Financial Stability Board warns that we may be in an AI bubble

“We know at the dotcom period that those asset valuations — very eager to catch the latest technology, the latest darling of the markets — led to some exuberance. We saw this in the housing price bubble before the great financial crisis. We might be seeing that now.”

OpenAI’s Sam Altman is a great example of this, having said last month that he won’t accept a company valuation of anything under US$1 trillion.

Similarly, Chopmaker Nvidia became the first company to be valued at $5 trillion, and AI related firms have gained roughly $27 trillion in market value since November 2022.

While these AI firms are seeing returns, they are running at major losses, other than NVIDIA.

As a result, this could lead to a major price correction, which with so much invested in these AI firms, could create a bubble burst and an economic shock, something the FSB is incredibly worried about.

Elon Musk’s SpaceX is proof of this, having gone public with a $1 trillion valuation, which quickly peaked at $2.64 trillion in June this year. However, the market correction has seen that value drop by $1.2 trillion to a current value of $1.4 trillion to $1.5 trillion in just under 6 weeks, a 46 per cent drop.

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The FSB is concerned with the fact that investment is focused heavily on a small number of companies, which means an overcorrection could cause major issues for the economy.

"It does look like some of the valuations ... are quite up for the markets overall and for some of these companies. But I'm not a stock market prognosticator. I can't tell you how much further they'll go, whether they're justified or not. But it is something we monitor and discuss and work on trying to make sure that things don't go badly,” Schindler added.

When asked if the finance industry had protections against a bubble, Schindler simply said “I do hope so,” adding that banks are “largely proven pretty resilient to shocks” since the 2008 global financial crisis. However, he said the nonbank sector is much larger than it was in 2008 and much less regulated, adding that the financial system is “always evolving.”

“There could be build-ups of risk in parts of that sector that it's harder for us to assess. So, I can't say it will all be fine," he added.

The FSB also critiqued AI firms for the way they are acquiring AI assets, with firms using debt to increase returns on investment.

“If it's just mom and pop putting $100 in the stock market, that's one thing. If it is mom and pop leveraging that ten times over, that's something else, because the repercussions when something causes it to unwind are much more significant.”

Earlier this month, the European Central Bank warned that AI could be disruptive for the global economy, regardless of whether the bubble bursts or the technology succeeds.

“If AI overdelivers, it will impact financial stability. If AI underdelivers, it will impact financial stability,” said Apollo Global Management’s Torsten Slok at one of the main panels during the annual meet in Portugal.

A successful AI could result in major unemployment and create major instability in the economy, as nobody can afford to spend anymore. However, if AI fails, the major investments in it will also fail, creating economic issues.

“The internet proved to be better than anybody imagined, created whole new businesses, but we still got the dotcom bubble,” said Bank of Canada governor Tiff Macklem.

“It doesn’t mean there can’t be a period where the market gets ahead of itself, and you see an entrenchment.”

However, Commonwealth Bank of Australia chief economist Luke Yeaman said that while the bubble is concerning, it's not a repeat of the dotcom bubble.

“There are reasons to be concerned,” he said.

“Forty artificial intelligence companies account for half the US stock exchange. That is a big concentration of risk.”

However, Yeaman said that while AI valuations are currently inflated, they are likely to be corrected, and that the technology has real value for the future.

“Traditional valuations of AI are high. We do expect to see some corrections over time. But at CBA, we don’t think this is dotcom 2.0. Fundamentally, they look solid. We think there is real value in artificial intelligence over the next few years,” he said.

“Importantly, there is big upside in AI. If adopted well, we could see productivity lift of 1 per cent a year is entirely plausible, optimistically 2.5 per cent or pessimistically 0.5 per cent.”