Are you ready for the AI financial bubble?

July 24, 2023

Prediction. Artificial intelligence (AI) will cause a speculative financial bubble this decade. Are you ready for it? 

An AI bubble seems probable and likely as soon as later this year (2023), or as late as late 2029. Note that an AI bubble burst in 2029 would coincide with the 100th anniversary of the market crash of 1929 and the Great Depression. As the COVID19 pandemic demonstrated, certain catastrophic events tend to repeat themselves every 100 years or so. Be smart. Prepare now just in case. 

Humans and Bubbles 

Speculative financial bubbles have occurred throughout human history, and will continue to occur. Financial bubbles are driven by human irrationality. You can always bet on human irrationality. First and foremost, we are emotional creatures. Emotions come first, and rationalizations follow. Humans can be seen as organic computers programmed to seek pleasure and avoid pain. Seeking the perceived pleasure of financial gain, and avoiding the pain of missing out, humans fall into irrational herd behavior that leads to financial bubbles.

Here are some some notable speculative financial bubbles in human history:

    Tulip Mania (1636-1637): The tulip bubble in the Dutch Republic saw the prices of tulip bulbs surge to unsustainable levels before collapsing abruptly.

    South Sea Bubble (1720): The South Sea Company, which was granted a monopoly on trade with Spanish colonies in South America, saw its stock price soar to extraordinary heights before crashing, causing significant financial losses for investors.

    Mississippi Bubble (1719-1720): The Mississippi Company, founded by John Law, a Scottish economist, experienced a speculative bubble in France as it gained exclusive trading rights to the French colonies in North America. The bubble eventually burst, leading to a financial crisis.

    Railway Mania (1840s and 1850s): In the United Kingdom, there was a speculative frenzy in railway company stocks, fueled by the belief that railways would revolutionize transportation. Many companies were overvalued, and the bubble burst, causing financial distress.

    Wall Street Crash of 1929: One of the most infamous bubbles, this event marked the beginning of the Great Depression in the United States. Speculative buying and excessive use of margin contributed to the stock market's rapid rise and subsequent catastrophic collapse.

    Dot-com Bubble (late 1990s-early 2000s): The dot-com bubble involved a surge in the stock prices of internet-based companies, driven by excitement over the potential of the internet to revolutionize the world. Many of these companies had little or no profits, leading to a sharp market correction in the early 2000s.

    Housing Bubble (mid-2000s): In the mid-2000s, a housing bubble emerged in several countries, including the United States, Spain, and Ireland. Rapidly rising home prices and easy access to mortgage credit led to a speculative frenzy in the housing market. The bursting of the housing bubble triggered the global financial crisis in 2007-2008.

    Cryptocurrency Bubble (2017): The surge in the prices of various cryptocurrencies, including Bitcoin, Ethereum, and others, led to a speculative bubble. Prices skyrocketed before experiencing a sharp correction. Really smart people were caught up in the crypto frenzy. Many still believe on a potential crypto comeback. 

AI Bubble 2023? 

In 2022, the stock market went down by approximately 25% from its prior peak in November 2021. By November 2022, the market began to recover. As of today on July 23, 2023, the market has recovered significantly, and is only about 5% below its all time high. As of today, for example, the S&P 500 index is only about 260 points from its all time record high. 

Arguably, the recent market recovery, and the resurgence of a bull market, has a lot to do with the emergence of the generative AI technology. The lack of regulation, emergent technology, and heightened media attention is leading to frothy speculative investing in the digital technology sector.

RATS and Humans

Humans and rats share a common ancestor named protungulatum donnae. This rat-like mammal survived eating insects in times when Earth was ruled by dinosaurs. Anyways, we are not discussing evolution today, but rather financial bubbles. To understand bubbles, we came up with an analytical framework that we call RATS. It stands for regulation, attention, technology, and speculation ("RATS"). These are four key factors in all financial bubbles. 

Using the "RATS" factors, study some past bubbles to see what you can learn from them. You will quickly identify patterns that will help you prepare for an upcoming AI bubble. 

The Tulip Bubble 

The tulip bubble, also known as "Tulipmania," was a speculative bubble that occurred in the Dutch Republic (modern-day Netherlands) during the 17th century, specifically in the early 1630s. The bubble involved the rapid rise and subsequent collapse of tulip bulb prices. 

Regulation

There were no regulations in place to prevent speculative investment in tulips. In response to the speculative frenzy surrounding tulip trading, the Dutch government tried to regulate the market by imposing restrictions on speculative trading in February 1637. This regulatory intervention was too late to prevent the bubble, but contributed to the decline in demand and prices that led to the burst of the tulip bubble. 

Attention

The rapid and incredible increase in prices draw a lot of public attention. Everyone was talking about tulip trading, which kept fueling the speculative frenzy of the bubble.

Technology

The Dutch were the pioneers in the technology (tool and method) of stock market trading. The emergence of the stock trading contributed to the popularity of, and wide accessibility to, tulip trading.

Speculation

Unlike other assets with inherent value, such as precious metals or real estate, tulip bulbs were essentially a speculative investment with no practical use or intrinsic value. At the peak of the tulip mania, the market became saturated with tulip bulbs as more and more people invested in them speculating on the irrational belief of ever-increasing prices. As supply outpaced demand, prices began to stall. As enthusiasm waned, investors became reluctant to continue purchasing bulbs at inflated prices. To make matters worse for tulip speculators, the early 1630s saw a general economic downturn in the Dutch Republic, which affected the overall confidence in the tulip market. Economic uncertainties made people more cautious about their investments. As prices started to falter, some tulip bulb holders decided to cash out their profits, leading to a sudden increase in supply. This added to the downward pressure on tulip prices. Soon, people began to doubt the sustainability of the tulip market and its sky-high prices. Trust eroded, further dampening demand and accelerating the decline. The accelerated decline led to a sudden collapse in tulip prices, causing panic among investors, and sparking a massive cascade of sell-offs. Many people who had purchased tulip bulbs at high prices found themselves with significantly devalued assets, resulting in substantial financial losses for many.

While the tulip bubble had a significant impact on those involved, its overall economic impact on the Dutch Republic as a whole was relatively limited. The Dutch economy rebounded after the bubble's collapse, and the Dutch Golden Age of the 1600s continued with its robust trade, commerce, stock market trading, and cultural achievements. The tulip bubble is a historical example of a speculative frenzy, and serves as a cautionary tale about the risks of speculative investments and herd behavior following unsustainable market euphoria.

The Railway Bubble

The railway bubble, also known as railway mania, was a speculative frenzy that occurred in the United Kingdom during the mid-19th century, in the 1840s and 1850s. It was a period of excessive speculation and investment in railway companies, driven by the belief that railways would revolutionize transportation and bring significant economic growth and prosperity. They did, but that does not mean that all railway investments were profitable. 

Using the "RATS" framework, we can identify similar patterns. 

Regulation

There was minimal government oversight and regulation of the railway industry, allowing speculative excesses to go unchecked. The British government actually offered various incentives and subsidies to promote railway investments as a means of boosting economic growth and improving connectivity. 

Attention

The railway industry received significant attention, with the entire investment base of the UK focused on the prospects of the technology. It was thought that railways would revolutionize transportation, which it did. It was assumed that all investments in railway would pay off, which was not the case. In the mid-1840s there were hundreds of railway projects proposed or underway, which exceeded the capacity of the economy to absorb them profitably back then. Many individual projects failed even though the railway industry was a success overall. 

Technology

The early 19th century saw significant advancements in railway technology, making it a more feasible and efficient mode of transportation compared to traditional means such as canals and horse-drawn carriages. The emergent railway technology was indeed revolutionary, and became incredibly successful worldwide. Yet again, the success of a technology or industry does not guarantee the success of every single project or development in said industry or technology.

Speculation

Investors, including both individual speculators and institutional investors, were eager to participate in what they believed was a groundbreaking and profitable industry. Many saw railways as the key to industrial progress. They were correct in that forecast and assessment. However, due to excessive optimism and greed, investors rushed to buy shares of railway companies without thoroughly assessing their viability. The formation of joint-stock companies and the rise of limited liability made it easier for individuals to invest in railway ventures, leading to a surge in the number of railway companies. All this led to inflated stock prices, and rapid gains in paper wealth. As multiple companies sought to build railway lines between popular destinations, competition grew, resulting in the duplication of tracks and inefficiencies in the network. As the railway bubble expanded, it became increasingly evident that many of these projects were financially unsound and could not generate the expected returns. Many railway companies went bankrupt, and the British economy experienced a period of economic downturn and financial distress. The railway bubble burst in the late 1840s, leading to a sharp decline in railway shares and significant financial losses for many investors blindsided by their own greed and negligence. 

While the railway bubble had severe consequences for many investors and the overall economy, it also left a lasting impact on Britain's infrastructure and transportation network. Many of the railway lines built during this period remain in use today, contributing to the development of modern transportation systems. The railway mania serves as yet another historical example of the dangers of speculative investing for particular investors, and the importance of prudent risk management in financial markets.

The Dot-Com Bubble

The dot-com bubble, also known as the internet bubble, was a speculative frenzy that occurred in the late 1990s and early 2000s. It centered around the stock prices of many internet-based companies, particularly those involved in technology, e-commerce, and online services. The internet bubble was fueled by an optimistic belief in the potential of the internet to revolutionize business and society. Just as in the case of the railway, the internet did in fact revolutionize the world. However, that did not mean that every single internet related investment was profitable. In the contrary, many internet companies, projects, and initiatives were complete failures.  

Using the "RATS" framework, we can identify similar patterns present in most financial bubbles. 

Regulation

While there was plenty of market regulation in place by the time of internet bubble, nothing prevented investors from speculating on ever-increasing prices of stocks and assets related to the internet. That is probably the way it should be. Smart investors should do their homework about potential investments, and stay diversified knowing that all investments, even those in revolutionary technologies can fail. 

Attention

Media coverage and public hype about the internet and internet companies were enormous. Many startups with little or no revenue, and little chances of becoming profitable in a highly competitive market, were able to attract substantial investments solely based on their internet-related ideas and concepts. 

Technology

The 1990s saw significant advancements in computer science and internet infrastructure, making the World Wide Web accessible to the general public. This opened up new possibilities for online businesses and created excitement about the immense potential for growth and innovation. For the most part, predictions and industry forecasts were correct overall. However, that did not mean that at the individual company level, every company or project would succeed in the internet industry. 

Speculation

 

The stock prices of internet companies skyrocketed, even for those with unproven business models. Many investors bought shares solely because they believed prices would keep rising, not because they had a solid understanding of the fundamentals. Investors were eager to capitalize on the perceived limitless opportunities presented by the internet. Venture capitalists and individual investors poured money into internet startups, hoping to strike gold with the next big thing. Valuations of many internet companies quickly became disconnected from their actual business potential. Traditional valuation metrics were largely ignored, leading to extremely high price-to-earnings ratios. While some internet companies were successful and profitable, many others were burning cash without generating sustainable revenue streams. This lack of profitability became increasingly evident as the bubble expanded. As investors rushed to sell their shares, stock prices plummeted. The dot-com bubble burst in early 2000 when investors began to realize that many internet companies were overvalued and lacked the fundamentals to support their inflated stock prices. 

The aftermath of the dot-com bubble saw a sharp decline in the stock market, with many internet startups going bankrupt or experiencing significant losses. Some established companies that survived the bubble, however, continued to grow and evolve, shaping the modern internet landscape we know today. As all bubbles, the dot-com bubble serves as a cautionary tale about the dangers of speculative investing and the importance of conducting thorough due diligence before making investment decisions. While the internet bubble brought significant losses to many investors, it also contributed to the development of critical internet technologies and laid the foundation for future innovations. As we all know, the internet did fulfill its promise of revolutionizing humanity.

The Crypto Bubble

The crypto bubble, also known as the Bitcoin bubble, refers to a period of speculative frenzy that occurred in the cryptocurrency market, particularly surrounding the digital currency Bitcoin, as well as other cryptocurrencies. The bubble was characterized by a rapid surge in the prices of various digital assets, driven by hype, investor enthusiasm, and the belief in the transformative potential of blockchain technology.

Regulation

The cryptocurrency market, especially in its early stages, was relatively unregulated. The lack of regulatory oversight made crypto more susceptible to manipulation and fraudulent activities, further exacerbating the speculative nature of the market. Eventually, actual regulation or the prospects of it had a chilling effect on crypto investments. 

Attention

As news of Bitcoin's invention spread, it captured the imagination of people interested in digital currencies and alternative financial systems. As Bitcoin and other cryptocurrencies gained popularity, they received significant media coverage, drawing even more attention to the market. This increased media exposure and attention fueled speculative interest in everything and anything having to do with crypto, including but not limited to non fungible tokens (NFTs). 

Technology

Bitcoin, the first decentralized cryptocurrency, was introduced in 2009 by an anonymous person or group using the pseudonym Satoshi Nakamoto. Bitcoin was based on a potentially revolutionary database technology referred to as the blockchain. The technology allows for market participants to validate transactions without need for a trusted bank or intermediary. 

Speculation

Many investors were attracted to the crypto market with the hope of making substantial profits in a short period of time.  In the case of Bitcoin, its supply is capped at 21 million coins, creating artificial scarcity and adding to its appeal as a proposed store of value. The speculative nature of the investments, rather than a focus on underlying technology or utility, led to price bubbles. Fear of Missing Out (FOMO) on significant gains drove more people to invest in cryptocurrencies, contributing to the exponential price increases. Initial Coin Offerings (ICOs) became a popular fundraising method for blockchain-based projects. Companies issued their own cryptocurrencies or tokens, and investors bought them with the expectation of potential future value appreciation.

The crypto and Bitcoin bubble experienced several significant price surges and subsequent corrections. Notably, the market reached its peak in late 2017, when Bitcoin's price surged to nearly $20,000, and when many other cryptocurrencies also saw significant price increases. However, the bubble burst in early 2018, leading to a sharp and sustained decline in cryptocurrency prices.

Lessons learned and how to prepare for the upcoming AI bubble

The AI bubble may look different, but in essence it will be similar to past bubbles in history. The AI bubble may not necessarily resemble Tulipmania or Cryptomania, but may resemble the Railway bubble and the Dot-com Bubble. 

There are many lessons to learn from previous financial bubbles that can help us prepare for an upcoming AI bubble. The regulatory environment will allow the development and emergence of revolutionary technology that will gather attention and lead to speculation. 

As with all bubbles, the AI frenzy will be seen as "different", unprecedented, and revolutionary. Initially, there will not be any regulations preventing or impeding the development and emergence of revolutionary AI technologies. New AI systems will gather incredible amounts of media attention, both traditional media and social media. Some companies and entrepreneurs will make fortunes overnight. Incredible technological feats and insane financial gains touted by all media and evangelical enthusiasts will fuel a speculative bubble. Once the bubble of speculative investing takea off, it will keep growing until it pops and burst. 

After the AI bubble burst, the path will be built for the AI technology to keep growing and expanding. The AI industry will be incredibly successful in the long run. There is no way back. Progress, like time itself, is the unidirectional accumulation of information. Once humans know a path to convenience, there is no way to unlearn it. 

As history has shown us repeatedly, the fact that a technology will succeed greatly does not mean that every investment, company, or project in the technology will be successful. In fact, the contrary is true. The vast majority of individual projects will fail. However, in the long run, the technology and industry will prevail and flourish. That is what can be predicted about the upcoming AI bubble.

Great fortunes will be made (and lost) in the next couple of decades as humanity develops AI. To profit from AI, stay rationally diversified, and stay tuned to Creatix. This is just beginning. 

Creatix.one, AI for everyone.