WEBVTT - This Is How The Unicorn Bubble Will Burst 0:00:10.760 --> 0:00:14.120 Hello, and welcome to another episode of the Odd Lots Podcast. 0:00:14.160 --> 0:00:18.479 I'm Joe Wistful and I'm Tracy Allaway. So, Tracy, the 0:00:18.560 --> 0:00:22.600 last month in markets has been pretty interesting, wouldn't you say? Uh, 0:00:24.040 --> 0:00:26.840 interesting is definitely one way of putting it. It's been 0:00:27.160 --> 0:00:31.280 massively volatile, and I'm sure quite stressful for quite a 0:00:31.280 --> 0:00:35.960 few investors. Definitely stressful for several investors. But also I 0:00:36.000 --> 0:00:39.200 would say, you know, as it often is, unfortunately good 0:00:39.240 --> 0:00:42.199 for us in the financial media business, because some very 0:00:42.240 --> 0:00:46.639 good stories to write about, talk about and dive into. Right, 0:00:46.720 --> 0:00:49.760 there's been no shortage of headlines, that's for sure. One 0:00:49.800 --> 0:00:52.080 of the big things that we've been writing about has, 0:00:52.080 --> 0:00:54.480 of course been the massive sell off that we saw 0:00:54.600 --> 0:00:58.000 in technology stocks. Yeah, that's exactly right. Like lots of 0:00:58.040 --> 0:01:02.000 things have happened in the last month and really all year, 0:01:02.120 --> 0:01:05.160 with many global markets selling off. But I do think 0:01:05.200 --> 0:01:09.600 what's really striking and what felt different about this past 0:01:09.680 --> 0:01:12.920 month is how violent some of the selling has been 0:01:12.959 --> 0:01:18.080 in technology companies that heretofore have seemed really maybe bulletproof. 0:01:18.120 --> 0:01:21.320 And you know, I'm thinking of companies like Amazon, which 0:01:21.680 --> 0:01:24.200 was at one point of worth over a trillion dollars 0:01:24.240 --> 0:01:26.960 and then very quickly lost about a quarter of its 0:01:27.000 --> 0:01:33.399 market cap. Others like Netflix and Google and Facebook, which 0:01:33.440 --> 0:01:37.080 had been struggling since the summer. Very much a different 0:01:37.800 --> 0:01:40.280 tone to the trading of these companies, And of course 0:01:40.319 --> 0:01:42.880 it might just be a blip, but maybe it's a 0:01:42.959 --> 0:01:46.240 sign that just sort of that pure optimism that people 0:01:46.280 --> 0:01:49.560 felt towards these companies have started to fade, right. And 0:01:49.600 --> 0:01:52.600 I think that's one reason why the month felt so stressful, 0:01:52.680 --> 0:01:56.120 because you saw these stalwarts not just of the technology sector, 0:01:56.480 --> 0:02:01.360 but really of the entire market, uh suffer during this downturn. 0:02:01.560 --> 0:02:04.240 So you know, think about the major components in the 0:02:04.280 --> 0:02:08.040 SMP five hundred the thing stocks like Facebook and Amazon 0:02:08.200 --> 0:02:11.640 and Google really make up a big proportion of that. Yeah, 0:02:11.680 --> 0:02:14.000 exactly right. And and and you know, not to be 0:02:14.080 --> 0:02:17.920 labor this point, but these were also incredibly important stocks 0:02:17.960 --> 0:02:21.680 for hedge funds, and many of the successful long short 0:02:21.800 --> 0:02:26.040 managers were successful because they made big bets, concentrated bets 0:02:26.080 --> 0:02:29.160 on these companies. So when they fell apart, or when 0:02:29.200 --> 0:02:32.360 the stocks fell apart, is really wreaked havoc. Now, the 0:02:32.360 --> 0:02:35.600 other thing that's interesting to me is we live in 0:02:35.639 --> 0:02:37.960 a time where there are a lot of really big 0:02:38.000 --> 0:02:41.880 tech companies that are not public or their tech ish companies. 0:02:41.880 --> 0:02:46.040 So whether it's Uber, Airbnb, we work a lot of 0:02:46.040 --> 0:02:50.120 these tech or tech adjacent companies that are gigantic, much 0:02:50.160 --> 0:02:53.600 bigger than many of the public companies out there, that 0:02:53.639 --> 0:02:57.480 have sort of feasted on, you know, incredible growth and 0:02:57.560 --> 0:03:01.400 incredible access to private market money. And of course, one 0:03:01.440 --> 0:03:03.880 of the questions that rises in light of the tech 0:03:03.960 --> 0:03:06.839 sell off is if the public market is turning more 0:03:06.880 --> 0:03:08.839 negative on tech, then what does it mean for these 0:03:08.880 --> 0:03:12.040 companies that people are very obsessed with, but that you know, 0:03:12.120 --> 0:03:16.160 haven't really proven themselves to be durable businesses yet, right, 0:03:16.200 --> 0:03:18.240 because they've all been sort of lining up with the 0:03:18.280 --> 0:03:21.040 expectation that if they wanted to I p O there 0:03:21.040 --> 0:03:23.840 would be this huge amount of demand, and then suddenly 0:03:24.000 --> 0:03:29.640 the recent market route kind of puts that into question. Although, well, 0:03:30.160 --> 0:03:31.880 I have a lot of thoughts about this, so I'm 0:03:31.919 --> 0:03:35.280 sure whatever we're about to discuss it'll be a good conversation. 0:03:35.360 --> 0:03:38.000 Joe Great, I think it will be too. So all 0:03:38.120 --> 0:03:41.360 that being said, I wanted to introduce our guest for 0:03:41.360 --> 0:03:45.200 this week's episode. We're going to be speaking with Bill Janeway, 0:03:45.320 --> 0:03:50.400 the legendary economist Himond Minsky characterized him as a theorist practitioner. 0:03:50.440 --> 0:03:54.480 He spent thirty five years in venture capital affiliated with 0:03:54.520 --> 0:03:58.200 Warburg Pinkus, and he is affiliated member of faculty at 0:03:58.280 --> 0:04:02.880 Cambridge University. And I recently read his book Doing Capitalism 0:04:02.920 --> 0:04:06.640 in the Innovation Age, which really speaks to what I 0:04:06.680 --> 0:04:08.680 think is the sort of question of the moment about 0:04:08.720 --> 0:04:13.920 the relationship between entrepreneurship and financial markets and speculative activity. 0:04:14.480 --> 0:04:18.680 He's a rare voice that can sort of combine firsthand 0:04:18.720 --> 0:04:21.880 experience with how the investing world actually works with a 0:04:21.920 --> 0:04:27.000 sort of economists academic perspective. So in light of that, 0:04:27.240 --> 0:04:29.720 and in light of his experience, I want to bring 0:04:29.760 --> 0:04:32.080 in Bill, Bill Janeway, thank you very much, Joe, it's 0:04:32.120 --> 0:04:35.000 great to be here. And Tracy, good to meet you. Yeah. 0:04:35.040 --> 0:04:39.600 The unicorn bubble is an extraordinary phenomenon, So let's let's 0:04:39.600 --> 0:04:43.360 first put it into a more general context. One part 0:04:43.360 --> 0:04:46.800 of that context, of course, is the maturation of the 0:04:46.800 --> 0:04:51.840 digital revolution. The fact that, as Facebook and Google have demonstrated, 0:04:52.240 --> 0:04:56.040 it is possible to adjust markets numbered in the billions 0:04:56.120 --> 0:05:01.320 of users with extraordinarily little friction, little expense. So the 0:05:01.360 --> 0:05:05.800 notion that limitless growth may be available for other digital 0:05:05.800 --> 0:05:10.440 service businesses is plausible. But second, there's also a more 0:05:10.520 --> 0:05:15.240 narrow context, and that is that for nine years from 0:05:15.240 --> 0:05:19.640 the global financial crisis until just within the last twelve months, 0:05:20.320 --> 0:05:25.560 the financial markets, the financial system, and investors but operating 0:05:25.720 --> 0:05:30.200 in an unprecedented environment, an environment in which the risk 0:05:30.279 --> 0:05:34.279 free real rate of interest has been effectively zero or 0:05:34.279 --> 0:05:41.719 even less. That has pushed institutional investors principally mandated and 0:05:41.839 --> 0:05:46.040 chartered to invest in liquid public markets to behave in 0:05:46.040 --> 0:05:50.520 a way that my view is fundamentally unsustainable. They have 0:05:50.560 --> 0:05:55.120 been paying premium valuations relative to what's available in the 0:05:55.160 --> 0:05:58.520 public market to buy and this is the key to 0:05:58.640 --> 0:06:03.560 buy illiquid secureties, securities they can't sell. Now. I'm not 0:06:03.600 --> 0:06:07.120 a great fan of business schools, but finance one on 0:06:07.200 --> 0:06:09.680 one at any business school in the world will tell 0:06:09.760 --> 0:06:13.480 you that there is a value to liquidity for an 0:06:13.480 --> 0:06:17.280 investor to be able to change her mind when she 0:06:17.360 --> 0:06:22.200 believes that circumstances have changed. But these investors from the 0:06:22.240 --> 0:06:26.599 public market world who have been piling into the new 0:06:26.880 --> 0:06:31.719 unicorn want to be digital giants, have been have been, 0:06:31.760 --> 0:06:36.400 as I say, paying premium values to buy illiquidity now 0:06:36.440 --> 0:06:39.960 before we dive further into that. And I love that 0:06:40.120 --> 0:06:43.200 sort of framing of that in the central tension there, 0:06:43.240 --> 0:06:45.839 because you put it much better than I was. I 0:06:45.920 --> 0:06:48.640 just want to take a quick step back because I 0:06:48.760 --> 0:06:52.000 characterized you, or it wasn't actually me, but I you're 0:06:52.080 --> 0:06:56.440 characterized as a theorist practitioner, so you spent several decades 0:06:56.520 --> 0:07:01.279 in tech venture capital. We're also an academic economists, and 0:07:01.320 --> 0:07:03.640 I think that's rare because you often hear, you know, 0:07:03.720 --> 0:07:07.600 sort of investors claim that economists don't really understand how 0:07:07.640 --> 0:07:10.960 their world works, and maybe that's true in many cases. 0:07:11.280 --> 0:07:15.760 Tell us a little bit about your academic background and 0:07:15.800 --> 0:07:19.880 how it has informed your view of the investing game. 0:07:20.040 --> 0:07:23.520 Delighted to so, I I took a martial scholarship to 0:07:23.600 --> 0:07:27.040 Cambridge way way back back in the mid sixties, and 0:07:27.120 --> 0:07:30.320 I did a doctorate in economics under the students of 0:07:30.400 --> 0:07:34.120 John Maynard Keynes, and I I, how shall I say, 0:07:34.280 --> 0:07:38.480 I internalized a set of pretty fundamental lessons, one of 0:07:38.480 --> 0:07:42.440 which is that in the world of finance and of economics, 0:07:42.680 --> 0:07:46.800 we are all doomed to be making decisions under conditions 0:07:47.320 --> 0:07:51.960 of uncertainty. We cannot know the full consequences of the 0:07:52.040 --> 0:07:58.840 decisions that we make that involve investing money, resources, time, energy, 0:07:59.040 --> 0:08:03.560 and therefore there is an in powerful incentive to construct hedges, 0:08:04.200 --> 0:08:08.080 ways to protect ourselves when what we hoped wouldn't happen 0:08:08.440 --> 0:08:11.600 does happen. This is where it links to my life 0:08:11.640 --> 0:08:16.200 as a practitioner. I learned in the trenches of venture 0:08:16.240 --> 0:08:19.920 capital investing in I t at the frontier from the 0:08:19.960 --> 0:08:23.000 late nineteen seventies right through the great tech book bubble 0:08:23.320 --> 0:08:28.240 that peaked in two thousand. I learned two basic lessons. 0:08:28.680 --> 0:08:32.400 I call them the two fundamental theorems of venture capital. 0:08:33.000 --> 0:08:38.520 The first is corporate happiness is positive cash flow. A 0:08:38.720 --> 0:08:43.720 business that is generating more cash because it's customers give 0:08:43.760 --> 0:08:46.120 it more cash than it costs to deliver them, the 0:08:46.160 --> 0:08:51.320 product and service has achieved a kind of liberation from 0:08:51.360 --> 0:08:56.080 dependence on the problematic access to external capital when needed. 0:08:56.520 --> 0:08:58.600 That's from the point of view, if you like, of 0:08:59.320 --> 0:09:03.560 the how shall I put it, the rational, practical, common 0:09:03.600 --> 0:09:09.000 sensical entrepreneur, which not all entrepreneurs are. The other the 0:09:09.120 --> 0:09:11.880 other lesson is from the point of view of the investor. 0:09:12.160 --> 0:09:15.960 It's what I call cash and control. The only joint 0:09:16.040 --> 0:09:21.040 hedge against the fundamental uncertainty of investing in early stage 0:09:21.040 --> 0:09:25.880 companies at the frontier of technology. Cash means you have 0:09:26.480 --> 0:09:31.560 unequivocally access to enough cash to buy the time to 0:09:31.720 --> 0:09:35.000 find out what's going on when what is going on 0:09:35.240 --> 0:09:40.280 is bad, and control means you have enough control to 0:09:40.480 --> 0:09:44.000 shift the parameters of the problem. In my personal experience, 0:09:44.400 --> 0:09:49.840 that usually not always, usually began by firing the CEO. Okay, 0:09:49.920 --> 0:09:54.280 let's switch back to the unicorn bubble. Here we have 0:09:54.760 --> 0:09:58.040 a set and there are many, I think globally now 0:09:58.120 --> 0:10:01.120 it's considered there's something like to hundred and fifty to 0:10:01.240 --> 0:10:07.040 three hundred unicorns who are characterized by burning billions of 0:10:07.120 --> 0:10:11.520 dollars of cash per year in pursuit of limitless growth. 0:10:12.040 --> 0:10:17.000 The notion of actually working to deliver positive cash flow 0:10:17.600 --> 0:10:22.199 from operations is seen as a kind of needless constraint 0:10:22.640 --> 0:10:26.720 on the pursuit of that limitless growth. And on the 0:10:26.760 --> 0:10:30.680 other hand, the investors, motivated as we all know by 0:10:30.720 --> 0:10:34.880 that famous phrase fomo fear of missing out, have have 0:10:35.280 --> 0:10:40.880 not just been providing the cash on extraordinarily attractive financial terms. 0:10:41.040 --> 0:10:46.560 In many cases, they've been yielding control, governance ownership to 0:10:46.679 --> 0:10:49.400 the founders of the company, no matter how much money 0:10:49.440 --> 0:10:53.920 those founders raise from investors. So, Bill, I already have 0:10:53.960 --> 0:10:56.480 a bunch of questions, but I guess my main ones. 0:10:56.600 --> 0:11:00.480 You were talking about liquidity earlier and this idea that 0:11:00.559 --> 0:11:06.240 investors maybe under paying for illiquid assets that they're assuming. Um, 0:11:06.280 --> 0:11:08.960 I guess that means you think that they might have 0:11:09.080 --> 0:11:13.400 difficulty exiting their tech investments. And then secondly you're talking 0:11:13.400 --> 0:11:16.800 about the value of cash flow in a company, and 0:11:16.840 --> 0:11:20.439 I guess my question is why are investors so comfortable 0:11:20.920 --> 0:11:27.439 continuously pouring more money into unprofitable unicorns uh such as uber. 0:11:27.640 --> 0:11:30.040 You know you mentioned the fear of missing out, but 0:11:30.440 --> 0:11:33.360 I guess the question is, at what point does the 0:11:33.400 --> 0:11:37.520 fear of missing out transform into the fear of not 0:11:37.840 --> 0:11:41.640 making any money ever, So, just to be clear, Tracy, 0:11:41.640 --> 0:11:44.720 I was saying that these public market oriented investors have 0:11:44.800 --> 0:11:51.320 been overpaying for ill liquid securities and that consequently they 0:11:51.360 --> 0:11:54.280 don't have the opportunity to change their minds if they 0:11:54.280 --> 0:11:58.000 decide that maybe the future isn't quite as bright as 0:11:58.040 --> 0:12:00.120 it's supposed to be or as they hoped it would be. 0:12:00.760 --> 0:12:04.840 I do think that it's not just the existence proof 0:12:05.240 --> 0:12:09.840 of the facts of this enormous potential for establishing global 0:12:09.960 --> 0:12:15.239 or near ex China global franchises, particularly in the consumer 0:12:15.320 --> 0:12:18.720 the digital consumer economy. As I said at the beginning, 0:12:18.800 --> 0:12:24.240 I also think the broader financial context really matters, with 0:12:24.400 --> 0:12:28.400 risk free real rates of interest essentially at zero and 0:12:28.400 --> 0:12:31.840 and even going out on the both the credit spread 0:12:31.960 --> 0:12:36.640 and term spread in pursuit of greater returns. Having had 0:12:36.840 --> 0:12:41.680 since two thousand and eight very marginal opportunity to make 0:12:41.840 --> 0:12:45.840 any kind of positive real return, I think investors have 0:12:45.960 --> 0:12:48.440 been reaching for risk. They've been able, they've been going 0:12:48.600 --> 0:12:52.960 further out onto the risk spectrum, which when it comes 0:12:53.000 --> 0:12:57.680 to the to the unicorns, has to be extreme uncertainty 0:12:57.720 --> 0:13:01.800 about what the outcome will be for whether it's it's 0:13:01.880 --> 0:13:05.640 it's Uber, which has challengers in many markets, which is 0:13:05.679 --> 0:13:11.840 facing regulatory frictions, which has the opportunity to see how 0:13:11.880 --> 0:13:16.600 the same social media that enables Uber to grow extraordinarily 0:13:16.920 --> 0:13:22.480 also enables the drivers to establish some countervailing market power 0:13:22.920 --> 0:13:26.120 in terms of the the conditions under which they work. 0:13:26.800 --> 0:13:30.440 These are really big economic uncertainties which the investors have 0:13:30.559 --> 0:13:35.840 chosen to ignore. If there's any catalyst for shifting that mindset, 0:13:36.400 --> 0:13:39.080 I expect it will be the same catalyst that has 0:13:39.160 --> 0:13:44.480 had such an impact on the broad public tech stocks, 0:13:44.559 --> 0:13:49.760 and that begins with the return of access to real 0:13:50.200 --> 0:13:55.920 positive rates of interest, as treasuries move up, as the 0:13:56.080 --> 0:13:58.880 tenure I think is now up around three point two percent, 0:13:59.320 --> 0:14:04.440 as we see credit spreads open up for liquid junk bonds, 0:14:04.640 --> 0:14:07.520 and you know typically they sell in double digits. If 0:14:07.559 --> 0:14:11.680 you have ten twelve percent available in a liquid more 0:14:11.760 --> 0:14:14.679 or less liquid junk bond market, I think that's likely 0:14:14.720 --> 0:14:18.640 to dampen then perceived need to go way out on 0:14:18.679 --> 0:14:21.320 the risk spectrum and behave in the way they have 0:14:21.440 --> 0:14:25.920 been so Ultimately, just to clarify, now, if the if 0:14:25.960 --> 0:14:28.360 what we've seen in the month of October turns out 0:14:28.360 --> 0:14:31.200 to be just a blip and tech stocks continue to rally, 0:14:31.280 --> 0:14:34.239 then maybe this is all sort of an academic discussion. 0:14:34.600 --> 0:14:38.160 But at some point, the divergence between what public markets 0:14:38.160 --> 0:14:40.840 are telling us and the kind of access to capital 0:14:40.960 --> 0:14:44.800 that private markets depend on, it can't last for too long. 0:14:44.840 --> 0:14:47.480 Eventually there has to be some convergence. Yeah, look, the 0:14:47.520 --> 0:14:50.600 definition of a bubble and this is some really great 0:14:50.680 --> 0:14:52.840 academic work. This is where I love to move back 0:14:52.840 --> 0:14:56.160 and forth from the world of the practitioner to the academic, 0:14:56.440 --> 0:15:01.280 there's some great work to first world class economists Jose 0:15:01.480 --> 0:15:04.880 Shankman at Columbia un Shin at the Bank for International 0:15:04.960 --> 0:15:08.400 Settlements have have defined in a way a signature of 0:15:08.400 --> 0:15:12.160 a bubble. That's when the price rises, demand goes up. 0:15:12.640 --> 0:15:15.800 When prices rise, demands supposed to fall. Right. But when 0:15:16.040 --> 0:15:19.200 in a financial bubble, when the price of the securities 0:15:19.240 --> 0:15:22.560 go up, demand increases, and we've certainly seen that in 0:15:22.560 --> 0:15:25.400 the world of the unicorns. What that means is that 0:15:25.800 --> 0:15:29.760 the price of the securities are being decoupled from any 0:15:29.800 --> 0:15:35.320 concern with cash flow past, present or future. Sooner or later, 0:15:35.760 --> 0:15:40.680 all bubbles burst sometime. They leave behind really productive assets 0:15:40.680 --> 0:15:46.200 like railroad railway lines, or electricity grids or internet fiber. 0:15:46.680 --> 0:15:50.080 But they all bust. Now, the good news about this 0:15:50.200 --> 0:15:54.680 unicorn bubble is first, as it when it busts, there's 0:15:54.720 --> 0:15:59.480 no leverage. The economic consequences are going to be very limited. Second, 0:16:00.120 --> 0:16:02.600 no doubt out of these two hundred and fifty or 0:16:02.720 --> 0:16:06.720 three hundred wanna be fangs, there will be several that 0:16:07.120 --> 0:16:14.640 established themselves as long term, sustainable, valuable businesses. You know, 0:16:15.400 --> 0:16:19.200 back at the in the tech bubble, Amazon raised five 0:16:19.600 --> 0:16:22.280 and sixty million bucks in the end of the first 0:16:22.360 --> 0:16:26.680 quarter of two thousand, about two weeks before the then 0:16:26.680 --> 0:16:29.480 old time peak of the nastac. If it hadn't raised 0:16:29.560 --> 0:16:33.720 that money under bubble conditions, it would have gone bankrupt 0:16:33.760 --> 0:16:37.520 within six months. Jeff Bezos learned the lesson. He's got 0:16:37.680 --> 0:16:42.400 multiple levers for forcing gobs and gobs of positive cash 0:16:42.400 --> 0:16:45.600 flow whenever he wants to, whenever the market tells him 0:16:45.600 --> 0:16:48.400 he needs to. In the meantime, he can invest for 0:16:48.640 --> 0:16:53.520 maximum continued growth. Given that he has, he can generate 0:16:53.720 --> 0:16:58.040 positive cash flow whenever he chooses. My view is that 0:16:58.480 --> 0:17:02.960 the Unicorn boards and their entrepreneurs are going to be 0:17:03.120 --> 0:17:08.360 challenged to demonstrate that, like Jeff bezas, they have plausible 0:17:08.840 --> 0:17:13.679 path to positive cash flow that are within their own control, 0:17:14.240 --> 0:17:19.000 that don't depend on limitless access to the kind of 0:17:19.040 --> 0:17:24.439 capital that for a time has been available. So is 0:17:24.480 --> 0:17:28.719 there anything special about tech in particular that makes it 0:17:28.800 --> 0:17:32.040 more of a target for easy money or for capital 0:17:32.200 --> 0:17:35.439 just you know, trying to find anything to invest in. 0:17:35.560 --> 0:17:38.840 Because this easy money story, the search for yield, We've 0:17:38.840 --> 0:17:43.240 heard people talk about it across a variety of financial assets, 0:17:43.400 --> 0:17:47.320 right corporate bonds, being um. Probably the most prevalent example. 0:17:47.880 --> 0:17:51.000 People talked a lot about the shale oil story is 0:17:51.000 --> 0:17:54.639 actually a capital market story. Is there something about tech 0:17:54.720 --> 0:17:58.640 here that makes it unique? Sure, it's growth, And the 0:17:58.720 --> 0:18:03.120 thing that makes it un in this environment is that 0:18:03.240 --> 0:18:06.600 when you're investing in growth, the rate at which you 0:18:06.760 --> 0:18:12.480 discount the future really really matters. And when you can 0:18:12.600 --> 0:18:18.320 discount the future at rates that reflect the FED and 0:18:18.400 --> 0:18:21.000 for that matter, the Bank of England's the European central 0:18:21.000 --> 0:18:25.720 banks commitment to very very very very low to negative 0:18:25.840 --> 0:18:30.119 interest rates in the nine ten years after the global 0:18:30.160 --> 0:18:34.600 financial crisis, it means that that future value, however speculative, 0:18:34.720 --> 0:18:39.399 it may be just as much much larger. And you know, 0:18:39.440 --> 0:18:42.440 it's exponential. This is not a kind of linear exercise 0:18:42.440 --> 0:18:45.359 and arithmetic. If the rate at which you're discounting the 0:18:45.400 --> 0:18:49.359 future rises by one percent ten years from now, the 0:18:49.440 --> 0:18:51.600 value of something of a buck ten years from now 0:18:51.960 --> 0:18:57.520 declines by a lot. And that's the biggest threat I think. 0:18:58.000 --> 0:19:00.320 I think there are two threats. Actually, One is this 0:19:00.400 --> 0:19:06.680 financial threat, this shift in the financial environment that differentially 0:19:07.320 --> 0:19:14.200 penalizes high growth investment opportunities. The second is the growing 0:19:15.000 --> 0:19:21.760 recognition or the increasing inability to ignore the frictions that 0:19:21.960 --> 0:19:29.320 do affect even these extraordinary new companies with their potentially 0:19:29.840 --> 0:19:35.919 billion user markets. I mean the regulatory frictions, the political 0:19:36.000 --> 0:19:39.679 frictions which have been emerging around the world, not just 0:19:39.800 --> 0:19:43.560 in the United States, city by city, country by country 0:19:43.600 --> 0:19:46.439 over the last year or two. Before we go too 0:19:46.560 --> 0:19:48.520 much further, I want to go back something I've been 0:19:48.560 --> 0:19:51.600 thinking about listening to when you talked about um your 0:19:51.640 --> 0:19:55.240 sort of academic history and having studied under the students 0:19:55.280 --> 0:19:58.760 of Canes, when you talk about the lessons you've internalized, 0:19:58.880 --> 0:20:02.560 I have to say, in a way they seem obvious. Okay, 0:20:02.600 --> 0:20:06.120 companies should have access to positive cash flo I mean 0:20:06.320 --> 0:20:10.320 I think that that would not surprise people. Control matters, 0:20:10.680 --> 0:20:14.080 the future is uncertain. None of these things strike me 0:20:14.119 --> 0:20:18.320 as being particularly controversial. But how in your view do 0:20:18.400 --> 0:20:23.840 these insights differ from, say, what economists elsewhere may have thought. 0:20:24.080 --> 0:20:26.800 Well here that that's a great question, Joe, because the 0:20:26.840 --> 0:20:29.439 fact is I went on my thirty five years sabbatical 0:20:29.600 --> 0:20:33.520 from the academy because in the early nineteen seventies it 0:20:33.600 --> 0:20:40.359 became clear that mainstream academic economics and mainstream academic finance 0:20:40.920 --> 0:20:44.200 had kind of drunk the kool aid, the kool aid 0:20:44.480 --> 0:20:49.080 of the where the building mathematical models that could be 0:20:49.119 --> 0:20:53.440 solved logically, and they were based on in both areas, 0:20:53.440 --> 0:20:58.160 both fields based on the concept the fantasy of what 0:20:58.440 --> 0:21:02.160 has been called in the literature too much, the rational 0:21:02.280 --> 0:21:07.880 representative agent, the agent in the market who has an 0:21:07.880 --> 0:21:11.679 omniscient view of the future, not just of what's going 0:21:11.680 --> 0:21:15.399 to be the result of her actions, but of the model, 0:21:15.520 --> 0:21:20.840 a model which accurately explains how her and remember she's 0:21:20.880 --> 0:21:26.600 the representative agent. She represents all investors, all consumers, all firms, 0:21:27.119 --> 0:21:30.639 how those decisions will play out. This came to be 0:21:30.720 --> 0:21:37.359 known as the rational expectations hypothesis. It was dominant, it 0:21:37.440 --> 0:21:41.280 has been dominant for generation, with the models in the 0:21:41.359 --> 0:21:44.359 central banks and the treasuries of the world, not just 0:21:44.440 --> 0:21:47.560 in academia, based on this view. Now, there are a 0:21:47.600 --> 0:21:50.120 couple of aspects of this that are pretty obvious when 0:21:50.119 --> 0:21:53.360 you stand back and assert that the power of that 0:21:53.520 --> 0:21:57.480 most rare resource common sense. First of all, if you 0:21:57.520 --> 0:22:01.160 have one rational agent, one represent of of agent, that 0:22:01.200 --> 0:22:04.440 means that she is her own creditor and debtor. You've 0:22:04.520 --> 0:22:09.880 just excluded a financial system by construction. Nothing that happens 0:22:09.920 --> 0:22:12.400 in the stock market, the bond market, or the banking 0:22:12.440 --> 0:22:15.960 system can have any effect on the real economy. That 0:22:16.200 --> 0:22:22.240 is the central reason why all of the authorities were 0:22:22.280 --> 0:22:26.879 so caught by surprise in two thousand and eight. It 0:22:26.960 --> 0:22:30.720 does sound like common sense, as you say, to put 0:22:30.760 --> 0:22:35.120 it the way I put it, in terms of uncertainty 0:22:35.160 --> 0:22:39.600 about the future, need for ability to provide effective hedges 0:22:39.680 --> 0:22:43.919 against that uncertainty. But as I say, for a generation, 0:22:44.119 --> 0:22:47.720 and not just from the University of Chicago, the doctrine 0:22:47.720 --> 0:22:52.640 the dogma that markets will be self correcting as rational 0:22:52.720 --> 0:22:58.200 agents exercise their omniscient knowledge in a world that they 0:22:58.280 --> 0:23:02.320 fully understand you. It was it was Alan Greenspan in 0:23:02.359 --> 0:23:05.080 the hero in the Hearings in two thousand and nine, 0:23:05.119 --> 0:23:08.440 after Lehman went bust in the World pros, who said 0:23:08.480 --> 0:23:11.760 that he found a flaw in his thinking. The floor 0:23:11.800 --> 0:23:15.600 in his thinking was his belief that those rational, self 0:23:15.680 --> 0:23:22.719 interested bank bosses and private investors would all behave for 0:23:22.760 --> 0:23:25.680 their own best interests, as if they knew what their 0:23:25.680 --> 0:23:29.640 own best interests actually would be. And instead, of course, 0:23:29.680 --> 0:23:32.480 what we saw was everybody running for the exit to 0:23:32.520 --> 0:23:37.159 protect themselves, with a consequence that was catastrophic for the world. 0:23:38.280 --> 0:23:42.320 The good news. The good news is that for those 0:23:42.359 --> 0:23:47.240 academic disciplines of economics and finance, two thousand and eight 0:23:47.400 --> 0:23:50.480 and the great recession that followed are the gifts that 0:23:50.680 --> 0:23:56.400 keep on giving. They have motivated a return to empirical 0:23:56.560 --> 0:24:00.840 study of markets, of economies of finance, a chuill systems 0:24:01.400 --> 0:24:06.040 with a much more realistic view, which is beginning to 0:24:06.119 --> 0:24:10.119 emerge in the literature. And you know, it took a 0:24:10.160 --> 0:24:14.679 generation for the economics that failed us so badly in 0:24:14.720 --> 0:24:18.480 two thousand and eight to become dogma. It'll take a 0:24:18.560 --> 0:24:21.520 generation to undo it. It It won't happen overnight. But there 0:24:21.600 --> 0:24:24.080 is good news out there for the for the longer 0:24:24.240 --> 0:24:26.640 term and how we think about this world we're all 0:24:26.680 --> 0:24:29.840 trying to survive in So we're talking a lot about 0:24:29.840 --> 0:24:32.560 two thousand and eight. If we fast forward to now, 0:24:32.640 --> 0:24:35.000 as Joe and I were discussing in the intro, over 0:24:35.000 --> 0:24:37.040 the past month or so, we've seen a lot of 0:24:37.080 --> 0:24:42.640 angst amid the tech stocks and amongst tech investors. Does 0:24:42.680 --> 0:24:45.840 the wobble in the public market in particular, does that 0:24:45.960 --> 0:24:49.560 suggest that the whole edifice of tech funding starts to 0:24:49.680 --> 0:24:53.240 fall down, that the vcs and the private markets aren't 0:24:53.280 --> 0:24:56.520 going to be able to depend on an exit through 0:24:56.720 --> 0:24:59.280 I p O s and that begins to sort of 0:24:59.320 --> 0:25:04.000 create a downward spiral invaluations. Do you see that happening? Well, 0:25:04.040 --> 0:25:06.880 I certainly see exposure to it now. You know, as 0:25:06.920 --> 0:25:09.800 we all know, it's very hard to predict, especially the future, 0:25:10.400 --> 0:25:13.119 but I think we can see that there's a link 0:25:13.800 --> 0:25:20.600 from the movement towards quote normalizing interest rates to feedback 0:25:20.640 --> 0:25:26.560 and impact on the value of assets whose future returns 0:25:26.680 --> 0:25:29.760 dominate their current returns. And of course there's no set 0:25:29.800 --> 0:25:35.720 of assets more of that category than the unicorns. Second, 0:25:36.080 --> 0:25:41.400 institutional investors will find that there are adequate returns available 0:25:41.520 --> 0:25:47.720 at much lower risk than buying into the digital wannabes 0:25:47.880 --> 0:25:52.840 at at super supervaluations with no guarantee of an exit 0:25:52.920 --> 0:25:55.960 path through a public market or any other way. So 0:25:56.040 --> 0:25:58.399 I think we have to expect that the world is 0:25:58.400 --> 0:26:01.200 going to look a lot more fragile over the next 0:26:01.240 --> 0:26:04.320 period of months and years going forward. And as a 0:26:04.400 --> 0:26:09.879 final point, um, you know, my work is very definitely 0:26:10.040 --> 0:26:14.520 deeply involved at the interface between the financial and economic 0:26:14.640 --> 0:26:17.359 markets on the one hand and the political process on 0:26:17.400 --> 0:26:21.320 the other and the other lesson Another long lesson that 0:26:21.400 --> 0:26:25.919 goes way back in our history is that markets ultimately 0:26:26.000 --> 0:26:31.800 depend on the credibility and plausibility of the political underwriting 0:26:32.080 --> 0:26:35.480 as and when bad things happen. We sure learned that 0:26:35.520 --> 0:26:39.480 in two thousand and eight, and I think we I 0:26:39.480 --> 0:26:42.720 think it's legitimate to have a concern going forward about 0:26:42.720 --> 0:26:46.960 the quality of political underwriting in the United States today. 0:26:47.080 --> 0:26:50.000 I'm glad you brought this up because I before we go, 0:26:50.040 --> 0:26:53.000 I want to hit on sort of another major theme 0:26:53.359 --> 0:26:56.040 of your writing, which we haven't talked about at all. 0:26:56.480 --> 0:27:00.159 And again I suspect it's another area where uh lot 0:27:00.200 --> 0:27:02.720 of investors might bristle at this. But something you point 0:27:02.720 --> 0:27:06.760 out is that the areas where venture capitalists have been 0:27:06.800 --> 0:27:10.040 most successful have all been areas in which there has 0:27:10.080 --> 0:27:14.639 been an extraordinary amount of government spending to invest in 0:27:14.720 --> 0:27:18.960 basic research, the sort of expensive capital investment that often 0:27:19.080 --> 0:27:22.800 early stage private money isn't forthcoming for. And you point 0:27:22.800 --> 0:27:26.480