AI investment race could turn debt-fuelled boom to bust: BIS

THE race to build infrastructure for artificial intelligence is on track to surpass previous technological booms that ended up in severe market disruptions, the Bank for International Settlements (BIS) said.

Borrowing and financial ties between hyperscalers and AI developers increase the risk of broader financial turmoil, if productivity gains fail to justify the massive investment, the bank warned in a study published on Tuesday (Jul 14). 

“The more capacity the sector builds, the higher the productivity bar it must clear to sustain the boom, so a larger boom is both more likely to disappoint and more damaging when it does,” wrote Phurichai Rungcharoenkitkul, an economist at the Basel-based institution. 

Tech companies are investing heavily in AI infrastructure to capture future growth, funding the expansion with a mix of bond issuance and more complex financing arrangements. In some cases, the financing has become circular, with companies involved in building cloud infrastructure taking equity stakes in AI developers in exchange for commitments to purchase computing capacity.

For the BIS, an umbrella group for the world’s central banks, the AI investment boom shares many of the features of past technology-driven boom and bust cycles. These include the US canal mania of the 1830s, the British railway mania of the 1840s, and the dotcom boom of the late 1990s, each of which ended in sharp corrections and broader economic disruption.

The scale and rapidity of the AI investment race suggest any fallout could be even bigger.

“The potential demand for AI services is clearly vast and could justify a substantial expansion in computational power,” Rungcharoenkitkul said. “Yet relative to its pre-boom trough, the current buildout is on track to outgrow every previous episode only three years in.” 

Analysts at JPMorgan Chase and Goldman Sachs estimate AI-related spending to approach US$6 trillion by 2030, much of which will be financed with debt. 

The BIS study examines an AI sector in which firms compete in a winner-takes-most market, where investment across the industry drives overall progress but the rewards accrue to only a handful of winners. That dynamic encourages excessive investment across the sector, making the boom increasingly fragile.

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As with past technological breakthroughs, the AI investment race is creating financial vulnerabilities, said the BIS report, with companies using more debt and creative financing structures to gain first mover advantage. This could exacerbate and accelerate losses in case of a bust.  

“Rising leverage and more complex financing structures have raised questions about the financial stability risks of the current AI boom,” wrote Rungcharoenkitkul. “The competition that over-builds the boom is also what selects the fragile financing that turns it into a bust.” BLOOMBERG