Time to Get Real About Artificial Intelligence

There’s never really a good time for a new bubble mania.  But usually, they have the decency to come at the tail end of an extended bull market, as a sort of blow-off top.

That’s when investors, blinded by greed and confident from a long period of success, throw caution to the wind.  They recklessly chase share prices higher with the expectation of bagging easy riches.

The dot com bubble mania blow-off in the run up to the new millennium was a true classic.  It was preceded by an 18-year bull market and triggered by a new, game-changing technology.  The subsequent downside – a 75 percent collapse of the NASDAQ – was timeless.

The current AI bubble mania is an odd duck.  With the roll out of ChatGPT, roughly 6 months ago, the AI bubble mania has inflated within an extended bear market rally.  Hopeful investors are getting suckered in at the worst possible time.

Year-to-date, the NASDAQ is up 26 percent.  Yet, it is still down over 17 percent from its November 19, 2021, all-time closing high.

Year-to-date, NVIDIA and Apple, two companies tangentially related to AI that have piqued investor interest, are up about 160 percent and 43 percent, respectively.  Perhaps they will go higher.

Nonetheless, fear of missing out (FOMO) isn’t an investment strategy.  It’s a strategy for losing money.  Moreover, we anticipate the AI bubble mania is an episode that will be short-lived.

There are numerous other factors at play at the moment.  Major stressors in credit markets suggest the major indexes should deflate, before they really inflate in earnest.  In this regard, AI enthusiasm, as an investment opportunity, will prove to be a secondary sideshow as the bear market rally rolls over and commences its next leg down.

Here’s why…

Asking for Trouble

Relying on inflation of the money supply to deliver the appearance of economic prosperity is asking for trouble.  It always has been.  It always will be.

So long as the monetary inflation lasts, otherwise unprofitable businesses are able to remain above water.  Take the inflation away, and these businesses can no longer pay the bills.  The debt structure then crumbles.

Stimulus may appear to promote economic growth when the increased demand, and associated supply, remains one step ahead of increased prices.  This accommodating sequence, however, is not guaranteed.

Stimulus, as employed during the ridiculous coronavirus lockdowns, grossly outpaced demand, while supply faltered.  The excess fake money first appeared as savings.  Later, it was quickly deployed, thus chasing a dearth of supply.  Consumer prices subsequently inflated to balance the inflated supply of money and the lacking supply of goods and services.

Similarly, the abundance of cheap credit supplied by the Fed enticed borrowers to take on more and more debt.  This had the effect of chasing asset prices – including stocks, bonds, cryptocurrencies, digital token art, and real estate – higher.

From the Fed’s actions, and in concert with Washington’s rampant deficit spending, the largest wave of consumer price inflation in 40-years crashed down upon the economy.  The stimulus had gone too far.  Rising prices preceded a rising supply of goods and services.

Now, the central planners are discovering that once this stimulus money and credit have spilled into the economy it is difficult to remove.  Moreover, they’re proving that there’s no way to back out of an inflationary spell without producing a major economic upset.

The Mop Up Phase

In March of 2022, the Fed commenced its monetary policy mop-up phase.  Since then, it has hiked the federal funds rate from nearly zero to 5.25 percent.  It is widely anticipated that the Fed will pause at next week’s Federal Open Market Committee meeting.

At the same time, it’s likely the Fed will continue reducing its holdings of Treasuries and mortgage-backed securities by $60 billion per month and $35 billion per month, respectively.  In April 2022, the Fed’s balance sheet was over $8.96 trillion.  Currently, it’s at about $8.38 trillion.

This represents a reduction of about $580 billion over the last 14 months.  Along the way, however, there was about a $400 billion expansion in March for the bailout of Silicon Valley Bank (SVB).

Hence, bringing the Fed’s balance sheet back to below $4 trillion, which is where it was before the ridiculous coronavirus stimulus, is highly unlikely.  Moreover, as the SVB bailout has shown, balance sheet increases are swift, abrupt, and massive.

By this, we don’t expect the Fed to ever get its balance sheet much below $8 trillion for very long.  A Fed bailout will eventually be needed to address a forthcoming financial crisis brought on by relatively higher interest rates.  The Fed will execute the bailout by expanding its balance sheet and cutting interest rates.

This is why over the long term, credit expansion, and thus inflation, will continue indefinitely.  The Fed knows this.  But it also knows that elevated consumer price inflation makes it difficult to continue its policies of unabated credit expansion.

Thus, over the short term, credit must be tight to pull consumer prices back to within the Fed’s 2 percent inflation target.  This also makes an extended AI bubble mania highly unlikely.

Time to Get Real About Artificial Intelligence

No doubt, this is all one great big giant mess.  But it’s also much, much more.  It highlights the folly of managing an economy via the impulses and whims of a committee of unelected bureaucrats.

Without question, the 110-year track record of the Fed is abysmal.  The dollar has lost 96 percent of its value under the Fed’s stewardship.  In addition, the Fed’s tinkering with the money supply and interest rates has proven to be far more destructive to the economy than providing a stable money supply and allowing interest rates to be determined through the free market.

The seemingly inexhaustible supply of credit from the Fed has also indentured future generations of Americans to a massive pile of debt servitude.  Washington has proven it has zero inhibitions for resisting the Fed’s credit.

Over the years, the central bank has aggressively increased its intervention into free markets through mass credit creation and asset purchases.  This intervention has dramatically influenced the economy and has led to wild price distortions.

Looking back, the Fed’s seminal price distortion blowout was courtesy of New York Fed Governor Benjamin Strong’s “coup de whiskey to the stock market,” which occurred during the roaring 20s.  Strong was attempting to debase the dollar to maintain the inflated value of the British pound sterling.

Strong’s whiskey shots brought on an epic bubble and bust, followed by a 10-year depression.  What will the bubble and bust of this recent shot of mega stimulus bring?

Will an AI revolution miraculously divert a crash?  Will Apple Vision Pro – at just $3,500 per goggle – help us see everything so much more clearly?

Get real!

AI may one day be a game changing technology.  However, at this point in the credit cycle, it’s an investment reserved for fools and suckers.  Better to sit this one out for now.

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Sincerely,

MN Gordon
for Economic Prism

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