The Boom Bust Cycle and how it affects tech[Finance Fridays]
If you want to survive recessions, you need to understand this.
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Another crazy week,
Is it just me or are meltdowns getting a wee bit too frequent?
We’ve had a few too many ‘Lehman Brothers like’ financial institution scares. Credit Suisse is the most recent source of alarm. Media publications and finance experts on Instagram Reels are losing their minds. And clearly, we should be listening to these bastions of rationality and reason. Definitely ignore infidels like this, who are saying that the situation is more nuanced, and things are not as catastrophic as headlines make it seem.
In other news, remember our good pal, the crypto-broker Celsius? The totally not Ponzi-scheme, that was going to uproot the banking industry, which functioned very similarly to a bank (they’re totally not a bank though). Turns out that their CEO was pulling all his money out of the firm, while asking regular investors to keep their money on the platform. Not a given look, given that he has frozen out the accounts of millions of regular folk. More information on that below-
If that wasn’t enough, we’ve had another vicious wave of layoffs. Tech Giants are joining on this, with Meta grabbing a lot of headlines for the wrong reasons. A lot of gurus blame their investments into the Metaverse for this (as usual, they are wrong. A more detailed analysis of this coming soon).
And we have murmurs about a recession hitting Europe.
So what should I do when I have tons of attention-grabbing headlines to cover? Simple. Ignore them all. Instead in this post/email, I will be covering a very fundamental element of our economy and the business cycle- the Boom and Bust Cycle. Those of you who read my explanation of the Tech Crash will have heard of this term. In this post, I will cover the Boom and Bust cycle, what it is, how it impacts businesses, why it’s particularly vicious for tech, and how you can survive it.
What is the Boom and Bust Cycle- Simply put the economy is cyclical. The economy goes through phases of growth (boom) and contraction (bust). There are multiple factors that can trigger this (that’s a whole field of macroeconomics), but the underlying principles are largely similar.
What causes the Boom- The boom is typically fueled by 2 things- optimism and greed. If you have positive expectations for your finances, you’re more likely to spend. If a whole lot of people have this, then there’s a lot of money flowing through the economy. Businesses are able to secure money and expand quickly, and the economy expands. The markets look red hot, and you have tons of teenagers screaming about how they are investing geniuses on TikTok and how you’re a sucker for working 9-5s.
What causes the Bust- Eventually, the markets get too hot. Every third person on LinkedIn is an entrepreneur with funding for their revolutionary business. Some investors get nervous and start pulling money out. Central Banks raise interest rates, making newer loans more expensive. Now everyone is freaking out, causing things to cool down rapidly. People start spending less in anticipation of problems, making businesses less profitable. The bad businesses can no longer get money by talking about their new amazing Inu coin and go under. Interestingly all those profiles with Monkeys in their profile picture and .eth in their tag go missing.
Why this is vicious for tech- So why is the Tech Industry always in so much trouble when it happens? Many reasons. One is the scale of tech, which I covered in my post, Why Tech and Crypto Stocks are so extreme [Finance Fridays]. The other is that Tech is a much more dynamic field. It’s very hard to convince people that you have revolutionized civil engineering. More so, when you don’t have an actual product. This is not a huge concern in tech. Hitting the right buzzwords and marketing will get you a lot of money.
How to Survive this- Build yourself up. Keep an emergency fund, maintain your skills, and don’t panic. Remember this is a cycle. Just as the booms lead to crashes, crashes lead to booms. As long as you don’t lose your cool, you will be fine. That’s all there is to it.
Are you ready to learn more? Get some chocolate milk and get comfy, because this will be a fun one.
Understanding the Boom and Bust Cycle
For you definition nerds-
The boom and bust cycle is a process of economic expansion and contraction that occurs repeatedly. The boom and bust cycle is a key characteristic of capitalist economies and is sometimes synonymous with the business cycle.
Simply put, an economy can be in either of two states. The boom is when the market is expanding, and there are tons of new roles. This tends to be coupled with inflation and low-interest rates, and these create an incentive for people to put their money into the economy and take more risks. In times like these, coming across VC money is easy, and there are lots of jobs for everybody involved. The stock market and other asset classes go up during these times.
We saw this over the last decade. The real-estate crash caused a bottomed-out market and historically low-interest rates. Combine this with insane advances in tech, and we saw amazing growth in the markets. The very high returns caused people to seek riskier and riskier ventures to beat the markets, and we saw the rise of entirely new asset classes such as crypto and NFTs. Amazing developments in Machine Learning saw billions of dollars being poured into extremely large-scale projects, without much due diligence. Things sound good
However, life is rarely that neat. The Pandemic happened. Economic activity shut down, and suddenly, everyone had to tighten their belts. Entire companies went under as they could no longer secure the funding. Things get dicey, putting a halt to the party. The tides pull back. The sound companies are left beaten, and the ones riding the wave w/o fundamentals are exposed to have been swimming naked.
While the Pandemic gets the blame for this shutdown, it is many ways a scapegoat. Even when Corona was just a beer, there were talks of a market slowdown. Central Banks were about to raise interest rates, and the markets were very skittish. The Pandemic caused governments to inject massive stimulus, which artificially inflated things. When this was taken away, the long-overdue correction came back. This crash feels a lot more vicious because of the additional push the stimulus gave the markets. The economy was like a Bodybuilder on Steroids. On a cycle, hormones are supraphysiological. When the steroid cycle is turned off, the hormones crash (Yes I watch a lot of MPMD). As the cliche goes- the higher the rise- the greater the fall.
For those of you that want a more detailed visualization of this process, watch the video below. This is a 30-minute video explaining how the economy works by the legendary investor, Ray Dalio. It will go more in-depth into this idea.
Now that you understand the cycle as a whole, let’s cover the Trillion Dollar Question- why does this cycle affect Tech so disproportionately?
Why Tech is so volatile
There are several things about Tech that make the cycle so dramatic-
Software moves quickly- Let’s go back to civil engineering. There are so many roads, bridges, and houses you can build. Material and Space constraints mean you are bounded in how quickly you can work. And if you screw up, people will die. Thus, you’ll work in a slow methodical manner. You will have a lot more checks and balances to go through. You won’t randomly mix up the composition of your cement to see if it can dry quicker/be cheaper. Failure in production is very costly (often fatal). Your process is setup to prevent errors. While this means that you won’t make as many mistakes, you also will not innovate/move as quickly. Software doesn’t really have these constraints. Which is why it moves so much quicker, even though civil engineering is so much older as a field.
Tech scales quicker- A familiar concept to regular readers. Tech really benefits from economies of scale. This makes it a very popular investment for VCs since it has the potential to scale to billions of dollars. My content has a monthly reach of around 500K people. I’ve only been writing for 2 years. Think of how hard it would be for physical businesses to reach that number. This is the power tech and platforms like Medium, Substack, YouTube, LinkedIn etc.
Tech is harder to understand- As I’ve covered here, it’s impossible to understand all avenues of tech. This makes selling smoke and mirrors to investors much easier.
The amazing results of Tech as a whole make VCs much more willing to invest. They can afford to invest into 10 risky bets, because even if 9 are garbage, 1 Legit winner will return their money, many times over.
While this ‘kiss frogs to find your prince’ approach is great for big investors (and Disney Princesses), this is not good for regular people. Regular people don’t have the capacity to filter the Beauties from the Pigs with elaborate makeup. The reason you hear about normal people suffering in the busts is that ‘smart money’ has many ways to pass the negative effects of these outcomes to regular folks. While you can try to play this game yourself, this requires a lot of resources, energy, and luck. Fortunately, protecting yourself is not too difficult. Let’s cover that next.
Protect yourself from this cycle
While there is nothing you can do to be 100% safe, there is a lot you can do to maximize your chances of coming out ahead-
Get Good Noob- The easiest way to not have to worry about layoffs- just be irreplaceable. Remember, layoffs are a financial decision. As long as your presence makes more money than your costs, you will be find. Read this, this, and this to do the highest quality work, become a 10x developer, and build a strong career in tech respectively. Show up here and develop your skills regularly. And you will be fine. However, sometimes you will be caught up in a lay-off through no fault of your own. In such a case you need the next thing.
Have an Emergency Fund- The worst thing you can do during a market crash is to sell your stocks to pay for your lifestyle. Have an emergency fund with 6-12 months of living expenses saved up. This way if you are laid off, you can continue to live without worrying about anything. If you are a great developer, you will find another opportunity quickly.
Sharpen your Skills- You want to make sure you have the ability to snap up whatever opportunities come your way. This involves a lot of preparation. Read the engineering blogs and make sure you know your domain. This way, you will be able to spot opportunities as they arise. However, that is not enough. Make sure you’re meeting with the right people (especially when times are good). This way, when things crash, you have a network to reach out to. I have detailed guides on networking on this newsletter, so give those a look. And use this guide to develop your LinkedIn profile to the top level. As I’ve shown many times on this newsletter, LinkedIn is an amazing way to get amazing roles without applying for them.
Relax- Drink water, sleep, exercise, and keep your cool. The internet and news is designed to alarm you. You’re fine. Things are good. Downturns are temporary. The loss you’ll cause your health by freaking out is wayy more than these downturns. You’ll be okay.
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