The Federal Reserve hiked interest rates on a band of 0.5 – 1 % this Wednesday. Ostensibly aimed at curbing the runaway inflation (not so high since the late 1970s), this move also brings back memories of the year 2000, when the rates were last hiked by this much. Those of us old enough to have lived through the Dotcom mania (the “bubble” of the early days of the internet era) would realize that one of the reasons why the Dotcom bubble burst was due to the “withdrawal” of the “easy money” in vogue through the 1990s. Indeed, Silicon Valley veterans would also remember how the then Governor of the Fed, Alan Greenspan (called the “maestro” for his legendary steering of the most expansive run in American history) referred to the “irrational exuberance” of the Dotcom pioneers. Indeed, Turn to the present and it is clear that the era of “excess liquidity” which fueled the Unicorn craze is coming to a close, and the effects that this would have on the many Unicorns (startups with Billion Dollar valuations) are as yet not clear, though there is every chance the “bull run” which these Unicorns have enjoyed would come to an end.
You can call me a Cassandra or a doomsayer, but the facts are clear that the Unicorn bubble has largely been due to the availability of cheap capital to anyone for the asking, especially for the Venture Capitalists (VCs) and Angel Investors based worldwide. Otherwise, how can one explain the astonishing rise of Theranos, the Unicorn which crashed subsequently after the exposure of many frauds there? Indeed, Unicorns like Theranos existed because of the idiom that “You Can Fool Some People All The Time”. However, the other part of this cliche is “You Can’t Fool All People All The Time”!!
So, here we are with the Fed signalling more rate hikes (though not as large as this one) which leads us to the “withdrawal symptoms” for markets and investors, who gorged on easy money, and fattened themselves on the back of near Zero or for that matter, even Negative rates (negative rates are an extreme instance of investors paying borrowers the money for their investments). Of course, it is early days yet and hence, I do hold my judgment on which Unicorns would go bust and which ones would survive. Suffice to say that those with real business models and returns to investors would stay the course, whereas others that do not have any “real beef” so to say, would go belly up.
While this can be distressing news to the Unicorns and those Startups aspiring to become the former, I would refer them to the laws of economics, where the markets are supposed to “return to equilibrium” sooner or later. On the other hand, it is the case that the markets have not really been following such economic principles, otherwise, how can one explain the stratospheric bull runs that they have had for a decade or so by now. Moreover, the pandemic necessitated low rates and more governmental largesse in various forms, towards the goal of “recovery” from the crises of the last two and half years. This led to the prolonged “suspension of belief” that is apparent for those following the markets and while, the present hike would necessitate some “correction”, the reason I mentioned I would hold my judgment, for now, is that there are no signs as yet about the predicted end of easy money.
This is mainly because investors and VCs are flush with money and given that ROI (Return on Investment) on the “real economy” or to use the 1990s phrase, “brick and mortar” economy is negligible compared to the returns from speculation and speculative investments. In effect, the returns from the physical economy are diminishing, leading to yield-hungry investors chasing (rather than being chased by) the founders of the Startups. It is reasonable to expect this “anomaly” to be rectified sometime in the future when “sanity” would be restored in the way the economy works. However, there are better minds than mine who can predict when the “normal” yield curve returns, and until then, my guess is that there is nothing to worry about for anyone who aspires to be the Next Big Thing. On the other hand, there are a number of reasons why this might not transpire, among them the possible Russian Default, the Evergrande and other Chinese real estate sector shocks, and most importantly, the resurgence of the virus. So, one has to keep fingers crossed for the moment.
Having said that, there is every reason to believe that History is Repeating here as the Dotcom bubble burst and the separation of the “winners and losers” during 2000-01 is still fresh in my memory. So, I expect startups to similarly go through a round of “catharsis” wherein those able to generate returns would weather the hikes, and the rest would bite the dust or bust. Indeed, Indian Unicorns are especially vulnerable here as the Era of Low Interest and Negative rates led to Western VCs flocking to India and other Emerging Markets in anticipation of high returns. Moreover, with competition from newly minted startups in Vietnam and other Asian nations can result in the VCs seeking their fortunes elsewhere. All in all, this would initially lead to more volatility before things settle down and the near term risks are many, while the longer-term success is for those who are in it for real. Here’s hoping to see some “real valuations” and not “dizzying” numbers being thrown around casually.
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