Crowding out

And this is happening in the context of a very robust capital market cycle, AI and otherwise.

One of the areas that's become a topic of conversation is this notion of a crowding out effect where 6% money for meta, that could be cheap for meta or a hyperscaler chasing what could be just an enormous right tail outcome for the equity perspective.

And so those capital demands, I'm curious where you come out on this or where your colleagues and you come out on this.

Are those potential demands for capital from the hyperscalers? Do they have the potential to crowd out, whether it's the U.S.

sees the capital as cheap as Meta might see it now.

How do you think about the unevenness of how the hyperscalers might see the cost of that capital versus... whether it's the man on the street taking a mortgage or an industrial company in the U.S.?

We actually see very little evidence of a crowding out as it relates to the hyperscaler issuance.

Our rates colleagues have previously flagged that some of the upward momentum on U.S. Treasury yields, for example, may actually be more closely linked to the commodity market moves as opposed to hyperscaler supply.

Welcome to PIMCO Pod.

In this episode, we discuss AI capital spending may be contributing to higher real rates, but there is little evidence that it's due to AI bond issuance crowding out treasuries.

Stay tuned after the conclusion of the podcast for additional important information.

The Credit Market Lens, AI CapEx and the Limits of Crowding Out by Latfi Karoui.

A popular narrative for the rise in bond yields over the past few months is that the debt-funded AI capital expenditure cycle is crowding out the treasury market.

The crowding out argument is compelling.

AI companies are expected to continue to issue unprecedented amounts of debt at a time when treasury supply remains elevated.

Because both ultimately draw from the same pool of investor capital, yields must rise to clear the market.

And when the Treasury auctions new bonds every weeks, week and asks lenders for a larger share of the world's savings, it's competing with every one of those other uses of the same dollars.

Economists call this crowding out.

When the government borrows more, everyone else who wants to borrow, a family buying a house, a business building a plant, has to pay a higher interest rate to compete for the same dollars, and that includes you.

Now, the United States faced a debt this large exactly once before, as we've described after nineteen forty-six.

Next, we talk about the intermediate term, roughly 5 to 15 years from now.

This is when the consequences become personal.

Interest keeps crowding out programs.

The Social Security Retirement Fund and the Medicare Hospital Insurance Fund reach their depletion dates.

That's my lesson from history, at least from my perspective.

In a sense, if I understand this, you get a crowding out effect, right? that the government basically is absorbing capital to sustain the debt that would otherwise have gone to investment in creating new products and new services.

Is that a fair concern?

Yes, clearly.

When you think about it, with the competition going on today for private capital, for the AI investments and other investments to build manufacturing back in this country, you have competition between the government and the private sector.

And the one thing that I warn people about is if you don't address the debt and the deficit...

The crowding out has to take place or we have to have massive inflation, which is another form of crowding out if the Fed monetizes that debt.

So you really have to think longer term or even intermediate term and say, wait a minute, how are we going to rationalize this debt, bring it into control in a sensible way over time, not overnight? You don't want to put the economy into a terrible crash.

when you think about these things and you think about this pie in the sky sort of breaking down, if you're painting pictures in your head, like, what's the one of those angles, or is there a different angle that you spend time thinking about?

I think that crowding out is real, and I think that it's its own inflation where-

Explain crowding out for all of our people.

Right.

Sorry.

That's okay.

[laughs] Crowding out is the idea that the U.S. government is a borrower like any other, in a way.

It has to come to market.

So I want to go to that about the – because Congress doesn't have the appetite and doesn't have the will to cut things.

Talk to me about this theory of crowding out, that you've got both – that you've got the – because it's a highly leveraged bet on a highly leveraged bet.

We got the – The AI company is still in the data centers, although they're being stopped around the country and thought through on a local level.

And that manifests in the numbers.

That's of the 162,000 announced today increase, plus the 52,000 recounts over 210,000 jobs.

Only, I think, 9,000 or 10,000 relate to data centers.

In that, though, you have a crowding out because it just announced today I think Anthropic's going for a $15 billion credit facility prior to their IPO.

You've got a crowding out here.