From crypto to housing, collapse of speculative wealth could refocus investment on real growth

Investors hoping to make a killingas cryptocurrencies rebounded from this year's plunge in valuations got a rude surprise last week after one of the most trusted exchanges for crypto trading, FTX, filed forbankruptcy.

But while old-school financial advisers may be tut-tutting at young and inexperienced crypto investors who they say should have known better,there are new signs a decline in speculative investments may be part of a trend that goes far beyond bitcoin and its manyimitators.

Suddenly things like house prices, tech company valuationsand fintech innovations, including cryptocurrency,that so recently seemed to be shooting for the moon are coming back down to Earth.

Get rich slow

Althoughmany people are getting their fingers burned as soaringspeculative investments slump, there are those who say the trend will benefit the economy.

Instead of encouraging get-rich-quickspeculation, rising interest rates mean areturn to the old-fashioned kind ofinvestments that use money and workers more efficiently tocreate real economic value.

Some expertssay that the most recent bitcoin decline does not mean that the financial innovation of cryptocurrencies has come to a dead end. Nor ishousing or the newtechnology implicit in social media companies such asTwitter or Meta'smetaverseinnately bad or useless.

But as interest rates rise and money gets tight, suddenly what seemed like an investment that couldn't lose has been exposed as one where the business model simply does not justify that optimism.

"A rising tide lifts all boats," goes a familiarbusiness aphorism. But Warren Buffett, a longtime advocate of slow growth, has added anotherthat has become almost as famous: "Only when the tide goes out do you know who's been swimming naked."

But as central bankers raise interest rates, it is not just reckless speculators and mismanaged businesses thataresuffering, said Lisa Forbes, a manager atSEED Winnipeg, a non-profit that teaches business skills and helps to find small loans for new entrepreneurs.

Fear of borrowing

"I'm working with people who [have what]you probably call ... micro businesses," said Forbes, whose clients often run single-person businesses suchascleaning contracts, small catering servicesor e-commerce retail.

Forbes grew up in Winnipeg, but her family comes from Peguis First Nation about 100 kilometresnorth of the city and many of her clients have indigenous backgrounds. She said rising interest rates are already hurting.

More and more, small self-financing entrepreneurs are reluctant to leave safe jobs and throw themselves into riskier ventures.

"The incredibly fast increase in interest rates is making it so that we've got people that are shy about wantingto get a loan," Forbes said, adding that canmean their business never starts oris under-capitalized and ultimately unsuccessful.

While much bigger, Software as a Service (SaaS) startups and their venture capital backers the backbone of recent tech business growth are also retreating from risk, withreports of North America-wide business failures.

"The fact is that the glut of capital in the past few years has resulted in too many companies in every market," Nick Mehta, CEOof the software companyGainsight, wrotein Inc.com earlier this year.

Wastingscarce resources

Canadian central bankers going back to at least governor David Dodge have worried about whether the economy is using its financial and human resources efficiently. In the past, economists warned that low rates would create zombie companies and prevent the self-renewing process of creative destruction.

Cheap and available money can be a godsend to newentrepreneurs, butMark Kamstra, professor of finance at Toronto's Schulich School of Businessat York University, is one of those who has worried that the cost of borrowing had recently become too low.

Especially as interest rates fell below the rate of inflation, investorswere able to make money doing things that added little value to the economy.

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"This is a feature of low interest rates that's really very troubling," Kamstra saidafter teaching a class last week. "You've got people who've an incentive to look for investments that pay very little because you can make money on a one per cent return."

The extension of that kind of thinking can lead to individuals or businesses borrowing huge amounts of money, called "leverage," for investments that make no money at all in the hope of eventual profits.Higher interest rates, Kamstrasaid, mean that collectively, we invest our resources more wisely.

He said this same kind of thinking can apply to real estate, where the arithmetic changes as interest rates go up.

"I have friends with $3-million homes, and I say, 'You are implicitly saying that living there is worth $200,000 a year,'" said Kamstra, who rents. "If I had $100,00, I could rent a palace."

In a world with scarce resources, he said, it may bea waste to pour money into tech startups or retail businesses or granite countertopsthat produce low yields, when instead you could put your money into a more difficult high-yield business such as mining and processing lithium that the world desperately needs to fight climate change.

A new dot-com bubble?

As Bank of Canada governor Tiff Macklem discussedlast week,one of those scarce resourcesis human capital, and Kamstraworriesmany of his students are going into low-yield technology businesses because they offer stock options andpay well now but might not last. "What if that's all just kind of a bubble?"

When it comes to cryptocurrency, Kamstrasaid he was skeptical when prices rose to last year'shighs, but he says that doesn't rule out their future use as an innovation toreducethe highcost of finance.

But it's not just older,traditional financial experts who are convinced that cheap capital and speculative fever got out of hand in the rush to cryptocurrency.

"The bitcoin bubble, and the overall hype around cryptocurrency and blockchain technology, can be compared to the dot-com bubble," LarisaYarovaya, who researches financial technology and market contagion at Britain's University of Southampton, said in an email interview.

It is no surprise to her that reports of thebankruptcy of crypto platform FTX is causing contagion.

Yarovaya said thegamification of online trading platforms made investing look easy and fun, but as crypto assets shot higherand low rates made returns on other investments seem measly, inexperienced investors were captured byhigh-risk "crypto-exuberance" that was really gambling, not investing.

Large and institutional investors may wellbe directed by rising interest rates to abandon speculation in favour of searching outhigher yields and long-term returns, but Yarovaya believesthose who participated in the crypto and meme stock booms maybe unconvinced.

Maybe the slogan "get rich slow" just won't be astantalizing to novice investors.