In economics, we are used to talking about casualties of high interest rates, companies that go bust under the pressure of debt, people who default when the cost of servicing a loan increases, or even government default when long-term interest rates rise. But what about the casualties of low interest rates? This week we’ve see three: the bankruptcy of WeWork; a reminder of the total collapse of the NFT market; and the conviction of Sam Bankman-Fried following the disintegration of his crypto empire. While these cases may seem far away, the same forces, in time, may bring down some highly leveraged local heroes.
If the rate of interest is kept too low for too long, all sorts of companies and ventures that wouldn’t otherwise have been financed, get their hands on money – and some of them blow it. There is nothing more worrying for an economy than the emergence of so-called “unicorns”, tech companies with a valuation of over $1 billion. Often seen as a sign of economic dynamism, these unicorns are often little more than mirage companies, with no business plan, no profit and no future when the rate of interest rises. (By the way, much of Dublin’s overpriced commercial property investments are little more than mirages.) WeWork was a unicorn, so too was the FTX crypto exchange and the NFT craze was unicorns on psychedelics.
WeWork was a glorified subletting company, whose main so-called innovation seemed to be a lick of paint. The brainchild of a photogenic CEO, Adam Neumann, the company leased offices from owners on long leases and then rejigged them on more expensive short leases. It rented them out as shared spaces with “hot desks” to accommodate a new type of worker, a nomadic creature who wanted urban workspace. Essentially, it was a time horizon bet – longer leases are cheaper than shorter ones and if interest rates remained low, the company could finance the long-term cheaply and extract rent expensively in the short-term.
Ten years ago, with commercial property still lagging after the crash and interest rates moving towards zero, this rather plodding insight was embraced enthusiastically by cash-rich investors. In the lead-up to an initial public offering in 2019, the company was valued at $47 billion, but the company was losing more than $200,000 an hour. Since it was founded in 2010, WeWork has not once turned a profit. Last Wednesday, WeWork, which leases office space in 777 locations across 39 countries, filed for bankruptcy. This company is one of Dublin’s biggest office tenants. These leases will come on the market now. Who is going to buy them?
There never was a business, just a mirage of hype. Crypto unicorns fed on low interest rates, seducing investors into opting for growth at some point in the future
The crypto collapse is well documented but again the stellar rise in this global scam, where invented tokens are marketed as money, was facilitated by zero-interest rates. As long as the cost of borrowing was zero, the cost of speculating is low. If it didn’t cost anything to believe in a fabricated future and enough other gullible sorts were speculating, why not take a punt on crypto? Without zero interest rates, this silliness might not have taken off with such vigour. Last week, Sam Bankman-Fried, the founder of collapsed crypto exchange FTX, was found guilty of all seven criminal counts against him. The FTX founder faces a maximum sentence of up to 115 years in prison.
He was taking people’s money, which was on deposit in his exchange, funnelling these dollars into his own fund and, to pay everyone, he created his own crypto token, known as FTT, which he hoped to swap for the real dollars he had lost. In this era of zero interest rates, many reputable investors lined up to back this guy. There never was a business, just a mirage of hype. Crypto unicorns fed on low interest rates, seducing investors into opting for growth at some point in the future.
The global crypto market stands at around $1.33 trillion – down from a peak of around $3 trillion back in 2021. The weekly average volume of trading in a 24-hour period has fallen from a height of $244 billion in May of 2021 to just $36 billion in recent weeks. The bottom has fallen out of this market. If some prices have held up, they’ve only done so as they are being manipulated by large existing holders managing the decline. Volumes tell us more than prices in falling markets. Prices can be stage-managed, trading volumes cannot.
The emperor and clothes came to mind far too late and investors and speculators realised their real money was trapped in businesses that were committed not to building wealth but to destroying value
If crypto was a mirage, what about NFTs – digital artworks, copies of originals, flogged as the real thing. Justin Bieber spent $1.3 million on something called a Bored Ape NFT in January of 2022. It’s now estimated to be worth $59,090. Global NFT sales declined last year by 89 per cent from a peak of $5 billion in January.
These crazes – fancy office leases, pretend currency or fabricated art – are all products of ultra-low interest rates and they were kept alive by incessant waves of propaganda about their cutting-edge technology creating a bright new world of dissenters and techno-evangelists. In reality they were just spending other people’s money. Once interest rates started to rise, the price of money did too. People re-examined these futuristic claims and the people making them. The emperor and clothes came to mind far too late and investors and speculators realised their real money was trapped in businesses that were committed not to building wealth but to destroying value, burning through investors’ cash.
One of the most influential ideas in economics is that of creative destruction, coined by Joseph Schumpeter. This is the essential fact of the capitalist system, where good businesses replace bad ones in a process that echoes natural selection in evolution. This is an ongoing process, which is never static – unless certain costs are subsidised or held too low. One of those costs is the cost of money, or the rate of interest. If this is held too low for too long, the process of natural selection fails and companies and businesses that would otherwise fail quickly are kept alive for far longer than they deserve. This is what happened in the past 10 years. Now the evolutionary chickens are coming home to roost.
What we saw this week is only the start of it.