Could the AI Boom Trigger a Global Debt Crisis? - Dylan Patel

transcript

So, you and I have been debating off air for the last few days whether there will be a sovereign debt crisis as a result of AI. And the logic is this. Um, AI is you you have a situation where as we were mentioning very little investment turns into a lot of money, right? So, the rate of return What a [ __ ] problem, dude. [laughter] Can't believe it.

No, it is a huge problem for everybody else who can't turn a little money into a lot of money, right? [laughter]

Um, the so the rate of return is incredibly high. Even at the data center level, you know, if you build if you like build a data center and you're like try give get get rented out to Anthropic or an open AI for like 10x what it cost you on a depreciated basis to build it. It's [ __ ] crazy. Um, and so you turn $1 to like $2 or $10 or something at the end of the year. The reason is the rate of interest higher. Now, if the rate of interest goes higher and if it does that for the entire economy and people are borrowing more and more money, they're competing against the other lending that the government would have done or that other companies would have done or that you as a consumer or a mortgage buyer would have done, uh, then that's just making it basically more expensive for everybody else to borrow. This has huge implications for tons and tons of people. Sorry, I'm going to go on a bit of a monologue here. Um, but we we we we we we've been thinking about this together. So, I think the US will be fine at the end of the day because they can if the data centers are built in America, you can fundamentally just like tax the data centers. But the way the current tax system is set up, you know, corporate income is like less than 10% of federal revenues and 80% plus is payroll taxes and income taxes, which as more and more automation happens will shrink. Um, at the same time on the spending side, currently 20% of tax revenue spending goes towards paying servicing the debt, basically paying interest payments on the debt. Um, now a lot of the debt is short duration, so it refurbishes every 5 years it rolls over. What What are you [ __ ] laughing at? Cuz you know, it's like things we've learned you've learned in the last [laughter] Yeah, like it's any different for you. It's like you got a degree in [ __ ] financial economics. [laughter] I didn't. Okay. The internet thinks I'm a V keeper. Few months, few months, few months. Yeah. [laughter] Um This is our business, Dylan. I know, I know. Sorry, sorry. Um [laughter] And uh so Now I'm self-conscious. [ __ ] No, it's good. You're doing good. I just think it's funny. [laughter] Million people listen to this guy who just learned about DEBT THIS MONTH.

UM SO YOU GO from 20% of If the supposed interest rates rise 1%, then the over a 5-year basis, the amount of the fraction of tax revenue that goes towards servicing the debt, basically, goes from 20% to 25%. If the rates rise 5 percentage points, that would go towards like north of 40%. But if you take into account the fact the government is borrowing $2 trillion every single year, then that goes from like 40% to like north of 60%. So 60% of tax revenue basically just goes towards paying interest payments on the debt. Now I think the US is going to be fine because also the tax base will increase if we let data centers get built in America. Um other countries are absolutely [ __ ] in my opinion. I was just looking at which countries have a lot of debt, have very little tax revenue, and also a lot of their debt is serviced quite often. And those countries, like Pakistan or Nigeria or something, I think are just going to be very [ __ ] in this new interest rate regime.

So so so this this this crowding out effect is actually like the thing that I've like is the reason it's not like yolo 1 billion gigawatts. Yeah, yeah.

Right? Um you've got you've got all these industries and countries that use a lot of debt, whether it's, you know, all these impoverished countries that you mentioned earlier that are just going to default, you've got like consumer packaged goods, right? Like all of these like companies that make things you see at Trader Joe's or wherever use a lot of debt. All these telecom companies use a lot of debt. And banks use a lot of debt. And so if interest rates go up um in the market, not necessarily the government set interest rate, but in the market the spread of interest rate uh between what the government says their federal rate is versus what everyone else is charging because Amazon wants to raise a hundred billion dollars of debt next year or whatever the hell the number is. Um you know, probably less, but um you end up with this like really challenging problem of where does the cash come from? Um there is some level that is funded by cash flows and cash flows keep going up, but the logical thing to do is to invest way more than your cash flows because then the returns in the future years will be amazing. So you have this delta, um and then what's pushing down on the delta is all of these other things, right? There's regulations against data centers, regulations against uh you know, consumers getting mad, uh politicians getting mad, regulations against AI, um the AI labs not releasing their latest models because of safety reasons, um all of these things and and and interest rates going up um are are are an influence on all of these things. So all of these things bend the curve from what does capitalism want in terms of just pure simple economics to what is the complex system that we have want and bends it lower and lower and lower to where not as many gigawatts as should be built will be built. Well, I interest rate is part of capitalism, right? Yeah, but like, you know, like in the simple economic model versus like the more complex what we have.

Yeah. Um what is the rate at which you think Amazon or Anthropic or whatever will be releasing bonds for debt next year? They do hundreds of billions of dollars of debt. What is the rate at What is the average rate? I I don't think Amazon will do hundreds of billions of dollars of debt. In total, let's say the big tech in total will raise and and all the clouds Yeah, yeah. In in the modeling that we do, we have about $11 trillion of capex from 2024 to 2029. Total?

Total. And if you do, you know, if you fund a lot of this with cash flows and as much as you can, you still end up with north of $5 trillion of credit that needs to be issued for this $11 trillion plus buildout. the AI revenue continues even 3x year over year?

AI revenue does go up. I don't think it can go up forever. I don't, you know, like just like you without like certain constraints being hit. I think certain labs will have certain incentives. Um and and labs are not the ones building all the compute in many cases, even though they're increasingly trying to go that way.

have all these cash flow. Like if their revenue keeps Whatever, that's fine. But if you How much did you say their revenue will be? You think they'll not have that much revenue?

No, I'm just saying till 2029, there's, you know, something on the order of $11 trillion of capex. And six of that is funded with cash. And five of that is funded with debt. Um and if that's the case, $5 trillion of debt being raised across the whole ecosystem does make interest rates go up. And then what prevents that, you know, there's a couple things. One, do labs increase their revenue per megawatt more and keep inference allocations large, in which case they're taking all this profit, they're accumulating all the profit across the S&P 500 cuz everyone's paying to, you know, reduce their costs. Um of course, their profits will also go up, but um you know, cash has to come from somewhere. Um so, there's an upper limit on how fast their revenue can grow versus the value they deliver into the world, and there's a diffusion aspect of the technology. Um but ultimately, labs revenue keep going up. They can't cash flow fund everything. The optimal scenario is you actually use credit as much as you can to fund because even if cash flows from the labs fund a lot of stuff, you want to build more than that.

Um and so, there is some amount of credit that gets built. Our current modeling has $5 trillion of credit and $6 trillion of cash-funded infrastructure investments through '29. Um and when you take that, you you've sort of got you know, this is not enough compute relative to what this demand growth is from the AI models. And so you've got the obvious answer, which is revenue for megawatt keeps going up.

Yeah, that that that makes sense. So, how much do you think interest rates will increase by 2029 as a result of all this?

Dude, you know, this is vibing a number, but if you're vibing a number out, you know, growth in the world and economy is growing up a lot, so why wouldn't interest rates Yeah.

for Amazon go from, you know, from where they are today. Um, I think Meta pay Okay, let's take what So, this is going to be extremely vibed out, but recently Meta's raised it like 5 to 6%. I don't see why they wouldn't pay 8% because they would happily pay 8% because the return from the compute that they're going to build is humongous. Right.

Um, and the market won't want them to, but if they they they don't want to pay 8%. The flip side is if they pay 8% versus the five they do, five and a half, six they do today, you know, 250 bips increase, that makes everyone else in the economy also pay 250 bips more. Yeah, yeah.

Which then causes a lot of things, right? Banks will scream because if their spread goes up, then their assets don't reprice their their their debt themselves reprice this faster than their assets reprice. Um, and you ultimately end up with they're losing tons of money if their credit spread blows up. The other consequences of this are Yeah.

This is a point you made, but the if interest rates rise, the discount rate increases, which means that the discounted cash flows of all equities Yeah. crater, which means that even though the stock market as a whole may be doing fine, like S&P 500 will be fine. Yeah.

Any individual stock will probably have just like cratered in value, especially the um, the Buffett like Berkshire type, you know, pay good cash flows for 30 year type of stocks. like it's like why would I pay this much for you know, um, you know, Johnson & Johnson? Right.

You know, like they're they're seen as a stable stock, good cash flows, they'll return their cash flows over time, or a railway company. Like why the [ __ ] would I invest that much if my discount rate isn't 3% or 5%? It's now 8% or 10%.

And and and for developing countries, what's the there Basil Halperin, who's a a good friend and he's an economist, he made this claim that we'll see a second Volcker shock. So, in the '80s to fight inflation, Fed chair Paul Volcker raised interest rates like more than 5% or it's like something like 8% real interest rates 8%, and that caused some 40 different countries, mostly Latin America, to default in that decade. And I think that will probably happen again. If you enjoyed this clip, you can watch the full episode here and subscribe for more clips. Thanks.