by Trevor Chow, Basil Halperin, and J. Zachary Mazlish
[Note: This is an appendix to "AGI and the EMH: markets are not expecting aligned or unaligned AI in the next 30 years"]
One naive objection would be the claim that real interest rates sound like an odd, arbitrary asset price to consider. Certainly, real interest rates are not frequently featured in newspaper headlines – if any interest rates are quoted, it is typically nominal interest rates – and stock prices receive by far the most popular attention.
The importance of real rates. However, even if real interest rates are not often discussed, real interest rates affect every asset price. This is because asset prices always reflect some discounted value of future cash flows: for example, the price of Alphabet stock reflects the present discounted value of future Alphabet dividend payments. These future dividend payments are discounted using a discount rate which is determined by the prevailing real interest rate. Thus the claim that real interest rates affect every asset price.
As a result, if real interest rates are ‘wrong’, every asset price is wrong. If real interest rates are wrong, a lot of money is on the table.
Stocks are hard to interpret. It may nonetheless be tempting to look at stock prices to attempt to interpret how the market is thinking about AI timelines (e.g. Ajeya Cotra; Matthew Barnett; /r/ssc). It may be tempting to consider the high market capitalization of Alphabet as reflecting market expectations for large profits generated by DeepMind’s advancing capabilities, or TSMC’s market cap as reflecting market expectations for the chipmaker to profit from AI progress.
However, extracting AI-related expectations from stock prices is a very challenging exercise – to the point that we believe it is simply futile – for four reasons.
- First, and most importantly, these companies will only have the possibility of high profits if transformative AI is aligned; under unaligned AI, the value of stocks along with everything else is converted to zero.
- Second, it is not obvious that even in the aligned case that these companies will earn high profits. For instance, OpenAI has committed to a capped profit model, and others may sign on to a similar ‘Windfall Clause’. Beyond corporate altruism, it seems extremely plausible that if a private company develops truly transformative AI technology then the state will (attempt to) nationalize and expropriate it to distribute the benefits more broadly, preventing profits.
- Third, stock valuations are extremely idiosyncratic: which stock should we be looking at? And critically, even if we take a basket of tech companies and average over them, then this only includes public companies. If the market expects transformative AI in 12 months, but only because it will be developed by OpenAI – a company which is not traded publicly – then this will not show up in any equity index.
- Fourth, and quite importantly, it is not obvious whether expectations of transformative AI would raise or lower stock prices. This is because, as described in the previous subsection, stock prices reflect the present-discounted value of future profits; and advanced AI may raise those future profits, but – as the central thesis of this piece argues – advanced AI would also raise the interest rate used to discount those profits. The net effect on stock prices is not immediately obvious.
- (In math, briefly: if the price P is the value of future profits D discounted at rate r, i.e. P=D/r, then transformative AI may raise future profits D but it could raise the discount rate r by even more.)
- (Higher growth causes lower average stock prices if the intertemporal elasticity of substitution is greater than one, rather than less than one. This parameter is subject to significant debate; see the linked slides for useful discussion. John Cochrane offers additional intuition here and argues that the empirically-relevant case is the one where higher growth causes lower equity prices: expectations for transformative AI would lower equity prices.)
If you want to use market prices to predict AI timelines, using equities is not a great way to do it.
In contrast, real interest rates do not suffer from these problems.
Also seems important to note: EA investing should have not only different expectations about the world but also different goals about the point of finance. We are relatively less interested in moving money from worlds where we're rich to worlds where we're poor (the point of risk aversion) and more interested in moving it from worlds where it's less useful to where it's more useful.
Concretely: if it turns out we're wrong about AI, this is a huge negative update on the usefulness of money to buy impact, since influencing this century's development generally becomes much less important. So even if we think the stocks are accurately priced, we probably want to bet a lot of money on the market being surprised in the direction of AI being huge and timelines being short, because if those are true, money would be extremely useful, and it's potentially worth giving up a lot of money in worlds where it's false.
(Edited to add: even more concretely, this means that stocks correlated to AI progress are underpriced for us even if they're not underpriced for a typical investor, and in particular riskier assets correlated to AI progress like options on AI/semiconductor/datacenter stocks are likely especially underpriced for our preferences. Also n.b. by "our preferences" I mean as donors -- I'm talking about the overall longtermist portfolio, not making investment advice for any individuals.)
I weakly agree with practically all the arguments in this post, but I think the conclusion is overstated. I suspect looking at stock prices is still quite valuable in light of these points -- especially semiconductor stocks, as I suggested in the tweet that you linked in this post.
It really only makes sense to talk about prices in a relative, rather than absolute sense. Normally people don't care about this distinction because they're talking about nominal prices, and the price of money changes slowly relative to a broad basket of goods and services. But in the context of this post, and especially my linked tweet, I think it's quite important to make the distinction.
When you say it's "not obvious whether expectations of transformative AI would raise or lower stock prices", did you mean in nominal terms (such as after an inflation adjustment)? If so, then I'd agree with the claim as written, but only to the extent that we're talking about the price of equities in general. In my tweet, I was talking about semiconductor stocks rather than the entire equities market. I think it's highly plausible that semiconductor companies will be more profitable ex ante than the average investment if investors begin expecting imminent transformative growth. Therefore, it makes sense to talk about the growth of semiconductor stock prices relative to broader equities.
You mention that,
This is a very reasonable point, and I agree it's something we should keep in mind when talking about how to select the right AI investment index. However, my (admittedly shallow) understanding is that semiconductor stocks are broadly public, considered hard to unseat by private competitors, and have largely benefitted whenever demand for computer hardware is expected to rise in the near-term future.
The real interest rate is a nice alternative measure to look at, but I'm not convinced that it's more reliable than something straightforward like semiconductor stocks. In addition to some nitpicks I have about the reliability of the argument in the main post (which I've talked to Trevor Chow about, at the very least), I'm just not convinced that the real interest rate is a particularly strong benchmark.
(And to be clear, both measures can be unreliable or both reliable. I'm just pushing back against the framing that one is reliable and the other isn't.)
In the main post, you allude to a "mouth-watering cumulative return of 162%" that one can get over the long-term if they bet on real interest rates rising. However, since my original tweet was posted less than one year ago, NVIDIA has already gone up approximately 161%. If aligned transformative AI is coming soon, I predict we'll again see a similar rise in semiconductor stocks, albeit with big uncertainty about exactly how much, and to what extent public semiconductor companies can capture that value.
Microsoft is planning to invest $10B in OpenAI and rumors are that their maximum revenue is $105B.[1]
Microsoft is currently trading at a revenue multiple of ~10x, so this would increase their valuation by $1T, or about 60%.
I think this is enough to show up in Microsoft's stock price. It will be interesting to see what happens to the stock if/when the OpenAI deal closes. My guess is that there will be a small bump, but nowhere near 60%.
Revenue is capped because of the weird term structure. But note that this doesn't include things like increased revenue Microsoft would get from using GPT for Bing, which could be much higher
Thanks for this interesting exercise. The one caveat I'd note is that the multiplier you use is based on annual revenue -- if the remittances from OpenAI to MSFT occur over a number of years, we would need to divide the $1T number that you calculate by that number of years.
(PS: amazing tiktoks)
Microsoft has now officially announced their investment and their stock is up ~1% but that's within normal daily variance. Probably the deal was considered likely enough to go through that a lot of the assumed benefit from this deal was already priced in before the official announcement, but I think it's pretty hard to look at a graph of Microsoft stock price and claim that the market is pricing in substantial benefits in the next year.[1]
PS: thanks :)
fwiw, I'm considering this a market inefficiency and purchasing Microsoft stock as my only non-index fund holding. Feel free to check in with me next year and see how much I regret this.