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I was on an airplane for the first time for business in a while and when I woke up from my nap I found my self staring at CNBC on the DirecTV seat back display. I never watch CNBC so I was attracted to the talking heads, who were silent since I didn’t have earphones in. I kept thinking I was watching ESPN with all the sports metaphors, blinking lights, constantly changing headlines, and tightly coifed and good looking men talking at me in rapid fire.
Between a headline about Carly Fiorina exploring a run for president and Zebra Technologies equipping all NFL players with tracking devices I noticed one about companies who were raising prices to inflation proof their business. At least, that’s what I thought it said since it flashed up there quickly between a headline about “Steel is on Fire” and then a video of Warren Buffett walking around without a headline so I had no idea why they were showing him.
The inflation proofing headline stuck in my head. We’ve had a very long period of low to no inflation, at least based on the way the government calculates it. While my cynicism around government math and how inflation is calculated is substantial, there isn’t much question that since 2008 capital has been extremely cheap. Fred Wilson wrote a great post titled The Bubble Question a while ago where his punch line was:
It is the combination of these two factors, which are really just one factor (cheap money/low rates), that is the root cause of the valuation environment we are in. And the answer to when/if it will end comes down to when/if the global economy starts growing more rapidly and sucking up the excess liquidity and policy makers start tightening up the easy money regime. I have no idea when and if that will happen. But until it does, I believe we will continue to see eye popping EBITDA multiples for high growth tech companies. And those tech companies with eye popping EBITDA multiples will use their highly valued stock to purchase other high growth tech business and strategic assets at eye popping valuations. It’s been a good time to be in the VC and startup business and I think it will continue to be as long as the global economy is weak and rates are low.
But I think cheap capital is only half of the equation. The other half is ever increasing labor costs across all aspects of the wage chain. When I was in business school in the 1980s, we talked a lot about the productivity paradox. The premise was that computers and automation would drastically improve productivity, making labor less important as tasks were automated, resulting in lower cost of labor.
As the technology industry rapidly evolved, the notion of non-productivity kept coming up. Nicolas Carr’s HBR Article “IT Doesn’t Matter” was probably the capstone piece around this and how companies could take advantage of the commoditization of IT, rather than how IT was a transformative input into companies and societies.
Suddenly, in 2010, technology was disrupting everything and the technology industry was booming. By 2013 everyone was talking about a bubble, even though the companies being created this time around were substantial. Once again, wages for IT employees and computer scientist were skyrocketing and suddenly coding schools were popping up everywhere, to the point that people are now saying that Computer Programming Is a Trade; Let’s Act Like It.
Capital remains incredibly cheap, so it’s flowing into wages. But that’s only at the high end of the market around technology jobs. At the other end of the spectrum, we have the famed jobless recovery with the elimination of massive numbers of jobs that previously existed, especially in industrial and Fortune 5000 companies. While this is happening, we have an entirely new class of entrepreneurs, or self-employed, being created by companies like Uber.
Yeah – this shit is super complicated and it plays out over a long period of time. In fact, it might only be really possible to understand what is happening in hindsight. But the combination of cheap capital and expensive labor has created a very powerful economic dynamic which right now is driving massive innovation across virtually every industry sector around the world.
We know that extremely low cost of capital will not last forever. We know that eventually there will be real inflation again. And we know that wages can’t increase endlessly. I wonder what happens to the allocation of capital, entrepreneurship, and the impact on society when capital gets expensive again?