Future Growth Will Be Driven By Banks, Not the Fed | Andy Constan

Key Concepts

• Shift in Credit Creation: A transition from Federal Reserve-driven monetary policy to private sector credit creation is underway, driven by the scale of funding needed for AI buildout and onshoring.
• Funding Gap & Circular Flows: The promises of AI investment and onshoring exceed the capacity of the US banking system to fund them through traditional means, necessitating asset sales and potentially currency devaluation.
• Skepticism Towards Onshoring: Many onshoring initiatives are driven by national security concerns rather than economic efficiency and may rely heavily on subsidies.
• AI’s Dual Impact: AI presents both investment opportunities and the risk of job displacement, potentially impacting consumer confidence and borrowing.
• Importance of Funding Analysis: Focus should shift from evaluating the promises themselves to analyzing how they are being funded.

The Emerging Credit Landscape

The discussion centers on a significant inflection point in the economy: a move away from central bank dominance in influencing balance sheets and liquidity growth towards a system driven by private sector credit creation. For the past decade, the Federal Reserve has been the primary driver of liquidity. However, the sheer volume of commitments related to AI infrastructure, onshoring, and general economic growth necessitates a level of funding the Fed is unlikely to provide. This places the onus on the private banking sector. A crucial distinction is made between money creation (exclusive to the Fed and commercial banks) and credit creation (the transfer of existing funds), with the latter activating existing capital without necessarily increasing the money supply. The success of this transition hinges on a demand-pull scenario – a genuine need for credit driven by investment – and the willingness of banks to lend at adequately compensated interest rates. The process of credit creation involves a borrower requesting funds, bank approval, deposit creation, and subsequent spending, activating the funds within the economy.

The Scale of the Promises & Funding Challenges

The current “promises” – encompassing AI, onshoring, and broader economic growth – are considered excessive relative to what would typically be required for a stable economy. The US banking system, with approximately $20 trillion in assets and a capital-to-assets ratio of roughly 10% (with stress occurring at 8.5%), can realistically generate around $2 trillion in credit. This falls short of the funding demands of these promises. The shortfall will likely be addressed through a “circular selling of assets,” primarily involving foreign entities selling US Treasuries to fulfill their commitments. Currency devaluation, specifically a decline in the US dollar, is presented as another potential, though undesirable, funding mechanism. The speaker expresses skepticism that all these promises will be honored due to these funding difficulties.

Case Studies & Real-World Examples

Several examples illustrate these points. Oracle’s recent corporate bond issuance to fund data center construction, trading at 70-80 basis points over tights, demonstrates increased credit risk. MicroStrategy’s practice of issuing stock to purchase Bitcoin exemplifies the circular flow of funds. The Hyundai example highlights the potential economic inefficiencies of onshoring driven by political pressure rather than sound investment principles. Even with government subsidies, such investments may not be economically viable. The recent failure of the “data center” investment thesis, where initial enthusiasm waned upon the debt coming to market, serves as a cautionary tale. Japan and Germany are cited as examples of countries experiencing relatively high interest rates, suggesting a potential global trend.

AI, Onshoring & the Business Cycle

AI and onshoring are identified as the two primary drivers of the current business cycle. However, unlike traditional investment cycles that create jobs, AI-driven automation carries the risk of worker displacement, potentially dampening consumer confidence and reducing the willingness to borrow and invest. The government’s existing debt burden, coupled with anticipated onshoring-related issuance, creates a challenging environment for interest rates and credit spreads. The speaker emphasizes the importance of monitoring the funding of these initiatives, not just the initiatives themselves.

A Call for “Old School Macro”

The speaker advocates for a return to “old school macro” – a focus on fundamental business cycle analysis and careful examination of financial flows. He stresses the need to avoid “getting stuck in the last war” and to reassess existing assumptions (“priors”). Investors should carefully analyze market dynamics, funding sources, and the potential impact on interest rates and credit spreads, recognizing that the current economic environment is unique and requires a reassessment of traditional investment strategies.

Conclusion

The core takeaway is that the economy is entering a new phase where private sector credit creation will be paramount. The scale of funding required for AI and onshoring initiatives presents significant challenges, potentially leading to asset sales, currency devaluation, and a reassessment of economic assumptions. A critical focus on the funding mechanisms behind these promises, rather than the promises themselves, is essential for navigating this evolving landscape. The success of this transition hinges on restoring “animal spirits” and a willingness of banks to lend at appropriate rates, while acknowledging the potential for economic inefficiencies and job displacement.