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The Money Squeeze That's Choking the Economy — Transcript

by Casual Finance · 3,318 words · 485 segments · language en · Watch on YouTube

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0:00In the last 4 weeks, seven central banks
0:02raised interest rates. New Zealand went
0:04first, then Europe, then America, then
0:06Japan, then South Africa, Norway, and
0:08this week, Australia. For America, it
0:11was the first rate hike in 3 years, and
0:13every single headline said the same
0:15thing about it. Central banks raise
0:17rates to fight inflation. 9 days after
0:19the Fed hike, billionaire investor Bill
0:21Ackman posted a question on a platform I
0:24still refuse to call X, and it set off
0:26an argument across the entire finance
0:28industry. I think the Fed might have
0:30just made a mistake. Am I right or am I
0:32wrong? To understand what he's trying to
0:34say, you have to start with what a rate
0:36hike is actually supposed to do. A
0:38central bank doesn't control prices. It
0:41controls the price of borrowing money.
0:43So, when the Federal Reserve, or any of
0:45the other six, raises rates, it's making
0:47money more expensive on purpose. More
0:49expensive money is supposed to mean less
0:51borrowing. Less borrowing means less
0:53building, less hiring, and less
0:55spending. Fewer dollars chasing the same
0:57stuff is what's supposed to slow the
0:59economy down and cool prices off. That's
1:02the playbook the Federal Reserve has run
1:04since the dawn of time, but there's a
1:05problem with running the old playbook on
1:07the new economy. The single biggest
1:09driver of investment in America right
1:11now is the AI buildout. And no, this
1:13isn't another one of the AI is a bubble
1:15videos you've probably seen a million
1:17times on YouTube, but you can't follow
1:19what's happening to the price of money
1:21without talking about the people
1:22spending the most of it. Bill Ackman's
1:24point is that the race to build
1:25superintelligence has, in his words, a
1:28near infinite return on investment. So,
1:30the people in the AI race will pay
1:32whatever it costs to get more money to
1:33invest. He laid it out as a question.
1:36What if higher rates don't reduce demand
1:38and investment, and the demand for
1:39compute will remain incalculable? Mark
1:42Zuckerberg said the exact same thing
1:44last year. If we end up misspending a
1:46couple of hundred billion dollars, I
1:48actually think the risk is higher on the
1:50other side. That's a man describing a
1:52few hundred billion dollars spending
1:53mistake as the safe option. That's also
1:56the basis of Ackman's claim. A rate hike
1:58is meant to slow demand and investment,
2:01but this one can't work because it
2:02doesn't reach the one thing the Fed
2:04needs it to reach. And the Fed's own
2:06people are saying the same thing. This
2:08week Fed Governor Lisa Cook said it in a
2:10speech, "In the short term, AI appears
2:12to be adding inflationary pressures to
2:14the economy, postponing inflation's
2:16return to our 2% target." But how do a
2:18bunch of companies racing to build the
2:19world's best brain rot generator end up
2:21causing persistent inflation? Now, this
2:24is going to get a little nerdy and
2:25technical for a second, but bear with me
2:27because it'll all make sense by the end
2:28of the video, and it explains the whole
2:30argument Ackman is making. The Fed's
2:32playbook of hiking rates only works if
2:34borrowers actually respond to the rate
2:36increases. Money gets expensive,
2:38companies pull back, and demand cools
2:40off. But if the thing a company is
2:41buying is something they believe they
2:43have to buy to stay competitive, like
2:45energy or AI compute, then the companies
2:47are going to buy it at any price, which
2:50creates a situation where demand doesn't
2:51respond to the price at all. Economists
2:54call that inelastic demand. When this
2:56happens, interest stop working as a
2:58break. It just becomes another input
3:00cost. Companies don't stop borrowing,
3:02and they don't stop building. They eat
3:04the higher interest expense as a cost of
3:06doing business. And instead of demand
3:08falling, that higher cost of capital
3:10gets passed through to the market as
3:11higher prices, to the consumers, to you
3:14and me. This is what's known as cost
3:16push inflation. It's what happens when
3:18buyers aren't doing anything different,
3:20but the raw ingredients, the energy or
3:22the debt it takes to make the product
3:24got more expensive. So, the business
3:26passes you the bill. And this isn't some
3:28fringe idea. This mechanism even has a
3:30name, the cost channel of monetary
3:32transmission. A 2002 study from the
3:35National Bureau of Economic Research
3:36found that in the '60s and '70s, rate
3:39hikes didn't cool prices down first.
3:41They actually did the opposite. A
3:43surprise quarter point hike pushed
3:44consumer prices up for more than 2 years
3:46before they finally started to fall.
3:48Because when debt and interest become
3:50essential inputs, making them more
3:52expensive doesn't kill inflation. It
3:54just gets written into the final price
3:55tag consumers pay, which is where we are
3:57today. Big tech is pouring hundreds of
3:59billions into debt-financed AI data
4:01centers with no sign of slowing down.
4:04That's how Ackman lands on his
4:05conclusion, the hike doesn't cut
4:07inflation, it adds to it. Then the Fed
4:09sees inflation rising and hikes again.
4:11In his words, "And the problem is
4:13compounded as the more the Fed raises
4:15rates, the more inflation we will have,
4:17and the more the Fed will need to raise
4:19rates further and so on, which turns
4:21into a loop. The hike feeds inflation,
4:23and inflation feeds the next hike."
4:25Ackman thinks that ends in a spiral. And
4:27to be fair, we've already seen this
4:29start to play out right in front of our
4:31eyes. But before I show you that, let's
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5:48Now, back to what's currently unraveling
5:50in the markets. The Fed raised rates on
5:52a Wednesday. On Thursday, CoreWeave, the
5:54company that rents AI chips out to
5:56everyone else, launched a $3 billion
5:58bond sale. By Friday, they had so many
6:01orders, they raised the size of the sale
6:03to 3.7 billion. That same Friday, a
6:06Bitcoin miner called CleanSpark sold
6:08$2.3 billion of junk bonds at 8 and 1/4%
6:12to build a data center in Georgia for
6:14Meta. It was the first junk-rated bond
6:16ever sold on a Meta data center and
6:18attracted demand more than four times
6:20the deal size. Then, the next week,
6:22SoftBank sold $11.1 billion of bonds in
6:25the largest high-yield corporate bond
6:27sale in history to pay for its stake in
6:29OpenAI. And then, Akamai signed an $11.6
6:33billion deal to supply computing power
6:35to Anthropic. And finally, Anthropic's
6:38public filings this week showed Broadcom
6:40lending them up to $42 billion to lease
6:42chips. So, add it all up, and in the two
6:45weeks after the first American rate hike
6:47in three years, after the Federal
6:49Reserve tried to slow down demand and
6:50investment in the economy, the AI race
6:53lined up roughly $70 billion in new
6:55financing. This year, AI companies are
6:58spending roughly $15 billion a week. But
7:01in the two weeks following the rate
7:02hike, borrowing was roughly $35 billion
7:04a week, which means the Fed raised the
7:06price of borrowing money for the first
7:08time in three years, and the AI
7:10companies responded by borrowing at
7:12nearly double the pace of the current
7:14spending. And to top it off in the week
7:15after the hike, Goldman Sachs raised its
7:17forecast for next year's AI spend to
7:20$1.2 trillion.
7:22That's inelastic demand, the thing you
7:24slept through in freshman econ. This is
7:26what it looks like in the wild. The Fed
7:28raised the price of money, and the one
7:30borrower it needed to slow down didn't
7:32slow. So, the question is, if the hike
7:34didn't slow borrowing, then what did it
7:36do? Because a higher interest rate
7:38doesn't just disappear. It shows up
7:41somewhere. And to find where, you have
7:43to know what the price of money is
7:44actually made of. When you lend somebody
7:46money, you're asking for two things
7:48back. The first is protection, or the
7:50inflation premium. Whatever inflation
7:52eats over those 10 years, you want that
7:54paid back. Otherwise, you'd lend a
7:56dollar and get back 80 cents. The second
7:58is a fee, or the real interest rate, an
8:00actual payment for going a whole decade
8:02without your own money. That fee is the
8:04real price of money. Normally, those two
8:06get mashed together into one number.
8:08That's the headline number you see on
8:09the news. But, America sells two kinds
8:12of bonds, the regular kind, and a kind
8:14where the payments rise with inflation,
8:16called TIPS, where the protection is
8:18built in. When you put the two side by
8:20side, the gap between what they pay is
8:22the bond market's own inflation
8:24forecast, updated every trading day. And
8:26whatever's left over after you subtract
8:28it, is the real price of money. Which
8:30means the bond market has been
8:31publishing its own inflation forecast
8:33every afternoon for years. And the
8:36entire financial press has been asking a
8:38guy on Bloomberg instead, like he's got
8:40a crystal ball. So, here's what that
8:42forecast did over the two weeks after
8:43the Fed hike. The same two weeks Japan,
8:46South Africa, Europe, Norway, New
8:48Zealand, and Australia all hiked, too.
8:50The day before the Fed hike, it sat at
8:532.38%.
8:54Today, it's less than that. The wrong
8:56direction for the headlines. And it's
8:58lower today than it was back in May.
9:00Headline inflation is 3.4%.
9:03Strip out food and energy, and it's 2.4,
9:06the lowest since 2021. But, the point
9:09isn't that inflation's fine. It's that
9:11the market, whose entire job is pricing
9:13inflation, looked at seven rate hikes
9:15and didn't flinch. The market isn't
9:17betting the hikes make inflation worse.
9:19It isn't betting inflation gets worse at
9:21all, which should mean borrowing costs
9:23are calm, except they aren't. It cost
9:25America more to borrow for 10 years
9:27right now than at any point since 2001.
9:30Britain is paying the most since 1998.
9:32Germany, since 2011. And Japan, the
9:35country that spent 30 years paying
9:36almost nothing, the most since 1996. The
9:40biggest economies on Earth all paying
9:42more at the same time. So, the inflation
9:44forecast from the bond market is flat,
9:46and borrowing costs are at the highest
9:48levels in decades, both at the same
9:50time, which means the world isn't paying
9:52up for inflation. So, what is it paying
9:54for? Go back to the day before the hike.
9:56Since then, the 10-year is up about 30
9:58basis points. The inflation forecast, as
10:01we just covered, is down. So, all of
10:03that rise and then some is the real
10:06price of money. Then, if we go back
10:08further to May 4th, or more commonly
10:10known as Star Wars Day, that's the day
10:12the inflation forecast peaked and
10:14started falling. Since then, the real
10:17price of money is up almost a full
10:18point, and a third of that full point
10:21showed up in the 2 weeks after the hike.
10:23Then, if we keep going back even further
10:25to February 27th, or more commonly known
10:27as International Sword Swallowers' Day,
10:30that was the day before the war shut
10:31down the Strait of Hormuz, the 10-year
10:33is up more than a full point since then.
10:35The inflation forecast accounts for
10:37about 10 basis points of that. The real
10:39price of money is all the rest of it,
10:41which means 92 cents of every dollar of
10:44this year's rise is the price of money.
10:46The market isn't paying up for
10:47inflation, it's paying up for money
10:49itself, and the reason why comes down to
10:51who's bidding the price of money up.
10:54This year, governments and companies are
10:56borrowing about $29 trillion from the
10:58world's bond markets. That's the count
11:00from the Organization for Economic
11:02Cooperation and Development, the club
11:05world's developed economies. It's a
11:07record, and about 4 trillion more than 2
11:09years ago. In a normal auction, when the
11:11price keeps going up, hands keep going
11:13down. That's the whole idea of a rate
11:15hike. Make money more expensive, and the
11:17room thins out. Except two bidders in
11:19this room don't check the price, and
11:21they're the two biggest bidders in the
11:23room. The first is every government on
11:24Earth. Governments across the developed
11:26world will sell about 18 trillion
11:28dollars of bonds this year, up from 12
11:30trillion 4 years ago, and 78% of that
11:34isn't paying for anything new. It's
11:36replacing old debt as it comes due and
11:38rolling it over at today's higher rates.
11:40They aren't borrowing for anything new.
11:42They're borrowing because the bill came
11:44due and they had to pay for it. The
11:46second bidder is the AI race. On the day
11:49of the hike, the new Fed chair, Kevin
11:51Warsh, was asked why long-term rates had
11:53been climbing all year. He gave three
11:55reasons. The economy is strong,
11:57geopolitics, and in his words,
11:59competition for capital. The so-called
12:01hyperscalers are out in the market
12:03raising funding, and so the competition
12:05for capital is real. Two weeks later,
12:07Isabel Schnabel of the European Central
12:09Bank said real interest rates, the real
12:11price of money, have risen at a time
12:13when the global economy is facing
12:15substantial demand for funding from both
12:17the public and private sectors as fiscal
12:19deficits remain elevated across many
12:21countries and the AI buildout advances.
12:23Translate all this out of central bank
12:25speak. Governments and the AI race are
12:27bidding for the same pile of cash, and
12:30that demand is pushing the price up. And
12:32to see how far this has gone, just look
12:34at where the price of money was 5 years
12:36ago. Money was so available that in
12:38August 2021, the real price of 10-year
12:41money in America was negative 1%.
12:44Lenders were effectively tipping the
12:45government for taking their money off
12:47their hands. Today, it's nearly 3%, the
12:50highest since 2008, a swing of more than
12:53four full points. Kevin Warsh described
12:55it in a speech that should have been
12:57called the good old days. He said, "It
12:59was a widely held view that an excess of
13:01capital would sit on the sidelines for a
13:03long, long time. All the good stuff had
13:05been invented, so growth would be low
13:08and slow." Then he said, "Well, times
13:10sure have changed. We've come to a hinge
13:11point in history." What he's basically
13:13saying is somebody invented a chatbot,
13:16and those chatbots are expensive to run.
13:18And this isn't the first time America's
13:19been in a similar position. 60 years
13:22ago, in 1966, the country faced the same
13:25squeeze. A government spending more and
13:27more to pay for a war in Vietnam and a
13:29business investment boom so hot that
13:31companies were ordering machines faster
13:33than anyone could build them. The
13:34president's message to Congress that
13:36September said, "There is a 10-month
13:38average backlog on machine tool orders
13:40alone. On many machine tools, the order
13:42backlog exceeds 15 months." So, the Fed
13:45did what the Fed does when they need to
13:47slow things down. They pushed the policy
13:49rate from a little over 4% to nearly 6
13:51by November, but the boom didn't care.
13:53Business investment still rose more than
13:5512% that year. Banks only had so much to
13:57lend and businesses were paying whatever
13:59it took to borrow it. So, the money went
14:01to the factories and the mortgage market
14:03went dry. Housing starts fell 38%
14:06between January and October. The rate
14:08hike didn't stop the bidder who wasn't
14:10checking the price. It stopped the one
14:12who was. So, President Lyndon B. Johnson
14:14stopped raising the price and went after
14:16the bidder. He said, "Our capital
14:18markets are clogged with excessive
14:20demands for funds to finance investment.
14:22These demands bid interest rates higher
14:24and higher and draw too large a share of
14:26credit from other important uses." And
14:28on November 8th, 1966, President Lyndon
14:31B. Johnson signed a law suspending the
14:33investment tax credit. He took the
14:35subsidy away, which in his words was to
14:37restore more normal interest rates and
14:39ease tight money and credit conditions
14:41and to free funds and resources for home
14:43building. Within months, the Fed was
14:45easing and housing starts were climbing
14:47again. And the next year, business
14:49investment didn't grow at all. The break
14:52that worked wasn't raising the price of
14:53borrowing. It was a break on the bidder.
14:56If the biggest bidder in the room
14:57doesn't check the price, raising the
14:59price doesn't stop him. It just clears
15:01out everyone standing behind him. So
15:03now, look at today's room. The AI race
15:06has only been speeding up. The week
15:07after the hike, Wall Street raised its
15:09forecast for it. A Fed governor says
15:11it's inflationary. The Fed chair says
15:13the competition for capital is real and
15:15the only break being pulled is the one
15:16that doesn't slow them down, which is
15:18also where I come in for a quick
15:20shameless plug. Every headline this
15:22month pinned the blame on inflation.
15:24Meanwhile, the bond market's own numbers
15:25have been saying something else all
15:27year, and almost nobody listened. That's
15:29what this channel is for. I spend a lot
15:31of time researching to make these
15:32videos, so if you found any of this
15:34interesting, it would mean the world if
15:35you hit subscribe and left a comment
15:37letting me know what you thought of this
15:39video. Because seven central banks
15:41raised the price of money this month by
15:42hiking rates. It's a 100-year-old tool
15:45built for an economy where the biggest
15:46borrowers in the room check the price.
15:48Where expensive money meant the economy
15:50slowed down and prices cooled off.
15:52That's the whole playbook under attack
15:54from the start of this video, but it
15:56only works if somebody flinches. And the
15:58people the government needs to flinch
15:59aren't flinching. The biggest borrower
16:01took on $70 in the two weeks after the
16:03hike, and then watched Wall Street raise
16:05its forecast for next year anyway. The
16:07second biggest is every government on
16:09earth borrowing to stay borrowed because
16:11the debt matures when it matures. And
16:13the world where that didn't matter, the
16:15one where money was free and lenders
16:17tipped the government to take their
16:18cash, is gone. Kevin Warsh said it
16:20himself, "Times sure have changed." And
16:23that's the problem. The world the rate
16:25hike was built for isn't the world we're
16:27in today. It's the old playbook on a new
16:29economy.
16:34>> [music]

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