I sincerely want to make your morning, every morning.

Whether that’s by delighting you with history, sharing market ideas, or telling you about something funny that happened to me, I hope you come away from every issue thinking, “That was a great way to spend 7 minutes of my morning!”

The last thing I want is to confuse you. As Alfred Hitchcock once said, “A confused audience doesn’t emote.”

So I’m going to clear up a few things today.

But before I do, I must apologize for going nearly the entire summer without diving into the mailbag. It’s already the “season of mists and mellow fruitfulness,” as Keats described autumn, and that makes it far too long since I’ve directly addressed your concerns.

Buy Now, Pay Later

Did you leave something out of your Microsoft/Nvidia example? When Microsoft buys the chips, it doesn’t record a new asset…doesn’t it just change one asset (cash) for another (chips)? Please explain. Thank you, Jeff C.

Hi Jeff!

Yes, you’re right. Microsoft exchanges cash for equipment. If it pays $1 billion for the chips, cash falls by $1 billion, and equipment rises by $1 billion. Total assets are unchanged at purchase.

MSFT capitalizes the purchase instead of recording the entire amount as an expense. I should have explicitly mentioned the corresponding reduction in cash. All this happens on the balance sheet.

But my point was about the income statement.

NVDA recognizes the revenue from the sale, while Microsoft spreads the equipment’s cost over its useful life through depreciation. Assuming a useful economic life of 5 years and no residual value, that would mean $200 million in depreciation expense per full year once the equipment is in service, even though Microsoft has already paid the entire $1 billion.

I will also tighten my wording about NVDA. The sale becomes revenue, not profit, because NVDA must deduct the cost of the chips it sold.

Thanks for helping me clear that up.

And right on cue, we have Girard:

Hi Sean, I have been mulling over this exact scenario with the company’s fixed-asset purchases and depreciation. I am a CPA, and depreciation should start only when the assets are put into service. Next, what happens when these assets aren't put into service and linger for a year or two because the data centers are stalled? These companies are then looking at significant writedowns, because the assets they purchased are “old” technology, and the newer technology is better, faster, and costlier? The companies would then have to write down the value of the existing assets. In my opinion, this is where earnings will suffer. Girard P.

Hi Girard! Yes, I should have specified that depreciation generally begins when equipment is ready and available for its intended use, not when it’s purchased.

If chips sit unused while waiting for a data center to be built, the technology can overtake them before depreciation even begins. That could mean a big hit to earnings through an impairment.

Remember, though, that newer chips don’t automatically force a writedown. Older chips may still earn enough to justify their balance sheet value.

Delays and obsolescence can trigger an impairment review, which assesses whether the recorded asset amount, in this case, the chips, remains recoverable.

Without going too deeply into the weeds, if the expected cash flows from the chips fall below their carrying value, the chips are written down to their fair value, and the writedown becomes a big expense against earnings.

So yes, the cost could hit earnings quickly through a writedown, rather than gradually through depreciation.

Say What?

Hi Sean. Rude Awakening is one of the few things I feel I must read every day. I love your insights, information, and historical perspectives.

I can usually keep up with your points, but this sentence threw me: “The genuinely uncomfortable observation is the dollar falling as yields rose, which points to term premium and fiscal compensation rather than a hawkish policy path, which is a slower, more corrosive problem than a rate scare.”

Can you simplify that for me? Thanks, Willy G.

Thanks for the kind words, Willy! Let’s simplify my gobbledegook.

When investors expect the Fed to raise interest rates, Treasury yields often rise, and the dollar strengthens, because higher rates make dollar investments more attractive.

But yields had risen while the dollar fell. That suggests investors want higher returns for taking longer-term risks in U.S. government debt, rather than just expecting more Fed hikes.

“Term premium” is the extra return investors demand for lending over a longer period. By “fiscal compensation,” I meant the extra return for concerns about government borrowing, deficits, and their consequences.

Think of a borrower whose lender says: “I’ll still lend to you, but I want more interest because I’m less comfortable with your ability to repay me.”

That combination doesn’t prove investors are losing confidence in America’s finances. Currencies and bonds move for many reasons. But it raises concern.

A “rate scare” is investors worrying about the Fed’s next few decisions (which they still are, despite Wednesday’s soft PCE reading).

The slower, more corrosive problem is investors gradually demanding more compensation to hold American debt. That makes government borrowing more expensive. And with interest expense already the second-largest line item in the budget, it’s expensive enough!

Wrap Up

My thanks to everyone who wrote in. Please keep them coming at feedback@rudeawakening.info, as I’ll be keeping a closer eye on the mailbag.

Have a wonderful weekend!