Every financial landscape has its share of booms and busts. Usually, these speculative frenzies emerge at the tail end of a bullish market, creating a climactic surge that ultimately leads to a significant downturn.
During such times, investors, fueled by greed and confidence from previous successes, abandon caution in pursuit of quick profits. A prime example of this was the dot-com bubble in the late 1990s, which ignited after an 18-year bull market, only to see the NASDAQ plummet by 75% shortly after its peak.
The current wave of enthusiasm surrounding artificial intelligence (AI) presents a unique situation. Its rise accelerated with the introduction of ChatGPT approximately six months ago, yet this bubble is unfolding amidst an extended bear market rally. This could lead hopeful investors into making poor decisions at the worst possible moment.
As of now, the NASDAQ index has climbed 26% year-to-date, but it remains more than 17% below its all-time closing high from November 19, 2021.
Prominent companies like NVIDIA and Apple, which are loosely affiliated with AI, have seen their stock prices skyrocket, registering increases of about 160% and 43% respectively. While there’s potential for further gains, relying solely on the fear of missing out (FOMO) is a dangerous strategy that could lead to significant losses. We expect the AI bubble to be short-lived.
Multiple factors are at play, and major stress points in credit markets suggest that the leading stock indexes should retract before experiencing any significant growth. As such, the enthusiasm surrounding AI as an investment opportunity is likely to become a minor sideshow as the current bear market rally begins its next downturn.
Asking for Trouble
Leveraging monetary inflation to create an illusion of economic prosperity is a risky venture, one that has historically led to trouble. As long as money supply inflation continues, unprofitable businesses can stay afloat. However, once that inflation subsides, those businesses often can’t meet their obligations, leading to systemic failure.
While stimulus measures can give the illusion of promoting economic growth—when demand and supply are in balance—they are not sustainable. The stimulus provided during the recent pandemic far outstripped demand, leading to inflated consumer prices and an imbalance that cannot be sustained.
Furthermore, the abundant cheap credit fueled by the Federal Reserve has encouraged excessive borrowing, inflating asset prices across various sectors, including stocks, bonds, cryptocurrencies, and real estate. This surge in consumer price inflation has reached levels unseen in 40 years, largely driven by the Fed and government spending going unchecked.
Now, policymakers are grappling with the aftermath. Once monetary stimulus is injected into the economy, retracting it is no small feat, and often leads to substantial economic disturbances.
The Mop Up Phase
In March 2022, the Federal Reserve launched a phase of monetary tightening, raising the federal funds rate from near-zero to 5.25%. Anticipations are that there may be a pause at the upcoming Federal Open Market Committee meeting.
Simultaneously, the Fed is expected to continue its monthly reductions of Treasury and mortgage-backed securities by $60 billion and $35 billion, respectively. The Fed’s balance sheet has decreased from over $8.96 trillion in April 2022 to approximately $8.38 trillion today.
This represents a reduction of around $580 billion over the past 14 months, though there was a notable $400 billion expansion linked to the bailout of Silicon Valley Bank. Given this context, returning the Fed’s balance sheet to below $4 trillion seems implausible. Interventions like the recent SVB bailout reveal just how swift and massive balance sheet increases can be.
Consequently, it’s improbable that the Fed can keep its balance sheet significantly below $8 trillion for any extended period. Future financial crises necessitate bailouts that would lead to the expansion of its balance sheet and lower interest rates. This signals a continued cycle of credit expansion and inflation.
While the Fed is aware of these dynamics, it faces the challenge of dealing with elevated inflation rates that complicate its credit policies. As such, maintaining tight credit in the short term is essential to rein in consumer prices, making a prolonged AI bubble quite unlikely.
Time to Get Real About Artificial Intelligence
The scenario we find ourselves in is complex and troubling. It underscores the dangers of managing an economy based on the whims of unelected officials. The Federal Reserve’s 110-year record is appalling, with the dollar losing 96% of its value under its guidance. The Fed’s manipulations of money supply and interest rates have proven more harmful than beneficial, favoring stability instead of intervention.
The relentless flow of credit from the Fed has saddled future generations with an overwhelming burden of debt. There has been a persistent disregard for responsibly managing the economy amidst unchecked credit expansion and market interference, resulting in significant price distortions.
Historically, the most notable distortion came during the 1920s due to New York Fed Governor Benjamin Strong’s attempts to control the dollar’s value, which led to an epic bubble and subsequent depression. One wonders what the aftermath of today’s massive stimulus will entail.
Will the anticipated AI revolution somehow avert an imminent crash? Will innovations like Apple Vision Pro, priced at $3,500 per unit, provide the clarity we seek?
It’s time to be pragmatic. While AI holds promise as a transformative technology, investing in it at this juncture in the credit cycle may be futile and perilous. It might be wise to take a step back for now.
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Sincerely,
MN Gordon
for Economic Prism
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