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Patrick 00:00

Welcome back to the Barclays Brief. It's a bright morning here in London, but I've been thinking about how foggy the short-term outlook for markets feels right now. Headlines are shifting fast, and it's easy to focus on one part of the picture at a time and then lose your perspective, because beneath the more negative headlines we’re seeing, a largely a cyclical investment cycle driven by AI, but also energy and defence is gathering momentum. And the scale of capital being deployed here is enormous.

Taken together, this points to something way bigger: a step change in global capital spending. So the question is what does that bigger picture tell us?

I'm Patrick Coffey, and sitting opposite me today is Christian Keller, our Chief Economist in our Research business. He's just published a chapter called ‘Supersize Me’ as part of our Global Outlook. Christian, thanks for being here, great to have you on.

Christian 00:58

Thanks, Patrick. Thanks for having me. Good to be here. Was a tough one to get out the Global Outlook in volatile times like this.

Patrick 01:05

I'm sure. How many rewrites did the front cover take?

Christian 01:08

You know, as, geopolitics moved on, we had to adjust it a few times.

Patrick 01:14

So, Christian, I was, rereading that chapter of your ‘Supersize Me’ on the train into work today, and in it you argue that we're at the early stages of a major investment cycle in advanced economies. That kind of feels a bit optimistic to me so what gives you the conviction that we're about to enter a new phase of much higher infrastructure investment?

Christian 01:39

That conviction, in part, is driven by the fact that, you know, when you look at investment cycles, you really have to think of longer time spans. We looked at 150 years of UK and U.S. data, and what you see is that while investment is very volatile, it does come in cycles. Typically, you know, ten to something year cycles that, you see an acceleration of investment and typically that is associated with some of new technologies where companies and, economies need to invest in something.

It is certainly punctuated by wars, financial crises, these type of disruptions. But ultimately what dominates is, that that kind of new technology and investment that comes with it and the reorganization of an economy

Patrick 02:22

around that new investment.

Christian 02:23

Yeah, exactly.

Patrick 02:24

And so by new investment, you're talking about AI presumably?

Christian 02:27

Exactly. In this case, I'm talking about AI and also all the infrastructure that comes with it. So the energy needs but also, the investment IT equipment etc., as AI becomes, a proper general purpose technology diffused throughout the economy, and then a bit separate as the defence cycle, I don't know, but let's talk about that separately.

Patrick 02:46

Well we'll definitely talk about that I'm sure.

Okay. So there's lots to cover here. Let's start with AI. Help me put the hyperscaler investment cycle into some context. You know, I find as I get older, I'm increasingly drawn to historical analogies. I've been reading a lot about US railroad investment in the 1850s, the Apollo space program in the 60s, and the telecoms boom of the 90s.

So where does the AI CapEx cycle really sit in comparison to those CapEx booms?

Christian 03:15

Yes, I think historical comparison is actually a very useful tool because it offers perspective. As I said earlier, we have a whole road 150 years of data. And the interesting thing is, if we look at the US hyperscale investor this year, you get about to the average annual investment that was done in the US during that railway boom, you just mentioned.

So we are in that category and that is one of the biggest. It's way bigger than the Apollo space program, a highway program in the US in the, in the 50s to 70s. And it's also actually a bigger than, than the telecoms already in some ways.

Patrick 03:54

Is there anything else in history be bigger than this AI CapEx boom?

Christian 03:58

Well, we have some interesting artifact, we found that, there was a purchase by the US of the Louisiana Territory. So this is a bigger investment if you want to count that. But, you know, frankly, that was very particular. We threw it in there just, as a comparison.

But as I said, AI is now up there with the railroads, it should be a pretty big boom.

Patrick 04:18

And can you just put some numbers around, around that investment relative to other cycles for us?

Christian 04:22

Yeah. Look, when we look at the build out of the US railroads, we have that is 2% of GDP. And we think the that's about where the US hyperscalers end up right now when we look at the committed, investments,

Patrick 04:36

okay. And, and that AI investment is adding up to a sort of notable increase in aggregate investment for the entire economy, or is it more of a reallocation of investment?

Christian 04:47

Yeah, that's a very, very good point. And, you know, we don't want to be naive here. For example, if you look at just the fourth quarter of GDP data last year, actually overall investment despite very strong AI related investment wasn't that strong. So there seems to be some replacement going on. However, over time, if you see AI as a technology that needs investment, as I said, not only in the AI itself, the data centres, but then also in other equipment, AI related and in the energy it is likely to be additive, not 100%, there’ll be some offset, some replacement, but it's hard to see that you have such a boom. It would then be fully offset by reduction of investment elsewhere.

Patrick 5:28

Yeah, and clearly AI is the most visible part of this whole story, but your work suggests it's only one building block. How important interlinked then, are energy security, defence spending and economic resilience in turning this into a kind of broader, more durable CapEx boom?

Christian 05:47

It's important to also, to see that we are looking at this kind of as a cycle in advanced economies, and I think the regional distribution is not fully equal. So the AI is particularly done. Hyper scaling is particularly done in the in the US data centres. When it comes to defence. We see Europe as a region that has not invested much in defence.

That's clearly coming back. But putting into context, well, if you look at general purpose technologies, it's always that you have a core investment, you know, in the 90s it was  computers or so, but then you have a lot of investment around it. We see it now already, what we call the, you know, AI related IT equipment investment. And then you have the energy.

And the energy is largely, you know, to provide the electricity for the data centres. But there's more going on. You know, there's a general electrification, there would be a lot of investment need in grid technology, etc. to offer the electrification that's coming independently of AI.

I think those two are together. Defence is somewhat independent, even though the reality is that a lot of the defence will depend on AI, there's probably some into linkage there as well.

Patrick 06:51

Sure. Just coming back, you mentioned advanced economies. Why do you focus on advanced economies here? Why not just global economies?

Christian 06:58

Good point. Because this is really where we saw on the global perspective the investment weakness. If you go back, you know, we had ratios of 26% as a share of GDP, what advanced economies were investing. And that then really came down all the way to, you know, last year was a 22% or so. On a global scale, investment was relatively stable, what happened? China.

China came in early this century, obviously with joining the WTO. Massively high investment ratios close to 50 coming down below 40 now, still very, very high. But you know, you had this peak of China investment that seems to be coming off now. And as I said, after two decades almost of low investment and these things, a lot of signals are now for those advanced economies, in particular US, Europe, Japan, you know, now basically coming back up,

Patrick 07:46

I see. So you got to strip out China, focus on the advanced economies. And you're seeing you think we were kind of at a trough last year and you expect that investment cycle to increase. You also made the point that geopolitical shocks, clearly we're talking about Iran at the moment, aren’t just risks to growth.

But they're also catalysts for investment. How should we think about that shift, particularly when it comes to energy and defence?

Christian 08:10

Yes. In the short run, you know something that is a key ingredient to oil activity already or energy in general, becoming more expensive is not a good thing. But I think what we've had also together over the last two decades with, with China is, you know, we had a high focus of all our supply chains globally, manufacturing, energy, everything really on efficiency, there were no redundancies: everything was just in time.

And obviously with the corona crisis, I think it came home that people realised, well, it is dependent on a few factories in China in the same town producing everything we need. Now, the ongoing crisis with energy in the Gulf is bringing home to Europe in particular, that they are very reliant still on energy in certain regions and places like China have much higher storage capacities, etc.

So what I'm saying here is it probably dawns now to Europe or, across the world to the advanced economies in particular, that they need to go from, you know, just in time to just in case. And that does require investment in hardware, as I said, storage facilities when it comes to oil, you know, larger warehousing for manufacturing goods, etc., and creating some redundancies all this should be adding to investment needs.

Patrick 09:18

I love that expression. Just in time to just in case. It's worth remembering though that AI, energy, defence obviously you talked about they're facing a boost in investment. They only account for about a third of all investment in advanced economies. So with that in mind, what are the biggest constraints that could limit how far this investment cycle actually runs?

Christian 09:40

Some are very obvious. I mean, defence is typically at least led by the private, by the public sector, I should say. And the public sector is stretched. And Europe, you know, has just, you know, to tell you the story of a country like Germany, you know, that in the mid-60s was spending 5.5%, was over 5% on defence, went all the way down to 1.5, is now back to two, wants to go to five.

But you know Germany does have the fiscal space with many other European countries don't. So fiscal space is an issue. But I think they will have to find ways, you know, maybe through common European issuance etc. But you're right that interest rates are going up in part because of the high investment and of course, the offset of not knowing, you know, whether investment in other areas maybe go down a bit, you know, that could be offset.

Patrick 10:21

Understood. Hey, let's just pull it all together. If this investment cycle does play out how you expect, which is essentially advanced economies, spending a lot more money, what does that mean for the macro backdrop? You know, for growth, inflation, the way that central banks think about policy over the next five years?

Christian 10:41

If things pan out as we think and, you know, a cycle we see always as investment growth, right?

You would expect that to accelerate. Typically these cycles are about a decade. You know they peak pretty much in the middle. So what you would expect is in the next five years or so accelerating investment. What does it do? It means there's more demand for capital. And if you know, savings investment, the savings ratios don't rise immediately, you would think, what is the price for capital? It's interest rates. So that famous R star that real interest rate you would think could be higher. At the same time, and that is much debated elsewhere as AI is of course potentially a huge pressure on wages. So you could see inflation, core inflation, it's wage related to be weaker.

Then again what you would likely see is continued price pressures on commodities because it is commodity intensive: energy and electrification needs copper. I mean, all of these metals you've probably talked about elsewhere already, they may see continued price pressures. That's what people also talk about, a commodity supercycle, which that seems to go hand in hand with that kind of a CapEx supercycle that we're about to see.

Patrick 11:46

Yeah. Christian, thank you so much. I spoke at the start about wanting a bit more perspective at a time where we're being bombarded by headlines It's great to have you on and talk about this longer term piece because AI, defence, energy, economic resilience are so key in the market right now.

And the numbers that you've written in the note just so big, it's great to have you here.

Christian 12:07

Thanks, Patrick. Great to be here.

Patrick 12:10

A couple of things that I'm going to be walking away from this conversation thinking about: Firstly, if you look back at 150 years of data, you can see that investment is volatile, but it does come in cycles.

The typical duration of each investment cycle is about a decade, and the cycle shape tends to be symmetric around the peak. After two decades of subdued capital spending in advanced economies. We appear to be at the cusp of an enormous investment cycle, being driven not just by AI, but by energy security, defence infrastructure, economic resilience. And it's worth remembering these aren't cyclical decisions, they're strategic ones. They're being reinforced by the vaery shocks dominating today's headlines.

So when you put it all together, by the end of this decade, investment to GDP ratio could reach or even exceed the levels last seen in the 1990s. Thanks for tuning in to the Barclays brief today. Do hit subscribe to stay up to date with the latest views of our thought leaders, and we'll be back again next week.