(Kitco News) - Steve Keen has spent two decades telling anyone who'll listen that markets watch the wrong debt. This week he put a clock on it.
"I would give the bubble in AI less than a year to go," the Australian economist told Kitco News.
The number at the centre of that call is difficult to verify from outside the companies themselves, and Keen did not provide the underlying data during the interview. His estimate is that revenue from users who'll actually stick around runs at about a fifth of what these firms are spending.
"Those frivolous users are disappearing, and the revenue from serious users, which may be sustained over time, looks like about one-fifth of the cost levels that these firms are caught up in," he said. "So I expect massive losses coming out of that."
In 2010, readers of the Real-World Economics Review voted on which economist had warned earliest and most clearly about the coming financial crisis. Keen came first. Nouriel Roubini came second. He wrote "Debunking Economics," built the modelling software Minsky and Ravel, and is writing How Economists Will Destroy Capitalism, which he said Polity Press plans to publish.
Not a rerun of 2008
Before going further, a qualification Keen made himself, and it matters more than anything else in the interview.
He is not forecasting another banking-led collapse.
"I'm not expecting a debt crisis this time round in the same way I did back in 2007, because the level of credit demand is quite low, relatively speaking," he said. Using a series that extended only through the first quarter of 2025, Keen put the share of spending funded by new borrowing at roughly 4% to 6% of GDP. On his data it peaked at 15.4% in the third quarter of 2006.
The trigger he's watching comes from outside the financial system, from disrupted physical supply working its way into company cash flows.
"It's not a financial crisis like 2007. It's a crisis of being able to service the financial sector debts because you've damaged the productive system," he said. "We're going to find companies which would normally be able to service their debts quite comfortably, suddenly find they won't be able to get the inputs to produce the outputs."
What follows, he said, is "a patchwork" of bankruptcies.
"Pickleball courts"
The comparison he reaches for isn't 2008. It's the 1840s.
"I think we're about to see the bursting of a very large bubble on the scale of the railway bubbles back in the 19th century," he said. "Because so many firms have thrown large amounts of money into data centers and AI."
Companies have borrowed more than $410 billion this year for data centres and other AI investments, according to data compiled by Bloomberg. QTS Realty sold $3.9 billion of bonds to fund a Georgia facility tied to Microsoft at a yield of about 7.23%, Bloomberg reported, noting the investment-grade paper yielded more than some mid-tier junk-rated debt. For context, the U.S. government borrows for 10 years at roughly 4.7%.
Keen thinks the lenders will wish they'd charged more. "A lot of those data centres are going to find that 7% looks damn good compared to the losses you're going to make."
He also pointed to something the housing bubble never had to deal with. A house still shelters people after 30 years. A GPU stops being competitive after three.
"When you get data centres, after three or four years, the GPUs that drove that data centre are no longer competitive, so you're forced to renew the investment again," he said. "If you are not making the money that justifies it when you go to the renewal stage, you don't."
Which leads him somewhere unflattering for the buildings themselves. "That's why I think pickleball courts is a fairly sensible idea of how a lot of these data centres will end up being used."
So far, the market disagrees. August investment-grade issuance set a record for the month, following record totals for June and July, according to Bloomberg data, and demand has kept pace with supply. Buyers keep showing up.
Keen's answer is that they always do, right up until they don't. "Initially, people are still carried along by the euphoria." Asked why professional lenders turn up late to cycles like this one, he didn't soften it. "They don't understand the cycle."
What it means for gold
Keen's read on the metal is less comfortable than most experts offer.
"I always regard gold as a speculative commodity that does well when people are worried about the financial system," he said. "And so obviously the worries of the financial system are driving gold's price up right now."
But he had a warning about what happens in a real crisis, when assets that normally move against each other suddenly don't.
"Gold can also fall if people actually find they've got calls coming in from other assets which they're losing money on, and they sell gold to cover those positions," he said. "So rather than hedging your bets, you amplify your risk."
Asked whether gold protects against a debt deflation, which is what happens when everybody pays down debt at the same time and the economy shrinks faster than the debt does, he said it can. Then came the condition.
"If you are levered and you've got gold as an asset and you've got a debt you can't service, then you're likely to sell the gold. So it's not a one-way bet."
Gold reached its dollar record in late January and has not returned to it.
"Private sector debt is the one that matters"
The AI call sits inside a framework Keen has held since before the last crash, and it runs against where most of the market is looking.
"The conventional theories just obsess about the level of government debt and ignore private sector debt," he said. "My point has always been that private sector debt is the one that matters. When private debt starts to plunge, that's what causes serious downturns in the economy."
It comes down to who owns a bank.
"The great disadvantage of being a household or a firm is you don't own your own bank," he said. "Households and firms don't own their own banks where the government does, and that makes an enormous difference."
Federal Reserve data shows U.S. household debt peaked near 98% of GDP around 2009 and has since fallen to roughly 68%. Keen doesn't dispute that households paid a lot down. He disputes that it went far enough. On his figures, aggregate private debt peaked near 170% of GDP and sits around 150% now. After the Great Depression, the same ratio fell by about two thirds.
"We've still got 85% of the private debt level that applied at the peak of the crisis," he said.
Where the money actually comes from
Asked where the half a million dollars comes from when somebody takes out a mortgage, Keen didn't hesitate. "It's created by the bank when it does the loan."
"In the real world, banks are not credit rating agencies, they are money creation systems," he said. Citing work by Richard Vague, Keen said the U.S. money supply went from roughly $5 trillion in 2000 to about $25 trillion by 2024, with more than 90% of that coming from private lending rather than government.
"So it's not the government creating the money that's maybe creating the inflation. It's the private sector."
Where he parts with Ray Dalio
Ray Dalio wrote on LinkedIn on Friday that the U.S. government's financial condition is at an inflection point. He put a debt crisis at roughly three years out and told investors to hold 10% to 15% of a portfolio in gold.
Keen said the timing could be similar. He rejects the mechanism.
"Even Ray Dalio, whom I've got a lot of respect for in general, and he focuses on the role of credit and so do I, his understanding of the accounting of how money is created both by the private sector and by governments is just wrong," he said.
"I do expect some of the same sorts of crises that Dalio's expecting, but it comes out of the private sector, not out of the government sector, and the timing tends to be similar."
On Washington's own books, he waved the worry away entirely. The government's finances, he said, "are rock solid because it can pay for anything denominated in its own currency. The private sector can't do that."
He doesn't trust the stress tests
The Federal Reserve reported in June that all 32 large banks in its annual stress test stayed above minimum capital under a scenario that modelled commercial property down 39%, house prices down 30% and unemployment at 10%. Aggregate capital fell 1.6 percentage points, the smallest drop since 2020. Capital, in this context, is the shareholders' money that absorbs losses before depositors take any.
Asked what the test missed, Keen needed four words. "I think it missed money creation."
Then he told a story. Richard Vague, before the crisis, asked a senior bank economist what he made of household leverage and was told that yes, liabilities had risen, but so had assets. As Keen tells it, the line came back as "that's a trade I'll take any day." Vague got out before the crash.
"Priced for perfection"
Asked what would prove him wrong, Keen named the AI call first, then widened it out. U.S. house prices are above their 2007 levels and going sideways. The cyclically adjusted price-to-earnings ratio, a long-run measure of how expensive stocks are, has been higher just once, in the 2000 bubble.
"So I think everything is priced for perfection," he said. "And we're not about to experience perfection."
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