Rob Kaplan on the Fed, AI, and How Globalization Is Happening Without the US

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1:51Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal. And I'm Tracy Alloway. Today, you are listening to a special episode of the podcast. It was recorded live at the Future Proof Conference in Huntington Beach. Yep. We're going to be speaking with former Dallas Fed President Robert Kaplan. He is now vice chairman of Goldman Sachs. Again, this was recorded live on stage at Future Proof. So take a listen. All right. Let's just kick it straight off. That jobs report that we got last week, in your view, with your Fed hat on maybe, is a 50 basis point rate cut in play for the next meeting?

2:29I think 50 basis points is still unlikely. I think we've been of the view for the last few months the job market was weak. This latest report was a little weaker. Having said that, the reason 25 is more likely than 50 is the jobs market is not falling off a cliff. We didn't get shrinkage. And inflation is running at 2.75 % to 3 % above target. And so it sort of puts a little bit of a headwind on doing more than 25 basis points. I mean, I take your point, but the report was still a huge surprise. So if you were in the newsroom when that number came out, just 22 ,000 jobs added, there was a sort of collected gasp because it was way below basically the entire range of expectations for that particular month.

3:19If you're at the Fed and you see a number like that, what does 22 ,000 actually tell you? Or are you sitting there going, well, maybe I'll wait for the revision until I really make up my mind? I don't know that the weakness in the jobs market was a big surprise to the Fed. They didn't know exactly what the number would be, but they expected it to be anemic. The reason that the unemployment rate has stayed low is we've shut down undocumented immigration. We have not ramped up legal immigration. And as you well know, we are deporting some number of workers and chilling 10 to 15 million undocumented immigrants who are in the workforce.

4:03and some percentage of them are not going to work. And so supply is anemic. We've thought for the last few months that hiring was kind of, we said, at stall speed. You should assume if GDP growth is one quarter, one and a half percent, hiring is going to be anemic. So we could debate the number, but I don't think it was a big shock that it was weak. And I think it wouldn't surprise me to see the next number also lethargic. So why aren't we falling off a cliff? We still are running a large deficit. We have tax incentives coming. We're in the middle of an AI data center power boom, as you just heard about in the previous session.

4:44And I think that's still bolstering the economy. Well, then let me take the flip side of Tracy's question, because, OK, maybe setting aside reasons for concern, the flip side, as you mentioned, inflation still running above target by most measures. The stock market, I haven't actually, I don't know what it's doing today, but it's very close to all-time highs, regardless of what it's doing today. All kinds of people are having a really nice time on the beach in Southern California. What is the evidence that, as currently standing, that Fed policy is actually restrictive? Clearly, the FOMC has come around to this view of cuts.

5:19It seems like cuts are locked in. But you don't have to have the FOMC view anymore. Is it obvious that cuts are needed at this point? Yeah, I think if it were not for the weakness that we've seen in the labor market, the Fed would want to stand pat. Because it's one thing to be above your inflation target. We're not moving toward the inflation target. We're going sideways to backing up. But with this weak labor market, I think it brings the fact you need to cut into play. Now, what's the neutral rate? I think the neutral rate today, you've got a 2.75 % inflation rate, 75 basis point real Fed funds rate.

6:00It means the neutral rate to me is around 3.5%. We don't have a lot of space to cut to get to neutral, but I think you've got 75 to 100 basis points. I think the goal of the Fed will be cut in September, stay restrictive, and if the labor market stays weak, keep going. If it stabilizes, then you have the option to hold off. And I think that's what they'll do. Just going back to financial conditions and stock markets at all-time highs, I mean, if the Fed cuts at this current juncture, call it an insurance cut or whatever, but if the economy re-accelerates after that... Which it may. Yeah, which it may.

6:39Would you be worried about that side of the outcome, given that, as you said, inflationary pressures seem to be going sideways to possibly up. Yeah, so a lot of people look at financial conditions and see it as a reason the Fed shouldn't act. I actually come at it from someplace different. The economic statistics are reflective of what's going on right now. In fact, even more than that, what has gone on, not even what's going on right now. The stock market and other financial markets are an assessment of what's going to happen for the next three to five years. As we know, we're in the middle and the early innings of an AI data center power boom.

7:23I don't think it's showing up yet in a lot of productivity, but I think a year or two from now it will. The stock market, rightly or wrongly, I think is making that bet. It's betting that productivity is going to improve. Corporate earnings are going to get better. You're not seeing it show up in the current economy. The Fed's job is to look at financial conditions, but adjust policy based on the current economy, not the bet the market's making for two or three years. I'm glad you brought that up about the AI boom, the data center boom, and so forth, and that it's not showing up yet in productivity, but it may be showing up in greater strain on the grid.

8:01It may be showing up in greater strain on certain electrical gear that's necessary that's been in shortage for all manufacturers for years now. That's right. As of right now, in September 2025, could we say that if anything, the AI boom is like sort of having a crowding out effect or slightly inflationary, where the costs right now, just on a static extent, setting aside the bet, are a bit of a drag? There are two big structural initiatives that are being pursued by this administration. One is regulatory review and regulatory relief, because they want to ease the speeding to adoption of AI and get more capital available.

8:41But the second thing is there's an extensive re-review of the power grid. We are behind China in having enough power to fund the AI explosion. We've got to invest more in geothermal, more modular nuclear. We need to make it easier to run a refinery, make it easier to do transmission. And I think you're going to find there's going to be enormous efforts because we are behind. And in some states, to your point, there is a crowding out. And I think people are afraid at some states, the leaders are afraid to take more data centers for fear. It's going to crowd out individuals. So this is a big structural initiative that isn't getting in the press a lot, but it's a big initiative going on in this country that's a dramatic change and it's needed.

9:29What does that actually mean for Fed policy? Because if I think about this crowding out idea and all the demand for databases and the things that power them, we have seen electricity prices start to go up. I know the Fed, the Fed's preferred inflation measure is X energy and food prices. But on the other hand, electricity prices feed into the cost of pretty much everything. And also, this doesn't seem like a bottleneck that we're going to be solving, you know, within the next two or three years or even 10 years, to be frank. If you're at the Fed right now and you see electricity prices going up, how are you thinking through that pressure?

10:06So let me put it in context. There are cross currents. I mean, real cross currents. You just mentioned one. On the one hand, you've got the government is trying to reduce government-directed spending and replace it with more incentives, tax incentives. Obviously, the tariffs have been put in place. Those are slowing growth. And they have a tendency to raise costs. They might be one time. And the labor force, as I just mentioned, we are actually decelerating and reducing labor force growth because of immigration policy. That's actually helping us be at full employment. And the Fed's been taken by that, but also makes prices stickier, wages stickier.

10:53At the same time, you just said, you've got these booms in AI and the grid, and you've got, we need more labor, we need more power, and that actually stresses prices. So when you're at the Fed, when you've got this kind of confusion, I think that's one reason why they've done nothing so far this year. But I think the labor market is forcing their hand where if it gets even weaker, they really don't want that. And that's why they're acting.

11:29Thank you.

11:59is Ecolab. Better performance, better outcomes, better impact. Ecolab. Now every location is your best location. For enterprise organizations, managing all your food needs is a tall order. But with EasyCater, you get a single workplace food vendor with the tools and resources to make it easy. Giving teams across your organization an easy way to order from a huge variety of restaurants, all on one platform. All while consolidating your corporate food spend so you You can control costs, streamline billing and payment, and simplify reporting. EasyCater, your business tool for food. To learn more, visit easycater.com slash podcast.

12:39You're thoughtful about where your money goes. You've got your core holdings, some recurring crypto buys, maybe even a few strategic options plays on the side. The point is, you're engaged with your investments, and public gets that. That's why they built an investing platform for those who take it seriously. On Public, you can put together a multi-asset portfolio for the long haul. Stocks, bonds, options, crypto, it's all there. Plus an industry-leading 3.8 % APY high-yield cash account. Switch to the platform built for those who take investing seriously. Go to Public.com and earn an uncapped 1 % bonus when you transfer your portfolio.

13:23That's public.com. Paid for by Public Investing. All investing involves the risk of loss, including loss of principal. Brokerage services for U.S.-listed registered securities, options and bonds, and a self-directed account are offered by Public Investing, Inc., member FINRA and SIPC. Crypto trading provided by Backed Crypto Solutions, LLC. Complete disclosures available at public.com. Let's talk about AI in China a little bit more. You mentioned the power element, and there are a lot of people anxious about the constraints on the U.S. grid and all these big CapEx numbers, and can the grid even support that?

13:52What else is different besides the electricity component? Because some people we've talked to talk about there's a very different attitude towards the tech diffusion, particularly out of China or supply chains that run through China. So, and I just got back from Asia and I was in China last week. When we talk about AI, we tend to look at the hyperscalers, these big giant companies that make up a disproportionate share of the S &P 500 and they're spending hundreds of billions of dollars. They're making a lot of money. When I'm in China and we talk about AI, they talk about the word you used, diffusion.

14:33They talk about regular businesses, the McDonald's of China, Lucan Coffee in China, regular - We have them in New York City right now and I tried one and it's very good actually. Yes, but those companies are actively using AI to lower costs. And you got to remember, so why is that happening? I'd say we're further along, China's further along than we are. Why? Their margins are lower. They're doing it out of necessity. Our margins in the US, our companies are higher. And so they're not as much pressure to lower costs and make AI experiments. In China, they don't have a choice. It's so competitive.

15:11They need to lower costs. But the thing that struck me, there's a lot to learn from what they're doing in China. Normally, if we were a little more globally integrated, we would learn those things and bring those learnings back to the United States. And it reminded me that globalization is not dead. The United States is choosing to play a different role in it and stepping back. But I got to tell you, the other thing I saw there is there's more coupling going on between China and other countries that are aggressively. Canada is much more aggressive in trying to form new partnerships. So I think globalization and the AI story go together.

15:55And I got to tell you, globalization not going away. And the U.S. is going to have a choice in the years to come how much of a role we want to play in participating. But it's going to happen with us or without us. So we can sit here and ask you what you saw in China and what your thoughts were about China. but I am very aware that when you go on that type of trip, you have Chinese clients who are asking you your thoughts on the U.S. and what's going on here. What are the type of questions that you're getting from Chinese clients at the moment? What are they interested in? So the biggest item I'd say of discussion is, and I used to be in Asia for the first part of my career, And what I found in Korea, Taiwan, China to a large extent, their whole effort was to go from low value added manufacturing to high value added manufacturing.

16:46And they tried to wean off of lower value added manufacturing. So what's an example? T-shirts and sneakers used to be made in China. Today they're made in Vietnam. why China wants to move up the value chain because their feeling is they're going to raise the standard of living to higher value-added manufacturing. The question sometimes I get when I'm over there is if you're going to reshore to the United States are you going to really reshore lumber, aluminum, some of these other lower value-added manufacturing wouldn't solidify in the relationship with Canada and Mexico makes sense where you can get cheap natural resources from Canada, cheap labor from Mexico, and solidify North America.

17:36And so I'd say they're not critical of us, but they're scratching their heads a little bit to say, what's the strategic rationale? Because you're tied on labor, you normally want to move up the value chain, and I think they realize that some of these tariffs are also intended to help generate revenue and reduce the deficit. They understand that. They're just questioning how strategic it is. Well, let me ask you a question on the question of what are we going to bring back in the United States, if anything. Just from your perch at Goldman, do you see any private money that's come into the U.S. for fresh sort of, I don't know, greenfield capital investment, either in something low margin or high margin, because the tariffs have changed the math and made that investment economical?

18:27So I will say there, yes is the answer. I think there are U.S. companies that will do more on the margin manufacturing here. I've talked to overseas companies, including, I won't mention the name of one contract manufacturer in China. They are building more in the United States. And so the thing is, I don't know how long it will take, what the magnitude will be. But yes, it is happening. The flip side of that is there are many companies in the U.S. that benefited from access to lower cost goods. And I won't mention their name, but you know some of them. And their margins are being squeezed. And then I talked to a number of small businesses that don't have the leverage to manage these tariffs, and some of them will actually go out of business or are considering it by the end of the year.

19:22This is a little bit of an unfair question, but I'm going to ask it anyway. If you had to choose one right now, would you say that tariffs are more effective at bringing back manufacturing to the U.S. or more effective at raising income for the U.S. government at a time when people are worried about the deficit? I think we'll start with the second part. Tariffs raise revenue, but they slow growth. And so for every dollar of tariff revenue, you have to accept you may give some back and a little bit lower growth. I think that trade is very much worth it if you're bringing back high value added manufacturing.

20:05I don't know if it's such a good trade if you are pushing to bring back lower value added. I think this administration knows that, and I think they'll be more strategic. I think you can do both. I think you could level the playing field, get more tariff revenue, some level of tariff revenue. I think we were thinking they were going to be closer to 10 % than 20%. I mean, the high teens is a little higher than we expected. And you can also, yes, on semiconductors and other strategic areas, you can re-domicile those. I think the question is, you sure you want to go down the road of lumber and aluminum, or do you want to let Canada do it?

20:48Is that a good strategic trade? I'm not sure. Since you mentioned it, why is the neutral rate of interest, to the extent that we can form some educated guess as to what it is. Why is it so much higher than it was in, say, 2019, in your view?

21:06So the fact of the matter is, I think if you go way back in the Stone Age to 2019... It does seem like forever ago. It does. I think if we had not had COVID, I think right before COVID hit, the 10-year treasury, I think it was in the neighborhood of maybe one and three quarters to two. The Fed funds rate was in the mid ones. I think we would have inched our way up a little higher. We didn't know how good we had. All those people were complaining, oh, yields are so low. And then now they all wish they could go back there. Yeah. Listen, the inflation rate today is stickier. Back in 19, it was probably one and a half, one and three quarters.

21:47I still think even then the neutral rate, real rate was three quarters of 1%. So the neutral Fed funds rate back then I think was 2.5-ish. Today it's closer to 3.5, but there's only one reason for that. The inflation rate's higher. If inflation got back down to 2, I think you'd see the neutral rate back down to 2.75.

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23:05The point is, you're engaged with your investments, and Public gets that. That's why they built an investing platform for those who take it seriously. On Public, you can put together a multi-asset portfolio for the long haul. stocks, bonds, options, crypto, it's all there. Plus an industry leading 3.8 % APY high yield cash account. Switch to the platform built for those who take investing seriously. Go to public.com and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com. Paid for by public investing. All investing involves the risk of loss, including loss of principal.

23:44Brokerage services for US listed registered securities, options and bonds in a self-directed account are offered by public investing, Inc member FINRA and SIPC crypto trading provided by backed crypto solutions, LLC, complete disclosures available at public.com slash disclosure. Did my card go through? Oh no. Your small business depends on its internet. So switch to Verizon business and you could get LTE business internet starting at$39 a month when paired with select business mobile plans. That's unlimited data for unlimited business. There we go. Get the internet you need at the price you want.

24:15Verizon business. Starting price for LTE business internet, 25 megabits per second unlimited data plan with select Verizon business smartphone plan savings. Terms apply. Since you mentioned sticky inflation, there's one other thing that seems to be top of mind at the moment, which is Federal Reserve independence. And we should talk about that. But I guess we can get your thoughts on, you know, that specific idea in a second. But one thing that seems surprising so far is that we're having this debate about what happens to the Federal Reserve with what seems to be a more activist Trump administration that seems to want to have a heavier hand in monetary policy.

24:52We haven't really seen much response from the market. If you look at the long end, it doesn't seem like there's a big risk premium building there. What's going on? So let's make two comments. So regarding political independence, let me just make sure I frame this. Regulatory policy at the Fed is not underlying not politically independent. It hasn't been for a number of years. What do I mean by that? You get a new president. They pick a new head of supervision. And it very much has been influenced for the last many years by whoever's in office. The balance sheet, I would argue, is maybe a little bit in the gray area.

25:32On setting the Fed funds rate, though, the Fed has been politically independent. Why is the market, you said, not reacting more to this? I mean, the reality is the stock market likes the idea of lower rates. I think the thing, it's not that the markets aren't reacting. The stock market likes it. So it's starting now to take into account, makes the real acceleration you talked about more likely. The gold market is very much taking note of it. And gold is up more than 35 % year to date. I see it's up another 1 % today. So it has. And I actually think duration on the long bond while the tenure is rallied because of slow growth, I still think we have an issue.

26:19We've got$37 trillion of debt to sell on our way to$40 trillion. I think that the bond market may pay at the long end will pay attention to how this current situation works out. What is going on? How much more gold talk is there these days than there were a few years ago? Well, I actually, I've gone back over, looked back over the last 50 years. When's the last time we got a rally in gold like this? Yeah. I think in the aftermath of the Great Recession, remember the Great Recession, the Fed took its balance sheet from 800 billion to 4 trillion, okay and stopped and we started to run it down a little bit in response to covid we went from four trillion to nine trillion and we authorized six trillion dollars of extraordinary spending in a 27 trillion dollar economy and the gdp uh the net debt to gdp went from mid 70s to over 100 percent.