The AI Bubble Paradox: A Looming Bust in a Sea of Debt

My concern is that the current AI boom is a paradox that will tip our debt ridden global economy over the edge - and the real economy is too fragile and small to pay it off .

On the surface, it's driven by technological marvels and unprecedented investment. Beneath, however, it's built on a foundation of precarious financial leverage, including massive government and corporate debt, and a shadow mountain of derivatives. Asset managers enticing pension funds into passive investment strategies in an increasingly top heavy market and, the circular investment by Elon Musk and the latest 300bn Larry Ellison and Sam Altman deal should be scrutinized. This combination suggests that a potential bust would be unlike past downturns, with far-reaching and amplified consequences for the global economy.

Beware the unstable financial foundation of a global economy that is already highly leveraged. The total outstanding government and corporate debt has, thanks to no growth in the real world, reached staggering levels - now well over $200 trillion (GDP was 110.55 trillion US dollars for 2024 and projected to be around 113.8 trillion US dollars for 2025). This debt exists in the form of bonds, with governments and corporations needing to borrow to finance everything from public services to R & D.

• Crowding Out Corporate Investment: When governments issue a large amount of debt to fund their operations (or to stimulate the economy), they are competing with corporations for capital. This can drive up interest rates, making it more expensive for companies to borrow for long-term investments like building new factories or, in the case of AI, constructing data centers. This crowding out effect can stifle the very innovation the boom is supposed to be encouraging.
• The Debt-fueled Boom: Many of the companies at the heart of the AI boom are not yet profitable. They've been able to raise vast sums of money not because of their current earnings, but because of cheap debt and high investor confidence. This creates a feedback loop: cheap money fuels growth, which attracts more investors, which in turn justifies more debt.

The Derivatives Multiplier

The real risk, however, lies in the derivatives market. Valued at over $600 trillion in notional value (many times the size of global GDP), this "mountain" is a financial risk amplifier. Derivatives are complex financial instruments whose value is derived from an underlying asset, like a bond or stock.

• Magnifying Losses: In a downturn, a small drop in the value of an underlying asset can trigger huge losses on derivatives. The interconnected nature of this market means that a crisis in one sector (like AI) could cause a cascade of defaults, as companies and financial institutions that have bet on the growth of the AI industry are forced to unwind their derivative positions.
• Hidden Risk: The sheer complexity and opaque nature of derivatives make it nearly impossible to fully assess the risk in the system. The last major financial crisis showed how derivatives could transform what began as a subprime mortgage problem into a global financial meltdown. In the case of AI, the underlying "asset" is even less tangible and more volatile: the future, unproven profitability of an industry.

The Inevitable Bust

When the AI bubble inevitably pops—whether due to the rapid obsolescence of infrastructure, a lack of profitability, or a loss of investor confidence—the impact will be magnified by the debt and derivatives overhang.

• Accelerated Market Crash: The sell-off of AI stocks would be exacerbated by margin calls and forced liquidation of derivative contracts. This would create a "run on the bank" of a different kind, with investors scrambling for liquidity, causing asset prices across the board to plummet.
• A Sovereign Debt Crisis: A severe corporate crisis, particularly if it affects major banks and financial institutions, could trigger a sovereign debt crisis. Governments would be forced to bail out collapsing industries, adding to their already crippling debt. In a highly leveraged world, this could quickly lead to a loss of faith in a nation's ability to pay its debts, resulting in higher borrowing costs and a prolonged recession.
• Impact on Main Street: The burst of the bubble wouldn't just affect financial markets. Pension funds and individual investors who have been lured into the boom would see their savings evaporate. Companies would cut back on spending and lay off workers, leading to a surge in unemployment and a decline in consumer spending.

Unlike the railway or internet booms, where the infrastructure and technology had a long-term, durable value, the AI boom is centered on technology with an incredibly short shelf life. Combined with the unprecedented levels of debt and the explosive potential of derivatives, this creates a recipe for a bust that could be far more devastating than anything seen before. Rather than the current boom being treated as an opportunity for wealth creation, it is a perilous game of musical chairs being played by handful of oligarchs and VC spivs profiting but leaving us on a financial tightrope. Meanwhile, with China and the BRICS taking a different path, perhaps Europe, like the BRICS, would be prudent to risk being left behind. Because when the baton is passed on they could play the US at their own game and pick up the pieces 10 cents on the dollar.