‘The Founders’ Is an Excellent Book

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Reprinted from RealClearMarkets

Every so often Cato Institute co-founder Ed Crane reminisces about the early days of libertarianism, and in particular the make-up of the movement as gatherings began taking place. Though the lover of liberty in Crane has always and everywhere relentlessly defended the natural right of individuals to live as they want, he remarks in comical fashion that until those meetings of libertarians in the 1970s, he had no idea just how many “alternative” lifestyles there were.

It’s his proud (with good reason) way of reminding us newbies of just how far libertarianism has come. Though libertarianism surely gave meaning to “fringe” in the 1970s, it’s in modern times a very established, perhaps even elite movement populated by rather prominent people eager to promote the Founders’ vision of freedom. While president of Cato, Crane could claim board members that included FedEx founder and CEO Fred Smith, LBO legend Ted Forstmann, News Corp. founder Rupert Murdoch, cable and communications mogul John Malone, and industrialist David Koch; Koch at the time of his death one of the richest men in the world. Crane founded the Institute with Koch’s brother, Charles. Away from Cato’s board, there’s long been speculation that Amazon founder Jeff Bezos swings libertarian, to read Nike co-founder Phil Knight’s brilliant memoir Shoe Dog is to think he too might be libertarian, actor Vince Vaughn is out in the open about his ideology, and realistically many more big names.

Please consider the above paragraph with the ‘70s libertarian gatherings top of mind. Would anyone have bet way back then that what was once so strange would eventually be populated by so many accomplished individuals? The realistic answer is no. Crane somewhat uniquely saw a future that very few did.

Crane’s vision came to mind while reading Jimmy Soni’s thoroughly excellent new book, The Founders: The Story of PayPal, and the Entrepreneurs Who Shaped Silicon ValleyThe Founders is of course about the remarkable collection of talent that found its way to what became PayPal, and the impact these amazing minds had and continue to have on Silicon Valley and beyond. Notable about what some refer to as the “PayPal mafia” is that many in the “Mob” who created a company were “techno-utopian libertarians.” Soni’s clear that the latter bothers some, but he’s also respectful about this truth. These plainly different thinkers are playing a major role in Silicon Valley’s present, and by extension they’re rushing a very different future into the present with their remarkable creativity.

Where it gets interesting is that just as libertarianism and Cato seemed unlikely to have staying power in the 1970s, so did it seem unlikely that what became PayPal would ever make some noise. That PayPal’s chances were incredibly slim was and is somewhat of a statement of the obvious. True entrepreneurs believe deeply in something that most others reject, ridicule or both, and they certainly believe deeply in a future that the established commercial players see as unlikely. We know this because if the well-capitalized commercial leaders of the present shared the view of the entrepreneurs who see opportunity, they would co-opt their ideas. As Todd Pearson recalls to Soni (Pearson an early employee of Musk’s X.com), the big credit card companies “should have killed us when they could have.” So should the big banks have done that. Neither did. Tomorrow’s remarkable successes are never obvious.

More on banks, Elon Musk (a Cato donor in the past) had interned at Bank of Nova Scotia while still a student at Canada’s Queens University. Though he learned very little from the bankers for whom he toiled, Musk paradoxically learned a lot. He sensed that the industry had repelled the creative minds capable of taking banking to where it should be, which is why he directed $12.5 million of his $21 million in proceeds from the sale of his first technology company (Zip2) to X.com. X.com would, in Musk’s mind, be a one-stop financial services shop that would upend the world of banking.

Computer programmer extraordinaire Max Levchin, and his initial investor in Peter Thiel, came at the money question seemingly from a different angle. Soni reports that Levchin had come to the conclusion that eventually “everyone would be carrying supercomputers in their pockets,” and in doing so, they would have lots of important information in their pockets. When asked by Thiel “So what’s the point?” of your idea, Levchin responded that if someone has the computer in their pocket stolen, they’re out of luck. “You need to encrypt this stuff.”

Musk as mentioned founded X.com, while Levchin, Thiel and others founded Confinity, which eventually became PayPal. As most readers will know before they read Soni’s book, eventually the two competitors merged. Of course, we’re getting ahead of ourselves.

We are because the very idea of the companies merging, let alone surviving, surely seemed unlikely in the early days. The death rate among Silicon Valley companies is well known to be somewhere north of the 90% range, at which point there was a question of talent. In getting Confinity started, PayPal’s future COO (David Sacks) tells Soni that “We had to recruit our friends because no one else would work for us.” Please think about that. Really, how many companies wind up with a market capitalization of $300 billion (when Soni’s book went to print), or $139 billion as of the writing of this review?

That PayPal is worth so much today is the surest sign of how farfetched its business model was in the earliest of days. Efficient market types like to quip that $20 dropped on the sidewalk won’t last long, which means a business concept capable of valuation in the hundreds of billions will logically be snapped up quite a bit more quickly than the $20 bill. Unless no one believes in the concept(s). That a business line that was ultimately so valuable wasn’t entered into by credit card companies, banks, or for that matter just a well-capitalized enterprise eager to expand, is the surest sign that what became PayPal was seen as delusional, impossible, or more likely than not, not worth contemplating to begin with.

Soni crucially writes that “Brilliance, noncomformity, availability, and the willing suspension of disbelief” defined “Confinity’s first hires and formed the foundation of its culture.” Musk’s X.com could clearly claim better access to talent given Musk’s track record (Zip2), not to mention that in recruiting new human capital, his employees could tell prospective hires that “he’s got thirteen million in.” Still, Soni’s line about the “willing suspension of disbelief” speaks loudly to just how low the perceived odds for the combined entity’s success were.

Funny, interesting, or both on its face is the libertarian angle to all this: a movement that came to be well outside conformity norms, and a company populated by more than a few libertarians, is a story (or many stories) in itself. The main thing is that what eventually looks credible very often doesn’t look that way in the early stages. Markets – including political or policy markets – are once again too efficient for that. Some creative (commercial and political) minds happened upon something remarkable, and Soni is thankfully telling their story. Is there a connection between their opposite thinking about public policy that informs their ongoing prosperity in the land (Silicon Valley) of opposite thinking? This is a question that will occupy your reviewer’s mind for a long time. For now, we can just see through Soni that the “techno-utopian libertarians” (Thiel at this point is the most famous of Mafia who is “out” about his ideological leanings) who created PayPal “have built, funded, or counseled nearly every Silicon Valley company of consequence for the last two decades” on the way to a “combined net worth [that] is higher than the GDP of New Zealand.”

About what PayPal became, it’s worth stressing yet again just how outlandish it all was. To be clear, you’re reading a review of an excellent book in 2022. The seeds of what became PayPal began being planted in the late 1990s. The timing is crucial because Soni reminds readers that “In the late 1990s, only 10 percent of all online commerce was conducted digitally – the vast majority of transactions still ended with a buyer sending a check by mail.” Please stop and think about this. Please do so while thinking about Levchin, Thiel and others imagining people “beaming money from PalmPilot to PalmPilot.” While most were still concluding online transactions via regular mail, “Thiel and Levchin envisioned a cashless mobile world, with Confinity linking central banks, credit card companies, and retail banks.”

Of course, this was just the vision of Thiel and Levchin. At a time when people were plainly very fearful about transacting over the internet, Musk envisioned creating a jack-of-all-trades financial services concept online. Particularly for the readers of this review who are younger, it cannot be stressed enough how out of context these visions were as the 20th century neared its close.

That the ideas were so outside the proverbial box surely vivifies Musk’s recollection twenty years later that PayPal “was a hard company to keep alive.” In Soni’s words, it was “a four-year odyssey of near-failure followed by near-failure.” Soni reports that one trade publication observed about PayPal (the publication seemingly inclined to be more open to innovative ideas), that the U.S. needed it “as much as it does an anthrax epidemic.” As always, entrepreneurs are so very different from you and me. What they see when they open their eyes (and close them) is not what 99.99999% of the rest of us see.

Which brings us to some of the people. About Peter Thiel, the German immigrant who’d “spent his childhood checking off all the right meritocratic boxes” of the Stanford and Stanford law variety, Texan and Stanford senior Ken Howery told his girlfriend that “Peter might be the smartest person I’ve met in my four years at Stanford.” Though he’d received offers from top financial firms, he had decided to work for Thiel (quite literally in a closet on Sand Hill Road) and his eponymous investment firm.

Levchin was an immigrant from the Soviet Union who found his way from Chicago to the University of Illinois, Urbana-Champaign. It had a growing reputation in the computer space at the time of his arrival, only for Levchin to get happily lost in the joy that was programming, starting up businesses, and all the other exceedingly rare things for the typical college student, but that were and are seemingly so common among those of opposite mind.

Musk’s background is probably at this point best known. He came up in South Africa, but as brother (and fellow entrepreneur) Kimbal relayed to Elon’s initial biographer Ashlee Vance, “South Africa was like a prison for someone like Elon.” The brothers Musk eventually made their way as mentioned to Canada, and soon enough to the United States (Musk completed his studies at Penn), the country that Musk (according to Vance) upliftingly “saw in its most clichéd form, as the land of opportunity and the most likely stage for making the realization of his dreams possible.”

It’s not known if Thiel and Levchin felt as movingly about the U.S. as Musk did, but that’s really not the point. What is the point is the genius that none of us benefit from when rare talent isn’t matched with the United States. To the latter, some will respond with “If you can tell me which immigrants will thrive, I’ll stamp their passports.” Such a response misses the point much as your reviewer’s use of anecdote to make a case for open immigration would similarly miss the point. Anecdote is a lousy policymaker, as is emotion. But so is the notion of government choosing who will get to test themselves on commerce’s biggest stage. Which means the answer is that we would be wise to rely on a way of thinking that’s long informed the thoughts of Cato co-founder Crane: someone who cares enough about himself to get to the United States, or who is the child of parents who care enough to get their child to the United States, is American for having done just that. At which point, let’s allow the markets to render a verdict on human capital.

While not every immigrant will thrive in the way that Musk, Thiel et al plainly have, let’s at least be realistic in saying we’ve likely never heard of any of the three if they’d spent all their days in Germany, Russia, and South Africa. Which means we can say that in depriving humans of the chance to take the proverbial final test (paraphrasing Ken Auletta) that is the United States, we’re most certainly depriving ourselves and the world of spectacular commercial advances that could only happen here. How about an “Only in America” approach to immigration? Since it so often can only happen here, let’s stop keeping the immigrants out. They make the United States, America.

They also remind us of how pointless our education obsession is. And this isn’t just because Thiel to this day funds the entrepreneurial dreams of those willing to skip the whole college thing.

The focus on education is pointless precisely because the entrepreneurs feverishly rushing an all-new future into the present are taking us places that education quite simply cannot. This is worth thinking about now in terms of the recent announcement from FedEx founder Fred Smith that he’ll be stepping aside soon as CEO. It’s regularly pointed out that a Yale professor gave a Smith essay about overnight delivery a C, and this story is used by more than a few (including libertarians) to make a case that colleges and universities are hopelessly calcified in thought, hopelessly left-wing, etc. etc. Such an analysis misses the point. It does because readers can rest assured that while Smith’s professor gave him a C, countless investors gave Smith and his far-fetched idea an F. It’s not just professors who don’t see the future staring them in the face.

Applied to what eventually became PayPal, Thiel described the capital raising process to Soni as “excruciating.” Soni writes that Thiel et al “presented over one hundred times – with pitch after pitch falling flat.” Again, Smith’s C at Yale is a distraction from the much bigger, and much more uplifting truth that entrepreneurs succeed in the face of endless ridicule from investors. In short, finance is surely littered with individuals who passed on FedEx in the 1970s, and Paypal decades later. The future is opaque for individuals well beyond academia.

At the same time, we can’t just let academia off of the hook. The entrepreneurial are yet again working to take us in all new directions. Which means that what they’ll do can’t be taught. By extension, entrepreneurialism certainly can’t be taught. In Thiel’s case, he was a law grad hoping for Supreme Court clerkship. What about the latter informed what he became other than Thiel not getting tapped for the clerkship? Levchin loved the technology access that the University of Illinois provided, but Soni reports that when asked how he learned “management,” he cites Akira Kurosawa’s film classic The Seven Samurai as his “sole source” of knowledge about the craft. What about PayPal’s idea man in Luke Nosek. He tells Soni that “my education was about the things that I do – not the things that they’re making me do.” As for Musk, to say that school shaped his live mind is too silly for words…

None of this is a knock education in a broad sense. The bet here is that U.S. colleges and universities won’t just survive going forward, but that they’ll thrive; with each passing year the schools attracting more and more people from around the world eager for time at this great piece of Americana. At the same time, neither school, nor trade schooling, nor even time at an investment bank can necessarily educate tomorrow’s entrepreneurs. Again, they see things in entirely different ways, and difference of thought cannot be taught.

Which brings us to Linux versus Microsoft. About the debate inside what became PayPal over which was superior, the argument itself speaks or spoke to the folly of instruction, or coding school, or something else entirely that might educate the U.S.’s future technologists. Good luck with it. Levchin was a Linux guy, Musk favored Microsoft. Your reviewer is hapless when it comes to understanding either, and no amount of education could alter the previously expressed truth. The short answer here to the differences between the two is that per Soni, Microsoft software is the “Honda minivan” compared to the Apple-like elegance of Linux. That’s the best your reviewer can do. In Soni’s case, he chose to write a book for more than someone like me. In other words, The Founders goes well more into detail about the debate that took place with regard to “coding” or “programming” software. That he did was more than this reader needed, but it’s not a critique of Soni’s decision.

Indeed, the battle inside PayPal was to a not insignificant degree fought over what software (if that’s the right word) would be the backbone of the PayPal payments system, and it was one that played a significant role in Musk’s eventual ouster as CEO. Fascinating there is that the latter occurred while Musk was away on a belated honeymoon with first wife Justine. It seemingly had to happen that way given Musk’s powerful charisma. Had he been in town to give his side, he might have influenced an outcome in ways that Thiel, Levchin and others did not want. Soni describes it all cleverly: “a fair trial” for Musk “required Musk’s absence.”

For readers of this review, that the biggest PayPal shareholder in Musk was eventually pushed aside is hopefully indicative of how successful PayPal was becoming. And that’s not a knock on Musk. To this day there are debates or discussions (including, obviously, in The Founders) about what PayPal might have become had Musk remained in control. The view here is that it’s impossible to know with any certainty simply because in the words of Musk himself, “PayPal was a hard company to keep alive.”  

This is important when thinking about Musk’s removal. Though funding had become easier such that by the year 2000 “We were getting fire-hosed with cash” (Musk), the cash was also flying out the door. Amid increasingly passionate investor interest in the company, the expense of running the company was growing. In this environment, and amid fights about software along with what PayPal would be (Musk’s financial superstore or the giant of E-Commerce payments), Musk’s vision lost. All of which exists yet again as a reminder of the unknowns that surround business even in hindsight. Still, the fact that there was a fight to have signals that what looked unlikely was increasingly likely as a business success.

It’s also useful to point out (as Soni does) the timing of the $100 million funding round alluded to in the above paragraph. PayPal was “fire-hosed” not long before public internet shares started to crater on the way to a bust for the sector. Timing can obviously be so crucial. It makes one wonder what remarkable businesses did not have time on their side in 2000. The main thing is that the investment saved PayPal at a moment when skepticism was growing. Soni quotes Musk in an interview conducted with a University of Pennsylvania alumni magazine about a “speculative frenzy” that had led to the funding of many “Potemkin villages out there built on flimsy foundations.” Musk’s conclusion then was that “many, many will fail.” Did this make him a seer? Realistically no. As George Gilder has long argued, what Musk deemed a “speculative frenzy” was in fact a “growth spurt” whereby massive amounts of information (good and bad) was created via intrepid investment. The important thing is that good and bad information is good. In looking back on the 2000-2001 bust, the shame then and now is that it’s looked at with such weary, shuddering eyes, and that slow-witted politicians and regulators responded with all sorts of rules. Why? These rushes of investment into new ideas are beyond transformative. We need more of them, not less. As your reviewer has argued, we’ll know crypto is for real when the early players collapse.

Perhaps equally interesting is that Soni writes of Thiel expressing skepticism or worry similar to that expressed by Musk. Thiel was so much of the view that a correction was looming that he felt the aforementioned $100 million raised should be directed to his hedge fund so that internet shares could be shorted, and PayPal even better positioned in terms of cash after the decline. The board rejected his idea out of hand, and for obvious reasons. The lawsuits that would have emerged from such a baldly speculative bet would have been endless. Still, if it had been doable it’s fun to imagine the kind of cash that could have been raised for PayPal, along with other investment ideas that were surely on Thiel’s mind at the time.

Of course, as is well known to readers, capital for internet concepts became far scarcer for a time after the correction that PayPal narrowly beat. This rates further mention because PayPal’s next, $90 million capital raise in 2001 came from foreign investors. While domestic investor interest in Silicon Valley had for a time decreased, foreign interest in the sector was still keen. It’s all a reminder of a truth that sadly eludes Left and Right about the Federal Reserve: its power to influence the economy on its best day is vastly overstated. If we ignore that the Fed can’t create a penny of credit as is, the laughable notion of Fed “tightness” presumes that the U.S. economy is an autarkic island of economic activity that stodgy banks even more laughably finance in total. More realistically, finance is broad and very much global. When U.S. investment sources went conservative in 2001 and beyond, other investors filled in for them.

PayPal itself was and is a mocking rejection of central bank obsession. While the Fed has long acted as a rate follower of the big U.S. banks, credit sources have continued to price the latter at costs unrelated to the droolings of economists. Soni notes how PayPal paid interest on deposits (5%) well above the market or “Fed” rate as a way of getting customers in the habit of keeping their funds out of traditional banks. As previously mentioned, the financing of PayPal’s growth was global in nature, and happened without regard to Fed fiddling with the alleged short rate for credit. After which, readers need only think how very expensive it was for PayPal to secure investment during a four-year period (1998-2002) when the monetarily confused (ironically, many were Milton Friedman “monetarists” and Ludwig von Mises “Austrians”) claimed the Fed had made money “easy.” These individuals (many who would claim a libertarian lean) wore their very academic cluelessness on their sleeves. In the real world of commerce, access to capital is never cheap. Even when PayPal was per Musk being “fire-hosed” with investment, the investment was offered in return for equity; meaning it was yet again very expensive.

For this reviewer, the extraordinary cost of credit then and now raises a question about whether or not the PayPal experience, during which time all manner of existential threats (fraud, eBay, banks, credit-card companies, along with PayPal’s own customer-acquisition strategy) revealed themselves, actually changed the views of the “techno-utopian libertarians” inside the company that is the subject of Soni’s book. Knowing how always expensive-to-access capital routinely threatened PayPal’s existence, did this change their views about the power of the Fed, and in particular its alleged ability to decree “easy” credit? This question is asked given the belief here that its Fed obsession is one of the weakest aspects of libertarianism. Without defending the Fed for even a second (let’s abolish it as it serves no useful purpose), the popular narrative that it’s relevant to economic activity one way or the other just isn’t serious. PayPal’s remarkable story is the latest one to reveal this truth in spades. 

Silicon Valley is a persistent reminder of how unimportant the Fed is, along with banks and central banks in general. Despite this glaring rejection of the importance of central banking, the conventional in thought continue to act as though what central banks do actually matters. Except that the PayPal crowd about which Soni writes happily isn’t conventional in thought. To Musk money “is an information system.” Amen. That’s all money is. It’s a measure. Soni is clear throughout that Musk in particular saw X.com as much bigger than a financial services entity. It would seemingly redefine money, or in your reviewer’s eyes hopefully return money to its traditional meaning as a stable measure of worth; as in return money to a credible “information system” moving resources to their highest use instead of a floating, economy-sapping medium that it’s become. Is reviving money as a measure still on Musk’s mind? Perhaps Levchin or Thiel’s? One can hope.

In Soni’s case, he wrote a book before The Founders about George Gilder’s hero in Claude Shannon. Shannon of course viewed money in its proper light. How interesting that he turned to PayPal’s story as his next big project. Will the story of money’s re-invention be something that Soni writes about in the future? One can hope that the biggest achievements of the PayPal “mafia” are in the future. Freeing the world of floating money would make PayPal, Facebook, Tesla, SpaceX, and the other major achievements of the PayPal minds appear small by comparison. Time will tell.

For now, it should be said that Soni has written an essential book about some remarkable people. On February 15, 2002 PayPal went public at a billion dollar valuation, and seemingly against all odds. What a huge achievement that spawned so many others. What an achievement by Jimmy Soni in telling the essential story of PayPal, and the amazing people who made it happen.

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