Think back to the halcyon days of the dot com boom. This was a time after Greenspan declared “irrational exuberance”. Long Term Capital Management collapsed in 1998, and Greenspan decided to risk propelling exuberance to a level beyond irrational. Super-duper-irrational exuberance?

Anyway, Greenspan cut interest rates a few times in late 1998. Technology companies were able to raise $5 million or more with just a sketch on a napkin (“serviette” for those outside the US). Companies at a “later stage”, though without revenues, could raise $30 million. A company called “Webvan” was able to raise nearly a billion dollars without ever becoming profitable.

These companies should not have been able to raise so much capital. At any given point in the development of a company, there are only so many things that need spending. Not to mention can be justified to investors.

It is obvious in retrospect that those particular companies wasted investor money (if not the broader principles), after investors booked the losses, but it was anything but clear at the time. Keith recalls debating the so called hypothesis of efficient markets with some people who believed that all market prices are correct. That all changes in price are random, unpredictable.

We have written a lot about how falling interest rates cause capital consumption. It drives speculation, which is a process of conversion of one speculator’s wealth into another’s income. No one wants to spend his wealth, but people are happy to spend their income.

Force-Feeding Capital

Greenspan’s super-duper-irrational exuberance shows another mechanism. An equity market boom force-feeds companies more capital than is good for them. Consider the AOL acquisition of Time Warner. By any rational measure, the latter was a much bigger company. Take your pick of assets, revenues, profits, etc. However, by one irrational measure—which is the one measure that mattered—AOL was bigger.

It had a larger market capitalization.

Whereas Time Warner was merely an old media company, AOL was everything hip and new-economy-ish. And technology. Tech was going to change the world, don’t’cha’know? So the latter acquired the former. The super-duper-irrationally exuberant stock market had given AOL the currency with which to buy anything it wanted to buy. In a normal world, AOL could not have acquired Time Warner. But a stock market boom fueled by falling interest rates under central bank socialism is not a normal world.

At the end of the day, the AOL Time Warner merger was a failure. So was Webvan. So were the companies who raised millions before they had a business. And so many others. Keith recalls a statistic that something like 2.5% of GDP was invested in technology startups in 1999. We will get back to this point in a moment.

There has got to be a principle, an iron law of investing, that for each enterprise there is an appropriate amount of investment. By lowering yields, which causes share prices to rise, the central banks are injecting more capital than businesses can rationally use. Therefore they use it irrationally. This is inevitable because the very metric to measure rationality and irrationality is collateral damage of the central bank’s monetary policy.