The Bubble is Somewhere Else

There has been a lot of consternation over a bubble in startup valuations.  A lot of people are comparing the current state of tech valuations to 2001.  It’s not like that at all for a few reasons.  There are certainly tech companies that are going to have to do some down rounds.   We will see some tech companies that we thought were giants become midgets again.

However, I think that the Federal Reserve and other national banks have created another bubble in response to the financial crisis of 2008.  There is a debt bubble and my friend Yra Harris wrote about it.  There has been a large increase in the global growth of debt.  Debt is a double edged sword.  One edge is sharper than the other.

The Federal Reserve has really screwed up, big time.  Virtually all the national banks have screwed up.  The way this story will not be pretty.

If you think about sources of capital as going to the racetrack, there are three windows.  Win, Place and Show.  Win might be selling equity.  It’s the most expensive form of capital.  VC capital or PE capital is not cheap.  The only way to pay it back is an exit.  The Place window is going to a banking institution and borrowing.  No give up of equity, but you have to pay it back.  The Show window is growing from cash flow.  For some businesses, this is an appropriate option.  For high growth businesses, it’s not an option.

One of the sexiest things about debt for companies, startups included, is that they can grow their business without giving up equity. If cash flows can’t cover that debt, the bank comes in and takes over.  They go through a painful bankruptcy.  No one wins.  Even the bank loses because they don’t get all their money back.

If McKinsey is correct and businesses in the world economy have levered up on cheap 0% interest debt, we are in trouble.  Not only that, but world governments including the United States, have been feeding at the 0% interest rate trough.  The Debt to GDP ratio is a good way to approximate the ability for a government to pay off it’s debt.  Here is the ratio under the Obama administration.

source: tradingeconomics.com

In sum, Obama’s been on a spending spree with no growth.  Not only that, but the policies of the Obama administration intentionally get in the way of growth.  The policies Hillary and Bernie are proposing are even worse.  If the American government were a private company, it would be bankrupt and out of business by now.  The bag holders are fully in place.