Sebastian Mallaby: Trump, the Fed, AI and Liquidity Risks for Advisors

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What happens when central bank policy, political power, and artificial intelligence collide at the same time? Hi everyone, I'm business coach Steve Sandusky for Barron's Advisor, The Way Forward Podcast. My guest today is Sebastian Mallaby. Sebastian is the Paul A. Volcker Senior Fellow for International Economics at the Council on Foreign Relations. He's also a longtime journalist and commentator and the author of 5 books, including The Power Law and The Man Who Knew, which is his definitive biography of Alan Greenspan. This is episode 4 in my miniseries on The Geopolitical Edge. Sebastian and I tackle the new battle lines that are forming between central banks, computing power, and political control. We start by discussing how well the Federal Reserve has performed its job and what may happen if the Fed gets captured and becomes the junkie for an administration clamoring for an easy monetary policy. We also explore how AI might become this generation's version of the 1990s globalization boom and potentially sparking a new wave of productivity which could justify looser monetary policy. From there, we discuss how venture capital, AI, and liquidity are reshaping not just markets, but the very structure of global power. This conversation is about understanding how central banks are navigating political pressure, how AI might trigger a new productivity boom or a new bubble, and how capital is no longer just about return, but about influence. Sebastian challenges us to rethink who holds the reins in this new era. Is it the Fed? Is it the VCs or the people who control the compute? With that, here's my conversation with Sebastian Mallaby. Well, the Federal Reserve has been in the news a lot here lately. And back in 2016, you published a book about former Federal Reserve Chairman Alan Greenspan called The Man Who Knew. And my understanding is during the writing of that book, you spent a lot of time with Greenspan. You obviously have a lot of knowledge about the inner workings of the Federal Reserve and its impact on markets. So where I'd like to start is just zooming out a little bit and getting your perspective on the role of the Federal Reserve and how well has the Federal Reserve been performing that role going back to, let's say, the beginning of the Greenspan era back in 1987?

Sure, it's a good question because the answer about how well the Federal Reserve reforms is not constant over time. And in some ways, when Alan Greenspan became the Fed chair in 1987, it was sort of the beginning of, I would say, the consolidation of a good period. In the '70s, it had been pretty disastrous. The Fed had let peacetime inflation really get outta control, and it did that in the absence of something equivalent to the COVID shock, which we experienced more recently. There was the double oil shock in the 1970s, but I think that was a much smaller price shock than COVID was. And COVID was just unprecedented in the amount of uncertainty it created. So I kind of slightly am charitable about my judgment of the post-COVID inflation. But the '70s really was a straightforward mistake by the Federal Reserve, just not being tough enough early enough to raise rates and control inflation, partly because of the political climate. And so coming into the Greenspan period, you had a double challenge as a central banker. One was to actually know what it meant to be a monetary policymaker, right? So there had been this period where the dollar was anchoring the global system. It was notionally tied to gold until 1971. And so monetary policy was a lot more simple because you had this sort of exchange rate anchor. Then you had no anchor in the '70s. That's why everything went out the window. And then you have a sort of experiment with monetarism under Paul Volcker from '79 to '87. But actually Volcker abandoned that experiment 2 or 3 years into his term. And so then again, there was a sort of ad hoc, okay, you know, if inflation looks a bit high, we'll raise rates. It's sort of making it up as you go along. And during the Greenspan period is when inflation targeting came in, the sort of clear idea that the objective is to basically get inflation at around 2%. and hold it at 2%. And so one thing that happened and made the Fed much more powerful was a clarification of what the goal was, you know, inflation targeting. And then the second thing is in order to do that, you need political independence. And that had not been taken for granted in the past. Nixon had bullied the Fed under Arthur Burns in the early '70s quite aggressively. And that was why Inflation got out of control and Volcker fought for Fed independence rather successfully, but by the end of his term, it was not locked in. And there was a presumption when Greenspan came in in 1987 that the Fed would be pushed around again, that Greenspan was a Republican economist appointed by a Republican president, presumably to do what the Republicans needed politically to get reelected. And Greenspan turned out to be willing to be very, very inconvenient to President Bush. So in that '89 to early '93 time period, Greenspan's policies pretty much cost the elder Bush the election against Bill Clinton because he was tough on inflation in a way that infuriated Republican presidential administration. And that's what in my mind really cemented independence. And I think thereafter the Fed has been basically pretty effective. In targeting inflation, maintaining its independence, and delivering price stability, with the exception of this COVID period. But as I said, if you remember that time when you didn't know if a new variant was coming out, you didn't know how effective the vaccines would be, you didn't know how the psychology of workers had been changed in terms of their work shyness, you didn't know whether your trading routes with China would open up again or whether China would continue in a lockdown. I mean, so many things were wildly uncertain in that period that although I do have criticisms of the Fed late '22, early '23, they're kind of a bit more subtle. And basically, I think the Fed has been doing a good job.

Well, you mentioned that President Nixon was pretty hard on Arthur Burns, who was his chairman back in that time, and wanted him to, I guess, to keep interest rates low. So it's sort of déjà vu all over again here because we've got President Trump is hammering Chairman Jay Powell, at least as we're having our conversation here today, he's still chairman. And, you know, obviously lots of talk about whether he'll get fired or not. And going back to Greenspan as well, he focused on inflation targeting, as you mentioned, and he did a great job at that. But also, if we go back to the late '90s, we had the great bubble in the dot-com, and then we had the big burst. And then leading up to the housing crisis, '05, '06, '07, he was kind of loose with monetary policy as well because inflation was under control. And so, as you well know, a lot of the criticism about Greenspan was he didn't prick the asset bubble to some extent. Now, of course, that wasn't really his mandate. But do you see that we may be running into the same situation here if Trump does get his way and either he fires Powell or he limits his ability and puts a shadow Fed in there and nominee, and then eventually it looks like he's going to nominate someone in that position who will try and lower rates. Now, of course, the Fed chairman can't unilaterally do that. They've got to get the other folks on the committee there to help with that. But do you see we're running into that same issue where the Fed is going to lose its independence, it's going to become really politicized, and we're just going to have a melt-up in the financial markets followed by a big crash very similar to what we had with the dot-com period and the housing crisis period, the great financial crisis?

Yeah, I think there's a couple of questions in that which are both pretty interesting. So one is this thing about bubbles, and I agree with you. And in fact, that's sort of the central point of my Greenspan biography is that he was great at targeting inflation, normal price inflation. He was terrible about bubbles, and it's quite hard to do both at once effectively, but I do criticize him in my book for being too passive in the face of asset price meltups, as you say. So you had the tech bubble of the late '90s when it burst, the economy was supported by aggressive rate cuts, but you can't cut those rates aggressively without there being a knock-on effect. And the knock-on effect was a real estate bubble, which really came back in a big way, right as Greenspan was leaving office, 2006, 2007, as we know. So I do agree with you that the bubble side is something the Fed still hasn't fixed. It's kind of got its head around. The price of eggs, if you like, but not nest eggs, how we save our money is destabilized by these perpetual bubble cycles. The other part of your question, I guess, is around whether the Nixon attacks on Arthur Burns are being repeated today in President Trump's attacks on Jay Powell. I think, yes, the attacks are similar. I think the difference is that Jay Powell himself was in the US Treasury under the elder Bush witnessed how Greenspan was actually attacked then by the Bush administration and saw how Greenspan successfully resisted. And I mean, I've talked to Jay Powell when I was researching my book. I know he sort of both knows directly the experience of how Greenspan fought for independence, and he's also read my book and internalized some of these messages as far as I'm told. And it's not rocket science, but I mean, essentially a Fed The Fed chairman is a political figure and you need to go make strong alliances on the Hill in the key committees in the Senate so that if you get attacked by an aggressive president, you have allies who can sort of block stuff the president might want to get through. And, you know, a new Fed chair would have to be approved in the Senate if key senators were not willing to cooperate with the president about that. That would frustrate him. And I think Powell has been quite effective in quietly amassing alliances on the Hill in the way that Greenspan used to do before him.

The two mandates of the Federal Reserve, maximum employment and stable prices. There's nothing in there about pricking asset bubbles or foreseeing asset bubbles. Do you think that they should take into consideration at all what is going on with asset prices. You know, to Greenspan's credit, one of the things that he was able to do was he was able to realize that through globalization and other factors, we had this huge productivity boom in the '90s such that we could have pretty good economic growth without inflation. And so he seemed to be okay with that. That may be reversing today, clearly, as we're trying to, you know, onshore manufacturing and bring stuff back here. So this idea of globalization keeping down prices is probably not a tailwind anymore. It's probably a headwind. So how do you see the role of the Fed incorporating what's happening with asset prices in their decision-making as it relates to interest rates and monetary policy?

Well, I think that the primary goal for the Fed remains normal price stability. And you know, that's the first thing you've got to get right. And if you let that get out of control, it's painful to force prices back down to a regular 2% rate of increase per year. And it's also incredibly politically unpopular. As we saw, you know, in the last election cycle, one problem for the Democrats was that they were held responsible for the COVID inflation, you know, fairly or unfairly, but they were blamed. And so I think, you know, American people really don't like inflation and the Fed needs to keep that under control. And it's important for business planning to have a sense that, you know, prices are not going to radically move around. But I think once you've achieved that target, there are moments when basic price inflation seems to be under control more or less, but there's a signal from asset prices from the stock market from the bond market, from the real estate market, that things might be getting too frothy, that animal spirits are a bit too high. And that matters because if the deepest role of the Fed is to sort of stabilize the economic cycle, try not to go through booms and busts because the busts are so painful, then clearly a bubble bursting does threaten a recession. And it's not just wiping out the savings of 401(k)s and so forth, which is bad enough. It can also lead to an actual recession. So I think there are moments, and I would say that 2022 was one where if you recall, there was an everything bubble. And to my mind, that was a signal that one should raise rates. And so team transitory, which at the time was saying, hey, we don't need to be raising rates because, you know, there's some inflation in prices, but that's transitory. It's caused by COVID. It's going to go away by itself. I think it would've been good to add to that discussion, hey, but there's this incredible bubble going on in asset prices. That's an additional reason why you should think about raising rates earlier. And if they had done that, they would've raised rates not in the spring of '22, but they were basically 6 months later than they might've been if they had taken asset prices into account.

Well, there's an elephant in the room here. Which is artificial intelligence. And so how do you think about the potential scenario where, again, going back to the '90s, we had globalization, which is helping to keep inflation in check. We had the rise of China. Everybody's moving stuff over there. It's a lot cheaper. Is it possible that with artificial intelligence that that basically assumes the role of what globalization did back in the '90s and helps keep inflation in check. And so it is okay if the Federal Reserve were to drop interest rates 2 or 3 percentage points because we've got AI and we're not going to have inflation and we're going to have this melt-up in stock prices. We're going to have this great economy for some period of time. And then, of course, you know, the party ends at some point. Is that a plausible scenario here?

Well, I mean, you're right to say that if globalization is stalling, technological progress could sort of compensate for that. And indeed, when Greenspan retired and wrote his memoir, the last chapter sort of outlined two background reasons for the stable inflation during the Greenspan years. And, you know, he was kind of being a bit modest and saying it wasn't just my policy. There are these deep factors out there. And the two factors were globalization, yes, but also the internet and the price destruction that came from the internet, putting downward pressure on prices, keeping inflation under control. And so today you're right, you know, the tailwind in terms of, you know, controlling prices from globalization has pretty much stopped. Whether it's quite reversed, I don't know, because although you've, you know, depends how the tariff war goes. But clearly technology is progressing at a very rapid rate right now, and we see this already in areas like software coding, where software teams are way more productive than they used to be. If you had 500 people working on your software 2 years ago, maybe you only need 300 now because their productivity has gone up so much with all these AI coding assistants, which kind of do autocomplete for you as you're writing the code. So there's this thing called Vibe Coding. You kind of like express roughly what you want to the system and the system will actually write the code for you to some significant degree. So software is at the front edge of this, but there's other areas like call centers and entry-level white-collar research jobs where AI is really useful and does displace human labor to a significant degree. And that's only going to get more. So I think that does mean that prices probably come down in some areas of the production system. It's not across the board, you know, in services, face-to-face, you know, people waiting tables in restaurants, what have you. You're not going to have an AI, you know, bringing the food to your table yet. Robotics is behind AI as in chatbots. So it's not all across the economy. And I think, you know, although I am bullish on what AI means, when I say bullish, I mean, it's not necessarily great for society, but it is going to have a big effect, a powerful effect on economic productivity. I think it would be risky for the Fed to kind of set policy presuming that those effects are coming through the pipeline fast. I think you have to wait and see actual price changes and then use monetary policy to respond to those. Don't say to yourself, oh, we've got AI, so there's not going to be inflation. That would be foolish because you just don't know how quickly businesses will be able to integrate AI into their production systems. I mean, there are going to be some things where AI is integrated, the quality of the product goes up, the price doesn't really go down. So price destruction isn't a certainty. And it's going to be spotty. It's going to be some things will come down, other things won't. And in the meantime, of course, AI means an enormous investment boom, billions and billions of dollars being spent on data centers, on new power supply for those data centers. And that is inflationary. So you have this offsetting effect of this surge in investment spending. So I don't think it's clear in the kind of one-year sort of view whether this is inflationary or deflationary. And I think the Fed would be unwise to set policy based on AI.

Well, and there's another big factor in here as well, which is demographics. And if we look across the world, China in particular is probably the biggest example of a declining population. Their birth rates are super low. Here in the U.S., I think our fertility rate is like 1.6 or 1.7 when we need about 2.1 births to replace our population. So we're going to start seeing that. Of course, we've clamped down on immigration, which means we may actually see net negative immigration here in the US. And you combine that with a very low birth rate here. And, you know, we could see declining population in the United States before long. So it seems like there's a tension there as well when it comes to, well, what is that going to do to inflation? And offsetting that is we've got AI. So it seems like we've got these competing things. Some things are like, this might reduce inflation. Other things like having fewer people might increase inflation as we have more demand for labor. And we've seen what Meta has done, you know, paying $100 million, $200 million deals to get these AI researchers on their team. So obviously, you know, some people are making out like a bandit here when it comes to, to compensation. So it doesn't seem like there's any easy answers here and that the Fed has an extremely difficult job trying to accommodate and think about what are the interactions of all these competing tensions here?

Yeah, I mean, again, I think on the Fed, the monetary policy committee has to focus, you know, pretty specifically on what are the actual price signals and not get into this, you know, what are the demographics, what's the technology? Because as you say, it's extremely complex to kind of figure out how all those things net out. How quickly those steep trends affect prices. And so I think for the Fed, it's better not to be too distracted by that. It is though an astonishing coincidence. I mean, almost uncanny that right at the time when you have declining workforce sizes across both the US and other advanced economies is when AI is coming on stream. And providing kind of AI workers in a way to make up for the decline in the size of the labor force coming from demographics. And it's almost like, whoa, that's a funny coincidence. But anyway, and I think what's hard to predict though, is the rate of both those things, because obviously you can say, well, fertility is falling, but we don't know what immigration rates will be over the next— we might have a good guess over the next 3 years of the current presidency. Beyond that, harder to say what immigration rates will be. We don't know what retirement ages are going to do. We don't know what female labour force participation might do. We don't know, I mean, in the UK where I'm sitting right now, there's been a really weird decline in the size of the workforce because many, many more people are declaring themselves disabled. And this is kind of a COVID overhang effect. So there are sort of things that affect the size of the labor force, which are quite tricky to predict. And so AI is not going to kind of neatly produce AI workers right at the right pace to fill the open slots created by retirees. But it is an interesting offsetting effect. But at the same time, what I worry about with AI is that the anxiety it causes both to workers who might lose their jobs, but also just of people who don't like change to be too fast, they find it upsetting and confusing, that in some ways, because of that anxiety that's generated by AI, it creates political stresses that then make it harder to do the kind of sensible reforms that you might want. To help us all adapt to a world of AI. So I mean, in some sense, what's gonna happen with AI? Well, there's going to be this extraordinarily powerful technology, which will be owned by a handful of companies, which will make big profits. We can't predict which companies exactly, because, you know, if you take Google, Google is at the cutting edge of AI, but at the same time, it's traditional money gusher search. Is under enormous pressure from AI, which is why the stock price has been pretty unexciting in the last 6 months or a year. And so it's like how all this stuff nets out is pretty unpredictable. So I couldn't sit here and make a prediction about which company specifically will gain from AI, but I can say some companies are going to win this game and the technology is so powerful that they're going to make a huge amount of money. Then you've got the AI scientists going to Meta being paid 100 million bucks per person in some cases. I mean, this is just like off the charts. So you've got these big kind of new sources of profits and income, which would be very narrowly distributed to some actors in the economy. So in the meantime, you're going to have, you know, job displacement, insecurity, and so forth in other bits of the economy. You might hope that you could like take some of the gains from one corner and redistribute in the form of whether it's universal basic income, more generous education grants so people can retrain, you know, better child support. You know, there are different theories about how you would redistribute, but you would do something to take those extraordinary productivity gains and wealth gains from AI and share them around a bit so that it's less explosive politically. But trying to make those difficult reforms, as you know, in Washington, DC, it's never easy to get any of this through. And in a world that becomes more polarised, more anxious, more partisan, and more divided, it's harder to see the political system generating thoughtful, intelligent remedies to AI-driven stresses because of those very stresses. So, that's where I get a bit pessimistic.

But what I also find interesting is that the stock market doesn't seem to care about that. I mean, as we're talking today here in late July, it's record highs again here in the US. And so, how do you reconcile all of the challenges that we see out there with the fact that financial markets continue to go up? Is it just simply the corporations because of capitalism, they find a way to make a profit regardless of what the environment is. They're dynamic. And we have this economic system, not just in the US, but in, in many other countries around the world where there's a dynamism in there that they can adapt and adjust to anything that gets thrown at them and still find a way to make a profit.

I mean, I think, of course, the US economy is extraordinarily dynamic. Corporations are adaptable, and they do find a way to make a profit, as you say. But having said all that, the US economy was dynamic 5 years ago, 3 years ago, 10 years ago. I mean, we have the basic same structure of a market economy as we did before. And what's changed this year with the current political configuration is that uncertainty from policymakers is just way higher, right? We don't know whether the tariffs are going to be 10%, 50%, or what. We don't know whether Fed policy will be super aggressive, slightly aggressive, or what. We don't know what kind of Fed chair will replace the current one next year. There's a lot of uncertainty around the rule of law, which is a fundamental bedrock of the US capitalist system. And so I think uncertainty surely makes it tougher to run a business because how do you invest with confidence if you don't know what the basic political and economic operating framework is going to be, you know, 2 years from now. And so I think I am surprised that the stock market is up at a record level, given that we've introduced this uncertainty, which ought to be troubling it. And I guess my leading theory for this is simply weight of money, that people have a lot of savings, they've got to put them somewhere. If you look around the world, the second biggest economy is China and they've got all kinds of capital controls and they are, geopolitical rivals verging on enemies. And so if you put your money in China, it's pretty risky. You might be told as an American investor, you can't get it out again. Probably have to play it through the Hong Kong market, which is a bit complicated. So China's not a great place to go invest. What are you going to do after that? You're going to look at Europe. Well, Europe has all kinds of macro problems, very bad government debt trajectory in a core country like France. Populism in France, populism in Germany, threatening policy stability, a lot of serious issues in Europe. So that's not super attractive. You can look at Japan, but we all know that's been stagnant for a long time. And so what are you going to do?

There is no alternative, right?

The old Tina. Right. It's Tina. Yeah. So you sort of, you know, people freaked out at the beginning of the year, said, I'm taking money out of the US stocks. But then after a while it's like, ah, Tina. Yeah. That's my leading theory as to why the market's up.

Yeah, well, you also touched on something in there too that I think is extremely critical, which is liquidity. So we've just got the one big beautiful bill that was passed that's going to add several trillion dollars in additional, you know, debt beyond the baseline debt that was already going to happen without that bill. And if Trump gets his way and we get someone in there that's going to significantly lower short-term interest rates, I mean, the economy is just awash, at least here in the U.S., it's just awash in money. And we saw during COVID with all the stimulus money, you know, people just sat at home and they traded meme stocks all day long. I mean, that's an exaggeration, but it's like when all this money is thrown out there, people are going to speculate with it. And so it seems like there's some factors here that are certainly underpinning the market that on the surface may not make rational sense. But when you look at what is powering that, with all the money that's out there, it's going to happen. But again, the party always ends at some point. And I think that's the key thing is like, do you happen to have like any signals that you might be watching to say, hey, I think it's about time that this party is going to end? Is there any dashboard, so to speak, that you might monitor to determine if we have to pay the piper here?

Yeah, I think the classic signal, which in fact came into play earlier this year, is the long bond rate. Because the Fed can cut the short-term interest rate, but, you know, investors set the 10-year Treasury rate or the 10-year corporate rate. And I'd be looking at the Treasury rate in particular because I think the US government's debt position now is the worst since the Second World War as a share of GDP. And with the big budget deficit in the big beautiful bill, that's only going to go up. You know, there's a question about whether investors are willing to carry on financing the US government when it's accumulating this enormous debt stock, when debt service payments exceed military spending. And it really is a sort of bit of a tipping point in terms of the debt dynamics of the US. We've been through a period, if we look back to the '90s, you know, there was a period when the government debt was relatively under control. Indeed, government was running a fiscal surplus in the late '90s. And so the debt wasn't a problem because the debt stock wasn't that big. Then you go through the enormous bailout of the financial crisis in 2008. So the government debt stock goes up a lot, but that's fine because you're in quantitative easing, interest rates are super low. So the servicing of the debt is very cheap, even though the debt stock is high. And then you get through COVID and all of a sudden the debt goes up enormously again because of all the spending on stimulus checks and all that. The IRA bill from President Biden, the CHIPS Act, all this industrial policy spending. So the debt goes up and at the same time interest rates go up because inflation is unleashed. And so now you've got the double whammy of a high debt stock and higher interest rates. And the question is where do we go from here? And if the government continues to run big fiscal deficits, that's a signal to bondholders that this may not be quite as a safe bet as it used to be. Maybe the government will have to tolerate inflation to get down to suppress the real value of the debt stock. Because one way you get out of a big debt is you have inflation. If investors expect some inflation, they're going to demand a higher bond rate to compensate for the inflation. But then of course, if they demand a higher bond rate, that causes the cost of servicing the debt stock to go up even further. And then you get that spiral, which is very dangerous. And so the beginning of that spiral is what you saw after the April Liberation Day tariff announcement. And that's why Treasury Secretary Scott Bessant was able to go into the President and say, hey, this is really getting nasty. We can tolerate the stock market going down, but if the bond market goes down and long rates are going up, we have to be really careful. And I think that signal remains the one we all have to watch if we're looking out for something nasty coming down the pike.

2, maybe 3 years ago on this podcast here for Barron's, I interviewed Professor Stephanie Kelton. You may know her, and she's a leading proponent of modern monetary theory. So we don't need to go down that rabbit hole, but that's something to think about as well. It's like you and I are about the same age. I mean, I remember back in the Reagan period back in the '80s, and everybody was complaining about the budget deficit back then. And you look at what the deficit was then as a percentage of GDP, and you look at what it is today as a percentage of GDP, you know, it's dramatically higher. Yet here we are. You know, inflation's under control. And, you know, I'm not an apologist here for massive government deficits. But again, so many people want to have simple solutions to very complicated and nuanced problems. And I think that one of the things I'm trying to get across in this series of episodes here talking about geopolitics is there are no simple answers to these problems. And I'm, you know, having extremely knowledgeable people like you that have researched a lot of these different ideas. It's really interesting to, to get your take on these things and trying to add to a knowledge base here to understand that simple solutions, you know, we have to really dig underneath the surface here and try and identify what are some of the signals out there that we should be watching for to see if there is going to be a turn in the economy, a turn in the financial markets and what are the particular investments that might benefit from those turns as well? And one of the things we've talked about, gold, Bitcoin and whatnot. So there's different things out there that seem to be doing okay in this kind of environment. So I don't know if you have any thoughts on any of that there.

Well, I think you're exactly right, Steve, to sort of put your finger on this point that there are trade-offs and there are difficult choices. So if we think about what the president would like to see happen, he'd like the Fed to cut rates. And that would help him out in that the big national debt might become cheaper to service, to pay the interest on. Now I say might, because of course, as I said before, you could cut the short rate and find the long rate goes up, right? That's possible. But okay, let's just assume that the playbook works and you cut short rates, long rates come down too, and then it's cheaper to service debt. That's the president's vision. The problem with that vision is that With lower rates combining with a big fiscal stimulus, what you get is inflation. And that's precisely what happened when the Fed held rates low during COVID at a time when the government was spending a lot on COVID relief. And that's not the only reason, because there were supply chain bottlenecks too. But that's one reason, maybe the most important reason is just that this big demand shock from fiscal policy, putting more money into the system and not counteracting that with higher interest rates. And so the risk in— you can go with the president's vision and get the debt service down, but then you get inflation. If you want to avoid inflation, you have to put up with the high interest rates. And it was in some sense, this sort of dilemma that led Nixon back in 1971 to just blow up the whole monetary system. The dollar had been anchored to gold, and he just broke that link because he was in a position where to keep the link, he would've had to have much tighter fiscal policy, much tighter federal budgets. And he didn't want to take the political pain of delivering tight federal budgets. So he said, you know, the heck with this. And he just inflated his way out by devaluing the currency, letting inflation rip, by bullying the Federal Reserve so that it wouldn't raise rates. And then you got the 1970s inflation that we all remember, and that was a painful thing to get out of. It took two recessions, not one, when Volcker came in to squeeze the inflation out of the system. So that's just deferring the pain. It's not avoiding it. And I hope we don't go down that path of letting prices get out of control, but that is clearly the trade-off that the president seems to favor.

Yeah. And we actually talked about the Nixon shock in the last episode with Edward Fishman, who I know you know. If you want a little more detail on that, you can certainly go back to that episode with Edward Fishman and get some detail there. So you mentioned Nixon here a couple of times. So of course we've got Watergate, and in 1976 the film came out, All the President's Men, and one of the most famous lines from that film was, 'Follow the money.' So as you think about this idea of follow the money, who or where does global financial power actually reside today if you're following the money?

So if we're talking globally, one of the big shifts in the last, I don't know, 10 years or so has been the rise of the Persian Gulf, the UAE, Qatar, Saudi Arabia, sort of more vibrant, more sophisticated players in the global financial system. And they've accumulated enormous savings and sovereign wealth funds because of the energy exports that they've produced over time. And they really want to deploy that capital into technology companies, other things around the world, real estate, what have you. And so there are enormous pools of capital in the Middle East, which often explain non-Middle East names. Like, you know, if you take Masayoshi Son, the technology investor and his Vision Fund, you know, where did the Vision Fund come from? He went to the Persian Gulf and raised the money there. If you look at famous American private equity funds, where are they raising money? Well, all over the place, but including quite a lot in the Middle East. So I think that's an interesting shift in how global finance works. The rise both in amounts of money, but also in sophistication. The story in the '70s was there were high energy prices. Saudis had a lot of money. They deposited at Citibank. Citibank then lent it out to Latin America. The Latin Americans went bust. So that was intermediated through the banking system. So you had a banking crisis, but today it's intermediated in a much more sophisticated way through all kinds of capital markets operations, whether that's, you know, huge large-scale private equity, whether that's venture capital in Silicon Valley, whether that's real estate funds. But the UAE is a bit of a melting pot. Dubai, you know, Abu Dhabi, of kind of crossroads of financial power.

So you wrote a book called More Money Than God back in, I think it was 2010. And that's how I first found out about you. I read that book. I thought it was phenomenal, basically talking about the hedge fund world. And then you also wrote a book called The Power Law, which is your most recent book about venture capital. And in both of those, I don't know that you explicitly say this, but you seem to imply that power doesn't necessarily reside in, say, Washington or Beijing or, you know, some other of these power centers like the Middle East that you just talked about, but it may reside more with the people who have the capital. And so when I talked about follow the money, it's sort of like follow the capital. But in this age of AI, do you think that that may be changing? And so now, rather than power resides with capital, maybe it's more like power follows compute in the sense that are we really heading toward a world where the most important institutions are no longer governments or even firms, but maybe it's AI models? And if so, who would end up as the central bank of AI?

That's a great question. So I think you're right. And in a way, obviously as a writer of books, I try to, you know, focus on whatever seems exciting and sort of not exciting in a kind of, oh, this week exciting, but a kind of this decade exciting is what I'm trying to do. So as you say, I wrote a book about hedge funds, which came out in 2010. Hedge funds had had a terrific boom in the previous maybe 15, 20 years. And I was kind of describing that and describing this pinnacle moment for hedge funds. Then with the Wall Street crash, the Dodd-Frank financial regulation, you had a bit of a clampdown on finance and then quantitative easing compressed all the spreads in markets. And so if you think about a hedge fund as somebody who is paid to price risk, you might price one bond relative to another bond or one stock relative to another stock brilliantly well. But if all the spreads between these different instruments have been compressed, you're just not being paid as much to get it right. And so hedge fund returns went down in the 2010s. And I wrote a book then, the one about Greenspan and central banking, which came out in 2016. But my next book was about venture capital because technology had become the new Wall Street. Technology was the source of extraordinary power, extraordinary profits, extraordinary dynamism in how the capitalist system was working. And I think you're right that AI is the new thing. And not coincidentally, my next book, which I've now written, but it hasn't come out yet, is about one of the major AI labs. And I think that is the locus of power. Now, is it the models or is it the people who build the models? I mean, for the moment it's the people, right? It's the—

Well, and Zuckerberg would agree with that, right? Because he's paying the $100 million to get these people.

100%. You know, you see that in the salaries. And even before Zuckerberg was throwing silly money around in the last month or so, the salaries of AI scientists were off the charts, you know, in the multimillion package. Even if it wasn't $100 million, it was still more than a million. So that tells us that the expected value being created by AI scientists and AI engineers is really, really enormous. If you look at the uptake of ChatGPT after it was released in November of 2022, it was the fastest uptake of any online product ever. And I suspect it's true that Sam Altman the leader of OpenAI, has created more paper value. Like if you take the notional value of OpenAI as established by private funding rounds, he's probably created more value faster than anybody else ever. Just the speed of it from 21, 22 to 4 or so years later now, it's been incredible. I forget the latest valuation, but it's right up there. And so I think that's where power does reside in the hands of an amazingly small number of AI builders. And finance is kind of just throwing itself at these AI firms to kind of get participation. Interestingly, without necessarily a very good theory of how the monetization is going to make it financially sensible. I mean, it's a bigger version of the broadband bubble in the late 1990s where everybody understood because of the internet that building high bandwidth communications infrastructure, fiber optic and so forth, was going to be very important. It was an A+ technology, but it turned out to be a, you know, D- business model and all those broadband builders essentially went bust and investors lost their shirts. Because there was overcapacity created and nobody could monetize, right? And in some ways, AI now looks a bit like that. You've got OpenAI, you've also got Google's Gemini, you've got Anthropic's Claude model, you've got Elon Musk's Grok, the xAI project, you've got Microsoft building its own internal models now, you've got a bunch of Chinese labs, you've got Mistral in France. Now, all of these people are building frontier AI chat technologies. And so ChatGPT is by no means a monopoly. In fact, you can switch out and get pretty much the same service from at least 2 or 3 or 4 competitors. And so how do they monetize in the future? And it may work, right? They are charging some people $200 a month for their high-tier service, and people are paying that. But is that sustainable? Can you ramp that up to offset the enormous costs of buying the data centers, buying the power generation you need? We don't know. It could be a genius investment. It could be a terrible investment. And so I do feel like finance is chasing talent where talent has the upper hand. We know that the people getting paid $100 million by Meta are going to be paid $100 million. We don't know that the investors who are pouring money into OpenAI are going to make a good return.

You're a journalist, you're a writer, you understand the importance of narratives. So let's say that as time goes forward and we have short-term interest rates are slashed by 3 percentage points, the economy, the markets, they continue to just melt up. We've got this surge in liquidity and we've got AI, which is out there generating all of this content. It's driving specific narratives. And we're sort of getting into this era of an algorithm-driven speculative storytelling situation. Is there a possibility that we could be entering sort of a post-truth regime where technology and AI unleashes a storytelling narrative that does it faster and more effectively than anybody's ability to really process the underlying fundamentals. Could we enter a situation like that? And if so, what might the implications of that be?

Yeah, I mean, when I think about this question, I borrow an idea from the writer Yuval Harari, who wrote a bunch of great books. Sapiens was his first big hit, I think. And he has this point that what marks humanity off from other species on the planet is the ability to tell stories. Stories unite groups of people, allow us to coordinate actions over big groups, whole nations sometimes, because we share common narratives that allow us to collaborate together. And a narrative might be a belief in the US dollar, for example. I mean, why is this piece of paper in my wallet worth anything? It's because we all believe the story that it's worth something. And it's a powerful narrative set up over a bunch of time with the Federal Reserve behind it to make it work. And so that's why we can have a big successful economy because we have one currency that we can all believe in. And I think Yuval Harari's point is that you can hack the operating system of human society. If machines are now going to create the narrative, if the most compelling stories are going to be coming from AI, and that could include AI video, right? Because there's programs like Veo produced by Google, which make these incredibly compelling on-demand, believable, but potentially totally fake videos of what looks like real but isn't. So I do worry in some sort of very big picture sense that Narrative is in danger of spinning out of control. People can make up any story they want. I mean, I give humans credit enough to believe that they will react against that. They'll be smart enough to figure out that you have to be careful what you believe. And it's also true that we shouldn't pretend that narrative has been always true, always stable, always shared in the past. I think there was probably a kind of golden era of common narrative when everybody watched Walter Cronkite on the evening news, whenever that was, '50s, '60s, '70s.

And believed him.

And believed him, right. But we've had the splintering of the kind of three-network oligopoly on news relating, you know, ever since the rise of the internet, the rise of podcasts, the rise of talk radio, the rise of social media. So this has been a long process of moving from kind of unified perceived truth to much more contested truth. And AI is another twist in that ratchet. So there was the yellow press at the turn of the 19th, 20th century when all sorts of stories were being made up. So humanity has been through these periods of fake news before, and we survived it. And I hope that we'll figure it out again. But it's certainly something to watch.

So hopefully we'll end here on a positive note. So I want to give you the final word here. So you're talking to a world full of financial advisors out there. What are some final parting words of wisdom that you would want to share with financial advisors as they think about how they should be helping guide their clients through all this uncertainty that we find ourselves in the world today?

You know, that's a really great question. And I think today allocating money is as challenging as I can ever remember. I mean, I've been writing about money management for a long time, and my book on hedge funds was 2010, but obviously I was doing journalism for The Economist magazine on money management before that by a long way. So in my, you know, rather embarrassingly extended period of watching all this, I do really think that this is just super uncertain because you've got the geopolitical uncertainty, you've got the kind of political domestic uncertainty as we discussed with the current administration. And then you've got this extraordinary technological upheaval with artificial intelligence, which is just on a different magnitude to what the internet was, I believe, in terms of the impact it's going to bring. So it is difficult. And I think difficulty means probably more— I would sort of advocate a kind of barbell strategy here. One is that you're playing defense to some extent, you're diversifying your bets, because it is uncertain and your portfolio needs to account for the fact that we could get a big spike in inflation if you had a different Fed chair who did cut rates by 3 points, as you were saying. I mean, that is a very, very, very inflationary scenario when you look at the fiscal position that the federal government is also— we've got double injection of money. You need to be a bit hedged against inflation. At the same time, the US preeminence I still believe in it, but I think it's less certain than it was 2 years ago. So I think slightly less overweight the US than has been traditional for many portfolios in the last 10, 15 years where overweight the US was clearly the right thing. I think now being a little bit more global in your allocation probably is smart. And then I would say, think about AI. As I said, it's hard to know who monetizes, but I think we do know that it's going to come, it's going to drive up productivity, it's going to drive up growth rates. What does that mean? I would say, for example, it means that real estate in the center of desirable cities has to go up because there's going to be more, a bigger GDP, and it's going to be unevenly distributed. And the people who have a lot of money to spend, one thing they reliably will want is real estate in desirable places. And so that feels to me like people played the Silicon Valley story through real estate. If you owned real estate in the Valley, that was almost as good as owning stock in Apple. And so I think in a world where you can't tell whether NVIDIA wins or Google wins or Meta wins or whatever, and by the way, the winners might be private companies, which are hard to get your money into. So you can't even do that. Real estate might be a proxy for how to play this game. So I think some sort of collection of bets that you can get into directly in AI and energy and data centers makes sense. But then I would say that the classic sort of positional good is real estate and positional goods, you know, survive inflation, survive inequality. And I think that's a pretty good bet.

Sebastian, this has been fantastic. I appreciate your, your time here today. And for folks that they want to stay in touch with you and the great work that you do, of course, they can look up all your books at their favorite place to get books. But is there another way for them to stay top of mind with the work that you're doing?

Well, I'm a senior fellow at the Council on Foreign Relations, the New York-based think tank. And so you can look me up at Sebastian Mallaby, Council on Foreign Relations, or CFR. But my main focus is book writing. So please take a look at those books, and there'll be a new one out soon about AI.

All right. That's all for today. Make sure you like and share this podcast through your favorite social platforms And for more great podcasts, visit us at barons.com/podcast. Take care and be safe.

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