing of financial markets and capital allocation, where in particular from the US, which is heavily overweighted, but more generally from developed economies towards emerging economies where most growth potential, most human capital, most productively enhancing investments lie.

• 16:02Demetri Kofinas?

  Do you think we started to see that after Trump's inauguration and also when he held his Liberation Day rally? Is that the first time that we really began to see that great rotation or rebalancing?

• 16:15Speaker 01

  There have been several signs, right? I mean, again, you know, I might be getting this wrong. I'm not up to date on my economic history, but Keynes is rumored to have said something along the lines of, you know, the market can stay irrational longer than I can stay solvent, or something to that effect. And, you know, I have been wrong in the timing before, but I think I've never felt as confident as today that this has actually begun. I mean, in terms of actual signs, there've been at least, I think, three, let's call them incidents, that lasted from a few days to a few weeks since Trump's inauguration

• 16:58Speaker 01

  that have included, you know, unforeseen disturbances, sudden liquidity black holes in US Treasury markets, a significant, I think around 10% decline in the value of the dollar, which previously had been sort of the great attractor, right? Because I think the dollar saw, what, 30, 40% rise in a weighted average value over the past several years, to the point where I think as much as 80% of international capital investments into US financial markets from the Europeans, the Japanese, the Asians, et cetera.

• 17:40Speaker 01

  Have more or less been unhedged, something you know, very few financial investors would ever seek to do in any other markets. That's because they benefited from the outsized supernormal S and P returns year after year, combined with this massive rise in the value of the dollar. Now, whatever worked with the tailwind in one direction is possibly likely to unfold even faster going in the opposite direction. Because as much as you know, the speed of investments into the fashionable theme of the day such as AI, et cetera,

• 18:21Speaker 01

  can gain momentum, exits are almost always more, more rapid. And I think this is one of those self perpetuating things where. So as an example, I think S and P five hundred has, you know, done reasonably well in, in dollar terms, right? But if I recall correctly, for Euro and sterling based investors, the annual return has either been negative or at least, you know, much closer to zero than for US dollars invested because of the dollar valuation, right? Over what timeframe are you describing? Since Trump's inauguration, right? Or since the beginning of the year, and there's not, you know, that huge a difference between those two.

• 18:59Speaker 01

  And so, once you question the, what has been, you know, a running assumption of a strong dollar, and you think that further devaluation, depreciation of the dollar is a real possibility, you immediately either reduce your exposure by beginning to underweight what has been an overweighted allocation to the US and slash or you start hedging part of your dollar portfolio risk, right? In which case, that process of hedging, because of, you know, the way hedging works, in itself drives a further depreciation of the dollar, which further increases the case for hedging, et cetera. So I think we are at the cusp of that.

• 19:43Speaker 01

  The inertia of markets, the fact that we have, you know, market valuation based indices being the great attractor of investment flows, et cetera, means that any movement in this, it's gonna be, there's a lot of inertia in moving away from current allocation. So even if. Everyone, let's say, you know, seventy percent of large asset managers would have sort of changed their mind about future prospects for dollar and, you know, S and P returns. It is to be expected that the numbers in terms of outflows, changes in valuation,

• 20:25Speaker 01

  allocation, et cetera, would take several months to show. And I think we are at the beginning of that, but the evidence is not conclusive yet. But one would hope, for the sake of the rest of the world, for the sake of globally efficient capital allocation, for the sake of capitalism itself, that this great balancing has finally, if belatedly begun.

• 20:46Demetri Kofinas?

  So I want to flesh out this thesis and the existential crisis that you say faces pension funds and the larger crisis facing institutional investors that you write about in the Winter Is Coming paper. You've already mentioned two of the drivers, I think. One of them is the investment approach. You mentioned short-termism. There's also indexation, you know, how are managers benchmarking? Risk management, the definition of risk, these are all sort of variables that inform an investor's approach. You also spoke a little bit about the investment policy response to the great financial crisis, which is also, I think, a driver that you highlight in the paper. And there are also long-running structural challenges like demographics, debt, and I

• 21:29Demetri Kofinas?

  suppose, I don't know if you would agree with this, but I suppose we could throw into that bucket political sclerosis driven by the policy choices made over several decades that have led to the political climate that is facing not just America, but many countries in the West. Let's go through all three of these, if you don't mind. Maybe we can start with the structural challenges.

• 21:52Speaker 01

  Well, I mean, one big structural challenge, perhaps the biggest one, is the demographic challenge, right? So so many of headlines in American and European press have been focused on, you know, the demographic decline and particularly in the US right-wing pod sphere, right? Everybody from Elon Musk to other, you know, lesser known people have opined on how to increase US birth rates, particularly referring to, let's call them, you know, a particular kind of ethnicity, right? This has been a huge obsession into the far right governments in Europe, in particular in Hungary,

• 22:37Speaker 01

  also in the previous government in Poland, et cetera. And the reason this is so important is, right, again, if you look at that golden age of of the West, you know, post-World War Two, right up to the beginning of this century, a bit more than half of all the growth, increase in prosperity, et cetera, an increase in GDP was driven by an actual increase in the number of workers employed in the West, right? And that was owing to these favorable demographics, you know, baby boomers, et cetera. And productivity growth, which often gets a lot of attention, only accounted for about half of those gains, right?

• 23:19Speaker 01

  Now, what was a tailwind in driving these fantastic productivity gains in the West, fantastic GDP gains in the West, has, in the case of the US, which has, you know, slightly better demographics than us on this side of the Atlantic, or particularly than Japan and South Korea, right? Has stopped being a tailwind. So their US-born workers are, you know, either not contributing at all to an actual increase in the number, in the amount of US GDP, or, you know, marginally and fairly soon to turn negative, right? And in the case of Germany, Italy, Japan, Korea, et cetera, they've already, what tailwind has already become a headwind.

• 24:04Speaker 01

  So a declining demographic trend is likely to pull down estimated annual GDP growth potential in the West by between one and one and a half percent every single year, right? And there's no running away from it, because many different policies have been tried, including, you know, very

• 24:27Speaker 01

  Generous policies around taxation, around benefits for couples with three children or more in various European countries and East Asia, et cetera. And frankly, none of them have worked. So there isn't yet globally a single policy that has been tried anywhere in the developed world to substantially reverse the long-term decline in birth rates to a less than replacement level. And it's not a marginal decline, right? I mean, I think the decline has gone so far. The birth rate in I think South Korea, the replacement rate is supposed to be 2.1 kids per woman, and it's fallen to like 0.7 or something. In Japan, for the past more than 10 years,

• 25:12Speaker 01

  the sale for adult nappies against incontinence has far exceeded the sale for diapers and nappies for children, right? Just as, you know, something that'll sort of stick in your mind. So there is no getting away from these very unfavorable demographics and the massive headwind disposes, both in terms of, you know, possible GDP growth, financial returns, but also in the very unfavorable debt dynamics that is accounting for a significant and expected further rise in the debt to GDP ratio in rich economies.

• 25:50Demetri Kofinas?

  So I'm curious how much you've actually looked into the demographic numbers and explanations for why some of these countries have seen such a collapse, like South Korea, for example, which is at 0.72 today, the last I checked. Actually, it's probably less than that. That was a 2023 number. And South Korea is really a stunning chart to look at because their birth rate in the 1960s was six children per family, which essentially means that the parents were part of a six-child family on average, and their children either have one or no kids at all. What explains a collapse in a country like that, which was actually in the developing world and was seeing major upward trends in economic growth?

• 26:33Demetri Kofinas?

  And does that sort of run counter to the narrative that we have maybe here in Western countries that lower birth rates are strictly a result of economic underperformance and a rising wealth and income gap?

• 26:46Speaker 01

  Um. There's so many cultural differences across even South Korea and Japan, you know, which is sort of near neighbors and have a lot of cultural affinity, that it would be beyond my level of expertise to get into, you know, nuanced details and opine intelligently. But there are some idiosyncratic factors at least, and I think some of them are the very real career penalty that exists in most rich economies, from any, you know, half-promising career that a woman has, to, you know, as soon as they become mothers,

• 27:28Speaker 01

  the career penalty can be anywhere between five to ten years. And, and, you know, as you know, I now live in Norway, which together with Sweden and Denmark, has some of the most, you know, supposedly progressive, you know, couple female-friendly, child-friendly policies in the world. And yet, I see it in my peer group, you know, part of the Norwegian League, even in a place like Norway that has no lack of money, that has policies, you know, designed to be family-friendly, you get a full year of fully-paid parental leave, for example, there are flexi-work arrangements to accommodate mothers and so on and so forth.

• 28:09Speaker 01

  Even here, there is a career penalty, right? So if even a place like Norway and Sweden has been unable to, to eliminate that, Korea, I think, lies on, together with perhaps the United States, for different reasons, on the other side of that spectrum. A second big reason, again, instead of Korea and the developed world in general, is a significant delay in the age that couples settle down, right? And that's partly owing to the significantly higher education that women go for now. And I think it's universal across the developed

• 28:51Speaker 01

  world. It's hard for me to think of any country where women in present cohorts Are not on average significantly better educated and achieve higher educational degrees and better grades than men across the spectrum. So the delay also comes with actual, you know, fertility loss, which which declines quite sharply between mid twenty five and mid thirty fives. And that can be another factor. And there is one more issue around having to care for aging parents in societies where the state has not provided an adequate structure for all age care, which which is universal again.

• 29:35Speaker 01

  So there's a number of factors, pressures on time, incentive structures, delayed choice in settling down, et cetera. And that's one of the reasons why there isn't a simple policy wand. You can just sort of swipe and undo these many complicated, multi-layered structural changes that have driven the decline in birth rates. And so I think this is here to stay.

• 30:02Demetri Kofinas?

  Hmm. Excellent answer. Again, very, very complete answer, Sonny. So let me pose one sort of counter thesis to the discussion about demographics, and then let's get into some of the other drivers of structural challenges. Before we get into the pilot's response from the great financial crisis and investors approaches. What about the thesis that AI productivity, a boom driven by AI and the diffusion of AI technology as a general purpose technology, not unlike the internet or even more impactful, could supplant or mitigate the fall in birth rates and therefore essentially bridge the gap in growth

• 30:44Demetri Kofinas?

  that would otherwise result from these poor demographic figures that you cited earlier.

• 30:50Speaker 01

  Well, so, you know, was there a boom case for the railways in the 19th century? Yes, right? I think peak market capitalization, I might have this wrong, but if memory serves me right, railway firms or railway adjacent firms in the US stock markets at one point accounted for more than half of market capitalization in the United States, right? And I believe the current figure must be less than 1% or something. We all lived through, and I think you and I came of age, you know, in the internet bubble of the 2000s, right? And clearly, you know, something similar is going on with AI.

• 31:33Speaker 01

  One famous quote, I think, was it Krugman who said that?

• 31:38Demetri Kofinas?

  Yes, it was, it was, it was Paul Krugman.

• 31:41Speaker 01

  Yeah, what was the quote? Do you remember, Ray?

• 31:42Demetri Kofinas?

  I can find it right now. Give me a second here.

• 31:45Speaker 01

  And so there was a Robert Solow quote around computers are everywhere apart from in productivity statistics. So that was Robert Solow in the 80s.

• 31:54Demetri Kofinas?

  And Krugman's quote was that "The growth of the internet will slow drastically as the flaw in Metcalfe's law, which states that the number of potential connections in a network is proportional to the square of the number of participants, becomes apparent. Most people have nothing to say to each other!" exclamation mark. "By 2005 or so, it will become clear that the internet's impact on the economy has been no greater than fax machines." Wow. I mean, talk about perfectly getting it wrong and in some sense over-intellectualizing it, which I think is often a trap that people fall into at these types of turning points.

• 32:27Speaker 01

  That is true, right? That having been said, I mean, it's an open question, right? What do you and I think Facebook's net impact on global productivity has been?

• 32:42Demetri Kofinas?

  Oh, I wouldn't say that Facebook is the benchmark.

• 32:45Speaker 01

  No, no, it is, right.

• 32:46Demetri Kofinas?

  And I would agree with you that it hasn't been necessarily a positive force.

• 32:50Speaker 01

  So I think there was, you can kind of see where he might have been coming from. And I think it is still perhaps sensible to think that it's still not a settled issue, right? I mean, for all the- Positives in the growth in productivity, et cetera, that clearly, you know, the dimensions of the internet has given us. There's also a significant downside that has come with it.

• 33:15Demetri Kofinas?

  Yes, I think that when I look at Krugman's statement, the key flaw in his reasoning was that he saw the internet as a communication, primarily a network for personal communication.

• 33:30Speaker 01

  Absolutely. Rather than having access to all of the world's knowledge at your fingertips.

• 33:34Demetri Kofinas?

  Right. Rather than abstracting it to thinking about it as a network for communicating information.

• 33:39Speaker 01

  I agree with that. So I do not want, you know, 20 years from now to have this sort of code thrown back at me. But again, you know, I mean, I did train as an engineer. I follow the science. I have read and worked with and advise a number of, you know, AI-related ventures. And I think there is a real case to be made, right? I mean, I think it would be only honest if you and I were to admit that before ChatGPT and now, you still have to sort of, you know, go through the accuracy of stuff, et cetera. But familiarizing yourself

• 34:18Speaker 01

  with any topic, trying to, you know, so in the same way that Google was a massive jump in the ability to access the world's knowledge at your fingertips, this is the way of sort of organizing all of that, right? So there is clearly a case that you and I can do our jobs and many of our colleagues more quickly in less time, perhaps more comprehensively, if perhaps, you know, more overconfidently than would be the case. So there is something to it, you know, AI will contribute, I think, to a significant increase in productivity, right? And I wanted to add a second thesis to this. So, you know, we've all been worried

• 35:03Speaker 01

  about Japan, right? Because Japan is the first country of any size that has seen this demographic decline. And, you know, the rather unfair, slightly caricatured example I used of the sale of adult nappies being part of it. But, you know, they're riding gently into the sunset.

• 35:23Speaker 01

  But you know, in an unexpectedly half decent way, right? I mean, the worst predictions, the most sort of dire scenarios, et cetera. I mean, they haven't come to pass. And what we see is not just this sort of, let's call it forcible or, or, you know, regulatory increase in retirement ages, et cetera, which has been a part and parcel of, you know, rich country policies, right? But actually, old people voluntarily, even when they do not need the money for, you know, either reasons of avoiding loneliness or just staying active and engaged, et cetera,

• 36:05Speaker 01

  have participated much more in productive economy than one would have thought. And that combined with the, with Japan's, you know, early embrace of automation, right? Which we also see in China, robot shop assistants and so on and so forth, has meant that Japan has declined, or is declining much slower than had been anticipated, right? But it is still declining. So I agree with what you said, that both AI and this Japanese example, if replicated, as is likely in, you know, the rest of the rich world, will mean that demographic decline

• 36:49Speaker 01

  may not be as bad for GDP growth, productivity, financial returns, you know, debt prospects as one would have thought, had these not taken place. And yet, when gravity is so strong, the decline is so sudden, so sharp, so continuous as it is, it will still turn from a tailwind to a headwind, right? It's a question of degree. Maybe half of the impact would be mitigated, maybe the impact would be spread over two or three decades rather than one and a half or two decades, right? But it's still there, and that you can't get around.

• 37:32Demetri Kofinas?

  So one more question about AI before we go back to the structural drivers. And this one, I think, supports your thesis. So how much experience do you have using some of these large language models?

• 37:43Speaker 01

  I don't know what the median level of experience is, so I just say, let's call it a bit above our average.

• 37:49Demetri Kofinas?

  Okay, so I, as the audience knows, I've talked about this a number of times in the last year. I started really using ChatGPT in particular at the beginning of the year. And I found 4.5 Research, that version of ChatGPT, to be a very effective and useful thought partner. And I began to use it increasingly to help offload some of the pre and post-production process related to the show. Now, ChatGPT 5 Pro is the analogous version of the new model. And I actually, when I started using it, I felt like it was underperforming relative to 4.5.

• 38:29Demetri Kofinas?

  Now, my response to that was, or the way I rationalized it was, okay, this is probably because it's just, it's different and I need to learn how to use it. And that may be true, but other people have expressed similar concerns. And now I'm hearing an opinion express that maybe we have reached a kind of, at the very least, interim top in the performance of these models and in the way in which they have been scaled, which is to throw more and more compute at them. So let's assume for a moment that maybe we have reached an interim top in the productivity story around AI. Do you think that this could actually accelerate outflows from the United States?

• 39:09Demetri Kofinas?

  And accelerate the realization of the thesis that you have put forward?

• 39:15Speaker 01

  Well, I think there's three sub-points to your question. Let's take them each by turn, right? So the first is, how big A lead and how big a moat does the United States have vis a vis the rest of the world in AI, right? Now, I'm sitting in Norway. I use the same chat G P T that you do, right? We both have access, at least at a consumer level, to Claude and, you know, all the other proliferation of AI models that we see, right? So, I mean, in the same way that Google was important for the United States, particularly in terms of, you know, Silicon Valley, the thesis of Silicon Valley productivity

• 39:59Speaker 01

  and the money that went into Google and the jobs it created, the taxes. But, right? I mean, the biggest impact of Google in enhancing productivity, et cetera, was global, right? So I think that, and we remember the DeepSeek surprise. What was shocking to me was not when DeepSeek released the model and, you know, I think what was shocking to me was how shocked Americans were in particular, that, you know, China was so close at their heels, right? So I think that the moat around, you know, American lead on AI and how bullish. So let's say I'm very bullish on the future of AI, right?

• 40:43Speaker 01

  I think the link from that belief to bullishness on America, on the United States, or even, you know, the American stock markets. There are several assumptions in that that possibly don't hold up to scrutiny. Right? So that's one part.

• 41:04Demetri Kofinas?

  I just want to say one quick thing before you continue. My larger point and the reason why I emphasize the narrative around AI is that the companies that make up a big portion of the indices that global investors are invested in. Their valuations have been supported in large part by a narrative that the United States is going to lead the AI revolution. So that was why I was keen to note the story aspect of it. And specifically, the equity play, the financial markets played, not necessarily whether or not the United States would accrue similar benefits to its economy relative to Europe and the rest of the world.

• 41:45Speaker 01

  Absolutely. So that was going to be my second one, right? Now, again, going back to, you know, railways, electricity, any of these sort of, you know, internet and you remember all the hyper, wasn't Cisco Systems at one point the largest company in S and P 500, right?

• 42:02Demetri Kofinas?

  I believe that's right, yeah.

• 42:03Speaker 01

  Yeah. I mean, I'm not saying this is the case, right? But could it be, at least it's a, you know, non-negligible possibility, that Nvidia, you know, which is providing the infrastructure, the basic chip technology for the massive AI rollout, could be the Cisco of 2025? I don't know, but I'm just sort of, right? So now, did Cisco, you know, being so big, attracting so much capital, laying out so much optic fiber network, et cetera, was it good for the world and for productivity? Absolutely, yes, right?

• 42:42Speaker 01

  I mean, we're still reaping the benefits of the massive losses incurred by investors in that investment boom, just as in the US is still living off the legacy of the investment boom of the railways, right? I mean, we haven't really maintained our physical infrastructure, but that's what we're still living off. And so I think, again, you know, AI is almost surely going to be similar, where there is going to be this massive over-investment, which is going to put in place real infrastructure that will be useful several years into the future globally.

• 43:20Speaker 01

  But what proportion of these investments are likely to translate into outsized financial returns? For investors and I think the answer there is, you know, I mean, it's impossible to say I'm possibly going to have egg on my face in the future. But if you look at the past, it's not very promising, right? I mean, there's, there's hardly any money you and I pay for, you know, chat G P T subscription. And the even if one thinks that OpenAI and the other leaders in the industry would be able to reach the billion users, et cetera, in a much shorter time than, you know, Google and Facebook and Instagram, et cetera, right?

• 44:04Speaker 01

  And even if one thinks they'll be able to be twice as good at monetizing those billion users. It's still a very, very, very low probability that this is going to translate into oversized financial returns, particularly, you know, if one buys into present high valuations, right? Cause the answer to, you know, what's the different return you're getting? Always depends on what valuation you're buying at, right? And we are already at such inflated valuations that any investor buying in now into these A I plays

• 44:42Speaker 01

  is almost surely not really going to see anything like the outsized returns that, you know, these valuations supposedly based on, right? So that's sort of the second thing. And the third thing I wanted to say was that at the end of the day, right? I mean, A I is a great marketing label. But there's nothing intelligent about L L Ms, right? Um, I mean, in any commonly understood sense of the word Oxford English Dictionary sense, you know, intuitive understanding of intelligence. Uh, you know, all of these work went past this prorog.

• 45:26Speaker 01

  And one thing we've sort of learned is that, you know, the future. May have elements of the past, there'll be echoes, right? But it will be different. And there isn't any natural creativity and intelligence ascribed. And that's not to say that they are not useful, right? They are useful, but they are not going to be intelligent in any sense of the word that, you know, you and I think. I mean, they are probabilistic models based on massive amounts of data. And let me then conclude with the example you started with of, you know, chat G P T possibly plateauing, right? I mean, it's garbage in, garbage out, right?

• 46:08Speaker 01

  And once you have used in the training all of the publicly available sensible, human-generated, you know, data and research. The world has at its fingertips in the internet and in the books, et cetera, right? You run out of new training data. How does value added and the way these models work, right? They do repeated runs on that data to generate outputs, which are then fine tuned to match with the known data set, right? And then there isn't a human being, then, you know, they're giving comments as a general feedback.

• 46:48Speaker 01

  But there is no human being capable of adjusting two trillion parameters and weights in the models, right? So it's a very mechanistic, probabilistic approach that is fundamentally not intelligent and not able to connect dots in the way you and I are able to, at least on our best with a lot of caffeine. And so I think, yes, it's very useful. Yes, it's an amazing research assistant. Yes, in particular narrow domains such as DeepMind's AlphaFold, you know, which has genuinely revolutionized, you know, research in proteins. We have one protein structure used to be a PhD thesis.

• 47:31Speaker 01

  And now we have, you know, tens of thousands at the click of a button. There'll be areas, narrow areas, where it'll be genuinely transformational. But it's not going to replace intelligence. And at least some of the narrative, I believe, is is completely overhyped.

• 47:51Demetri Kofinas?

  All right, so let's try and wrap up this part of the conversation around structural long-term challenges. The other two that I mentioned besides demographics are debt and political sclerosis. What's amazing about reading that paper from 2016 is that even then, and you weren't the only one, there was concern about the level of sovereign debt. And in fact, I think this concern began to grow after the great financial crisis, when many countries internalized and put onto their sovereign balance sheets the liabilities of the private sector. And we have gone bananas since 2016. So I'm curious, why don't you update, give me your updated thesis on the role that debt,

• 48:30Demetri Kofinas?

  and in particular sovereign debt, has to play in informing the challenges that you laid out in this paper?

• 48:39Speaker 01

  So, two parts of this, right? So, one is that the 2016 worries and concerns about the rising level of sovereign debt, particularly in the rich world, not being sustainable, that investors running out of patience or interest in funding them, et cetera. They were helped out, right, by the massive QE-driven decline in interest rates, right? So I think between the fall of Lehman and the time that I wrote this paper in 2016,

• 49:22Speaker 01

  there had been like nearly 700 interest rate cuts in the world across the board, not to mention, what, 10 to 15 trillion dollars of QE, et cetera, right? So it meant that even as debt stocks rose dramatically, the cost of servicing that debt...

• 49:42Speaker 01

  Decline simultaneously. So there was no pressure brought to bear on rich country governments to address fiscal deficits as well as, you know, rising debt to GDP ratios.

• 49:58Demetri Kofinas?

  And capital recycling from the periphery to the core, that dynamic that had been in place before the crisis continued.

• 50:04Speaker 01

  Absolutely.

• 50:05Demetri Kofinas?

  So the developed world's debts were being financed by the developing world.

• 50:08Speaker 01

  Absolutely. And, you know, it is, again, you know, going back to, so I'm a red-blooded capitalist, having, you know, grown up in the, in a, in a, let's call it, you know, licensed, raw, slightly socialist India. I see the value, but red-blooded capitalism is very different from, you know, the kind of financial capitalism that is in play now. And, you know, very counter-intuitively, right? I mean, at a huge opportunity cost to their own economies, these countries with trade surpluses, many of them, you know, with petroleum surpluses, amassing sovereign wealth funds

• 50:49Speaker 01

  with opportunity costs in terms of either domestic interest rates or potential growth, et cetera, which could be five, six, seven, eight percent. Instead of investing in their own economies or in each other's economies, decided to buy US and eurozone debt at minus one, minus two percent, right? It's just phenomenal the way it happened. And then in 2019, you know, when it's sort of seen that things were coming to a head, that this could not continue. And of course, you know, it's very unfortunate and, you know, I mean, I lost friends in Corona crisis. It was horrible and, you know, a lot of people lost near and dear ones. But from a financial market perspective, it was a godsend

• 51:34Speaker 01

  because all of the new money pumped into the financial system, particularly in the rich world, further decline in interest rates, you know, fiscal pump priming on all cylinders, firing on all cylinders, meant that suddenly valuations across all asset classes, right? Be it housing, you know, equity markets, et cetera, just once again skyrocketed exactly when it seemed like financial returns in the West were running out of room. And of course, that meant that debts were accumulated, but once again, the pressure was not to repay. But that all changed with the inflation that we saw. And I think now,

• 52:17Speaker 01

  for the first time, particularly when we look at the long end of treasury markets and bunds and, you know, developed country debt, there is increasing, rising reluctance on behalf of investors to hold particularly long dated debt, while they're still willing to fund sort of near term debts. And so the average, so if you remember the Lehman crisis and the Eurozone crisis, one big concern that came up there was, and I think the UK was an outlier, so the UK had an average UK government maturity of like twelve and a half years. But for the US and particularly for, you know, Greece and France and Italy, et cetera, it was more like five or six years, right?

• 53:02Speaker 01

  So the rollover risk was pretty high. And I think we are once again, and remember in the heyday, I think, was it Austria issued a hundred year bond or something? I don't have, you know, Bloomberg in front of me now, but I wouldn't be surprised if it's trading at, you know, thirty cents to the dollar or forty cents to the dollar now, right? So we are beginning to see both a rise in real debt servicing cost in rich countries. I think in the US now, it's the largest share of GDP that it has been, at least, you know, in recent history, right? And across the rest of the rich world too, together with increasing strains at the long end of the curve.

• 53:43Speaker 01

  And so the room to run for continuing to borrow and spend as if there were no tomorrow for rich countries is really being squeezed. And I think it is a matter of, could be a few months, could be, you know, a few years of rising pressure before something has to give way. And before either we get a sharp further rise in.

• 54:14Speaker 01

  Interest rates at which investors are willing to rent to rich country governments, or you see drastic action of the kind we saw with Greece and Spain and Portugal and Ireland of fiscal austerity, right? I mean, one of the great truisms in sort of global economic history is that, you know, the stars of yesterday decline eventually, you know, as hubris catches up and the poor performers of yesterday, you know, forced into sharp discipline eventually become outperforming. I mean, the performance of Greece, for example, Spain, Portugal, Ireland, you know, which which suffered very hard times for a number of years peak euro crisis,

• 54:59Speaker 01

  right, has been quite remarkable. The recovery has been quite robust. And instead, we are seeing all the countries that include France, the US, etc., which never really had to pay that price by the bullet, now having perhaps overextended themselves and the widely coyote has sort of walked off the cliff. And it's just a matter of time before they look down.

• 55:23Demetri Kofinas?

  That's a great analogy. And the shortening of duration, the shortening of the duration profile is an alarming signal, in my opinion, and one that's easily overlooked because no one has any doubts that governments will find a way to pay their debts in nominal terms. But what follows from that is financial repression and fiscal dominance. And that could include capital controls, it could include incentive schemes that encourage greater investment in domestic assets, the likes of which we spoke about earlier with your UK example. I mean, France is another great example of a country that I think is ripe for this kind of intervention. Long term borrowing costs are now converging with Italy's for the first time since the great financial crisis,

• 56:08Demetri Kofinas?

  which I think reflect investor concerns about the sustainability of many of these explicit and implicit French government obligations. There are a few more things that I'd also like to talk about with you Sony related to investor incentives, inadequate financial risk modeling, and the broad adoption of passive indexation to tie up this conversation about how we've gotten into the mess that we're in. As well as the transference of political risk from EM to DM, which is something that we've spoken about on this podcast and that you've written about. And this has created many opportunities for investors and for a global portfolio rebalancing that we're going to dig into in the second hour.

• 56:51Demetri Kofinas?

  For anyone new to the program, Hidden Forces is listener supported. We don't accept advertisers or commercial sponsors. The entire show is funded from top to bottom by listeners like you. If you want access to the second hour of today's conversation with Sony, head over to hiddenforces.io/subscribe and sign up to one of our three content tiers. All subscribers gain access to our premium feed, which you can use to listen to the rest of today's conversation on your mobile device using your favorite podcast app, just like you're listening to this episode right now. Sony, stick around. We're going to move the second hour of our conversation onto the premium feed. If you want to listen in on the rest of today's conversation,

• 57:34Demetri Kofinas?

  head over to hiddenforces.io/subscribe and join our premium feed. If you want to join in on the conversation and become a member of the Hidden Forces Genius Community, you can also do that through our subscriber page. Today's episode was produced by me and edited by Stylianos Nicolaou. For more episodes, you can check out our website at hiddenforces.io. You can follow me on Twitter at Kofinas, and you can email me at [email protected]. As always, thanks for listening. We'll see you next time.