Here’s another thing AI is making worse: the cost of borrowing money

If the Reserve Bank raises interest rates for millions of households with mortgages this week, as expected, it will no doubt say it’s responding to stubbornly high domestic inflation. That’s true enough, but it’s far from the only reason why borrowing money is getting more expensive.

There’s another, global factor feeding into higher borrowing costs for huge borrowers such as governments and corporations, and that’s the AI craze.

Most gloomy AI stories centre on fears of a sharemarket bubble, the prospect of mass job carnage or, if we’re really feeling grim, the risk of human extinction. Lately, however, more attention is shifting to the monumental debt pile that is paying for the AI spending spree.

The borrowing binge is not only making investors nervous about whether all the AI investments will deliver the hyped and hoped-for profits. It has also intensified a race between big corporations and governments as they compete to borrow vast sums of money, and it’s one reason why some experts think higher interest rates are here to stay. In other words, it’s a story that matters for all of us, not just financial market types.

The companies at the heart of these debt worries are the “hyperscalers” – tech giants such as Google and Microsoft, which are behind the staggering investments going into data centres and other AI infrastructure.

Initially, those companies could pay for the AI infrastructure they needed from their enormous profits, but that’s now changed.

As the global AI build-out has expanded (some say it will rival past booms such as the construction of railways in the US) the tech giants have turned to credit.

They’ve borrowed huge sums by issuing corporate IOUs – bonds – and that’s set off a battle with other big borrowers such as governments and other big companies.

The Bank for International Settlements last week pointed out that bond issuance from the five largest hyperscalers reached US$222 billion ($315 billion) this year alone, and borrowing was increasing faster than past booms. “Even benchmarked against past credit booms, the issuance of AI-related debt is rapid,” it said.

Higher bond yields drive up fixed-rate mortgages, but the jury is still out on what the AI craze means for the variable rates set by central banks such as the RBA.

When a few tech giants are hoovering up that much money, it forces others to compete more fiercely to get funding, raising the cost of funds by pushing up bond yields.

This matters to all of us because some of the biggest borrowers in the world are governments – which are feeling the sting of higher interest costs as the bond yields have increased. The great AI borrowing binge isn’t the only reason bond yields have risen this year, but it’s a significant part of the story.

Commonwealth Bank’s head of market strategy and rates research, Adam Donaldson, explains that there is “enormous competition” for money in the market for government bonds (IOUs issued by the states and the feds). When Google’s owner Alphabet issued its first Aussie dollar bond in August, Donaldson notes, it included 10 and 20-year bonds – timeframes often used by governments to borrow.

“That 10- and 20-year, that’s very much the space that sovereigns and the states occupy when they’re borrowing, so it’s a direct source for competition for funds,” he says.

Or as European Central Bank policymaker Martins Kazaks told Reuters recently: “There is a global fight for money. Investment in AI is one of the key factors driving up the cost of money.”

AI is not the only reason there’s a global fight for money. Governments are also borrowing like mad because they have big deficits that needed to be financed, and because of large-scale spending on the green energy transition, or higher defence spending.

But when you add the competition of the AI-fuelled debt surge into that quest for funds, the cost of borrowing money goes up.

Donaldson estimates the AI story probably adds about 50 basis points to the yield on a 10-year Australian government bond, meaning the government is paying more to borrow money. He says that would imply roughly an extra $3 billion in annual interest costs for the federal budget for this year.

Some investors wonder if the global contest for money will also drive up costs or Australian banks, which also rely on overseas markets for a significant chunk of their funding. Commentary from the big four as they deliver results over the next fortnight may shed light on this.

Does this mean the AI craze is pushing up the cost of your mortgage?

It’s not quite that simple. Higher bond yields drive up fixed-rate mortgages, but the jury is still out on what the AI craze means for the variable rates set by central banks such as the RBA.

Some economists believe the size of the AI credit boom is affecting the balance between investment and savings, which are seen as the long-term drivers of global interest rates. The idea is that when there’s more investment than savings, it increases the so-called “neutral” rate (the theoretical rate of interest that neither stimulates nor slows economic growth).

The neutral rate can’t be measured, but the concept is important because it’s used by central banks when setting the “stance” of monetary policy (moving interest rates).

Lately, some economists have argued that neutral rates have risen significantly, and one reason for that is the competition for money that the AI bonanza has helped fuel. If they’re right and “neutral” rates are indeed higher, this would mean the actual interest rates people have to pay could be higher than they were previously, just to maintain the same stance of monetary policy.

Against this, others claim AI could ultimately increase productivity, which would tend to support lower interest rates. As with all things AI, no one knows what the final impact will be.

But we do know that the companies behind the AI mania have gone on an almighty debt binge, and that’s feeding into higher borrowing costs for governments when their budgets are already strained.

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