The Federal Reserve Is Surely Not the Cause of Silicon Valley’s Swinging Ax

While the exclamation “that’s impossible” gives rise to a lot of slammed doors in the normal world of commerce, it cannot be stressed enough that the business environment in Silicon Valley is anything but normal. In northern California a track record of failure routinely appeals to VC investors, as do outlandish business ideas that elicit “that’s impossible.

Failure doesn’t hurt you in the technology space simply because just about every tech start-up goes under rather quickly. Furthermore, a winning track record likely signals that you’re not attempting the commercial leaps that most would respond to with “that’s impossible,” but that pay off incredibly handsomely when it turns out that what’s impossible is actually possible.

The intrepid leaps that are the norm in the Valley came to mind while reading Washington Post columnist Catherine Rampell’s recent column about a presumed link between Federal Reserve interest rate hikes and layoffs in the technology sector. Rampell contended that a decade plus of “ultralow interests rates generated a tide of cheap money” such that tech high flyers “easily got financing.” That’s one way of looking at it, but Rampell might agree that what the Fed does has no real impact on the financing of technology companies. It doesn’t because as she notes, these companies have long only offered only a “faint promise” of success.

About the Fed and interest rates, it should first be said that the central bank can’t make money “cheap” any more than Mayor Adams in Rampell’s New York can decree apartments cheap. We borrow money for what it can be exchanged for, at which point markets set the real cost of credit just as they set the cost (nosebleed) of apartments in New York. If the Fed could actually control the price of borrowing, it would work as well as rent controls did in Manhattan. Meaning not at all. Markets always speak.

Furthermore, Rampell would likely agree that Fed rate fiddling is of little consequence in Silicon Valley as is. As she once again notes, the startup culture that defines business in the Valley is dominated by businesses with a “faint promise” of success. What her correct description indicates is that a Fed that projects its influence through banks can’t much influence the funding of businesses that banks can’t touch with a ten foot pole.

How we know the above is true is that the banks the Fed tries to manipulate the lending of are presently paying very small amounts of interest on the deposits in their care. What the latter tells us is that banks are taking little to no risk with loans, but per Rampell, Valley startups have but a “faint promise” of success. In other words, startups are the riskiest of the risky. If banks financed what fails stupendously the vast majority of time, they would be insolvent.

Rampell writes that “a lot of these [Silicon Valley] business models were simply not built for a world where borrowing might someday be costly.” This is where Rampell errs. She surely knows that lending has nothing to do with the business models of startups, and more importantly, it most definitely has nothing to do with VC funding models.

The simple truth is that there’s no interest rate that would compensate venture capitalists in Silicon Valley. Since they’re backing businesses pursuing the impossible, there’s no way they would loan money to what might vanish soon. Better yet, they can’t lend. They can’t simply because the very few winners pay for all the losers that populate VC funds. If VCs were in the business of lending, and in particular at rates the Fed vainly attempts to set, they would no longer be VCs. The losses in funds constructed like this would much more than drown out the wins.

Which is why Rampell’s assertion that the Fed is the source of Valley malaise doesn’t ring true. More important, and as I note in my latest book, The Money Confusion, Valley VCs were tightening up on funded startups well before the Fed acted. In the technology sector financing is always incredibly expensive, and markets always talk above the delusional machinations of would-be central planners. What the Fed does really doesn’t matter.