When capital becomes scarce, people must strictly evaluate its most effective uses, and the cost of capital (i.e., market interest rates) rises accordingly.

Written by: plur daddy

Translated by: AididiaoJP, Foresight News

We are facing a fundamental shift in market dynamics due to the capital expenditure cycle in the field of artificial intelligence, which has led to a shortage of financial capital.

This will have profound effects on asset prices, as capital has been in abundance for a long time. The Web 2.0 and SaaS models that drove the market boom of the 2010s had very low capital demand, which allowed a large amount of excess funds to flow into various speculative assets.

While discussing the current state of the market yesterday, I suddenly realized some things. This may be one of the most insightful articles I have written in a long time. Next, I will gradually break down the underlying logic behind this.

There are parallels between capital expenditure in artificial intelligence and government fiscal stimulus, which helps to understand its operational mechanism.

In fiscal stimulus, the government issues national bonds, which are taken on by the private sector as long-term bonds, allowing the government to obtain funds for use. This money circulates in the real economy, generating a multiplier effect. Due to the multiplier effect, the ultimate impact on financial asset prices is positive.

In capital expenditure for artificial intelligence, large tech companies finance themselves by issuing bonds or selling national bonds (and other assets), also taken on by the private sector for duration, and then the companies invest the funds into projects. This money also circulates in the real economy and forms a multiplier, positively impacting financial asset prices.

As long as there is idle capital in the economy, this process can run smoothly. It is effective and can broadly uplift the market. This has been the case in recent years, where capital expenditure in artificial intelligence has acted like additional economic stimulus, boosting both the economy and the market. But the problem is: once idle capital is exhausted, every dollar invested in artificial intelligence must be drawn from other areas. This will trigger a fierce competition for capital. When capital becomes scarce, people must strictly evaluate its most effective uses, and the cost of capital (i.e., market interest rates) rises accordingly.

I emphasize again: when funds are scarce, there will be a clear differentiation between assets. The most speculative assets will suffer disproportionate losses, just as they gained disproportionate returns during capital abundance but lacked productive investment opportunities. From this perspective, capital expenditure in artificial intelligence actually plays a role akin to "reverse quantitative easing," producing a negative rebalancing effect on portfolios.

Fiscal stimulus rarely faces this dilemma because the Federal Reserve usually becomes the ultimate buyer of national bonds, thus avoiding the crowding-out effect on other capital uses.

The term "funds" here can be used interchangeably with "liquidity." The term "liquidity" can be confusing because it has many different meanings.

Let me give an analogy: funds or liquidity are like water. You need the water level in the bathtub to be higher to make financial assets (those floating rubber ducks) rise. There are several ways to do this: either increase the total water volume (lowering interest rates or quantitative easing), or clear the inflow pipe (like the current reverse repurchase operations as a form of "pipe clearing"), or reduce the outflow from the bathtub.

Currently, discussions about liquidity in the economy mostly focus on money supply. However, the demand for money is equally critical. We are currently facing excessive demand, which has led to a crowding-out effect.

Media reports indicate that the world's wealthiest investors—such as the Saudi sovereign fund and SoftBank Group—are nearly out of funds. Over the past decade, global investors have "feasted," holding a large number of assets. Let's deduce what this means: when Ultraman reaches out to them to fulfill their previous funding commitments, unlike in the past when funds were abundant, they now must first sell some assets to raise the money. So what will they sell? Likely those positions with insufficient confidence: selling some poorly performing Bitcoin, some SaaS software stocks facing industry disruption, redeeming some underperforming hedge fund shares. And these hedge funds, in response to redemptions, will also have to sell assets. Falling asset prices will undermine market confidence, tighten financing conditions, and trigger more sell-offs in various sectors… This effect will transmit layer by layer through the financial markets.

Complicating matters, Trump chose Walsh. This is particularly concerning because he believes the current problem is too much money, while the reality is quite the opposite. This is also why a series of changes in the market have been accelerating since his nomination.

I have been trying to understand why memory chip manufacturers like SNDK and MU have significantly outperformed other stocks. Of course, one reason is the surge in product prices. But more importantly, these companies' current and recent earnings are very strong, even though everyone knows that earnings are cyclical and will eventually decline. When the cost of capital rises, the discount rate also increases. Speculative assets with long durations and future cash flows are pressured, while assets that can generate cash flow in the near term are favored.

In this environment, cryptocurrencies, as sensitive indicators of liquidity, will naturally suffer severe blows. This is why their recent decline seems bottomless.

Highly speculative retail favorites struggle to maintain their gains, and even sectors with improving fundamentals are finding it difficult.

Due to demand for funds exceeding supply, yields on sovereign bonds and credit bonds are rising.

It is no longer possible to be blindly optimistic and simply go long.

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