The AI Time Bomb

This will explode in our faces.

Photo by Logan Voss on Unsplash

A few weeks ago, OpenAI seemingly proposed that the US government back its loans, only to walk it back after a huge backlash. Why would they ask for this? Well, let’s be clear, this is really OpenAI asking for a bailout for when things inevitably fall apart. But that isn’t really the whole story. You see, this isn’t OpenAI trying to lock in “corporate socialism”. OpenAI, like all generative AI projects, is not, and will never be, profitable, and almost its entire value is based on hype-driven speculation (read more here). Such a bailout would not save them from collapse. No, this is the AI giant desperately trying to prevent the ticking time bomb at the core of the AI bubble from exploding. Sadly, though, the fuse is already lit.

How? Well, all we have to do is follow the money.

As always, none of this is financial advice.

Funding AI

The AI boom was initially funded by the mountains of cash tech giants like Microsoft, Google, Amazon, and Meta had amassed from not paying enough tax for the past two decades. This gave the likes of OpenAI their big leap forward and instigated the generative AI hype.

But, as I have covered before, AI experiences diminishing returns, meaning that AI development costs increase exponentially. As such, the AI boom threatened to drain these tech giants of all their liquid cash. So, the industry switched to equity financing, which involved selling off shares to raise enough cash to keep the lights on. However, this quickly devolved into the infamous circular financing deals between OpenAI, Nvidia, Oracle, CoreWeave and Microsoft, which, in the end, wasn’t even enough cash to cover the spiralling costs of AI.

So, over the past year, Big Tech has turned more and more towards debt financing, or taking out loans, to cover their mounting AI costs. To give you an idea of how rapidly they are taking on debt, Big Tech is predicted to spend $400 billion on AI in 2025 and has issued $200 billion in AI-related bonds (or debt) so far this year, with half of that happening since September.

Those of you with even a moderate understanding of finance might see this debt as a giant red flag. Keeping a wildly unprofitable venture going by rapidly taking on debt is just going to make the cash problems worse.

But wait — it gets so much worse.

AI costs are really spiralling out of control. AI expenditure is set to double next year. By 2028, Morgan Stanley predicts that the AI industry will spend $2.9 trillion, the vast majority of which will require debt financing. According to J.P. Morgan, the AI sector will need $1.5 trillion in bonds (or debt financing), to cover the costs of constructing planned data centres alone.

Given the amount of money being poured into AI, you would assume that the models would improve significantly and become profitable. But no, in fact, much of the science suggests this gigantic expenditure isn’t going to make the AIs much better at all (read more here). In fact, OpenAI itself has had to admit they can’t make their models much more accurate than they already are (read more here), which is a serious problem, as corporate AI adoption rate and revenue growth are beginning to stall (read more here and here) because the models aren’t good enough. So, OpenAI is pivoting to other markets, like social media apps and web browsers, to generate more revenue, but even if it dominated these markets, there simply wouldn’t be enough available revenue to cover its losses (read more here).

This ludicrous expenditure isn’t about long-term growth, developing better AI, or even making these business models remotely sustainable. It is about short-term speculative gain, and seemingly nothing more.

However, the real ticking time bomb is the way they are financing this speculative drive — the bonds.

Bonds, CDS & AI

To understand why, we need to understand what a bond is and how it relates to Credit Default Swaps (CDS). Stick with me; this gets juicy, I promise.