Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, quantum teleportation, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

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In today’s post: why China will keep losing the trade war; online lending for consumers and small businesses is on the rise; fuel cell electric vehicles are ready for the mass market; military AI creates moral hazards; is Apple building the ultimate space-based walled garden?; fear of money-losing startups creates opportunities for long-term investors; Vanguard will lose a key mutual fund patent in three years as their innovation slows; paleoburrows; solar winds; and lots more below…

Stuff about Innovation and Technology
How I Learned to Stop Worrying About China
China’s been trying to catch the West in semiconductors for decades and has little to show for it despite $100B’s in targeted spending. Why? Because monopoly platforms and profits can’t thrive in China. This is why China lost the trade war with the US – they rely on foundational technology and creativity that could only be created under Western incentives (see the Macro section of SITALWeek #214 for more thoughts on the delicate but important balance between equality and freedom). Innovation requires free expression of creativity without fear. For a period of time, China did allow Alibaba and Tencent to create monopolies and monopoly-like profit pools, which caused them to pull ahead of the Western Internet platforms in terms of innovation. But, then they reversed course as Jack Ma relinquished his control of Alibaba and the government took increased control of the sector through board seats, censorship, etc. The West can maintain the innovation that will continue to create more progress and solve more problems for the entire planet by taking a smart approach to balancing monopoly formation with regulation – more on that in last week’s newsletter (in case you missed it): “How I Learned to Stop Worrying and Love the Monopoly.”

Combat AI a Looming Reality
Militaries around the world are investing in AI to work alongside humans in combat situations. The head of AI for the Pentagon, with an estimated $4B annual research budget, envisions systems that determine what weapons to deploy and when – analyzing and making decisions faster than humans. Meanwhile, the Royal Australian Air Force is testing autonomous drones that make their own AI-based decisions; the craft are self piloted and could fly in large numbers alongside a human-piloted drone or aircraft. This military AI investment is ratcheting up the controversy amongst AI leaders, like Amazon and Google, and their employees: should technology leaders work alongside governments to more safely develop military AI, or are the stakes too high? Can tech companies afford not to be involved? A lot of this technology is increasingly cheap and built on open-source projects, which makes it feel very much like Cold War 2.0 – where we hope to rely on mutually assured destruction to save ourselves from ourselves.

AI’s the New Teacher’s Assistant
“Bakpax is a computer vision system that converts handwriting to text and interprets what the student meant to say. The system’s auto-grader teaches itself how to score...” and immediately gives students results after they snap a photo of their homework with their phone. The software saves teachers time and provides feedback on which students need help on which subjects. The NYT reports on this and other AI tools making their way into classrooms. 

POS Lending Still Small, but Trending
Affirm is running away with the market for online point-of-sale lending. One big customer is the connected fitness company Peloton – Affirm enables customers to buy a bike for $58/mo instead of $2300 up front (over 40 months, with a zero-interest-rate loan). Their competitor Afterpay is the fastest growing POS lending tool targeted at smaller-ticket items with faster payback. Despite significant growth, only 2% of consumers have used online point-of-sale loans. While POS lending is nothing new, and not terribly different than the branded store credit cards of the past, it’s quite easy to see how disruptive this could be to the traditional credit card lending establishment – if and when it combines with digital wallets and becomes more mainstream. As long-time readers know, I am all for anything that chips away at the negative-sum, innovation-destroying card/banking oligopoly!

Online SMB Loans Up in 2019
Small business loans granted by the top-5 lending platforms (PayPal, Square, OnDeck, Kabbage, and Credibly) grew 39% y/y in 2019. SMBs grew their portion of loans from online sources from 19% in 2016 to 32% in 2018 (this data comes from this WSJ article, but note that the article is filled with errors and mistakes – I guess the editors were out on holiday!). Some of the bigger lenders, such as Amazon, PayPal and Square, have significant advantage given their transaction data on the merchants that use their platforms. These loans are essentially working capital lines that can be paid back out of revenues, which gives many of the big lenders a big data and risk advantage as they actually collect the revenue on behalf of SMBs. One online lender, OnDeck Capital, charges average rates of 45%! As a Gen X’er, I’m in no position to stand on a soap box here, but a lot of these suspect loans are likely going to the same Millennials that fell prey to student loan ploys. While I think there are a lot of predatory and misleading tactics taking place, some common sense on the part of borrowers seems in order. In total, SMB loans in the US are far below their $329B 2007 peak, with $254B lent out in 2018. This seems to be another example of online loans that might have otherwise gone on credit cards.

Virtual Kitchen Explosion
The NYT reports on the rapid rise of virtual kitchens (restaurants in shared spaces with no consumer-facing infrastructure that are designed to prepare orders for delivery only). With more and more evidence that vertical integration of delivery and centralized food prep is exploding, how many existing restaurants will be shut down over the next decade? As I wrote in the Evolution of the Meal, I would guess we see a huge churn away from traditional grocery stores and restaurants toward bundled, subscription, vertically-integrated food services. Perhaps the vast majority of restaurants as we know them today will cease to exist. As food turns into an information-platform business, the rules of the Internet will apply: network effects, high NZS (non-zero sum), vertical integration (all the way down to the farm!), speed, selection, and price will dominate in the creation of a winner-takes-most platform.

Video Games a Spectator Sport with Growing Fan Base
Twitch continues to dominate the market for watching other people play video games, with 20% growth (maintaining around 72% of hours viewed). Normally with information-based platforms, we would see a power law phenomenon – whereby the most popular things gains more and more share; but, notably, there has been a de-power lawing of game watching as 2018’s leader Fortnite dropped 28% in 2019, enabling a half dozen games to gain share and flatten the distribution. There was even a brand-new game, Apex Legends, which cracked the top 10. Perhaps it was a one off, or perhaps it speaks to the diversity of gamer choice – implying there may be many mega winners in the future of video games. Watching game personalities chat (or live vlog on Twitch) is also growing rapidly this year – and would be #2 in hours watched if it were a category in gaming. This report from Stream Elements has many interesting stats.

SaaS Founder Favors SaaS Investing
One of the founders of Atlassian, maker of collaboration software, diversifies his multi-billion dollar holdings by investing in...other software companies! It’s hard to disagree with the logic, as explained by Armina Rosenberg, the head of Mike Cannon-Brookes’ Grok Ventures: “One of the main ways we play listed equities, and we are talking our own book here, we believe enterprise software-as-a-service companies are driving innovation globally, they are making processes cheaper better and faster...A lot of people observe that we are going from Atlassian to another SAAS stock but diversifying away from technology actually doesn’t make any sense because technology actually touches on every sector.” Here at NZS Capital we couldn't agree more with that sentiment!

Spotlight on Semis
After finishing the decade as the best performing sector in US equities, semiconductors have been in the spotlight lately. Recent articles by mainstream journalists trying to writeup the industry have made us realize just how few folks around the world these days seem to actually understand the semi supply chain and the complexity of manufacturing (for example, here are a couple of somewhat naive articles: Bloomberg on Samsung and the Economist on TSMC). The sector has gone through two decades of virtually no venture capital investment and a decade of consolidation, all of which has bolstered several pockets of compounding advantage, notably in manufacturing tools, design software, leading-edge manufacturers, and select areas of microcontrollers, FPGAs, GPUs, etc. With 1) EUV (mind-bogglingly complex leading-edge tech) manufacturing finally in production, 2) an explosion of new end markets with connected devices and cloud-based AI, and 3) better-than-ever economics, the industry appears poised for long-term growth (albeit with cyclicality tied to the global economy). That said, problems remain to be solved, and their complexity is skyrocketing – this article from Semi Engineering touches on some of these challenges, including interconnects, 3D structures, power, and packaging (chiplets).

FCEV (Fuel Cell Electric Vehicle) Chicken and Egg Problems
Toyota and BMW reckon that hydrogen fuel cells are ready for the mass market, but they need to make 500,000 units to cross the point of good economic returns. And, unlike the case with today’s battery-powered EVs – which already have ubiquitous access to electricity – support infrastructure for FCEVs would need to be put in place. Given that EVs are already at scale for consumer autos (which can often afford the down time associated with re-charging), FCEV tech would be more likely to find traction in the commercial and factory vehicle industries – as filling up an FCEV takes about as long as gassing up. Platinum is a big price driver today, with FCEVs using 3-4x (~30g) as much as internal combustion vehicles.

Music Streaming Stuck (for now) as Fixed-Margin Middlemen
Music executive and Beats co-founder Jimmy Iovine believes that the streaming music industry won’t scale because of the power law of listening: streaming is concentrated amongst a handful of artists while the long tail is tiny – according to Iovine, an artist like Drake has more streams than every song from the 1980s! This distribution further fuels the power of the labels. This analysis tracks with the piece I wrote earlier: Music as a Loss Leader. More recently, I’ve  suggested that an accelerated move into “talk radio” – otherwise known as podcasts, but including local sports, news, and drive-time DJs – is warranted and that perhaps Liberty is trying to do just that with its increased ownership in SiriusXM, Pandora, and iHeartMedia. It’s not clear that it’s a dead end for streaming platforms or that Apple or Amazon will win because they can subsidize the business. The labels' power is only growing stronger, but there are still several hours a day of listening that could end up being original content with meaningful cost leverage. At some point, someone like Spotify could get big enough to drive a record-label “blackout” (like we’ve seen in the carriage wars between broadcasters, networks, and cable companies), and the tide will turn for the streaming industry, but it could be a long time from now. 

iSat?
As SpaceX, Amazon, and others race to launch global Internet satellite platforms, Apple is reportedly working on their own satellite technology. While it’s not yet clear what they would use it for, given Apple’s propensity for privacy, a global, vertically-integrated Internet platform exclusively for iPhone users could create the ultimate walled garden. It’s also possible Apple would leverage the commercially-deployed SpaceX network of satellites to work with its products – it would be interesting if they made an exclusive deal for the capacity of one of the Internet satellite arrays.

Cashless Economy Vulnerable to Natural Disasters
Buried in the coverage of the tragic wildfires in Australia is this tidbit about the near-cashless economy seizing up as the telecom infrastructure went down: “With even landlines down, and banks closed and ATMs empty, the cashless economy in some areas seized up, according to fire brigade officials.”

Miscellaneous Stuff
Best Decade Ever!
The author of The Rational Optimist explains that the last 10 years have been the best on record: “...bad things happen while the world still gets better. Yet get better it does, and it has done so over the course of this decade at a rate that has astonished even starry-eyed me.” It’s a clear message of hope for the long-term collective well-being of humanity (at least until the Universe fully cools...but even then hopefully someone reboots the simulation!). Constants of humanity: things are always getting better over the long term, but over the short term people believe things are always getting worse. Pessimism sounds smart, but ALWAYS bet on optimism.

Chip-to-Chip Quantum Teleportation
By manipulating single particles of light inside programmable semiconductors, scientists were able to use quantum phenomena to teleport the state of entangled photons between chips that are separated from each other across space. Effectively, the two chips are entangled in the quantum wave function (along with the researchers doing the measurement). The process has primary application in quantum communication, which allows for information transmission across space without any physical connection (and therefore could never be intercepted or remotely hacked). China currently leads the world in quantum communication, and one of the lead researchers on this paper, published in Nature Physics, has notably returned to Peking University to continue work in the field. 

Vagus Nerve is Endogenous Chill Pill
Your vagus nerve connects your enteric nervous system to your brain. In other words, it connects your “gut feelings” to your higher-order cognition. The connection is particularly important for maintaining homeostasis, mood, and the relationship between bacteria and our digestive system (“The Strange Order of Things” Damasio p. 133-136). This article on the vagus nerve discusses its ubiquitous importance, including in mood regulation (perhaps because 95% of the body’s serotonin is produced in the enteric nervous system and connected to the brain via the vagus). You can take care of your vagus with stretching, deep breathing, yoga, massage, and other forms of movement.

Implausible Physics in Kids’ TV Induces Cognitive Overload
Thanks to the variable nature of UHF TV signal availability in the 1970s, differential access to the kids' show Sesame Street set up a perfect variable-exposure test. It turns out that kids who watched the show did better academically, with an even stronger positive impact for kids from lower-income households. SpongeBob, on the other hand, impairs the performance of 4-year olds on various tests of focus. But, it’s not the fast pace or annoying characters from SpongeBob that causes the problem; rather, it’s the number of physics-defying acts in the show (like when a car winds up in outer space) that causes some sort of overload to kids' brains. It seems to have just a short-term impact though, with no evidence of long-term damage. This article covers more on the long history of collaboration between kids' TV and research science.

Geologic Legacy of Prehistoric Earth Movers
Paleoburrows are tunnels 4-5 feet in diameter and up to thousands of feet in length dug by (presumably) giant sloths 10,000’s of years ago throughout South America. The creatures, some of which were the size of modern elephants, lived in both South and North America, but most of the caves (which, curiously, are much larger than would seem necessary for shelter) have been found almost exclusively in southern Brazil.

Antibiotic Manufacturers are an Endangered Species
Antibiotic makers are all going bankrupt and big drug companies have abandoned the industry due to lack of profits. In a bit of a Catch-22, in an effort to combat the rise of antibiotic-resistance, doctors are prescribing fewer antibiotics, which makes the profit pool for design of new antibiotics even smaller! Development of a new antibiotic is reported to cost north of $2B. This may be an industry that requires government intervention for national security reasons.

Magnetic Reversals Send Solar Wind Soaring
The stream of charged particles emitted by our sun’s corona (i.e., solar wind) is caused by reversals in the sun’s magnetic lines in the “cool” coronal holes, which reach temps of only 2M degrees Fahrenheit. This insight comes from the NASA craft that traveled to within 27M miles of the sun (marking the closest approach to date by an artificial object). By 2025, the craft will be within 4M miles of the giant hydrogen-to-helium fusion reactor.

Stuff about Geopolitics, Economics, and the Finance Industry
VC Flight Clears Way for Real Long Term Investors
VCs and investors are running scared from companies that aren’t profitable according to this WSJ article. This fear bubble and funding pullback might create an opportunity for late-stage investors to run against the herd and look for opportunities to invest in startups that have a clear path to profits, even if it's far in the future. Analysis comes down to customer acquisition cost vs. lifetime value. If enough data are given, most investors can be thoughtful about estimating the probability of successful platform creation. As is always the case with new disruptive ideas, they take much longer, but are much bigger than anyone can foresee.

Vanguard Lends Name to Chinese Robo Advisor
Vanguard has partnered with Alibaba’s Ant Financial to roll out a mutual-fund-picking robo advisor in China. The new platform allows people with more than $100 to invest in 5700 local mutual funds, representing 80% of Chinese-run funds. It sounds like Vanguard is really only bringing their brand name to the table at this point. China’s current mutual-fund market is around $2T, or about 1/3 of Vanguard’s $6T in global assets under management. Following new regulation 2017, several Western investment companies are working to JV their way into China. 

Double Taxation of Mutual Funds Sunsets in 2023
Meanwhile, Vanguard is no longer the price leader in their core business, and this Barron’s article criticizes the company for a lack of innovation. Mainly, advisors believe the company has not invested in technology like its rivals have in recent years – despite the company likely raking in $2-3B in operating profits on $10B of estimated revenue. There’s a very interesting detail about Vanguard which isn’t well known: they’ve sat on a patent for decades that allows only them to avoid the plague of mutual fund double taxation via annual distributions. If they had open sourced that technology, I’d wager that Vanguard would have created multiples more value for investors than the have by offering low-cost index funds. But that patent expires in 2023, which should allow the $10T mutual fund industry to get the same tax advantaged treatment as ETFs in the US.

Millennials’ Low Trajectory of Economic Success 
This report from the New America Institute outlines Millennial’s wealth-accumulation gap. Specifically, they point to the Great Recession, higher debt, and less home ownership as having compounded the problem of economic stagnation compared to prior generations. In case you missed it, I talked about the pending 5 year bump in household formation and other trends from the Millennial Sneaker Wave, which is just getting underway.
✌-Brad

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and are subject to change without notice and may not reflect the opinion of NZS Capital, LLC (“NZS”).  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. I often I try to make jokes, and they aren’t very funny – sorry. 

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