The fury from Facebook and its friends over Cambridge Analytica’s misuse of their database to help elect President Trump is matched by the reality that Facebook officials voluntarily allowed use of their data to help elect Barack Obama in 2012. Given these realities, close to 100% of the users of Facebook (everybody except the modest Obama/Trump demographic) should be furious that their data was used for the candidate they did not prefer. The costs of social media are becoming apparent, while its benefits appear increasingly illusory. How much of Silicon Valley’s post-2000 output has been a complete waste of money?
As Peter Thiel memorably said in his 2011 manifesto “What happened to the future:” “We wanted flying cars; instead we got 140 characters.” Thiel himself is critical of the slowing of truly life-enhancing innovation over the past 40 years, pointing out that most everyday objects outside the immediate electronics field have seen very little improvement. Indeed, Thiel doubts the official productivity statistics, believing the United States is very little more productive than in 1975. He also pointed out in his 2011 piece the extraordinary statistic that the average return on venture capital in the period since 1999 was negative. The last six years of economic upswing have improved that return somewhat, but over the period of almost 20 years since 1999 it is still no more than 3-4%, far below the return on even the stodgiest conventional investments.
With monetary policy having been distorted for 22 years, and exceptionally distorted since 2008, you would expect some misguided investment to be going on. In the late 1990s, that misguided investment consisted of the dot-coms. In 2008, it consisted of much of the housing and more particularly the housing finance sector, together with the derivatives associated with it. This time around, interest rates have been more distorted and for longer than at any other time in human history. You would therefore expect the stock of “malinvestment” as Austrian economists call it, to have become equivalently enlarged.
Malinvestment is damn difficult to spot while it is happening – you may remember all the soothing words from Fed chairman Ben Bernanke and others in 2006-07 that subprime housing loans were only a tiny market, and that the losses from their collapse would be correspondingly modest. Currently, there are not all that many signs of malinvestment in the general economy. The IPO market has been very subdued for years, while housing is clearly less overextended than it was in 2005-06, with mortgage lending standards solider than they were then, although modest excesses are beginning to appear.
Leveraged buyouts have run at a high level, and stock buybacks at an extraordinarily high level – these are clearly malinvestment if you take into account the excess prices that are being paid and the leverage that is being created. However even though there are excesses here it is difficult to believe that major industrial companies like Boeing and AT&T, which have liquidated their equity base through share buybacks, are intrinsically houses of cards liable to collapse at any time. (Of course, as with subprime housing debt, the difficulty of believing in a collapse may be part of its inevitability.)
Nevertheless, even when you have taken account of housing and the “Fortune 500” buyback disasters, there would appear to be a lot more malinvestment to account for. If the amount of malinvestment at the end of each bull cycle is roughly proportionate to the extent and duration of interest rate distortions during the cycle, then, to use a cosmological analogy, there should today be a huge amount of “dark matter” malinvestment, that we cannot see but which is nevertheless lurking in the shadows to crash the global economy in the next downturn.
When you look at the tech sector, there are substantial signs that much of the “dark matter” malinvestment may be lurking there. The appallingly low returns on venture capital investments, which have been concentrated in that sector, are themselves an indication that much of that venture capital investment has been misdirected. The misfortunes of Uber, a taxi service with a little software attached which private equity investors had run up to a $70 billion valuation, are a further indicator that private equity money has also been misspent. Indeed, given the mediocre and worse returns they have achieved, there can surely be no question that the private equity and venture capital sectors have been appallingly over-capitalized in the last two decades, with far too much money available for their own good. This cannot fail to have produced an appalling amount of economic waste.
Looking more closely at Facebook and the social media space in general, we can see one mechanism by which investors’ money has been poured down a rathole. Venture capital and private equity money has been used to attract users of social media, but those users have a very high cost of acquisition and generate nothing like the returns necessary to compensate for the cost of acquiring them. The hope of such investment has been to establish a near-monopoly, in which “network effects” will allow the social media company to “monetize” those users at a much higher return per user, justifying the heavy initial investment.
However, the much advertised “network effects” in social media are nothing like as significant as has been claimed. Facebook has been losing users in North America, and its user profile has transitioned from teens and young adults to older adults, who have woken up to the new technology and want to share photographs of their cats and grandchildren. Other social media, such as Twitter and Snapchat, are facing the same economics: they are funded by venture capital investors to burn through losses in a desperate attempt to acquire users, but at some point they reach a natural limit, and find themselves competing frantically with Facebook and Google for the same stagnant pool of Internet advertising dollars.
Economically therefore, much of the consumer-focused social media business is a dead-end; far more money has been poured into it than it will ever be worth. Thiel is also right, however, about the technological implications of social media. They have been an utter waste of the last 15 years of human creativity in terms of improving the possibilities and life experiences for mankind as a whole, let alone for that tiny fraction of mankind (or, by all means, personkind) that produces intellectual advances and has better things to do with its life than veg. out on Facebook.
With U.S. interest rates slowly inching upwards, we can hope that technological development will gradually re-orient itself to more productive areas, such as robotics and above all genetic engineering, with its civilization-enhancing possibilities of life extension and species improvement. Nevertheless, the next few years will be rough, with the malinvestment of the last decade requiring to be liquidated. Resources (money and good people) cannot be redeployed to more productive areas until they have been removed from the dross. All the super-intelligent people who have gone to work in social media over the last few years need to be made redundant and retrain themselves as rapidly as possible for more economically productive occupations.
As for Facebook itself, its poor-quality, politically-focused leftist management make it ripe for Schumpeteran destruction. Some of this will come from regulation; the indignation expressed at Cambridge Analytica’s use of Facebook data in the service of President Trump should not lead responsible regulators to allow it to use the same data in the service of whichever leftist loon is nominated to oppose Trump in 2020. Some of it will come from taxation; the gigantic rents accumulated by Facebook and Google during their temporary monopolies have already attracted the greedy attention of the EU, which sees a 3% excise on social media advertising as a cost-free source of revenue for its ever-expanding administrative maw. But much of Facebook’s likely decline will come from it simply going out of fashion, as consumers realize the ultimate reality: the costs of sharing all their data with the likes of Facebook greatly exceed its modest benefits.
Without the trillions poured into social media, we will at last have the resources to make the advances that Peter Thiel – and any thinking friend of humanity — know to be the ones that truly matter. With Fed policies no longer subsidizing investment in rubbish, those areas will also in the long run be the most profitable.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)