Artificial Intelligence Will Kill Inflation

(Editor’s Note: There will not be any commentary next week.)

Amazon’s most profitable business was an unintentional success….

In 1994, ex-hedge fund investor Jeff Bezos founded Amazon as an online bookseller. He was looking to cash in on the growth of the internet. But, six years later, the startup was hemorrhaging cash despite explosive revenue growth. Management sought ways to increase website traffic and drive more business. So, it needed to find ways to become more profitable.

The company wanted to be more than just an online marketplace for books. It looked to disrupt the brick-and-mortar retail industry. It quietly started a service to help merchants create online shopping sites. That would allow retail giants like Macy’s and Target to use the Amazon platform to drive sales. The business was called Merchant.com.

To serve all these clients, Amazon would now need huge databases and servers to house all the information it would soon process. And it would have to provide ways for customers to access this information.

But the process was more complicated than originally thought. Former AWS chief and current CEO Andy Jassy said in an interview with TechCrunch that it started separating the supporting hardware and software processes into distinct business units.

But the leaders of these units wanted to show why they were the best. Their desire for success wound up creating more competition… they were all fighting for the same resources and accolades. That’s when Amazon’s management team had another problem to solve.

In 2003, Amazon held an executive retreat at Bezos’ Beverly Hills home. Management was there to discover how it could get its separate business units to better work together. That’s when Amazon’s leadership realized it had developed an internet-infrastructure business.

By offering up the use of its databases, server farms, and compute processes, it could save companies everywhere tons of money spent on building out individual infrastructure. It would also spare them the costs of constant upgrades.

The management team decided there had to be more companies looking to more effectively use proprietary data to create better online experiences for their customers.

And that’s when AWS was born…

By creating a one-stop shop, Amazon could solve infrastructure problems for companies everywhere. It would save businesses the cost of buying hardware and software. In addition, those businesses wouldn’t have to fork out even more money for expensive upgrades… they could pay Amazon to do it for them instead.

Hypergrowth ensued. Since Amazon began breaking out AWS numbers in 2013, the unit’s revenue has swelled more than 25 times. And since the division’s launch in 2000, overall operating margins have doubled.

Yet, like most other cutting-edge technologies, the ability of AWS to improve profits for other companies was misunderstood at first. Analysts and investors couldn’t comprehend the concept. Amazon had built a platform that featured “products including compute, storage, databases, analytics, networking, mobile, developer tools, management tools, IoT, security, and enterprise applications” all in one place.

Not only that, but companies could pay for these functions as they went instead of having to fork out tons of upfront money to build a system whose capacity would never be tested. Instead, businesses could store data in a safe place, at a fraction of the cost, and then reference it down the road to make any and every process more efficient.

By doing that, companies could save on costs while better serving their customers. In other words, they were putting money back into their pockets.

Between 2009 and 2020, the increasing use of this new technology helped keep inflation costs under control, despite a long period of easy-money policies from the Federal Reserve. In fact, in 2018, after trying to understand why prices wouldn’t rise, central-bank Chair Jerome Powell said Amazon was helping to drive down inflation.

Fast forward to today… inflation is high, and our central bank is trying to get it back under control. It has raised interest rates at one of the fastest paces ever, to try and accomplish the task. And, after two years of waiting, the goal line of 2% inflation growth appears to be in sight.

But there’s another catalyst that likely propels inflation and interest rates even lower in the coming months and years… Artificial Intelligence.

According to brokerage firm Goldman Sachs, roughly two-thirds of all occupations in the U.S. are exposed to some form of AI. In addition, it believes roughly 25% to 50% of those workloads could be offloaded by using AI.

Goldman thinks the employment of such technology could boost productivity while increasing global economic output by $7 trillion over the next 10 years. In other words, workers would be able to do more in less time, making businesses everywhere more profitable.

So, don’t get caught up in the noise around AI stocks. The media is quick to highlight the share-price gains of companies like Nvidia. The naysayers are saying the stocks have run too far too fast. But they’re too caught up to see the obvious story that lies in front of them.

What the boobirds aren’t paying attention to is the economic potential. The profitability of companies like Nvidia and Amazon is booming for a reason… they provide a service that makes enterprises more profitable. And, as others catch on, they’ll employ AI to make their businesses better or risk getting left behind in the dust.

At the end of the day, the improved productivity means companies may be able to hold prices steady, or even charge less for goods and services, because costs are dropping. The change would help drive inflation growth lower as costs ease. That would give the central bank all the room it needs to cut interest rates even more, powering a steady rally in the S&P 500 Index.

Five Stories Moving the Market:

Japanese consumer spending in January fell by the most in 35 months, due to decreases in new car purchases amid factory suspensions, lower energy bills amid warm weather, and the backdrop of higher spending in the same month last year from post-pandemic travel subsidies – Reuters. (Why you should care – worsening household spending could erode the case for Bank of Japan interest rate hikes)

Federal Reserve Chair Jerome Powell told lawmakers the central bank was “not far” from being able to cut interest rates and that rates were far above levels that might be anticipated during periods of mild inflation and moderate growth – WSJ. (Why you should care – Wall Street recently lowered its rate cut expectations for 2024, meaning the Fed has a low bar to hurdle)

Broadcom said it expects $10 billion in revenue from chips related to artificial intelligence this year, but the shares fell after the company did not update its annual revenue forecast of $50 billion – Reuters. (Why you should care – the company suggested the custom chip business could command sizeable gross margins, highlighting the demand potential for AI products)

Marvell Technology forecast first-quarter results below market expectations due to soft demand in its wireless infrastructure, consumer, and enterprise markets – Reuters. (Why you should care – inventory destocking by customers weighed on demand but the company is encouraged by the impact of AI on its data-center business moving forward)

The European Central Bank held its key interest rate at a record high and signaled it won’t begin cutting rates before June, as policymakers lowered their expectations for inflation and economic growth this year – WSJ. (Why you should care – slowing economic and inflation growth are two outcomes the ECB seeks before it cuts interest rates)

Economic Calendar:

ECB’s Holzmann Speaks (4 a.m.)

Fed’s Williams Speaks (7 a.m.)

Change in Nonfarm, Manufacturing, Private Payrolls for February (8:30 a.m.)

Baker Hughes Rig Count (1 p.m.)

CFTC’s Commitment of Traders Report (3:30 p.m.)

Fed Releases Balance Sheet Updates on Commercial Banks (4:15 p.m.)