Fiscal Vespers

Photo by Jeremy Perkins on Unsplash

America’s strategic goals teeter on the edge of a looming fiscal cliff

Capitalism gets a bad rap, some of it deserved. But the magic of capitalism — the kernel that consistently thwarts those who wish to overthrow it — is its ultimate truth-seeking nature. Dreams can defy economics for only so long before expenses, tradeoffs, risks, decisions and strategies have to be brought into balance. It’s an economic system that demands an accounting, a reckoning, with truth. It’s not always instant, and it certainly isn’t always pretty to watch, but the capitalistic asymptote heads toward unvarnished rationality.

America’s curse is that even as it piously prays to the priests of financial capital, it regularly engages in flights of fancy freighted with fiscal illogic. We’re a consumer society, and we drive a hard bargain. We want Sam’s Club superpower supremacy: in bulk, cheap, and with an affordable membership program coupled to a smiling greeter that checks our card. We want pathbreaking laboratories, world-class medical facilities and schools and top-notch public services, but at tax rates that feel like theft. Even as we lose more properties on the Monopoly board, we just want to accelerate our drive past Go and pause on Free Parking.

Our approach to governance is to always be shopping for that three-for-one special, and never quite finding it. But there are no specials, there are no deals, and the capitalistic reckoning is fast approaching.

This week, Fitch downgraded U.S. debt a notch from AAA, mirroring a similar downgrade made by S&P back in 2011 that remains in place to this day. Just like in 2011, the immediate cause of Fitch’s announcement was the high-wire act of lifting the debt ceiling earlier this summer. But unlike in 2011, there are now far greater concerns about the mathematics of America’s fiscal order, and not just the political logjam on Capitol Hill.

In the 2023 fiscal year, the federal government’s deficit is $1.4 trillion, an increase of 170% over the previous year according to the Treasury Department. The Congressional Budget Office’s analysis shows that these deficits are set to expand. The combination of higher borrowing costs and yawning government deficits is exponentially increasing the nation’s recurring interest costs, to say nothing of state and local governments that face their own extensive fiscal woes. In the third quarter of 2020, America’s annualized interest payments were $516 billion. Just three years later, that’s nearly doubled to $970 billion, overtaking the Department of Defense’s budget for the first time.

It’s not just Congress that’s been profligate, as American consumers have matched the government’s voracious appetite for debt with their own verve. American revolving debt (i.e. credit cards and similar products) expanded nearly 30% in the two years between April 2021 and May 2023 as measured by the Federal Reserve, increasing by $282 billion in the wake of three rounds of pandemic stimulus checks. On a nominal basis, it’s the highest credit card debt the country has ever reached.

The debt-addled spending has certainly fueled inflation (those eye-watering travel fares to Europe this summer didn’t come from the ether), but more importantly, it’s maintained growth in the American economy even as most financial indicators have pointed toward recession. Borrowing from the future to pay for present stability comes at a cost though, one that capitalism enjoys rectifying. The valuation of trillions of dollars of commercial and residential real estate have yet to reconcile with the new reality of high interest rates, a scale of value collapse that could still prove devastating.

The even greater reckoning to come though is America’s global position at the forefront of science, defense and development. U.S. competition with China is predicated on matching aggressive investment from Beijing that has allowed China to take the pole position across the Global South if not much of the industrialized world.

Just as America needs to strategically invest, it finds itself strangulated by crimson tides of red ink.

No domain has gotten more attention than the race at the frontiers of science, with strong echoes of America’s competition with the Soviet Union still very vivid among the Beltway set. Last year’s passage of the CHIPS and Science Act offered a headline investment of tens of billions of dollars into semiconductor research, fab construction and expanded funding for research institutions, most notably the National Science Foundation (NSF).

Yet, in this year’s budget negotiations, science funding is now recoiling from its heady highs. The House committee has proposed a 5.9% reduction to the National Institutes of Health (NIH), and the Senate’s counterpart countered with a paltry 2% increase last week (roughly matching President Biden’s recommendation). Final numbers will arrive as the House and Senate reconcile their different versions of the budget, but in an inflationary environment, such small numbers ultimately shrink the work of the NIH. Thankfully, the NSF is on course to fare better.

Compare that milquetoast commitment to scientific expansion to the authoritative vision of Xi Jinping, who has placed technological self-determination and scientific prowess as one of China’s top objectives. America of course remains the leading global home of science, but that leadership is predicated on long-horizon science investigations consistently funded by Congress. A reversal of our recent surge in investments could undo almost all of its value.

As we turn toward defense, there is growing awareness that America’s fiscal position and its strategic goals are no longer in alignment. In a breathtaking report published last week, RAND described an America chastened by what might be dubbed imperial overstretch in the Paul Kennedy sense:

Over time, the tasks borne by U.S. forces grew more numerous and more demanding as their capacity to accomplish these tasks stagnated. Ernest Hemingway observed that a person goes bankrupt in two ways: “Gradually, then suddenly.” The same could be said for U.S. military dominance and, more broadly, for the solvency of U.S. defense strategy.

Crisis after crisis has hit America (just this week, a coup in Niger has upended geopolitics in the Sahel – and we don’t even have the time to talk about it!), forcing defense planners to thin the military’s posture across more theaters, more types of combat and more adversaries than ever before. The situation is acutely tenuous:

Collectively, these trends have created a growing gap between the goals of U.S. national security strategy and the ways and means available to support those goals. Left unchecked, these trends will almost certainly lead to increased regional instability, reduced U.S. influence and security, and metastasizing challenges to U.S. and allied interests.

RAND argues for an adaptable posture that leverages allies and could cost the United States only tens or small hundreds of billions of incremental spending. That’s already asking for a lot, and America struggles to fund even high-leverage initiatives in defense. The Office of Strategic Capital, a much-ballyhooed initiative at Defense to connect trusted private investment into the defense industrial base, looks set to miss authorization for its loan program this year after the department failed to ask for authorities from Congress. We’ll try again next year, I guess.

The general crisis at Defense is equally matched at the State Department, where under-funding for Asia-Pacific has now yawned to historical proportions. A report from State to Congress obtained by Foreign Policy last week showed that the department is tens of billions of dollars short in countering China’s extensive diplomacy, investment and programming across the Pacific and around the world:

The Biden administration says matching China’s growing diplomatic and military muscle in the Indo-Pacific is one of its top priorities. Yet according to State Department budget documents, there is a $41.3 billion gap between what the Biden administration has given the State Department and the U.S. Agency for International Development (USAID) and what those departments anticipate needing to carry out that mission over the next five years.

That’s a nice segue from defense to development, where USAID was in the spotlight this week after Congressman Matt Gaetz called for the agency to be abolished. Gaetz knows how to pull a media stunt with the best of them (“USAID does not serve a meaningful purpose. It is used as a slush fund for international wokeism”), but his views align with a growing number of congressmen balancing domestic investment with overseas influence. Only one of those two blocs vote in elections.

The pullback on American aid echoes a similar retrenchment in the United Kingdom, where foreign aid budgets were cut under former Prime Minister Boris Johnson, leading to this week’s depressing report from the Foreign Office of what tighter budgets have meant for Britain’s influence and standing in the world.

Reckoning, accounting, atoning. The theology of capitalism is forcing America to confront its position in the world with renewed clarity, and the acuity isn’t pleasing. Reversions on science, defense and development are just a few of the myriad areas where retrenchment is being ushered in this year. And that’s still assuming America can hold on to an annual deficit of 6% of GDP while interest rates remain at recent historical highs. There isn’t an Ozempic for the federal budget, nor a Black Friday special that might match our desires with our checkbooks. Capitalism’s kernel of truth wins another day.

Lux Investment: Reflex

Grace Isford; Reflex co-founders Nikhil Rao and Alek Petuskey; and Brandon Reeves (L to R)
Grace Isford; Reflex co-founders Nikhil Rao and Alek Petuskey; and Brandon Reeves (L to R)

Summer has been busy here at Lux, and nowhere has it been busier than in the world of AI. Python over the last decade has become the programming language of choice in the AI community, building upon the language’s widespread usage in data science. Yet one of Python’s weaknesses is its limited support for building web applications, which have traditionally been the province of JavaScript. It’s a gap that we’re excited to finally see filled.

Lux led a $5 million seed round into Reflex (formerly Pynecone), a platform that allows developers to build frontend and backend web applications cohesively with just one language: Python. Lux partners Grace Isford and Brandon Reeves wrote up the company’s story and our thesis for the company, while TechCrunch’s Ron Miller wrote a great funding announcement on Reflex as well.

Podcast: We need to go deeper with the inception of deep geothermal energy

Image design by Chris Gates
Image design by Chris Gates

Historians survey the past and the Twitterati (X-erati?) process the events of the present day. But what does it mean to search the future for clues of what’s to come — and how much longer will we have to wait for it?

In this episode of "Securities", I welcome Lawrence Lundy-Bryan, research partner at Lunar Ventures and the publisher of "State of the Future”, a Deep Tech Tracker whose distinguishing feature is its extraordinarily wide remit to investigate the interstices of science and technology and find the morsels of innovative goodness that will power the planet in the years ahead. Also joining is Lux Capital’s own scientist-in-residence Sam Arbesman, who is certainly no stranger to the crazy ideas straddling science fiction and science fact.

Lawrence shares his unique approach to identifying and evaluating emerging technologies such as deep geothermal energy. We then pivot to exploring Lawrence’s approach of finding the future through the methodology of “horizontal scanning.” What’s to come? Listen and find out.

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Lux Recommends

  • Sam recommends an IEEE Spectrum piece on Gottfried Wilhelm Leibniz’s search for a machine of truth, part of a series on the history of natural language processing. “Leibniz’s central argument was that all human thoughts, no matter how complex, are combinations of basic and fundamental concepts, in much the same way that sentences are combinations of words, and words combinations of letters. He believed that if he could find a way to symbolically represent these fundamental concepts and develop a method by which to combine them logically, then he would be able to generate new thoughts on demand.”
  • Our summer associate Ken Bui has been looking into China and generative AI. He highlights two pieces, an article by Qiheng Chen in The China Project on “China sets restrictions on generative AI, but leaves room for innovation” and a paper by Matt Sheehan through the Carnegie Endowment on “China’s AI Regulations and How They Get Made.”
  • Not a long read, but I do think we should all take a gasp: Uber has finally turned a profit, after an estimated $31.5 billion in cumulative losses. It apparently takes a dollar to make, well, three dollars, given the company’s current $93 billion market cap. It has come a long ways from when I used to write about its frankenboard.
  • Our summer associate Koko Xu enjoyed this classic debate between Peter Thiel and Marc Andreessen at the Milken Institute. He also points to Sam Lessin’s latest column in The Information on “The End of Venture Capital as We Know It”. “You will know you are doing real venture capital when you aren’t competing with other investors to finance a deal but are instead offering to invest in people, industries and ideas that don’t yet have access to capital.”
  • Our Sam loved Riley Black’s question, “How Many Dinosaurs Remain Undiscovered?.” “Future finds are likely to be of small dinosaurs. Big dinosaurs were often found first because their remains were more resilient to scavenging, weathering and destruction than those of smaller animals, and museums liked having large, impressive dinosaurs to reconstruct for patrons.”
  • Finally, Ken, who has terrible taste, proffers Tammie Teclemariam’s screed against burrata in “A Big Fat Blob of Boring: Can we cool it with all the burrata balls?.” I’ll say this: You can take my (burrata) balls out of my cool, dead hands.

That’s it, folks. Have questions, comments, or ideas? This newsletter is sent from my email, so you can just click reply.