Before a new factory produces anything, someone has to build it.
That means orders for equipment, contracts for suppliers, and paychecks for workers. The spending arrives before the additional production.
Kevin Warsh captured that sequence during his recent IMF appearance: “On the path to that positive supply shock, we’re seeing increases in aggregate demand.”1
He was discussing artificial intelligence. Add defense spending, and the industrial implications become considerably larger.
Follow the orders
AI infrastructure requires chips, power, cooling, construction, and electrical equipment. Defense requires ships, aircraft, missiles, communications systems, and the factories that produce them.
Underneath both are overlapping demands for engineering, electronics, precision manufacturing, materials, and skilled labor.
The money comes through different channels. Companies finance AI investment through cash flows and capital markets. Governments finance defense purchases through public revenue and borrowing. Suppliers invest to fulfill the orders.
That spending reaches the machine shop buying another CNC machine, the electrical contractor hiring another crew, and the manufacturer training its next production shift.
BACK TO BASICSCome on. This is Econ 101.
We’re spending heavily to build things that will help us produce more. But the spending arrives before the additional capacity.
When equipment, materials, electricity, and labor are constrained, stronger demand can push both real output and prices higher. That is the stage Warsh’s observation describes.
And honestly, I don’t understand the surprise. We learned this in Econ 101. If demand moves faster than supply can respond, you should expect price pressure.
People have good reasons to care about higher prices. But higher prices during an investment boom do not, by themselves, mean the investment thesis is broken.
Real economic output increases in both stages: stronger demand raises production first; expanding supply raises it further.
These diagrams isolate that mechanism. They do not explain every price increase or predict the size of future growth.
Real economic output increases in both stages.
1. More demand → more real output
2. More supply → more real output
THE BULLISH PARTWhat the spending leaves behind
Constraints are also a reason to invest. An order backlog can support another machine. Greater confidence in future demand can justify a larger facility. Labor shortages can strengthen the case for automation and training.
As those investments become productive, the economy can produce more, easing price pressure relative to a world where capacity stands still.
Execution matters. A budget announcement is several steps removed from a supplier receiving payment. And additional military capacity does not automatically expand civilian supply.
But I am bullish on the businesses making this expansion possible: the foundries, equipment suppliers, component manufacturers, engineers, and skilled trades.
The enduring economic prize is greater productive capacity: better facilities, stronger supplier networks, and people equipped to produce more.
The demand is arriving.
The opportunity is to build what comes next.