The ax is swinging in Silicon Valley. Among crypto, social media companies and more traditional software services companies Market values have collapsedfollowed by a wave of redundancies. In some cases, you can blame mismanagement and unforced errors (see: Elon Musk’s tragic Twitter takeover). Strange deals were also made elsewhere. (See: The Recent Collapse of Cryptocurrency Exchanges FTXwhich has reportedly used billions of dollars from its customers’ fortunes to fund risky bets made by its subsidiary.)
But that’s actually the bigger problem With competent, honest managers at the top, many of these business models were simply not made for a world where borrowing could one day become expensive. Some companies need reliable cheap money to make the bill. And many assumed interest rates would remain ultra-low forever.
Warren Buffett said that you can only see who’s been swimming naked when the tide is out; Well the tide has receded and it’s a veritable nudist colony out there.
Which business model is so dependent on low interest rates? A typical example could be a company that relies on future network effects. Company X decides to invest tons into growing its customer base with big discounts or other incentives, which can result in short-term losses hoping for eventually becoming mega-profitable a decade later.
Think: An on-demand delivery startup. A ride hailing business. Maybe even an established company taking an expensive bet on the next big thing, like Facebook’s parent company Meta play tens of billions of dollars to one day rule the Metaverse.
These types of business strategies may have made sense when interest rates were near zero. But at 5 or 6 percent or even higher? It’s harder to get the math to work.
Even companies that appear solid in the long term, such as electric vehicles, are struggling in this new environment. For example, Tesla makes cars that people want, and they Come The move to clean energy will bring them even more customers. But over the past year or so, the company’s market value is still about down half.
Why? It’s easy to blame the fact that Tesla’s CEO Musk wreaked havoc on Twitter; This likely didn’t give Tesla shareholders much confidence in his judgment.
But even without that sideshow, Tesla’s valuation would likely still be hurt by tightening financial conditions. A year ago, Tesla still had market value surpassed that of its closest five greatest rivals combined, although it’s nowhere near selling the most cars or making the highest profits. It was the eighth-Most profitable car company in the world last year. Investors have bet Tesla’s profits will fall Someday stand out, dwarfing those of its peers, and low interest rates made the prospect of those future gains more attractive.
In a world of higher interest rates, those future gains are more heavily discounted.
In a way, the past decade of low interest rates has been a boon that we have largely squandered. When borrowing was essentially free, businesses and governments had the opportunity to make large upfront investments in things that would pay off in the future: increasing housing supply, investing in new equipment and technology, better infrastructure, universal preschool, clean energy.
It’s easier to justify large investments, such as converting a utility company to solar, when funding is around zero percent, rather than over 5 percent; the annual borrowing costs are lower and the investment pays back faster – it reaches its break-even point.
But instead of smart, forward-thinking investing, we have plenty of get-rich-quick private-sector bubbles and some wasteful, deficit-funded tax cuts.
A mystery is why Businesses and governments stopped making these forward-thinking investments when they had the opportunity. Part of the answer is that executives and politicians face some bad incentives: Your company (or country) might be better off making big investments today to increase productivity, but if those executives don’t believe they’re there to To earn credit for the benefits, why bother? It’s better to rake in a little more profit next quarter or send out another round of tax cuts or stimulus checks when they can reap the glory (and maybe a payday).
Last year, Congress finally approved major investments in infrastructure and climate. Which, to put it bluntly, we should be thankful for. It’s just a shame these decisions are being implemented just as funding costs are rising — when we’re getting a lot less bang for our buck and every penny counts.