Few believe that these valuations are grounded in reality. The vast sums being poured into artificial intelligence are speculative bets, and there is as yet no evidence that any sustainable profitability might come as a result.
That’s because the truth is that no-one currently knows how to really use AI productively or how to translate its promise into revenue. Despite that, though, hundreds of billions are being invested in AI, and stock market valuations have become detached from any reasonable expectation of earnings – the classic sign of a bubble.
A stock market crash is, then, almost inevitable. And what we know is that when such bubbles burst, they tend to do so suddenly. Right now, investors know a correction must come, but every fund manager, hedge fund, and pension fund stays in the game because leaving early risks missing out on the last gains.
This herd behaviour, best described as their fear of being the first to leave the dance, ensures that markets will continue to climb until they fall off a cliff.
When the crash comes – almost inevitably first in the US and then rippling across the world – the initial effect will be sharp falls in share prices. Every major crash since 1929 has wiped out a large share of notional wealth in a short time.
The greater the over-valuation, the deeper the correction will be – and because this bubble is so concentrated in one sector, technology and AI, the likelihood of a severe and rapid fall is high.
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It will look as if trillions of dollars have vanished. In the UK alone, it could be as much as £1 trillion – more than three years’ national income. But that is essentially an illusion as most of the supposed losses will only exist on paper.
To compare this to something more familiar: when a supermarket cuts the price of baked beans by 20p, the value of all its beans falls on paper, but no money is actually lost until they are sold. The same applies to shares but, since the vast majority of shares are rarely sold (unlike beans), most of the wealth “lost” in a crash never really existed as money.
However, that does not mean a stock market crash is harmless. The knock-on effects can be significant.
Pension funds will see the value of their shareholdings fall. For defined benefit pension schemes that have promised fixed incomes, employers must top up the resulting deficits. That means diverting money away from business investment to plug pension holes, reducing productive activity.
For defined contribution savers, the impact is personal – those close to retirement can see their savings decimated overnight, shattering their retirement plans and cutting future living standards.
At the same time, some investors will gain. As people rush out of the stock market, they will seek safety elsewhere, and most especially in government bonds. This will push up bond prices and, because effective bond yields or interest rates move inversely to their price, this drives down interest rates across the board.
These lower rates then reduce the cost of borrowing for governments and households alike. If these lower rates feed through into mortgage costs, they can eventually provide households with more disposable income and thus stimulate spending, aiding recovery – but that takes time.
Meanwhile, for those who have borrowed to fund their share speculation, a crash can be ruinous. Hedge funds and private equity firms, which have often been major buyers of assets with borrowed money, are probably most particularly vulnerable. When asset prices fall, their collateral might evaporate. If as a result they cannot meet their obligations, the losses then fall not just on their shareholders but also on the banks that lent them money.
A crash in equities can therefore spill over into the banking system, as it did in 2008, creating systemic risk for the financial system worldwide.
When that happens, governments face a stark choice: they either let banks fail and risk the collapse of their payments system, or they intervene to save them.
In 2000, Gordon Brown acted early to prevent the dot-com crash from spreading. In 2008, Alistair Darling had no choice but to bail out the banks to prevent total economic chaos. Without government intervention, the cashpoints would have stopped, supermarket shelves would have emptied and not been refilled, and society would have ground to a halt within days. Could that happen again? The uncomfortable answer is yes. The financial system is now even more interconnected than it was in 2008.
The shadow banking world, from hedge funds to private equity and other non-bank financial institutions, is vastly larger and also much less regulated.
The risks have simply been shifted around rather than removed. The Bank of England knows this, but has done little to address it.
The deeper problem is that the lessons of 2008 have been ignored. We still do not have a national banking infrastructure capable of keeping basic payments running if commercial banks fail.
Retail banking remains tied to speculative investment activity. The culture of the City, with its excessive bonuses and short-termism, is intact. Even the modest reforms introduced after 2008 are being rolled back by Rachel Reeves’s Treasury.
I argued back then, and do so again now, that we need fundamental reform. Ordinary banking for individuals and small businesses must be separated entirely from speculative and trading activity.
We need a publicly-owned bank to guarantee stability and provide lending for social and green investment. We need a payment system that cannot be brought down by market panic. Instead of dismantling what little regulation we have, we should be strengthening it.
That said, the next crash will not be avoided by wishful thinking. However, its consequences could be managed if governments chose to act in the public interest. We could, for instance, nationalise banks that require bailout support and keep them in public ownership.
We could ensure that any money injected into the economy is used for productive purposes, such as funding decarbonisation, social housing, and care, rather than letting it inflate property or asset prices again.
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We could regulate hedge funds and private equity as the systemic threats they are, not as if they were simply adventurous investors.
We could reform the bond market to make clear that the government does not depend on private finance to spend; rather, the City depends on the government to provide a safe place to park its surplus funds.
These are choices, not inevitabilities. Crises create the opportunity for change. The question is whether we will seize it.
If we once again let finance dictate the terms of recovery, another decade of austerity, asset inflation, and inequality will follow. But if we confront the power of the City of London – and even leave it behind by making Scotland independent – we could use the next crash to rebuild an economy that serves society, not speculation.
The coming crisis could mark the end of neoliberalism or it could mark its grim rebirth. That will depend on the courage and imagination of those in power.
When the bubble bursts, it will be ugly. But it could also be liberating if we finally say “never again” and mean it. Hope, after all, is the one asset no market can inflate, and no crash can destroy. And that is what we have to cling to.
