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This is an opinion editorial by Jimmy Song, a Bitcoin developer, educator and entrepreneur and programmer with over 20 years of experience.
Link to the audio read of the article.
Startups are a giant fiat game.
They are perceived to be the engines of the economy, the drivers of innovation and the creators of wealth. In reality, they mask the Cantillon effect and make the rich richer while making the poor poorer. They waste money and burn through capital like there’s no tomorrow. Startups embody the “get rich or die trying” mentality like insecure Hollywood hopefuls.
Even the few that make it subsidize their good or service through large infusions of newly-printed money, eschewing profits for the prospect of growth. Losing money to add customers is a constant tradeoff, with the hopes of being able to price out competitors to eventually become monopolies. They all hope to graduate to stock market darlings like Tesla, Amazon or Alphabet. With large government interventions likely, even the darlings will likely degenerate to zombie companies like IBM, GE or GM once their fiat-induced monopolistic edges are dulled. Such is the lifecycle of fiat companies, which is as depressing as the life of factory-farmed chickens and just about as gross.
This is a hard essay for me to write, having been a startup veteran of more than 20 years. Yet as I study fiat money and how it changes the incentives everywhere in the economy, I’ve come to the conclusion that startups are as much a grift benefiting from Cantillon effects as investment banks are. They just have the illusion of being more productive because of how busy the people in them are.
Company Valuations, Or Speculations
There are two ways companies can increase in valuation. The first is the traditional way, which is to make more profits. A larger profit means a larger dividend, making the equity in the company worth more. The price increases in equity are rational, or what we would call “having a fundamental basis.” Think getting good grades in school because you actually study and know the subject.
The second way to increase in valuation is through boosting investor demand. Of course, investor demand with traditional investors is directly correlated to the first metric, increased profits, but this is not the case with most modern investors. Modern investors just want to buy what everyone else wants, before they want it. This is what we would call “speculation.“ Think getting good grades in school because of grade inflation.
Speculation is a perception game where valuation increases because of the perceived desirability of the asset. The desirability could be based on fundamentals or based on pictures of a dog. For speculative purposes, it doesn’t really matter. Demand for the equity, whatever narrative it is based on, drives the price.
Investing has traditionally been based on sound fundamentals. Money was invested for some reasonable return, not based on equity price appreciation. Real returns like dividends determined whether money came in. This is how equity pricing used to work.
For the past 40 years, this has decidedly not been the way equities have been valued. Amazon has never paid a dividend, for example, yet continues to attract investment dollars. It attracts investment because of the narrative and speculation around the stock. This is what we call a “Keynesian beauty contest.” The money is invested not for real returns like coupon payments or dividends, but on equity appreciation.
Stock purchases are like infomercials now: way too optimistic sounding and ending in regret. We all know these narratives sound too good to be true, yet perceive other people will buy them anyway and want to get ahead of the crowd. Many such investments have little to no fundamentals but that doesn’t matter if the narrative is good enough to get money in. This is the dominant investment paradigm today because yield has disappeared and price appreciation is the only edge left.
Fiat Equity Valuations With No Opportunity Costs
Equity valuation has trended away from yield and the culprit, as you might expect, is fiat money. In a hard money system, attracting investment requires a return because the money is scarce. Being scarce, buying equity has opportunity costs.
Under a hard money standard, capital demand has to be satisfied from existing stock as new money can’t just be printed. Hence, attracting investment is more difficult as there are many other investments that someone with the money can make. Returns, in other words, have to compensate for the scarcity of money. As a result, equity valuations tend to be based on fundamentals.
Under a fiat monetary system, money is much more abundant and that means there is almost no opportunity cost for money. Investment can be financed, which is not really investment at all, but an arbitrage. Savvy investors can get loans at a low rate from a bank and get a higher return through investing in equities of some kind. The difference is their profit and this is what all fiat investing has become. Every hedge fund, investment bank and venture capital fund is essentially this exact game of leverage and arbitrage at some level. The money in these funds is an illusion, created ex nihilo in the form of loans and then leveraged into an asset.
The abundance of money means that over time, there’s always more money chasing investment opportunities. Attracting investment dollars becomes a much quicker and easier way to increase the valuation of companies than in turning a profit. This is why valuations go way higher during monetary expansion.
Profit is difficult and requires delivering needed goods and services to the market. Attracting new investment dollars in a fiat monetary system is much easier. The strategy is simple: Hype the equity to the right people and watch the newly printed money roll in. Why sell to the free market when you can sell equity to Cantillionaires? Why make a product when you can pump and dump?
Startups Are New Money Magnets
The abundance of money means that the game of attracting money is relatively easy. Newly-printed money is always looking for returns and even a weak company in a fiat money printing spree will attract money. As long as there’s a perception that there will be more investors, the speculative bubble will keep pumping.
Profit becomes secondary to the narrative or perception. Something popular will attract more printed money than something profitable. Valuation will not reflect profitability, but popularity. Profit will only marginally make something more popular and is thus not a priority. This is why so many startups in the past 20 years have been so focused on retail. Perception of growth is more important than profit when selling equity to Cantillionaires. To attract retail, companies offer subsidized goods and services, but the discount comes through dollar expansion.
The game is not about providing a good or service, but about attracting more newly printed money. And why do investors put money in? Because keeping it in dollars is a melting ice cube. Every company is competing, not to make good products and services, but to be the best store of value.
The Moral Quandary Of Insane Startup Valuations
If the asset inflation we’re seeing is funded by dollar expansion, we have to start asking some tough questions about where the insane valuations we are seeing come from. Ultimately, all dollar expansion is theft from current dollar holders. Many of the holders are some of the poorest and most vulnerable people in the world, such as the people suffering from hyperinflation. The dollar is their refuge currency.
The large valuations of equities come on the backs of the poorest of the poor. The rich Silicon Valley insiders, Wall Street bros and startups win while the poorest lose out. Every startup that fails is subsidized by North Koreans who can’t buy rice with the USD in their pocket because prices went up.
Startups are as much the Cantillon winners as Wall Street investment bankers are. Everything about them, including the below-cost goods and services, the sweet perks and large salaries are ultimately subsidized by newly-printed money.
Hype Cycles And Narratives
The biggest companies of the last 20 years have something in common: They are really popular at a retail level. It’s relatively rare to see B2B companies make it big anymore because they don’t have enough retail mindshare to really make it big. The fact that the biggest companies in the world, such as Tesla, Amazon, Apple, Google and Facebook, are also household names is not an accident. The narrative around the companies is more important than the actual profits they make because they are competing to be stores of value.
Think about Uber, Netflix or Snapchat. These are all companies that have some level of mindshare in the retail investor’s mind. That mindshare translates to more investor demand in the company which will create a higher stock price faster than profits.
Perception is part of these companies’ DNA. Their market caps reflect just how much people think they will attract new money, not how much value they add. Because their stock prices are so dependent on public perception, they’ve become much more political and spend lots of money on PR.
This is unsurprising because that’s how all of these companies grew up.
Startup Politics
Startups these days are largely not funded through savings but through venture capital (VC). Even from the start, most startups are in money magnet mode instead of profit mode. To attract investment, they have to play political games.
The dirty secret of VC firms is that most of them do very little due diligence. They pile into what everyone else is investing in. I called them “monetary aristocrats” because their role is very much political. Their main skill is in getting in on “hot” deals rather than in finding innovative new ideas that change the economy.
VC firms do this because getting in on hot deals is a good indicator of what will be popular and attract money in the future. If it can attract money from Cantillionaires now, it’s likely to attract money in the future. Popularity is what matters because newly-printed money is way more important than a good business model or even profit.
So what do VCs choose startups based on? It’s not really about making money anymore, but about who can attract further investment. Thus, the story, or the narrative, around the company is more important than any profit. Perception, even if built on smoke and mirrors, is more important than the fundamental underlying business. The whole thing is a game of image.
Of course, most of these startups fail and therein lies the rub. Capital, most of it newly printed, is wasted on trying to make these companies into unicorns. Even the unicorns are really just substituting as a store of value and have inflated valuations because of the dollar’s poor record.
If this sounds familiar, it should. This is how altcoins operate. It’s not a…
Read More: Bitcoin Songsheet: Like Altcoins, Startups Are New Money Magnets
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