Interest rates and Venture Capital

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Essays

Ben Bernanke wrote a great series for the Brookings Institution, where he is a Senior Fellow, on why interest rates remain so damn low in so much of the world. His major points were not really a surprise, but were very clearly laid out, and included the following considerations:

Secular stagnation
It costs less to make a a good today than it did last year, or last decade, and so the ultimate price has gone down too, so the wages associated with that good are under pressure. People are also simply consuming goods more efficiently, thanks to ever-perfecting information about supply and demand.

Global savings glut
Government policy in emerging markets, particularly in Asia, has encouraged building cash base over the last 20 years, perhaps in a reactionary manner to the credit booms (and subsequent volatility) in some of these markets. As a result, there are full savings accounts, but not much investment.

Term premium
The term premium is how much extra juice you get for taking a slightly longer term view, manifesting in the expected price and yield of future bonds. Future bonds aren’t expected to be any cheaper than they are today, and so holding longer term bonds today is considered lower risk by the market.

Why does this matter to you? Well, valuations are high, unicorns and so-called decacorns abound, new funds are announced on what seems like a weekly basis, and we are trying to figure out when it’s going to stop. But it’s also important to understand why: while most of the discussion has focused on how many more startups there are today, and how much bigger the internet is than the last big boom (an order of magnitude), the interest rate trend is a very interesting one to watch, and a highly relevant one. 

There is robust revenue growth in the private high-technology sector, and decent liquidity because of the cash-rich big companies: there are real yields in this business (double digits, sometimes even > 20% IRR) where it’s very hard to find them in traditional investments. As such, professional investors (individuals, institutions of all types) are looking for more upside, and are more willing to take risks on the alternative investments classes (of which venture is a part). And so at the Limited Partner level – investors who fund venture capital firms – there is eagerness to get access to yield, just like at the VC level there is interest in getting access to valuation markups and big exits. 

The points Bernanke made, by the way, are points of view about why interest rates are persistently low, but are not the only points of view. Many smart people claim that secular stagnation is indeed partly because of deflationary tech (which creates efficiencies and thus lowers prices), but also because regulation lags, and in some cases undermines, investable opportunity in parts of the world where there should be higher ‘natural’ rates of GDP growth. And others still might argue that secular stagnation is a function of the rich countries having the rug pulled out from under them in 2008, but since the world’s financial systems are so intertwined, maybe they have put low-interest overhangs on growing countries who have looked to rich countries for liquidity. And finally, some people think that any notion of ‘macroeconomic analysis’ at the global level is silly, since the factors in individual countries (government, natural resources, demographics, historical asset bases) are wildly diverse. What do you think?

I am not an economist, but I do enjoy thinking about these things, because they do affect our business.

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