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It’s not a bubble until it bursts -

It’s not a bubble until it bursts

If you work at a startup in Silicon Valley it’s impossible to go around without hearing about THE bubble. Everyone has an opinion – it’s not a bubble, it’s a bubble but only for early stage, it’s a bubble just like the one in the 90s, it’s a bubble but not for facebook, and I could go on.

Bubbles explained like you’re a four-year-old

Let’s first go to Bubble Economics 101. A bubble, which is a process, happens when assets are valued at an unreasonably higher price when compared to their intrinsic value. In other words, you’re selling chicken liver for the price of foie gras (I love food analogies!), maybe because you expect chicken liver to become as uncommon and sought after as foie gras, or maybe because you just found a bigger fool to buy at that price. A bubble is the result of an abundance of cash, scarcity of assets, or a combination of the two. A bubble is also a vicious circle since every time you buy something for an unreasonable price you’re taking one asset out of the market and injecting cash into that same market. In brief, a bubble is a legal-ish Ponzi scheme and you don’t want to be the one without a chair when the music stops.

The big problem of calling something a bubble is that you need to know what the intrinsic value of an asset is and that is a very tricky question because we like to rationalize. For example, you know what the price of bread is so it should be easy to spot overpriced bread if tomorrow you go to the bakery and they’re charging $50 for a baguette. But if this process occurs in the course of 4 years in the context of a shortage of wheat, we’ll rationalize it. If you don’t believe me, just look at gas prices. There are bubbles happening around us all the time but only a very small number of those actually get big enough to become relevant. And yes! The dating scene is very prone to bubbles.

False positives

Back to THE Bubble, you can see how evaluating the intrinsic value of startup assets is really hard – companies are private, we know very little about their business and we mostly know the good news (or you’re facebook’s PR department). But say we had access to all the numbers, would that help? The intrinsic value of a company is a function of future earnings and we’re not exactly talking about large stable businesses. You can imagine that anyone who claimed Google was overvalued at $85 IPO price is feeling pretty foolish right now. But who could tell in 2004? Would you have predicted MySpace implosion 5 years ago? Hell no!

Or would you? That’s when we get to the problem of type I errors or false positives. There is always someone predicting bubbles, economic crisis and the end of the world (BTW, it’s tomorrow so if those guys are right someone should give them a prize in the after life). You know the story, every time there’s a bubble or crisis, a few stories come out about “the guy” who saw it coming. What nobody asks is how many times that guy saw it coming and it never came. If you’re not a false positive kind of person (usually that comes with high doses of pessimism), trying to predict a bubble is like buying the winning lottery ticket. And if someone starts arguing with “the fundamentals”, please say out and loud “Bullshit!”

It is not a bubble until it bursts

When finally the bubble bursts, everyone saw it coming, and that is when the false positives and false negatives all gather around beers talking about how obvious it was and how “the fundamentals” just didn’t make sense. And they will make a ton of money writing books about how everyone was a fool for not seeing it (and they will find some random statement they’ve made in the past to prove they saw it coming all the way). That is the moment when the bubble really comes together! It’s when it bursts.

So you have three options. You can be the bitter let-me-hide-in-my-bunker-everytime-I-hear-armageddon false positive, the condescending it-was-so-obvious-that-I-never-told-anyone-about-it false negative, or you can tell those two to screw themselves, ride the wave, and raise money as early as you can. You know, once the bubble bursts it’s too late to say, “I saw it coming”.


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