Has Finance Become Totally Detached From Reality?

0:00 The economy is not the stock market, and the stock market is not the economy.

0:04 But whether we would like to admit it or not,

0:05 they do have an impact on one another,

0:07 just not always in the ways we might expect.

0:10 Despite a very long list of problems

0:12 in the economy being faced by a majority of people,

0:14 the Dow is, or sorry, was, over 50,000 setting new records.

0:19 On top of this, we have seemingly developed entire

0:21 industries built around playing hot potato with bankrupt companies.

0:25 Without understanding the true mechanics of how these financial niches work,

0:28 it can look like the entire system has become completely divorced from reality.

0:32 The uh good news is though,

0:34 that once you do understand how all of these systems work together,

0:37 you will see that they have become very stupid,

0:40 just for a whole different set of reasons.

0:42 So many folks are drowning under the weight of credit card debt

0:46 as the number of accounts with delinquent

0:47 balances has more than doubled [music] since 2021.

0:51 The private credit side of the business that has seen a real sentiment shift.

0:54 Apollo, Ares, Blue Owl, and KKR seeing significant declines week to date

0:59 while those more exposed to private equity.

1:01 Steward Health Care was at one point

1:03 the largest private hospital system in the country.

1:06 When the private equity-backed network filed for bankruptcy last year,

1:09 it devastated providers and patients.

1:12 The Dow was over 50,000 I don't know why you're laughing.

1:15 You're a great stock trader, as I hear Rostin.

1:18 The Dow is over 50,000 right now.

1:23 If you pay any attention to financial news,

1:25 you've probably heard the same line every

1:27 time the stock market has a little whoopsie-daisy.

1:30 Every time [music] green line does not go up,

1:32 we are told some company or the market has lost,

1:35 destroyed, or wiped out however many billions of dollars.

1:39 But all right then, where does that money actually go?

1:42 It might not surprise you to learn that headlines like

1:44 this are written more for shock and awe than genuine insight.

1:47 But the simple truth is that the money doesn't actually

1:50 go anywhere because it never existed in the first place.

1:53 Sort of.

1:54 If you can look beyond the flashy headlines like

1:56 this and actually understand what they are trying to say,

1:59 you're going to be much better equipped to make sensible

2:01 financial decisions when everybody else is busy losing their minds,

2:04 and if they are lucky enough, maybe even their retirement savings, too.

2:08 This basic understanding has probably actually

2:10 never been more important than it is

2:12 right now because the stock market is breaking new records every single week.

2:16 Nobody knows if or when the party will stop,

2:19 but what we do know is that in this particular case,

2:22 the money doesn't actually have anywhere else to go.

2:25 So, there are really three different levels of technical

2:28 explanation for what happens to money during a crash.

2:31 The good enough for most people level,

2:32 the armchair market analyst level, and then the level that considers debt,

2:36 consumption, and all the different asset markets

2:38 that are getting kind of weird at the moment.

2:40 Now, most people don't even get level one right,

2:43 but I promise none of this is as complicated

2:45 as the financial bros would like you to think.

2:47 And actually seeing how these markets work is the only way

2:50 to understand how messed up they really are at the moment.

2:53 But all right, most of the time when headlines

2:55 are talking about billions of dollars being destroyed or whatever,

2:58 what they are really saying is that the market capitalization

3:01 of a company or group of companies has been repriced.

3:04 This is just calculated using the number of outstanding shares

3:07 multiplied by the price the last share was traded at.

3:09 So, for example, Nvidia currently has about 24 billion outstanding shares,

3:14 and right now those shares are trading at a price of about $170,

3:18 which gives the company a market cap of $4.1 trillion.

3:21 If for some reason tomorrow,

3:22 people decided to start trading Nvidia shares at $85,

3:26 then it would halve the market cap of the company,

3:28 and you would inevitably see headlines about Nvidia losing $2 trillion.

3:32 But they didn't really lose $2 trillion.

3:35 They were just revalued using this very crude calculation.

3:39 Now, technically, this could actually help Nvidia's ongoing business operations.

3:43 Since the AI boom, the company has been doing a lot of share buybacks.

3:47 Well, they will use their profits to buy company

3:49 stock off existing shareholders to take it out of circulation.

3:52 They're only supposed to do this when

3:54 management thinks the company is undervalued.

3:56 So, if their stock halves in price,

3:58 they will get twice as many shares for the same money,

4:00 which should be a good thing, right?

4:03 Well, this is assuming, of course,

4:04 that they are just doing stock buybacks to drive up an already hyped-up stock.

4:08 Part of what is making the current stock market so strange at the moment is

4:12 that by far the biggest net purchaser

4:14 of shares in these companies are these companies.

4:16 According to the Fed's Z1 financial accounts,

4:18 households made net purchases of about $100 billion of stock in 2024.

4:23 This was dwarfed by listed corporations that did

4:25 over $625 billion worth of net buying,

4:29 meaning that companies were buying six times more

4:31 of their own stock than actual stockholders were.

4:34 Now, that doesn't seem great, but it's actually worse than it sounds.

4:38 The whole point of a stock market is that it's supposed to be a place

4:41 where companies can go and sell their shares

4:44 to raise money to fund business operations.

4:46 This net sales figure also includes the company

4:48 subtracting from this net number by conducting IPOs.

4:51 The total gross value of stock buybacks

4:53 was over a trillion dollars within 2024 alone.

4:56 It just so happens that companies also

4:58 raised about $375 billion in the same year.

5:01 Now, this has helped to increase

5:03 market capitalization by driving up share prices,

5:06 but that's not even the biggest problem.

5:08 It will actually get more important later on as we

5:10 go into how asset markets are supposed to function.

5:13 But for now, for level one,

5:14 a market crash is just a readjustment in market capitalization.

5:18 Unless a company is planning to sell its

5:20 own stock to raise money to fund future projects,

5:22 its day-to-day market capitalization shouldn't impact its performance.

5:26 Market capitalization is kind of like GDP.

5:29 It's a number that we use a lot because it's sort of easy to calculate,

5:32 and it's good enough as a rough indication of if

5:35 things are going in the right direction or not.

5:37 Now, a lot of people when they learn

5:38 this, take it to mean that market cap is irrelevant.

5:41 A $10 banana is no better than a banana that's on clearance for $5.

5:46 And while that's true, a sudden price drop on anything can be an indication

5:49 that there is something rotting away beneath the surface.

5:52 So, for the next level of understanding,

5:54 you need to do what the journalists writing the headlines aren't willing to do,

5:58 [music] and actually follow the money.

5:59 Now, I know I just said that if a stock halves in value,

6:02 that doesn't necessarily mean that any money has gone anywhere.

6:05 But in highly liquid markets, such a scenario can only really happen one way.

6:10 The Nasdaq doesn't get to slap a 50% off clearance

6:13 label on Nvidia stock like Walmart does on questionable milk.

6:16 The way the price moves in these kinds of markets

6:19 is that if there are more sellers than buyers,

6:20 the price falls, and if there are more buyers than sellers, the price rises.

6:24 When people are panic selling stocks,

6:26 they are still getting money in exchange for their stocks.

6:29 It may not be as much as they wanted,

6:31 but what they then do with that money is where things get interesting.

6:34 Let's say you had some spare money.

6:36 Yeah, I know, but just pretend with me for a second.

6:39 With your pile of cash, you have some options.

6:42 You can invest into the stock market, real estate, bonds, [music] gold,

6:45 alternatives like cryptocurrency, or you could just hold onto your cash.

6:49 Alternatively, if you just want to enjoy your life right now,

6:52 you could spend that money on goods and services like a new car,

6:55 a bigger house to live in, or a nice vacation.

6:57 All of these activities that improve your quality

6:59 of life are generally classified as consumption.

7:02 Depending on where you and everybody else who has spare money puts their cash,

7:06 it will increase the value of these markets.

7:08 So, if everybody buys gold,

7:09 its price will increase as demand increases on an asset with limited supply.

7:13 Now, stocks, bonds, and real estate are kind of unique because

7:16 they generate their own cash flow to give money back to you.

7:19 Stocks do this through dividends,

7:21 bonds through interest, and real estate through rent.

7:23 Those cash flows come from other people deciding

7:25 to put their money into the consumption pile,

7:27 which becomes revenue for these three asset classes.

7:30 But all of these other assets really only make returns

7:32 by having more people buy in at a progressively higher price.

7:35 When the stock market crashes,

7:37 what is really happening is everybody trying to grab

7:39 their cash out of that particular asset market.

7:42 They do this either because they think the market

7:44 won't generate as much cash flow in the future,

7:46 or more often, just to get their cash out before

7:48 everybody else lowers their price by taking their cash out.

7:52 Now, if you were lucky enough to get

7:53 your cash back before everybody else, you have a choice.

7:56 During a lot of market crashes,

7:58 people just want to hold onto their cash because they are afraid

8:00 they will lose their jobs and nothing else is generating cash flow.

8:04 But eventually, you will need to put your money somewhere,

8:06 and that predicament is what is creating such a big problem right now.

8:10 Sure, maybe you think that the stock market might be an AI-fueled bubble,

8:14 but if you sell your positions, where exactly should you put your money?

8:18 Gold is at all-time highs, real estate is risky with today's interest rates,

8:22 cryptocurrency is highly correlated with the stock market,

8:24 goods and services are more expensive than ever,

8:26 and people are even starting to question

8:28 the long-term safety of the bond market.

8:30 People are quickly running out of safe platforms to stand on, [music] which

8:33 has got a few people saying that maybe these markets aren't actually broken.

8:37 Maybe it's the money that's broken.

8:39 So, it's time to learn how money works, to find out if money actually works.

8:44 This video is sponsored by Factor.

8:46 I used to waste so much money ordering takeout because I just

8:49 did not have the time or energy to cook after a long day.

8:53 Factor is America's number one ready-to-eat meal service.

8:56 Their meals are fresh, chef-crafted, and ready in just 2 minutes.

9:00 No cooking, no cleanup, no excuses.

9:02 They have over 100 meals, breakfast, shakes,

9:05 and snacks to [music] choose from every week, so you never get bored.

9:08 What I actually like about Factor is the quality.

9:11 Their meals are made without refined seed oils, sugars, or artificial junk,

9:15 and most of them pack 30 g of protein or more.

9:18 It keeps me full and focused without me having to think about it.

9:21 Whether you're focused on high-protein,

9:23 low-carb, calorie-smart, or even GLP-1 support,

9:26 they have options that match your goals without sacrificing flavor.

9:29 I've been enjoying the peppercorn spice filet mignon,

9:32 and it's been a go-to for me on busy weeks.

9:35 They've also added more Mediterranean-inspired

9:37 and gut-friendly [music] options recently, which is a nice change of pace.

9:41 It's a kind of variety that keeps me coming back.

9:43 Head over to factor75.com or click the link below and use my code

9:47 HMWUF to get 50% off your first box plus free breakfast for 1 year.

9:53 One per box with active subscription.

9:56 Free meals applied as a discount [music] on first box.

9:58 New or returning subscribers only.

10:00 Varies by plan.

10:01 Sign up today.

10:03 The way that money flows in and out of these markets can

10:05 have a big impact on the way that you live your life,

10:07 even if you don't actually have that much in any one of these respective piles.

10:11 Increasing housing prices have become a defining

10:13 financial problem of young generations as people

10:15 can't afford a place to start their own lives or their own families.

10:19 House prices have outpaced inflation by a lot,

10:22 which I know is not exactly shocking to most of you,

10:25 especially if you have watched any of the dozens of videos we

10:28 have made about the structural problems

10:30 and broken incentives in the housing market.

10:32 But the key here is that when we measure price increases relative to inflation,

10:36 we are only measuring relative to the consumption

10:38 pile here with the consumer price index.

10:41 The problem with this is that it doesn't

10:43 reflect the changing gaps between these other money piles.

10:46 Real estate, for example, has grown faster than consumer prices,

10:49 but relative to fixed assets like gold, it's actually gone backwards.

10:53 An article published by Jonathan Hobbs, a chartered financial analyst,

10:56 compiled this data to show that if you were

10:58 paying for the average American house today in gold,

11:01 you would be spending about half as much as you would have been back in 1991

11:04 and roughly a quarter of what you would have been paying in the early 2000s.

11:08 Now, the article itself used this data to build a case for just buying gold,

11:12 but the reality is basically any assets would have had the same effect.

11:16 If you were paying in S&P 500 indexes,

11:18 the relative fall in house prices would have been even greater.

11:21 So, [snorts] there were two lessons from this.

11:23 One is that investing is important.

11:25 I hope you already knew that.

11:27 But the deeper lesson here is that it's become much easier for people with lots

11:30 of money in these piles to buy basically anything they want from these piles.

11:35 There's only so much money that people can spend on consumption,

11:38 so wealthy people naturally throw the rest into one of these.

11:41 As they have grown, they've provided more money to people who own them

11:44 and since most of them were already

11:45 maxing out what they could throw into consumption,

11:47 they put even more back into these piles

11:49 creating a feedback loop of wealth generation.

11:51 A basic look at the historic numbers makes this pretty clear.

11:54 Market returns over the past 60 years have averaged just [music] over

11:57 10% and inflation has averaged just over 4% If you include taxes,

12:02 this generally means if you can consume

12:04 less than 4% of your invested assets annually,

12:06 you can live forever without touching your principal.

12:09 This basic arithmetic is the foundation of things

12:11 like the financial independence retire early movement.

12:14 But for extremely wealthy people who can easily afford

12:16 to live on less than 4% of their net worth,

12:18 they can compound wealth faster than they can spend it.

12:21 Now, compare this to most people who earn their income by selling their time.

12:24 Most wage increases are indexed to consumer prices if you are lucky,

12:28 which has been the slowest growing one of these piles.

12:31 This has made it harder and harder for the wages to compete

12:33 when both groups want to put their money into the same area.

12:36 A lot of what the wealthy are buying

12:37 is different from what working people are buying,

12:40 but there are some areas where these cross over.

12:42 Real estate is just the most obvious and socially destabilizing example of that.

12:47 The reason this is happening now is that the [music]

12:49 growth in these asset piles has become unprecedented.

12:52 We have been paying a lot of attention

12:53 to what the money printer has done to consumer prices,

12:56 but these other money piles have soaked up much

12:58 of the excess cash and it has put non-asset owners further behind.

13:02 Now, the point of this is not that inequality has become worse.

13:05 You already knew that.

13:06 But a new problem coming from that is

13:08 how these increasingly consolidated markets are behaving.

13:11 According to the Fed,

13:12 participation in the stock market is approaching all-time highs,

13:14 which sounds like a good thing.

13:16 But this is mainly been driven by lots of people investing very small amounts

13:19 of money through platforms with low fees

13:21 and low barriers to entry like Robinhood.

13:23 The real money in these asset markets is more

13:25 consolidated than it has ever been with the top 10%

13:28 of households owning 93% of all equities the last

13:31 time this data was collected at the end of 2024.

13:34 In a market panic, the reason why people sell

13:36 their assets is because they want to make sure they

13:37 have enough cash on hand to cover their most

13:39 basic consumption needs if they lose their source of income,

13:42 which for most people is their job.

13:44 Unfortunately, job losses and market downturns often go hand in hand.

13:48 However, as these assets have become more consolidated amongst people

13:51 who can easily cover their living expenses several times over,

13:54 there have consistently been more people with lots

13:57 of spare cash to buy in versus

13:58 the people that need to sell out to cover themselves in a hard time.

14:02 Put another way, if unemployment was

14:03 to hypothetically spike tomorrow for any particular reason,

14:06 most of the people losing their jobs would not have a meaningful pile

14:09 of assets to sell to cover themselves while they were looking for a new job.

14:13 And it's not like we would miss the consumers either.

14:16 A majority of the consumer spending in the economy now comes from the top

14:19 10% of households and corporate profits are

14:21 primarily driven by selling stuff to other corporations.

14:25 Sounds pretty bad, right?

14:26 Well, it gets worse.

14:28 Remember those record-setting stock buybacks from earlier?

14:31 Well, they have outnumbered net household share purchases six to one

14:34 adding even more people to the side piling money in.

14:37 If you add this to the rise of index funds

14:39 that mindlessly buy and hold a broad selection of shares,

14:41 it's easy to see how lopsided the market has become.

14:44 Now, this does not mean that markets can't fall,

14:47 but what it does mean is that they can stretch far further

14:49 and stay irrational far longer than they could ever before and while they do,

14:53 they are throwing off money like never before

14:55 for people to buy up every other asset market.

14:58 Sounds pretty bad, right?

15:00 Well, it gets worse.

15:01 A huge amount of this money recently has

15:03 been tied up in chasing returns from AI.

15:05 These companies have spent trillions of dollars on this project so far.

15:09 If you ask anybody what they think about the investment market surrounding AI,

15:13 they are all going to say the same thing.

15:15 Internet bubble.

15:16 Bubble.

15:16 There will be a bubble.

15:17 We are in an AI bubble.

15:17 Bubble.

15:18 Bubble.

15:18 Bubble.

15:18 Yeah, that's right.

15:20 We are in a bubble and it's easy to see why they might think so.

15:23 The entire market is being by a few firms speculating about the future of AI.

15:28 They are all playing a game of say a bigger number every quarter.

15:31 The products they are releasing are a long way from covering

15:34 the cost they are incurring and every day it just looks like

15:36 this whole game is being held together by tech CEOs passing

15:39 around the same pile of money to make their numbers look good.

15:42 This is to say nothing of the outside

15:44 geopolitical risks that could smother this whole industry.

15:48 The more you look into the current state of the market,

15:50 the less flattering it looks behind the scenes.

15:52 But the most dangerous thing in the world is not what you don't know,

15:56 it's what you know for sure that simply ain't true.

16:00 If everybody has agreed that this is a bubble,

16:02 then why are informed investors still piling

16:04 billions of dollars into it every month?

16:07 Are they dumber than us or do they see something that regular people don't?

16:11 Now, I want to say that for the record,

16:13 I think this whole thing is absolutely cooked.

16:16 However, the best way to really understand something is

16:18 to not seek out information that confirms your beliefs,

16:21 but instead those that challenge them.

16:23 So, to play devil's advocate,

16:25 how is it possible that this whole thing is not just speculative mania?

16:29 Now, the thing about bubbles is that usually they

16:31 take some kind of outside force to pop them.

16:33 The dot-com collapse was kicked off by a combination of factors,

16:36 but three really stand out.

16:38 Microsoft being sued for violation of anti-trust laws,

16:41 MicroStrategy doing a massive revising of their financial

16:44 results causing their stock to fall

16:46 60% in a single day and getting them into hot water with the SEC,

16:49 and a single article that pointed out the unviable business

16:52 model that a lot of dot-com companies were running on.

16:55 A few years later, the housing bubble

16:56 was popped by the subprime mortgage crisis, which itself was kicked off by rate

17:00 resets and loan originators filing for bankruptcy.

17:03 So, if the AI industry was in a bubble,

17:05 it's had a lot of things that have come a long way which could have popped it.

17:08 Market instability around tariffs, legislative controls over AI chips,

17:12 rising interest rates,

17:13 legal challenges over training data, organizational shocks,

17:16 infrastructure problems, concerning studies over business use cases,

17:19 and what looks like increasingly desperate

17:21 attempts to generate any kind of revenue.

17:23 That's not to mention that if one article

17:25 back in 2000 could start unraveling the dot-com bubble,

17:28 surely the daily articles coming out about the problems

17:30 in this industry should do the same, right?

17:33 Well, so far at least, the market has pretty much just shrugged all of this off

17:36 and it's been able to do this for three very important reasons.

17:40 The first is where all of this money is actually coming from.

17:43 Over the last decade and a half,

17:45 big US tech companies have slowly built up an enormous pile of cash.

17:49 Outside of insurance or financial firms,

17:51 which are legally mandated to have cash on hand for compliance reasons,

17:54 tech companies like Microsoft, Meta,

17:56 Apple, and Alphabet have more cash than any other companies on the planet

17:59 after saving it away for the better part of two decades.

18:02 They had been doing this for two reasons.

18:04 The first was that before 2017, tax laws heavily incentivized shifting cash

18:08 into offshore accounts primarily held in Ireland.

18:11 The exact structures that they used to erode

18:14 these profits into a haven like this were very complicated,

18:17 but once the cash was there,

18:18 they couldn't really touch it unless they wanted to pay tax on it.

18:21 This means that they just slowly accumulated

18:23 cash waiting for something to use it on.

18:26 However, in 2017, these companies were offered a one-time deal to bring

18:30 back these offshore savings into America for a small tax concession,

18:33 which gave them all a lot of dry powder to make some big local investments.

18:37 Now, they have used a lot of that money to do share buybacks

18:40 and they have kept a lot of it abroad to fund their international operations,

18:44 but they also earmarked billions for future capital expenditures.

18:47 Now, the second reason they built such

18:49 huge cash reserves was because for a while,

18:51 these companies were actually struggling to find projects worth investing in.

18:55 They had become so dominant in their respective

18:57 markets that spending a lot of money on development was seen as an unnecessary

19:01 expense that wasn't really worth the risk.

19:03 Today, that is obviously changed in the big companies

19:06 that are driving most of the expenditure on data centers

19:09 are almost making up for a lost decade where

19:11 they were arguably not investing enough money into new projects.

19:14 This also applies to all of the money they are

19:16 introducing into the system to support less established firms like OpenAI.

19:20 Sure, the money is getting passed around a lot once it's in the system,

19:24 but the initial source of these funds is largely coming

19:26 from piles of cash these companies had sitting on the sidelines.

19:29 This means compared to something like the housing bubble,

19:31 which was propped up on a lot of debt and rigid derivatives,

19:34 these companies are at least building a top a solid fiscal foundation.

19:38 Now, of course, having a strong foundation does not guarantee

19:40 that the house you build on top of it will also be good.

19:43 Similarly, just because these companies happen to be

19:45 holding on to trillions of dollars doesn't necessarily

19:48 mean that setting it all on fire to chase one single bet is a good idea.

19:51 It also doesn't mean that regular investors won't get burned

19:54 if this money suddenly gets yanked back off the table.

19:57 One of the most concerning trends that has developed in the space is

19:59 the circular dealing between all of the companies

20:02 involved in different areas of this industry.

20:04 We first covered this about 2 months ago when Oracle stock

20:07 price spiked after reporting a huge data center rental commitment from OpenAI,

20:11 who had raised billions of dollars from Nvidia,

20:13 who made that money in the first place

20:15 by selling graphics cards to companies like Oracle.

20:19 Since then, the deals have only gotten bigger and reporters have done a really

20:22 good job piecing together just how far and wide this web of financial goes.

20:27 Now, most commentary has rightfully called this out

20:29 as companies pulling themselves up by their own bootstraps.

20:32 They're making their revenue look better than they

20:34 really are by investing in their own customers.

20:37 Not exactly a sustainable business model.

20:40 However, to play devil's advocate again, there is something to be said about

20:44 this strategy from a risk mitigation perspective.

20:47 When people look back with the benefit of hindsight at the dot-com bubble,

20:50 they all say the same thing.

20:52 Yeah, the market was dumb, but after a major correction,

20:56 there were still some big winners that emerged.

20:58 Some of them being the same tech companies involved in the AI market right now.

21:02 Nvidia investing into a company like OpenAI

21:05 right now looks a little bit suspicious,

21:07 but had a company like AOL invested in Amazon back in 1999,

21:11 we would probably be a little less critical.

21:13 By investing up and down the supply chain,

21:15 if you could call it that, these companies are in theory maximizing

21:19 the chance that they will capture the value eventually generated through AI.

21:22 There is also one other really important detail that a lot

21:25 of people gloss over when exposing this financial circle jerk.

21:28 It's easy to look at this and conclude that this whole

21:31 market is just a Ponzi scheme propped up by investor hype.

21:35 The only problem with that deduction though

21:36 is that they aren't really taking investors' money.

21:39 Net it out, the major players in this industry are paying out far more money

21:43 through dividends and stock buybacks than they

21:45 are taking in through stock issuance or borrowing.

21:48 When compared again to the dot-com bubble, the story was very different.

21:52 Hyped companies were dependent on bringing

21:53 in a continuous stream of investor money to keep

21:56 the lights on in businesses that made no

21:58 profit and often didn't even make any revenue.

22:01 A company like OpenAI is also in this position,

22:04 where if they don't keep on bringing in new investors,

22:07 they won't be able to continue operating.

22:09 But, they are not raising money from regular investors.

22:12 They're primarily getting it off companies that have plenty of cash to invest.

22:16 Now, I am not exactly going to say I feel bad for big tech

22:21 but nothing they do with their money right now is going to be popular.

22:25 If they make capital investments into data centers,

22:27 people will say they are blowing their money

22:28 on chips that will be obsolete in 2 years time.

22:31 If they buy their own shares,

22:32 people will call them out for driving up demand on an already overvalued stock.

22:36 And if they buy shares in other companies,

22:38 people will call them out for circular dealing.

22:41 Yeah, I know.

22:42 I am sure they are truly devastated.

22:44 Now, with all of that said, that doesn't mean that these companies

22:47 and the wider economy are completely safe.

22:50 Share prices are clearly elevated

22:51 on the expectation that AI products and services

22:54 will eventually bring in trillions of dollars

22:56 to major participants in this industry.

22:58 If this doesn't pan out, then those prices could be reconsidered very quickly.

23:02 The major incumbent players aren't at immediate risk

23:05 of collapse because they still have far more

23:07 cash than debt and they still have functional

23:09 parts of the business to fall back on.

23:11 Their biggest risk is that if this does go tits up,

23:14 then they will have to explain to their investors

23:16 why they thought it was better to spend

23:18 hundreds of billions of dollars on redundant data centers

23:20 instead of just paying out that money to them.

23:23 Now, nobody can truly predict what the future of AI

23:25 will look like and even the CEOs themselves have admitted that.

23:28 But, they are framing it like this.

23:30 They are betting $500 billion on a dice roll.

23:33 If it comes up six, they will make $10 trillion.

23:36 It's a risky bet, but [music] that doesn't necessarily mean it's a bad bet.

23:41 Oh, and it takes the sting off knowing that the government will probably

23:44 be there to comp them some chips if they just keep the game going.

23:47 But, we don't say that part out loud.

23:49 So, then if the gamble doesn't pay off, will we all end up paying for it?

23:53 Well, we might already be,

23:55 but you wouldn't know if you just looked at the numbers.

23:58 Making economic policy or business decisions without reliable data

24:01 is like trying to fly a plane without reliable instruments.

24:05 It's just not going to work.

24:06 By their own admission, the Bureau of Labor Statistics and other

24:09 government agencies in charge of collecting

24:11 data have produced less reliable numbers over

24:13 recent years and it's only getting worse.

24:16 A week before releasing the controversial jobs report,

24:18 the Bureau made another press release talking about major

24:21 compromises they were making in the collection of consumer prices.

24:25 This data is used to make the consumer price index,

24:28 which is what they use to measure inflation.

24:30 So, it's kind of important.

24:32 To make matters worse,

24:33 everybody from politicians to venture capitalists have started jumping

24:36 in to provide solutions to a problem they really don't understand.

24:39 But, there are three big reasons why these compromises are being made

24:42 in the first place and three reasons why it's probably only going to get worse.

24:47 The first reason is that markets are changing faster than ever

24:50 and traditional agencies are struggling to keep

24:52 [music] up with new economic realities.

24:54 For example, the jobs report that is suddenly stirring

24:57 up so much controversy is really two [music] different surveys,

25:00 the establishment survey and the household survey.

25:03 The establishment survey is what was getting so

25:05 much attention and it works by asking thousands

25:07 of businesses and government agencies how many people

25:10 they have on their payroll for that month.

25:12 Now, these surveyed businesses supposedly include small, medium,

25:15 and large employers, but this already presents some challenges.

25:19 Large employers are more likely to have dedicated human resource departments

25:22 that can respond to these surveys as part of their full-time job,

25:25 whereas small businesses on average aren't as timely

25:28 if they bother doing it at all.

25:30 The actual survey only takes about 20 minutes and for a lot of larger companies,

25:34 it's built in automatically to their payroll software.

25:37 But, for a small business owner already putting in long weeks,

25:39 a 20-minute survey on payroll statistics often isn't the best use of their time.

25:44 Even if they do respond to this completely optional survey,

25:47 it's usually not until after the report has already been published.

25:50 According to the Bureau themselves,

25:51 they have been publishing recent reports with as little as 55%

25:54 of the total eventual collected data and it's only getting worse every year.

25:59 To account for this difference, the BLS uses imputed data,

26:02 which is just a nice way of saying guessing based on previous results.

26:06 If they are still waiting on lots of small businesses to provide their data,

26:09 they will look at what small businesses have said in the past compared to large

26:12 businesses that have already provided their responses

26:15 and use that to make the report.

26:17 As any good finance bro will tell you,

26:18 past performance is always the best predictor of future results.

26:22 Now, hopefully you all know I am joking,

26:25 but this system is normally good enough for most months.

26:28 But, the times where the strategy really

26:29 suffers is during periods of rapid change.

26:32 Small businesses feel the impacts of bad

26:34 economic conditions faster and are normally

26:36 the first to either let go of staff or go out of business completely.

26:40 So, if reports are only using data

26:41 from big businesses and then guestimating the rest,

26:44 then they won't notice these job losses until

26:46 they have to go back and do revisions, like what is happening right now.

26:50 Now, this has been the case since the survey was first conducted.

26:53 Not to sound too alarmist,

26:54 but these massive downward revisions were last consistently

26:57 seen during the run-up to the global financial crisis.

26:59 But, what's changing now is that smaller businesses are just

27:02 responding less overall and there are a lot more of them.

27:06 The rate of new business creation has increased massively since the pandemic.

27:10 In the past, these were normally real businesses

27:13 that had a good chance of creating real jobs for real people and we are still

27:16 imputing economic data based on that old assumption.

27:19 Really, what most of these new

27:21 businesses actually represent is people registering

27:24 for their side hustle as an Uber driver in the gig economy.

27:27 This not only goes a long way to explaining declining survey response rates

27:30 because your average person driving Uber isn't going to fill out a BLS survey,

27:34 but it also creates two bigger problems.

27:36 The first is that it overestimates real job creation based on outdated

27:40 assumptions and the second is that even if this data was accurate,

27:44 it doesn't capture a more pressing reality.

27:47 We could create a million new jobs next month and it won't do you much

27:51 good if you are working three of them and still can't afford to make ends meet.

27:55 And so far, all of this is just one report.

27:58 There are dozens of agencies across America and the rest

28:00 of the world that are failing

28:02 to properly account for changing financial realities.

28:05 The Bureau of Labor Statistics is the one cog

28:07 in the machine that is making headlines at the moment,

28:09 but other agencies like the Census Bureau, the Treasury,

28:12 the Bureau of Economic Analysis, the International Trade Commission,

28:15 the Department of Agriculture,

28:16 as well as the data collecting branches of the IRS and the Fed all rely

28:20 on each other to produce reliable numbers

28:22 that they themselves put into their own calculations.

28:25 For example, when the Bureau of Economic Analysis produces GDP data,

28:28 [music] about 70% of that is based on consumer data

28:31 collected by the Census Bureau in their retail trade surveys.

28:34 Inter-agency data sharing, as this is known, is not a result of laziness,

28:38 but rather a feature of the system so

28:40 that every department is overlooking every other department.

28:43 But, you can probably start to see the problems.

28:46 Uncertainty in any part of the system creates uncertainty in the entire

28:50 system and that can be really useful for certain groups.

28:53 The first are politicians who get to cast

28:55 out on numbers that might make them look bad.

28:58 But, let's be honest,

28:59 they never let numbers get in the way of a good spin anyway.

29:02 The second group are large investment firms

29:04 with access to their own proprietary data collection techniques.

29:08 A report from a data firm

29:09 published by Newswire estimated that investment management

29:11 firms could spend as much as $15.4 billion this year on alternative data,

29:16 which really just means anything not published

29:18 publicly by government agencies or the media.

29:21 That is 20 times the annual budget

29:23 of a department like the Bureau of Labor Statistics.

29:26 These firms are regularly employing tactics

29:28 like using private satellite imagery or just

29:30 running their own surveys where they will

29:31 actually pay participants for more timely responses.

29:34 The better their data is compared

29:36 to the publicly available data released by government agencies,

29:39 the more they can make on that data asymmetry.

29:42 Now, you might think this sounds a little

29:44 bit like insider trading, but it's not.

29:46 Technically, the information they are collecting

29:48 is out there for anybody to collect,

29:50 and it's not their fault if the average goober on Robinhood

29:52 doesn't have access to a fleet of spy satellites to collect it.

29:56 This creates the second major problem with our economic data.

29:59 It's more profitable to privatize the numbers.

30:02 The BLS, for example, has 10% fewer staff and a 15% lower budget than it

30:06 did in 2010 following the global

30:08 financial crisis after accounting for inflation.

30:11 Now, that doesn't sound terrible,

30:13 but the scope of its operation has also grown considerably in that time,

30:16 making its job a lot harder overall.

30:19 The fewer resources they have to actually go and collect primary data,

30:22 the more they have to rely on guestimations based on historical correlations.

30:27 An article ironically published by Bloomberg

30:29 last week reported that the agency would no longer be collecting consumer prices

30:33 from certain rural regions due to budget constraints.

30:35 According to the report, the volume of data they are effectively making up

30:39 has more than tripled in the last 6 months alone.

30:42 The reason this is so ironic is because Bloomberg

30:44 is one of the biggest data retailers in the world.

30:47 Every one of those black and orange screens filled with random spreadsheets

30:50 and stock charts you see in videos on trading floors is a Bloomberg terminal.

30:54 Each one of those computers costs about

30:55 $30,000 a year in an ongoing subscription.

30:58 And the reason that big investment firms pay that much is because it

31:01 gives their staff access to information

31:03 that just isn't available to regular people.

31:05 Anyway, budget cuts can create a vicious but convenient cycle for these parties.

31:10 These departments have their budgets cut,

31:12 so they don't have as many resources to collect reliable reports.

31:15 These unreliable reports with big adjustments are then

31:17 used to show how pointless these departments are,

31:19 so they get their budget cut even more.

31:22 The average voter doesn't really understand what these people do.

31:25 The average politician doesn't like having their work critiqued.

31:28 And the average industry group would love it

31:30 if they had a monopoly on good reliable data.

31:32 And that's the third major problem that's quickly getting much worse.

31:36 Even if these numbers were absolutely flawless, are they even relevant anymore?

31:40 There are lies, damn lies, and then there are statistics.

31:44 It's a quote so old that nobody even

31:45 knows who originally came up with it anymore,

31:48 but it's remained relevant for hundreds of years.

31:50 A survey that I ran on all of you while I was putting this video together found

31:53 that an overwhelming majority did not think that current

31:56 economic statistics were an accurate reflection of the real economy.

32:00 Most people who are paying any attention to these numbers

32:03 while still living in the real world inherently understand this.

32:06 The idea that what is causing

32:08 this disconnect is a secretive group of statisticians

32:10 plotting away behind the scenes to make

32:12 politicians look bad is frankly [music] pretty dumb.

32:14 But there is actually an element of truth in it.

32:17 A report by Cambridge University found that as we have

32:19 become more politically polarized and less likely to answer surveys,

32:23 only the most partisan among us actually

32:25 bother responding to be counted in the data.

32:27 A business owner who supports a party currently in power is

32:30 much less likely to respond to a survey with negative economic implications,

32:34 and they are much more likely to respond if they have good news to share,

32:37 like having hired new staff.

32:39 It's less exciting than a shadowy conspiracy, but it is still a problem.

32:43 Unfortunately, it also just distracts from the bigger problem.

32:47 A lot of attention is being paid to the referees

32:49 to see if they are keeping an accurate score,

32:51 but nobody has stopped to ask why they are monitoring a jousting league.

32:55 A lot of the data they collect

32:56 is completely outdated in today's economic landscape.

32:59 And a great example of this is the ballooning government debt.

33:03 For more than a quarter of a century at this point,

33:05 we've become very well acquainted with the images

33:07 of this debt clock and the increasingly

33:09 regular government shutdowns where they play

33:11 hot potato with this ballooning hand grenade.

33:13 If all of that wasn't annoying enough,

33:15 there is almost uniform flip-flop between politicians

33:18 taking turns to be very concerned about

33:20 fiscal responsibility depending on if they are in or out of power at that time.

33:25 I believe we are finally putting America

33:27 on the path towards fiscal reform and fiscal responsibility.

33:30 Republicans in Congress raised the debt

33:33 three times when Donald Trump was president,

33:36 and each time with Democrat support.

33:38 Would anybody ever use that to negotiate with?

33:40 They said absolutely not.

33:42 That's a sacred created He doubled the debt.

33:45 It's a powerful message,

33:47 but they do seem to forget about it pretty quickly once they are in office,

33:50 and fixing it would require actual sacrifice.

33:53 And if we are being honest with ourselves,

33:55 it's almost easy to see where this indifference is coming from.

33:58 We were told we were at an inflection

33:59 point when we crossed $10 trillion in debt, and then $20 trillion,

34:03 and now we are approaching $40 trillion in debt or 130% of our GDP.

34:08 The rate in which we are taking on new debt is also accelerating.

34:11 Almost half of all of our outstanding borrowing

34:14 has been done in just the last 6 years.

34:16 And yet, on the surface,

34:18 you would be forgiven for thinking not much has changed.

34:22 And I don't just mean that in the sense

34:23 of why haven't we turned into Greece yet?

34:25 Because this also raises a more important question.

34:28 The government has spent $15 trillion more than it has

34:31 brought in in taxes in just the last half decade alone.

34:34 So why don't we feel $15 trillion richer?

34:38 When will this debt actually become a problem?

34:41 So the federal government has a massive amount of debt

34:43 that is really only been trending in one direction.

34:46 And there are ultimately only six options we have to deal with it.

34:49 We can grow our way out of it, we can inflate our way out of it,

34:52 we can raise taxes, cut spending, turn into Japan,

34:56 or continue to kick the can down the road.

34:58 So far, politicians have been promising this first

35:00 option while overwhelmingly relying on this last option.

35:04 And it's important to understand the fundamentals

35:06 of why we can't keep on doing this.

35:08 Because I mean, it's worked out pretty well for us so far, right?

35:11 As of the time of making this video,

35:13 the USA has never defaulted on its debt repayments.

35:16 Although it has gotten shockingly close

35:18 on an increasingly frequent number of occasions.

35:20 But to be fair, a lot of these near misses were crises of our own creation.

35:25 It sounds dumb, and to be honest, it is dumb.

35:28 But not many people actually understand the real mechanics of, well,

35:32 how this money actually works.

35:34 You may be under the misconception that the national debt has been ticking up

35:37 every second of every day since we last ran our budget surplus back in 2002.

35:42 Sensationalist media reporting and iconography like the debt

35:45 clock certainly haven't helped with that understanding.

35:48 But as an example, our national debt actually shrunk ever

35:50 so slightly between Q4 of 2024 and Q2 of 2025.

35:55 This was because prior to this, the debt ceiling was suspended,

35:58 effectively taking the self-imposed cap off

36:00 how much the government could borrow.

36:02 When that suspension ended on the 1st of January 2025,

36:05 the debt ceiling came back into effect,

36:07 and the government found itself already at its credit limit.

36:10 To fill this gap, the government mostly just used

36:12 the money it had sitting around in the Treasury General Account.

36:15 There are some technicalities, but really this is effectively just

36:19 the checking account for the federal government.

36:21 It's a big bank account held with the Fed that taxes and other

36:24 federal receipts like tariffs go into, and all

36:27 of the expenses of the government, including debt repayments, come out of.

36:31 The Treasury Department releases a daily report of everything that goes

36:34 into this account and everything that comes out of it.

36:37 So you are welcome to balance the government's checkbook.

36:39 Currently, there is over $900 sitting in this account.

36:43 A near record high outside of major events around the pandemic.

36:46 When the debt ceiling was reintroduced last

36:48 year and we temporarily couldn't expand the debt,

36:51 we spent down this account from just over $800 to less than $300 over 6 months,

36:56 including a bit of a boost from April tax receipts.

36:59 Today, the debt ceiling has been increased again

37:01 to $41.1 trillion after the passage of the One

37:04 Big Beautiful Bill Act added $5 trillion

37:07 to our credit limit back in July last year.

37:09 In the 3 months that followed that, we

37:11 had already added an additional $1.4 trillion

37:14 to the debt with some of this extra

37:16 money going towards topping this account back up.

37:19 Now, it's important to understand these basic financial mechanics because

37:22 one of the most immediate risks that lenders are afraid

37:24 of is what happens if the government doesn't raise the debt

37:27 ceiling and we run out of money in this account.

37:29 We have actually come incredibly close three times in just the last 15 years.

37:34 In 2011, there was political brinkmanship over reducing the deficit.

37:38 In 2013, it was the same threat used

37:40 to push back against the Affordable Care Act.

37:42 And in 2023, Congress once again demanded a cutback in government

37:46 spending or else it would refuse to lift the limit.

37:49 At the climax of the standoff,

37:50 the Treasury had less than $40 billion left in its account.

37:53 Even after taking extraordinary measures

37:55 like delaying payments towards pension accounts,

37:57 there was less than 48 hours of regular spending before the Treasury just

38:01 simply wouldn't have anything left to fund

38:02 the government or pay back its lenders.

38:05 Now, threatening to push the government into default

38:07 in the name of fiscal responsibility is a little

38:09 bit like refusing to pay back your credit

38:10 card because you are starting a new budget.

38:13 The real reason the government plays this dumb game so much

38:15 is because it's a good way for Congress to threaten the president.

38:18 These stunts have had real consequences because while theoretically the US can

38:22 technically always cover its debt by printing more of its own money,

38:26 we have demonstrated that we might

38:27 eventually choose not to over political squabbles.

38:30 The longer we can keep kicking the can down the road,

38:32 the more dangerous these games become.

38:35 Shaking the Jenga tower gets riskier and riskier the higher we stack it.

38:38 Playing chicken with a debt half the size

38:40 of our GDP wasn't a great idea to begin with.

38:43 Playing the same games with a debt level we have today

38:45 has had real consequences even if it wasn't an outright collapse.

38:49 Following the standoff in 2023,

38:51 our credit rating was downgraded by Fitch from a perfect AAA to a AA+,

38:55 meaning that federal borrowing was no longer seen as completely risk-free.

38:59 And since then, we have only been downgraded further still.

39:02 To put things in a perspective,

39:04 US federal debt is now rated similarly or even lower

39:07 than a lot of mortgage-backed securities were back in 2007,

39:10 which obviously sounds bad.

39:12 So the actual risk of people holding US debt never getting

39:15 their money back is effectively zero because at the end of the day,

39:18 we can ask the Fed to just print more cash.

39:21 But even a small pause in repayments is an indication

39:24 that the government might not have this whole situation under control.

39:28 And since so many systems in the global economy rely

39:30 on using Treasuries as effectively an immutable cash flow generator,

39:34 any uncertainty casts out over a lot more than

39:36 just getting an interest payment a few days late.

39:39 The risk to bondholders is not that they

39:41 won't get the money back that they were promised.

39:43 Even if it is delayed, they will get their money back.

39:46 [music] The real risk is that by the time they do,

39:48 the money they receive won't be worth it anymore,

39:50 either because it's been inflated away or because

39:52 nobody wants to use US dollars anymore.

39:55 If Treasuries can't be relied on as the foundation of global financial plumbing,

40:00 that is just one thing that could undermine the expected future value.

40:03 Another risk is that US dollars themselves won't be in demand

40:06 if America becomes a less dominant middleman in the global economy,

40:10 which well, I mean, yeah.

40:12 That's clearly not an unfounded concern.

40:14 All these potential future problems means that lenders want

40:17 to see higher returns to compensate them for these risks.

40:20 When the Treasury borrows money, it effectively runs a reverse auction.

40:24 It says it needs a certain amount of money and promises

40:26 a higher and higher rate until people agree to give them that money.

40:30 In recent months, as more groups have been

40:31 looking to diversify away from the increasingly questionable dollar,

40:35 these auctions have gone on for a lot longer than we have been used

40:38 to and we have had to offer a lot more interest than we did in the past.

40:41 [music] On top of interest rates that have also risen.

40:44 As more and more of our debt is rolled over onto these higher rates,

40:48 the total amount of money that we are dedicating just

40:50 to covering interest has almost tripled within the last 5 years alone.

40:54 And unfortunately, that in turn presents a risk to investors who want

40:57 even higher rates to compensate them for risks posed by higher interest rates.

41:02 We have actually spent a similar portion

41:04 of our GDP on interest payments in the past,

41:07 but that was back in the 1980s when interest rates were as high as 19%.

41:11 The only thing that made this possible was

41:12 the fact that our total debt was a lot lower.

41:15 So, even a much higher rate didn't cost as much as today.

41:18 The total debt burden that we are carrying around now means that just a 1%

41:22 increase in interest rates will carve more than 1% of our GDP in repayments.

41:27 If we really are just going to try and kick the can down the road,

41:30 the number one most important thing we can do is

41:32 to make sure that road is as smooth as possible.

41:35 But, since we seem utterly incapable of doing

41:37 that, maybe we should explore some other options.

41:40 The best option would have be to grow our way out of the debt.

41:42 And politicians in particular love this idea because it

41:45 is theoretically the option that requires the least sacrifice.

41:49 If you have $20,000 of credit card debt and you make minimum wage,

41:52 well, that's a major problem.

41:54 But, the same debt for someone making a quarter

41:56 of a million dollars a year is much less of a concern.

41:59 By working off that same basic assumption,

42:01 if we grow our economy faster than the debt, we can keep things under control.

42:05 The reason this is such a popular idea is

42:07 because economic growth is an objective in the first place.

42:10 And if it lets us hand-wave away another problem, that is even better.

42:13 No politician really wants to run on the idea of sacrifice and hard times.

42:17 So, they go full Wolf of Wall Street

42:19 and propose dealing with your problems by getting rich.

42:22 Now, to be fair, our debt-to-GDP ratio has actually shrunk over the last

42:26 5 years from a pandemic high of 132% down to about 121% today.

42:32 It's still not great, but it is at least showing that the economy

42:35 is growing faster than the debt, right?

42:38 Well, yes, that's actually true.

42:40 But, there are three problems with this simple assumption.

42:42 The first is that we are measuring economic growth

42:44 and debt from the starting point of the pandemic

42:46 when the economy was locked down and we

42:48 took out massive loans to fund big stimulus programs.

42:51 The second is that by zooming out and observing a more long-term trend,

42:55 it becomes clear that outside of this little anomaly,

42:57 we are still overwhelmingly trending in the wrong direction.

43:00 And finally, this is just measuring the total debt,

43:03 not how much we actually need to pay on it.

43:05 To use the same analogy again,

43:07 $20,000 in credit card debt is a lot worse than a $20,000 mortgage.

43:11 And that's because of the interest rate.

43:13 Because lenders are demanding higher rates from the Treasury

43:16 in conjunction with a higher cash rate from the Fed,

43:18 we are now paying around 4% of our GDP in interest payments alone.

43:22 A 4% GDP growth rate would be considered extremely

43:25 good and we would need to achieve that every year,

43:28 year after year, just to compensate for the interest payments now.

43:32 In reality, since the year 2000,

43:34 we have actually achieved an average annual growth rate of around 3%.

43:38 And compared to a lot of other countries, we are actually doing pretty well.

43:41 So, with this much money going to interest alone,

43:44 just growing our way out of the debt ain't going to cut it anymore.

43:47 Another option is something that actually seems pretty logical.

43:50 Fire up the money printers and inflate our way out of it.

43:53 Treasuries have a nominal face value and most have fixed interest rates,

43:57 with only the exception of a measly

43:59 $2 trillion worth of outstanding inflation-protected securities.

44:02 If we halve the value of our money,

44:04 we could effectively halve the value of our debt.

44:07 If you took out a million-dollar

44:08 fixed interest loan in Zimbabwe before hyperinflation,

44:11 you would have been able to turn around a year later,

44:13 sell a loaf of bread and pay off

44:15 your debt a thousand times over with the proceeds.

44:17 Now, it doesn't need to go that far,

44:19 but if we let our inflation run higher than average for a few years,

44:22 it could bring down the real value of this debt.

44:25 The problem is that this only really works once.

44:29 To lenders, this is almost the same thing as default.

44:31 Remember, their only real risk is that the money they get back from holding

44:34 these bonds isn't worth what they were expecting it to be when they bought it.

44:38 Sustained inflation would help to reduce

44:40 the burden of the current outstanding we have.

44:42 But, next time the Treasury goes to borrow more money,

44:44 investors are going to demand even higher rates to compensate

44:47 them for the falling value of the dollar over time.

44:50 Higher than expected inflation compared to other economies could also

44:53 further undermine the US dollar as a global reserve currency.

44:57 Not to mention, wreak havoc on regular people who

45:00 are already suffering from a cost of living crisis.

45:02 The inflate-away our problems by just printing

45:05 more money does sound simple in theory,

45:07 but it will almost certainly do more harm than good.

45:10 So, that only leaves us with some of the less fun paths forward.

45:14 The simplest solution of all would be to do

45:17 what anybody would suggest if you have a debt problem.

45:19 Make more money and spend less of what you make.

45:22 In government speak, raise taxes and cut spending.

45:26 Now, we tried to cut back in spending

45:27 starting around this time last year and overall, it did not go great.

45:32 Unfortunately, a lot of our spending is not discretionary.

45:35 So, without fundamentally reshaping the rules around pensions or healthcare,

45:38 the government can't directly control how much it spends in these categories.

45:42 Outside of that, the largest expense category is

45:44 just the interest on our debt and without defaulting,

45:47 we are stuck with that, too.

45:49 The military is the next big expense and this is something we could change.

45:53 But, there are two problems with that, especially right now.

45:56 The first problem is that we have actually increased our military spending as we

46:00 have simultaneously decided to become more

46:02 isolationist and interventionist at the same time.

46:05 Now, we don't need another armchair general,

46:07 but the second problem is something much more within our wheelhouse.

46:11 Military recruitment is way up,

46:13 which may be a sign of people wanting to do their patriotic duty.

46:16 But, it also may be a sign that young people

46:18 and in particular young men couldn't find a job anywhere else.

46:22 Cutting military funding right now could expose some

46:25 major holes in other parts of the economy.

46:27 We're investing that record number dollars,

46:31 have no choice, in the United States Armed Forces.

46:35 Also creating a lot of jobs, but we're not even doing it for that reason.

46:40 So, all right.

46:41 Maybe we just raise taxes, right?

46:43 The One Big Beautiful Bill was one of the largest sweeping tax cuts ever,

46:47 especially for higher-income earners and asset owners.

46:50 So, that probably wasn't a step

46:51 in the right direction down this particular path.

46:54 But, would it even matter?

46:55 Total federal receipts, as in how much the government receives in tax

46:59 and all other forms of revenue as a share of GDP,

47:02 has been remarkably consistent since the end of the Second World War.

47:06 Even during the '50s and '60s,

47:08 when we were taxing top income earners as much as 90%,

47:10 the total revenue we brought in was comparatively identical to today.

47:14 The problem is, since then and now,

47:16 the spending of the federal government has almost doubled.

47:20 We just have more programs, commitments, and expenses,

47:23 so this data does on the surface support the idea

47:26 that taxes alone aren't going to fix this, right?

47:29 Well, that is true.

47:30 But, it's often used to redirect away from the issue of taxation entirely.

47:35 We still tax comparatively little compared to most of our economic peers.

47:39 And who is paying those taxes has changed considerably,

47:42 even if the end result has stayed consistent over time.

47:45 According to IRS statistics, the burden of this revenue has shifted largely

47:48 onto middle-income earners and away from wealthy asset owners.

47:52 These are very taxing taxes that impact

47:54 people with the highest propensity to spend, work, and reinvest when possible,

47:58 which means this tax shift is likely also shifting the very same economic

48:02 growth that we are still hoping could grow us out of our problems.

48:06 On the flip side, a lot of the extra government spending

48:08 that we are doing is flowing

48:09 more directly to private enterprises through grants,

48:12 contracts, [music] credits, subsidies,

48:13 bailouts, rebates, partnerships, and guarantees.

48:16 So then, what does private equity actually do with all of that money?

48:20 Private equity is nothing more than any investment company

48:23 that invests into assets that are not listed on public markets.

48:27 The variety of private equity companies is enormous.

48:29 Some private equity firms will invest in very early startups

48:32 and give them money to grow their business and acquire new customers.

48:35 These firms tend to go by the name venture capital,

48:38 but that's still a type of private equity.

48:40 Other private equity companies focus on buying alternative assets like airports,

48:44 toll roads, intellectual property rights, and carbon credits.

48:48 These firms offer liquidity to asset holders that would find

48:50 it almost impossible to sell what they own without their services.

48:54 You can't put your North Dakota drilling rights

48:55 on Facebook Marketplace and expect to find a buyer.

48:59 If something is worth money,

49:00 there will be a private equity firm that will try and make a deal out of it.

49:04 There are even private equity firms that are called a fund of funds,

49:07 which you guessed it, raises money to invest into other private equity funds.

49:11 But, when you hear politicians, journalists,

49:13 and angry people online talking about private equity,

49:16 they are normally talking about the buyout funds.

49:19 If you can start and run a successful buyout fund,

49:21 there is a good chance you will become a billionaire because these firms

49:25 are fine-tuned to make the most amount

49:26 of money possible from buying entire companies.

49:29 So, if you wake up one day and decide

49:31 to start a private equity firm specializing in corporate buyouts,

49:34 here is what you will actually need to do in three easy steps.

49:38 Step number one is before you even think about going out to find

49:41 your first investor or acquisition opportunity

49:44 is to get your corporate structure right.

49:46 As a savvy private equity fund manager, your firm's legal setup is key.

49:50 It's complicated by design, enabling you to minimize personal risk,

49:54 maximize personal gains, and navigate complex financial regulations effectively.

49:58 Your strategic move is to form a Delaware

50:00 limited partnership where you'll be the general partner.

50:03 The Delaware limited partnership is popular in private

50:06 equity due to its legal benefits and operational flexibility.

50:10 Here, you have the power to make

50:11 critical investment decisions and manage day-to-day operations.

50:14 A crucial element of the setup is the limited partner agreement or LPA.

50:18 The LPA is a contract that outlines the terms between you,

50:22 the general partner, and your limited partners, typically your investors.

50:26 The LPA details everything from investment strategies

50:29 to distribution of profits and loss allocations.

50:31 It's the rulebook that governs the partnership,

50:33 ensuring clarity and structure in the relationship

50:35 between you and your investors.

50:37 As the general partner, the LPA empowers you to steer the fund's investments

50:41 while outlining your responsibilities and the scope of your authority,

50:44 balancing control with accountability.

50:46 This structure, with its well-defined LPA,

50:49 provides a stable framework for managing the fund,

50:51 offering protections for both general and limited partners.

50:54 If you have too much control,

50:56 nobody will want to invest their money into your fund.

50:58 And if you don't have enough control,

51:00 then you won't be able to run your fund effectively.

51:02 In the movie The Big Short,

51:03 Michael Burry's character played by Christian Bale gets

51:06 into an argument with one of his biggest

51:07 investors who questions when other investors in the fund

51:10 would be eligible to pull their money out.

51:14 My God, Mike.

51:15 Burry had made a very risky investment at this point

51:17 in the movie that most of his investors didn't agree with.

51:21 So, if they could pull their money out, they probably would.

51:24 But, Burry's firm had rules about withdrawal eligibility written into a mandate,

51:28 so they were stuck until Burry's investment paid off.

51:30 Had they been able to pull their money out early,

51:32 Burry would have had to close his positions,

51:34 and everybody in the fund would have missed

51:36 out on one of the greatest investment opportunities ever.

51:39 So, this structure is essential to running your private equity fund effectively,

51:42 but you're not done yet.

51:44 You will also want to add a management

51:46 company that is technically separate from the firm,

51:48 but can give advice to the fund and the acquired companies.

51:51 This is the part of the business that is full of the Harvard

51:53 MBA analysts that you will need to pay $250,000 a year

51:57 before bonuses because they're the ones doing the math and due diligence

52:00 on whether a company is a good investment or a bad one.

52:03 While you're at it, you'll want to make yourself

52:05 or a trusted business partner the chairman and CEO.

52:08 Once you have the structure in place,

52:09 it's finally ready to start schmoozing investors

52:12 and finding beloved companies to drive into bankruptcy.

52:15 All you are really as a private equity general

52:17 partner is a middleman between investors and good investments.

52:20 So, the second step is the simplest part, but also the hardest part.

52:24 As the head of a private equity firm,

52:26 you'll be taking money from investors and using

52:28 it to make investments into private companies.

52:30 Those investors can make the same investments by themselves,

52:33 so you need to try hard to convince them that their money is better

52:35 with you because you can make them

52:37 better returns even after taking out your fees.

52:40 Those fees are normally a two and 20 structure.

52:43 Your firm will get 2% of all assets you have under management every year.

52:46 This 2% is used to pay the salaries

52:48 of the expensive Harvard MBAs working in your management company here.

52:52 So, once they have been paid, there won't be much left over for you,

52:55 but that's what the 20% is for.

52:57 20% of all returns over a pre-agreed-upon rate, called the hurdle,

53:02 will be paid to you as an additional bonus.

53:04 If you agree with your investors on an annual hurdle of 10% per annum,

53:08 but your firm actually delivers 20% returns,

53:10 you get to keep 20% of those additional

53:12 returns for yourself as the firm's general partner.

53:15 So, there are some big incentives for you to make some big returns.

53:18 You also have an incentive to manage as much money as you

53:21 can because it's better to get 20% of a bigger pie overall.

53:24 So, one of your most important jobs is just getting people to invest with you.

53:28 The first step in raising money from investors is that you

53:31 will need to put some of your own money into the fund.

53:34 If you aren't already a billionaire,

53:35 your own money won't be enough to start acquiring whole companies,

53:39 but this still does two very important things.

53:41 The first thing is that it shows other investors

53:43 that you are willing to put your money where

53:45 your mouth is and that you will take good care

53:47 of the fund because it's your money at stake, too.

53:50 The second thing putting your own money into the fund

53:52 does is create an exciting little tax loophole,

53:55 which means you are going to pay a lower tax rate than most Americans,

53:58 but you will see how later.

54:00 Once you have put your own money in, you need

54:02 to convince other people to trust you with their money,

54:04 which is why it's normally a good idea to start a private equity fund after you

54:08 already have industry connections and experience.

54:10 If you don't have any of those connections just yet, don't worry.

54:14 Some investors will also give you money if you

54:16 have a lot of experience in a particular industry.

54:19 So, let's say you have owned and managed hotel chains before.

54:22 You can create a private equity company that will

54:24 just invest in hotels and other hospitality businesses.

54:27 The number one best way to attract

54:29 more investors is to generate consistently high returns.

54:32 Do this for long enough and you might even have so many investors that want

54:35 to give you their money that you will have to start turning them away.

54:39 But for now, you will have to start small with your first acquisition.

54:42 Your team of analysts at your management company will work with investment

54:45 bankers who act like realtors for people looking to sell their companies.

54:49 Your analysts are going to be looking

54:50 for companies that generate profit with good cash flow

54:53 in a stable industry with improvements that can be

54:55 made by your private equity firm to increase profitability.

54:58 Since you have told your investors that your skills are in managing hotels,

55:01 your team will also need to look for deals that are in the hospitality industry.

55:05 Buying a pharmaceutical company could violate

55:07 the investment terms of your limited partner agreement,

55:09 and you could get sued by your investors.

55:12 If you spent your entire career managing hotels,

55:14 you won't know about running a pharmaceutical company.

55:17 They also need to work with investment bankers to find

55:20 companies that want to sell at a decent price.

55:23 Once a business is found,

55:24 the private equity team will work with the investment bankers to draft

55:27 an indication of interest and conduct due diligence on buying the company.

55:31 The private equity team will also start talking to other investment bankers

55:34 and private lenders to try and take out a loan to finance the deal.

55:38 If your firm was only able to raise a pitiful $100 million

55:41 from investors and the company you want to acquire is also worth $100 million,

55:45 you are risking your entire firm on one bet.

55:48 What you need to do instead is show a bank

55:50 that the company you want to acquire has stable

55:52 profits and good operating cash flow so that you can

55:55 get a loan for $90 million to finance the deal.

55:58 You can then use $10 million of your own money to perform a leveraged buyout.

56:02 If you have only used $10 million,

56:03 you can also do these 10 more times before you have deployed all of your money.

56:08 The companies you acquire are called portfolio companies,

56:11 and your job now is to get as much

56:12 money as possible out of them for your investors.

56:15 Private equity firms have a bad

56:17 reputation for gutting companies, laying off staff,

56:19 and saddling them with tons of debt, and that's because they do this a lot.

56:24 Since you own the portfolio companies,

56:26 you can tell their CEOs what to do, and if they don't listen,

56:29 you can just appoint your own CEOs that will do

56:31 exactly what you and your management team tell them to do.

56:34 There are a few strategies that private equity managers, such as yourself,

56:38 like to employ to increase the returns of their portfolio companies.

56:41 One strategy is consolidating the operations of all the companies in the firm.

56:45 Since you are investing in hotels,

56:47 you can merge the booking, housekeeping, staff administration, rewards points,

56:51 and contracting all under one entity to save

56:54 on overhead and offer a better overall product to customers.

56:57 But if that's too creative,

56:58 then you can always use your team of analysts to find

57:00 the areas of the business to cut costs like employee head count,

57:03 employee benefits, and employee training.

57:05 But you don't have to be creative.

57:07 You don't even need to cut costs.

57:10 You can just use the company's profits to pay down the $90 million

57:13 in debt and then sell the company even if you don't grow it.

57:16 It's kind of like buying a house and having

57:18 a renter pay down your mortgage for you.

57:21 This kind of Ivy League business advice doesn't come for free.

57:24 Even though the management fee is considerably less than what

57:26 you can get if you get a return on your investment,

57:29 it's still a lot of money once you have over

57:31 a billion dollars worth of companies under management in your portfolio,

57:34 which brings us to the third and most

57:36 important step of this whole operation, getting paid.

57:40 By cutting expenses and improving business operations,

57:42 your portfolio of companies should now hopefully be

57:44 worth more than what you paid for them.

57:46 So, now you need to turn those paper gains into cold hard cash.

57:50 The easiest way to do this is to sell the companies at a profit to a buyer.

57:54 You can call up another investment bank,

57:55 and they will give you three options to sell your companies.

57:58 The first option is you could take your companies public through

58:01 a SPAC or IPO and sell them to the general public.

58:04 The second option is to sell them to a strategic buyer like

58:07 an even bigger hotel chain that wants

58:09 to acquire your portfolio through an acquisition.

58:12 And the third option is you could sell it to another investor like another

58:15 private equity fund or a family office that just wants to continue growing it.

58:19 Now, if you think you're in the first category of public investors,

58:22 I've got some bad news for you.

58:24 The collective value of all American publicly

58:26 traded stocks is now over $58 trillion.

58:30 That's more than a three times increase from just a decade ago,

58:33 and American public stocks are now the second largest

58:35 asset class in the world behind only Chinese real estate.

58:38 These amazing returns, coupled with new technology which makes getting

58:41 into the market easier than ever before, has meant that more Americans than ever

58:45 are stock owners benefiting from this strong market.

58:48 Investing is the best tool for average people to build up

58:51 wealth to fund some of the most important life goals like retirement,

58:54 sending their kids to college, or leaving some money behind for their children.

58:58 With more people than ever benefiting from the stock market,

59:00 it means what is good for investors is good for everybody.

59:04 The only problem is basically everything I have

59:06 just said is complete You are not an investor,

59:11 but it's really important that you think you are.

59:13 So, the rate of stock ownership is approaching all-time highs,

59:16 but those highs are probably lower than you expect.

59:19 According to a Gallup survey, just 61% of households own any stock at all,

59:24 either directly or through a mutual trust.

59:26 This data is roughly in line with the Fed estimates,

59:29 which suggests that we have now surpassed the previous peak of household

59:32 stock ownership that was reached just before the market crash of 2008.

59:36 More people owning more stocks is great,

59:39 but the problem is that these record levels have only been hit for two reasons.

59:43 The first reason is that most of these stocks are held in 401k accounts,

59:47 which have become far more common

59:48 as old-fashioned employee pension plans slowly go extinct.

59:52 This is putting the market risk in retirement onto workers,

59:55 but overall a diversified portfolio should

59:57 be safer than an employee pension scheme

59:59 which had been completely evaporated in dozens

1:00:01 of high-profile corporate bankruptcies in past decades.

1:00:04 This is not really a sign of households owning more stocks though,

1:00:07 because in the past employer pension schemes would invest their employees

1:00:11 pension accounts into the market to help fund the liability,

1:00:14 so the only thing that's really changed

1:00:16 is what entity is holding onto the shares.

1:00:18 The second reason that more people own shares now is because

1:00:20 it's become easier thanks to low-cost

1:00:22 or zero commission brokerages like Robinhood.

1:00:25 Now, that isn't necessarily a good thing.

1:00:27 Investing should be a part of a sound financial plan,

1:00:30 but it will not make you rich by itself.

1:00:33 According to Robinhood's most recent filing,

1:00:35 its average funded account had less than $5,000 invested in total.

1:00:39 Another report published by the finance firm Stilt found

1:00:42 that almost 43% of Robinhood users had FICO scores below 650.

1:00:46 A survey conducted by the Wall Street Journal found that debt

1:00:49 relief was one of the primary motivators for using the investing app.

1:00:53 Now, I don't want to crush anybody's dreams here,

1:00:55 but the chance of being able to generate investment returns greater than

1:00:58 the interest payments on high-risk consumer credit

1:01:01 is effectively zero in the long term.

1:01:03 There are people who get lucky,

1:01:05 but the vast majority of these investors would be much better taking the money

1:01:10 they are putting into Robinhood and using

1:01:12 it to pay down their high-interest debt.

1:01:14 If you do happen to have a consistent strategy for generating

1:01:17 returns above the interest rate of a low credit score car loan,

1:01:20 then you don't have to worry about those anyway,

1:01:22 because Citadel or Jane Street would

1:01:24 probably offer you a seven-figure signing bonus.

1:01:27 Clearly a lot of these users are

1:01:28 not being realistic about generating consistent returns.

1:01:32 They're gambling.

1:01:33 It's probably no coincidence that the fall

1:01:35 in active users for Robinhood lines up almost perfectly with the rise in active

1:01:39 users for sports gambling apps like DraftKings,

1:01:42 FanDuel, and the various casino offerings.

1:01:44 A report by Bloomberg found that these investors were taking their money

1:01:48 out of stocks to top up their accounts on these platforms.

1:01:51 And really, they have about the same chance of hitting a five-leg parlay as they

1:01:54 do making money on a zero-day-to-expiry out

1:01:56 of the money call option on orange juice futures.

1:01:59 So, the number of people owning shares for the first

1:02:01 time is misleading at best and outright dangerous at worst.

1:02:06 But, you are probably better than that, right?

1:02:09 You might have a buy and hold portfolio that you make regular contributions to.

1:02:13 You don't have any high-interest debt,

1:02:15 and you might even watch low-energy boomers like Ben Felix or The Plain

1:02:18 Bagel that give realistic guidance on how to invest your money.

1:02:21 Surely you are an investor, right?

1:02:24 Wrong.

1:02:26 Statistically speaking, the only difference between you,

1:02:28 the average person watching this video,

1:02:30 and someone blowing up their Robinhood account is

1:02:32 at least those guys have a little bit of self-awareness.

1:02:35 This video was actually inspired by a comment on our video

1:02:38 about farmland becoming the target of major investment firms.

1:02:41 I don't want to call that particular commenter out,

1:02:44 but they said something like, "Even if investors do buy up all the farmland,

1:02:47 it doesn't matter because we are the investors through our pensions,

1:02:51 retirement savings accounts,

1:02:52 or direct holdings." This line of thinking has been used to protect investors

1:02:56 in the past with big bailouts because if markets are allowed to suffer,

1:02:59 then people will lose their life savings.

1:03:01 The reality is that stock ownership in America is

1:03:04 incredibly concentrated in the hands of very wealthy people.

1:03:07 According to a Fed survey of consumer finances,

1:03:09 the top 10% of Americans own 93% of all stocks.

1:03:13 So, everybody worth less than $1.6 million

1:03:16 is really just fighting over the scraps.

1:03:18 Even within the top 10%,

1:03:20 stock ownership is still incredibly concentrated with the top

1:03:23 0.1% increasing their holdings faster than any other group.

1:03:27 These people are investors as a majority of their earnings power

1:03:30 will be derived from dividends

1:03:32 and capital appreciation from their shareholdings.

1:03:34 The detail is that very few of them got there by investing alone.

1:03:38 Most of the wealth in the very highest percentiles of wealth was

1:03:41 made through a combination of investing

1:03:43 and either running a successful business,

1:03:45 having a career as an extremely well-paid executive,

1:03:47 or just inheriting their investments.

1:03:49 There is a similar misconception that millionaires get rich

1:03:52 by building an average of seven different sources of income.

1:03:55 Just like the idea of being an investor can make you rich,

1:03:58 this is based on an element of truth.

1:04:00 It's based on an IRS report that studied households between 1998 and 2002,

1:04:05 and it found that high-net-worth respondents had reportable

1:04:07 tax [music] income from dividend income from stocks owned,

1:04:11 earned income from paychecks, rents from rental real estate,

1:04:14 royalties from selling rights to use something they've written or invented,

1:04:17 capital gains from selling appreciated assets, profits from business they own,

1:04:20 and interest from savings, CD bonds, or other lending activities.

1:04:25 The thing is, at least four out of those required

1:04:27 the household to have money invested in the first place.

1:04:29 So, they didn't really get rich from having multiple sources of income.

1:04:33 They had multiple sources of income because they were rich.

1:04:36 So, what this means is that for the vast

1:04:38 majority of even the most diligent investors,

1:04:40 it's better for them to focus on increasing their earnings to buy

1:04:43 more investments than it is to focus on hyper-optimizing their investments.

1:04:47 In the best-case scenario, if you have got yourself a good job,

1:04:50 made responsible financial decisions,

1:04:52 and are consistently putting money away into an investment portfolio,

1:04:55 not only are you in the top 5% of people,

1:04:57 but you are still a worker that happens to have some investments.

1:05:00 Now, there are actually three reasons why

1:05:02 it's really important for you to think otherwise.

1:05:05 The first reason is that people that think

1:05:07 more about their investments tend to make worse investments.

1:05:10 A study by UC Berkeley found that stock portfolios held by female

1:05:13 investors generated annual returns of 1%

1:05:16 higher than their male peers on average.

1:05:18 1% might not sound like a lot,

1:05:20 but compounded over a multi-decade investing horizon,

1:05:23 and that small difference could easily double or triple a portfolio size.

1:05:27 For single men and single women, the difference was even wider at 1.44%.

1:05:32 What was the cause of these higher returns?

1:05:34 Women just cared less about investing,

1:05:36 so they didn't try to fine-tune their portfolio as much as men did.

1:05:39 There is an entire industry of market makers and prop trading firms

1:05:42 that can only make money when there is dumb money active in the market.

1:05:45 So, there is a multi-billion-dollar that really

1:05:48 needs you to trade your investments as much

1:05:50 as possible so they can pick up a few cents every time you do.

1:05:53 The second reason is that if people think they are investors,

1:05:56 they are a lot more receptive to pro-investment

1:05:58 policy either from their government or their companies.

1:06:01 Bailouts loosen investment regulations, lighter work protections,

1:06:04 and business subsidies overwhelmingly benefit investors

1:06:07 often at the expense of workers.

1:06:09 Other questionable practices like corporate investment into single-family homes,

1:06:13 leveraged buyouts, anti-competitive practices,

1:06:15 and market consolidation are surprisingly hard to push

1:06:18 back against because lobbyists immediately bring up the fact

1:06:21 that restricting these practices would hurt people's retirement

1:06:24 savings if these businesses couldn't do what they do.

1:06:27 If people think they are investors,

1:06:28 it's a lot easier to get support for these policies.

1:06:31 The third reason is that people who

1:06:33 think they are investors are better consumers.

1:06:35 A survey of 2,070 respondents conducted

1:06:38 by the market research firm Ticker found that consumers

1:06:40 were 80% more likely to purchase from a company that they own shares in.

1:06:44 Apple shareholders were more likely to buy an iPhone.

1:06:47 Amazon shareholders were more likely to be Prime customers,

1:06:50 and Tesla shareholders were much more likely to drive a Tesla.

1:06:54 It's highly unlikely that the investment returns

1:06:56 from these companies will cover the purchases unless

1:06:58 you made a significant investment when these businesses

1:07:00 were much smaller than they are today.

1:07:02 If you buy a few Tesla shares because

1:07:04 you believe in the vision of electric self-driving cars,

1:07:06 and you also pick up a Model 3, then you are a consumer that just so

1:07:10 happens to also own some shares, not an investor.

1:07:14 Companies know about this trick,

1:07:15 and some of them even offer special deals to shareholders in the business.

1:07:19 The Carnival Cruise Line Corporation, for example,

1:07:21 offers shareholders discounts on trips if they

1:07:23 own at least 100 shares in the company,

1:07:25 which amounts to about $1,800 as of the date of making this video.

1:07:29 They don't offer these deals because they think

1:07:31 a few retail investors will bolster their stock price.

1:07:33 They do it because it's effectively a loyalty program

1:07:36 that people tie up hundreds of dollars to join.

1:07:39 Now, the most important piece of nuance amongst all

1:07:41 of this is that investing is still incredibly important.

1:07:45 But, go and watch this extended cut video next to find out why companies are

1:07:48 quietly going out of business despite a record

1:07:50 high number of Americans investing in them.

1:07:53 And don't forget to like and subscribe to keep on learning how money works.