Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / How AI Investment Is Masking Real Economic Stagnation
Transcript
- Lucas: If walking through the economy with us has made something click, consider supporting the show directly. A couple of dollars a month is genuinely what keeps these going — buy me a coffee dot com slash fexingo, if you've gotten something out of them. Luna: It really does help keep the research rigorous without compromising on the deep dives we like to do. Lucas: Thanks for that support, it means a lot. Let's get back into the weeds. Look at the numbers coming out today, specifically the divergence between the stock market and the actual ground-level economy. The S&P five hundred is up two point two percent over the last five days, hitting seven thousand eight hundred nineteen. Meanwhile, real GDP growth for the second quarter just came in at two point two percent annualized, down from two point five percent earlier in the year. Luna: That gap feels wider than usual. Are we seeing tech stocks pull the index up while the rest of the economy drags? Lucas: Exactly. And here is the specific anchor I want us to drill into: the nature of the growth driving those tech gains. It is no longer about selling more widgets or services efficiently. It is about capital expenditure. We are seeing massive spending on infrastructure for artificial intelligence by the largest technology firms. This spending boosts their revenues and profits in the short term, but it does not necessarily translate into broad-based productivity gains for the rest of the economy yet. Luna: So the money is moving, but it is trapped in building the pipes rather than filling the buckets. Lucas: Precisely. Think about the JOLTS data from August. Job openings have dropped to seven thousand thirty-nine thousand, down from over seven point three million earlier in the year. Unemployment has ticked up to four point two percent. Nonfarm payrolls added only twenty-nine thousand jobs in September. That is barely above the recessionary threshold. Yet, corporate earnings reports from the big tech names show record profits. How do you reconcile record profits with a labor market that is effectively freezing up? Luna: Because the profits are coming from efficiency plays and margin expansion, not from hiring sprees. They are spending billions on chips and data centers, which counts as investment, not wages. Lucas: Right. And this creates a weird distortion in our inflation metrics. If you look at the CPI, it is sitting at three hundred thirty-four point one. Core CPI is three hundred thirty-seven point eight. Inflation is sticky, not because wages are skyrocketing across the board, but because the cost of producing goods and services is being propped up by these enormous fixed costs. Companies are passing on the amortization of these expensive AI infrastructures to consumers. Luna: Is that actually true though? Or are they just absorbing the cost to capture market share before competitors catch up? Lucas: That is the debate. But look at the PCE price index. It rose to one hundred thirty-one point six. The core PCE is at one hundred thirty point five. Prices are still rising. When you combine rising prices with stagnant job creation and slow GDP growth, you start to see the contours of a new kind of stagflation. Not the oil-shock stagflation of the seventies, but an investment-led stagflation where wealth concentrates in assets while wages stagnate. Luna: It feels like we are pricing in a future productivity boom that hasn't happened yet. What happens if the AI payoff takes longer than expected? Lucas: Then you get a correction. But right now, the market is rewarding the spenders. NVIDIA and Microsoft are leading the charge. Their balance sheets are swollen with cash reserves, allowing them to continue investing despite the slower macro environment. This bifurcation is key. You have a small group of companies driving the index higher, while the Russell two thousand, which tracks smaller companies, is only up one point two percent. Small businesses are feeling the pinch of high borrowing costs and weak demand. Luna: So the health of the overall market is hiding the fragility of the broader economy. That sounds like a recipe for a sudden shock. Lucas: It is. And consider the trade deficit. It hit one hundred five point six billion dollars, the widest since before the previous round of tariffs. We are importing more while domestic production isn't keeping pace with consumption. This puts pressure on the dollar and keeps import prices elevated. When you add that to the sticky services inflation, which Luna often highlights, you have multiple vectors pushing prices up without corresponding income growth for the average worker. Luna: Services inflation is the part that really bites people. Rent, insurance, healthcare. Those aren't things you can automate away easily. Lucas: Exactly. Automation hits manufacturing first. Services remain labor-intensive. With job openings falling, you would expect wage growth to cool, which should help inflation. But average hourly earnings are still at thirty-seven point eight dollars. Wages are creeping up, driven by scarcity in specific sectors like skilled tech labor, even as the overall job market cools. This wage-price spiral risk is dormant but present. Luna: Does the Federal Reserve see this? They seem focused on the cooling labor market to justify rate cuts, ignoring the asset bubble. Lucas: They are watching the wrong mirror. The FOMC targets employment and stable prices. Both are technically meeting their dual mandate goals, albeit narrowly. Employment is near full capacity, and inflation is trending toward two percent. But they are missing the structural shift. The economy is becoming more capital-intensive and less labor-intensive. This reduces the need for workers but increases the cost of capital for everyone else. Luna: Which means interest rates stay relevant longer. Even if they cut, the cost of doing business remains high for non-tech sectors. Lucas: Correct. The ten-year Treasury yield reflects this uncertainty. Breakeven inflation is holding at two point three six percent. Markets are telling us they expect inflation to stick around. Investors are demanding compensation for holding nominal debt because they fear that the central bank will eventually be forced to print money to support the debt burden created by all this investment. Luna: So we are betting on debasement rather than deflation. That changes how you allocate capital. Lucas: It does. Gold is up slightly, but the real play is in assets that benefit from low rates but also have pricing power. Tech giants fit that bill. But for the average investor, it is a tough landscape. Your portfolio might look good because of your tech holdings, but your purchasing power is eroding. You are richer on paper, but poorer in reality. Luna: That psychological gap is dangerous. People feel rich when their 401k goes up, then go grocery shopping and feel broke. Lucas: Right. And that disconnect leads to political pressure. If the benefits of this ai driven growth are perceived as exclusive, social cohesion frays. We saw hints of this with the headlines about men losing ground in the labor market and demographic pressures piling up. The economy is changing faster than institutions can adapt. Luna: The World Bank just warned about AI concentration risks. They are seeing it too. Growth is being lifted by East Asia, but the distribution within Western economies is uneven. Lucas: Yes, the World Bank lifted its East Asia Pacific outlook to four point five percent, partly due to AI adoption. But here, we are stuck in a two-percent-growth trap. The innovation is happening, but the diffusion is slow. Diffusion is where the real productivity gains come from. Until every hospital, school, and small business uses AI tools effectively, we are just burning cash on infrastructure. Luna: So the next eighteen months are critical. If adoption doesn't accelerate, those capex numbers look like waste. Lucas: That is the risk. And if it looks like waste, the valuation multiple compresses. The S&P five hundred is trading at a premium. It needs perfection. One miss in earnings guidance from a mega-cap tech firm could trigger a re-rating. But even if they miss, the underlying economic stagnation remains. The problem isn't just the stocks; it's the economy underneath them. Luna: It feels like we are standing on a bridge made of glass. Beautiful to look at, but shaky underfoot. Lucas: That is a good image. And the foundation is the labor market. If unemployment ticks up further, consumer confidence drops. Consumption drives half the US economy. If people stop spending because they feel squeezed, those tech profits shrink too. It is a closed loop. Luna: So the solution isn't just better AI, it's better wage distribution. Make sure the gains reach the bottom. Lucas: Ideally. But politics makes that hard. Tax incentives for investment are easier to pass than universal basic income or massive retraining programs. So we are left with this hybrid model. High tech growth, low broad growth. Luna: A hybrid economy. Sounds unstable. Lucas: It is. But it is also dynamic. Change is uncomfortable. The question is whether we can manage the transition without causing a crisis. Or if the crisis is already here, just hidden in the averages. Luna: Hidden in the averages. That is the phrase I am taking home. Thanks for digging into this, Lucas. Lucas: Anytime, Luna. Let's see if those averages hold up next quarter.