How markets could topple the global economy

If the AI bubble bursts, an unusual recession could follow.

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If America’s stock market crashes, it will be one of the most predicted financial implosions in history. Everyone from bank bosses to the International Monetary Fund has warned about the stratospheric valuations of America’s tech companies.

Central bankers are bracing themselves for financial trouble; investors who made their names betting against subprime mortgage bonds in 2007-09 have resurfaced for another “big short”. At any sign of a wobble, such as a recent slight weekly fall in the Nasdaq index of tech stocks, speculation mounts that the market is on the precipice.

And no wonder. The cyclically adjusted price-earnings ratio of the S&P 500 index of stocks, propelled by the “magnificent seven” tech giants, has reached levels last seen during the dot.com boom. Investors are betting that the vast spending on artificial intelligence (AI) will pay off.

Yet, the numbers are daunting. For companies to achieve a 10 per cent return on the AI capex projected by 2030, they will collectively need US$650 billion (S$846 billion) of annual AI revenues ~ equivalent to over US$400 per year from every iPhone user, reckons JPMorgan Chase, a bank. History shows such lofty expectations are often disappointed, at first, by new technologies, even if they go on to change the world.

Yet, although a market crash would surprise almost nobody, few have thought about its consequences. That is partly because the chances of a big fall in stock markets bringing about a broad financial crisis are, for now, slim.