Look up Business Cycle Theory

VCs believe in network effects, VCs believe monopolies are worth burning cash to achieve, VCs believe operating businesses can achieve what software businesses like google and Facebook achieved.

Question their belief but don’t blame monetary policy or government for a clear investment thesis driven by private actors that is based on prior success of similar models.

Banks lending to small businesses, hire interest rates, tighter monetary policy would not change current VCs investment thesis or make them any less willing to pursue these models.

Lyft just IPOd with a market cap of ~20 billion on net income of minus 1 billion that is part of a 3-year down trend.

If monetary policy is causing inflated stock prices (and it isn't causing consumer inflation, so it probably is pooling in asset markets) then it seems quite rational for a VC to invest in Lyft for the sole purpose of having a stock to float without paying any attention to the other details. The evidence there is simply having a ticker and buzz is more valuable than details like returns and profits.

Lyft is basically employing its customers to make its revenue look good. It is difficult to see how they will translate that into a good idea.

I think that is confusing second and third order considerations with first order considerations that actually drive investors choices.

Perhaps monetary policy affects the macro environment by making investment money available, but each investment is a micro decision by one firm, driven by a thesis. I find it hard to believe that investors think monetary policy is an important basis for betting on Lyft or the like.

That’s like say “I won’t start a company unless tax rates are lower”. No one does that, no one cares, maybe we care later. But when you’re thinking about the founding decisions paying taxes is several orders removed from: product, team, financing, revenue, break even etc.

" ... then you're a product" 2.0. Somewhat similar to the role of a patient in the medical business - ie. the role of gauge boson mediating the insurance-provider field interaction.

Lyft went to IPO. A lot of people made a ton of money on the back of that.

Until that stops happening, what incentive is there for VCs to not do this?

VCs aren't some unique species that have cracked investing. Human nature is the same as always: people will do stupid stuff. If someone turns up with a check for $100m, you don't check to see whether you can invest it safely. You become a true believer, you gather assets, and if you weren't a true believer at the start you will be after you make enough...it always ends badly but this is why cycles happen.

In fact, the last cycle has been particularly unusual because we have actually see the bad firms driving out the good ones (I don't know about VC but it is happening everywhere else). And this is definitely due to monetary policy.

You are right. At the level of the investment, people aren't saying we should seed this company because of monetary policy...but no-one says this in any bubble. Rather what happens is that the demand for securities goes up and finance finds ways to fill this demand. Human nature being what it is, this always ends badly.

To say this another way: people will find endless ways to rationalise a bad decision. And if someone is paying you to make bad decisions sound good...well then, what do you think will happen?

Btw, just generally, I think VCs are less sophisticated than the average investor. The current environment has just been very forgiving. I don't think we will see anything like this again (if central bankers lose control which seems inevitable), literally firms with billions in cumulative losses trading for $10bn+. These IPOed firms will probably destroy hundreds of billions in capital alone.

Your answer itself hints at how important human psychology is. 'People do stupid stuff'. Robert Schiller won a Nobel price and said basically that.

Go look at the interest rates every year in the 90s and tell me that they causes the dot com bubble. Then ask yourself if maybe investors overestimated the possible success of many business and were willing to pay crazy multiples above earnings because the 'normal rules of business don't apply to internet firms'. When the stock was skyrocketing, psychology and greed take over as it feels like confirmation that the original thesis is correct. Bitcoin recently followed a similar dynamic. In neither case was monetary policy the major driver.

Monetary policy is essential, none of the things you mention are more important. Why? Because the boom can't occur without monetary policy (this is usually not obvious to people who have only looked at US financial history where capital markets are developed).

Lots of reasons are given ex-post to rationalise these movements i.e. changing technology "caused" the Canal boom...but technology is always changing. And human nature is certainly interesting...but it is an invariant (just like technological change). The enabling factor is always money. Btw, this isn't to say that, for example, regulation wasn't a factor in 2008...it was but the thing is that regulation is always a problem because when money gets loose then regulations follow.

Examples of booms without bubbles: post-WW2 in the US, financial conditions were stable in the few decades (not strictly true but for our purposes) because the the main concern of monetary policy was government finance. Another example: Japan 1960s-1992, MOF had total control over lending so no bubble (only popped when they lost it).

In these cases, you need to really understand how money is being created and intermediated. If you understand this then you understand why bubbles do and do not occur. If you look at unimportant things like technology, you only have reasons why bubbles do occur (this is the kind of terrible history that you presumably learn at law school).

You also picked one of the absolute worst examples to demonstrate your point. The Greenspan Put was vital, "irrational exuberance" and the contrast between that approach and that of a McChesney Martin (for example) is important. Even just the change in policy under Greenspan...really bad example. I tried but was unable to think of an actual example...

No-one cares about Bitcoin. We are talking about financial history, not Beanie Babies.

My point is there is no one factor that is primarily responsible for all bubbles. There may be similar sets of factors that reoccur, but to say that monetary policy emerges as the singular most important factor throughout history doesn’t seem to me to be defensible.

Post-WW2 was a unique context because vast amounts of capital were being used to literally rebuild Europe. The US was basically the only manufacturer of scale, so I make sense that there wouldn’t be an asset bubble when there were vast numbers of projects that required capital and that were economically and financially stable rather than hype driven.

I will have to think about Japan as an example, I haven’t read the history in quite some time, I am definitely open to it being an example of a bubble cycle driven by monetary policy. My impression was that trade with the US and demographics seemed to be more a driver but I’ll look into it and post if I am persuaded.

You provide no evidence that the factors I list matter less than monetary policy. I actually think the Greenspan Put (ie low interest rates to stimulate the economy) is a good example because many people, including, it seems, you, identify that as the most causal and important factor in creating the subprime crisis. This type of monetary policy is relatively new, yet asset bubbles have existed throughout history, even where there wasn’t even a unified currency let alone a Federal Reserve that set such policy.

In fact, evidence suggests that it was driven by a new financial business model, securitization, where loans were no longer held by banks but placed into a special purpose companies with shares of that SPV sold to investors.

Underwriting began to be meaningless as the companies originating loans wanted more volume because they got fees and held no risk. Investors were told that financial engineering meant these assets were AAA and safe.

Also throw in the fact that investment banks that were doing the financial structuring were no longer general partnerships (where individual partners are personally liable for partnership debt) but for the first time limited liability companies or corporations, and you get a clear picture of psychological, and new business model innovation, driving the bubble.

Similar story with the savings and loan crisis. Monetary policy is easy to blame until you look deeper. As in the financial crisis, you had financial innovation “Junk Bonds”, and regulation changes that let S&Ls take risks and deploy capital where they were previously restricted. All while monetary policy was tightened drastically, which should deflate asset bubbles not create them.

Further it is a good counter example to the Greenspan Put because monetary policy was exactly the opposite of Greenspan; Volker was jacking up interest rates to kill inflation and yet Savings and Loans were taking crazy risky bets and created real estate and junk bond bubbles. If you’re theory is valid, it should have a prediction on what monetary policy would create. Simply saying “it is the most important factor” gives no information. What happens when monetary policy is tight and rates are high. What happens when it’s the opposite.

Lastly, you seem to imply that someone controls monetary policy. The financial crisis made it clear that shadow banking, derivatives, and general flow of funds between banks was orders of magnitude bigger than any thing the Fed controlled. These monetary instruments were the real driver of the mortgage bubble, not any monetary stimulus through low interest rates.

Is monetary policy important. Yes. Does it explain why Uber and Lyft and every other unicorn are getting investment easily. No. Does it predict or cause most bubbles. No. I am open to being convinced otherwise.

It has nothing to do with wealth inequality. Whether you're pooling $100 from a million people, or $20 million from 5, the economics of venture capital are the same. Wealth inequality has nothing to do with this.

The purpose of venture capital (for investors) is diversification. It is an uncorrelated, positive (hopefully) return stream. Investors want to combine uncorrelated return streams as much as possible, due to the AM-GM inequality. The geometric mean of a series with a given arithmetic mean is higher when that series is less volatile.

This happens to retail investors all the time.

> On the other you have a lack of small investors with lower risk tolerance. Both of these are results of wealth inequality.

Citation needed. Retail investors buy all kinds of risky shit. You can do all of these same things with retail investors money. You don't need any wealth inequality whatsoever to explain venture capital.

This is somewhat related to how I perceive the economy of China working. Whenever I visit there I marvel at all the infrastructure projects and you realize it doesn't need to "make money" over there. The government just decides what to build and loans itself money to get it done.

Yes. Hence the 'mal' part.

Investment should be going towards enterprises which produce actual value. If the only way you can produce value is by throwing away money through predatory pricing, then you aren't creating value. And so without any value to create, eventually you blow up and lose a bunch of people their money.

When enough people lose enough money, people stop lending their money so freely and the business cycle starts the contraction phase. Now good enterprises have trouble getting capital, so they delay purchasing all of those cool servers/computers/whatevers. Since the companies selling those things now receive less orders, they order less from their suppliers, etc. Suppliers go under. People lose their jobs. People without jobs spend less, which kills demand further. Fuck. etc.

If it helps to have a misleadingly simplified 1 phrase summary: you can think of malinvestment as taking money from workable enterprises in the future and funnelling it into shitty enterprises now.

The service is merely being subsidized by investors who believe in such practice.

Is it a bad investment? Maybe, their investors did not think so and they were free to compare it with other options you deem obviously better, considering you're even saying Uber and the like are stealing these other business would-be money...

In principle, in a fair market economy, that is OK because someone has to take the risk of being wrong about what is a good idea.

The concern being voiced is that monetary policy is diverting resources away from people who are known to make good long term decisions and towards people who have access to loans from the central bank. At some point the people who are borrowing money can't pay it back and the losses are revealed - not in and of itself a problem; those responsible take the hit. But in the mean time, the people who would have used the resources more sensibly to build infrastructure or sustainable logistics chains havn't been because they weren't being given the time of day by the markets.

The worry is that a dropping tide lowers all ships. If value is being systematically destroyed and the cause is government incentives then the potential for that to crop up in unexpected places is quite high. I'm always tempted to link monetary policy to the themes of pension issues, low real wage growth, poor infrastructure and rising inequality seen in the US.

Economic value exceeds or matches market value. Market value drives revenue. Profit is a function of revenue and cost.

These are well defined terms; please be careful saying things like "If they aren't making a profit they aren't creating value." It detracts from your otherwise strong argument.

If that line were true, non-profit organizations wouldn't exist.

But we aren't really talking about that sort of concern here, we are talking about for-profit companies that aren't doing research and any externalities are tenuous.

It is completely unreasonable to say that such a company could be creating value. They are clearly a wealth transfer mechanism from who-knows-where to consumers. It doesn't make sense if it isn't malinvestment. People love to pull out hypothetical externalities to justify things they like that just aren't worth doing; they aren't going to justify running a corporation at a loss.

A very interesting statement. I'd like to understand this cash path. Can anyone describe the flow of cash from the central bank to Silicon Valley VC firm? How exactly does this work?

Also do low central bank rates guarantee the kind of money losing VC investments we're seeing? Are their other central banks outside the US with low rates but no accompanying flurry of money-losing investments?

I'm going to have a blog post about the economic situation that led me to taxi driving. The tl/dr is basically that they loaned me a car for 12 hours at a time. In the beginning I made enough to make it worth my while...

I see 2 main factors as to why:

* federation

* cost

These two factors combined unlocked possibilities (ex: universal delivery service) or significantly improved existing industries (Uber app is far more convenient than finding then phoning the local taxi company and hoping blindly for the taxi to arrive).

Federation eases the use of the service as you don't have to either setup your own service (for example, hiring delivery guys for your restaurant) or find out the local services available (if they existed in the first place), and discover which one is good, which one is bad. The last decade development of mobile networks and smartphones was the catalyst for this evolution.

Cost is the other aspect, these services are cheaper than legacy alternatives. But this second aspect is key. On one hand, these services are losing money like crazy, on the other, they have a detrimental social impact, basically exploiting loopholes in the legislation to have "low rights" workers with no protection. But this will change at one point, laws and court decisions will close the loopholes, and the magic money tree will dry up, meaning these services will become significantly more expensive.

The question, when this will happen is: Was the federation improvement enough to sustain this industry long term? Or was the cost the major factor? If it's more of the second, these start-ups will mostly collapse, if it's more of the first they will become sustainable businesses (specially given it's easy to start using using these services, it's a bit harder to stop using them).

I'm still puzzled as to why these companies are losing so much money, and I cannot help but think these could have have been created with more reasonable losses for their first few years and now, they should nearly be cash flow positive.

But the business cycle is not a bad thing. One important feature of the cycle is that as investment seeks new opportunities nobody knows with certainty what will succeed and what will fail in advance. The down part of the cycle clears out the losing investments.

If the free market business cycle has any strengths, surely this is one of them: allowing big money to be both smart and stupid, allowing the wealthy to take dumb risks and lose to those who are more nimble, more insightful, more industrious.

- it's inefficient wasted energy and capital

- it causes bubbles which eventually pop, resulting in booms and busts

- it pulls resources away from other opportunities

I am definitely not a fan of Uber, Amazon, and the like. I really don't like this model that is being pursued in much of SV. I understand Peter Thiel and others reason for wanting monopolies; it is rational from the perspective a firm and investors, but it is highly irrational from the perspective of that firm within society, and an investor as a citizen within a country. The more monopolies exist the smaller the economic pie will be over time. The more they concentrate resources to extract outsized profits, the less space there is for innovative startups. The more they abuse pricing power, the less customers they have.

Hardly; it'll just be a transfer from VCs with too much money to everyone else in the economy. We could probably use more of that.

Profitable companies are typically win/win/win for customers, employees and investors. Unprofitable companies are win/win/lose at best.

Take all the money the investor had lost, and if you had simply paid the employees the same for doing nothing and given the rest to the customers it would be a Pareto dominating outcome. The difference is destroyed wealth -- it's how much worse off society is because those investors didn't invest in profitable companies. Aside from the transfer of wealth, they really are setting fire to money.

- that alternative investments with predictably better profitability characteristics existed

- that customers would have preferred wealth transfer in the form of cash or financial assets instead of in the form of goods or services.

For example, maybe I don’t mind forgoing a direct cash transfer from Lyft investors because what I really need is on-demand transportation. If, in response to my ride requests, they told me what the real fare would have been and transferred to my bank account the real fare minus what I would have been charged, I’d still be left without the ride I wanted (and the whole infrastructure and network of drivers to ensure future rides). It could be perfectly rational for me to value receiving that wealth transfer in the form of a ride and operated ride service more highly than receiving it as cash.

The second point makes sense too. I think a weaker argument along those lines still works, though -- Something like, "If they couldn't become profitable by raising prices they're burning that money."

Ford is a profitable company, and if they set their prices to zero they would deliver more value than their cash hoard before they went bankrupt.

If Lyft upped their prices to juuust below your marginal utility for a ride and still weren't profitable, the Pareto argument (plus a penny) is pretty solid.

The VCs are gambling with someone else's money though. They raise money from institutional investors: pension funds and insurance companies. Ultimately the little guy will pay via government bailouts, pension reductions, and higher insurance premiums.

It's a mixed bag really, a lot of it has to do with pensions sometimes being run by untrained elected officials, or them buying whatever bs a pe or hedge fund shop is selling them.

It's interesting to see how this might relate to wealth inequality as well. If investors had less money and consumers had more, would they choose a less-subsidized Uber over traditional cab services as readily?

That in turn may incentivize some businesses to "pivot" to an on-demand model purely to get their foot in the door with some investors, regardless of whether it makes business sense. Remember Kodak's stock skyrocketing in 2017 when they released KodakCoin? [1].

My opinion is that it is worrying that the line of thinking is that "the profits will come once they're a monopoly". The actions you take to be profitable are different from the ones you take to be a monopoly. Uber and Airbnb have used their millions to circumvent local laws and lobby for their interests. Microsoft in the 90s used their OS monopoly to prevent OEMs from bundling rival's software on their machines.

Monopolies might be great for shareholders but they're not good for consumers and they don't incentivize innovation. And here, I'm not talking about "natural monopolies" like utility companies and telecom network infrastructure.

[1]: https://www.nytimes.com/2018/01/30/technology/kodak-blockcha...

Compare with a boom-bust cyclical model where boom times make raising money easier for everyone. Under this model, overly enthusiastic investors eventually get discouraged after losing a lot of money, so the amount of investment money available changes a lot and thinking of it as zero-sum doesn't really work.

Either is possible; or other options - like Uber is making money per ride in some regions and losing in others.

In short: create the appearance of a successful business, convince others (suckers) that it's a great investment, profit from selling your shares.

Yes it is possible. But people consistently overestimate how easy it is to do this. Would you bet billions of dollars on being able to fool other managers of billions of dollars? I wouldn't.

For the most extreme variant of this, VC investors in Dropbox or YouTube or whatever don't need to care about whether those companies eventually go bankrupt.

So, investors might believe that Uber can actually make it, but as VC goes they are just looking at Uber being on track up to their exit. They don't actually worry about the deep long-term. So, there's less difference than you might think between consciously creating a false appearance and exiting versus believing (though perhaps wrongly) that the business will be viable beyond the exit. The VC folks are focused on the period up to their exit either way.

And what if they win out in building a monopoly?

I'd say it is. On the one hand, it's good for you that receive a cheap service at the expense of VCs. On the other hand, the economy is far far better exploring multiple solutions, some of which will stick, than entering the dead way of what an experts comite consider sensible.

Once the capital is burnt, the survivors will be healthy businesses. As for the little guy can't compete (is that really always true?) I'd say it's the value for society that matters eventually.

[1] https://www.nytimes.com/interactive/2018/08/02/technology/ap...

[2] https://www.marketwatch.com/story/this-1-chart-puts-mega-tec...

Engineer salaries will decline, companies like atlassian, datadog and elastic search will take a hit, etc.

How does that work with failing businesses? If a business turns into a shit-show, everyone on board is forced to ride the ship down to the seafloor?

I agree with the little guy can't compete problem though. But that has been around forever. E.g Amazon has driven many smaller companies out of business by just being able to sustain massive losses for prolonged periods.