The Social Media Bubble
Facebook's (NASDAQ:FB) $19 billion takeover of WhatsApp (largely financed by issuing more of FB's inflated stock, hence the price tag is in a way actually an illusion) has predictably produced a very wide range of reactions. Jeff Macke at Yahoo's Daily Ticker was describing it as a "brilliant deal," heaping scorn on critics who in his opinion just don't understand the value of a business employing metrics other than the money it actually makes (or stands to make in the future even under very generous assumptions, since a major attraction of the service is that it is actually free for one year, and thereafter costs a pittance). "They'll eventually figure out how to make money from it," according to Macke. Perhaps Facebook's shareholders were no doubt relieved to hear it.
On the other end of the spectrum of reactions, Peter Schiff is criticizing it as just another outgrowth of the latest Fed-induced credit and asset bubble, noting that such pricey takeovers are typically only seen when oodles of money from thin air have flooded the system.
The valuation metrics applied to the WhatsApp acquisition are clearly a throwback to the infamous "eyeballs" measure that was fashionable to determine the value of various internet stocks in the late 1990s stock market bubble. On the other hand, Mr. Macke has a point when he notes that a large user base is probably more valuable than it appears based on traditional valuation measures such as current profitability (which is essentially non-existent in this case). Stock market traders often love companies that have no earnings whatsoever and instead have a large "fantasy" component. As long as there are no hard data on earnings, there can be no "earnings disappointments" either - instead one is free to fantasize all day long what the business might one day make. The sky's the limit.
There can of course be no doubt that there is a major asset bubble underway. The true broad US money supply TMS-2 has risen by about $4.7 trillion since the beginning of 2008, an increase of roughly 90%. Its still massive 8.2% year-on-year growth rate actually represents a slowdown. Whenever the money supply increases, prices somewhere in the economy will inevitably rise. It is in the nature of the distribution process of newly printed money that it initially tends to enter the markets in which titles to capital are traded. This in turn makes such seemingly absurd takeover prices possible - FB's stock has risen to a recent trailing P/E ratio of 116 and it has used mainly its inflated stock for the purchase (there is a $4 billion cash component as well).
Incidentally, the value of the deal exceeds the amount of money raised by FB upon its listing.
US money TMS-2 (broad true money supply) - picture of a massive inflation since the year 2000, accelerating markedly since 2008.
Clearly, the "social media" bubble is a close cousin to the Internet bubble of the 1990s. The business concept certainly has merit, but massive money supply inflation combined with a good "story" that is driving investment in these stocks has by now resulted in a run-away bubble in valuations. This ensures that capital malinvestment is occurring, since malinvestment is a result of the distortion of relative prices in the economy due to inflation. Even so, it is not our intention to be critical of those attempting to make money from this bubble. It is after all an excellent way to protect the value of one's savings against the central bank's inflationary policy, just as long as one is able to exit in time. In the end there will be numerous people left "holding the bag" when the bubble collapses (traders misjudging the situation at a critical juncture), but it is not up to us to criticize the activities of speculators - the ones best able to foresee future developments will reap well deserved profits, while those unable to do so will be weeded out by suffering losses.
Click to enlargeFacebook - a darling of speculators in the social media sector of the market. Many have reaped large gains, but some will be left holding the bag when the asset bubble eventually deflates.
Nevertheless, the falsification of economic calculation engendered by loose monetary policy is doing untold damage to the economy and therefore deserves to be criticized sotto voce. The bubble in asset prices is a symptom of this process, hence Schiff's critical remarks on the somewhat loony price paid in this recent takeover. Here are a few excerpts from his article:
"Given the size and extravagance of the Facebook deal, it may go down as one of those transactions that define an era (think AOL and Time Warner). Facebook paid $19 billion for a company with just 55 employees, little name recognition, negligible revenues, and little prospects to earn much in the future. For the same money the company could have bought American Airlines and Dunkin' Donuts, and still have had $2 billion left over for R&D. Alternatively they could have used the money to lock in more than $1 billion in annual revenue through an acquisition of any one of the numerous large cap oil producing partnerships. Instead they chose a company that is in the business of giving away a valuable service for free.
The popular talking point is that the WhatsApp has gained users (450 million) faster than any other social media site in history, faster even than Facebook itself. Based on its rate of growth, the $42 per user acquisition cost does not seem so outrageous. But WhatsApp gained its users by giving away a service (text messaging) for which cellular carriers charge up to $10 or $20 per month. It's very easy to get customers when you don't charge them, it's much harder to keep them when you do.
Some say that texting revenue is unimportant, and that the real value comes from the new user base. But how many of the 450 million users it just acquired don't already have Facebook accounts? And besides, Facebook itself hasn't really figured out how to fully monetize the users it already has. In other words, it is very difficult to see how this mammoth investment will be profitable.
From my perspective, the transaction reflects the inflated nature of our financial bubble. The Fed has been pumping money into the financial sector through its continuous QE programs. The money has pushed up the value of speculative stocks, even while the real economy has stagnated. With few real investments to fund, the money is plowed right back into the speculative mill. We are simply witnessing a replay of the dot com bubble of the late 1990's. But this time it isn't different."
We agree with Schiff's emphasis on the speculative nature of the deal and what the price paid tells us about the increasingly distorted state of the economy due to the Fed's loose monetary policy. Whether it makes sense for FB in principle to acquire a company like WhatsApp is obviously a different cup of tea. It is noteworthy that news that FB's shareholders have just been diluted to the tune of $19 billion by an acquisition offering such dubious prospects of ever making money was greeted in the stock market by bidding up the price of FB's stock even further.
One feels reminded of the many deals Yahoo (NASDAQ:YHOO) made in its heyday in 1999, when it shelled out billions to acquire properties like "GeoCities" (a kind of Myspace/Facebook forerunner offering personal web hosting to users, bought for $3.57 billion), Broadcast.com (which was bought for a then incredible $5.9 billion) and others. Just as a reminder: when Yahoo bought GeoCities, it was the third-most popular destination on the web. It never made a dime in profit, and today only GeoCities Japan remains online.
Of course none of this proves that FB's acquisition of WhatsApp is destined to be similarly ill-fated. It does however serve as a reminder that paying huge prices for profitless companies at the peak of a bubble can easily turn out to be a big mistake at a later stage. However, this is a problem that only concerns FB and its shareholders and the speculators who are risking their own money by betting on success. The fact that it is a symptom of a bubble whose instigators deserve to be criticized is a different matter.
Criticism From the Political Left
Judging from his writings, Robert Reich seems to be to the left of his own party, but certainly not so far to the left as to advocate the discredited system of communism (since the collapse and bankruptcy of this repressive system is still relatively recent history, very few people support it openly these days. Many do however keep the myth alive that it was "just not implemented properly"). Reich has commented on the WhatsApp takeover as well, starting out with a routine complaint about inequality:
"If you ever wonder what's fueling America's staggering inequality, ponder Facebook's acquisition of the mobile messaging company WhatsApp."
Unfortunately there is no further elaboration as to why this takeover is "fueling inequalityso the," sentence is a non-sequitur. We are simply left with the assertion that the takeover is somehow "fueling inequality," without learning why that should be the case (presumably it is because the founders of WhatsApp have become rich overnight). After reciting the details of the takeover, Reich continues:
"The winners here are truly big winners. WhatsApp's 55 employees are now enormously rich. Its two founders are now billionaires. And the partners of the venture capital firm that financed it have also reaped a fortune.
And the rest of us? We're winners in the sense that we have an even more efficient way to connect with each other.
But we're not getting more jobs."
So after subtly playing the envy card (what temerity of the founders to have become rich!), Reich admits that the service provided by WhatsApp is valuable to consumers. But something is still bad about the whole enterprise. Not only have the creators of the service dared to become rich by accepting FB's loony takeover terms (if they hadn't accepted those we would have every reason to call them idiots), but according to Reich, it is not enough for the company to provide a service valued by consumers - it has committed the unforgivable sin of not creating "jobs for the rest of us."
What follows is essentially a Luddite rant condemning economic and technological progress and concluding with a perfunctory call for "more redistribution":
In the emerging economy, there's no longer any correlation between the size of a customer base and the number of employees necessary to serve them. In fact, the combination of digital technologies with huge network effects is pushing the ratio of employees to customers to new lows (WhatsApp's 55 employees are all its 450 million customers need).
Meanwhile, the ranks of postal workers, call-center operators, telephone installers, the people who lay and service miles of cable, and the millions of other communication workers, are dwindling - just as retail workers are succumbing to Amazon, office clerks and secretaries to Microsoft, and librarians and encyclopedia editors to Google.
Productivity keeps growing, as do corporate profits. But jobs and wages are not growing. Unless we figure out how to bring all of them back into line - or spread the gains more widely - our economy cannot generate enough demand to sustain itself, and our society cannot maintain enough cohesion to keep us together."
If he had written this in the 1920s, he would have complained about how the ranks of workers in the agricultural sector were dwindling, and how the motor car was destroying many industries surrounding the horse and the associated jobs, from buggy whip manufacturers to saddle makers to the producers of horse-drawn carriages. Not only that, the increasing mechanization of factories due to the introduction of inventions such as the assembly belt was making more and more manual labor unnecessary. But is more socialism the answer?
The problem with such critiques - which ironically are a staple of so-called "progressives" - is that they misconceive the nature and aim of economic progress, which is precisely to relieve people from the tedium of labor by increasing economic productivity. Does Reich believe that thousands of people breaking their backs in inclement weather harvesting grain would be preferable to having the work done by a combine harvester? He is careful not to state that outright, but the old Luddite claim that technological and economic progress are "destroying jobs" nonetheless is clearly his main argument.
One would think that the history of capitalism stands as a constant reminder of how misguided this notion is. It is based on an error Marxists have made from the very beginning: the assumption that the economy is static, that there is a rigidly fixed "economic pie" that needs to be distributed according to the precepts of socialist bien pensants at the top. What is usually left unsaid is that they and their advisors are held to deserve a slightly bigger slice of said pie than the "rest of us," as compensation for the heavy responsibility they bear. It is after all difficult and serious work to oversee the coercive expropriation of those deemed to have earned "too much."
It is utterly vain to complain about technological progress and demand socialist measures to address its alleged shortcomings. Martin Wolf at the Financial Times has recently made similar arguments, which is all the more ironic considering that he has also demanded "more money printing by central banks" at the top of his voice at numerous occasions. This activity is of course the main reason for both growing wealth and income inequality and the structural weakness of the economy. Newly created money enters the economy at discrete points and early receivers will necessarily benefit to the detriment of later receivers. It just so happens that the earlier receivers are usually already much richer than the later ones.
And yet, those on the left never address this problem. At most they complain about the privileges enjoyed by commercial banks. While there is undoubtedly good reason for being critical of the banking cartel's legal privilege to create money from thin air (as an aside, this point specifically is usually also not criticized by the left), one must not lose sight of the fact that the central bank is the fulcrum on which the system rests. However, you will never come across "progressives" critical of the existence of this institution as such. It is simply against their authoritarian instincts to condemn a central economic planning agency. All they occasionally do is demand that it implement even looser monetary policy, on the misguided belief that this will create genuine economic growth. We on the other hand would argue that on the contrary, the economy's recovery has been held back by the policy and much of the economic activity and the large corporate profits Reich bemoans are essentially bubble illusions that are set to disappear rather quickly once the inflationary policy as much as pauses.
It is true that innovation and technological progress are "disruptive." They do make many older businesses and production methods superfluous. At the same time though they create new jobs that as a rule didn't even exist before. This requires people to adapt to the changing landscape, but such changes are far slower than it often appears. Existing "outdated" capital will always continue to be employed as long as it is profitable to do so, regardless of the fact that better production methods may be coming into existence concurrently. An unhampered market economy always adapts smoothly to such changes; continual change is after all a hallmark of the market process. Labor meanwhile remains a scarce resource as long as there are unfulfilled wants and unused resources with which labor can be combined. Have all our wants been fulfilled? Are there no longer any unused resources on the planet to which labor could be applied?
The causes for institutional unemployment and the "reverse distribution" of wealth are precisely to be found in the fact that we do not have an unhampered market economy, but that large parts of the economy are centrally planned and subject to intervention. It is a grave error to believe - as Reich evidently does - that the situation can be improved by increasing intervention even more.