Bridgewater Alum Paul Podolsky on What Russia Tells Us About the Future of the Global Order
What this covers
Bridgewater alum, author, and investor Paul Podolsky shares how he’s assessing Russia and its threat to the global order following the death of Alexei Navalny, what it takes for economies to succeed in the modern world, and the implications for investors.
Record Date: February 22, 2024
The views of external speakers do not necessarily reflect the views of Bridgewater.
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Podolsky argues that Russia and China's authoritarian systems are fundamentally incompatible with modern wealth creation, which requires rule of law, free information flow, and functioning capital markets; therefore the West will continue to prevail despite current geopolitical tensions and domestic political challenges.
- Medieval authoritarian systems cannot sustain innovation or capital markets because free information threatens autocratic control
- Brain drain and capital flight from Russia and China prove talented people recognize the system's inability to generate wealth
- Per capita GDP, voluntary vs. involuntary union membership, and migration patterns demonstrate Western institutional superiority
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The West is unambiguously winning the struggle between Western open societies with rule of law and closed authoritarian societies.
“The West is, unambiguously. And the easiest measure of this is in per capita GDP.”
The Soviet Union was an involuntary union requiring force to hold together, while the European Union is voluntary and Ukrainians are fighting to join it, demonstrating preference for Western systems.
“the Soviet Union was an involuntary union. The European Union is a voluntary union. Ukrainians are literally giving their life in large numbers to say we don't want to be part not only of the Soviet Union or anything related to the Soviet Union. We want to be part of the European Union.”
The conditions for creating wealth are not secret: rule of law, functioning capital markets, free information flow, and complex supply chains—and the West knew this which is why it won the Cold War.
“when it comes to knowing the conditions that create wealth, it's not a secret at all. And what And that's the reason why the West won the Cold War, the Soviet Union lost.”
Productivity and growth fundamentally depend on two factors: income from productivity/cleverness and borrowing from functioning capital markets; if both break, economic collapse is unambiguous.
“productivity and growth is basically income and borrowing. The income comes from productivity and cleverness. The borrowing comes from functioning capital markets. If those two things get broken, it's unambiguous what happens next.”
US political system's use of lawsuits rather than violence to resolve political disputes, even bitter ones, represents a fundamental difference from authoritarian systems that use murder.
“in the United States, if you can't stand somebody, uh, you sue them, which could be an awful process... Trump is being sued and Trump supporters think that it's unfair and the people can't stand him think that it should go more quickly. And Biden is being sued for, you know, or being whatever this investigation for all this stuff. But that's fundamentally different than murdering people. And so my my point is is yes, we have horrible conflicts, but I think that there's a broad agreement that by enough of the population that murdering people for disagreeing with them is not okay.”
When Russia won't win is defined as whether global investors will pour money into Russia for wealth creation and economic growth—they won't and are trying to get money out—which means Russia has already lost in the modern economic sense even if it creates temporary geopolitical disruption.
“when you say Russia won't win, I guess the question is what's the definition of winning? Global investors are not pouring money into Russia. In fact, if anything, they're trying to get money out of Russia if they haven't already. So, I really think it comes down to the nature of the regime.”
The descent into Putinism in Russia did not happen overnight but occurred through very gradual, incremental steps, similar to the timeline from post-WWI Germany to Hitler's 1933 chancellorship.
“Going there repeatedly over time, the the descent into Putinism did not happen in one day. It happened very, very gradually. Very, very small steps. And Germany, too, if you look at from, you know, the end of World War I and the Beer Hall Putsch, etc., you know, people who know their German history, it was years between when the first really radical elements rose and then when Hitler became chancellor in 1933.”
The US has had massive historical crises including Civil War, Great Depression, and Vietnam, but still maintained institutional legitimacy—demonstrating that all countries face crises but Western institutions prove more resilient.
“doesn't mean the United States doesn't have massive problems. It does. And it always has. And it's had huge political crises going, you know, the the Civil War, the Great Depression, and and then Vietnam... The US has always had crises. And all countries have crises. So, I don't want to act like one place is perfect, the other place is flawed. But, if you look at this in terms of where people are going to, per capita GDP, depth of capital markets, rule of law, infrastructure, blah blah blah blah blah blah blah blah, the West is is is is crushing it.”
Navalny was killed for being a truth-teller who documented Russia's corruption through objective data, showing that Russia ranks 120-130 out of 180 countries on Transparency International corruption index.
“Navalny, I think that, you know, what happened to him was biblical in a way if you want to use that metaphor... which is that he was a truth-teller. He was trying to say that there's a dynamic corruption. If you look at objective measures like Transparency International has really good, I think the last time I looked, Russia's something like 120 or 130 out of 180 countries in corruption. I.e., it's horribly corrupt. Navalny showed in detailed data-driven ways how that corruption worked. And he was killed for that.”
China's deflationary weakness is a radical change from the 1980s-1990s boom where China was the most significant factor driving global growth due to high volatility around its growth rate.
“And this is really a radical change uh to the boom that was in the backdrop of global growth in the '80s and the '90s. If you look at, you know, it's the second biggest economy in the world, but if you look at the contribution to GDP growth, China was the most significant factor because the volatility of their growth, even though the overall level of growth was less than the United States, the vol around it was higher. So, they drove more of global growth.”
Russia 2.0 and China 2.0 attempted to maintain authoritarian control while developing capital markets, but this is impossible because capital markets require free information flow which threatens authoritarian rule.
“The 2.0 versions of the Soviet Union, uh both in China and Russia, are well, we'll maintain authoritarian control, but we'll develop capital markets. But, what you can see is is that to have capital markets function, you need to have free-flowing information. And if you have free-flowing information, it immediately becomes a threat to that type of rule. And that's what the tension is.”
When authoritarian regimes try full bore to control information, wealth begins to reduce and all talented people flee, creating a self-reinforcing collapse.
“And the minute that they full full bore try to control the information, you begin to see the wealth begin to reduce, and all the talented people flee.”
Putin's deceptive strength lies in nuclear weapons—he knows NATO will not attack because of the nuclear deterrent, so he is 'playing a game of chicken' by attacking Ukraine knowing that escalation is constrained by this threat, but he is also damaging Russia because talented people are fleeing.
“The only reason they're not doing it is because of Russia's nuclear weapons. And Putin is smart enough to know that the only reason they're not doing it is because of the nuclear weapons. So, he's picking out somebody weak and disrupting the world. He's doing enormous damage to Russia because all of the talent is fleeing Russia. But he's playing a little bit this game of chicken because if it comes too terrible, NATO can attack, but then NATO will be worried about this. So, it's his strength, I think, is deceptively weaker than it actually is, because he's not actually taking on the opponents that could really take on the Russian military and do great harm to it.”
The smartest people in Russia have gotten out, representing a huge gain to the countries they emigrate to but a massive loss to Russia with long-term consequences for growth.
“The smartest people in Russia have gotten out. Yeah. And this is a huge It's a huge gain to the countries they go to, but it is a massive massive loss. But, if the most talented people flee, it has huge long-term consequences for the growth of the place.”
There is a non-zero possibility that the Russia-Ukraine war escalates in a way that is really, really, really dangerous, with potential for rapid market shock of 20-30% stock market decline.
“there is some non-zero possibility that this war escalates in a way that is really, really, really dangerous... by the time that's priced in the markets, you won't have time to blink. You know, the stock market would be down 20, 30% in the blink of a second.”
Investors need portfolio hedges such as short rates positions or out-of-the-money calls on oil and natural gas to protect against geopolitical escalation scenarios.
“in any portfolio, I think you need to think about sub assets that can protect you in that type of scenario... you know, Bridgewater doesn't run this portfolio, but people who run portfolios that are like stock only, I couldn't possibly imagine having a portfolio like that in this environment. You want to have some sort of things in the portfolio and now it's actually much easier to get that protection than it was, you know, an allocation to short rates, uh you know, possibly some out-of-the-money calls on on oil or something like that, or you know, natural gas.”
Russia's capital markets have completely ceased functioning and it has become a pariah state allied with Iran and North Korea, making it impossible to see reliable pricing on Russian assets.
“if you go to a Bloomberg machine and you try to see what the price is of the Russian ruble or Russian bond. It used to have somewhat functioning capital markets. Those things are all over now. It's become a pariah state that is allied with Iran, with North Korea.”
China's system under Deng Xiaoping could produce unbelievable wealth and create armies of billionaires, but Xi's shift toward emphasizing political orthodoxy over economic dynamism is now reducing investment opportunities.
“China's system under Deng Xiaoping can produce unbelievable wealth, and it produces an army of billionaires. But if person number one begins to shift what their priorities are, then it shifts what the investment risks and opportunities are there. And, you know, from my perspective, the Chinese leadership right now is putting much more emphasis on political orthodoxy than uh economic dynamism. And that's being reflected in asset prices.”
China's deflationary sucking sound could profoundly affect Western central banks' monetary policy, shifting toward accommodation rather than restriction.
“And I think that it's inflationary sucking sound from China could be profound. It also relates to, you know, what are inflation pressures in Japan, in Australia, where you want to be in fixed income, etc.”
China's economy is currently weak and deflationary due to shrinking population from one-child policy, significant brain drain of innovative people, and a massive real estate bubble that will take a long time to resolve.
“weak is the first answer, and deflationary is the second answer... The income in China is is significantly challenged for a number of reasons. First thing is is they have a a shrinking population. A legacy of terrible Soviet era policy to the one child thing way back when, but that has direct impact for the vibrancy of the economy. The second thing is is they have a very significant brain drain. In other words, the innovative people uh particularly the entrepreneurs are rattled by the policy of uh Xi and even this is more difficult to prove, but certainly all my contacts are saying it, uh afraid of actually making money because it could make them a target. So, if you have entrepreneurs that are worried about making money, this is clearly not good for productivity and innovation.”
The US is like Europe in that it has to actively work to keep people out, rather than force people to stay, demonstrating Western system superiority through migration patterns.
“Just like in Europe, they have to fight to keep people out, the same thing is happening in the United States.”
Russia is militarily weak despite nuclear weapons; NATO could rapidly defeat Russian conventional forces if not constrained by nuclear deterrence, similar to overwhelming US victory in 1991 Iraq War.
“If the Western military wanted to take out Russia and stop what was going on there, they could do it very, very quickly... It would be a picture of a little bit like what we saw in the Iraq war 1991, if you remember that, where there was all this concern the US was going in, how would they do it against Soviet military technology, and they obliterated them. And they obliterated them because of much better technology. And that is true today.”
China's system can be characterized as Confucian cultural hardware running Soviet authoritarian software.
“I think that the the right framework to look at China Is it is um Confucian hardware. Chinese cultural hardware with Soviet software.”
China has world-class capabilities in certain sectors and innovative people, but long-term growth prospects remain challenged.
“China has certain aspects of what it does that are world-class and amazing people. You know, I I love spending time in China. I love talking to my Chinese contacts, just like I do the Russians, actually. The people are fantastic in both places. But, I think that that's a real challenge to growth going forward”
China's total debt-to-GDP ratio is roughly comparable to the US level, but more concentrated in certain sectors, suggesting structural vulnerability.
“you know, you've had a you know, you've had this massive real estate bubble. And getting out of that, I think, is going to take a long time. So, the the forward-looking picture for China in terms of income and borrowing, I think is you know, they're looking at their total total debt to GDP, it's roughly where the US is, but the you know, but more of a clogged in certain sectors.”
Russian stocks from 1900-1916 kept pace with US stocks and had low correlation to them, but the 1917 revolution wiped out investors, demonstrating that historical valuation attractiveness provides no protection against regime collapse.
“if you looked at Russian assets in 1916 before the 1917 revolution, you'd see the same thing. If you compare US stocks to Russian stocks from the end of the Civil War until 1916, Russian stocks keep pace with US stocks and are lowly correlated to them. Then came 1917.”
There is no stable asset allocation and no stable store of wealth; this is the core premise of Podolsky's upcoming book, implying all investment frameworks must account for regime change.
“the book I have coming out, my third book, is coming out this fall. Um it's called the Uncomfortable Truth About Money. And the core element there is that there is no stable asset allocation, and there is no stable uh storehold of wealth. It does not exist. And developed world countries can become emerging market countries. In other words, what happened in Germany in the '30s is an example of that. And I think that if it happened in Germany, it can happen anywhere.”
Emerging markets are fundamentally defined as places that are less wealthy primarily because they have weaker rule of law, and this creates significant portfolio risk that investors often underestimate.
“Emerging markets basically means places that are less wealthy largely because they have weaker rule of law. That's it. And the risk of carrying those in your portfolio is significant.”
Russia's political culture is approximately 500 years behind the West, characterized by a medieval system where a king kills people who disagree with him, similar to 15th-16th century European autocracy.
“the political culture in Russia is about 500 years behind the West. It's medieval... In other words, if you have a system where there is a king and the king kills the people who disagrees with him, that's not that unfamiliar for Europe in the 1400s and 1500s.”
China's brain drain of innovative entrepreneurs—people afraid of making money because it could make them targets of Xi's policies—directly undermines productivity and innovation.
“the innovative people uh particularly the entrepreneurs are rattled by the policy of uh Xi and even this is more difficult to prove, but certainly all my contacts are saying it, uh afraid of actually making money because it could make them a target. So, if you have entrepreneurs that are worried about making money, this is clearly not good for productivity and innovation.”
Election integrity is a critical monitor for systemic health; if the political process breaks down as it has in Russia, Venezuela, and Germany, then asset markets face existential risk.
“That's why I've watched very quickly to see very carefully to see whether election integrity holds up. If election integrity holds up and somebody is elected people believe it's they hate the person, but they believe the process was was legitimate. They'll wait it out. And then you'll I think asset markets will be fine. The risks become if the political process begins to break down as it has in Russia, as it has in Venezuela, as it did in Germany. Like that is disease that can spread. And it's a disease that can land anywhere.”
Developed world countries can become emerging market countries, demonstrated by Germany's transformation in the 1930s, implying investors must prepare for this possibility anywhere.
“developed world countries can become emerging market countries. In other words, what happened in Germany in the '30s is an example of that. And I think that if it happened in Germany, it can happen anywhere. So, you can get these breakdowns. I think that that that Russia is a very similar example to what happened in Germany.”
Modernity is fundamentally about allowing innovative disruptive technology to flourish through repeated cycles of creative destruction, freedom of information, and this is the core wealth-creation machine.
“allowing innovative disruptive technology to do its thing to move from canals to combustion engines to electricities to computers destroy tons of jobs, create tons of jobs, freedom of information. That is the wealth creation machine. And if you look over a couple hundred year time frame, it's obvious. It's not the least bit secret.”
Putin kills political opponents like Litvinenko publicly and spectacularly to broadcast a message and achieve the same intimidation effect Stalin achieved through mass killing, but with fewer victims.
“when he killed the spy Litvinenko in London, he's doing this to send a message. So, Stalin had to kill millions and millions of people, and I think Putin's thought is is you can accomplish basically the same by killing a few people and making it be horrific and broadcasting it cuz it has the same basic effect.”
The US currently faces domestic political tensions with unpopular candidates (Trump and Biden), but this could rapidly change into systemic risk if isolationism becomes acute and breaks US commitment to global order.
“if these two candidates are going to be the nominees of their parties, Donald Trump and Joe Biden, um they're highly unpopular in in in even among within their own parties. Um, and so even though you say that the sort of axis of resistance is is losing, that could quickly change, could it not, if we have a breakdown in order or or a predominance of isolationist thinking in, let's say, the US, the leading economic and military power. If that isolationism becomes acute, I mean, do you factor that into your assessment of risk in as an investor around the world?”
Podolsky had exposure to Russian assets in his personal portfolio before the invasion but pulled everything out because the risk of Putin invading, while low-probability, would result in permanent capital loss if it occurred.
“I was actually had a portion of my portfolio in Russia ahead of the invasion. And I pulled the entire thing out because I said, 'Listen, the risk of Putin invading is low, but if it happens, I'm never going to get my money back.'”
In both Russia and China, investing means taking a massive bet on a single person: Putin in Russia and Xi in China, making investment returns highly dependent on that individual's decision-making.
“In Russia, person number one is Putin, and everything matters there. And in China, person number one is Xi. And so, if you're invested there, you're taking a huge bet on that person. Now, that could go well or poorly.”
Russia is being forced by global economic pressures (not by choice) into modernity, which is disconcerting for Russian leadership and populace accustomed to pre-modern governance; similar pressure is happening globally where countries must adapt to technological disruption whether they like it or not.
“Russia is being dragged kicking and screaming into modernity. And modernity is very disconcerting...the very broad expanse of this over the last couple of hundred years is that allowing innovative disruptive technology to do its thing...And so, what's happening now is that certain parts of the world are being forced into that, and it's unfamiliar.”
Success in the modern world requires rule of law, protection of intellectual property, functioning capital markets, and complex international supply chains—none of which Russia has—making territorial conquest irrelevant to wealth creation.
“success in the modern world is not about stealing land from your neighbors... What leads to wealth is innovation. And innovation requires a whole series of preconditions. Um first of all, there has to be rule of law and protection of intellectual property. There needs to be deep functioning capital markets that are able to be resolved through disagreements through legal ways, not through violence. And you need to have very complex uh supply chains that thread through multiple countries to be able to produce the type of wealth that the United States right now is producing.”
Russia is commodity-rich while China is commodity-poor, and China's supply chains have vastly higher productivity, making the two countries structurally very different despite sharing Soviet governance model.
“Russia is commodity rich, China is commodity poor, and the productivity of the supply chains in China are unbelievable. There's a reason why people are only very slowly uh replacing them. The work ethic is totally different. The emphasis on education is different. So, they are very, very different, but they share Soviet software.”
South Africa and China have shown sympathy for Russia, which Podolsky interprets as indicating their leadership misunderstands what creates wealth and represents a litmus test of geopolitical alignment.
“I mean, to me, this is just the policy makers can be great in these places, but the leadership shows a real misunderstanding of what creates wealth. You know, South Africa has been sympathetic to them. China has been sympathetic to them.”
Russia looked attractively priced before the invasion based on risk premiums: Russian banks had lower spreads to US banks and higher real yields and dividend yields than justified by portfolio optimization.
“Russia looked pretty darn good before this. If you were to look at the risk premium on Russian banks compared to US banks, they were unbelievably attractive. Russia was paying much higher dividend yields, had much higher real yields. If you looked at it from a portfolio optimization standpoint, there was a really good argument for having sub exposure to Russia ahead of this.”
Many EM investors currently have money stuck in Russia years after the invasion because they held bonds expecting safety, demonstrating the failure of traditional risk diversification in geopolitical crises.
“And I know EM investors who still have money stuck in Russia years later.”
Podolsky is skeptical of China's official GDP numbers but believes their inflation numbers are accurate, showing zero inflation reflecting weak demand.
“I'm a little bit skeptical about the GDP numbers, but the inflation numbers seem spot on to me, which is that there is no inflation.”
The host Jim Haskel is an editor of Bridgewater Daily Observations and frames the episode around implications for investors during an era when the US-led world order is under threat.
“I'm Jim Haskel, editor of the Bridgewater Daily Observations. One of the defining dynamics we repeatedly come back to in the BDO for a long time now is the implications for investors during this era when a rules-based US-led world order is under threat.”