How Big Tech Offloaded The Risk Of AI

SUMMARY

Scott Galloway and Ed Elson analyze the growing off-balance-sheet debt among major technology companies, highlighting the risks of opaque financial structures in the AI sector. They also discuss the inflationary impact of rising oil prices and tariffs, the shifting global economic landscape favoring China, and the realities behind the apparent surge in new business applications in the United States.

MAIN POINTS

• Scott Galloway is appointed to the University of California Board of Regents and reflects on the importance of accessibility in education. [6:00]
• Major tech companies such as Alphabet, Microsoft, Amazon, Meta, and Oracle are revealed to have more off-balance-sheet debt than reported debt, largely through special purpose vehicles (SPVs) for data center financing. [9:01]
• The risk of AI data center investments is being offloaded from tech companies to private credit funds, raising concerns about whether these funds are accurately assessing the risks involved. [13:00]
• Discussion centers on the role of leverage in economic growth, the potential dangers of excessive or opaque debt, and the need for transparency and responsible underwriting. [18:01]
• Concerns are raised about misleading accounting practices, such as the use of unconventional profit metrics and the lack of reliable disclosure from investment banks and tech companies. [22:00]
• Tariffs and rising oil prices are identified as key contributors to persistent inflation, with new tariffs imposed on Brazil and Canada and oil prices spiking due to Middle East conflict. [29:03]
• China is highlighted as a major beneficiary of the Iran conflict and global energy transition, dominating clean energy manufacturing and gaining geopolitical influence. [32:00]
• Bond markets are signaling increased long-term risk for the US, with Treasury yields at multi-year highs and concerns about mounting national debt and deficits. [38:02]
• The discussion turns to the societal impact of inflation, emphasizing how persistent inflation erodes prosperity and comparing US inflation rates unfavorably to other G7 nations. [41:02]
• The US is criticized for reducing clean energy investments and depleting emergency oil reserves, while China accelerates its dominance in renewables. [47:00]
• A record number of new business applications is reported, but most are likely non-employer businesses, suggesting the boom is more about side hustles than true entrepreneurship. [53:01]
• The rise of the 'founder' identity among young people is examined, with many pursuing side hustles and adopting entrepreneurial titles without leaving traditional employment or taking significant risks. [59:00]
• Galloway shares personal experiences to illustrate the real risks and sacrifices of entrepreneurship, contrasting them with the superficial adoption of founder titles. [1:09:01]
• Advice is given that joining a fast-growing company as an early employee may offer better risk-reward than founding a startup, and that distressed investments can be lucrative for investors. [1:12:01]
• The AI market is described as bifurcating, with China rapidly increasing usage of low-cost models and the US focusing on high-end frontier models, echoing trends seen in the automotive industry. [1:13:01]
• Predictions are made that US inflation will remain elevated above 4% for the foreseeable future, with little relief expected in the near term. [1:14:01]

DETAILED ANALYSIS

The episode opens with a discussion on the complexity of modern financial instruments, drawing parallels between the current AI investment landscape and the buildup to previous financial bubbles, such as those involving collateralized debt obligations (CDOs) before the 2008 crisis. The hosts highlight a recent investigation revealing that major technology firms—Alphabet, Microsoft, Amazon, Meta, and Oracle—are carrying $1.65 trillion in off-balance-sheet obligations, surpassing the $1.35 trillion in officially reported debt. This is primarily achieved through the use of special purpose vehicles (SPVs) to finance data centers, allowing companies to avoid directly increasing their own debt loads.

Instead, private credit funds provide the financing, and the tech companies rent compute power from these SPVs.

This structure effectively shifts the risk from the tech giants to private credit providers, pension funds, and insurance annuities, raising concerns about the transparency and stability of the system. The hosts note that while such arrangements can be seen as financially prudent from the perspective of the tech companies, they also create opacity and potential systemic risk. The situation is compared to the mechanisms that fueled the 2008 financial crisis, where complexity and lack of transparency obscured the true extent of risk in the system.

The discussion delves into the broader implications of leverage in the economy. While leverage can drive growth by enabling more investment and economic activity, excessive or poorly understood leverage can lead to instability. The hosts emphasize that the current AI buildout is heavily reliant on the assumption that data centers will generate returns far exceeding their construction costs.

However, the responsibility for accurately modeling these risks now lies with private credit funds, not the tech companies themselves. This shift in risk assessment is problematic given the lack of regulation and the recent failures within the private credit industry, such as the bankruptcy of First Brands, which exposed the vulnerabilities of these opaque financial structures.

Concerns are also raised about the use of unconventional accounting metrics, such as 'community adjusted EBITDA' and 'EBTIT' (earnings before training interest and taxes), which can obscure the true financial health of companies involved in the AI sector. The hosts argue that traditional gatekeepers, including investment banks and regulatory bodies, have failed to enforce rigorous disclosure standards, leaving investors with limited reliable information. They advocate for diversification as a key strategy for individual investors to mitigate the risks posed by these opaque practices.

Attention then shifts to macroeconomic factors contributing to inflation. The episode details the impact of new tariffs imposed by the US on Brazilian and Canadian goods, as well as the surge in oil prices driven by ongoing conflict in Iran and disruptions in the Strait of Hormuz. These developments are identified as significant drivers of inflation, with US consumers bearing the brunt of higher costs.

The hosts cite data showing that US inflation remains the highest among G7 nations, and they warn that persistent inflation, if not addressed, will erode the long-term prosperity of American households.

A critical theme is the shifting global economic landscape, particularly the rise of China as a dominant force in clean energy and technology. The hosts argue that while the US expends resources on tariffs and military interventions, China quietly consolidates its position in renewable energy, electric vehicles, and battery manufacturing. The episode references Pew Research data indicating that global perceptions of China have improved relative to the US, a trend attributed to strategic missteps in American economic and foreign policy.

The hosts express concern that the long-term consequences of current policies—including mounting national debt, high deficits, and diminished international alliances—will be felt for decades, with future generations facing higher interest rates, reduced growth, and diminished global influence.

The conversation also addresses the apparent boom in new business applications in the US, noting that nearly six million applications were filed last year. However, a closer examination reveals that only 1.7 million are classified as high-propensity businesses likely to hire employees. The majority are non-employer businesses, often side hustles or solo ventures with little impact on job creation or economic growth.

The hosts attribute this trend to a combination of economic anxiety, the allure of entrepreneurship, and the influence of social media culture, particularly among younger generations. They caution that the romanticization of entrepreneurship often overlooks the significant risks and sacrifices involved, as illustrated by Galloway's personal experiences with starting and funding companies.

Advice is offered to those considering entrepreneurship: joining a promising company as an early employee may offer a better balance of risk and reward than founding a startup, and investing in distressed or overlooked sectors can yield strong returns. The episode concludes with a look ahead to major earnings reports from leading tech firms and the Federal Reserve's upcoming interest rate decision. Predictions are made that US inflation will remain elevated, and the AI market will continue to bifurcate, with China gaining ground through the widespread deployment of affordable models while US firms focus on high-end, high-margin offerings.

The hosts underscore the importance of understanding the underlying risks and dynamics shaping the current economic environment, urging listeners to remain vigilant and informed.

LINKS

• Subscribe to the Prof G Markets newsletter.
• Order Notes On Being A Man.
• Follow Scott Galloway on Instagram.
• Follow Ed Elson on Instagram.
• Follow Ed Elson on X (Twitter).
• Read Ed Elson's Substack.
• Subscribe to Prof G Markets on Spotify.
• Get answers from Prof G on TikTok.
• Explore more Prof G Media content.
• Get 30% off a Framer Pro annual plan.
• Explore mortgage options with SoFi.
• Learn more about VCX, the public ticker for private tech.

KEYWORDS