Tag Archives: startups

How Tech Unicorns Are Just Like China’s “Ghost Cities”

Since the Great Recession, there has been an explosion of interest and activity in the tech startup arena. Tens of thousands of tech startups have been founded in recent years and there are now over three hundred new “unicorn” startups that have valuations of $1 billion or more. The startup gold rush began as countless entrepreneurs attempted to follow in the footsteps of Facebook founder Mark Zuckerberg and the “Google Guys,” Larry Page and Sergey Brin. Unfortunately, the majority of today startups – including today’s hottest unicorns – are burning copious amounts of cash. In this piece, I will make the case that today’s startup phenomenon is very similar to China’s construction of countless empty “ghost cities” for the purpose of creating jobs and economic growth.

Though the U.S. was the epicenter of the Global Financial Crisis of 2008 and 2009, China’s economy was still strongly affected as well. After all, China’s largest export market – the U.S. – had just succumbed to a powerful recession. In an attempt to cushion the economy and create growth again, China’s government announced a RMB¥ 4 trillion (US$586 billion) stimulus package and helped to encourage an aggressive debt binge. A good portion of this stimulus package and debt binge was used to build massive infrastructure projects, extravagant government buildings, and entire cities throughout the country.

A very high proportion of China’s construction projects over the past decade were basically make-work projects that were undertaken for the purpose of creating jobs and GDP growth, despite the fact that they are typically wasteful and inefficient. Make-work projects are very common in centrally-planned economies like China. The economist John Maynard Keynes was a strong proponent of make-work projects and is even known for saying, “the government should pay people to dig holes in the ground and then fill them up.”

As an adherent of the pro-free market Austrian School of economics, however, I vehemently disagree with make-work projects and Keynesian-style stimulus programs because they create tremendous waste and misallocation of resources, which ultimately leaves society poorer in the long-run. China’s numerous empty “ghost cities” are an eerie reminder of the gross misallocation of resources that has occurred in the past decade. China’s government and real estate developers were hoping that “if you build it, they will come,” but that hasn’t proven true for many of the country’s brand new cities and malls that are almost completely devoid of people. There are an incredible 65 million empty apartments in China currently, which amounts to approximately a fifth of the country’s housing stock.

The pictures below show some examples of these empty cities:

Meixi Lake development near the city of Changsha. Source: Kai Caemmerer
Zhengdong in Zhengzhou in Henan Province. Source: Wade Shepard
Evergrande Splendor Kunming. Source: J Capital Research

Now, it’s time to discuss why the startup mania of the past decade is very similar to China’s construction of grandiose infrastructure projects and ghost cities. In addition to the housing and stock market plunge, the U.S. lost 8.7 million jobs during the Great Recession, so the Federal Reserve was desperate – just like China was in 2009 – to engineer another economic boom to create jobs and GDP growth again. China relied more heavily on fiscal stimulus, while the U.S. relied more heavily on monetary stimulus. The Fed cut and held interest rates at ultra-low levels for much of the past decade and pumped trillions of dollars worth of liquidity into the U.S. financial system via its quantitative easing programs. Unfortunately, dangerous economic bubbles and other distortions form when central banks and governments aggressively interfere with financial markets, especially interest rates. The chart of the Fed Funds rate below shows how bubbles form when interest rates are at low levels:

The Fed pumped trillions of dollars worth of liquidity into the U.S. financial system via its quantitative easing programs, which can be seen in the chart of the Fed’s balance sheet since QE started in 2008: 

When central banks use monetary stimulus to create an economic boom, they usually succeed (until the boom turns into a bust, of course). What they don’t know, however, is what sectors of the economy are going to boom as a result of their stimulus. Each cycle is different – it was telecom and dot-coms in the late-1990s, housing and banking in the mid-2000s, and tech startups in the current cycle. The explosion of venture capital activity over the past several years can be seen in the chart of the monthly count of global VC deals that raised $100 million or more:

Trillions of dollars worth of central bank-created liquidity has been sloshing around the globe looking for a home, and a portion of it found its way into unicorn companies that are worth billions of dollars each. Most of these unicorns came of out virtually nowhere and amassed tremendous valuations despite hemorrhaging cash, which is a tell-tale sign of a bubble.

The majority of startups and unicorns are burning astounding amounts of cash – even those that have made it all the way to the IPO stage. For example, the 15 tech unicorns that went public over the past three quarters lost a combined $6 billion in 2018 despite having a lofty combined valuation of $178.3 billion. 

Like China’s grandiose infrastructure projects and ghost cities, the majority of today’s tech startups only exist – at least at their current scale – because of stimulus, and are not economically viable, as evidenced by the billions of dollars they are hemorrhaging with no end in sight. China’s infrastructure projects and ghost cities and today’s tech startups serve essentially the same purpose – to create jobs and GDP growth, economic viability be damned.

The creation of tens of thousands of tech startups leads to the hiring of scores of technology professionals, renting tremendous amounts of office space, buying computer and office equipment, and paying for professional services, which all serve to boost economic activity. Meanwhile, the boom that is driving all of that activity is basically bogus. The same phenomenon occurred during the mid-2000s housing bubble, when soaring housing prices led to a surge of construction and lending activity, which created jobs for construction workers, real estate agents, and mortgage bankers. Of course, when the housing bubble burst, many of those workers lost their jobs; I expect today’s tech startup bubble to end in a similar fashion.

As stated throughout this piece, government and central bank interference in the economy creates dangerous distortions, bubbles, and waste. Austrian School economists call this kind of waste and bad investments “malinvestment” –

“Malinvestment is a mistaken investment in wrong lines of production, which inevitably lead to wasted capital and economic losses, subsequently requiring the reallocation of resources to more productive uses. “Wrong” in this sense means incorrect or mistaken from the point of view of the real long-term needs and demands of the economy, if those needs and demands were expressed with the correct price signals in the free market. Random, isolated entrepreneurial miscalculations and mistaken investments occur in any market (resulting in standard bankruptcies and business failures) but systematic, simultaneous and widespread investment mistakes can only occur through systematically distorted price signals, and these result in depressions or recessions. Austrians believe systemic malinvestments occur because of unnecessary and counterproductive intervention in the free market, distorting price signals and misleading investors and entrepreneurs. For Austrians, prices are an essential information channel through which market participants communicate their demands and cause resources to be allocated to satisfy those demands appropriately. If the government or banks distort, confuse or mislead investors and market participants by not permitting the price mechanism to work appropriately, unsustainable malinvestment will be the inevitable result.”

It’s almost impossible to find better examples of malinvestments than China’s empty cities and the tens of thousands of profitless tech startups that have taken the world by storm over the past several years. Future economics students are going to study those phenomena as case studies in how not to run an economy. Of course, it’s still party time in China and in the startup world for now, so the warnings of skeptics like myself fall on deaf ears. But, inevitably, all of the post-Great Recession stimulus-driven booms are going to violently end, and the GDP growth, jobs, and stock price gains created by them will be reversed.

New Silicon Valley Stock Exchange Is A Warning Sign For The Startup Bubble

For the last several years, there has been a tremendous amount of activity and hype in the tech startup arena. In addition to the tens of thousands of startups that been founded in recent years, there are over three-hundred new “unicorn” startups that have valuations of $1 billion or more. Most of these unicorns came of out virtually nowhere and amassed tremendous valuations despite hemorrhaging cash, which is a tell-tale sign of a bubble. The recent announcement of a new Silicon Valley stock exchange for “hot startups, particularly those that are money-losing” is an indication of the amount of hubris and hype there is in the startup arena right now –

Long-Term Stock Exchange CEO Eric Ries

The U.S. Securities and Exchange Commission approved the creation of the Long-Term Stock Exchange, or LTSE, a Silicon Valley-based national securities exchange promoting what it says is a unique approach to governance and voting rights, while reducing short-term pressures on public companies.

The LTSE is a bid to build a stock exchange in the country’s tech capital that appeals to hot startups, particularly those that are money-losing and want the luxury of focusing on long-term innovation even while trading in the glare of the public markets.

The stock exchange was proposed to the SEC in November by technology entrepreneur, author and startup adviser Eric Ries, who has been working on the idea for years. He raised $19 million from venture capitalists to get his project off the ground, but approval from U.S. regulators was necessary to launch the exchange.

The tech startup bubble formed as a result of the Fed and other central banks’ extremely loose monetary policies after the Great Recession. In a desperate attempt to jump-start the global economy again, central banks cut and held interest rates at virtually zero percent for much of the past decade and pumped trillions of dollars worth of liquidity into the global financial system. The chart of the Fed Funds rate below shows how bubbles form when interest rates are at low levels:

Loose global monetary policy led to an explosion of venture capital activity over the past several years:

Trillions of dollars worth of central bank-created liquidity has been sloshing around the globe looking for a home and a portion of it found its way into unicorn companies that are worth billions of dollars each:

Today’s unicorns are equivalent to dot-com companies in 1999 and will have the same fate, unfortunately. Though some of the unicorns will survive and become successful in the longer-run like Amazon and eBay, there is going to be a tremendous shakeout that is going to slash valuations and weed out the Pets.coms and Webvans. Thousands, if not tens of thousands, of tech startups are going to fold when this bubble bursts. The abysmal performance of two recent high-profile unicorn IPOs, Lyft (down nearly 50% since its IPO) and Uber, may be a sign that air is starting to come out of the unicorn bubble. It will be interesting to see if the Long-Term Stock Exchange will be able to go live before the unicorn bubble bursts.

WeWork’s $1.9 Billion Loss Is A Typical Tech Bubble 2.0 Story

On Monday, unicorn WeWork reported that it lost $1.9 billion on $1.8 billion revenue in 2018. WeWork is a company that provides shared workspaces and related services for startups. WeWork can be thought of as a company that sells “picks & shovels” to the startup community and is, therefore, a play on the tech startup bubble that I’m warning about.

Like most other unicorns and the startups that it serves, WeWork is hemorrhaging cash left and right (which is very fitting):

WeWork is attempting to cash in on the explosion of tech startup activity over the past five years (which I’ve explained is a byproduct of the Fed-driven stock market bubble):

The U.S. stock market bubble and the tech startup bubble formed because the Fed and other central banks cut interest rates to ultra-low levels and flooded the world with trillions of dollars worth of liquidity in order to encourage an economic recovery after the Great Recession. There are some worrisome parallels between today’s liquidity-driven tech startup bubble and the early stages of the 1920s German hyperinflation (which started out as a liquidity-driven boom), when the newly printed money found its way into countless businesses that were recently formed (which is what we call “startups” today). It seemed like an innovation boom, but it was just pushing paper around.

The excellent book “Dying of Money” describes this phenomenon well:

Along with the paradoxical wealth and poverty, other characteristics were masked by the boom and less easy to see until after it had destroyed itself. One was the difference between mere feverish activity, which did certainly exist, and real prosperity which appeared, but only appeared, to be the same thing. There was no unemployment, but there was vast spurious employment – activity in unproductive or useless pursuits. The ratio of office and administrative workers to production workers rose out of all control. Paperwork and paperworkers proliferated. Government workers abounded, and heavy restraints against layoffs and discharges kept multitudes of redundant employees ostensibly employed. The incessant labor disputes and collective bargaining consumed great amounts of time and effort. Whole industries of fringe activities, chains of middlemen, and an undergrowth of general economic hangers-on sprang up. Almost any kind of business could make money. Business failures and bankruptcies became few. The boom suspended the normal processes of natural selection by which the nonessential and ineffective otherwise would have been culled out. Practically all of this vanished after the inflation blew itself out.

I believe that a very high percentage of today’s startups are actually malinvestments that only exist due to the false signal created when the Fed and other central banks distorted the financial markets and economy with their aggressive monetary stimulus programs after the global financial crisis. See this definition of malinvestment from the Mises Wiki:

Malinvestment is a mistaken investment in wrong lines of production, which inevitably lead to wasted capital and economic losses, subsequently requiring the reallocation of resources to more productive uses. “Wrong” in this sense means incorrect or mistaken from the point of view of the real long-term needs and demands of the economy, if those needs and demands were expressed with the correct price signals in the free market. Random, isolated entrepreneurial miscalculations and mistaken investments occur in any market (resulting in standard bankruptcies and business failures) but systematic, simultaneous and widespread investment mistakes can only occur through systematically distorted price signals, and these result in depressions or recessions. Austrians believe systemic malinvestments occur because of unnecessary and counterproductive intervention in the free market, distorting price signals and misleading investors and entrepreneurs. For Austrians, prices are an essential information channel through which market participants communicate their demands and cause resources to be allocated to satisfy those demands appropriately. If the government or banks distort, confuse or mislead investors and market participants by not permitting the price mechanism to work appropriately, unsustainable malinvestment will be the inevitable result.

It’s inevitable that the startup bubble is going to burst and tens of thousands of unprofitable startups around the globe are simply going to close their doors. Companies like WeWork, which sell the “picks & shovels” to the startup bubble, will go down with the ship. If WeWork is hemorrhaging billions of dollars during the best of times, just imagine what will happen when the overall startup bubble bursts?! It’s not a pretty picture. Even if you don’t invest or work in the startup sector, it still affects you and your investments because the U.S. startup bubble is a major driver of economic activity and job creation since the Great Recession.

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As Seen On Forbes: CompSci Demand Is Soaring Due To Tech Bubble 2.0

As seen on Forbes by Real Investment Advice’s Jesse Colombo – “Computer Science Demand Is Soaring Due To Tech Bubble 2.0.”

For the past several years, I’ve been warning that the tech startup boom (and the surge of interest in “coding”) is actually a dangerous bubble that is driven by the U.S. Federal Reserve’s ultra-loose monetary policies since the Great Recession. A recent New York Times piece called “The Hard Part of Computer Science? Getting Into Class” describes how young people are clamoring to study computer science:

Lured by the prospect of high-salary, high-status jobs, college students are rushing in record numbers to study computer science.

Now, if only they could get a seat in class.

On campuses across the country, from major state universities to small private colleges, the surge in student demand for computer science courses is far outstripping the supply of professors, as the tech industry snaps up talent. At some schools, the shortage is creating an undergraduate divide of computing haves and have-nots — potentially narrowing a path for some minority and female students to an industry that has struggled with diversity.

The number of undergraduates majoring in the subject more than doubled from 2013 to 2017, to over 106,000, while tenure-track faculty ranks rose about 17 percent, according to the Computing Research Association, a nonprofit that gathers data from about 200 universities.

Economics and the promise of upward mobility are driving the student stampede. While previous generations of entrepreneurial undergraduates might have aspired to become lawyers or doctors, many students now are leery of investing the time, and incurring six-figure debts, to join those professions.

The tech frenzy can be seen in the chart of the monthly count of global VC deals that raised $100 million or more since 2007. According to this chart, a new “unicorn” startup was born every four days in 2018. 

Read the full article here.

Air Is Coming Out Of The Silicon Valley Startup Bubble

ZeroHedge published an article I found interesting called “For Silicon Valley’s Startups, The Bill Is Finally Coming Due“:

Silicon Valley startups like Hustle, an ad-messaging company that spent lavishly on things like on-tap kombucha and arcade games for employees, are learning the hard way that party is coming to an end and the bill is finally due. Earlier this month, the company announced mass layoffs according to the WSJ . This depressing scene is now playing out across countless Silicon Valley startups, which sprung up like mushrooms when the money was easy and which are now starting to fold as the decade-long credit cycle tests the limits of the current bubble. 

Startup investors and company founders warn that the unchecked growth of the past several years—which by some metrics exceeded heights from the dot-com boom—is hitting a limit. A rout of publicly traded technology companies is fostering newfound restraint for investors in Silicon Valley, especially for younger, cash-strapped startups like Hustle.

Startup investor Sunny Dhillon told the WSJ: “The unbridled optimism that inhabits our world is getting a shot of realism.”

To be sure, the warning signs were easy to spot, starting with the shrinking number of seed deals, which fell to just 882 in Q4 versus more than 1500 that took place three years ago.

Because VCs have a tendency to follow technology stocks, the NASDAQ’s recent 12% pullback from its Sept 2018 highs put pressure on many startups: scooter companies Bird Rides and Lime both had to lower their valuation targets in order to raise capital during their last funding round. Other startups are failing outright, like Munchery, a meal kit service that had raised more than $100 million from VCs.

The latest events in the Silicon Valley startup world confirm the warnings I made a few months ago in a piece called “The Startup Bubble Is A Derivative Of The Stock Market Bubble“:

The world has gone completely startup crazy over the last several years. Spurred by soaring tech stock prices (a byproduct of the U.S. stock market bubble) and the frothy Fed-driven economic environment, countless entrepreneurs and VCs are looking to launch the next Facebook or Google. Following in the footsteps of the dot-com companies in the late-1990s, startups that actually turn a profit are the rare exceptions. Unfortunately, today’s tech startup bubble is going to end just like the dot-com bubble did: scores of startups are going to fold and founders, VCs, and investors are going to lose their shirts.

The chart below shows the Nasdaq Composite Index and the two bubbles that formed in it in the past two decades. Lofty tech stock prices and valuations encourage the tech startup bubble because publicly traded tech companies have more buying power with which to acquire tech startups and because they allow startups to IPO at very high valuations.

In the chart below, I compared TechCrunch’s monthly global VC deals chart to the Nasdaq Composite Index and they line up perfectly. Surges in the Nasdaq lead to surges in VC deals, while lulls or declines in the Nasdaq lead to lulls or declines in VC deals (yes, I’m aware that correlation is not necessarily causation, but there is a causal relationship in this case).

Unsurprisingly, the decline of the Nasdaq over the past few months is putting a damper on the tech startup bubble. I believe that much more extensive declines are ahead as the stock market bubble unravels, which will lead to even more pain for the tech startup bubble.

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VC Spending Hit An All-Time High In 2018 Thanks To Tech Bubble 2.0

CNBC just published a piece about how venture capital spending hit an all-time high in 2018, surpassing the dotcom bubble record:

Venture capital just had its highest spending year in history.

The amount of money firms spent on private companies hit a new all-time record in 2018— well above the previous watermark from the dotcom boom.

Last year, venture capital firms spread roughly $131 billion across 8,949 deals, according to data published by Pitchbook and the National Venture Capital Association Thursday. The previous record was a $100 million total notched in the year 2000.

Although the dollar amount jumped by more than 57 percent from $83 billion last year, the number of deals went down. Deal count fell by about 5 percent this year from a roughly 9,400 total last year.

Cameron Stanfill, Pitchbook venture analyst who co-authored the report, said sky-high price tags for start-ups accounted for the new record total despite having fewer deals.

“There is a lot of money competing for a finite amount of companies, and that’s pushing prices up,” Stanfill told CNBC in a phone interview.

Though most people look at record VC spending as a sign of a strong, healthy economy, my research has found that the current VC boom is the result of another tech bubble that inflated due to the Federal Reserves ultra-stimulative monetary policies of the past decade (read my recent article about this). Unfortunately, this tech bubble is going to end just like the late-1990s dotcom bubble did – in another disastrous bust.

The chart below shows the monthly count of global VC deals that raised $100 million or more since 2007. According to this chart, a new “unicorn” startup was born every four days in 2018.

The chart below shows the Nasdaq Composite Index and the two bubbles that formed in it in the past two decades. Lofty tech stock prices and valuations encourage the tech startup bubble because publicly traded tech companies have more buying power with which to acquire tech startups and because they allow startups to IPO at very high valuations.

In the chart below, I compared the monthly global VC deals chart to the Nasdaq Composite Index and they line up perfectly. Surges in the Nasdaq lead to surges in VC deals, while lulls or declines in the Nasdaq lead to lulls or declines in VC deals.

Please watch my video presentation to learn why the U.S. stock market (and, therefore, the VC and startup arena) is experiencing a bubble. Though this presentation is a couple months old and the market has fallen since then, it’s still relevant for understanding how the bubble inflated and why much further downside is still ahead.

Now that the Nasdaq has fallen sharply, it wouldn’t be surprising to see VC activity wane. Unfortunately, I believe that we’re only in the early stages of the stock market and tech bust – a bubble that took nearly a decade to form does not disappear in a mere three months!

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The Startup Bubble Is A Derivative Of The Stock Market Bubble

TechCrunch recently posted a fascinating chart of the monthly count of global VC deals that raised $100 million or more since 2007. According to this chart, a new “unicorn” startup was born every four days in 2018. Unfortunately, this is even more evidence of the tech startup bubble that I have been warning about.

Big Funding Rounds

Here’s the list of “unicorn” companies worth more than $1 billion as of the third quarter of 2018:

unicorn-q1-3-2018

The world has gone completely startup crazy over the last several years. Spurred by soaring tech stock prices (a byproduct of the U.S. stock market bubble) and the frothy Fed-driven economic environment, countless entrepreneurs and VCs are looking to launch the next Facebook or Google. Following in the footsteps of the dot-com companies in the late-1990s, startups that actually turn a profit are the rare exceptions. Unfortunately, today’s tech startup bubble is going to end just like the dot-com bubble did: scores of startups are going to fold and founders, VCs, and investors are going to lose their shirts.

The chart below shows the Nasdaq Composite Index and the two bubbles that formed in it in the past two decades. Lofty tech stock prices and valuations encourage the tech startup bubble because publicly traded tech companies have more buying power with which to acquire tech startups and because they allow startups to IPO at very high valuations.

Nasdaq Composite Index

In the chart below, I compared TechCrunch’s monthly global VC deals chart to the Nasdaq Composite Index and they line up perfectly. Surges in the Nasdaq lead to surges in VC deals, while lulls or declines in the Nasdaq lead to lulls or declines in VC deals (yes, I’m aware that correlation is not necessarily causation, but there is a causal relationship in this case).

VC Deals vs. Nasdaq

Please watch my recent presentation about the U.S. stock market bubble to learn more:

I believe that a very high percentage of today’s startups are actually malinvestments that only exist due to the false signal created when the Fed and other central banks distorted the financial markets and economy with their aggressive monetary stimulus programs after the global financial crisis. See this definition of malinvestment from the Mises Wiki:

Malinvestment is a mistaken investment in wrong lines of production, which inevitably lead to wasted capital and economic losses, subsequently requiring the reallocation of resources to more productive uses. “Wrong” in this sense means incorrect or mistaken from the point of view of the real long-term needs and demands of the economy, if those needs and demands were expressed with the correct price signals in the free market. Random, isolated entrepreneurial miscalculations and mistaken investments occur in any market (resulting in standard bankruptcies and business failures) but systematic, simultaneous and widespread investment mistakes can only occur through systematically distorted price signals, and these result in depressions or recessions. Austrians believe systemic malinvestments occur because of unnecessary and counterproductive intervention in the free market, distorting price signals and misleading investors and entrepreneurs. For Austrians, prices are an essential information channel through which market participants communicate their demands and cause resources to be allocated to satisfy those demands appropriately. If the government or banks distort, confuse or mislead investors and market participants by not permitting the price mechanism to work appropriately, unsustainable malinvestment will be the inevitable result.

Rising interest rates and the overall tightening monetary environment will lead to the popping of today’s stock market bubble, which will then spill over into the tech startup bubble.

If you have any questions about anything I wrote in this piece or would like to learn how Clarity Financial can help you preserve and grow your wealth in the dangerous financial environment ahead, please contact me here.

These Are The Headlines You See In A Bubble

The world has gone completely startup crazy over the last several years. Spurred by soaring tech stock prices (a byproduct of the U.S. stock market bubble) and the frothy Fed-driven economic environment, countless entrepreneurs and VCs are looking to launch the next Facebook or Google. Following in the footsteps of the dot-com companies in the late-1990s, startups that actually turn a profit are the rare exceptions. Unfortunately, today’s tech startup bubble is going to end just like the dot-com bubble did: scores of startups are going to fold and founders, VCs, and investors are going to lose their shirts. In this piece, I wanted to show a collection of recent news headlines (all from Business Insider) that capture the zeitgeist of the tech startup bubble – please remember these when the bubble bursts and everyone says “what were we thinking?!”

These Silicon Valley venture capitalist trading cards should tell you where we are in the cycle (close to the end) (link):

VC Cards

When trillions of dollars worth of central bank “Bubble Money” is sloshing all over the globe looking for a home, startups are a popular holding container (link):

5 startups

Since when did throwing “insane” amounts of cash into a hot industry ever end well? It never does and this time will be no exception. Masayoshi Son is definitely “Bubble Drunk.” (link):

Masayoshi Son

So, she started as a VC at age 17?! And the companies she invested in are worth billions? That’s what happens when central banks hold interest rates at record low levels for a record length of time and flood the economy and financial markets with trillions of dollars worth of liquidity. As the old saying goes, “a rising tide lifts all boats.” Also, “never mistake a bull market for brains.” (link)

24 Year Old VC

During a bubble, it is common to see fantastical stories about young wunderkinds getting hired for grown-up jobs, starting companies, making fortunes, etc. in the industry that is experiencing a bubble. (Undoubtedly, the parents play a very large role in opening doors for these kids and getting them media coverage – “it’ll look great when applying to Harvard!” ). Another example of this is the story of the 11 year-old “cryptocurrency guru” that was circulating during the crypto bubble earlier this year before the crypto price implosion. (link)

Coder

Pretty soon, you will see many more headlines like this (link):

25 Most Valuable

I believe that a very high percentage of today’s startups are actually malinvestments that only exist due to the false signal created when the Fed and other central banks distorted the financial markets and economy with their aggressive monetary stimulus programs after the global financial crisis. See this definition of malinvestment from the Mises Wiki:

Malinvestment is a mistaken investment in wrong lines of production, which inevitably lead to wasted capital and economic losses, subsequently requiring the reallocation of resources to more productive uses. “Wrong” in this sense means incorrect or mistaken from the point of view of the real long-term needs and demands of the economy, if those needs and demands were expressed with the correct price signals in the free market. Random, isolated entrepreneurial miscalculations and mistaken investments occur in any market (resulting in standard bankruptcies and business failures) but systematic, simultaneous and widespread investment mistakes can only occur through systematically distorted price signals, and these result in depressions or recessions. Austrians believe systemic malinvestments occur because of unnecessary and counterproductive intervention in the free market, distorting price signals and misleading investors and entrepreneurs. For Austrians, prices are an essential information channel through which market participants communicate their demands and cause resources to be allocated to satisfy those demands appropriately. If the government or banks distort, confuse or mislead investors and market participants by not permitting the price mechanism to work appropriately, unsustainable malinvestment will be the inevitable result.

As I’ve explained in a recent Forbes piece:

When central banks set interest rates and hold them at low levels in order to create an economic boom after a recession (as our Federal Reserve does), they interfere with the organic functioning of the economy and financial markets, which has serious consequences including the creation of distortions and imbalances. By holding interest rates at artificially low levels, the Fed creates “false signals” that encourage the undertaking of businesses and other endeavors that would not be profitable or viable in a normal interest rate environment.

The businesses or other investments that are made due to artificial credit conditions are known as “malinvestments” and typically fail once interest rates rise to normal levels again. Some examples of malinvestments are dot-com companies in the late-1990s tech bubble, failed housing developments during the mid-2000s U.S. housing bubble, and unfinished skyscrapers in Dubai and other emerging markets after the global financial crisis.

The chart below shows how recessions, financial crises, and bubble bursts have occurred after historic interest rate hike cycles:

Fed Funds Rate

I believe that rising interest rates and the overall tightening monetary environment will lead to the popping of today’s stock market bubble, which will then spill over into the tech startup bubble.

Please watch my recent presentation about the U.S. stock market bubble to learn more:

If you have any questions about anything I wrote in this piece or would like to learn how Clarity Financial can help you preserve and grow your wealth, please contact me here.

Throwing Money Into Tech Startups Will End In Tears

The tech startup boom has been one of the most important and visible economic “growth engines” of the past half-decade. The boom was spurred, in large part, by the success and excitement over Facebook, Uber, Airbnb, and similar companies, which led to a widespread search for the “Next Facebook” or billion dollar “unicorn” company. Unfortunately, the tech startup boom has devolved into a dangerous bubble as a result of record low interest rates and the trillions of dollars worth of liquidity that is sloshing around the globe as a result of central bank quantitative easing (QE) programs.

As an Austrian economist, I believe that central bank manipulation of borrowing costs (typically by holding interest rates too low) creates false signals or “fool’s gold” business and economic booms that trick investors into jumping into “hot” trends, only to lose their shirts when borrowing costs are inevitably increased again. These bad investments are called malinvestments, and occur largely as a result of central bank market distortions rather than organic market forces. I believe that a very high proportion of today’s tech startups will prove to be malinvestments when the current boom turns into a bust.

A recent Wall Street Journal article describes the latest phase of the startup bubble quite well –

SoftBank’s Billions Spur Global Race to Pour Money Into Startups

Silicon Valley Venture Capital Chart

The Silicon Valley money machine is once again in high gear, thanks largely to SoftBank. The conglomerate is injecting billions of dollars into tech, in turn causing deep-pocketed global investors—and some U.S. venture firms—to arm up in response. A record level of late-stage money is flooding in, threatening to keep some startups out of the public markets even longer while heightening concerns that the sector is overvalued.

In recent months, hotly contested companies like ride-hailing service Lyft Inc. and dog-walking app Wag Labs Inc. have received hundreds of millions of dollars more than they sought. Bidding wars are re-emerging, and some once-staid foreign investors are expanding U.S. offices and ditching their ties and suits to court talented entrepreneurs.

“The top companies have as much heat around them as ever and continue to get bid up,” said John Locke, who runs late-stage investing for venture-capital firm Accel Partners.

Also:

The big-check bug has spread to U.S. venture-capital firm Sequoia Capital, which is in the process of raising up to $13 billion, including an $8 billion fund for late-stage companies, the largest ever for a U.S. venture-capital firm.

Sequoia was previously content with smaller sums; its largest fund to date is $2 billion. But it made the decision last year to go bigger, seeing an opening to keep investing in companies as they stay private longer and grow larger.

This flood of private investment has heightened concerns it will create a shaky foundation for startups. When money rushes into Silicon Valley, startups historically have overspent by advancing into expensive new markets or battling with competitors in price wars.

“We’re encouraging the excessive use of capital,” Bill Gurley, a partner at Benchmark, said of venture capitalists at a February tech conference. “We’re all doing it because it’s the game on the field.”

Softbank, a Japanese conglomerate, announced in October that it was planning to invest as much as $880 billion into tech startups. At the time of that announcement, I recoiled in horror at the idea of companies “throwing” money into tech startups just because it was a hot, heavily hyped sector:

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Sound, long-term business decisions are not made by picking an arbitrary dollar or yen figure and throwing it into a hot sector. This behavior is the hallmark of a liquidity bubble in which there is too much cash clamoring into unprofitable investments. Throwing ever-increasing amounts of cash at unprofitable startups won’t make them profitable – it’s just “throwing good money after bad.” While this is common sense, many business leaders aren’t seeing the obvious because they’re completely drunk on the startup bubble euphoria. I have no doubt that Japan’s Abenomics stimulus plan (in which over $4 trillion worth of new Japanese yen was printed) has played an important role in encouraging Softbank to jump headlong into the tech startup bubble with gobs of cash.

Thanks to the tech sector hype and high tech stock valuations, VCs are looking to cash in on their tech startup investments by going public, just like during the late-1990s Dot-com bubble –

Silicon Valley Venture Capitalists Prepare for an I.P.O. Wave

 Investors, bankers and analysts said they expected a wave of initial public offerings to bring some of the most highly valued and recognizable start-ups to the public market over the next 18 to 24 months — and billions of dollars in returns to their executives and investors. The potential bonanza would follow years of waiting as a few dozen companies amassed valuations without precedent in the private market.

Already, 2018 has gotten off to a fast start. Two of the biggest start-ups still sitting on the sidelines — Dropbox, an online file storage company, and Spotify, the streaming music service based in Sweden — successfully went public over the past month. Tech I.P.O.s have already raised more than $7 billion this year — more than all of 2015 and 2016, and more than half the $13 billion they raised last year, according to the market-data firm Dealogic.

While the mainstream financial world sees the current tech startup boom as a legitimate technology revolution, I see it as a gigantic, liquidity-fueled malinvestment bubble. As the Fed and other central banks remove liquidity as the economic cycle matures, the stock market bubble will burst, which will spill over into tech startups. When the tech startup bubble pops in earnest, I expect thousands, if not tens of thousands, of startups to fold. While the world should have learned from the Dot-com bubble, today’s tech startup bubble proves that we didn’t, so we are doomed to repeat the lesson.

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