The Three Types of Money Behind Silicon Valley's Rise to Dominance

Two of them are real. The third, notsomuch.

[NOTE: this is a bit that I’ve been fiddling with for the book. I keep getting stock on where it goes and how to phrase it, so I’m using this post to air the ideas out a bit.]

An image of three card monte, h/t wikipedia, the last good part of the web: https://en.wikipedia.org/wiki/Three-card_monte

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1.

Michael Saylor’s company, MicroStrategy is fascinating. (Derogatory.)

Microstrategy is a publicly traded firm, founded in 1989. For decades, it was what we might call a normal software company. They built and sold actual products, and the fate of the firm was tied up in its ability to build better (or cheaper) products than its competitors. But then Saylor caught the Bitcoin bug, and boy did he catch it bad.

By 2020, Michael Saylor decided to go all in on Bitcoin. And ever since, Strategy (they recently dropped “Micro” from their name. I’m not going to call it Strategy though, because I still have a bit of self-respect) has effectively just become a large pot of bitcoin. Any money they have, they use to buy Bitcoin. Any money investors hand them? Right into Bitcoin.

You might intuit that a company with basically no products and some overhead costs would be valued at roughly the value of its assets (the Bitcoin pot) minus overhead. But Microstrategy stock trades at twice the value of the Bitcoin pot.

There are, I’m sure, some economists who, armed with enough time and fancy theorems, could explain why this is all very rational. (With enough time and fancy theorems, one can rationalize any set of existing events.) But I suspect it is more elementary than that: Saylor, as the world’s most public Bitcoin bull, has become the mascot of a memestock. If you believe Bitcoin is the future, then you will be predisposed to buy some MSTR stock. People who like to bet on Bitcoin, but don’t want/can’t have direct exposure to it just buy Microstrategy instead. There are enough such people to double the rationally correct price.

Or, put more plainly, Microstrategy trades at double the value because that’s simply what some people are willing to pay.

This cannot go on forever. But it can go on for an unreasonable amount of time. Indeed, it already has.

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2.

A company’s stock is, in theory, supposed to reflect its underlying fundamentals. There is meant to be a direct relationship between the company’s current profits, its potential for future profits, and its stock price.

Nearly 90 years ago, John Maynard Keynes raised questions about whether this was actually the case. In his General Theory of Employment, Interest, and Money (1936), Keynes described the stock market as more akin to a beauty contest where each judge was encouraged, instead of selecting the most beautiful contest, to pick which contest the other judges were likely to select. This concept has been referred to ever since as a “Keynesian beauty contest.”

In modern parlance, we might describe a Keynesian beauty contest as vibes-based.

Tesla stock soared after Donald Trump’s November victory, not because a Trump win presaged a surge in Tesla sales, but because LolElonJustWonThePresidency. The Elon-vibes were immaculate. Tesla’s stock, today, stands at 311.47/share. That makes it nearly a trillion dollar company, with a price-to-earnings ratio of 152.69. Tesla’s last few quarterly earnings reports have been abysmal, by the way. The company keeps missing its sales targets. And that was before Elon made the brand unbelievably toxic among the segments of the public most likely to purchase an electric car.

As Hamilton Nolan pointed out, this makes Tesla extremely vulnerable.

if Tesla were to retreat even to a PE ratio of 40—comparable to that of big tech companies, which themselves enjoy higher PE ratios than industrial companies—that would imply a decline in the company’s value of 3/4. It would go from being a trillion-dollar company to a $250 billion company, only a bit larger than Toyota. That would represent a loss of around $100 billion in wealth for Elon Musk.

I am not surprised that Tesla’s stock valuation surged after the election. Whatever a share of Tesla was worth in the Keynesian beauty contest before, surely it would be worth more afterward, amidst all the braying fanboys’ triumphant howls.

I will be equally unsurprised when and if the stock craters. Live by the meme stock, die by the meme stock.

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3.

I used to say that inside every tech company there are really two businesses.

There’s the actual business, which brings a product to market and monitors success by comparing revenues and expenditures. Actual businesses are generally evaluated based on their capacity to bring in more revenue than they spend in a given year.

Then there’s the imaginary business of building the future. Imaginary businesses aren’t evaluated on their profitability. They are judged on growth, on their ability to convince investors that today’s pricy growth will unlock unlimited future profits.

The imaginary business determines the company’s stock valuation.

I still think this is basically right, but the more I have examined the history of Silicon Valley, the more it seems incomplete.

The amendment I would offer is that there are effectively three distinct types of money that have fueled Silicon Valley’s rise to dominance. There’s (1) government contracts, (2) direct product revenues, and (3) there’s investments and financial speculation.

(Y’know the passage in Marc Andreessen’s techno-optimist manifesto where he gushes about markets? “We believe free markets are the most effective way to organize a technological economy. Willing buyer meets willing seller, a price is struck, both sides benefit from the exchange or it doesn’t happen.” …Yeah, that really only applies to #2, even under optimal conditions.)

One could do a reasonable job explaining the evolution of Silicon Valley, and the broader tech ecosystem, just by focusing on how the balance between these funding sources have changed over time.

• There’s the origin story in government contracts (authoritatively documented by Margaret O’Mara), in which the rise of the semiconductor industry was effectively just a byproduct of the space race.

• There’s the transition period, when the government dollars from the DoD taper off, and the industry starts to focus on building a market for consumer products. That leads, among other things, to spinning off NSFNET and opening it up for commercial activity.

• Then there’s the dotcom boom, when tech companies started going public at wildly inflated valuations. This wasn’t the origin of speculative tech finance (Venture Capital has a longer history, tied up in modifications and carveouts to the tax code), but it was the critical acceleration point. VC used to be so much smaller than it is today.

• And there’s the malaise in post-dotcom crash years, when VC money froze and the DoD got very interested in funding any technologies that could help them identify and surveil terrorist networks.

• Then finally we have nearly 20 years of zero interest rate phenomena, with VCs minting absurd returns at minimal risk, and paying next to nothing in taxes.

I suspect that there is some mix of these three inputs that would be, well, healthy. If everything is government funded, we would not have nearly the rate of growth and technological development that competitive markets can spur. If everything was consumer products, we would have no internet access in rural areas, and nowhere close to enough basic research. A great many social goods are only achieved with government subsidy. And with no speculative finance — no IPOs, no VC funding rounds, the inputs for launching and scaling new companies and products would barely exist.

But I am quite confident that the current mix is deeply unhealthy. Speculative finance completely overshadows the other two. Companies are valued on the basis of their vibes — their aura of futurity. If the Keynesian beauty contest is just a sideshow, then it is really just a quirk.

And that’s a problem because, to quote Stafford Beer’s maxim, “The Purpose of a System Is What It Does.”

(we should all read The Unaccountability Machine by Dan Davies, btw.)

If the vast majority of a “for-profit” company’s fortunes are tied up not in generating profits, but in generating vibes, then we will inevitably be left with a vibes-based economy. The actual marketplace is little more than window dressing.

The central problem with Venture Capital is its size and scale. VC is only productive and useful so long as it is relatively small. The same goes for financial speculation, relative to the actual production of goods and services. It can only serve a useful purpose if it is not so large that it warps the economy.

If the money is all in vibes and gambles, then we will have a vibes-and-gambling based economy.

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4.

John Ganz contributes a helpfully excessive example in his recent review of Palantir CEO Alex Karp’s new book, The Technological Republic:

Palantir can already boast of having the Department of Defense, the Department of Homeland Security, the CIA, the Marine Corps, the Air Force (and so on) as customers. Not to mention Amazon.com Inc, Airbus SE and Merck & Co Inc. For all these behemoth clients, the company’s revenue is a relatively modest $2.87 billion. But at the time of writing, Palantir’s price-to-equity ratio is hovering around 600 times earnings, and its stock was the S&P 500’s best performer of 2024.

Palantir-the-actual-company is a modestly profitable government contractor. And, with Trump in office, it is reasonable to suspect Palantir will be benefit from some additional government business.

But Palantir-the-stock is 600 times the actual company. That is a castle in the clouds. Its pure fantasy, a meme stock whose sole supporting rationale is “some people are willing to pay it.” So naturally Palantir also engages in thought-leadership, through podcasts and public speeches and blog posts and book tours. The though-leadership isn’t meant to drum up product sales. It’s meant to sustain and extend the stock bounty. Palantir has to maintain the aura of futurity, because the stock is where the money is.

And this, mind you, is an utterly hollow number. If all of Palantir’s stockholders tried to sell their stock, the price would immediately crumble by… approximately 600-fold (give or take). It is quite literally a confidence game. If the vibes shifted, and investor confidence were to fall, then the stock would tank regardless of the government contracts or the product sales.

There are tricks that the tech-rich use to turn these fake speculative dollars into real money. The simplest of these tricks is to go to a bank and say “I would like a billion real dollars, please. You can charge me a nice little interest rate. We can use my stock holdings as collateral.”

They love this trick, both because it means they don’t have to sell stock (which could set off a deadly vibe shift) and because they don’t have to pay capital gains taxes on the loans.

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5.

If what your company mostly does is “turn government grants into research or public services,” then I think that’s fine. (Though I’d like us to adopt the suggestions from Jennifer Pahlka’s book, Recoding America. Government procurement processes sure could be improved, if we still lived in normal times...)

If what your company mostly does is “build products that people want, and sell them at a profit,” then that’s fine too. I’ll want sensible regulations, antitrust enforcement, and, y’know, taxes. (Marianna Mazzucato set out a good blueprint in her 2011 book, The Entrepreneurial State.) Markets are very useful tools, so long as they are bounded.

But if what your company mostly does is “roll out products and promises that goose our stock valuation,” then you’re just a gambling company. Even if that sometimes has positive byproducts, it’s a bad system and ought to have a metric ton of friction.

At an industry-wide level, there will always be a mix of these three inputs. When that mix gets out of hand, things go haywire. The problem isn’t the existence of these speculative finance endeavors; The problem is their scale. We’re living in the aftermath of too-much-speculative-finance/not-enough-regulatory-friction/nowhere-near-enough-taxation right now.

In the long run, of course, this all cannot last. But, to morbidly quote Keynes once again, in the long run we are all dead. I do not know how or when this house of cards collapses. I am not convinced it will be soon. And that is quite bad, because the larger the bubble, the louder the crash.

In the short term, a reasonable first step is to at least recognize this economic sector for what it is.

The value of much of the tech industry — indeed, most of the largest companies that dominate the Dow and the Nasdaq — is based primarily on vibes. It’s a gambling and speculation-based economic system. It is inaccurate to call these companies “for-profits,” because so little of their economic value is based in profit-generating activity.

So we ought to view all of their product announcements and public declarations through a vibes-based lens. The one skill that Sam Altman and Elon Musk clearly excel at manipulating the Keynesian beauty contest — signaling that this is what other people judge the future to look like.

Denying them that power, or at least dampening it, is a critical first step to building an internet that responds to real people, rather than imaginary ones.