Top economist Mohamed El-Erian warns the AI bubble will ‘end in tears’ and credit ‘cockroaches’ abound

He speaks in Yahoo! finance Invest, Al-Erian framed the current environment as one in which “cockroaches” abound but “termites” do not exist. This distinction is key: cockroaches are unpleasant occurrences that “come in groups” but do not “undermine the integrity of the system.” Conversely, termites erode the foundation.

Although a systemic shock is unlikely, the president of Queen’s College and the University of Cambridge and chief economic adviser at Allianz said he expected economic and credit crashes to occur as market participants “did their best to extract additional returns.” He added that loose financial conditions and a strong economy encouraged this, and some investors appear to have gone beyond their comfort zone and exceeded their ability to do due diligence.

Rational AI bubble

El-Erian told Yahoo that he, in collaboration with Nobel laureate Mike Spence, evaluated the artificial intelligence boom and concluded that the market is witnessing a “rational bubble.” While the total value created is significant, making it logical for investors to take a venture capital approach and “overinvest” because of the high payoff, there is a dark side: “there will be tears” and losses.

Elements of this bubble reflect past speculative periods, such as the dot-com era, where companies applied a label — now “artificial intelligence” — to their operations to attract capital, he said. What further contributes to the elements of a bubble is the fact that typical seed companies attract significant investment, but “not all of them will succeed.”

One of El-Erian’s main concerns is that there is not enough focus on diffusion, that is, the process of introducing AI into the workplace in a comprehensive and organized way. The United States currently lacks a comprehensive proliferation policy, unlike countries such as China and the United Arab Emirates. He added that if the proliferation is not handled properly, the full promise of artificial intelligence will not be realized.

Regarding corporate adoption, Al-Erian noted his concern about the prevailing mentality in companies, which currently view artificial intelligence primarily as a “cost reducer.” The real potential of AI, he said, is to boost employment and act as a “productivity enabler.” If the United States can get the spread right, the resulting large increase in productivity could allow monetary policy to be more flexible than it would otherwise be.

Pressure on the K-shaped economy

Beyond financial mishaps, El-Erian pointed to two main issues that could pose pressures: the need to refinance a large amount of debt at higher interest rates, and significant pressure on the lower end of the income distribution.

This focus highlights concerns about the economy’s K-shaped bottom. Low-income consumers are “verging on a recession,” he said, grappling with affordability concerns — a social and political issue, not just economic — and rising debt, including maxed out credit cards. Moreover, insecurity about future income, driven in part by the rise in layoffs reported in Challenger, Gray and Christmas and the impending changes to the workplace brought on by artificial intelligence, adds to their distress.

El-Erian warned that this pressure is not isolated: low-income families may be forced to stop spending because they are unable to, and this “will pollute the economy as a whole.” Although the upper class generally performs well on measures of income and wealth, it is not immune to the difficulties faced by low-income families.

El-Erian urged policymakers to realize that the future will be determined by “the tails of the distribution, not the belly.” In today’s structurally changed and fragmented world, leaders must realize that they are operating in a multimodal world and should not be fooled by the assumption of a normal, bell-shaped distribution.

For this story, luck Use generative AI to help with the rough draft. An editor verified the accuracy of the information before publication.