Markets are betting on an endless fiscal firehose to keep asset prices soaring, but a deeper look reveals a critical miscalculation. This analysis unpacks why incoming tariffs could flip the script from fiscal expansion to a sharp economic deceleration, challenging the entire "run it hot" thesis.
The Great Fiscal Head Fake
- “We got a bit of a head fake when the big beautiful bill came out... they didn't include any tariff revenues in that scoring... it's actually more likely that when you consider tariff revenue, we're going to go from say 7% of GDP deficit to... six, maybe even like five and a half.”
- “The US will still run deficits, but on an acceleration basis, it will look like a car that's still going at 100 km an hour but is decelerating because last year it was at 120.”
Initial government scoring of new fiscal bills suggested the US deficit would balloon from 7% to 8% of GDP, fueling bullish sentiment. However, this analysis critically omitted tariff revenues. When factored in, these tariffs could shrink the deficit to as low as 5.5% of GDP, creating a fiscal drag rather than a stimulus. For markets, the rate of change matters more than the absolute number; this slowdown represents a major deceleration, threatening the narrative of ever-increasing government spending.
The Two Engines of Growth
- “When you think about growth in an economy, there are really two ways to generate it. One is structural—demographics and productivity... There's a second lever to grow, which is cyclical growth, and you can generate this very simply by printing money.”
Economic growth stems from two sources. Structural growth, driven by demographics and productivity, is currently weak in the US due to near-zero labor force growth, leaving AI-driven productivity gains to do the heavy lifting. The second, more potent driver is cyclical growth, which comes from money creation—either public (fiscal deficits) or private (credit expansion). The market's recent performance has been overwhelmingly dependent on this cyclical, money-printing engine.
AI Capex: The Private Sector’s Lifeline
- “The private sector money creation in the United States is also going upwards... because of debt-funded capex... basically, taking on leverage to build AI data centers and AI infrastructure.”
The "run it hot" thesis assumes the money creation engine continues to accelerate, which would require massive new fiscal stimulus to offset the drag from tariffs. With that looking less likely, the burden shifts to the private sector. Currently, the primary source of private money creation is not consumer mortgages but corporate, debt-fueled capital expenditure into the AI revolution. This spending on data centers and infrastructure is a powerful force creating nominal growth and propping up the economy.
Key Takeaways:
- The market's trajectory hinges less on the size of the deficit and more on its rate of change. Tariffs threaten to slam the brakes on public money creation, but a private-sector boom in AI spending provides a powerful, if narrow, countervailing force.
- Watch the Second Derivative, Not the Deficit. The market cares about the acceleration of money creation. A deficit shrinking from 7% to 5.5% of GDP is a major decelerating force, even if the absolute number remains large.
- Tariffs Are a Stealth Tightening. Without larger offsetting stimulus, tariffs act as a significant fiscal drag, effectively tightening financial conditions and creating a headwind for economic growth.
- AI Capex is the Bull Market's Wildcard. The single most important driver of private money creation is debt-fueled spending on AI infrastructure. This is the primary force propping up nominal growth and could offset some of the public sector slowdown.
For further insights, watch the full podcast: Link
This episode reveals why the simple "big deficit, stocks go up" narrative is dangerously flawed, introducing the critical concept of fiscal deceleration and its potential to kill the 2025 boom.
The Fiscal Head Fake: Re-evaluating US Deficit Projections
- The conversation begins by dissecting a recent market "head fake" concerning the US fiscal deficit. Initial analysis from the Congressional Budget Office (CBO)—the non-partisan agency that provides economic data to Congress—suggested the deficit would expand from 7% to 8% of GDP.
- However, the speaker, an economist, points out this scoring critically omitted potential tariff revenues. When these revenues are included, the forecast shifts dramatically. Instead of expanding, the fiscal deficit is now more likely to shrink, potentially falling from 7% to as low as 5.5% of GDP. This raises a crucial question for investors: how will markets, conditioned to expect ever-increasing government spending, react to a period of fiscal tightening?
Understanding the Two Drivers of Economic Growth
- To analyze the impact of a shrinking deficit, the speaker outlines the two primary ways an economy can grow:
- Structural Growth: This is the economy's long-term potential, driven by demographics (labor force growth) and productivity. The speaker notes that recent US policies have suppressed demographic growth, leaving AI-driven productivity as the main engine for this component, which he estimates at around 1.5% real growth.
- Cyclical Growth: This is short-term growth generated by money creation. It acts as a powerful lever that can be pulled by either the government or the private sector to boost economic activity beyond its structural potential.
Public vs. Private Money Creation: A Balancing Act
- The speaker explains that cyclical growth comes from two distinct sources of money creation, which often work in opposition to each other.
- Public Money Creation: This occurs when a government runs a fiscal deficit, cutting taxes or issuing stimulus checks to inject money directly into the private sector (households and corporations).
- Private Money Creation: This is driven by credit expansion, such as when banks issue mortgages or corporations take on debt for capital expenditures (capex). The speaker highlights the Netherlands as an example of a country with a fiscally conservative government but a highly leveraged private sector, showing how money creation finds an outlet.
- For Crypto AI investors, a critical insight is the speaker's identification of debt-funded capex for AI data centers and infrastructure as a major source of private money creation in the US right now. This is a powerful tailwind for the AI sector, showing up directly in corporate earnings and nominal GDP growth.
The "Second Derivative": Why the Rate of Change Is Everything
- The episode's central thesis is that investors must look beyond the absolute size of the deficit and focus on its second derivative—the rate of acceleration or deceleration in money creation. This concept measures whether the pace of money creation is increasing or decreasing compared to the previous period.
- The speaker uses a powerful analogy to explain this: “it will look like a car who's still going at 100 km an hour but it's decelerating because last year it was a 120.” A large deficit (the car going 100 km/h) can still be a headwind for markets if the fiscal impulse was even larger the year before. This deceleration is what truly matters for asset prices and economic momentum.
- Strategic Implication: The prevailing "run it boiling hot" market thesis assumes the fiscal car will continue to accelerate. However, if new tariffs are the primary fiscal policy and are not offset by larger stimulus, the US will experience a significant fiscal deceleration, challenging the foundation of the current market rally.
Conclusion
- The episode's core insight is that the rate of change in fiscal stimulus, not its absolute level, is the key driver for markets. Crypto AI investors must shift their focus from headline deficit numbers to the "second derivative" of both public spending and private AI-related credit creation to accurately forecast market liquidity and growth.
