Regulatory Risk is Coming For AI | David Woo on AI Data Center CapEx and Iran War

**Jack Farley** (0:00)
Today's episode is brought to you by the Teucrium Corn Fund, ticker CORN. Let's get into it. Very pleased today to be joined by David Woo, independent economist, known for his game theory-based forecasts on global markets and geopolitics. David, welcome to Monetary Matters.

**David Woo** (0:16)
Thanks for having me.

**Jack Farley** (0:17)
David, what do you think about AI, the huge capex in data centers that's now global, and just the AI data center trade?

**David Woo** (0:25)
For me, the big takeaway from the first quarter was the fact, by the way, the combined capex of the five hybrids scalers, that is Microsoft, Google, Amazon, whatever, Oracle and Facebook, were actually down for the first time in three years, actually on a quarter on quarter comparison. In fact, even on a year on year comparison, the growth rate dropped relatives to the fourth quarter last year.
Then not to mention the fact that obviously, in the first quarter, these hyperscalers were paying more for whatever they were buying from Micron, Samsung and practically everything else. Okay, so as a result, if they're paying more for the same stuff that they were buying, and they're spending actually less than they did in Q4, what this means is that actually capex in real terms was probably down quite a bit. Okay, now it's interesting that why people got so excited because they think earnings growth is going through the roof up 25%. But let me tell you why. Imagine Microsoft, all Microsoft did was to pay $100 more per basically membership to Micron. Now Microsoft only expense, let's just say 10% of that because they only expense the capex essentially based on depreciation. So I just say they have to expense $10 of the $100 increase in Micron chip, okay? Micron, because this is just literally like free money because they just literally they don't even have to produce more, they're just charging more. That is 100% basically margin business, okay? So they can basically book an increase in profit by $100. So 100 minus 10, that is combined earnings go up by $90 just because Microsoft is paying $100 more to Micron, okay, for the same chip. What I'm saying to you is that ironically, the inflation of the components that go into data centers have actually given ironically a boost to basically nominal earnings growth because equity investors are dumb. They only look at nominal and rather than real. For them, wow, nominal looks great. But I think so from that point of view, this is actually very important because so I'm telling you ironically, I don't disagree the notion that more capex to the extent that hyperscalers think that there is more upside for them in terms of productivity growth, in terms of whatever it is, that's bullish for AI. But I would argue, by the way, not only there was a slowdown, but actually the slowdown in real terms probably was quite considerable. On top of that, in the first quarter, I think the numbers were in general, essentially the window dress by token maxing, as you know.
We know all these software engineers were racking up massive consumption of AI.
For example, Amazon, Amazon at a certain point were ranking their software engineers based on who's using more AI.
So everybody was trying to max out their AI usage. As a result, you saw the surge in AI usage. This is why, you know, what you probably heard this, you know, the CEO of Uber coming out a few weeks ago saying that they ran through their entire token budget for the year in just four months and have very little to show for and now they're reigning back. So what I'm telling you is that very likely we're probably going to see a slowdown in Q2. So Q1 numbers were very impressive, no doubt about that. OK, and I think it's for the wrong reason. I think Q2, you're probably going to see a slowdown.

**Jack Farley** (4:05)
So you said that there was a slowdown in actual CAPEX in Q1?

**David Woo** (4:08)
Yes.

**Jack Farley** (4:09)
Quarter over quarter, wow.

**David Woo** (4:11)
In US dollar terms, there was a quarter and quarter drop. In a year on year, basically growth rate decline in Q1.

**Jack Farley** (4:20)
Wow.

**David Woo** (4:20)
This is even before we're taking account of the inflation, probably we saw in Q1, which were driven down, essentially the real increase, the volume increase in the actual CAPEX.

**Jack Farley** (4:31)
So what explains that quarter over quarter decrease in CAPEX from the fourth quarter of last year to the first quarter of this year? And how come no one else is talking about this?