[subjectHarold]

Monetary policy is everything. Read financial history.

VCs aren't some unique species that have cracked investing. Human nature is the same as always: people will do stupid stuff. If someone turns up with a check for $100m, you don't check to see whether you can invest it safely. You become a true believer, you gather assets, and if you weren't a true believer at the start you will be after you make enough...it always ends badly but this is why cycles happen.

In fact, the last cycle has been particularly unusual because we have actually see the bad firms driving out the good ones (I don't know about VC but it is happening everywhere else). And this is definitely due to monetary policy.

You are right. At the level of the investment, people aren't saying we should seed this company because of monetary policy...but no-one says this in any bubble. Rather what happens is that the demand for securities goes up and finance finds ways to fill this demand. Human nature being what it is, this always ends badly.

To say this another way: people will find endless ways to rationalise a bad decision. And if someone is paying you to make bad decisions sound good...well then, what do you think will happen?

Btw, just generally, I think VCs are less sophisticated than the average investor. The current environment has just been very forgiving. I don't think we will see anything like this again (if central bankers lose control which seems inevitable), literally firms with billions in cumulative losses trading for $10bn+. These IPOed firms will probably destroy hundreds of billions in capital alone.

[digitaltrees]

I studied financial history extensively. I wrote a paper in law school about the origins of the financial crisis and studied most economic and financial panics for 200 years. Monetary policy is rarely the most important factor. Trade policy, Fiscal policy (government spending across national, state, local and community), Regulatory incentives, technological changes whose importance is overestimated or underestimated, Social demographics, and human psychology are all way more important than monetary policy both in contributing to bubbles and fixing the crisis that follows.

Your answer itself hints at how important human psychology is. 'People do stupid stuff'. Robert Schiller won a Nobel price and said basically that.

Go look at the interest rates every year in the 90s and tell me that they causes the dot com bubble. Then ask yourself if maybe investors overestimated the possible success of many business and were willing to pay crazy multiples above earnings because the 'normal rules of business don't apply to internet firms'. When the stock was skyrocketing, psychology and greed take over as it feels like confirmation that the original thesis is correct. Bitcoin recently followed a similar dynamic. In neither case was monetary policy the major driver.

[subjectHarold]

Cool, you wrote a paper in law school. I wrote two dissertations at UG and PG level.

Monetary policy is essential, none of the things you mention are more important. Why? Because the boom can't occur without monetary policy (this is usually not obvious to people who have only looked at US financial history where capital markets are developed).

Lots of reasons are given ex-post to rationalise these movements i.e. changing technology "caused" the Canal boom...but technology is always changing. And human nature is certainly interesting...but it is an invariant (just like technological change). The enabling factor is always money. Btw, this isn't to say that, for example, regulation wasn't a factor in 2008...it was but the thing is that regulation is always a problem because when money gets loose then regulations follow.

Examples of booms without bubbles: post-WW2 in the US, financial conditions were stable in the few decades (not strictly true but for our purposes) because the the main concern of monetary policy was government finance. Another example: Japan 1960s-1992, MOF had total control over lending so no bubble (only popped when they lost it).

In these cases, you need to really understand how money is being created and intermediated. If you understand this then you understand why bubbles do and do not occur. If you look at unimportant things like technology, you only have reasons why bubbles do occur (this is the kind of terrible history that you presumably learn at law school).

You also picked one of the absolute worst examples to demonstrate your point. The Greenspan Put was vital, "irrational exuberance" and the contrast between that approach and that of a McChesney Martin (for example) is important. Even just the change in policy under Greenspan...really bad example. I tried but was unable to think of an actual example...

No-one cares about Bitcoin. We are talking about financial history, not Beanie Babies.

[digitaltrees]

Bitcoin is a good example because many people view it as an alternate to fiat currency that is “manipulated” by central bank monetary policy. Yet human psychology created a boom and a bust. We are talking about the history of asset bubbles and misalignment of capital. Why are bitcoin and beanie babies excluded examples of asset bubbles in your mind? They seem to show that People do stupid things regardless of monetary policy

My point is there is no one factor that is primarily responsible for all bubbles. There may be similar sets of factors that reoccur, but to say that monetary policy emerges as the singular most important factor throughout history doesn’t seem to me to be defensible.

Post-WW2 was a unique context because vast amounts of capital were being used to literally rebuild Europe. The US was basically the only manufacturer of scale, so I make sense that there wouldn’t be an asset bubble when there were vast numbers of projects that required capital and that were economically and financially stable rather than hype driven.

I will have to think about Japan as an example, I haven’t read the history in quite some time, I am definitely open to it being an example of a bubble cycle driven by monetary policy. My impression was that trade with the US and demographics seemed to be more a driver but I’ll look into it and post if I am persuaded.

[digitaltrees]

Lets keep it civil. You suggested to “read history”. I responded with evidence that I have in fact read relevant history thoughtfully and arrived at a different conclusion.

You provide no evidence that the factors I list matter less than monetary policy. I actually think the Greenspan Put (ie low interest rates to stimulate the economy) is a good example because many people, including, it seems, you, identify that as the most causal and important factor in creating the subprime crisis. This type of monetary policy is relatively new, yet asset bubbles have existed throughout history, even where there wasn’t even a unified currency let alone a Federal Reserve that set such policy.

In fact, evidence suggests that it was driven by a new financial business model, securitization, where loans were no longer held by banks but placed into a special purpose companies with shares of that SPV sold to investors.

Underwriting began to be meaningless as the companies originating loans wanted more volume because they got fees and held no risk. Investors were told that financial engineering meant these assets were AAA and safe.

Also throw in the fact that investment banks that were doing the financial structuring were no longer general partnerships (where individual partners are personally liable for partnership debt) but for the first time limited liability companies or corporations, and you get a clear picture of psychological, and new business model innovation, driving the bubble.

Similar story with the savings and loan crisis. Monetary policy is easy to blame until you look deeper. As in the financial crisis, you had financial innovation “Junk Bonds”, and regulation changes that let S&Ls take risks and deploy capital where they were previously restricted. All while monetary policy was tightened drastically, which should deflate asset bubbles not create them.

Further it is a good counter example to the Greenspan Put because monetary policy was exactly the opposite of Greenspan; Volker was jacking up interest rates to kill inflation and yet Savings and Loans were taking crazy risky bets and created real estate and junk bond bubbles. If you’re theory is valid, it should have a prediction on what monetary policy would create. Simply saying “it is the most important factor” gives no information. What happens when monetary policy is tight and rates are high. What happens when it’s the opposite.

Lastly, you seem to imply that someone controls monetary policy. The financial crisis made it clear that shadow banking, derivatives, and general flow of funds between banks was orders of magnitude bigger than any thing the Fed controlled. These monetary instruments were the real driver of the mortgage bubble, not any monetary stimulus through low interest rates.

Is monetary policy important. Yes. Does it explain why Uber and Lyft and every other unicorn are getting investment easily. No. Does it predict or cause most bubbles. No. I am open to being convinced otherwise.