In the wake of Donald Trump's demand for Iran to reopen the Strait of Hormuz, a critical energy artery, the potential consequences for the global economy, and specifically the AI industry, are coming into sharp focus. The immediate concern is the impact on energy costs, which, if sustained, could threaten the very foundation of the AI boom.
The Energy-Intensive AI Sector
AI, an energy-hungry industry, is facing a unique challenge. As Sam Altman of OpenAI pointed out, the training of AI models requires significant energy, akin to the energy consumed by humans during their formative years. This energy-intensive nature of AI development and operation is a critical factor in its economic viability.
Global Impact
The rising energy costs are not just a US concern. Many oil-importing economies, particularly in the Global South, are facing severe shortages, leading to unprecedented measures like curfews and work-from-home mandates. While the US, as a wealthy oil exporter, can mitigate these concerns to some extent, it cannot escape the global rise in energy costs entirely.
Financial Fragility
The AI sector's financial model is built on a foundation of debt-financed investments. The Bank of England's Financial Policy Committee has highlighted the potential link between energy costs and the share prices of AI companies. The conflict with Iran, and the resulting energy price hikes, could exacerbate pre-existing fragilities in markets, potentially impacting the sector's ability to generate expected returns on its significant investments.
A Boom at Risk
The World Trade Organization's Chief Economist, Robert Staiger, has warned that a prolonged period of high energy prices could "crimp" investment in AI. The WTO's Global Trade Outlook report underscores the importance of AI-related investments, accounting for 70% of investment growth in the US last year.
Financial Engineering and Risks
The financial engineering underpinning the AI investment boom is complex and reminiscent of the pre-2008 financial crisis era. Off-balance sheet special purpose vehicles and asset-backed securities are prevalent, raising concerns about the opacity of these arrangements and the difficulty in tracking total liabilities.
Potential Trigger for Distress
Higher energy costs, volatile interest rates, and weaker consumer demand, all potential consequences of the Middle East war, could be a trigger for distress in the AI sector. The interconnected nature of the AI ecosystem means that any distress could propagate rapidly, potentially cascading across multiple layers of financing.
Conclusion
The AI sector's ability to generate revenues that justify its sky-high valuations is already being questioned. Higher energy costs could prompt a reevaluation of these valuations, and given the intricate financial structures in place, the repercussions could be far-reaching. Trump's actions in Iran may have set in motion a chain of events with consequences he could not have foreseen, potentially derailing the AI boom.
