1. Size the borrowed portion of growth — with a deliberately conservative multiplier
The repeatable method
- Establish the excess deficit rather than the headline one: the current deficit as a share of GDP minus a normal-cycle level. Only the excess is the stimulant.
- Choose a fiscal multiplier at the low end of the contested range, not the middle. Making the estimate conservative is what stops the conclusion depending on an assumption nobody agrees about.
- Multiply: excess deficit share × multiplier = the share of measured GDP growth that is fiscally manufactured.
- Compare that figure directly against actual measured growth over the same window. The ratio is the finding, and it is far more informative than either number alone.
- State the implication in terms of what remains: growth net of the fiscal contribution is what the private economy is generating on its own, and it is the number that survives if the deficit normalises.
Here: the excess is framed against normal, not zero — "when federal red ink is running at
four percent above normal — say, 6% of GDP deficits vs. a more typical 2%." The multiplier is deliberately low: "how much is the subject of
intense debate. Yet
even assuming only a 0.5 'multiplier effect' this would still amount to around
2% of artificial economic growth." Set against
Aug-26's scorecard — GDP "averaged
roughly 2%" since late 2024 — the conservative estimate accounts for essentially all of the measured growth.
Watch for
- The deficit share flattening or falling, which withdraws the dose whether or not anyone intends it — a fiscal impulse (the change in the deficit) turns negative long before the deficit itself is small. Watch too for the honest counter: a multiplier this low may understate the effect, which would make the borrowed share of growth larger, not smaller.
2. Normalise corporate profits for the fiscal contribution before you value the index
The repeatable method
- Treat aggregate corporate profit as a flow identity, not a measure of corporate skill: the Levy-Kalecki equation makes government dissaving one of the sources feeding profits in aggregate.
- Take the theoretical one-for-one relationship as an upper bound and then subtract the offsets explicitly — trade deficits leaking spending abroad, and higher rates from the same borrowing raising interest costs.
- Estimate what share of current aggregate profit is attributable to the excess deficit. Even a rough range changes the picture.
- Recompute the market multiple on normalised profits — earnings as they would be with a normal-sized deficit — instead of on reported earnings.
- Read the result as a statement about margins, not about price. The claim is not that the index is overpriced against today's E, but that today's E contains a component that mean-reverts.
- Cross-check with a sales-based measure, which is immune to the margin question entirely.
Here: "corporate profits also receive a
tremendous up-lift from emergency levels of U.S. government largesse. In theory, there is a
one-to-one relationship, per the widely accepted Levy-Kalecki Profit Equation… a
$1 trillion jump in the federal deficit inflates corporate profits by a similar amount" — with the offsets named: "
elevating trading deficits, as well as raising interest rates as surging government borrowing '
crowds out' the private sector." This is the mechanism under the archive's standing valuation claim from the
Aug-17 Update: "on a
normalized profit-margin basis, the S&P 500 is far more overpriced than it superficially appears," reached there by noting the index's forward P/E
fell 21× → 20× across a 50% return — so the return was all E. The sales cross-check is the same house Price/Sales yardstick applied to the index in the
Aug-24 Update's treatment of cyclicals.
Watch for
- The moment the deficit stops growing: under the identity, profits need the deficit to keep increasing to keep contributing growth, so a merely-stable large deficit removes the tailwind without any policy tightening at all. Watch too for the offsets swamping the effect — a widening trade deficit and rising corporate interest expense can neutralise the fiscal transfer.
3. Ask who is financing a capex boom and with what — the financing channel is where the second-order effect lives
The repeatable method
- For any spending boom, separate the amount from the funding source. The amount tells you about demand for equipment; the funding source tells you about pressure on the cost of money.
- Determine whether the capex is funded from operating cash flow or from newly issued debt. Cash-funded capex is largely self-contained; debt-funded capex competes for the same savings pool as every other borrower.
- Size the borrowing against the other large claimant — here, the government — and ask which one is price-insensitive. The borrower who must fund regardless of rate sets the marginal cost for everyone else.
- Check the direction of the crowding-out. Conventionally the state displaces the private sector; where private borrowing is large and price-insensitive enough, the causation can invert.
- Add the channel to the other forces acting on the same rate and treat the long yield, not the capex itself, as the transmission point into every other asset.
- Ask what happens to that rate if the capex fades — the pressure comes off, but so does the growth and the earnings it was supporting.
Here: "another enormous economic accelerant currently is
AI-related spending…
highly unlikely to be maintained longer term. It is also having the
bizarre effect of driving up the government's borrowing costs due to the
deluge of hyperscaler debt raises to fund their
$700 billion plus annual expenditures on the great data center build-out. In other words, this is a
reverse 'crowding out'." The read-out that the dose is still running is
NVDA: "(Nvidia's second-quarter results reported yesterday indicate this AI spending boom will
continue to run white hot.)" Stacked with the week's other two sources of pressure on the same yield — the deficit, and
Aug-26's "
8.4% year-over-year surge" in publicly held Treasury supply — against a Treasury attempting to hold that yield down (
Aug-25).
Watch for
- The shift from cash-funded to debt-funded capex within the hyperscalers, which is the specific tell that the boom has outgrown its own cash generation — and the credit-spread response to those issues, since widening spreads on data-centre-related debt would be the earliest sign the market is rationing it. Watch also for the double-fade case: AI capex slowing and the deficit impulse turning negative in the same window removes both stimulants at once.
4. Check the precedent as a share of GDP — then split the verdict between the drivers instead of issuing one call
The repeatable method
- Before judging whether a spending boom pays off, place it in history scaled to the economy. Absolute dollars across decades are meaningless; share of GDP is the comparable unit.
- If no prior episode reaches the current scale, say so and treat it as a genuine absence of evidence — a fact that constrains bulls and bears equally rather than confirming either.
- State the strongest version of the opposing case in the other side's own terms, and concede it where it deserves conceding.
- Then separate the drivers and judge each on its own record. Two stimulants running at once do not have to receive the same verdict.
- Where a driver has a long historical track record, use it. Where it does not, remain explicitly agnostic. The asymmetry in the verdict should mirror the asymmetry in the evidence.
- Finish with the observable that will adjudicate it — the market price already reacting to the imbalance.
Here: the scaling check is borrowed and double-sourced — "per the following graphic from the Columbia Business School, as relayed by Luke Gromen in his August 14th newsletter, prior eras of excessive spending to finance efficiency/technological breakthroughs have never represented such a large share of GDP" — and it produces a question, not an answer: "what happens to the economy when these double doses of amphetamines inevitably fade?" The bull case is stated fairly ("the productivity boost from AI will be so mammoth that these outlays will easily pay for themselves") and conceded ("this may well turn out to be the case"). The verdicts then diverge: on the fiscal dose, "the odds are that much higher excessive government spending will turn out to be a big disappointment," because "the facts are undeniable that America's economic growth dramatically decelerated over the last 25 years while deficit spending has exploded." Adjudicator: "the long-term bond market is clearly beginning to sniff out the unsustainability of this situation."
Watch for
- Actual productivity statistics rather than capex announcements — the bull case is testable, and measured productivity growth accelerating durably would settle it in the bulls' favour and justify the spending after the fact. On the fiscal side, watch for the opposite of the 25-year pattern: deficits rising with accelerating growth would break the record Hay is relying on.