It’s easy to overlook just how much virtual goods are being bought and sold and the growing impact these are having on the real economy. What are virtual goods? If you are a gamer, this would be obvious but bear with me here because for a very large portion of the population, virtual goods brings up big questions marks. In the past, I’ve discussed some of the games from a company named Zynga such as Farmville. In this game, users spend time to build their virtual farms, raise animals and improve the general look & productivity of whatever happens on the farm. Spending time is always a great help but what if you could “speed up” things by buying “virtual farming equipment”, virtual land or other goods? That is exactly what has been happening in Farmville and in hundreds of other games.

Yes it is becoming mainstream

I saw an interesting chart on Twitter the other day which detailed the “top grossing” applications in the Itunes store. Take a look and you will notice that 3 of the top 4 at that time are actually free applications!! How? Because users start playing, and become so involved that they decide to make virtual good purchases to further themselves. This is very much a real business.

What is being purchased?

You  can see a very interesting breakdown from Sillicon Valley Insider here:

Investing in virtual goods?

One thing that is not entirely clear yet is how to profit as most of the companies involved remain private. Zynga is scheduled to become public later this year and will become a great play although it will be interesting to see how expensive the company will be trading. One interesting play would be Ebay (EBAY) as its Paypal payments units has been putting a lot of energy and resources on micropayments for virtual goods among other things. The big danger for Paypal is that both Apple and Facebook are putting a lot of energy on making their applications go through their own payment systems instead of alternatives like Paypal to collect a share on the payments. The one place where Paypal remains well positioned is on Google’s Android.

The other day I had a discussion with a friend of mine who said he had heard about China‘s economy overheating and the fact that the government was trying to slow things down by doing a few things mostly geared towards the exploding real estate market. My friend said that the argument did not make any sense and that the Chinese should be thrilled that their economy was growing so fast when everywhere else around the world things were going so badly. I could see his point in a way but did explain my point of view on the situation.

Yes, an economy can grow too fast

First off, let’s clear something off. Many bad things can happen to an economy and we won’t try to name all of them but I think it’s fair to say that inflation is probably the most dangerous in most countries. Why? Because it creates a bunch of issues that have very bad effects on the economy. A few examples? International investment is rarely done in countries with high inflation rates. Why? Because those countries currencies usually lose value quickly which destroys any return that was made through the actual investment. As well, high inflation usually must be resolved through high interest rates which can cause a recession. I could go on and on but the basics are that inflation (and deflation) is a major threat. That is why central banks in industrial countries have their goals measured in terms of the inflation rate rather than economic growth. Most countries aim for 2% or so of annual inflation.

Now back to our main issue

The fact is that each country has a theoretical economic growth target. How is it determined? Economic growth would originate from:

Economic Growth = Working Population growth + Productivity growth

Each country is different and the more a country is advanced, the more difficult it becomes to post huge productivity growth every year. For example, the Chinese have a lot to learn and to do in terms of increasing their productivity either through more advanced technologies, equipment, etc. For most of these things, they can simply buy equipment abroad or learn techniques developed in foreign countries. The US however is much closer to the cutting edge which makes it much more difficult to improve as fast.

When an economy starts growing faster than what is theoretical growth is, it usually means that resources such as workforce and capital are missing which causes companies to start paying more and can bring inflation to spiral out of control. Let’s not forget that most economies would much prefer grow at a steady rate (as much as possible) for 20 years and than having 5 years of intense growth followed by a 2 year recession, in each 7 year cycle.

Hopefully this clears things up a bit?