OpenAI’s Open Source Strategy, Volatility & Tariffs, and Automation’s Consequences w/ Byrne Hobart

Yeah. So, I think that part of what we learned is that there's this weird, you know, I think one of the first ways to look at this is to compare the first and second Trump administrations because one of the things that was going on in the first Trump administration was that between non-Trump Republicans and just Democrats, it was really hard for Trump to do a lot of the things that he kind of impulsively wanted to do. And there was also just not a ton of long-term planning from the Trumpy Republicans on exactly what they wanted to do. So there was just a natural level of ambient chaos throughout that first administration. And my assumption was that we'd see pretty much the same thing the second time. But it turns out that a lot of people spent the years from about 2021 to early 2025 figuring out exactly what it is that they'd want to do. And so you had this spree of executive orders right at the beginning. And you know, a lot of them were just hitting the high notes on things that Trump had always said he wanted to do and hadn't really gotten around to doing. And kind of looked like, you know, just from the neutral standpoint of does this administration have its act together? Do they have coherent goals that they're actually trying to pursue in a way that makes sense? It kind of looked like they really scaled things up. And then the tariffs were one of the first cases where it was just this kind of last-minute sort of spontaneous decision. And one of the reasons we know that is that there were a couple blow-by-blow articles in different publications. New York Times, Wall Street Journal, I think Politico also had one that just talked through here's how this process actually came about that Trump had other options. He went with the most aggressive and kind of bluntest one. And you know, one of the things that stood out there was just this administration is suddenly as leaky as the first Trump administration. So, in some ways it is like this high watermark for state capacity Trumpism in that he did actually implement this tariff thing that he'd been talking about for decades. And at another level, it was the last gasp of state capacity Trumpism because the way that some of the earlier Trump moves seemed to work was that some very smart heterodox right-wing person from the think tank world was coming up with exactly the plan that they would use on immigration or on how higher education is funded or whatever and then they just implement it day one and it's a shock and awe thing. And then with tariffs, presumably there were such plans. They all apparently got torn up and discarded. And now the administration is trying to negotiate other deals. But what it looks like is that Trump does react when the market goes down if it goes down enough and he has enough people in his orbit who tell him this is actually a disaster and that the only reason the market's not down more is that everyone thinks that he'll back down. And one of the problems is this actually creates a really strong incentive for China in particular to do things that make the US equity market go down. So that's not good. We now have this situation where you know one country that is much more centralized, much more top down and has far weaker checks and balances is able to deploy its economic power in order to make things difficult for the US. And the US just doesn't have the same capacity to reciprocate. Although there is a lot that we can do. So, yeah, that kind of setup is just not good.

And then yeah, you look at the market and you kind of see roughly what you'd expect to see given that there was general bad news expected and the specific bad news was worse than expected where stocks go down, volatility goes up. And one of the things that you saw at that time which there are a couple explanations for is that treasury rates went up. And in general since about 1998 it has been very reliable that when stocks are down treasuries outperform and that if you want to have a more balanced, you know, a kind of safe and not perfectly cyclical portfolio you have a mix of stocks and bonds and usually one of those trades is winning when the other one isn't which as we were kind of reminded of like this was always theoretically true but it was good to get a bracing reminder of this in 2022. That only works if inflation is low. Because when inflation is low, that means that when the economy slows down, central banks just want to eject a lot of liquidity to speed things up. And that tends to push rates down. But when inflation is high, they can't automatically always do that. They have to consider whether they're actually pushing price levels up more than they're pushing growth up. So that weakens the correlation. And there is a level at which tariffs are just inflationary. They are a tax. They're a tax that shows up in terms of higher prices paid by consumers. So straightforwardly inflationary. If you offset that tax with a tax cut, you now have higher consumer prices and a little bit less revenue for the federal government because of the dead weight loss. And so to keep US standards of living flat, you actually do need to do some inflationary things. But then the other piece is that there's a narrative that the US dollar will no longer be the reserve currency. I think that to the extent that that's true, it is just it takes way way longer than frankly than one president's term to actually put that into effect. But also that doesn't seem to be the big driver of treasuries moving. You know, we'll have to see as different data from different countries comes out, but it doesn't seem like there are that many countries that are just mass panic liquidating treasuries because again, they seem to think and they're probably right that a lot of this tariff stuff will be reversed and that they shouldn't make these long-term changes to their plans just based on short-term tariff considerations. But one of the things to consider is that if Trump gets his way, then countries that were running a trade surplus with the US will have to buy American-made goods to offset that. And what they bought instead was treasuries. And so even if Trump does actually negotiate the deal of his dreams with all of these countries and they're all buying American gas turbines and medical equipment and planes and weapons and LNG and soybeans and whatever else, that means they're not buying our Treasury bonds. So in that case, Treasury should go down. And also if Trump just does a tariff and offsets some of the impact with a tax that's also inflationary. So treasuries go down. It's only like the scenario where treasuries actually outperform right now is one where tariffs are mostly completely or completely unwound. We do mostly return to the status quo. But we return to the status quo having gone through this very disruptive period where markets went down and a lot of capital expenditure plans both in the corporate sector and the private sector were deferred and everyone's a bit more nervous. So they're saving a bit more money. In other words, if there's a recession, but it's kind of a separation of powers recession where one way it would happen because I don't think it's that likely that Trump just completely blinks and says, 'Yeah, I accidentally made a series of gigantic mistakes over the last several weeks and they're all my fault.' But the main way that that happens is through Congress or the courts which means that in the end treasuries are actually this really interesting bet on the future constitutional structure of the US. So if you are a believer in a strong executive branch for better or for worse then you think that Treasury yields go up and if you are a believer in separation of powers then you probably expect a recession but it's kind of a dodge a bullet recession and you expect Treasury yields to go down. So that's where we are on that side.

Another piece of the treasury market though is that one of the big trades that a number of large hedge funds do is the treasury basis trade which is basically betting on the gap between treasury futures and the actual bonds themselves. And in some ways this is just the simplest possible trade because you can look at the value of treasuries supplied by futures. You look at the value of treasuries that you actually buy. You look at how much you have to pay to finance them, how much capital you have to put up and you can calculate very straightforwardly what your return is on buy the treasury, sell the future and then either exit that trade at some point if the prices converge or just when the futures reach their expiration date. You have either rolled onto the next set of futures or you just exit the trade like you deliver your futures to close out the short futures or you deliver your bond to close out the short futures position. And this trade it is kind of like at one level really really simple trade at another level you can do some more complicated things with it because not all bonds are created equal and there are different times when you might adjust your position size etc. So it's like there's room to do interesting stuff there. The main way that it seems to work is that if you are a gigantic hedge fund and you do a lot of business with every major bank and you are constantly negotiating the terms of what you borrow from them, what you would often want to do is be able to borrow larger amounts of money than you really need and on better terms than you really need. You know, have a lot of essentially dry powder. And if you have that dry powder, why not put it into a trade that can be very straightforward, like the basis trade, and just take advantage of that. So, some of what could be happening is that some of the funds that have been doing that, they have other ways they can use their liquidity. So, they are gradually reducing their exposure to that trade. I don't know for sure, but it is a plausible explanation for how rates are moving right now. So, that is another piece.

And then we can finally move to what everyone means when they talk about the market, which is the stock market. So, stocks had some of their worst three-day stretches in a very long time. One of their worst one-day performances in a really long time. And I thought the most interesting thing there was anytime any kind of asset moves a lot, people will make jokes about how the market's not efficient. And these jokes have varying levels of seriousness. And I think pretty much anyone who's discussing market efficiency in a serious way is discussing it as this sort of directionally true thing but not as this completely ironclad principle where every price is always and everywhere the exact value of the asset in question because you know you can always just create any fake trade and immediately prove that that's not true. Like you can log into your brokerage account and look at some thinly traded company, wait till the market is closed so it has a wide bid-ask spread and then you could if you felt like it buy 100 shares at some price that is wildly off the market and then obviously that price is not the efficient market price like the valuation for that company based on your 100 share trade is not the true worth of that company. So it's never strictly true, but I think it is actually worth talking about what market efficiency means in different dimensions when you look at a really volatile period like this. And especially when you look at things like market rallying on the rumor of a 90-day pause and then market ripping on the fact of a 90-day pause and then market being choppy as that pause kind of gets squished around a little bit in terms of what it actually means and to whom it applies. And as people also digest the possibility that the US will not in fact be able to negotiate dozens of bilateral trade agreements in a three-month period given that those agreements typically take many years of negotiation to actually get right instead. And so the way that I look at that volatility and especially volatility around things like there's a rumor stocks rip, you know, the value of the S&P rises by several trillion dollars and immediately comes back down. The way I'd look at that is that when the market is volatile, the price of liquidity is higher. And one of the measures of the price of liquidity is how much do the stocks move when you buy a given amount. So in a market that is efficient with respect to prices, you would not actually expect these huge swings in volatility. Or you'd expect smaller swings in volatility because the world is more uncertain, but it's not trillions of dollars of intraday fluctuations more uncertain, just more uncertain than usual. But if you think of liquidity as something for which there is a market and that liquidity is expensive when the situation is really uncertain and when whoever takes the other side of your trade knows that there could be some huge news story that they got a fraction of a second too late and that they turn out to have made a bad trade. In a case like that, stocks should actually move pretty massively on fairly small, fairly insignificant news flow. So, I wrote a couple pieces kind of touching on that from different angles over the last week or two, including just one look at kind of why the markets crash a lot faster than they rise. Because if you go back and look at the best one day up days, the best single day up days in the S&P 500's history, they are not good times. They're not times that you associate with it was a great time to own stocks. Like a lot of the best days in the S&P's history are in the 1930s, early 1930s when everything was falling apart. Some of them are in spring of 2020 again things were falling apart. Some were in 2008 and then you have one I think from 1987 a couple days after the crash. So pretty much anytime someone is fully invested on one of the best days in S&P history, it's because they were fully invested on one of the worst days in S&P history, too. And that's just another reflection of volatility gets really really high. And that means that whereas like if you look at periods where the market just generally did well like the 1950s you don't have a lot of crazy days in part because just the flow of news during a good economy is things are always just slightly like things were always looking good and they're always looking slightly better. Like the big positive news in 1955 will be something like Ford made a slightly larger slightly more expensive car and fortunately gas prices are extremely stable and therefore people will buy this slightly more expensive car. So this is slightly good news but it's not world-changingly good. The world-changing news is almost always really bad news especially for large publicly traded companies. So if you look at something like AI, it is good news for just the economy and for human flourishing in general that we can offload a lot of intelligence to machines. It's also really really bad news for any company where they have like this implicit balance sheet position of we have a lot of people together. We have built all these tools for coordinating them and getting them to do fairly low value added white collar work and now that work can be done orders of magnitude more cheaply and more quickly and we can check the work more easily etc. So it often means like it's good news for the world and then the profits of the public companies that are a large portion of the market are sometimes impaired. We're actually just very fortunate that this is a case where there's a labor-saving technology that is primarily being built and deployed by very large cap companies that are very profitable and that are able to convince their investors that this will be profitable too. You could totally imagine a case where there is an AI-driven bear market because we just have a slightly different configuration of what companies are large cap companies and what companies aren't.

Yeah. So I think one piece of this is just that to the extent the tariffs are actually a negotiating tool, it is just going to like anytime you do that you open yourself up to some level of embarrassment because if you are a good negotiator, you do not get what you said you wanted. Like that is the whole point of being a good negotiator is that you got what you did secretly want but the other side feels like you compromised and that you actually met them halfway. So, yeah, to the extent that Trump is actually doing a really really clever five-dimensional chess thing here, then yeah, he's not going to get all the things he says he wanted. And I think that some of the messaging just it is in Trump's interest regardless of what the end goal is for the implied end goal to be that the US is manufacturing a lot more stuff and that China in particular is manufacturing a lot less. Now there are plenty of configurations of the world where that either doesn't happen or happens to only a very small degree or the US shifts what it manufactures but doesn't actually increase manufacturing output that much in the aggregate and the US still ends up better off but some of these goals it is again like I'm sure that there were really sophisticated plans for particular parts of particular supply chains that could realistically be moved to the US and other parts that could be moved to US aligned companies and other things that we could do to sort of box China in where we find different countries or collections of countries that can in the aggregate mimic some of China's comparative advantages and in some cases we just won't like you just can't really mimic the density of the social network that is Shenzhen in addition to all of the equipment and all of the people and all of the infrastructure like that part just has to get built over time. And if not everything is co-located in the same city or the same set of cities then it is going to run less efficiently. And in that case what we're doing is basically buying insurance. So if we take a supply chain that was all China and move it to it's 80% not China and you know you have four or five different countries that each have a big chunk of it but nobody has a majority of it then that's just a world where a lot more intermediate goods spend a lot more time on ships and there are a lot more cases where people are trying to coordinate something but they all speak different languages and so there are miscommunications and things like there is a lot of noise and friction in that and one difference between that world and the continued reliance on China status quo world is that in the latter you can have situations where the US can no longer buy drones or the US can no longer buy GPUs. There are a lot of things you know the GPU supply chain like we don't directly buy them from China but we buy them from places that are very close to China and places that are if you look at a map in China that are part of China. So definitely there is definitely a case for saying that if the US were spending a little bit more on some of its strategically important imports but also knew that those imports would still be available if there were a conflict with China that the US would be better off and also a conflict with China would be less likely in a scenario where China can't immediately remove the US's access to some critical inputs. But yeah, we'll see how the tariff regime and how the negotiations evolve to get us either in that direction or maybe back to the status quo or maybe to some world where there are more barriers to trade and the US out of necessity is manufacturing more. But I think in that world there's also the question of which companies would actually want to invest in the US. And we do know that there is a set of policies that can get companies to invest in the US because private sector spending on fixed capital did actually rocket over the last couple years mostly because partly because of AI induced demand but also because of this targeted subsidies for particular strategic industries. Some more strategic than others, but it did work. And I think that it's actually harder to credibly engage in a strategy like that, like if you wanted something like the IRA or CHIPS Act but just targeting say defense and dual-use technologies that could be applied to defense. I think people would be telling you like we want cash upfront before we build our drone factory in Texas. We don't want the promise of future subsidies because you had just promised this great trade rearrangement and then you unpromised it and then repromised parts of it and so on. So, we just can't underwrite a long-term investment in the US on the basis of a strategy that changes day-to-day. But, you know, there's a level of subsidies where you can underwrite that, but that's also a level of subsidies where you are subsidizing grift. So if you pay people upfront enough money that it is worthwhile to build a drone factory in the US, there are people who are going to take the money and do other things with it. And this is actually a problem that China had too. They had this massive scandal with chip fab in Wuhan actually where a lot of the money seems to have just disappeared as well as some of the people involved. And it's unclear if they disappeared themselves or got disappeared. Either way, when there is aggressive industrial policy that tries to pay upfront because there's some policy expectation and stability, it does select for some fraud.

Well, I think that there are definitely parts of the free trade system that like absolutely you know the free trade system worked really well for the US in terms of GDP growth and it worked really really well for a lot of the developing world also in terms of GDP growth and the question is more about what is like is there a long-term goal where everything kind of equilibrates and equilibrates at US standards of living or equilibrates at some other standard of living and is the US willing to defer consumption in order to preserve industries that are high value, high margin, have a high upfront cost and a lot of uncertainty and that probably just don't come back if we lose them. And I think that's the piece where it gets trickier where if you have a planned economy but with some capitalist characteristics and the level of capitalism the economy can fluctuate opportunistically but the state is still able to direct a lot of resources towards the goals that it cares about then they can do catchup growth very straightforwardly and that was the story for a lot of the East Asian economic miracle countries like Japan and then later Korea, much less Taiwan. But they were kind of attached to Japan in a way that let them sort of free ride on some of what Japan was doing. But part of the approach in both Japan and Korea was we're going to subsidize industries that lower the cost and increase the pace of iteration in higher value added industries. So we know that if we dump enough resources into steel, we'll have really cheap steel. We'll be able to make cars. We'll be able to make low-cost export goods you know utensils and just like steel simple steel components and simple industrial components but we can also move up the value chain once we built that and anytime they're doing that you can have this period where a US manufacturer who used to produce goods for many different levels of that value chain you know some really low margin commoditized stuff some really high margin very specialized as they're able to outsource some of that or as they stop producing some of the low margin stuff because there is overseas competition, they actually end up with a higher margin business that has more competitive defensibility on its own. But then they can end up in a case where it turns out that it was actually valuable for them to have some of this lower margin, lower value added stuff specifically because it just increased their overall economic footprint. It meant that more people were working with the company. The company was working with more suppliers. It had more scale advantages, was able to promote more talent internally. And it is really hard to have this fluid way to promote a lot of really smart and effective people within a given organization if that organization's main job is to slowly shrink into its highest margin activities rather than continuously growing at all levels. So you can kind of look at Amazon as a sort of taking Japanese industrial policy and just doing it on a private sector basis within one company where they do think very long term. They are very happy to find something where the only limitation is their willingness to put a lot of capital into something and lose money for a while and then they just continuously scale it and try to ramp up the quality to whatever the acceptable level is and then ramp up the monetization continuously beyond that. And as long as what they're doing after that is reinvesting that in more of the same, then they're able to sustain that growth for a very long time. But as they do that, they end up having a very strong negotiating position with respect to many of the companies they do business with. And it's just, you know, over the last 20 years, it's always been better in the long run to be Amazon than to be someone who was doing business with Amazon. In any case where Amazon was the main dependency and the bigger they get, the more they are the main dependency for other companies. So I think that in that framework you basically want to have some way for either companies or countries to subsidize some low value added complements to the high value added stuff that they can export competitively globally. And if you lose that, it is just much more likely that you end up eventually losing the high margin, high return on equity things that were just that last layer because someone else has done the entire process that you did to get up to that point and they also know what that point looks like and they also know what the prices for those products are and as they get closer to being able to build them they also know more about the margins. So I think for free trade to be this really for people to be very long-term optimistic on free trade with sort of protectionist characteristics on the part of other countries you have to be optimistic that the US will just have some natural advantage in doing high margin things and that we don't actually need a lot of expertise in the lower margin stuff in order to achieve that and I think there's a kind of coherent model of the world where that is actually true and where as the US does less manufacturing we get more and more specialized in other things and because we're more specialized in those things and we have critical mass it's hard for anyone to compete with us and it does seem to be true for both consumer-facing software and business-facing software it is just really hard for other countries to build and scale companies the way that you can in the US but that also means that those same companies are vulnerable to a world where they're tightly integrated hardware and software bundles and at that point the companies that are good at the capital intensive operationally messy world of hardware they already know how to do that and US companies would have to relearn it.

Yeah. So I think the US we have like our general disadvantage in all of this is very high labor costs and there's an ambiguous disadvantage in terms of regulatory uncertainty where the old regulatory uncertainty was micro-level which is you want to build something you have no idea how long it will take. You have no idea how much money you will spend dealing with every single hold out. And we give a lot of people veto power and the power to delay things. And we have some rules that I think were very well intended but open themselves up to being manipulated. So there's a piece in the New York...

Times a couple months back talking about endangered species. And there is this kind of dark model where if you take a species that's not endangered and then you figure out you find two subpopulations, you split it up into subpopulations based on some unique trait and you're able to get each one of those classified as a species. Well, now you have two species and they both have smaller populations. And so if you divide them finely enough, you can eventually get your way you can define your way to an endangered species and then someone can't build the factory or the dam or whatever they want to build. And there seems to be some appeal to doing that. So the US had that kind of obstacle to re-industrializing that actually seems to be going away under Trump and it has been seamlessly replaced with the macro uncertainty of we just have no idea how US products will be priced relative to products made elsewhere in the world because we just don't know what the tariff situation will look like.

I think there are some categories like in drones it is just kind of weird that for military purposes the US does do drones but for law enforcement purposes there's a lot less of a US presence and that seems like a straightforward place where we can look at what's going on in Ukraine and say that drones are going to be a pretty important part of the world. We can look at just the general history of military equipment and say that it is good to have dual use producers. It is good to have companies that can from year to year make a lot of money selling passenger planes and can occasionally scale up their production of military aircraft or we look at the US auto industry which got huge over the course of the 1920s and say that it was actually from the perspective of a country that needed to produce a lot of tanks and jeeps. It was really really convenient that we had a lot of people who were in the business of putting tires on things that move and getting them off the assembly line as quickly and cheaply as possible. So, I think that something like drones makes a lot of sense.

I think that going through the list of inputs for like going through the list of raw materials inputs is probably more of like a check the box thing. And it is still it is annoying to me that China is able to disrupt the supply of rare earths because they are and I think this is more widely known than it was a few years ago. Like they are not actually rare. That's more of a branding thing. What is rare is the facilities to process them and China has invested in that. And that seems like this is actually a case study in why controlling your supply chain is strategic is that China can just tell the US that you don't get any rare earths for a while. And there have been a couple inputs like that that got disrupted during Russia's invasion of Ukraine. And it turned out that a lot of the companies that depended on those inputs were actually reading the headlines and knew that this was a risk and had done some stockpiling beforehand and did think of alternative sources. But on a country level, it actually seems like a very useful thing to do.

So I think that looking at it from the perspective of we take our currently globally competitive products. So planes, medical equipment, LNG and gas turbines and some other kind of industrial capital goods and we start iterating through the supply chain for those and look at one what are the cases where we depend a lot on imports from one country which is usually going to be China and then look at what where else we can depend on imports from or whether or not we could onshore that and if it is the case that onshoring that you know it requires some subsidies but not immense subsidies and it's you want to subsidize the factory so that the return on investment goes from 5% to 10% and not you want to subsidize if the return goes from negative 50% to 10%. Like if we find cases where it is that incremental subsidy that actually makes it worth doing, then we can look at what else is downstream from that input and then look again at is there a case where it is almost profitable for the US to build this and if so we might want to subsidize it so we can build it.

And I think that exercise actually gets continuously easier over time as you iterate over it because you get more used to underwriting this kind of thing and you also just get more visibility into the overall supply chain as more of it is located within the US or at least being carefully looked at from kind of a national security standpoint. So I would say that I think another piece of this is just the US annoyingly does actually have an advantage in just natural resource extraction. We whether it is drilling oil out of the ground or growing corn out of the ground, you know, things that come out of the ground, we just have good ground for that. So there's a different set of supply chains there where oil it is a very complicated industry with a lot of very specialized equipment. Some of that is manufactured domestically, some of that is not. And again, knowing what the dependencies are, knowing which countries could be, you know, which countries, if they are blockaded, mean that the US is impaired in its ability to supply a lot of oil and natural gas. It's useful stuff to know.

On the shipping side, Trump has talked about bringing back the US ship building industry. That would be very hard to do. China makes a lot of ships and it takes a long time to scale such an industry. And the US does have allies that also produce ships. So I think if I were building out high level industrial policy, I would probably say we should continue outsourcing that to countries that are actually capable of doing it. And there may be a category of ships like maybe a fully autonomous ship is just such a different design question from a ship that is crude that you could actually just build that supply chain from the beginning in the US. And I think that that is a case where we should be looking at what is the next step that hasn't scaled yet and trying to scale that domestically because it's just a whole lot easier to maintain high market share in something than to get the market share from zero to non-zero especially if someone else has already as part of their industrial policy subsidized the early stages of it.