In 2022, the tide went out, and we all saw who was swimming naked. Every company that was heavily dependent on borrowed funds either reduced staff or collapsed completely. Namely: Buttcoin firms, green energy, and all our favorite tech stocks. This trend has revealed the perverse incentives in modern markets to go all in on growth regardless if it makes sense to do so.

1. All employee compensation is a tax write-off, even stock options that do not technically cost the company anything. When employees are paid like this, they're incentivized to compete for market share even if it is not profitable to do so.
2. All job-producing infrastructure is a tax writeoff, even if it flops. Again, this incentivizes competing for market share.
3. All R&D is a tax write-off. This means R&D dependent firms are often tax-free, which does incentivize science but science is high-risk and rarely results in a marketable product. This results in a lot of pure-play firms that often crash and burn due to a single flop.
4. The Fed has in previous decades targeted an inflation rate of 1-2% in order to incentivize people to either spend or invest rather than hoard.
5. The Fed also targeted interest rates 2-3% in order to keep it easier for firms and individuals to borrow if needed. This is nice until you realize it makes stocks systemically more profitable than bonds during ordinary times.

These trends have been exaggerated by a number of equally important factors:

1. Foreign governments buy US bonds with printed money. The biggest of these was by far China, which targeted inflation above the US in order to incentivize export to the US. Yes, China was lending money to Americans so Americans would buy more Chinese stuff, but this trend is falling as we speak as there are reports that China is buying Russian gold instead of T-bills this year. There are others, however, as many states peg their money to the dollar and maintain US currency reserves NOT in physical dollars, but in dollar-denominated bonds. This global trend made the spread in the Federal Funds Rate razor thin and US debt even cheaper.
2. Everyone is looking for the "next Bill Gates" to make them rich. Everyone sees the returns of early investors in computers, and thus many people are aggressively investing into science they do not understand. Hindenburg Research, the infamous activist short seller, once reported they are mostly shorting fraudulent scientific firms and they're always finding more. There are even some venture capital firms that will go to universities and encourage students with good grades to come up with business ideas even if they don't really want to go into business.
3. Venture capital has exploded. There are twofold reasons for this, firstly what you see above as people are trying to invest as early as possible into "disruptive technology." Cathy Woods and her ARK Invest team are simply the most high-profile case of this folley, whose funds behave like a leveraged-NASDAQ 100 fund due to all the borrowing by the firms the "disruptive" fund holds. There are currently tens of thousands of formalized venture capital firms, over ten thousand hedge funds that are historically tech-heavy, tens of thousands of "angel investors" using their personal funds, and billion-dollar crowdfunding firms. Venture capital is about as reliable as crowdfunding despite the pretension to exclusivity, as both report a success rate of about a quarter. The amount of funds raised is also about the same, as crowd-funded firms have an average of 10-20 employees and raise $1-5 million dollars, whilst early-stage venture capital firms are about the same. YOU HEAR ME! ARE YOU LISTENING TO ME!!! VENTURE CAPITAL AND CROWDFUNDING- ARE THE SAME! The only difference is crowdfunding is heavy on innovative consumer products, and venture capital is heavy on innovative business solutions. Late-stage venture capital is often just as liquid and has similar returns as stock market investing. Nonetheless, it is possible to become a CEO the exact same way one becomes a movie star.

The results of all these structural and cultural oddities are accidental Ponzi schemes. I don't mean to accuse anyone of crimes, although that is easy to get away with in this environment. However, since debt is cheap and equity is easy, a firm of unqualified engineers can simply start work on something, lead on investors with promising results, and get progressively higher and higher valuations. The increase in the paper value of the stars allows them to borrow a lot to keep the firm going and live well... Until they run out of money, as all Ponzi schemes do. But in most of these cases, there was real science going on, there was simply no way to monetize it and/or the product was far more niche than anyone liked to believe.

You can see how the tech bubble was pretty inevitable. A whole new branch of science was created and all of the men who were in the field early on was propelled to the top regardless of competency. Many actually collapsed immediately due to infighting, as there are reports of firms screwing over their employees out of pay, there was one CEO who said "now I got the money I can live a disgusting frivolous life." I'm sure we all heard of Mr. Zuckerberg's personal feud with Mr. Saverin, but that was after the tech bubble.

But it wasn't just the internet. It happens. Every. Single. Time.

There was 3d printers, biotech (ongoing), fintech, robotics, lab meat (ongoing), quantum computing, lithium batteries, reusable rockets, verticle farming (yep, that's a thing), internet of things, and so on. Every new successful innovative firm also creates bubbles around them. For instance, the success of AirBNB drove up housing prices surrounding spaceports as hosts speculated they could get great money charging all the visitors. Or on YouTube the rapid success of early YouTubers flooded the site with new YouTubers, which ended when the firm became profitable and the "ad-pocalypse" occurred when suddenly creators realized how generous their pay was previously as the quantity and quality of their share of ad revenue fell. This trend was particularly severe on green energy, which also profits from heavy government subsidies which remove at least a third of end user cost.

The list goes on, and on, AND ON...

The general rule is the harder it is to explain the utility of your job to a layperson, the more high-risk your job is. Another general rule is that the best science is not profitable. The best science goes on in universities and in government labs where no one has to worry about marketing a product, while the private market is limit to what can reasonably bring a product to market in a short time. In other words, tech companies are applied engineering, engineering is applied physics, and physics is applied math.

But for our purposes, a comparison between oil and green energy firms are sufficient because they are roughly the same over the long term. One is so science heavy that it is impossible to assess the true risk, the other only innovates to improve the efficiency of existing system. One is subject to unfair scrutiny and punitive regulation to make them less profitable, and the other has over 30% subsidies from the Feds alone. One has been threatened with lawsuits whenever their profit margins got high, the other continues to receive grants and investors despite rarely turning a profit. The one rarely builds new installations, the other depends on installations that aren't built yet. YET THE RETURNS TO SHAREHOLDERS ARE ROUGHLY THE SAME. This isn't immediately obvious because of the high volatility of both, but the reason is oil giants own a cash cow and choose to return excess funds as dividends/buybacks to shareholders and/or pay bonuses to employees, while green energy firms can ascribe all growth to increasing valuations and market share.

Likewise, it's a statistical fact that the best time to invest is right after a crash. But who has reserves in the form of cash or bonds when cash loses value and bonds give meager returns? Likewise, the margin loan individual investors get is highly correlated to the Federal Funds Rate, and even if you don't use margin the price of options factors in the Federal Funds Rate.

Likewise, we all know that buttcoin has no real world value, but the amount of serious investors who put some of their money behind crypto exchanges is prodigious. The most common excuse was "diversification benefit," but everything buttcoin has a leveraged inverse correlation to interest rates as it was all held together by lies and borrowed money. And don't take this from me, kind sirs, as Jerrome Powell expressed the SEC's official position that they believed most if not all such firms were breaking the law.

Even more mature technology firms have shown their dependence on borrowed funds. So many have announced layoffs this year as to give the casual reader the impression another Great Depression has come, but statistically unemployment is very low this year with twice as many job openings as job seekers. You can see how men like Mr. Bezos and Mr. Gates can go a whole career getting bigger with borrowed funds and paying little if any taxes, as they are tax-exempt on the way up and can simply give their huge incomes away later whilst living off the proceeds of their original investment. There's nothing wrong with that, just know that's what businessmen are incentivized to do despite the extreme risks involved.

And I know that there are people from the Fed reading what people are thinking around here (Hello kind sir!). So consider this an open letter to the Federal Reserve Board. You have the power to fundamentally change the structure of markets through Darwinistic incentives, but cannot control the vices of men. In order to reduce long-term volatility and make it more difficult for fraudulent and unprofitable firms to cause disasters, a Federal funds rate of 3-5% should be targeted. This would mean that stocks will only slightly be more profitable than bonds, and only those who really do need to borrow will borrow. An alternative solution is to target an inflation rate of 0%, meaning a lot of dumb money would be removed from the market and cash reserves will be more available from many sources.

We can all see what these nominally small changes can do to the global market. We can see what happened during the quantitative easing of 2020-2021, and during the quantitative tightening of 2022. If the current policy continues into 2023, we can expect to see a yet further purge of fools and frauds. I, and many on this thread, strongly recommend the Federal Funds Rate stay roughly where it is for the foreseeable future and bring stability to the overall market and so high-risk high-reward investing will remain relatively niche for autists like us.

​

Signed,

-A Professional Historian, Amateur Investor.