The A.I. Boom and the Spectre of 1929

Of course, no two speculative booms are the same, but they share some common elements. In general, there is a lot of excitement among investors about new technologies – in this case, AI – and their potential to boost profits for companies well-positioned to take advantage of them. In the 1920s, commercial radio was a new and revolutionary medium: tens of millions of Americans listened to it. Sorkin points out that between 1921 and 1928, shares of Radio Corporation of America, then Nvidia, rose from $1½ to $85½.

Another characteristic of a stock bubble is that at some point its participants largely abandon conventional valuation metrics and buy into them simply because prices are rising and everyone else is doing it: FOMO rules the day. By some indicators, valuations were even higher during the dot-com bubble of the late 1990s than they were in the late 1920s. And according to the latest report from the Bank of England’s Financial Policy Committee, released last week, valuations in the US market are, to some extent, “comparable to the peak of the dot-com bubble”. This is true according to the price/earnings ratio adjusted for cyclical variations (CAP), which tracks stock prices relative to company profits on average over the previous ten years. If, instead of looking back, you focus on future earnings forecasts, valuations are less stressed: the Bank of England report notes that they remain “below levels reached during the dotcom bubble.” But that’s just another way of saying that investors are betting on rapid earnings growth in the years to come. And this is a time when many companies have so far seen little return on their AI investments.

Of course, not everyone agrees that stock prices have strayed from reality. In a note to clients last week, Goldman Sachs analysts said the market’s rise, which is heavily concentrated in the stocks of large technology companies, “has, thus far, been driven by fundamental growth rather than irrational speculation.” Jensen Huang, chief executive of Nvidia, whose chips power AI systems at companies including OpenAI, Google and Meta, said he believes the world is “at the start of a new industrial revolution.” However, even the authors of the Goldman report acknowledged that there are elements of the current situation “that rhyme with previous bubbles,” including sharp rises in stock prices and the emergence of questionable financing schemes. Last month, Nvidia announced that it would invest up to a hundred billion dollars over the next decade in OpenAI, the parent company of ChatGPT, which is already a big buyer of Nvidia chips and will likely need more to support its expansion. Nvidia has said OpenAI is not obligated to spend the money it invests in Nvidia chips, but the deal, and others like it, have sparked comparisons to the dot-com bubble, when some big tech companies engaged in so-called “circular” deals that ultimately didn’t work.

Another recurring feature of the biggest asset booms is outright chicanery, such as fraudulent accounting, trading worthless securities, and simple theft. Galbraith called this phenomenon a “bezzle.” In bad times, he noted, creditors are stingy and audits are scrupulous: as a result, “business morality is enormously improved.” In boom times, creditors become more trusting, lending standards deteriorate, and borrowed money is plentiful. But there “are always a lot of people who need more,” Galbraith explained, and “the bezzle is growing rapidly,” as it was in the late 1920s. “Just as the boom accelerated the rate of growth,” he continues, “the crash enormously accelerated the pace of discovery. »

Sorkin traces the fates of Albert Wiggin and Richard Whitney, who, at the time of the crash, were CEO of Chase National Bank and vice chairman of the New York Stock Exchange, respectively. Both men participated in the failed effort, orchestrated by Lamont, to stabilize the market. In 1932, Wiggin became director of the Federal Reserve Bank of New York. But during the Pecora investigation, which began that year, it emerged that beginning in September 1929, Wiggin had been secretly short-selling his own bank’s stock, using two companies he owned to make these transactions. He was forced to resign from the Fed. In 1930, Whitney, scion of a prominent New England family, became president of the stock exchange, but he was eventually exposed as an embezzler and served more than three years at Sing Sing.

Thinking about stories like these, it’s tempting to paint the Wall Street executives of the 1920s as a bunch of crooks. Sorkin resists the impulse. In an afterword he writes: “The difficulty is that, apart from the disgraced Richard Whitney and the disgraced Albert Wiggin, it is difficult to argue that any of the other major financial figures of the era did anything significantly worse than most individuals in their position and circumstances would have done.” » Given the role played by the Wall Street elite in inflating and promoting the bubble, this is either a generous view or a jaded commentary on the fallen nature of humanity. Regardless, it is true that speculative booms tend to take on a life of their own, creating incentives and opportunities that distort the judgment of people at all levels of the economy, from small investors and professional intermediaries to large corporations and financial institutions.

One aspect of the current boom that has not received enough attention is how it has spread from the stock market to the credit markets, where there has been a huge growth in so-called “private lending” from non-bank institutions, including private equity firms, hedge funds and specialist lending companies. Last week, news organizations reported that the Justice Department had opened an investigation into the collapse of First Brands, a Cleveland-based auto parts company that, with the help of Wall Street, apparently raised billions of dollars in opaque deals. A creditor told a bankruptcy court that nearly $2.3 billion in collateral had “simply disappeared” and requested the appointment of an independent examiner. A lawyer for First Brands said the company denied any wrongdoing and attributed the collapse to “macroeconomic factors” beyond its control.

The sudden disappearance of a single, heavily indebted company that operated in a sector far from the AI ​​frontier could be a one-off event, with no broader implications. Or, it could be a harbinger of what lies ahead. We won’t know for a while, maybe a good while. But in the words of 19th-century English journalist Walter Bagehot, quoted by Galbraith, “every great crisis reveals the excessive speculations of many houses which no one suspected before.” This time is unlikely to be any different. ♦