January 2021 - Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages by Carlota Perez

This month we read Carlota Perez’s understudied book covering the history of technology breakthroughs and revolutions. This book marries the role of financing and technology breakthrough so seamlessly in an easy to digest narrative style.

Tech Themes

The 5 Technology Revolutions. Perez identifies the five major technological revolutions: The Industrial Revolution (1771-1829), The Age of Steam and Railways (1829-1873), The Age of Steel, Electricity and Heavy Engineering (1875-1918), The Age of Oil, the Automobile and Mass Production (1908-1974), and The Age of Information and Telecommunications (1971-Today). When looking back at these individual revolutions, one can recognize how powerful it is to view the world and technology in these incredibly long waves. Many of these periods lasted for over fifty years while their geographic dispersion and economic effects fully came to fruition. These new technologies fundamentally alter society - when it becomes clear that the revolution is happening, many people jump on the bandwagon. As Perez puts it, “The great clusters of talent come forth after the evolution is visible and because it is visible.” Each revolution produces a myriad of change in society. The industrial revolution popularized factory production, railways created national markets, electricity created the power to build steel buildings, oil and cars created mass markets and assembly lines, and the microprocessor and internet created amazing companies like Amazon and Airbnb.
The Phases of Technology Revolution. After a decently long gestation period during which the old revolution has permeated across the world, the new revolution normally starts with a big bang, some discovery or breakthrough (like the transistor or steam engine) that fundamentally pushed society into a new wave of innovation. Coupled with these big bangs, is re-defined infrastructure from the prior eras - as an example, the Telegraph and phone wires were created along the initial railways, as they allowed significant distance of uninterrupted space to build on. Another example is electricity - initially, homes were wired to serve lightbulbs, it was only many years later that great home appliances came into use. This initial period of application discovery is called the Irruption phase. The increasing interest in forming businesses causes a Frenzy period like the Railway Mania or the Dot-com Boom, where everyone thinks they can get rich quick by starting a business around the new revolution. As the first 20-30 years of a revolution play themselves out, there grows a strong divide between those who were part of the revolution and those who were not; there is an economic, social, and regulatory mismatch between the old guard and the new revolution. After an uprising (like the populism we have seen recently) and bubble collapse (Check your crystal ball), regulatory changes typically foster a harmonious future for the technology. Following these changes, we enter the Synergy phase, where technology can fully flourish due to accommodating and clear regulation. This Synergy phase propagates outward across all countries until even the lagging adopters have started the adoption process. At this point the cycle enters into Maturity, waiting for the next big advance to start the whole process over again.
Where are we in the cycle today? We tweeted at Carlota Perez to answer this question AND SHE RESPONDED! My question to Perez was: With the recent wave of massive, transformational innovation like the public cloud providers, and the iPhone, are we still in the Age of Information? These technological waves are often 50-60 years and yet we’ve arguably been in the same age for quite a while. This wave started in 1971, exactly 50 years ago, with Intel and the creation of the microprocessor. Are we in the Frenzy phase with record amounts of investment capital, an enormous demand for early stage companies, and new financial innovations like Affirm’s debt securitizations? Or have we not gotten to the Frenzy phase yet? Is the public cloud or the iPhone the start of a new big bang and we have overlapping revolutions for the first time ever? Obviously identifying the truly breakthrough moments in technology history is way easier after the fact, so maybe we are too new to know what really is a seminal moment. Perez’s answer, though only a few words, fully provides scope to the question. Perez suggests we are still in the installation phase (Irruption and Frenzy) of the new technology and that makes a lot of sense. Sure, internet usage is incredibly high in the US (96%) but not in other large countries. China (the world’s largest country by population) has only 63% using the internet and India (the world’s second-largest country) has only 55% of its population using the internet. Ethiopia, with a population of over 100M people only has 18% using the internet. There is still a lot of runway left for the internet to bloom! In addition, only recently have people been equipped with a powerful computing device that fits in their pocket - and low-priced phones are now making their way to all parts of the world led by firms like Chinese giant Transsion. Added to the fact that we are not fully installed with this revolution, is the rise of populism, a political movement that seeks to mobilize ordinary people who feel disregarded by the elite group. Populism has reared its ugly head across many nations like the US (Donald Trump), UK (Brexit), Brazil (Bolsonaro) and many other countries. The rise of populism is fueled by the growing dichotomy between the elites who have benefitted socially and monetarily from the revolution and those who have not. In the 1890’s, anti-railroad sentiment drove the creation of the populist party. More recently, people have become angry at tech giants (Facebook, Google, Amazon, Apple, Twitter) for unfair labor practices, psychological manipulation, and monopolistic tendencies. The recent movie, the Social Dilemma, which suggests a more humane and regulatory focused approach to social media, speaks to the need for regulation of these massive companies. It is also incredibly ironic to watch a movie about how social media is manipulating its users while streaming a movie that was recommended to me on Netflix, a company that has popularized incessant binge-watching through UX manipulation, not dissimilar to Facebook and Google’s tactics. I expect these companies to get regulated soon -and I hope that once that happens, we enter into the Synergy phase of growth and value accruing to all people.

Yes, I do. I will find the time to reply to you properly. But just quickly, I think installation was prolonged by QE &casino finance; we are at the turning point (the successful rise of populism is a sign) and maybe post-Covid we'll go into synergy.
— Carlota Perez (@CarlotaPrzPerez) January 17, 2021

Business Themes

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The role of Financial Capital in Revolutions. As the new technology revolutions play themselves out, financial capital appears right alongside technology developments, ready to mold the revolution into the phases suggested by Perez. In the irruption phase, as new technology is taking hold, financial capital that had been on the sidelines waiting out the Maturity phase of the previous revolution plows into new company formation and ideas. The financial sector tries to adopt the new technology as soon as possible (we are already seeing this with Quantum computing), so it can then espouse the benefits to everyone it talks to, setting the stage for increasing financing opportunities. Eventually, demand for financing company creation goes crazy, and you enter into a Frenzy phase. During this phase, there is a discrepancy between the value of financial capital and production capital, or money used by companies to create actual products and services. Financial capital believes in unrealistic returns on investment, funding projects that don’t make any sense. Perez notes: “In relation to the canal Mania of the 1790s, disorder and lack of coordination prevailed in investment decisions. Canals were built ‘with different widths and depths and much inefficient routing.’ According to Dan Roberts at the Financial Times, in 2001 it was estimated that only 1 to 2 percent of the fiber optic cable buried under Europe and the United States had so far been turned on.” These Frenzy phases create bubbles and further ingrain regulatory mismatch and political divide. Could we be in one now with deals getting priced at 125x revenue for tiny companies? After the institutional reckoning, the Technology revolution enters the Synergy phase where production capital has really strong returns on investment - the path of technology is somewhat known and real gains are to be made by continuing investment (especially at more reasonable asset prices). Production capital continues to go to good use until the technology revolution fully plays itself out, entering into the Maturity phase.
Casino Finance and Prolonging Bubbles. One point that Perez makes in her tweet, is that this current bubble has been prolonged by QE and casino finance. Quantitative easing is a monetary policy where the federal reserve (US’s central bank) buys government bonds issued by the treasury department to inject money into the financial ecosystem. This money at the federal reserve can purchase bank loans and assets, offering more liquidity to the financial system. This process is used to create low-interest rates, which push individuals and corporations to invest their money because the rate of interest on savings accounts is really really low. Following the financial crisis and more recently COVID-19, the Federal Reserve lowered interest rates and started quantitative easing to help the hurting economy. In Perez’s view, these actions have prolonged the Irruption and Frenzy phases because it forces more money into investment opportunities. On top of quantitative easing, governments have allowed so-called Casino Capitalism - allowing free-market ideals to shape governmental policies (like Reagan’s economic plan). Uninterrupted free markets are in theory economically efficient but can give rise to bad actors - like Enron’s manipulation of California’s energy markets after deregulation. By engaging in continual quantitative easing and deregulation, speculative markets, like collateralized loan obligations during the financial crisis, are allowed to grow. This creates a risk-taking environment that can only end in a frenzy and bubble.
Synergy Phase and Productive Capital Allocation. Capital allocation has been called the most important part of being a great investor and business leader. Think about being the CEO of Coca Cola for a second - you have thousands of competing projects, vying for budget - how do you determine which ones get the most money? In the investing world, capital allocation is measured by conviction. As George Soros’s famous quote goes: “It's not whether you're right or wrong, but how much money you make when you're right and how much you lose when you're wrong.” Clayton Christensen took the ideas of capital allocation and compared them to life investments, coming to the conclusion: “Investments in relationships with friends and family need to be made long, long before you’ll see any sign that they are paying off. If you defer investing your time and energy until you see that you need to, chances are it will already be too late.” Capital and time allocation are underappreciated concepts because they often seem abstract to the everyday humdrum of life. It is interesting to think about capital allocation within Perez’s long-term framework. The obvious approach would be to identify the stage (Irruption, Frenzy, Synergy, Maturity) and make the appropriate time/money decisions - deploy capital into the Irruption phase, pull money out at the height of the Frenzy, buy as many companies as possible at the crash/turning point, hold through most of the Synergy, and sell at Maturity to identify the next Irruption phase. Although that would be fruitful, identifying market bottoms and tops is a fool’s errand. However, according to Perez, the best returns on capital investment typically happen during the Synergy phase, where production capital (money employed by firms through investment in R&D) reigns supreme. During this time, the revolutionary applications of recently frenzied technology finally start to bear fruit. They are typically poised to succeed by an accommodating regulatory and social environment. Unsurprisingly, after the diabolic grifting financiers of the frenzy phase are exposed (see Worldcom, Great Financial Crisis, and Theranos), social pressures on regulators typically force an agreement to fix the loopholes that allowed these manipulators to take advantage of the system. After Enron, the Sarbanes-Oxley act increased disclosure requirements and oversight of auditors. After the GFC, the Dodd-Frank act mandated bank stress tests and introduced financial stability oversight. With the problems of the frenzy phase "fixed” for the time being, the social attitude toward innovation turns positive once again and the returns to production capital start to outweigh financial capital which is now reigned in under the new rules. Suffice to say, we are probably in the Frenzy phase in the technology world, with a dearth of venture opportunities, creating a massive valuation increase for early-stage companies. This will change eventually and as Warren Buffett says: “It’s only when the tide goes out that you learn who’s been swimming naked.” When the bubble does burst, regulation of big technology companies will usher in the best returns period for investors and companies alike.

Dig Deeper

December 2020 - Do Androids Dream of Electric Sheep? (Blade Runner) by Phillip K. Dick

This month we read the classic sci-fi novel, Do Androids Dream of Electric Sheep? The book follows Rick Deckard, a bounty hunter searching out android robots who are pretending to be human beings. Along the journey, the reader is asked to consider: what does it mean to be alive? Philip K. Dick was a crazy sci-fi writer, producing many books and stories that became famous like The Man in the High Castle, Minority Report, and Total Recall. Although his writing career was prolific, Dick was a troubled individual. He was a heavy drug user, he married five times, he experienced drug-induced “paranormal activities” and he was physically abusive to at least two of his wives. While

Tech Themes

The common, modern depiction of a Turing Test

Are you an android? In 1950, British computer scientist Alan Turing conceived of the Turing Test, a hypothetical test to determine whether a machine can display intelligent behavior. Turing asked the question, “Can machines think?” and attempted to define a test whereby a human might be tricked into believing a machine was human. The test design is fairly complex but involves a human asking written questions to a machine in another room. If the machine can convince the interrogator that it’s human, then machines can “think.” This Turing test is mirrored in the Voigt-Kampff test used throughout the book. It’s unclear if the test works, and Rick Deckard almost misdiagnoses Rachel in the book's early parts. At the end of the book, the test is turned on its head, with Rick impersonating John Isidore (another human), trying to convince machines (in another room) to let him in. This role-reversal and the questioning of who is an android happens throughout the novel - at times, Rick, Phil Resh, and Harry Bryant might all be androids. These questions are the centerpiece of sci-fi lore. They are also explored in a similar style in the famous movie Ghost in The Shell, where people have now have some organs and limbs replaced by electric parts. When a cyber-attacker named the Puppet Master takes over the machine network of technological parts, it’s unclear who is human, who is an android, and who is possessed by the Puppet Master. In the video game world, this idea has also recently been explored in Detroit: Become Human. In the game, which is set up in choose-your-own-adventure style, players can play as humans or androids and choose whether they stay in character or break out of their controlled, android state. The idea of an interrogator or bounty hunter snooping out rogue machines has been explored across books, film, and video games. As technology has become more prevalent in our lives, the cultural mediums may have changed, but the classic philosophical question - what does it mean to be alive? - remains.
Predicting the future. The Blade Runner movie is famously set in Los Angeles, 2019, while the book is set in 1992 in San Francisco. The book itself was written in 1968, and the movie Blade Runner debuted 14 years later in 1982. In 2019, Blade Runner experienced a comic resurgence as its dark, bleak futuristic society of flying cars, fully intelligent artificial beings, and international space travel never happened. Today, predictions of computing and artificial intelligence abound. In his original Imitation Game paper, Alan Turing made one of the most famous AI predictions: “I believe that in about fifty years’ time it will be possible to programme computers, with a storage capacity of about 10^9, to make them play the imitation game so well that an average interrogator will not have more than 70 percent, chance of making the right identification after five minutes of questioning.” It’s tough to know if this prediction came true (other than the 10^9 part because that is only 1 GB), with some places claiming to have built algorithms that beat the Turing Test. Interestingly, one common theme emerges about these computing predictions - both experts and non-experts typically predict about 15-25 years out. In the Innovators, Walter Issacson posited that this was enough time to allow people to engage in imaginative thinking. Roy Amara, co-founder of the Institute for the Future, probably put it best: “We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.” How long run is the long run, though? As John Maynard Keynes proclaimed: “In the long run we are all dead. Economists set themselves too easy, too useless a task if, in tempestuous seasons, they can only tell us that when the storm is long past the ocean is flat again.” It is seriously hard to estimate the combination of changing technologies and infrastructures, which unlock completely new and cost-effective ways of building things. Will we have self-driving cars in 20 years? Will we have Artificial General Intelligence? Will we have quantum computing? I have no idea.
Technology and nature. One theme repeatedly explored throughout the novel is this balance or tension between technology and nature. World War Terminus has caused a layer of radioactive dust to fall over the world, killing animal life and changing the environment. Mechanical animals are the norm, and Rick dreams about procuring a real horse, ostrich, or goat one day. He regularly checks his Sidney’s Animal & Fowl Catalogue like a stockbroker checking the latest price change. A real animal is significantly more expensive than a mechanical version, despite it being nearly impossible to figure out whether an animal is real or fake. This mirror’s the book's whole premise - a real human is more important and valuable than an Android despite increasingly small differences between Androids and humans. Rick realizes this at the end of the book: “The spider Mercer gave the chickenhead, Isidore; it probably was artificial, too. But it doesn't matter. The electric things have their lives, too. Paltry as those lives are." Technology and nature have a tradeoff in today’s world as well. Cloud computing is certainly energy-intensive, but according to the companies that run those clouds (like Google Cloud or Microsoft Azure), it is significantly less intensive than having companies run their own data centers. Beyond the environmental impact, the behavior of nature is something to consider when operating a data center. A few years ago, Facebook data centers went down when a Snake chewed through a switchboard and took down all services. In 2014, a shark bit through an underwater Google fiber cable, and in 2012 a squirrel took down a Yahoo data center. Animals, technology, and nature are constantly interacting, sometimes in unexpected ways.

Business Themes

Status seeking and the growth of e-commerce. In the battle to achieve status, real animals are a highly sought after status symbol. Early on in the book, Rick engages in a jealous conversation over his neighbor’s real horse: “‘Ever thought of selling your horse?’ Rick asked. He wished to god he had a horse, in fact any animal.” After revealing that his sheep was electric, Rick’s neighbor kindly remarks that he won’t tell the other people in the apartment complex, suggesting that if people knew Rick had an electric sheep (rather than a real one), they would look down on him. While this interaction seems weird, it parallels so many interactions people have today. Vance Packard offered a description of “status seekers” in 1959: “People who are continually straining to surround themselves with visible evidence of the superior rank they are claiming.” As general consumption and wealth rose after World-War II in the US, luxury goods became more attainable for more classes. Globalization of supply chains also increased this trend. When commerce moved online, new shopping styles and behaviors emerged. E-commerce purchases can frequently replace feelings and there is even a psychological disorder caused by excessive purchasing: Buying-shopping disorder (BSD) is characterized by extreme preoccupations with and craving for buying/shopping and by irresistible and identity-seeking urges to possess consumer goods. Patients with BSD buy more consumer goods than they can afford, and those are neither needed nor frequently used. The excessive purchasing is primarily used to regulate emotions, e.g. to get pleasure, relief from negative feelings, or coping with self-discrepancy.” Dick may be signaling that humans seek status and importance compared to their reference groups, regardless of setting or what indicates that status to others, whether it be an expensive handbag or a goat.
Buy goat now, pay-later. 2020 saw the emergence of buy-now, pay-later (BNPL) vendors like Affirm, Klarna, and Afterpay. These companies typically offer zero-interest loans to consumers and get paid a 5% merchant fee for increasing purchases at e-commerce stores. The stores (like Peloton for example) increase sales and the consumers benefit from not having to pay a significant upfront payment. The other way these companies make money is by charging interest payments on specific types of purchases (likely where the merchant doesn’t want to give away a fee). These interest rates can be really, really high - averaging around 10-30% depending on the purchase. This is not a new concept and the idea of payday loans at predatorily high-interest rates has been around for over 30 years. Luckily, the purchases that these BNPL providers are financing tend to not be really high-value products, but it’s still concerning that some people are buying things without understanding the true value they will have to pay in interest. When Rick purchases a real goat, after killing three androids, he finances it, paying $3,000 upfront and entering into a three-year payment contract. Rick’s wife Iran is outraged at the cost of the goat: "‘What are the monthly payments on the goat?’ She held out her hand; reflexively he got out the contract which he had signed, passed it to her. ‘That much,’ she said in a thin voice. ‘The interest; good god — the interest alone. And you did this because you were depressed. Not as a surprise for me, as you originally said.” With BNPL providers now securitizing these consumer loans and selling them off to banks, I wonder if we will see any new regulation come to bear for the benefit of consumers. If people are not careful, they could be locked into long contracts with significant interest over time.
Two case studies in electric animals. Electric animals have actually been invented and while they may not be the equivalent of Goddard from Jimmy Neutron yet, they are pretty funny and interesting case studies. Sony released the AIBO dog in 1999 after many years of research. The original robot dog cost $2,100 (~$3,500 in today’s dollars) and sold about 65,000 units. The programmable software allowed the dogs to be used in a variety of situations including an AI soccer world cup. The initial popularity of the dogs waned, and price wars with new rivals caused sales to decline. In 2006, the AIBO dog was discontinued. In 2018, it made a resurgence and is now a barking flexible model that you can pet, play games with, and feed. Another tale of odd mechanic animals is Boston Dynamics. The company that spun out of MIT in 1992 produced massive quadruped animals including one called BigDog, that was capable of balancing, walking up-hill, and carrying significant amounts of equipment. The Company had trouble selling products though and was acquired by Google in 2013 for an undisclosed sum. This came at a time when Google was pushing heavily into robotics with Google Glass and what would become Waymo - they literally titled this Project Replicant (the name used for Android in the Blade Runner film). After some more years of underperformance, Google sold Boston Dynamics to Softbank in 2017. After years of development, the company finally released a product to consumers for a whopping $75,000. The dog is still pretty creepy and comes without a real face, unlike the Aibo. In 2020, it was announced that Hyundai had acquired an 80% stake in the business at a $1.1B valuation. We are still years away from having electric animals that mimic real-life animals and that may be a good thing.