Welcome to Stuff I Thought About Last Week, a personal collection of topics on tech, innovation, science, the digital economic transition, the finance industry, and whatever else made me think last week.

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In today’s post: network effects are important, but emergent behavior may be necessary for new product success; basic AR glasses are just around the corner, with a likely set of new emergent behaviors coming; the cultural revolution in music and movies in the 1960s and 1970s compared to the anti-culture trends of today's media; is gaming returning to a post-pandemic trendline, or is there a broader behavior shift away from the activity?; energy grid strain may cap construction; brush your teeth to avoid pneumonia; a silly indulgence on trying to understand higher rates in the context of US Treasury sales, and how it points to an increasingly zero-sum economy; and, much more below...

Stuff about Innovation and Technology
Emergence vs. Network Effects
One of the key characteristics that defines a complex adaptive system is emergent behavior. When a formerly isolated/unknown group of agents start interacting, we frequently see entirely new behaviors materialize, or emerge. Perhaps the most accessible and extreme example is consciousness, which is an emergent, seemingly magical, property of chemistry and physics. A bunch of separate molecules aren’t aware of themselves, but after a few hundred million years of evolution you get human consciousness. When we look at products and services from companies, there can be emergent behaviors on both the supplier side and the customer side, and often interaction between the two creates even more emergent behaviors. I would hypothesize that emergent behaviors are perhaps more powerful than network effects when determining the longevity of a product or service. If your product creates and uniquely supports a new behavioral paradigm, it might be possible to run away with the market. Consider smartphones: when Apple developed the iPhone, they took the tactic of increased vertical integration, eventually even designing their own highly complex semiconductors. This strategy of owning the operating system and hardware design allowed Apple to innovate at a higher speed, outpacing the competition for a sufficiently long time that they were able to create – and initially corner – the smartphone market, usurping the customer base of formerly dominant Nokia and Blackberry. I would characterize the speed of innovation, and the subsequent inventions that followed (including the smartphone itself), as emergent properties of vertical integration. The app store itself emerged from the integrated hardware+software focus of Apple creating a massive new ecosystem of developers and services. Ultimately, this emergence impacted how consumers interfaced with commerce, media, and a host of aspects of daily life. Fifteen years ago, we had burritos, cell phones, and credit cards. Now, we routinely combine these items in a here-to-for unprecedented way to order and pay for our customized meal or drink of choice using our phone. Entirely new businesses like Uber are made possible by indelible, phone-based behavioral changes. Not all emergent behavior is positive, and in any sort of looped system, there’s always potential for amplification of negative emergent behavior, which tends to be self-destructive to the system (something perhaps we are seeing with social networks and the influence of some algorithms on our lives today). Like Apple, Tesla has seen vertical integration enable accelerated innovation, allowing them to create new battery technologies that have left most of the competition behind, at least for now. However, there’s been no emergent behavior on the customer side of EVs (avoiding the gas station and car dealership don’t seem all that revolutionary). However, perhaps bi-directional charging combined with solar will, at some future point, create a distributed energy grid that prompts profound consumer behavioral shifts. And, if fully-autonomous driving is eventually rolled out to the average consumer, we will have all sorts of unpredictable emergent behaviors. New products don’t necessarily create emergent behavior, but, when they do, they can be even harder to disrupt than network effects. Network effects alone may simply not be enough to sustain a business. We can see this today with Meta's social networks, where a lack of positive, emergent behavior is causing consumers to shift their time to other forms of media.

AR Glasses for the Masses
In the next one to three years, consumers will likely have a choice of at least four basic augmented-reality glasses: Snap’s new AR Spectacles are currently available for developers; Google is testing their new glasses in the wild; Meta will be selling their new AR glasses to developers, with a consumer model planned for next year; and, there is the ever persistent rumor of Apple’s entry into the market, which may come to fruition in a couple of years. None of these glasses are full-featured platforms (in contrast to a product like the Magic Leap ML2), but they might be good enough to create unpredictable, emergent behaviors. It’s hard to say what the more basic AR overlay glasses will sell for, but if it’s <$1,000, we could see enough adoption to accelerate developer interest and a subsequent explosion of use cases. Apple and Google have the significant advantage by controlling the phone operating system, as these devices will act (at least early on) as simple extensions of the phone (see Meta-mess for more discussion on AR tech). That said, I couldn’t help but think about their physical resemblance to the shades in John Carpenter’s 1988 classic They Live. As I rewatched the movie last week, I realized that these glasses are likely to be salivated over by advertisers. Everything – the side of a building, the street, any item you see – becomes a customizable opportunity to billboard a product, service, or brand. Plus, there will be all sorts of gamification opportunities, like the phone-based PAC-MAN AR game in the Snap app at Comic-Con. The glasses in They Live are sort of the opposite of advertising – rather than promoting ads, they show what ads are really telling us to do: behave, comply, sleepwalk through life (there are far more points to make here, but I don’t want to spoil the movie if you haven’t seen it!). Perhaps the most interesting thing a developer could do with AR glasses is make an app that de-algorithms the world to show what life would look like without the vast influence of advertising and misinformation overload (see also Kyle Chayka’s recent New Yorker essay on Algorithmic Anxiety). One of Google’s use cases for their AR glasses is real-time translation and subtitles for conversations. Imagine a real-time translator that took what someone was saying and told you what they would otherwise say without algorithms influencing their opinions. It’s doubtful such an app would be approved by the app stores!

TikToking while Driving
Anyone notice the number of drivers livestreaming on TikTok and other platforms while driving?! I’m not on the road that much, but I’ve seen the behavior a few times recently, and it’s terrifying. With AR, livestreaming your surroundings automatically via your glasses seems potentially safer than having to focus on a hand-held device. But, then again, AR-equipped drivers will probably be swerving around invisible Godzillas in the middle of the highway. Traffic deaths are already at a 16-year high in the US. See also the Android vs. iPhone Safety Divide in #346. Drive safely!

Gaming Weakness
Google reported a noteworthy, albeit modest, decline in quarterly Play store sales last week, as consumers decreased spending on apps (see page 38 of the 10-Q). Google didn’t provide color on what was weak, but games still make up over half of Play store spending. Microsoft also noted that spending on Xbox games was down 6% last quarter and Sony reported a 15% decline in PlayStation play time. Sensor Tower reported that for the first time on the Apple App store, games were eclipsed by non-game app spending in June, with game sales still below June 2020 levels (after seeing a large pandemic boost). As I noted a few weeks ago, short-form video (TikTok and their ilk) may be eating into other media consumption habits. Meta is reportedly trying to morph into TikTok by altering their results and feeds in order to capitalize on this consumer behavioral shift. There are other dots we can try to connect here, including weakness in Netflix streaming subscriptions, and even Comcast reported a notable lack of growth in high-speed Internet subscriptions. But, patterns can be deceiving, and all of this may be related to high inflation or some other unknown interaction of behaviors as we emerge from the weird pandemic period. Regardless, in aggregate, there seems to be a real shift underway in how consumers spend their time and console gaming, for the moment, is losing out.

Green Grid Strain
The FT reports that West London is facing a potential power shortage, resulting in a ban on building new homes. The report blames, in part, a concentration of key data centers in the West London area hooked into the trans-Atlantic fiber. As countries around the world push for EV adoption and heat pump implementation (to offset natural gas dependance, e.g., the EU is working toward a goal of 15% natural gas reduction this winter) and we keep watching TikToks and creating silly AI artwork, we need to think carefully about preempting problems arising from the added strain on the energy grid.

Miscellaneous Stuff
Planet-Wide Proteome Structures
DeepMind’s AlphaFold has now released over 200M open-source protein structures covering nearly every organism on Earth that has had its genome sequenced. The remarkable accomplishment should open up many new paths of research.

Pneumonia from Poor Oral Hygiene
Regular tooth brushing might be the key to avoiding pneumonia infections for many patients in hospitals and long-term care. The bacteria that cause pneumonia, which preferably reside in the film that gathers on unbrushed teeth, can be easily aspirated into the lungs, causing infection.

VHS Revelry; Anti-Culture Revolution
If you’re a movie buff and/or Quentin Tarantino fan, I recommend his new Video Archives podcast. Along with long-time collaborator and fellow video store clerk Roger Avary, QT picks movies from the actual VHS archive of the store he worked at (he bought the archive when the store closed) and digs in. I am not sure if they will stay focused on the 1970s, but that was an interesting period in cinematic history that might shed some light on today's changing media habits. Starting in the mid-1960s, an era dubbed “The New Hollywood”, movies went from studio-driven to director-driven – from musicals and drive-in flicks for teens to more abstract, innovative, personal stories of conflict, largely in response to the rise of television and shifting cultural norms (perhaps also due to lots of experimentation with psychedelics!). John Carpenter of They Live (referenced above), was one such visionary among the pack of stellar, late-1960s USC-educated directors. The trajectory in music mirrored a similar path, morphing from crooning classics to psychedelic rock-and-roll madness. This period of media upheaval is interesting from a historical perspective, and we might be seeing a similar shift today. Although, this time around, it’s some sort of perversely inverted anti-culture revolution with short-form video and livestreaming heavily (and I would argue negatively, for the time being) impacting the art of storytelling and how we consume entertainment. When I use the world culture here, I mean a common culture, or common set of beliefs. One lens on the evolution of media is that every new format (print, radio, movies, broadcast TV, Cable TV, YouTube, Netflix, TikTok, etc.) fragments attention into smaller and smaller niche audiences. Another lens is that there is some underlying reason for the shift from one medium to another, e.g., demand for a type of expression that wasn’t possible on the prior dominant medium. It’s hard to pinpoint the common attributes of the types of expression taking place on new platforms today, but perhaps examining other periods of cultural/technological transition might be illuminating.

Stuff about Geopolitics, Economics, and the Finance Industry
High Rates Support US Treasury Sales
Over the last few years, the sale of US government Treasuries (and other debt instruments) has shifted somewhat from foreign to domestic buyers, including the US government itself. China now owns less than $1T in US Treasuries, down from a peak of around $1.3T in 2013. Overall, foreign entities own $7.5T in Treasuries, with Japan the largest holder at $1.3T, followed by China, the UK ($600M), and then a long tail of other countries. One explanation for the leveling off of foreign buyers is declining international trade, which peaked around 2011 (often, UST ownership is correlated with trade surpluses by foreign countries). Domestically, the Federal Reserve has accumulated substantial Treasury holdings in recent years. Before the 2008 financial crisis, the Fed balance sheet was under $1T. It ballooned to $4T in order to provide liquidity to the system during the great recession and is around $9T today. Mutual funds and money market funds owned by US citizens and cash-rich corporations have also hoovered up UST. During the pandemic, a significant portion of government-issued stimulus checks (which we can think of as funded by Treasury sales) went into savings, including money market and mutual funds. These funds then bought more US Treasuries, thus circularly funding government debt (fund ownership of Treasuries rose from $2.35T in 2019 to $3.44T in 2021).

With $9T in accumulated assets, the Fed is now infamously set to taper its balance sheet by letting current ownership of Treasuries and mortgage-backed securities roll off without replacing them. Consumers pinched by high inflation and a slowing economy are probably more likely to also be selling their Treasury-holding funds (or at least not adding to them). This situation potentially creates somewhat of a double taper, with diminished demand from both the Fed and corporate/private investors. However, even though the US government is no longer issuing stimulus checks, they will still need to borrow to fund the ever-growing deficit by rolling Treasuries as they come due and issuing new debt (although, this year at least, the government’s budget is running close to neutral). What happens when you have an increase in the supply of debt and no natural buyers? You need to raise interest rates to enticing levels. Higher rates make other, riskier assets, such as stocks, real estate, and highly-leveraged assets (like PE-owned companies) less attractive. Additionally, higher rates create stronger demand for US dollars relative to currencies issued by countries with lower rates.

Viewed through this lens, the recent rate hikes are a way to ensure that there is a healthy pool of both foreign and domestic buyers for US government debt even if the Fed, corporations, and citizens taper their holdings. Thus, fighting the inflation bogeyman, which the Fed chair himself claims to not understand, is perhaps the secondary (albeit still important) reason for higher rates. As long as US rates are higher than those of other countries, the government will have a sure supply of foreign and domestic investors to buy their debt. How high might rates go? It all depends on how much the Government, Fed, and other investors collectively want to sell, and how strong the dollar is relative to other countries. If the economic outlook in the US is relatively stronger than it is around the world, then rates won’t have to go up as much for the safe haven of US-dollar Treasuries to be relatively more attractive to buyers. In that regard, having less direct exposure to the war in Ukraine does benefit the US on a relative basis, as does having less dramatically slowing population/labor-force growth vs. Japan, China, and Europe (although, the outlook for US population growth is not rosy in the not-too-distant future). The US also has access to energy, and retains, at least for now, the so-called reserve currency. However, higher rates and slower growth will mean reduced tax revenues, which may increase the deficit (along with new spending initiatives like the CHIPs Act).

If the US outlook weakens significantly, the Fed may simply not be able to unload anything off its balance sheet. In 2017, the Fed tried to sell some assets and the banking system froze up overnight, so they backed off. The same may happen now. Recent research from the Atlanta and Kansas City Fed implies that rates could rise sharply – but not catastrophically – if the Fed were to unwind assets now, but the offload would certainly be easier to digest during more positive, stable economic times. So, if the US weakens relative to other nations, the Fed may need to reduce/eliminate its sell-off ambitions. There are some helpful tailwinds, such as the deflationary forces of an aging population and accelerating automation/innovation, as well as the self-correcting mechanisms of a market economy. However, it’s unclear how the scales will balance given the absence of 21st-century, formerly-dependable tailwinds arising from steady labor-force growth, globalization, and accommodative fiscal/monetary policy. Things feel a bit tenuous as we try to navigate a Goldilocks path of just-high-enough interest rates to allow the government to keep borrowing (and the Fed to taper) while avoiding a catastrophic unwinding of our highly-leveraged economy.

The punishment for the last couple years of over-stimulus – combined with the loss of the population-growth economic engine and ebbing global trade – seems like it could create more of a zero-sum economy for the foreseeable future. That means the best investment opportunities will be companies creating non-zero-sum outcomes for their customers: solving problems and keeping costs low by continually innovating, automating, adapting, and creating more value than they take. The non-zero-sum game has long been a winning strategy, and it received a significant boost with the dawn of the Information Age and increasing transparency. However, creating more value than you take is now perhaps one of the only paths to prosperity for many companies, simply because the only way to take share from competitors is to offer a better value proposition. Enterprises that continue to solely rely on fading tailwinds of population growth, globalization, and low interest rates will likely find themselves adrift with few options.

I’ve indulged here in trying to explain the Fed’s interest rate machinations and the various forces that will constrain and buoy the economy going forward. Of course, trying to divine the future is a silly waste of time – we cannot know precisely what the future holds with any degree of certainty. So, this oversimplified story I’ve spun, based on a few meager data points, may have little resemblance to the path we travel through time. It’s impossible to identify (let alone comprehend or explain) the myriad forces at play in the global economy, which is one of the most complex adaptive systems we are aware of! While this exercise doesn’t help pin down the future, it does reinforce our decade-old thesis from when we first penned a draft of Complexity Investing: the world is a complex adaptive system and the future cannot be known; therefore, focus on adaptability and non-zero-sum outcomes, and you will do as well as you can.

✌️-Brad

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