What is up with the American political economy and financial markets?
Federal government spending’s running at an annual deficit of $1.9 trillion. What’s more, private financial markets are undertaking a capital-intensive technology buildout with only a hypothetical understanding of how it will all be paid for.
But that’s not all. There are persistent supply constraints, escalating geopolitical chaos in the Middle East, and relentless political pressure from President Trump on Federal Reserve Chair Kevin Warsh to cut interest rates in the face of elevated consumer price inflation. What’s an investor with a small pile of retirement savings that he schlepped day in and day out for over 30 years to do?
This does not appear to be a standard run of the mill business cycle driven by consumer confidence or inventory management. Rather, it appears that fiscal and monetary policy, geopolitical reality, and massive technological ambition are bumping into physical capacity limits. Understanding what’s going on is essential for anyone trying to preserve capital or position their portfolio for the coming decade.
The standard macroeconomic policy guide outlined by Keynes called for contracting government spending and allowing the private sector to carry the load during periods of economic growth and tight labor markets. Instead, policy makers have pursued several decades of mega federal deficits, even through periods of economic expansion. This has produced a national debt that tops $40 trillion.
At this point, government spending has become completely disconnected from the underlying economy. Swelling entitlement obligations and massive defense spending have turned fiscal expansion into a standard operating procedure rather than an emergency response tool.
By refusing to constrain its borrowing and spending, the U.S. government has created a massive structural demand for capital. The U.S. Treasury must continuously issue trillions of dollars in fresh debt to refinance maturing obligations and fund current deficits.
Fueling the Fire
In an environment with elevated inflation, Treasury investors normally demand higher yields to hold this excess of debt. At the same time, debt service costs and political expediency demand cheaper money. This is why President Trump pounds the table and beats his chest for lower, artificially suppressed, interest rates, regardless of whether the underlying inflation landscape warrants such monetary easing.
When political mandates demand lower interest rates while government spending and fiscal deficits are completely out of control, the Fed must choose between accommodating the federal debt burden or containing runaway consumer price inflation.
Lowering the federal funds rate in the face of a $1.9 trillion deficit is like hitting the accelerator while the engine is already running hot. It introduces additional liquidity into an economy that has been distorted by too much credit to begin with. This makes returning to the Fed’s arbitrary two percent inflation target impossible.
Moreover, while more credit can be created out of thin air, additional supply of goods and services cannot. The war in the Middle East has escalated beyond a localized crisis. Global shipping capacity and insurance markets are being stressed. Container ships, forced into long, costly detours around major choke points, are consuming more fuel.
These supply line disruptions directly feed into consumer price inflation. But unlike consumer price spikes driven by temporary retail supply and demand imbalances, the current increase in prices is driven by higher input costs for raw commodities, diesel fuel, and basic chemicals.
As these fundamental inputs become more expensive, those cost increases ripple through every aspect of the economy. Manufacturers, builders, and oil refiners face rising capital expenditure requirements just to maintain existing operational capacity.
Shortages are no longer isolated occurrences that can be quickly addressed by economic activity. High-end transformer units for electrical grids now require multi-year lead times. The availability of rare earth elements and critical industrial metals in the U.S. are suffering from chronic underinvestment in mining and refining infrastructure. Thus, raw building materials carry heavy geopolitical risk premiums.
And as physical input shortages meet continuous credit creation, the price of real physical assets and necessary industrial inputs move relentlessly higher.
Betting the Farm
Now, added on top of this delicate financial and economic environment is the largest technological capital spending boom in modern history. Building modern data centers to serve the uncertain promise of Artificial Intelligence requires vast amounts of specialized hardware, massive expanses of land, and extraordinary quantities of electrical power.
Hyperscalers and technology companies – like Microsoft, Alphabet, Amazon, Meta, and Oracle – are pouring hundreds of billions of borrowed dollars into transformer yards, custom cooling systems, high-bandwidth interconnects, and advanced semiconductor collections. In fact, hyperscalers are collectively expected to spend nearly $700 billion on capex in 2026 alone.
Yet there is no guarantee there will be revenue to support the investment. They may, in effect, be setting money on fire.
What began as an effort financed directly out of cash flows generated by highly profitable software and search monopolies has moved toward debt markets and outside structured financing. Silicon Valley and Wall Street have joined forces to construct complex off balance sheet Special Purpose Vehicles (SPVs), private credit arrangements, and asset-backed debt instruments to fund the endless purchase of chips, turbines, and real estate.
As the technology sector consumes capital from corporate bond markets and private credit institutions at this scale, it competes directly with U.S. Treasuries and traditional industrial borrowers for global savings. This massive draw on financial capital accelerates the upward pressure on long-term real interest rates. Hence, we have a situation where capital is becoming expensive precisely when the real economy needs it most for the AI infrastructure buildout and energy grid upgrades.
And again, where will the return revenue come from? A computer chip or an AI algorithm can be duplicated at nominal marginal cost once created.
According to Jessica Wachter, a finance professor at the University of Pennsylvania’s Wharton School, “If a productivity boom fails to materialize, the current buildout will be the largest misallocation of capital in history.”
In short, hyperscalers are betting the farm on what may end up being a very lean harvest. Without a bountiful yield how will they ever pay back all the money they’ve borrowed?
Beyond Speculative Bets
As debt-financed capital pours into data center construction, it accelerates competition for the exact same physical resources needed to rebuild domestic manufacturing, expand grid reliability, and build housing. Local power utilities will have to choose between serving residential customers or offering long-term power purchase agreements to massive data center operators.
The resulting competition pushes energy rates higher across the entire economy. This means increased operational expenses for traditional businesses and higher utility bills for households.
In addition, because these data center projects are increasingly leveraged through structured finance, the broader financial system absorbs significant concentration risk. If the hypothetical revenue streams from AI applications take longer to materialize than debt maturities specify, these buildouts will run out of capital.
You see, debt-funded capital expenditures, like a power plant or a toll road, require immediate, predictable returns to satisfy interest obligations. But the rollout and use of AI in a way the generates meaningful revenue – if ever – follows an unpredictable timeline.
Given this landscape, it is likely that over the next decade stock market investors will be disappointed in the returns they receive from a growth fund or S&P 500 index fund. When money was virtually free, public debt was manageable, and energy costs were stable, high multiples could be applied broadly across the entire stock market. But in an environment characterized by elevated consumer price inflation, higher interest rates, and elevated input costs, index level growth will be far different than what was experienced over the last decade.
Companies that own hard physical assets, hold long-term power contracts, control scarce raw material supplies, or maintain absolute pricing power will thrive. We believe the stock market will increasingly reward real cash generation, and reliable dividend payments, over speculative long-term revenue promises.
Investors who are early to recognize the physical and financial realities the American economy and financial markets are facing will be far better positioned to preserve real wealth and capture sustainable long-term returns in the years ahead.
[Editor’s note: Get a free copy of an important special report called, “Anti-Fragile Bargain – Why You Should Own this Monster Dividend Fortress,” when you join the Economic Prism mailing list today. If you want a special trial deal to check out MN Gordon’s Wealth Prism Letter, you can grab that here.]
Sincerely,
MN Gordon
for Economic Prism
Return from When Capital Hits Physical Limits to Economic Prism
