In economics, “bubbles” result from an overvaluation in a market. Products or trends gain traction in financial markets, incentivizing a herd mentality in approaches to investment strategy. People flock to profit from the bandwagon, pouring capital into products, services, trends, or industries simply because of popularity. Take the prominent example of the 2008 housing crisis, a direct consequence of cheap credit and subprime loans. The increase in real estate purchases, based on the assumption that housing prices would go up forever, caused the housing market to crash; as a result, millions of homes became worthless, and major banks filed for bankruptcy. Likewise, the 17th century Tulip Mania in the Netherlands caused the coveted flower to surge above typical asking prices after it became a status symbol for the wealthy elite. The following months saw an over 90 percent drop in tulip pricing after tulip merchants flooded the market, and the high asking prices could not be sustained. In both cases, the impetus can be placed on the collective sense in the illusion of value and its harmful consequences.
We can draw similar parallels to our current illusion, AI, hence the term AI bubble. Something that I would argue has the potential to be more detrimental when the illusion pops, as the bubble spans multiple companies and soon, continents.
Everyone’s money is in the same place. The top seven performing stocks on the NASDAQ, otherwise known as the Mag 7, all have heavy ties to AI development, and a vast majority of Americans have some form of investment in them. Whether through their 401ks, which automatically invest funds, or financial advisors who encourage financial allocation in high-performing stocks. It is understandable that the higher perceived value draws public interest and support because those who invest directly benefit from the number of individuals who buy in. Share prices rise, wealth increases, and the cycle persists.
The bubble will also continue to grow with the tokenization of the NASDAQ, as of this September, which has opened the American stock market to a global audience. Now anyone with a mobile device can, in essence, invest in the stock market at any time. The potential billions of new investors from around the world will only exacerbate the fatigue and overvaluation surrounding AI development until the bubble pops.
I see the bubble bursting from one of two catalysts, or a combination of such. The first is if AI companies fail. This would be prompted by a scandal or failure to deliver on performance, causing investors to no longer perceive the stock as valuable and to rid their portfolios of the undesirable shares. Another, which I believe is more likely, is if early investors cash in, creating a deep panic within the market as prices plummet, leaving the vast majority of investors with much less than what they put in. The scope of our current AI bubble exposes the clear underlying flaws in the American financial system, because we reward investment based on assumptions rather than profit. This is an extremely unstable investment strategy that forces investors to put all their eggs in one basket and creates harmful concentrated co-dependencies on private capital.