Vruz sent me a copy of this CIBC research report called "Heading For The Exit Lane." I read it this morning and I've been thinking about it for most of today. So I uploaded it to Scribd and reblogged my favorite line in the report on my tumblog. But that didn't get the report out of my head.

This oil thing sure has legs. Even if we aren't in a "peak oil" situation (and even the Saudis can't agree about that), we've gotten to a price point where consumer behavior is going to change significantly over the next few years. Over the long term, that's a good thing. The world economy is addicted to oil, largely because it's been so cheap for so long. But it's not cheap anymore and given the pace at which the rest of the world is developing these days, it's not going to be cheap ever again. Unless we find another source of energy that is a lot cheaper than oil and I am not aware of any developments that will get us there soon.

This has bigtime ramifications for slowing growth and rising prices (inflation). And these impacts will not be limited to the US economy. They will be felt worldwide. The hypergrowth economies of China, India, Brazil, Russia, and other developing economies may not be impacted as much as the more mature economies like Japan, Europe, and most of all the US. Russia, in particular, stands to benefit greatly from the spike in oil prices.

Slower growth and rising prices (inflation) cannot be good for equities. Rising rates, which is what will have to come, will not be good for any kind of financial assets.

Which, of course, leads me to venture capital. The value of your equity in a startup company is a financial asset. It may not be publicly traded but like all other financial assets it is ultimately worth the present value of future cash flows discounted at an interest rate that takes into account market rates of interest plus a risk premium.

We've been operating in a world where real interest rates have been hovering around zero (at least in the US). And that has propped up the value of equities and venture capital assets have been part of that prop-up.

All we have to do is look at the 70s to see the effect of low growth and high inflation (stagflation). Here is a chart of the Dow Jones Industrial Average during the 1970s.

Yes, that's right, the Dow Jones Industrial Average ended the 1970s right about where it started.

I wasn't in the venture capital business in the 1970s. I was a teenager that decade. I remember Vietnam, Watergate, the oil shocks, the gas lines, Gerald Ford, whip inflation now, Jimmy Carter, the Iran hostage crisis, and Paul Volcker and Ronald Reagan.

The first venture capital firm I worked for, Euclid Partners, was formed in 1971. The two founding partners, Milton and Bliss, raised about $4.5mm in 1971. They didn't raise another fund until 1983. They strugggled mightily during the 1970s with their portfolio and ultimately made it work when the technology market took off in the early 80s. I heard a bunch of stories from them about that time and it was not an easy time to be an entrepreneur or a VC.

Surely the next 10 years won't be identical to the 1970s. A lot has changed, particularly the global economic environment. But it's also clear that the economy we are in (and maybe have been in for the past 18 months) is going to be tougher for owners of financial assets than the past 20 years have been. And I don't think the startup economy and venture capital is immune to this new reality.