The Economy is Fine?, VC Funding Declines, Non-Negotiable Expectations

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1:18Welcome to Big Technology Podcast Friday edition, where we break down the news in our traditional cool-headed and nuanced manner. I am joined this week, as always, by Ranjan Roy. Ranjan, welcome. Hello. And we also have a very special guest, Jim McKelvey, friend of the show, co-founder of Square and founder of Invisibly is here. Jim, welcome. Thank you. It's going to be fun. Yes, it will. So you are also an independent director on the Federal Reserve of St. Louis. I'm currently the chair of the St. Louis Board of the Federal Reserve. Okay, so that gives you a great amount of perspective on what's going on in the economy, which is awesome because I have no idea what to make of this and I don't think a lot of people do.

2:05So here are just a couple of factors that we're dealing with. We have inflation that's high, close to 5 % core, which is double what the Fed wants. Yet the S &P is rising. It's up about 7 % this year. We have banks failing. Anybody who listens to this show knows that well. and the Fed is continuing to hike rates. And then, of course, we have slowing growth, but we're still growing as an economy. And I put this all together and I say, huh? So I'm just kind of curious what you make of all this and how people should be thinking about it. I honestly think things are fine. I mean, I've been in the meetings.

2:41You have a very smart, very dedicated group of economists and central planners and central bankers who are doing as well as we can given we had to jam, you know, a couple extra trillion dollars into the economy to stop a global health crisis from cratering the world economy. So let's not forget, you know, kind of that everything was great. And then we had to shut off the economic engine, not just of the United States, but of the world. And that in doing so, we caused this, you know, sort of one time spike. And that's that's sort of what's brought us to where we are. Now, I say sort of because we don't know precisely the effects of it because we've never done it before.

3:24Like we've never taken in human history a functioning world economy and shut it down for health reasons. But that's exactly what we did during COVID-19. So uncharted territory. But from within from within the Fed, I think it's going pretty well. Like I would I disagree with some of the decisions that are implemented. I agree with others, which is kind of how it should be. Like, we don't want unanimity. You want a bunch of people like me and the people who matter. I don't matter. I chair a regional Fed board, but we report in the Midwest and the St. Louis, you know, sort of Fed is five state region, but I'm just one voice of many, but you want different voices and that's what we got.

4:07So all told, it's not great. We would like to see inflation coming down. We think we are. We think we've seen that. That's probably why you saw the S &P jump. But we were also seeing some persistent core inflation, as you mentioned. So that's kind of a bummer. And we're working on that. And the great thing is that the FOMC and Powell in particular have been very trustworthy, which is to say they do what they say they're going to do. And that gives the markets a lot of confidence. It doesn't necessarily improve the markets, because if he says we're going to raise interest rates, then markets tank.

4:46But like the fact is that this guy's been 100 percent credible for his whole tenure. So, you know, trust. I think that point about it's fine, that's actually the weirdest feeling right now, for everyone who's been watching the kind of like utter chaos of the last few years, because in a way, as Alex, as you're saying, the numbers are pretty fine. Like inflation is decelerating. Job growth is not decelerated. It's decelerated slightly, but it's still good. We're in one of the best job markets, you know, in history. At every level, everything actually looks like they might do this soft landing and we might maintain growth and we might maintain inflation might come down and the economy might be okay.

5:32But I think, is that why everyone's so scared? Because we're just not used to things functioning properly? No, things have been properly functioning for over a decade. And I'd say we properly functioned in the course of a pretty major economic disruption. Like now it didn't function perfectly, you know, but that's like, oh, the fire department had to respond and they put out the fire. This doesn't mean the building didn't partially burn, right? So you don't have I mean, COVID-19 was a massive economic shutdown. I mean, the skies over Mumbai were clear blue for months. That's how badly we were impacted.

6:12And, you know, we tend to say, well, but I wish everything was perfect. We didn't have a pandemic. And I'm like, yeah, I wish we didn't have one either. But we did. And I think we did a pretty good job. And more than that, you know, having been on the inside the entire time, I can tell you that the team who wrestles with these problems, these are great people. They are not politicians. As a matter of fact, when you join the Fed, as I did, you give up politics. So I'm politically neutral now. I'm neither Republican or Democrat. I vote against or for both sides. You know, it's just not this thing that gets caught up in politics, which almost happened during the banking shutdown.

6:50Like if you want to talk about the, you know, the sort of the scary thing, which was you say all these bank failures. Well, all right. Not too much has impacted people or businesses. We've had a couple of banks that have changed hands. And SVB was a big, scary deal. Okay. But to bail out SVB, as they did, I thought was the perfect solution.

7:16And, you know, we can talk about that if you want. But that was an example of the system working, right? Something went wrong and the people who were in charge fixed the problem. Okay. And that's kind of what you want, you know? You want the paramedics to show up, defibrillate. Patient goes, oh, okay. Yeah, I'm alive. Yes, but defibrillation doesn't always work though. It's got like probably a lower percentage chance. I mean, I know it's an analogy, but it has a lower percentage chance of working than a lot of people think it does. and now when we talk about fine we're like thinking okay are we going to hit a lot everything that i'm hearing now like that you sort of take into account all the the rumblings and it seems now that people were like saying okay previously we're going to have a soft landing or even no landing and the economy is just going to sink who was and now the consensus seems to be just you know the you know i mean that's talking that's the magic that's the double backflip it's happened like two out of the last 12 recessions.

8:12So how bad do you think, if we are going into a recession, do you think we're heading there and how bad will it be if we go there? I mean, recessions suck, except they do cure inflation, right? And if you're unwilling to accept a recession, then it's very hard to fix inflation because the market says, well, they'll never let it turn down. And therefore the market never cools off. And therefore you got inflation forever. And then that's way worse, okay? So I'm not minimizing the effect of a recession on people because, you know, I've lived through several and they suck. That said. Inflation, systemic inflation.

8:54Erodes everybody's money like you're getting poorer every day until we fix this. You don't want to get poorer every day and you're getting passively poor, which means your bank account looks the same. So you feel OK, but it's like this cancer. So, I mean, I'd rather not have cancer.

9:12Same here. So let me ask you then. Look, if given the option, I'm not... Controversial take there. We're the cutting edge of this podcast. Yeah. So let's talk about, though, some of the side effects that we might find as we end up making our way there if we end up there. So there's a lot of people that are now talking about the fact that we might have a credit crunch where banks are more reticent to lend. This is from Reuters. Credit crunch fears may already be taking shape. Here's directly from the article. A year of rising interest rates has already put smaller banks under pressure, competing for deposits that were leaking into treasury bonds and money market funds that paid more interest.

9:51The response, less lending, tighter credit standards, and higher interest on loans was already taking shape. Officials are now watching for signs that this has kicked into overdrive. So I'm curious from your perspective what you think about the potential for credit crunch. What really that means? I mean, is it just that like banks don't lend anymore? And how significant is that side effect of these rate raises if we end up hitting it? So that's what's supposed to happen. Okay. What you described to me was exactly what is supposed to happen. So to me, I'm like, yeah. Now, does that impact certain people?

10:30Sure. But nothing you said was scary. Now, what would be scary would be a, you know, a death spiral where you get this, you know, wage price inflation or some sort of perpetual recession like they have in Japan, you know, or something where like we never come out of it. But the U.S. economy is very vigorous. Employment is still kicking ass. I mean, that's the one thing that we look at and we're kind of going, wait a second, there's still way too many, you know, jobs open. and so everything you described yeah i mean you can whine and complain about it but i'm telling you it's like winter yes the leaves fall off the trees and it gets cold and you know ron is talking about how nice it was in new york today it's beautiful spring like spring comes but don't whine about winter or like then move to miami where you know we don't have it so big the tech scene is really blossoming in Miami, Jim.

11:32I'm going down to speak in two weeks. So, yeah. Okay. But I think that's exactly the point that, is it a credit crunch or is it just credit tightening because rates are going up? Exactly. Well, I mean, look, so, oh, I'm sorry. Go ahead. No, no, but I think you're making the exact point that we're just so not used to this, that this is how it's supposed to work, but people haven't seen it work in so long that I think that's where every little movement feels like it's much bigger than it potentially is, where it's just this is normal business cycle stuff. Yeah, but it's normal. And by the way, I would add that the banking cycle we've been through the last 15 years has been abnormal in that banks haven't been lending during that time.

12:14Like all that upswing, the banks weren't lending. Like I built a company that does a like does billions of dollars of lending in the bank's faces. Now, how could we do that? Well, the answer is they abandoned the small businesses. I mean, Square Capital lends out tremendous amounts of money at very fair rates. We make a return and everyone loves it. And the reason that market exists is because the banks abandoned it, not like in the last couple of months or years, but like over a decade ago, they stopped lending to small businesses because I actually don't know why. I won't fill in the blank there, but I can tell you that that's what allowed us to build, you know, sort of a massive lending business on top of a massive payments business.

12:59What's your guess as to why?

13:04I think it was too easy to make money just parking it at the Fed. Huh. Like you used to be able to just get this spread from the government and, you know, it's easy living on the government. lending is messy and risky and challenging and the feds really safe so you if you've got a positive return by just parking cash then that's what you do and if you and you know it's a great oversimplification i think i think it got too easy for banks and they just stopped doing the the tough work believe you lending is thanks stop ranking yeah i'm kind of i'm gonna keep reading different points of evidence to show that it might not be fun and let you tackle them, Jim.

13:48I'm getting a sense of the dynamics of this show, which is that we have Jim and Ranjan teaming up against me, which is fine. This is sort of how it goes usually. But let's just go through some of these things. The other thing that people are saying that could be a systemic risk is the fact that commercial real estate is not in a good point, not in a good place. That all these companies had long leases in these buildings and these buildings had all their money tied up in regional small and regional banks and if companies break their leases or just can't pay because they don't they're not going back to the office then this will eventually fall in the banks let me just read a a short thread from Zach Coleus who is a friend of the show venture capitalist in San Francisco he says my good buddy jay sidon at cushman just posted his latest q1 san francisco commercial real estate roundup he is not on twitter but it is good stuff so posting below it's incredibly grim employee employee office attendance continue to track continues to track right around 40 percent of its pre-pandemic level at this rate it'll be years before any sense of vitality returns to downtown overall vacancy is now 24.8 percent the highest on record and up slightly from last quarter San Francisco is sitting on 21.1 million square feet of vacant office space.

15:09Now, I know that this, you know, VCs like to talk about San Francisco because they're, many of them, for many of them, their point of focus doesn't extend beyond that 800 ,000 person city. And so I'm curious though, if this is, it does seem like it's something going on around the country. And so I'm curious, like what you think in terms of the bigger threat over here in terms of the commercial real estate issue. Yeah, well, I mean, we abandoned our office in San Francisco, moved it to Oakland. So that's a vote for the region and a vote against San Francisco. San Francisco was a disastrous place to build a company.

15:44I mean, if I won't say that I regret what happened at Square because Square was very successful. And we don't know how much of that was due to our location. But I will tell you the way we were treated as an employer was horrible. And eventually we had to leave. so um it was not a good place and i think a lot of tech companies are finding out that there are other places to go from san francisco that aren't as dysfunctional not to mention the fact that a lot of my friends in san francisco just flat out won't go there anymore like they're just afraid of the city and it's just kind of devolving that's san francisco so i mean if your stats from there but look office market in general of course like duh like you're at your house i'm at my house i've never been to ron's house but that i don't i don't guess you've got a bed and three guitars you know in your office if you do that's elon musk does you got a freaking bed in your office then you are my hr hero you know but yeah i mean you know here's three votes for working at home Yeah, but I do think, I mean, how do we conflate the commercial real estate, like whatever pressures it's facing?

17:02I mean, the work from home is only part of it, right? There's also just the overall economic cycle that it's also contending with. So it's getting hit on both sides. I think the more interesting thing to me here is how many sectors are inflated in their value and they're trying to do whatever they can to pretend they're still there. Because I'm guessing every commercial real estate company is trying desperately and will do whatever it can to just keep those values appearing like they're still high, the same way any late stage venture capitalist will be. Yes, I was about to use the analogy of like - Yeah, yeah, yeah.

17:37That's where I was going. That's where I was going. You would just extrapolate from the last funding round and everything's great, Stan. We just won't be able to give you any money back. Sure. Look, it's a double whammy. I think the real question is, you know, what happens to that real estate? Because real estate's interesting because it doesn't disappear. It gets repurposed, you know, and maybe it turns into housing. Maybe it turns into, you know, indoor farming. uh you know maybe it turns into uh you know space to put small fusion reactors i mean like i don't know um um and i sort of bet on this you know a little bit because i bought some buildings during the downturn just empty commercial buildings because they were you know kind of buy one get one free and um because i i kind of think that people are going to come back um because i've I've met with a lot of companies.

18:36This has been sort of my sort of side gig right now is just, you know, talking to CEOs about like, are you making your people come back? And if so, how and why? And, you know, that falls into two camps. Some are the, hey, we figured out remote work and it works great in our business. And therefore, we don't ever need an office. OK, cool. And, you know, block is kind of that way. Like we have offices and we love the offices, but they're not as full as they used to be and probably never will be. So so we don't need as much office as we did. So that's, you know, that's kind of one option. I'm seeing a lot of companies and one of my other companies forced everybody back.

19:10And when I say force, it's like get your ass into the office. And that company has had this sort of creative renaissance. And I think it was because people are bumping into each other the way they used to. so I don't think the office market is dead I think it's cyclically bad which means it's a good time if you got you know crazy guts to buy office you know buy go yeah I mean you'll look like a genius or an idiot so you know don't take investment one or the other so you don't see any broader risk out of the regional banking system for holding the loans on these buildings no they're going to get blooded you know they're going to oh they are going to get hit by it yeah yeah but the banking system is designed for stuff like this like cyclicality is not a unheard of problem it is something we deal with and again like the question is okay let's say the banking system is going to get hit what do i as an individual care and the answer is well not really that much like I my money's safe we've proven that so now as an investor do I care well yeah that depends on what I'm betting on right but as a as a banker and a consumer I'm cool all right so a product of all this economic uncertainty is that venture capital funding is down.

20:35We have a story that Ranjan picked up looking at global VC funding in the first quarter. It was$76 billion, which is nice, but it's 53 % down from last year's Q1, which was$162 billion. And that's even with$10 billion going to OpenAI. So that makes up more than 10 % of the entire amount of money going to startup companies was just that one investment there. So I'm curious what do you think about this decline in VC funding? I would think that that funding would continue to be robust because they have all this dry powder that they need to spend, that they've raised from LPs on long-running funds, but it doesn't seem like that's making its way to startups.

21:21Well, and I have a VC fund that's got close to a billion dollars that we move around, or I should say funds. Our funds tend to be smaller. but we have a lot of them. And yeah, things have tightened up a lot and we're happy about it. I mean, I think it's a good time to be in the venture capital business. I thought the last several years were ridiculous. We had founders getting funded for like really terrible ideas and really ludicrous business plans. And I mean, I could list them, but that's just gratuitous. I think the basic... We would welcome that. Well, I mean, it's fun. I guess it's good commentary, But like, here's the question you have to ask.

22:04Do good ideas die now because they don't get funded? And the answer is no, absolutely not. If you've got a good idea, I'll fund you. Like my fund will fund you. Like if not, I've got dozens of, you know, friends that funds who would fund you as well. And VC is just a hobby for me. Like I do this, you know, on the side. I can dabble in real estate, dabble in venture capital, but I don't define myself as either as a professional. um but in both cases yeah uh things are getting tighter and that's kind of good like if you have real value as a founder now's a great time to be a company founder fantastic i love downturns love it love it love it how do you but how do you see the dynamic of the dry powder playing out like is can venture funds be as patient as they need to be whether that's like you know, reducing investment for a year or two or three or whatever it takes and just sitting on it.

23:00Because I think that's like the tension right now where on one side you see these insane numbers that VC and PE is sitting on however many hundreds of billions of dollars of dry powder. But on the other, it's tight and things are going to get more selective and slowing down, which also I love your serenity. That's a good thing. But how do those two things get reconciled? Well, I mean, you know, this reminds me of the Stephen Wright joke. I bought powdered water, but I don't know what to add. Like, what is this powder? Because if you think about how a fund is funded, like, it's not like I write a check to Sequoia and say, here, Roloff, go crazy.

23:39You know, he calls capital as he finds and Sequoia finds opportunity. So yes, I've committed, you know, say a million dollars to a VC fund. That doesn't mean they've taken a million dollars. So yeah, they can say they've got a million dollars, but they haven't deployed it until they deploy it. They don't need me to write the check. And a lot of the people who are writing these checks are now, you know, kind of cash tight and some of them are missing their payments. So there might be a little ripple there. But the other thing is the VC world is tightening up in general. So you're getting better deals as a funder.

24:14So like it's all kind of balancing out. There's there's a, you know, a couple of invisible hands, you know, sort of sort of simultaneously at work here. But but it doesn't work, you know. So I personally think, again, don't care that much about the VCs. They kind of had a nice run for a while when capital was super cheap and anything that had potential yield could get investors. and so you know they rode on really mediocre uh overall performance like the you know look at the industry as a whole and you know you'd be better in t-bills right um but uh there were some funds that did exceptionally well and of course those are the ones that we talk about you know sort of like all my friends who come back from vegas are winners because the only people who won talk about it like the people who lost you know lost the ferrari at the crap table uh they don't they don't brag about that you know it's the guy that beats the house so um there's true selection bias in those stories but if you look at the overall industry i think it's healthy i think it's fine my question is if i have a good idea or a great idea is the money available absolutely now you'll I'm going to get a bunch of calls from this.

25:31People start texting me and go, Jim, you said you'd find a great idea. And I just, now shh, shh, shh. They have great ideas. You have to go through the process where we determine if we think it's a great idea, we're wrong like 60 % of the time, even with very, very smart people on it. But I've never seen a company with a truly great idea not get money and square funded in the middle of the worst like a real recession not this thing that might or might happen in some time now you know like now 2008 2009 like that was dark actually what when was the launch again it was right around there yeah 2009 it was like okay as the as the economy was then scraping the bottom um that's when we launched and uh everyone's like well there's no money available.

26:21We were like, well, that's great. And people's salaries expectations are lower and we can hire the best talent, which we did. And then, and then lo and behold, we had a pile of money thrown at us forever because we had a good idea. So I don't, I mean, this is sort of the thing I go into in the book, which is, you know, if you, if you read the innovation stack, you're going to hear me harp on this again and again, again. But like, I think if you're inventing something a recession is a great time to start just the best time in the world i would agree i mean big technology came out of like the depths of the covid recession and uh ended up being a good time to start so especially because the burn rate was low because you couldn't go outside you're a survivor exactly you're a cockroach nobody kills you i mean i'll take that yeah no it's a great cockroach and sewer rats man they're my idols yes i will get i got out of the way of a cockroach the other day like there was this cockroach walking down the street and it just had such swagger that i moved well come to new york i just had a rat run over my foot yesterday and everyone around me looked and no one even left i didn't even laugh i just kept walking oh my god sat down and finished your entree huh yeah this was not this was not on our list of topics to cover but new york has a once you brought up the roach.

27:45I figured I'd bring up the rat. No, New York has a rat czar now. It's actually pretty exciting. So she's a former school teacher. Her name is Kathleen Karate. This woman is my hero already. Her introductory press conference featured this line, you'll be seeing a lot of me and a lot less rats. I mean, do you have a better intro conference than that? She's amazing. But obviously the week that she comes into power, Ranjan gets a first foot encounter. That's because she's driving her out. She would not have seen it. Exactly. They're getting their last run-ins. The invisible ones. Exactly. So Ranjan, should we touch on the Uber story before we go to break?

28:31Yeah, yeah. I just read it. I liked it. Okay. So let me just... Triggered me earlier. Yeah. So I'm actually curious to get Ranjan's perspective on this. So last week on the podcast, actually this week on the podcast, a couple of days ago, Emil Michael, who's the former chief business officer of Uber, came on. We talked a little bit about this article in the Wall Street Journal that had the CEO of Uber, Derek Khashrassari, driving for the first time in his nearly six year tenure and finding all these problems in the app. And I wrote about it this week in a big technology story called What the Heck is Happening at Uber and basically looked at it in terms of what's going on, what it means about DARE's leadership, but also the fact that they could keep throwing bonuses at drivers because of zero interest rate policy and that's dried up.

29:15And now they need to focus on the app itself versus just the bonus pool money. So, Ranjan, I do feel like this is kind of in your wheelhouse and I'm curious what your reaction is to the story. I was amazed because when the Wall Street Journal story came out again, you know, Dara has gotten into a car and, you know, actually did some driving and suddenly found out that it's a clunky experience and it's terrible. As you said, six years in, I don't know who in the corporate communications team thought this was a good idea to push. But what was also interesting was there was probably this is one of those moments.

29:50There's like a few hour period where you saw people celebrating the story and being like, this is a CEO. This is a real CEO, you know, who's willing to get his hands dirty and drive, I think. And it's kind of odd to me because, again, Uber is such an interesting company of where it's going to go. because on some side, the stock has not performed amazingly, especially since its IPO. I think it's flatter down. But again, on the other side, Uber Eats is solidifying itself as a big competitor. The rides business is at least stabilized, even though competitors like Lyft just seem to be disappearing.