The Philosopher's Trading Experiment: Peter Thiel and the Big Short That Never Was
“Our mission is to make sense of the crazy world ... and to understand where there are great opportunities for returns. Not many people are asking the big questions.”
2008 looked like it was going to be Peter Thiel’s year. By the summer, his macro hedge fund Clarium Capital, which he had started after the sale of PayPal to eBay in 2002, was reportedly already up some 58% on the year. What had started with friends and family money had grown to a very respectable $6.4 billion.
In previous years, Thiel had laid out his macro views publicly: he had expected the housing crash, a deflationary collapse of the debt bubble, and the bull market in oil due to peak oil. The chess master had anticipated the market’s next steps.
And in January 2008, Thiel had published a lengthy essay titled The Optimistic Thought Experiment. Financial markets, he argued, were “eerily complacent” because mainstream thinking was “rooted in the nineteenth century, when the march of History and Progress were more optimistic and certain.”
Investors failed to consider the “apocalyptic dimension of the modern world”, which included extreme left-tail scenarios such as nuclear war and the collapse of capitalism. However, if the world came to an end, “all the money in the world would prove of no value. There would be nothing left to buy or sell.” Apocalyptic thinker or not, everyone lost. It simply didn’t pay to be an “apocalyptic investor.” Thiel singled out Buffett’s insurance operation as “perhaps one of the purest bets on the optimistic thought experiment.”
Major bubbles, Thiel argued, were driven by the forces behind globalization. He used it as an umbrella theme to capture communication, transportation, and integration of trade. Booms driven by the railroad, cars, the radio, and even the South Sea Company all reflected investor’s bet on a more globalized world. If this vision prevailed, globalization would usher in an age of unprecedented “freedom and prosperity”. Bubbles such as the dot-com mania could then be viewed not as exuberance but as moments of “unprecedented clarity” in which investors could see the farthest into the future.
If, however, globalization failed, the consequences were dire. The possible failure carried the apocalyptic dimension that was too dire for investors to seriously consider — “capitalism or even humanity itself may come to an end.”
“There are no good investments in a twenty-first century where globalization fails.”
This flawed thinking, he argued, was prevalent even among great investors who suffered from a “failure of the imagination” about the world’s possible future trajectories.
“What is truly frightening about the twenty-first century is not merely that there exists a dangerous dimension to our time, but rather the unwillingness of the best and brightest to try and make any sense of this larger dimension.”
They failed to wrestle with the risk of economic and political collapse which to Thiel was the “central question” in a world haunted by the specter of a collapsing debt bubble.
One needed to look no further than America’s bursting housing bubble.
“Consider the strangeness of the American context. One would not have thought it possible for the internet bubble of the late 1990s, the greatest boom in the history of the world, to be replaced within five years by a real estate bubble of even greater magnitude and worse stupidity.”
In contrast, Thiel was happy to tackle these thorny questions and earn a profit for his investors. Investors faced a world of “wholesale madness” and a “wildly mispriced macro context.”
“Things are likely to break in very asymmetric ways,” he predicted. “That presents enormous opportunities.”
And indeed, in the fall and winter of 2008, things broke. But despite his foresight, the year did not turn into a triumph for Thiel.
By 2011, Clarium’s assets were down 90% due to investor redemptions and “losses of 65% from the mid-2008 peak.” It was a stunning reversal of fortune.
According to one LP on Twitter, the remnants of the fund were profitably invested in private stock of Palantir (“I thought that Thiel … wanted to make it up to investors with one of the best things he had access to”).
In The Most Important Thing, Howard Marks writes that “extraordinary performance” comes from making “correct non-consensus forecasts.” These are “hard to make, hard to make correctly and hard to act on.”
“You can’t do the same things others do and expect to outperform. … Unconventionality shouldn’t be a goal in itself, but rather a way of thinking.”
Thiel had aced the first two conditions. He’d been contrarian and right. But he didn’t turn his predictions into outsize profits like a John Paulson or Michael Burry.
A former Clarium employee bemoaned they “could have been the big short”. And indeed, they could have been. But having the right idea was not enough. Navigating 2008 and its aftermath highlighted the importance of risk management and of finding the best instrument to express a view.
But before we dig in, let me make something clear. I am not writing this to point fingers at Thiel. Quite the contrary. First off, I believe that in our effort to become better investors, we have to study mistakes as well as successes. Ironically, Josh Wolfe told me he disagreed on this with Thiel:
“He likes to study successes and I like to study failures. I think that failures are more repeatable, you can see errors that are made over and over and again, that end up with the same bad outcome.” A Conversation with Josh Wolfe: Macro, Mentors, Motivation
More importantly, if the game of macro trading proved so challenging for someone with the mind of Peter Thiel, what does that mean for the rest of us?
Clarium is a valuable reminder that investing is as much about ideas as it is about execution. Even a correct and contrarian macro view does not guarantee profits. It can even turn into its own challenge. There is nothing more detrimental to keeping an open mind than having been proven right on a really big and contrarian thesis (call it the ‘big short syndrome’).
And yet I believe Thiel made a valid point when he lamented investors’ unwillingness to seriously contemplate the apocalyptic dimension. From Ukraine to Taiwan, from the energy crisis to climate change, from the potential of de-globalization to demographic collapse, all the devils are here. And the system is as leveraged and dysfunctional as ever. The apocalyptic dimension is uncomfortable to ponder. Nevertheless, we must do our best to grapple with its implications.
Before jumping into the story, I want to highlight two comments made by Thiel. First, his motivation for choosing global macro. For Thiel, the philosopher turned investor, it was an irresistible intellectual challenge:
“Macro was, and remains, the most promising way to invest. A macro manager can extract value wherever it exists; he isn’t pigeonholed.
Global macro … is probably the most stimulating style out there. Macro is intrinsically very interesting. There isn’t much that’s more engaging than thinking about how the world works.”
Generations of traders agree. As George Goodman wrote in The Money Game about a macro play:
“It is impossible to resist: international intrigue, the mockery of socialism, the chance to profit by the tides of history. “Tell me the game,” I said.”
A second reason was Thiel’s experience during the height of the dotcom bubble. Thiel pushed PayPal to close a massive $100 million funding round in March 2000, “at the very peak of the bubble.” He saw anecdotal evidence of the bubble all around him, “inflating on our Palo Alto doorstep.” Raising capital right before capital markets shut down was a formative experience.
“Had we done what everybody else was doing, which was to ignore the forest and just work on our particular tree, we wouldn’t have seen this enormous forest fire coming and we would have been burned along with everybody else. That really drove home the importance of the macro view.”
However, this seems like a treacherous way to start an investing career. Having outsmarted the market once, the investor is primed to look for the next bubble, the next major contrarian play that allows them to re-experience that intellectual high. Thiel already started with a contrarian bent. I believe his early experience further reinforced this approach and may have ingrained a bearish bias.
Alright. Let’s dig in.
Macro vs. startups
“Anyone who thinks the market is efficient gets fired.”
“A world distorted by the biggest financial bubble ever seen.”
Deflation and the right historical analogy.
Big ideas: bonds, oil, and stocks.
The great real estate bubble.
And then what? “We could have been the big short.”
The year 2008.