When should an entrepreneur or firm consume capital instead of accumulate it? Earlier this week Google executive chairman Eric Schmidt debated techno-guru-investor Peter Thiel regarding innovation and finance — and never once used the word capital.
Reason – among many other sites – is covering this story and published Thiel’s following comment:
I’m Libertarian, I think [technological stagnation is] because the government has outlawed technology…I think we’ve basically outlawed everything having to do with the world of stuff, and the only thing you’re allowed to do is in the world of bits. And that’s why we’ve had a lot of progress in computers and finance. Those were the two areas where there was enormous innovation in the last 40 years. It looks like finance is in the process of getting outlawed….
[Google]has 30, 40, 50 billion in cash. It has no idea how to invest that money in technology effectively. So, it prefers getting zero percent interest from Mr. Bernanke, effectively the cash sort of gets burned away over time through inflation, because there are no ideas that Google has how to spend money….
if we’re living in an accelerating technological world, and you have zero percent interest rates in the background, you should be able to invest all of your money in things that will return it many times over, and the fact that you’re out of ideas, maybe it’s a political problem, the government has outlawed things. But, it still is a problem….
the intellectually honest thing to do would be to say that Google is no longer a technology company, that it’s basically ‑‑ it’s a search engine. The search technology was developed a decade ago. It’s a bet that there will be no one else who will come up with a better search technology. So, you invest in Google, because you’re betting against technological innovation in search. And it’s like a bank that generates enormous cash flows every year, but you can’t issue a dividend, because the day you take that $30 billion and send it back to people you’re admitting that you’re no longer a technology company. That’s why Microsoft can’t return its money. That’s why all these companies are building up hordes of cash, because they don’t know what to do with it, but they don’t want to admit they’re no longer tech companies.
Brian Doherty of Reason asks readers if there was a way to poke holes into Thiel’s position.
The problem is, on one hand Thiel is accidentally right. Though in fairness it is not Google’s fault for the Federal Reserve’s low-interest rate policies (LIRP) and QE policies.
The problem facing innovation as a whole – one that I argue at length at Prometheus Unbound – has to do with capital structure. It is the Federal Reserve’s fault – not Google’s – for manipulating interest rates (no offense LIBOR-gate) and thus creating a poor investment climate, poor incentives to accumulate capital.
If I may quote myself, there is actually a two-front economic war on the development of technological innovation and building a singularity.
National debt is cannibalizing and monopolizing funds that could otherwise be spent by individuals and enterprises on innovative products and services. This same debt further crowds out private competition and productive endeavors as government agencies continue to promote national taxpayer-financed initiatives.1
This phenomenon creates a disincentive to compete with national agencies working on similar projects; after all, how can you convince a VC to privately invest in space flight when nearly a dozen government agencies worldwide already do that — you have to compete against what your taxes provide!2. In addition, skilled human capital is tied up in national programs and they are apriori ducat-for-ducat less productive in government-managed projects than in private endeavors.3 Imagine the innovations that could come from startups if this human capital was no longer tied up in impractical, unproductive Big Science projects.
The other attack is inadvertently from central banks, whose artificially low-interest rates, and sometimes zero-interest rates (ZIRP), creates a disincentive to save as well as inflationary conditions that drive up the price of commodities, rare-earth minerals, and other materials that are used in the construction of smartphones, telecom gear, computers, fab tools, and robots.45 In order to finance capital construction, in order to finance research, in order to finance an enterprise someone has to save.
When interest rates are being systematically suppressed globally this distorts time preference; it will cause planned investment by entrepreneurs to exceed planned savings by consumers. Or in other words, ZIRP signals to entrepreneurs to consume capital (borrow credit) which ultimately leads to malinvestment in a particular asset class or classes.6 As a consequence, because time preference is being distorted, market participants who would otherwise be saving or abstaining — and thus replenishing the stock of capital — take out loans to finance dubious projects that would otherwise not have been undertaken if interest rates were higher. This leads to an unsustainable boom and inevitably a bust.7
The end result, on top of innovation stagnation, is that this environment hinders consumers from being able to purchase high-quality computronium, and higher commodity prices have an unseen effect on manufacturers who are pinched from being able to produce and sell relatively cheap devices into consumer markets.8
Another problem with Thiel’s argument is that he, as an outside observer, is claiming to know what is and is not the right amount of war chest a company should and should not have. Unfortunately, there is no such thing as a “right” amount — it is entirely a decision left for market participants to figure out. Perhaps tech firms would be better off accumulating $100 billion in capital assets. Perhaps only $1 billion. It is impossible to know apriori.
Perhaps Intel’s recent $2.1 billion investment in ASML will ultimately be a poor decision in the long-run. Maybe if the Federal Reserve and other central banks were not suppressing interest rates and trying to reflate their way out of a recession — interest rates would be much higher. And thus the decision makers at Intel (e.g., asset managers) would have faced a set of different incentives to work with — maybe they would have done a share repurchase instead. Or issue a dividend. Or create a skunkworks subsidiary.
Similarly, if interest rates were 500 basis points higher, firms with relatively large war chests like Google and Microsoft would also have alternative investments to consider. Consuming capital is not always the most efficient choice — in fact, one could argue that there has been too little capital accumulation going on in the past five years and note enough accumulation — hence massive imbalances that various purging actions (e.g., recessions) are trying to rectify but cannot due to government intervention.
One last quibble: the central planners at national banks and treasury departments are (unintentionally) creating a climate of uncertainty (e.g., bailouts, subsidies, nationalizations) that sends conflicting signals to market participants. Perhaps tech firms such as Google or Microsoft are holding out for more certain fiscal environments. (For those interested, as an aside, Ludwig Lachmann made an entire career discussing the role uncertainty played in human action and economic coordination.)
For a thorough discussion regarding the boom-bust cycle, see p. 40 in Interventionism: An Economic Analysis by Ludwig von Mises.
- For a more detailed exposition as to how and why government funding of science crowds out private research see The Economic Laws of Scientific Research by Terence Kealey. [↩]
- In 2001 Andrew Beal attempted to break the monopoly power NASA held on space flight. If Scaled Composites could put a human in orbit on a shoe-string budget, what could taxpayers do with monies that were returned to them? The private sector would have billions to spend on research and development if tax funds were returned and used more efficiently through private finance [↩]
- See The Economic Laws of Scientific Research by Terence Kealey, in particular chapters 9–12. [↩]
- Benchmark interest rates set the bar for every financial instrument; its impact is felt across the entire financial industry. The fight over capital did not end with the death of Marx, the breakup of the Soviets, or the dispersion of the professional protesting class in Seattle. [↩]
- See Capital and Production by Richard von Strigl. [↩]
- Malinvestment and asset bubbles can and do occur across the entire spectrum of industries (e.g. tulips, real estate) including notably the dotcom tech boom of the late ‘90s and early ‘00s. Beginning on February 1995 the Fed lowered rates from 6% to 4.75% in 1998. Malinvestment occurred in part because time preferences were distorted by artificially low benchmark interest rates — rates that signaled to entrepreneurs that credit (capital) should be consumed. [↩]
- In economic literature this is called a boom-bust cycle and is an integral part of the Austrian Business Cycle theory. The Soviets and, in particular, Gorbachev recognized at the end that their capital stock was depleted — the planners had consumed so much capital that they could not maintain the very machines needed to make replacements for the machines, let alone advancements. The opposite of capital consumption is capital accumulation. See The Theory of Money and Credit by Ludwig von Mises, The Mystery of Banking by Murray Rothbard and “The Soviet Machine-Building Complex: Perestroyka’s Sputtering Engine” from the Office of Soviet Analysis published by the Directorate of Intelligence. [↩]
- Computronium is a term used to describe programmable mass. It has been used in a number of science-fiction books to speculate the material future of post-singularity civilizations. With the advent of the Z3 from Konrad Zuse, humanity has slowly converted ‘dumb’ matter into digitally programmable matter. See Accelerando by Charles Stross. [↩]