Semiconductor stocks took a beating last month due to concerns that spending on datacentres may not yield as much as envisaged coupled with rising credit to fund that capex. In response to that, Jensen Haung, the CEO of Nvidia last week announced that he is tying up with the world’s largest private equity and private credit firms to invest in what he termed as GPU as an asset class, that would essentially underwrite sustained demand for Nvidia’s chips. Now, like any other technology, GPUs are considered a depreciating asset thanks to inherent technological obsolescence. Tech bros might want us to believe otherwise so the party can continue. This aspect of tech obsolescence plays at the economy level as well. Eric Basmajan, writes about the ramifications of data centre capex dominating the investment component of the American economy in this light.
“Investment in computer equipment has exploded from 0.5% of GDP to 1.3% in under three years, surpassing even the dot-com peak. It is one of the most aggressive booms in the history of US investment…The spending is clearly real. The data centers, the computer equipment, and the race for new technology are pushing a true investment boom in this narrow slice of the economy.”
However, he argues this misrepresents the investment boom when adjusted for the obsolescence i.e, depreciation. “Total net investment, what the country actually adds to its capital stock after replacing what wears out each year, is near its lowest share of GDP outside the 2009 crash. That includes the AI spending boom.”
Given the G in GDP is ‘Gross’ and if much of the gross investment goes towards replenishing assets, this overstates growth in capital stock: “…Gross investment counts every dollar spent on structures, equipment, and intellectual property. There’s no distinction between the dollars that go towards building something new versus replacing something that is worn out.
Machines wear out, buildings age, and software goes obsolete.
Replacing what’s worn out is called consumption of fixed capital, or as it’s more commonly known, depreciation.
Before the capital stock can grow, investment first has to replace everything that wore out that year. What’s left over, gross investment minus depreciation, is net investment.
Net investment is the only part that makes the country’s capital stock bigger.
Net investment averaged 8% of GDP in the 1950s. Today it’s 3.8%.
Gross investment has been flat as a % of GDP while net investment has been declining sharply. The net line is what truly impacts the future. Replacing what is worn out is the spending we have to do simply to stand still.
Consumption of fixed capital, or depreciation, increased from 8% of GDP to almost 14%. There are many reasons for this, but the biggest is the type of investment we do today versus 40-50 years ago.
Our investment shifted away from long-lived structures and buildings toward shorter-lived equipment, software, and intellectual property.
The Bureau of Economic Analysis publishes the service life it assumes for every type of asset, and the contrast is stark.
A dollar invested in prepackaged software is mostly gone in three years. A dollar invested in a house lasts a working lifetime.
Software depreciates roughly 50 times faster than a home.
As investment shifted toward the shorter-lived end, the replacement bill exploded
…In the 1950s, 48 cents of every gross investment dollar added to the capital stock. Today, it’s 23 cents.
In the 1950s, about half of investment went to maintenance. Today, more than three-quarters does.”
The author then goes on to show what then is holding up the American economy – government spending for social transfers masquerading as consumption. And thereby explaining the expanding US deficit and consequently growing corporate profits and stock market boom.
“The federal government runs a budget deficit near 7% of GDP, but we just saw how the social benefits are running near 15% of GDP. The transfer bill is more than twice that size. Transfers alone absorb 85% of all federal receipts.
The deficit is not building roads, labs, and ports. At the margin, the government borrows money to fund transfers to households, which the households spend on consumption, driving consumption’s share of GDP higher while the net investment share grinds lower.
As a country, we are borrowing money to consume, but instead of households borrowing, the government is doing the borrowing for them.
Borrowed money is being consumed, not compounded.
A check from a government transfer payment that gets spent shows up as business revenue. Deficit-funded consumption flows almost directly into corporate profits.
This is not a conspiracy theory or even a judgment about whether this is a good idea or not; it’s simply accounting, and it’s been running for four decades.
That’s why this arrangement has been extraordinarily good for corporate profits and the stock market.
…Since stocks are held disproportionately by the wealthiest households, this dynamic widens the very wealth gap that the ever-increasing social benefits are meant to ease.”
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Note: The above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. The information provided is intended for educational purposes only. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India (SEBI) and is also an FME (Non-Retail) with the International Financial Services Centres Authority (IFSCA) as a provider of Portfolio Management Services. Additionally, Marcellus is also registered with US Securities and Exchange Commission (“US SEC”) as an Investment Advisor.
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