Will AI take all our jobs? Is it going to be a SkyNet-esque existential threat to humanity? Absolutely not. This fear-driven propaganda has been shoved down our throats for years now. In the real world, AI isn’t even that useful a tool. A recent MIT study found that 95% of AI pilots actually lowered productivity. AI can barely organise a back office, but that isn’t what makes it dangerous. You see, there is a very real chance it could destroy our economy from the top down, not the bottom up. Remember that moment from the “Big Short”, where a stripper tells Mark Baum she has a silly number of houses, and he suddenly realises a total market collapse is imminent? Yeah, we have just had that moment with AI. Let me explain.
Before we go on, do not take financial advice from this article. Conduct your own research and consult with financial experts.
I have already explained why the AI industry is in a bubble, and how it will affect the economy when it pops. If you want the details, click here and here.
But basically, no AI company or AI infrastructure is profitable. They are all losing money hand over fist. As such, they are using equity financing (selling shares of the company) or debt financing (borrowing money) to keep the lights on. However, because of the perceived notion of an AI race, the muddiness around AI’s real-world performance and the misinformed idea that an AI with more infrastructure behind it will be better, these companies’ values are tied to their expenditure. So they are also using equity and debt financing to spend hundreds of billions of dollars on AI expansion, which in turn raises their value, enabling more equity and debt financing to spend more and increase the value further and so on. However, not only are current AI models not accurate enough to be useful and profitable tools, but they have also reached a point of major diminishing returns. As such, the colossal amount of cash being pumped into them is only marginally improving them, meaning they will remain too inaccurate to even get close to their promised usefulness.
This is an obvious bubble. Values are being artificially pumped up when the core of the business is far from solid. We are even starting to get things like circular financing (Nvidia & OpenAI’s $100 billion chip deal) and AI companies hiding debt with SPVs (Meta’s $26 billion debt bid), which painfully mirrors other bubbles like the dot-com bubble.
I, and many others, have been warning of an AI bubble for years now. But major financial institutions have only just started to notice and ring the alarm bells.
A few days ago, the Bank of England said that it sees serious trouble ahead for global financial markets if investors U-turn on the prospects of AI, and, because of the reasons listed above, such a U-turn is possible. They even went as far as to say that “The risk of a sharp market correction has increased,” and that “If a sharp correction were to occur, tighter financial conditions could drag down world growth, expose vulnerabilities, and make life especially tough for developing countries.” A statement the IMF backed up.
Similar warnings came from Jamie Dimon, the head of the US’s largest bank, JPMorgan. In a recent interview, Dimon said he is “far more worried than others” about a serious market correction, which he said could come in the next six months to two years. Unlike the BoE or IMF, he didn’t directly blame AI, but we shouldn’t be suprised, as JPMorgan has massively invested in and lent to the AI industry under Dimon. He isn’t about to admit he is one of the people holding the murder weapon.
Deutsche Bank went one step further and actually calculated the extent of the AI bubble. They found that even with these interest rate cuts, the AI bubble is the only thing helping the US economy avoid a recession. Essentially, Deutsche Bank found that the AI industry’s utterly gargantuan investment in data centres is artificially inflating the US’s GDP. In fact, around half the current growth of index funds like the S&P 500 has been driven by the tech companies expending effort into data centres. It isn’t normal for a single industry to do that! If you exclude this expenditure from the US’s GDP, its growth has actually dropped off rapidly to near zero, which is a key warning sign of an upcoming recession.
This is all well and good, but the big question is, what will cause this gargantuan bubble to pop?!
This is where our “Big Short” moment comes in.
When Mark Baum was talking to that stripper, he realised a huge amount of mortgage debt had been misold. You see, banks and corporations purchase bundles of debt as an investment; these are referred to as debt securities or bonds. Because some loans are riskier than others, financial regulators grade these bundles from high-grade AAA bonds to trash D bonds, with anything above a BBB- being considered “investment grade” (i.e. is likely to get you a return).
In the early 2000s, banks were mixing low-grade, unsellable debt with a tiny amount of high-grade debt, and then grading the whole bundle as investment grade. This artificially inflated the debt market, creating a bubble that was not just ripe to collapse, but take down the entire financial system when it did.
But no one noticed. That was, until Mark Baum went to a strip club and discovered that the lady had been able to obtain five houses, all on dodgy mortgages. She must be massively overextending herself to afford that, plus her work has a hugely variable income. In other words, the debt from these mortgages should have been seen as low-grade, and she shouldn’t have been able to accrue so many, as the banks should never have taken such a risk. The only way she could do this was if debt had been misold, and there was a vast, unseen bubble.
Now, this exact scenario didn’t actually happen in real life. But Michael Burry and Steve Eisman (who Baum is based on) both independently found this bubble by realising highly risky debt as being as solid as investment grade.
So, let me ask you. Loans given to an industry that isn’t profitable at all, is running entirely off equity and debt financing and nothing else, and is in such a dangerously vast bubble that the largest, most influential banks and financial institutions in the world are warning that when it pops, it will wreak havoc on the global financial world. Do you think this debt is investment-grade, or not?
It should be seen as wildly risky, right?
Well, it turns out the AI industry has accumulated $1.2 trillion worth of debt, of which almost all has been sold on as investment-grade securities. That means more high-grade debt is now tied to AI than to US banks!
Back in 2008, rising interest rates stalled the housing market, and huge amounts of these risky mortgages deflated, which in turn meant a huge number of these high-grade securities went bust too. This triggered a reassessment of the security market, causing $1.9 trillion worth of securities to be downgraded from investment-grade to trash. The banks and financial institutions that had bought these failed, triggering a massive recession.
At its current rate of borrowing, the AI industry will easily hit this $1.9 trillion mark in a year, possibly even within the next six months.
The question is, what will trigger the reassessment of these AI debt securities?
Well, the BoE, IMF and JPMorgan all pointed to the Federal Reserve. If it falls under Trump’s control, and he changes policies as radically as he has indicated, they warn this will cause a “sharp repricing of US dollar assets, including in US sovereign debt markets.”
This will stop the cash train that is keeping AI companies afloat, as investors and lenders will become far more risk-averse, causing some AI companies to go bankrupt or need bailouts, which will trigger the forewarned investor U-turn.This will cause AI-tied debt to default, causing these securities to fail. Likewise, the repricing of US debt will also entail the reassessment of security grades. And just like in 2008, trillions of dollars of securities, which are used to prop up our financial system, will either fail or be reassigned as worthless, dooming us to another soul-crushing recession.
But, major players like Dimon think this “correction” could take up to two years to happen. Again, don’t forget that the AI industry is taking on exponentially more debt to keep itself going. The majority of that $1.2 trillion was generated in the past two years. So, in two years’ time, they could have sold far more than $1.9 trillion in mis-sold debt, and the financial fallout when its value gets reassigned to basically zero, will make 2008 look like a walk in the park.
In short, we want the AI bubble to pop sooner rather than later. Rip the band-aid off, so to speak. But either way, things are going to get worse before they get better.
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Sources: Bloomberg, Fortune, Sky, BBC, Fortune, Reuters, The Guardian, Will Lockett, Will Lockett, Fortune, JMR
If Jamie Dimond (who should be in prison) is worried and Paul Krugman is alarmed, it’s time to reorganize one’s investment basket to limit the risk. I don’t know why the market dropped 3% yesterday - probably a typical end of the week sell off - but if one’s portfolio did worse than that, it doesn’t look good for how one will do when the AI bubble bursts. AI is being promoted like Dutch tulips and many investors and businesses aren’t accurately assessing its value and risk, to their future dismay. It’s too bad, because it had great promise as an ectopic memory/aggregation tool.
Another trillion or so in crypto. PLus the overvaluation of the shares themselves. It's the GFC and the dotcom crash combined, twice over.