Big Picture Guys.

Bob Rubin and Larry Summers.

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What follows are excerpts from a recent interview conducted (mostly) by Jim Haskel of Bridgewater Associates, who oversees (among other things) Bridgewater ’s “Daily Observations” newsletter. “Daily Observations” is paywalled by the firm and unavailable on the web. The excerpts below are re-published with the firm’s permission.

Bridgewater is the world’s largest hedge fund. It has access to the smartest financial minds in the world. Generally speaking, each edition of “Daily Observations” features one or two of those very smart people analyzing and commenting on financial and economic issues.

In this case, Mr. Haskel interviewed two former U.S. Treasury Secretaries — Robert Rubin and Larry Summers — to hear their views on inflation, budget deficits, the neutral rate, the Fed, artificial intelligence, political paralysis and the possibility of another financial crisis. Among other things.

The transcript has been gently altered, by Bridgewater, for the sake of clarity. (Bold highlights are mine).

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Jim Haskel

So with that, let’s get right into the conversation, starting with Larry Summers.

Summers on the Decline of Inflation:

I think (one) question is what is it that explains the inflation dynamic? I think the theories that (a) it was all inherently transitory and had nothing to do with monetary and fiscal policy and all to do with COVID and that (b) changes in the gouging propensity are an important cause of inflation fluctuations are roughly ludicrous. And that the better way to understand the price of products is to think about supply and demand and shocks to the two of them.

And we had a massive shock to aggregate demand when we fought half of World War II in 2021 and in 2022, in terms of the expansion in fiscal policy that led to substantial upward price pressure. Of course, that price pressure manifested itself much more severely in sectors where supply was more inelastic than where supply was more elastic. But to blame that on sectoral developments in those sectors was a confusion, and it further committed the error of not understanding that because people were paying higher gasoline prices or higher car prices, for example, they had less money and were spending less on other things, which was contributing to disinflation in other sectors. So from my perspective, Milton Friedman, as always, overdid it, but was capturing stark truth when he said that inflation is about the overall price level, and that’s a sharply distinguishable subject from relative prices.

I think I missed, and there was more disinflation than I would have expected, because inflation expectations remained better anchored than I would have expected them to. Which is mostly a reflection of the fact that we had 30 years of price stability. And so, just as it really took quite a long time during the Vietnam War for inflation to substantially accelerate, when the Fed and fiscal policy were way behind the curve during the Vietnam War, I think the fact that the Fed eventually did step up, fairly dramatically, kept expectations more anchored than they would have been, and I think we caught some breaks in terms of what happened to food prices, what happened to immigrant labor flows, and to gas and energy prices. So I think we were beneficiaries of positive supply shocks with anchored expectations.

From that perspective, I think it is likely—and here I think I agree with you that if you think the neutral rate is in the 4s, and you think we’ve been the beneficiary of supply shocks and who knows what’s coming next, you don’t think the central tendency is that the Fed should cut interest rates by 225 basis points over the next 18 months. And so I would bet on less inflation cutting than the market does, though I think it’s always important to distinguish one’s degree of conviction. When I looked at the Fed dot plot in May of 2021 saying that rates would be zero until the summer of 2024, I thought I was looking at insanity. When I look at 225 basis points of cutting from here, it looks high relative to the way I understand things, but it doesn’t look insane from my perspective.

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Bob Rubin on the Big Dynamics He’s Watching:

I guess the only other comment I’d make is: Larry talked a lot about the Fed. I first met Larry in 1983, so we’ve had a long time to disagree about things. I’ve always felt that people overstate the role of the Fed in the economy. And I’m not an economist; I’m just a retread lawyer. But I’ve been around this for five decades, and basically that whole time, in one way or another, I’ve had responsibilities with respect to risk-taking, including at Goldman Sachs for a long time.

I think the Fed is one factor, but I think it’s only one of many factors. Looking forward, as an investor—which I happen to be—and also having consulting relationships with a number of organizations, the things I worry about most are the election because I have some very strong views as to what the effect can be with the two different results. I think geopolitical matters are obviously enormously risky. I think that our fiscal situation and climate change, while they’re long-run risks, can have short- or intermediate-term impacts, and I think you can see that already in the effects of climate change on supply chains and immigration. So I think we live in a very dangerous world, and I think the Fed is one factor, but it’s only one of many factors.

Now, on the plus side, people on the consumer side in our firm say, “We’re in a slowdown,” but there’s still some strength. There’s still some momentum. We’ll see where that goes, but I guess my view is you still have some meaningful momentum in the economy. If I were the Fed—this is me, and I don’t profess any expertise with this, but I’ve been around it for a long time—I would be worried about the possibility of a slowdown becoming too serious, but I would be more wary of the inflation side. Because I think if inflation would regenerate, it’s something Volcker once said to me—I’ve never forgotten it—Paul said that inflation can take on a life of its own. Inflation expectations, psychology—and it’s much harder to deal with than recession. And since I think that’s right, if I were the Fed, I would be very, very worried about this.

The only other factor I’ll mention is AI. I know Larry is on the board of OpenAI, so he knows a ton about it. But I also know a little bit about it because I’ve been taking tutorials for the last 11 months because it seemed to me this is going to be an important part of our lives. I think that as one thinks about, let’s say, the intermediate term—that’s a big deal. Now, that could be good or bad, with all sorts of considerations. I also think this election is an enormous deal. And I’m not being partisan right now, but if you look at the stuff that Trump has said about the Fed, the weaponization of the DoJ, tariffs, Article 5, and all the rest, I think he really poses enormous risks. And I think the markets just don’t seem to care about it. So that’s a very brief overview of my view of the world.

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Jim Haskel

A related issue to the dollar and to the growth and inflation topics discussed earlier is the impact of high government debt and deficits, because we’re now at a place where fiscal deficits are near secular highs and with virtually all credit creation in the economy coming from the government as opposed to the private sector. So the natural question is whether this situation is sustainable and what its effect will be.

Larry Summers

Let me just comment on one issue where I think Bob and I have somewhat different—but not completely different— views and are more converged than we have been at some points in the past. And that’s budget deficits.

Bob can speak for himself, and no doubt will, but I think it’s fair to say that he is in a fairly permanent state of alarm about excessive budget deficits and regards the prospect that America will overdo fiscal restraint as roughly paralleling the risk that I will go on some program that will cause me to become dangerously thin—that anything’s possible, but certain risks are really pretty remote.

I have a rather different view. I think of fiscal policy in the context of the structural features that are driving private saving and private investment. When it seems to me that the economy is in danger of producing a chronic excess of private saving over private investment, even at very low interest rates, I think that really quite expansionary fiscal policy is healthy and appropriate (a) because the very low level of interest rates makes it sustainable and (b) because it’s necessary, because I think economies operating at near-zero interest rates are prone to various kinds of financial misbehavior, financial excess, and bubbles.

So I don’t think the country was worse off between 2011 and 2019 because Simpson-Bowles wasn’t implemented. I actually think that if Simpson-Bowles had been implemented, given that we were already at zero interest rates and massive QE, there would have been a systematic risk of excessive deflation and disinflation without a healthy tool—because there wouldn’t have been any room for long rates to fall and so there wouldn’t have been any offsetting expansionary impulse. So I was very much not a fiscal hawk in the 2011-19 period. And I would stand by those judgments.

But in economics, unlike physics, you have to adjust your way of thinking to the fact that the world changes quite profoundly. And in the aftermath of the big run-up of debt and the many reasons to have real interest rate increases, it has seemed to me since 2021, with growing degrees of alarm, that we have a very, very serious fiscal situation developing, which is likely to manifest itself in one of substantial inflationary pressure, substantial indigestion in the Treasury markets with financial chaos, or substantial crowding out of what would be otherwise valuable private investment.

Bob Rubin

I’ll be very brief. Leaving aside the history of the fiscal policy and, as Larry said, we have somewhat different views, —we could debate whether that was a useful thing to have; my views were useful or not useful.

I think, looking forward, the CBO says the debt-to-GDP ratio now is about 98% or 100%. And they project 10 years out at 122%. I think most people think that as the CBO is bounded by current law, that a more realistic number is 130%, 135% or something like that, given geopolitical challenges and climate change. I believe I’m right in saying that the highest we’ve ever had was 106%, and that was the end of World War II. So we are into uncharted territory, and I’ll continue to think, as I have thought, and—although Larry doesn’t agree with this—I think it’s been constructive to have had this perspective over time in terms of constraints, however limited they may have been.

I think it’s a tremendous risk. And I think Larry briefly outlined what those risks could be. I think the politics of dealing with it are impossible because almost all Republicans in Congress have signed a little thing saying they’ll never raise taxes. Democrats are unwilling to deal with entitlements. And yet that’s where the ball games are in those two places.

I’ll make one other observation. If you take the year 2000 to the year 2022, I believe it was something like 45-50% of the increase in the debt was a result of two tax cuts—2011 and 2017. And whatever one may think about all sorts of issues, substantively, politically, ideologically, whatever it may be, I think an awful lot of it—and then if you look at the spending side of the budget, and you say what national security is likely to do and you consider what the non-defense discretionary consists of, there is stuff you could do on the entitlement side, but I do think most of the solution is going to have to be the tax side. And the politics of that, as I said a moment ago, I’m very troubled about it. I don’t see how we get out of this.

As Larry said, and I think he’s right—or he sort of said; I guess his thoughts were leaning in this direction—there could be all sorts of negative consequences as we go along the route: higher interest rates, something to do with the dollar, dynamics in the Treasury market. But at the end of the game, unless something changes politically—I mean, changes a lot—I think there’s a real risk of some kind of financial crisis. And even in a financial crisis, how do we know our two parties would be able to work together?

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Jim Haskel

And finally, here’s Larry Summers, an OpenAI board member. And he discusses his thoughts on AI and its impact on the economy, and you’ll hear him address the potential pace of AI’s impact and the types of jobs it might disrupt.

Larry Summers

My general reading on all technologies is that they happen slower than you think they would, and then they happen faster than you thought they could. And I remember Bob and I had a conversation—Bob, I don’t know if you remember this—in 1998, probably, or maybe it was early 1999. The young Jeff Bezos came for a business lunch at the Treasury, and we had a discussion, the general thesis of which was, gosh, we should be shorting shopping malls if we were investors. And that was basically a wrong insight for anyone who was trading rates at that moment. And it was basically a deep truth about the next 25 years.

Bob Rubin

General Growth did go bankrupt eventually.

Larry Summers

What you and I talked about, we had exactly the right conclusion. But as an actionable insight for the next five years, we were more wrong than right. And as a deep truth about the next 25 years, we were exactly right.

Similarly, if you’d asked me in 2000 when there would be electronic readers, I would have gotten it way early. And if you’d ask me in 2010 how likely it was that I’d stop reading physical newspapers by 2017, I would have thought that was really quite unlikely. So I think the rule “slower than you think and then faster than you thought they could” is a very powerful rule for thinking about AI and these other things.

The other two comments I’d make about AI are that it will come for IQ before it comes for EQ. Therefore, it may change a lot of relative valuations of different skills in quite profound ways and quite different ways than technologies have in the past. Frankly, it’s going to come for the skills of the people on this call more quickly than it’s going to come for the skills that salesmen and nurses have. And so I think it can lead to some quite profound changes in how it’s going to be seen. I suspect the fact that it comes fairly quickly for the skills of people who write articles is going to lead to some potential tendency toward exaggeration in what we read about its significance and the rapidity of its significance in the economy.

And the last thing I would say is I think there is a kind of category error in a lot of the discussion, which tends to always focus—as this one has so far—on this job category and that job category, and what’s it going to mean for jobs, and what’s it going to mean for disruption? And there’s another way to think about it, which is suppose the pace of scientific progress—whether it’s stuff like sequencing the genome or proving new theorems in math or understanding quantum physics—suppose the pace of scientific progress triples. How does that change the world? And the answer is probably “profoundly,” but you won’t necessarily get that right thinking in terms of specific job categories. And my sense is that there’s potentially quite large changes in the rate of scientific and technological progress.

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