Greater-Fool Economics

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Venture capital, as the arbitrage of innovation, is the poster-child of greater-fool economics. And groundbreaking innovation that spawns immediate global impact deserves so much better. Less apparent is how greater-fool economics haunts us all.

 

No meritocracy in sight

Now, for many institutional and private investors in venture capital that kind of public “coming out” of venture’s economic foolishness, along with the deplorable performance of quite a few Silicon Valley “emperors of venture capital”, preceded by the other 99.4% of firms that don’t produce renewable venture style returns to investors, maybe the impetus to simply hedge away from the overwhelming troubles in venture capital, and thus away from groundbreaking innovation as its investable attribute. Our economic “geniuses” get to chalk the aforementioned departure, attrition, and subsequent bottom-feeding up to the natural dynamics of underperforming markets, and life goes on.

The general partners of venture capital firms, too, get to save face by now publicly questioning their assertions of whether venture capital could ever scale, the market for technology innovation may be depleted, the “IPO windows” have mysteriously closed, our government is supposedly working against them, we have run out of visas to enslave more subprime entrepreneurs, and it is now supposedly impossible for general partners to make any money. If you tend to believe them, feast yourself on the venture capital roast, I wrote a while ago.

Now, when the going gets tough, I see and hear longtime general partners seriously contemplate a move into cushy retirement from their meritless management fees of stacked and parallel vintages of failure, or look to ride the coat-tail of yet another financial system or asset class in which economic fallacies are however to be uncovered. The remainder of “the club” stays on as a system driven by pathetically common and amoral reasons, that outsiders worship because they do not understand.

The vast majority of limited partners and general partners who deploy the safety hatch, drop out of this mess personally unscathed, leaving disillusioned entrepreneurs with a boulevard of broken big-ideas, the government with the attrition of 20% of GDP innovation could produce, and the abuse of trust from a pension-saving public, as the ultimate greater-fools with massive economic scars behind.

If venture capital had deployed a pure meritocracy (as a general partner publicly once claimed), the performance of venture capital would have left equal retribution of its performance to all parties involved, not the imbalance described above.

But the real problem in venture is not the monetary reserves spent by venture firms – and lost – but the opportunities they missed in supporting innovation that could have changed the world, along with the resulting atrophy of GDP we can no longer afford to lose.

 

Perfect harmony of greater-fools

Ten levels of bottom-heavy diversification in venture can only exist with the permission of nine levels of greater-fools, and flat-out economic unconsciousness.

Limited partners are greater fools because they allow the asset diversification they control and understand, to be padded with a totem pole of embedded risk (regardless of the investment thesis), combined with an almost endless fragmentation of risk and dollars, they have no clue about.

Venture capitalists are greater-fools because they think they can cut corners off their waning performance through the avoidance of prime risk, comfortably forgetting that the deployment of subprime risk can only yield subprime returns. Under the black box of in-transparency, they concoct an elaborate scheme of staged investments, avoidance of early-stage risk, investor socialism, price-fixing, collusion, resale of private shares to secondary investors and pump-and-dump sales to newly created brokerage firms.

Many wannabe entrepreneurs are greater-fools because they salivate for just a sliver of money that gets them started, blissfully lulled by Silicon Valley’s pageantry of false positivity, forgetting that real innovation with a propensity to change the world is not fed by a uniform investment strategy of spoon-fed $250K tranches.

The harmony of greater-fools works in perfect concert to infect a new and ultimate greater-fool: the public.

The public who has had no prior insights in what precisely composed the valuation of the growing companies in question, and at IPO is quickly under-sold by a stock-market (again, in violation of free-market principles) that gives preference to those who fast-trade to diversify their gambling risk over the intrinsic value of the company.

And this we call the pride of the world. No wonder value-investor Warren Buffet “does not understand venture.” Neither should we. In its current economic state, venture is modern-day robbery.

 

Economic fail machine

Venture capital has been unable to grow up to become a viable asset class for investors. Not because the investable attribute, innovation, with an 80% adoption greenfield has run out of steam but because the economics of its financial system by design perpetuates an institutional fail machine.

Greater-fool economics in venture not only destroys our capacity to innovate but keeps rewarding those who find new opportunities to sell to greater-fools.

But we give people in the venture business too much credit. Not just because we keep believing their promises amidst -30% 2-year post-IPO values, but also because we think they do that intentionally and with great malice. Sure, those in the venture business personally don’t lose much sleep or money over their demise, but they would like to make more. And they could.

I discovered the root-cause of venture’s dysfunction originates in our economic fail machine.

That we have created economic systems that perpetuate the mediocrity above, and venture capitalists take the derivative train for a glorious ride, as long as they possibly can. Our foundational economics are so broken that a venture capital rocket shooting for the moon will never reach its destination because its prior economic stages don’t deploy correctly.

The failure of venture capital comes from the flawed economics of asset management, which in turn comes from the flawed implementation of macroeconomics at the top of our economic food chain. So it behooves none of the greater-fools to hedge away from the problems in venture capital, for they are symptomatic of the recurring issues in all asset classes and the greater economy, that will meet its maker anywhere.

Let’s list some fallacies (across the chain) that turn those who do not pay close attention to economics into easy targets for greater-foolery:

  • Why do we promote ourselves as the leader of the free world, while none of the economic systems we deploy, adhere to free-market principles?
  • Why do we promote the pursuit of so-called free-markets, without specification of what constitutes one?
  • Why do we govern free-markets, without the specification of what maintains one?
  • Why do we expect any marketplace to auto-correct with economics that violates free-market principles and thus non-renewable?
  • Why do we expect our static implementation of 200-year old economics to stay in tune with the ever-changing dynamics to which it is applied?
  • If sustainability is our top priority, why then do we deploy finite financial systems eleven times the size of production, suppressing our competency in the latter.
  • Why do we deploy economics designed to optimize markets, while the construct of a market in actuality does not exist?
  • Why do we expect to grow our pensions through a stock-market that violates free-market principles, and thus by definition forms a misplaced proxy of the value of its listed companies?
  • Why do we deploy economics that defines unique roles for either side of the esoteric construct of supply-and-demand, while in reality, they apply to people – who can and will partake in both?
  • Why do we deploy economics that governs the unique roles for supply-and-demand, while in the pursuit of a free-market supply-and-demand require the same arbitrage?
  • Why do we attempt to deploy economics that vigorously tries to regulate supply-and-demand, rather than their exchange?
  • Why do we expect outlier investor returns from a funnel of 10 levels of bottom-heavy diversified and embedded risk?
  • Why do we expect to get access to a free-market model, with winner-takes-all propositions, through products that violate free-market principles?
  • Why do we expect to produce prime returns from the deployment of subprime risk?
  • Why do we expect to yield authentic socio-economic value and public trust with investors not held to the same meritocracy as entrepreneurs?
  • Why do we expect other countries to follow in our footsteps of economic foolery, given the above?

 

Real change

Our problems today are much more significant than those of venture capital (as our youngest asset class) alone. And the issues in venture capital made me as an entrepreneur wonder some five years back who allowed this foolery in the first place.

I went looking for answers.

None given, I decided to take action and reinvent economics as we know it. Because if we want to stay ahead and renew economically, we need to build the most reliable yet uncomplicated economic system we can think of in support of the evolution of humanity. Only then can we stay in tune with the entrepreneurial culture and resources we have at our disposal.

I now know we can reinvent ourselves and the world, but only with modern economics designed to breed authentic merit.

Not with the Neanderthal stick of outdated economics, we so frequently use to beat greater-fools into submission, which creates friction with people and countries culturally not yet ready to fit our one-size-fits-all economic mold. But with respectful and adaptable economics that apply to, and inspire all citizens of this world.

Now is the time for us to lead by economic excellence, rather than continue to lean on greater-fool buffoonery.

 

 

Discuss

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Georges van Hoegaerden
Georges van Hoegaerdenhttps://www.method41.com/georges
Georges is the Founder and Managing Director of method41. From analyzing the workings of policy, capital, and innovation, Georges noticed how these siloed constructs are woefully incompatible with the principles nature deploys to produce regenerative performance. With humanity stuck in a fabric of its own making, Georges set out to reinvent the operating-systems of humanity to fix the theory that determines what humanity can discover, aiming to fundamentally improve human adaptability to nature's entropy.
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