William Blair Commentary: The High Costs of a Soft Landing
In this episode of The Active Share, Hugo is joined by Rob Kaplan, partner and vice chairman at Goldman Sachs and former president and CEO of the Federal Reserve Bank of Dallas, for a conversation that explores the shifting economic and geopolitical dynamics in a post-COVID world. Together, Hugo and Rob touch on the pendulum swing away from excessive globalization, the importance of balancing national security concerns with the economic benefits of trade, and the need for informed debate when making decisions amidst global uncertainty.
Comments are edited excerpts from our podcast, which you can listen to in full here.
Looking at the U.S. economy, you've said we have the heating and air conditioning on at the same time. What do you mean by that?
Rob Kaplan: We have tight monetary policy and loose fiscal policy.
Tight monetary policy has had time to run and is having an effect. We're seeing it in anything that's interest-rate sensitive, and it's been challenging.
But in my judgment, the fiscal spigot is still robust. To put this in context, in 2019, we ran a deficit that was 4% of gross domestic product (GDP) in the United States. In 2020, we ran a deficit that was 15% of GDP, but that was to fight COVID. The thing that might shock people is that in 2021, we ran another 15% deficit, which was due to the American Rescue Act. If you take out an accounting adjustment, we ran another approximately 7% deficit in 2023. So far, we're running the same deficit this year.
If you had told an economist years ago that we were going to raise the federal funds rate to 5.25% or 5.5%, they would have predicted that the unemployment rate would increase. And if you told them we were going to raise interest rates and still be at full employment, they likely wouldn't be able to figure out how that's possible.
The reason it's possible is large deficits. But this fiscal spending won't last forever. And as that money starts to wane, we will end up discovering the organic power of the U.S. economy.
Is the current fiscal spending productive?
Rob: Yes. Yes. One example has been the creation of more than 20 new battery plants in the United States, spread all over the country. Each of them requires 15,000 to 20,000 workers.
However, those batteries will be produced at a price that's more than double what China produces. And at the same time, we're raising tariffs on Chinese batteries.
There's a history of creating industries that aren't globally competitive except for tariffs or other artificial restrictions, which eventually go away. Then those industries aren't competitive anymore.
The steel industry is a good example. Once we unleashed global competition, things changed. I'm nervous about creating these giant industries that may not be globally competitive, as those jobs may not be around 25 years from now.
But there are two positive things that could also happen because of this spending. One is productivity could improve. Two is agreement on legal immigration, which could lead to workforce growth.
Are you surprised that the bond market seems to be relaxed about the deficit level?
Rob: There are certain things in life where there's no textbook guide. I've spoken with people across industries and asked, Are you nervous about being able to sell Treasurys in the years ahead? The honest answer they give me is they don't know.
I haven't met anybody who has an authoritative answer to whether all this supply can be sold.
How is the United States working to prevent the weaponization of the dollar and manage the supply and demand for its long-term bonds?
Rob: The big issue facing the United States isn't people not owning the dollar. It's people not wanting to buy duration. The U.S. Treasury is dealing with this by shortening, or reducing supply, and tailoring their auctions to where demand is. They're being careful not to have failed 10-year or 30-year auctions.
Interest costs relative to GDP keep increasing. Can this be reversed?
Rob: Time is not our friend right now. These costs could hit $1 trillion by next year, even if the Federal Reserve (the Fed) can cut rates.
Options to reverse this trend are getting more difficult as well because it will take many steps, not just one or twolegal immigration reform; improved education; increased productivity; potentially rethinking Social Security, Medicare, and Medicaid; and maybe raised taxes. All these things are hard to do and require a bipartisan effort.
Why is advancing artificial intelligence (AI) and technology important given current labor market trends?
Rob: In the 1968 book The Population Bomb, author Paul R. Ehrlich said, There are so many people. How will we employ them all?
Today, we should be glad that we have AI and technology-enabled disruption because we have the opposite problemwe have enough jobs, but we may not have enough people. I think we need to put more effort into boosting ourselves from a technology perspective.
How has the private sector's role in crises changed over time?
Rob: Historically, when there was a crisis, it was always in the private sector. The government would then step in and help solve the problem. Today, that relationship has flipped. The United States' private sector is not perfect, but it's one of the best in the world.
I'm more worried about the government sector because we are going to be struggling with the debt issue soon.
For example, we're paying more for the 10-year and the 30-year relative to short-term interest rates, which means the cost of financing for every company in the country who borrows in the public markets increases. We can solve this, but we can't solve it if we're not even talking about it, and we need to be talking about it.
Is the United States capable of having a productivity surge?
Rob: It's going to be critical for the United States to increase productivity, especially in the services sector. It has an aging society that is becoming more leveraged at the government level and a system that relies heavily on the government sector for retirement and healthcare. We need money to fund these things.
What is the current economic situation for the average American consumer?
Rob: In the historical playbook of the United States, jobs are created, which then leads to a low unemployment rate. But the problem today is not that we don't have enough jobs; it's that costs are too high, particularly for the family that makes $50,000 a year or less.
When I speak with people at this economic level, they tend to share the same story: I can't make ends meet. I'm working two jobs. My child has left high school to help make ends meet. It breaks my heart.
The Great Recession was an unemployment crisis. This crisis is a crisis of the employedpeople who have jobs but still can't make ends meet.
How has the perception of globalization changed?
Rob: When I was growing up, globalization was the order of the day. Some might argue that it went too far, because while we can now outsource anything, we lost many industries. Post-COVID, the pendulum swung quickly to de-globalization, with the argument for making semiconductors in the United States being a good example. We went from one extreme to another, and the pendulum needs to be somewhere in the middle. I do hope certain goods are made in the United States again. There are also certain things worth trading. If somebody's willing to give it away, maybe we should take advantage.
What kind of approach is needed to fight inflation?
Rob: The difference between the United States and most countries in the world is that in the aftermath of COVID, the United States had a bigger fiscal outlay than any other country, including Europe. Nobody spent money like the United States spent money. Because of this, the United States has higher GDP and low unemployment but stickier inflation.
I think you need a whole-government approach to fight inflation. I have no doubt the Fed will do its job. We may argue they were 20 months late and too accommodating, but they're in the right place now. But if it's left completely to the Fed to fight inflation, the cost will be higher interest rates for longer. We'll have a soft landing, but it'll be the most expensive soft landing we've ever purchased.
How do you think about the relationship between China and the United States?
Rob: Regarding China, the United States will need to learn to walk and chew gum at the same time. China is a competitor and collaborator, and in some cases an adversary. But it's in the United States interest to be able to trade with China.
On the other hand, there are certain areas in which the two countries' interests are at odds, especially as it relates to trade. I would encourage the United States to be balanced in thinking. Something that is good for China may not necessarily be bad for the United States.
For instance, the energy transition is going to be enormously expensive, and the cost of labor is likely to be high because of lack of supply. The United States may not need to produce every good that will be truly strategic.
I was a Harvard Business School professor for 10 years, and I learned if you're not framing an issue and debating it, you're unlikely to come up with a good answer. There needs to be balanced conversation, especially when it comes to the relationship between China and the United States.
If we were having this conversation in 1982, I'd be worried about Japan crushing the United States. Is it the same with China?
Rob: No. China may have broad ambitions to compete with the United States, but some of the things that the United States fears China doing, China isn't doing out of strength but out of weakness.
China has terrible debt and demographic issues. It's over-leveraged. It doesn't have the economic dynamism the United States has. And it has a worsening aging problem.
But it is not in the United States' interest to bring any tension to an extreme head.
What has Harvard Business School, Goldman Sachs, and the Dallas Fed taught you about culture and leadership?
Rob: Each environment has a different culture, and to be successful in different environments, leaders must adapt their leadership style. What worked at the Dallas Fed is likely not going to work at Goldman.
At the Dallas Fed, there may not be growth, but there's also no paranoia because no one's going to put it out of business either. It was important to have a participative, persuasive leadership style.
But at Goldman Sachs, and in business in general, things like compensation, bonuses, promotions, and the power to fire and cajole people influence one's leadership style. Because if the firm is growing, it means lots of opportunity for growth.
When you return to Goldman Sachs, what will you focus on to make sure culture is as strong as it needs to be?
Rob: When I was at Goldman Sachs the first time, I didn't have a cultural framework, but I had instincts. Eventually I wrote something called, Questions Leaders Should Ask, because asking questions is more important than having all the answers.
At Harvard, I had the chance to study hundreds of companies and work with professors who have frameworks galore. I then wrote three books on leadership. It took me a long time to frame what I was doing, but I brought that framing to the Dallas Fed.
Going back to Goldman Sachs, I now have a different lens. It's a bigger firm today, with 45,000 people and roughly $50 billion in revenues. But I'm not as intimidated by those things as I used to be because I have a framework that will help me.
You seem to treat frameworks as your North Star.
Rob: There are three things you do as a leader whether you know it or not: diagnosis, determining options, and trying to achieve goals. Usually, we spend 80% of our time on goal achievement. What frameworks can do is help diagnose and determine options. They speed up our understanding of the world around us.
If you had to describe common characteristics of some of the best cultures you've participated in, what would they be?
Rob: For me, the ideal culture is rooted in a company's people, clients, and community. No one is worried about who gets credit. The focus is on how to make the firm, its departments, and its colleagues better.
Why do you think people say no vs. yes?
Rob: I run a venture philanthropy firm called Draper Richards Kaplan. Bill Draper, one of the partners, is a renowned venture capitalist. He said to me, Life goes a lot better if you learn to say yes once in a while.
I spent years during my career saying no because I was scared or because I didn't trust the other person. I went to Harvard because I said yes. I went to the Dallas Fed because I said yes. I'm back at Goldman Sachs because I said yes.
Life can be a lot better if we learn to say yes, but it takes trust and a belief that we can do our best. We may fail, but it'll be okay.
This article first appeared on GuruFocus.