Weekly Update from RLA Tax and Wealth Advisory

By:  Dennis Tubbergen

The Economic Realities of the Artificial Intelligence Industry

         The Chief Financial Officer of OpenAI, Sarah Friar, spoke at a “Wall Street Journal” technology conference on the topic of the potential of artificial intelligence.  During her speech, Friar said OpenAI is “looking for an ecosystem of banks and private equity” to support the company’s ambitious growth plans.  Friar also hinted at a role for the US Government to “backstop the guarantee that allows financing to happen”.  Ms. Friar did not elaborate further.  (Source:  https://realinvestmentadvice.com/resources/blog/openai-seeks-government-support/)

         The reaction to her remarks was not positive.  AI stocks fell hard. 

         Friar then attempted to ‘clarify’ her remarks, stating, “I want to clarify my comments earlier today.  OpenAI is not seeking a government backstop for our infrastructure commitments.  I used the word ‘backstop,’ and it muddied the point.  My point was that American strength in technology will come from both the private sector and the government playing their part.”

         The clarifying statement from Ms. Friar doesn’t seem to do anything but reinforce her original statement.  Bottom line:  OpenAI will need a lot more funding, a fact that Ms. Friar indirectly confirmed when she said, “Federal loan guarantees would really drop the cost of the financing”.

         Investors were not reassured when Sam Altman, CEO of OpenAI AI in an interview with billionaire Brad Gerstner, asked Altman how a company with $13 billion in revenues can afford $1.4 trillion in commitments?

         Altman had no answer, responding to Gerstner, “if you want to sell your shares, I’ll be happy to find you a buyer.”

         The combination of those two statements spooked AI investors, resulting in large losses for AI company stocks. 

         Later in the week, Altman commented, “To the degree the government wants to do something to help ensure a domestic supply chain, great.  But that’s super different than loan guarantees to Open AI, and we hope that’s clear.”  (Source:  https://www.zerohedge.com/markets/sam-altman-denies-openai-needs-government-bailout-he-just-wants-massive-government)

         Seems the AI bubble may be close to bursting, unless of course the government steps in as Altman and Friar hinted.  That seems to be unlikely, at least based on comments made by David Sacks, President Trump’s AI advisor.  Sacks stated, “There will be no federal bailout for AI.  The U.S. has at least five major frontier model companies.  If one fails, others will take its place.”  (Source:  https://www.zerohedge.com/markets/openai-cfo-disappointed-market-doesnt-have-more-ai-exuberance-seeks-us-government-backing)

         In the November issue of the “You May Not Know Report”, I note that one of the economic and investing themes moving forward will be the bursting of the AI bubble.  Perhaps this is the beginning of that trend.

Some Perspective on the “Everything Bubble”

         Michael Pento, a past guest on RLA Radio, published a piece last week titled “The Great Unraveling”.  (Source:  https://pentoport.com/the-great-unraveling/).  In it, Pento notes that the likely economic outcome is stagflation, an opinion that I share.

         He notes that current US non-financial debt is now $77.9 trillion, a number that is more than 250% of economic output.  That is significantly higher than at the time of the tech stock bubble collapse in 2000 and at the time of the Great Financial Crisis in 2008.

         Margin debt is also much higher, eclipsing the $1 trillion level.  Margin debt is up by 33% from one year ago.  This means that much of the rise in the stock market can be attributed to investors borrowing money to buy stocks.  History tells us that when margin debt begins to decline, a stock market correction often follows.

         U.S. government debt is now more than 120% of GDP, and interest payments on the debt are at about $1.2 trillion annually.

         Each of these three areas of debt is unsustainable individually; taken together, they are a debt time bomb.  

         Pento also notes that the middle class is going the way of the dinosaur.  Goldman Sachs conducted a retirement survey that found 40% of Americans are now living paycheck-to-paycheck.  That’s up from 31% in 1997.  Credit card debt is now $1.3 trillion, with a high level of delinquency.  Perhaps that explains some of the population embracing socialism recently at the polls.

         Stocks are overvalued.  The market capitalization to GDO ratio is at an all-time high, and the real estate market is also overvalued.  The home price to income ratio now exceeds 5, an all-time high, which puts home ownership out of the reach of many American households. 

          The Federal Reserve is reacting predictably.  When the Fed started tightening a few years ago, I stated that it wouldn’t take long for the central bank to reverse course and begin easing again.  We are now there.  The harsh reality for the Fed is an immediate deflationary, debt reset or more quantitative easing to attempt to kick the can down the road a bit further.

         Much of the world sees this.  That explains the recent price performance of gold and silver.  Since more easy-money policies are likely inevitable, that will likely have to mean more upside for precious metals.

         I’m suggesting to clients (as I have for many years) to prepare for stagflation.  Consumer prices will have to move higher, asset prices will continue to fall in real terms (and perhaps nominal terms as well), and the economy will contract.

         Since most of the consumer spending occurring today is from the top 10% of income earners, we may be just one market correction away from the beginning of the unraveling.

RLA Radio

         The RLA radio program this week features an interview that I did with Mr. Harry Dent, economist and multi-time best-selling author. I get Harry’s forecast for the stock market and the US economy.

        You can listen now by clicking on the "Podcast" tab at the top of this page.

Quote of the Week

“The problem with socialism is that you eventually run out of other people’s money.”

                                          -Margaret Thatcher