What must happen for AI’s trillion-dollar gamble to pay

What happened

When Jessica Wachter, a finance professor at the University of Pennsylvania’s Wharton School, wanted to assess AI’s impact on the economy over the next few years, she faced a long list of business and technical uncertainties. So she started with what she calls a “remarkable fact” that is not in question: A handful of so-called hyperscalers are investing huge amounts of money to build AI data centers. 1 trillion.

The risks, both to investors and to the economy, have become even greater this year, as these AI companies have begun borrowing large amounts of money to build more and more data centers. Free cash flow—operating cash flow minus capital expenditures—is expected to soon dip into negative territory for the group. 9 billion—its first shortfall since Google went public in 2004.

In the near term, it’s not a big financial worry for most of the companies. They make a lot of money and have very deep pockets. But debt is expensive, and some investors are losing patience. If future demand for the data centers’ computation power drops, the companies will still be on the hook to pay back the borrowed money.

What’s more, the risks are spreading to the rest of the economy as the loans get passed along via various financial mechanisms. It won’t be enough to simply cover the enormous price tags of the new data centers. Hyperscalers will also have to pay for the rising costs of capital as they borrow more money.

They will need returns that are impressive enough to justify all their spending to investors and creditors. And to add to those concerns, they will have to make up for the depreciation of billions of dollars in chips housed within the facilities—a ticking time bomb buried in the investments.

Performance of the expensive GPU chips at the core of the data centers—such compute electronics represent some 60% of costs—is roughly doubling every two years or so. The pace of progress helps explain the increasing wizardry of the AI models, but it comes with a cost.

Why it matters

It's a no-nonsense accounting approach to making sense of today’s historical AI buildout. 7 to break even by 2030, accounting for the cost of capital and a 15% return, and depreciation of the assets. Not impossible, says Wachter. The result would lead to the kind of economic growth that we saw during the US IT boom over a period of about 10 years starting in the mid-1990s.

” And if the hyperscalers cannot meet such profit goals? “Then they will fall behind on their interest payments, and that risks bankruptcy,” says Wachter, who was previously the SEC’s chief economist and director of its division of economic and risk analysis. ” It doesn’t take superintelligence to realize that today’s large investments in the infrastructure for artificial intelligence come with huge risks.

The hyperscalers will spend about $750 billion this year, building massive data centers scattered across the country. And the spending spree shows no signs of slowing. According to some projections, total AI capital investments from the hyperscaler companies—Alphabet, Microsoft, Amazon, Meta, and Oracle (which partners with OpenAI)—could be more than $5 trillion over the next four years. It’s one of the largest capital investments by any industry in history.

But there’s a problem that’s obvious to anyone paying attention. While the hyperscalers plan to spend trillions, total AI revenues will be around $150 billion to $200 billion this year, says Gary Gensler, who ran the SEC during the Biden administration and is now a professor at MIT’s Sloan School. “The challenge is that the spending does not have commensurate revenues yet. That’s a fact,” he says.

” At stake in that trillion-dollar question is the financial health of the giant AI companies and the overall US economy—the investments could soon balloon to around 3% of GDP. The answer could also determine the fate of the hugely expensive data centers themselves. No one really knows how profitable and useful these multibillion-dollar behemoths will be down the road.

Though AI models have made dazzling progress over the last few years, it’s anyone’s guess how much compute capacity we will need. The technology could become more efficient and therefore less dependent on raw computational power. Or demand for AI products could slow, or customers could turn to cheaper models.

What to watch

Owners of AI data centers that come online this year and next will need to spend billions more on the next generation of chips by the end of the decade if they want to stay competitive.