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The Eerie Familiarity of California’s Boom-Bust Cycle

The Bulwark

February 13, 2023

Those trying to ride a corporate unicorn to a major IPO should consider the lessons of their nineteenth-century forebears.

On January 24, 1848, James Wilson Marshall, a carpenter from New Jersey who had taken up residence near Sutter’s Fort in northeast California, was attempting to establish a timber mill to feed burgeoning construction in nearby Sacramento and, farther afield, the settlement at San Francisco. While surveying the building’s progress, Marshall happened to notice some “sparkling pebbles,” which he initially dismissed as quartz. He noticed more of the pebbles later that day and picked a few of them out of the riverbed. Marshall discovered the rocks “could be beaten into a different shape, but not broken,” meaning they were definitely not quartz—they were likely gold. He brought samples to his business partner, and together they conducted a few more tests. Marshall was right about what he’d found. News of his discovery spread. The California Gold Rush was on.

What happens in California rarely stays there; it tends to find its way into every corner of American life. In the three years after President James K. Polk announced the gold discovery to Congress, California’s non-indigenous population jumped from about 10,000 to 255,000. Before the end of the boom, more than 300,000 people from across the country and around the world came to seek their fortunes in the region’s rivers, streams, and mountains. Gold hastened statehood, complicated political tensions between North and South over slavery, helped finance and accelerate transcontinental rail and telegraph service, and added immense wealth to an already rapidly industrializing country. The California gold—a back-of-the-envelope calculation puts it at about $27 billion (in today’s dollars) extracted over seven years when the annual gross national product was around $80 billion (also in today’s dollars)—rapidly expanded the nation’s capital base and paid enormous dividends over time.

Those who sifted and dug the precious metal out of the ground often ended up not much better off than when they began, with much of what they earned going to the cost of their own accommodations and living as well as liquor, gambling, and other “off-book” pastimes favored by single men living on a frontier. It was the entrepreneurs supplying those wants and needs who made bank during the gold rush, and as they did, laid the foundation for the state’s go-go economic development over the next 150 years.

The number of parallels between the gold rush and the tech rush are remarkable. Again, a predominantly young, male population has flooded into the state from around the world—Silicon Valley is a United Nations unto itself, drawing some of the best brains from Europe and Asia—to build the digital economy. The Federal Reserve’s extended zero-interest policy fueled a speculative boom by shifting the “risk-curve” toward the kind of high-reward ventures for which Silicon Valley has become famous. The proliferation of digital technology has helped to heighten social and political tensions in American society in much the same way historian Ted Widmer says the “Lightning,” a popular name for the telegraph, did during the run-up to the Civil War. Easy money has spawned a “party-bus” work environment with lavish spending on salaries, stock options, and an arms race of workplace amenities designed to keep agile, well-educated, and ambitious workers happy. Economic “bubble” thinking is comparable between the two eras, too, with financiers and tech workers today all hoping to ride a unicorn into a public offering that will make them multi-millionaires. Ownership shares in the startups are even called “stakes,” echoing the terminology of nineteenth-century gold prospecting claims.

But just as gold played out in the 1850s, so has the Fed’s recent liquidity splurge. As recently as my last visit to Silicon Valley nine months ago, the party was still in full swing. Venture capital funding rounds peaked in 2021 with $311 billion invested across upwards of 12,000 deals that went predominantly to Silicon Valley businesses. In the pre-inflation before-times, “up-rounds” were the rule: New capital would regularly be injected at ever-increasing company valuations in an effort to speed technological development and returns at almost any cost. Startup CEOs got the side-eye from venture capitalists for any business strategy that seemed inadequately angled toward growth. Pension funds, hedge funds, and other institutional investors couldn’t shovel cash to these companies fast enough.

Over the past 18 months, though, the specter of an inflation spiral has brought the Valley back down to earth. Tight money means “down-rounds,” which reduce valuations and slow the stream of institutional cash, are the new rule. Start-ups with conservative, cash-flow-positive business plans are getting new investment. Stricter terms are being added to these deals; a salient one puts down-round lenders first in line for repayment in the event of an acquisition or bankruptcy. The irony is that the down-rounders of today are the up-rounders of yesterday: The people who couldn’t lend fast enough are now putting the squeeze on their customers. Money still talks, and when it speaks in Silicon Valley these days, it does so in sober investment-bank tones. Startup owners and employees are watching the huge Fed bux–fueled payouts they once hoped for as they recede towards a distant horizon.

What’s bad for individual startups and the broader tech sector may turn out to have a few upsides for the rest of the economy. One CEO recently told me he has been glad to feel like he’s “running a business” focused on making a profit rather than trying only to juice returns for VCs. The layoffs from Meta, Google, and Apple are also making it easier to find talent, although some of the small firms that would otherwise like to hire from the ranks of the recently unemployed are being constrained by the capital shortage. Stanford economist Erik Brynjolfsson believes the layoffs will ultimately help redistribute tech talent away from cryptocurrency and other low-value fads, which could redound to everyone’s benefit if some of that talent finds its way into manufacturing, healthcare, and other sectors.

In the 1850s, the people who migrated to California in search of easy riches were called Argonauts after the figures from Greek mythology who sought the Golden Fleece. When California’s rivers and hills stopped offering up treasures, the miners had to begin applying their energy elsewhere. The gold in the Golden State marked only the beginning of the greatest era of prosperity the planet has ever seen.