If you’re looking for things to worry about, check out the stock market. It might be giving cause for concern, at least a little bit. Wall Street Journal financial columnist James Mackintosh points out that just four giant technology stocks—Nvidia, Microsoft, Apple, and Alphabet—have added more market value this month than the rest of the S&P 500 combined. That, thanks in large part to investor enthusiasm about artificial intelligence. 

Mackintosh writes that he fears “the market is paying too little heed to the risks,” and then offers a few reasons why the earnings and share prices of Nvidia, the chief beneficiary of the AI-inspired rally, might be at risk. One scenario: Demand for Nvidia’s high-end graphics processing units falls because AI is overhyped and has yet to live up to its promise. In other words, demand will turn out to be a bubble and that bubble then bursts—as bubbles, by definition, always do.

“Bubble,” an ominous word even nearly two decades after the 2000s housing collapse. But bubbles aren’t necessarily bad things. A little bubble history:

• Bubbles in the 1700s and 1800s financed the development of railways, canals, telegraphs, and more.
• The 1920s stock market bubble in the US financed the development of radio, cars, airplanes, and more. 
• The late 1990s dot-com bubble caused huge overinvestment in internet companies, but it funded the buildout of internet infrastructure and rapid innovation in online business models. 

With each bubble came a crash, but the technologies remained. And those are just a few examples of bubble benefits highlighted in the 2022 paper “Kindleberger Cycles: Method in the madness of crowds?” by finance professor Randall Morck at the University of Alberta’s business school. The basic idea of the paper is that stock market bubbles and crashes can be a good thing for the economy in the long run, even though they cause plenty of financial pain in the short term. 

As Morck explains it, there’s perpetually too little investment in innovation and new technologies because the people and companies making those investments can’t capture all the benefits. (Much of the benefit goes to society as a whole.) Stock market bubbles help solve this shortfall by generating overinvestment in promising and much-hyped new technologies. Investors get excited and shovel way too much money into them. In the meantime, however, an enormous amount of money has flowed into the new technology, allowing it to more fully develop. From the paper:

Corporate R&D has a social return far above its internal rate of return to the innovating corporation, and so is chronically underfunded from a social perspective. Kindleberger cycles, irregularly recurring stock market manias, panics, and crashes, prominent in financial history, are also a major problem for mainstream economics. If manias inundating “hot” new technologies with capital sufficiently counter chronic underinvestment in innovation, economy-level selection may favor institutions and behavioral norms conducive to Kindleberger cycles despite individual agents’ losses in panics and crashes.

Those “Kindleburger cycles” are named after the economist Charles Kindleberger. He’s perhaps best known as the author of the 1978 book Manias, Panics, and Crashes: A History of Financial Crises in which he describes the historical pattern of booms, bubbles, and busts—driven by the inherent instability of financial markets and herd behavior—as typically being associated with the rollout of major new technologies or markets. Morck: “Each completion of the cycle ratchets productivity up to a higher baseline level after the economy recovers from the panic and crash.”

Even if the AI boom eventually goes bust, the flood of investment now might end up accelerating progress in key AI technologies, building lasting infrastructure such as data centers for future innovation, fueling experiments in AI applications across industries, and attracting talent to the field. While many companies might fail, the overall result could be a significant acceleration of AI capabilities that entrepreneurs will eventually put to productive use. The Kindleburger cycle abides.

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