Capital Musings

Politics, Business, and Innovation

Category: Business (page 1 of 11)

The tail risk of climate volatility

Barry Ritholtz was commentating over at Bloomberg View on climate change, with the initial stimulus being Hank Paulson’s article in The New York Times about “The Coming Climate Crash”. I have actually been thinking about climate volatility for some time now because it is one of the fundamental factors that drives not just our politics, but also our economy.

The History of Climate Volatility

Back in early 2011, at the dawn of the Arab Spring, one of the grievances was the intense inflation in food: whether you refer to the UBS Bloomberg Index, S&P GSCI, or Rogers Index, in the span of September to February, food prices had more or less risen 30%. In the developed world, where food is a relatively low portion of our budget, it causes a minor inconvenience. But in the developing world, where food consumes a larger portion of the household budget, it can be a principal cause of revolution.

I saw parallels with the Arab Spring and the historical revolutions across Europe in 1848, starting in Paris and rapidly spreading throughout the Germany and the Hapsburg Empire. One of the chief grievances in those instances was food pricing as well. The most ancient of supply shocks—famine—can be severe enough to cause whole societies to migrate. Two relatively modern instances are the Irish migration to the United States in wake of the 19th century potato famine and the Oklahoman migration to California during the 20th century dust bowl.

Indeed, there were unique forces in 2011 that were causing 30% food inflation in a span of only several months. Central Banks across the world had been cutting rates and experimenting with quantitative easing. An attempt to jumpstart biofuels also created a bit of a run on grains. But there were also supply constaints caused by some remarkable weather events.

In 2010, drought and fires had destroyed a quarter of Russia’s grain area and floods had affected half a million tons of wheat in Pakistan. The fires in Russia were so bad that you could see them from space. Australia had floods of Biblical proportion, with most of the province of Queensland being submerged and rainfall records being set, exceeding one metre at some weather stations. Perhaps an apt metaphor for 2010–2011 was that a “perfect storm” created an agricultural supply shock that contributed to the catalysis of simmering populist outrage.

Russian wildfires in 2010 captured from NASA’s Aqua satellite. Image width is approximately 900 km.

Russian wildfires in 2010 captured from NASA’s Aqua satellite. Image width is approximately 900 km.

Thinking of it as a Straddle

How have agricultural prices performed since that time? Over the long term, prices haven’t consistently gone up-and-to-the-right. In fact, according to International Grains Council, we have been able to keep ramping up production to meet demand. If you pull up the DJ-UBS Commodity Subindices on your Bloomberg or Thomson, there was a doubling of grain prices in the ’07–’08 time period, most of which receded. The rise in 2010 and the spike in 2011 were merely transitory. The magnitude of grain price rises haven’t been on the scale of, say, precious metals. And livestock is, surprisingly, priced less in 2014 than in 2004. Therefore, a good way to think about a climate-based investment thesis as expressed through commodities is that it behaves mainly like a volatile asset.

This is also what the payoff ratio of something like flood insurance essentially looks like as well. If a tail event like a hurricane occurs and damages your property, you receive a payout based off your insurance premium, with the premium equivalent in function to an option price.

In the Spring 2010 issue of Intelligent Life, an article called “What’s happened to the seasons?” profiles the impact of climate volatility on societies extremely reliant on agricultural yields. In Balaka, Malawi, unpredictable rains result in wilted maize. In Vietnam, cold snaps and floods destroy entire harvests. And in Kashmir, a traditional season called the tsonth has not happened for ten years.

How can these people come with greater unpredictability? Modern futures markets are actually descended from efforts by farmers to hedge harvest risk. It may be time to bring things full circle. While the most basic forms of financial services have been brought to the developing world in the form of microlending, more sophisticated financial products such as insurance and futures do not seem to have achieved the same level of success. Or at least, not visible success; I am not aware of large scale microinsurance ventures on the scale of Grameen or Kiva.

While the introduction of savings accounts would help smooth the volatility of incomes in non-agricultural sectors, farmers and ranchers will need financial products tailored to their needs. If the administrative costs can be brought down to a micro level, the farmers in Malawi would pay a small premium and receive a payout if rains destroy their maize. It’s the same principle behind the strategies used by a Cargill—the difference is that the opportunity is brought to those far more vulnerable.

Geopolitical Implications

The greatest irony, however, can be found in societies like Greenland. While climate volatility brings an end to traditional ways of life, it can open new vocations in certain countries.

Prior to assuming office, Aleqa Hammond the Prime Minister of Greenland, noted the following irony:

“If we are standing there, feeling sorry for ourselves, we can’t gain anything. So, we have to think: what does [climate change] bring? Some places will lose everything, and I feel very bad for them, but we are not in that position. The retreating of the ice gives Greenlanders a greater survey of what the country contains—the riches. We know that there is oil in Greenland. You can touch it, you can feel it…Now there are companies around the world showing interest in it.”

Intelligent Life, Winter 2009

The melting of the ice in Greenland actually makes it easier for oil exploration and production. But Greenland would not be the only beneficiary of the increase in climate volatility. Vladimir Putin was once quoted, “For a northern country like Russia, it won’t be that bad if it gets two or three degrees warmer,” since “we would spend less on fur coats” and “our grain production would increase.” This comes from the leader whose graduate school thesis was Mineral And Raw Materials Resources And The Development Strategy For The Russian Economy.

Although Paulson’s editorial was about a coming climate crash, there are indications that changes—whether you or not you believe it is anthropogenic—have already been well underway. The decrease in Arctic ice has finally made it a viable shipping route. Scott G. Borgerson has been sounding the bell for some time now, presciently in the March/April 2008 issue of Foreign Affairs in an essay called “Arctic Meltdown”. More recently, Borgerson published “The Coming Arctic Boom” in the July/August 2013 issue of Foreign Affairs.

The main theme of those pieces is the following: as the Arctic opens up, it provides both dangers and opportunities. Dangers in terms of a potential for a 21st century scramble for maritime territory. And opportunities in terms of cutting the shipping times between northern cities. While Prime Minister Hammond’s commentary was about turning Greenland into an Emirati-like petro state, energy is just one industry that can be empowered by these changes. Arctic nations can also use the receding of the ice to become a shipping and trading hubs, much in the same vein as Suez or Panama.


There are other risk factors unmentioned thus far. Intertwined with climate volatility is water: Lake Mead’s bathtub ring, water wars between American states, or the receding of the Aral Sea. These have other dimensions to them as well in terms of increased irrigation needs, population growth, and migration.

Whatever your political position, climate volatility is a real issue that will be consequential in human affairs. And whether or not it gets to the point where we intentionally cross the controversial geoengineering threshold, we are going to need to adapt to the uncertainties that lie upon the road ahead.

The Disruption Cult

The New Yorker recently released an article by Jill Lepore called “The Disruption Machine”, which attacks the disruption theory that was popularised in modern times by Clayton Christensen’s The Innovator’s Dilemma.

While Lepore has a good point that “old” companies are able to sustain their dominance, I think it’s because many of them actually recognised the disrupting technology and they co-opted or headed off the would be disruptors. IBM entered the PC business. Apple went headlong into the tablet business to “kill” their laptop business. Oracle bought MySQL. Intel’s development priority for the Haswell architecture was to protect their flank from ARM. Google and Microsoft have entered the cloud space with guns blazing to respond to Dropbox—they often provide a better dollar-to-space ratio than Dropbox.

One case where Lepore might have a point is when Cisco bought Flip. Flip died not because an inferior good disrupted it, but because a much better product came along: the camera phone. But when it comes to the general trend in cameras, I think Christensen’s model still holds. Everyone has a camera phone, but Nikons and Leicas are now relegated to niche markets.

CNBC has also released a list of the world’s top 50 disruptive startups. A few aspects of the list immediately stand out:

  1. Warby Parker is taking on the traditional company Luxottica, which was extensively profiled on “60 Minutes”. I’m cheering Warby Parker on.
  2. Browsing the rest of the Top 10, it is interesting to see two companies—Aereo and Uber—in regulatory limbo right now.
  3. Interesting to see AngelList on the disruptor list. I would have gone with WeFunder over AngelList.

Finding a future yet to be built

When Mary Meeker’s 2014 Internet Trends report was released, a friend wondered aloud what life was going to be like in ten years. While Meeker’s deck is a nice starting point, it is merely the tip of the iceberg. I thought it would be a good exercise to illustrate the mental models I use to keep both abreast and ahead of tech trends.

Ben Horowitz revealed this brilliant interview question on Charlie Rose: “What do you believe that nobody else believes?” It is a great way to ferret out independent thinkers.

It is also a wonderful counteragent to recency bias. Industry idols, extolled by the multitude, bring forth throngs of novices enheartened by the glisten of victors’ accolades. But the matches have already concluded and the outcome of the contest determined. You’ll end up investing in what is, almost by definition, consensus and, at best, a better mousetrap. Although that cuts off tail risk tremendously, it also cuts off the probability that what you are investing in or building will be earth-shattering.

Granted, the popularity of futurism ebbs and flows with the oscillations of technology bubbles. But you need a vision that will compel followers to sojurn down the Road to Calvary, as opposed to the comfortable paths found in the campuses of the publicly traded. You want to be able to create a Jobs-like reality-distortion field and be able to ask, “Do you want to sell sugared water for the rest of your life? Or do you want to come with me and change the world?” As the old cliché goes, “It’s crazy. But it might just be crazy enough to work!”

What does the future look like? A computer on every desk. A transistor in every pocket. Those concepts seem foreordained in retrospect. But even in the case of seemingly Olympian inventors, will is not fate. When something is distant enough to be evanescent in its abstractness, you need a vision that creates a concrete palpablility you can use bring the imagined into reality. And even if you are wrong about the future, you just have to be less wrong than your rivals.

The many visions of many futures
  1. Journey to the Antipodes to Find Secrets
  2. The Creatives
  3. The Leviathans
  4. The Mutationists
Journey to the Antipodes to Find Secrets

The best mental models (great Mungerism) of thinking about the future I have found come overwhelmingly from investors that spent a lot of time in industry, like Marc Andreessen or Peter Thiel. Peter Thiel put it in terms of finding secrets.

Essentially, if you see Kara and Walt covering the space, you’re most likely looking at post-chasm ventures, and that venture is well on its way to be publicly traded (if it isn’t already). So if not at the Re/Code Conference, where are some good places to find secrets? Two places that are, in many ways, the cultural antipodes to finance land, and even start-up land to a certain extent: the military. And academia.

At MIT, the Media Lab has created numerous technologies that have made products from the Kindle to Guitar Hero possible. MIT also had—what was legendary in scientific circles—Building 20.

UC Boulder actually has a Research and Engineering Center for Unmanned Vehicles. And while there are regulatory issues in the United States—both tech transfer and FAA—a swarm of companies around the world are entering the space. More competition means more innovation, and with problems as complex as UAVs, multi-industry applicable technologies are likely to arise from these.

While we’re on drones, I would be remiss not to mention DARPA, which creates a ton of cool tech and can afford to take a really long view given its DoD mandate. It was actually ten years ago that DARPA held its first competition for autonomous vehicles. It did not go well, suffice it to say. If I recall correctly, Carnegie Mellon’s vehicle went the furthest but got stuck in the middle of the desert. Ten years later, we have self-driving cars with no pedals or steering wheels coming out of a certain campus in Mountain View.

The Creatives

Speaking of which, I saw Larry Page +1 an article about how inventors should read more Sci-Fi. Jaron Lanier is on Microsoft Research staff and Cory Doctorow is on Google’s staff. Bruce Sterling hasn’t written Sci-Fi lately, but now consults for tons of tech companies.

One of the best ways to create a future is to make Steven Spielberg work on a Sci-Fi movie for you. That is a bit in jest, but in order to create an immersive world for The Minority Report, Spielberg held an idea summit. The plot of the movie is, in my opinion, rather forgettable. But the world-building was brilliant. Many technologies, including self-driving cars, large screen gesture control, and user tracking, are well on the way to market today. Not to mention that the technology used to understand gesture control has been adapted for use in autonomous robots.

Although I was a latecomer to the Sci-Fi genre, I see similarities between the film cartridges in David Foster Wallace’s Infinite Jest and what has essentially become the scramble for eyeballs that was the basis of Web 2.0. And Neuromancer, though dystopian, has great business ideas on many of its pages—not to mention the significant role of the zaibatsu in that novel, which bears similarities to the current battle between The Brobdingnagian Four.

The Leviathans

Speaking of zaibatsu, there’s a really rather curious phenomenon in that large companies often have the resources to create a new product cycle. But they aren’t the ones who end up capturing the product cycle. It’s usually some upstart (or comeback kid) who ends up executing.

If you read Who Says Elephants Can’t Dance? Lou Gerstner basically described the cloud, but it’s Amazon who dominates the space now. When Bill Gates wrote The Road Ahead in 1995, the book came with a CD that had videos of various future technologies—that other companies executed on: electronic wallets, tablets, smart TVs. If you read the Steve Jobs bio by Walter Isaacson, Sony had all the elements to create the mp3 player. They had the Walkman. They made hardware in the form of consoles. They even had a giant library of music because of their record label! But it was the iPod that won.

There’s a ton of factors that cause this phenomenon. Like bureaucracy/entrenched interests. The culture of asking for forgiveness in a small company becomes a culture of asking for permission in a large company. Unwillingness to cannibalize the product that made your company great. Or maybe it’s too far ahead of its time. Or stock option risk-reward profiles in a large company attract more risk-averse employees. But the main point is, if there is a giant company in a space, it shouldn’t necessarily deter small companies (great dramatization of the battle against Big Blue by the way is “Halt and Catch Fire”).

You have to invert your mental model when it comes to innovation. Economies of scale become diseconomies of scale. Competitive moats become competitive quicksand.

The Mutationists

I’d recommend three great books (1) Uncommon Genius by Denise Shekerjian; (2) Origins of Genius by Dean Keith Simonton; and (3) The Ten Faces of Innovation by IDEO. The basic takeaway I’ve taken from reading them is that the creative process and innovation are, fundamentally, about taking a bunch of seemingly unrelated ideas, putting them together, and seeing what happens. It’s like splitting genes, rearranging the nucleic acids, and getting something completely different. And though you will get many unfit genes along the way, it’s the only way to evolve.

This was one of the fundamental values that drove Apple: a technology that had traditionally been geeky should really be a liberal art (and keep in mind that during his exile from Apple, Steve Jobs was working with artists from Pixar).

When we see “4”, we see a number. Picasso saw a nose. So at school, he’d doodle the rest of the face on the blackboard. Suffice it to say, the traditional educational system is not conducive to this kind of independent thinking…

Back to the Deck

Anyway, back to the KPCB deck, regarding the section regarding foreign companies on page 127: China used cyber-espionage as a pretense to reëvaluate the usage of IBM servers? China has been discriminating against Windows 8 as well. This actually isn’t too distinct from the “protection of infant industries” policy we pursued during our Hamiltonian era, though here a bit of rising global power tension also has to do with it.

Protectionism can give indigenous enterprises leads that are hard to surpass, even by the multinationals. If you look at the OECD and G-77 ex-China, the overwhelming leading sites are Google and Facebook (by the way, Japan, the odd one out, loves Yahoo!). In contrast, the leading site in China is Baidu, not Facebook. Even if maintaining societal harmony, as opposed to Hamiltonian protectionism, was the primary objective behind restricting Google and Facebook, the Great Firewall of China nevertheless creates the same effect.

I suspect China is now in Meeker’s deck because of the Alibaba IPO—one of the biggest deals this year. But strong state control of the Internet basically ensured that the winner would be a domestic homegrown company.

Through the Silicon Mirror: Our world through games

Surveying one of Tropico’s cocoa plantations.

Surveying one of Tropico’s cocoa plantations.

I was examining the cocoa plantations of the Republic of Tropico in the middle of its election season when I received a push alert that Ukraine had elected a chocolate magnate. You might not have heard of the Republic of Tropico, a sovereign nation located on a Caribbean island in the vein of Cuba or Jamaica, because Tropico is an island that exists only in virtual reality. And there are also millions of others like it living in the pulses of electrons flowing through the silicon on our desks and in our pockets.

Technology has progressed to a point that we can now start to render virtual reflections of reality with high visual fidelity. On one end, you have the open world simulations, which are still relatively impressionist in their fidelity, but wide in their scope. Most notable is the multibillion dollar Grand Theft Auto franchise in which players can pursue fantasies vicariously through characters living in satirical facsimiles of New York (“Liberty City”), California (“San Andreas”), and Miami (“Vice City”). While those cities have heretofore been rendered as isolated islands, hardware permitting, Rockstar eventually plans to connect those cities to create one giant virtual world.

There are also developers that don’t go the satirical route—perhaps because their subject matter is less controversial—and actually create outright replicas of our world. The Microsoft Flight Simulator series included airports from Addis Ababa to Zurich, complete with radio frequencies and approach procedures. The later versions even downloaded real-time weather information that rendered in the simulation. An entire ecosystem of third party developers arose as well, working to make the simulation more immersive, ranging from detailed roads, so you could navigate under Visual Flight Rules, to airports rendered at a higher fidelity than the vanilla version.

On the ground, developer SCS Soft has received critical praise for what might not seem like a blockbuster premise at first blush: a trucking simulator. They really hit their stride with Euro Truck Simulator 2, which created a stylised version of Europe. It was successful enough to warrant the development of an American version, whose game world will eventually include more than 100 cities.

While it is by no means a matrix incarnate, but rather a stylised version of our reality, the breadth of world modelling hasn’t been this ambitious outside the flight simulator arena. It is this type of work that will develop the skills necessary to create a truly immersive next-generation virtual reality system. In fact, Oculus Rift almost seems tailor made for this use case. A search on YouTube of footage of Oculus Rift usage with Euro Truck Simulator 2 brings about some fairly immersive results.

The highest fidelity replication though can be found in simulations that contain the scope of their location modelling. In the Project Gotham series, neighbourhoods are modelled with street-by-street accuracy. Even closer to reality are the Forza and Gran Turismo racing simulations, so much so that we are arguably several years into the Ender’s Game era. The developer of Gran Turismo, which sponsors a real world racing team, uses its product as a talent search tool for its new driver development programme. Its drivers have actually performed remarkably well.

Aside: Self-Driving Cars

These ground level simulations also overlap with one of the hottest problems in artificial intelligence right now: autonomous driving. While the objective of the game developer is to pass the Turing test, the objective of the self-driving car developer is to keep the cars from getting into an accident. The games have heretofore used relatively simple algorithms. Follow a racing a line and brake if a car cuts you off. Introduce a few errors to make it seem more human. But the development paradigms between the two disciplines have started to converge. Elements of machine learning, which is the basis of real-world autonomous driving development, are reflected in the most recent release of Forza. While at this point, it is really just a form of asynchronous multiplayer competition, all that data could, theoretically, be used to teach an artificial intelligence how to race. Emulate the fastest drivers who drive clean laps and don’t emulate the drivers who get into collisions.

But simulation doesn’t just apply to the simstim of William Gibson or the virtual reality headset known by the moniker Oculus Rift. All the backtesting done by quants on Wall Street are, in fact, computer simulations. Even in investment banking and fundamental research, Excel models are really just simulated abstractions of real world businesses.

When you take away the graphical veneer of computerised gaming, at its core, we are merely interacting with complex mathematical equations, albeit in a multisensory manner. Considering that, why haven’t we seen games that can inform our knowledge about political economy in the same way doing laps around the virtual Nürburgring makes you a better driver—or vice versa, where going to Skip Barber at Laguna Seca will make you a better gamer?

Actually, there have been more than a few games which handle that subject matter, and they do it brilliantly.

Do virtual ministers dream of Tron bikes going through the streets of Sim-Davos?
Patent Drawing for The Landlord’s Game

Excerpt of The Landlord’s Game from the U.S. Patent Office.

Greg Mankiw created a presidential game to illustrate some basic economic concepts. And the Swiss National Bank has a monetary policy game that simulates some harrowing liquidity traps. Even the best economic board game ever created—The Landlord’s Game, an illustration of the evils of rent seeking—could be put through a Monte Carlo simulator. But you’ve probably never heard of those games unless you’re a die hard economics nerd. And you’re probably not interested in learning about them.

This is because positioning simulations as primarily pedagogical in nature don’t tend to result in boxes coming off the shelves. In fact, The Landlord’s Game languished, until it was repurposed as a different game that turned the premise on its head: Monopoly.

Introducing extremely compelling gameplay—where the one-more-turn dynamic that is the Holy Grail of game development dominates—is what ensures commercial success. And he who reaches the greatest number of people is the one whose Weltanschauung drives the conversation. Those are the games I want to examine.

Why even look at games? Why not just learn the equations and run them through Mathematica or Excel? First, I would argue that economics and politics can never be fully reflected in equations due to the innately human nature of those disciplines. To put it another way, you can create Monte Carlo simulations of Monopoly games to decide whether Illinois Avenue or Boardwalk are better investments. But you can’t flawlessly predict what a human is going to do in a particular circumstance. These are probabilistic, not deterministic, models. While a Monte Carlo simulation can help aid in decision making, it is the implicit knowledge and intuition that can only be gained by actually playing Monopoly that will distinguish a champion.

Furthermore, while mathematical equations only express an abstraction of a sliver of an actual complex system, they are the best tools we have at the moment. And actually interacting with these complex intertwined equations in a multisensory manner will yield a far better intuitive sense of the system than just seeing numbers change on a spreadsheet. Logos must be combined with pathos to leave impressions in our minds.

In short, understanding the analogies between cyberspace and meatspace, and developing the fluency to switch your mental state from one form to another, can create a deeper understanding of both areas. And these games can also help kindle passions in often dry topics: Monopoly for future real estate moguls and Diplomacy for future ambassadors. I personally first encountered the terms “Keynesian” and “supply side” not through Paul Samuelson or even Robert Heilbroner, but in a book about becoming a better SimCity 2000 player.

There has been a rich history of economics—often intertwined with politics—since the dawn of computer gaming. From the merchant capitalism modelled by Taipan! to the grand strategy and global political economy of, say, Europa Universalis.

However, considering the timeliness of the recent release of Tropico 5, I thought I’d start with that. Expect a piece out some time in the next week.

Entrepreneurs thinking twice about doing business in France

This morning, French President François Hollande declared that the GE offer for Alstom was “unacceptable”. While the need for state review due to the nuclear technology is understandable, extraordinary scrutiny regarding the rest of the deal—which seems to be the point of contention—is one more data point that feeds a larger narrative of the French government’s inhospitable attitude towards the business sector.

Along with Hollande’s 75% millionaire tax proposal—which was incidentally ruled unconstitutional—particularly worrying is the current Economy Minister Arnaud Montebourg’s history of calls for nationalization of assets of private companies.

But this inhospitableness does not stop at protection of old assets. There has been outright opposition to new companies. When Uber entered the French market, it wasn’t long until there were cases of vandalism against the new entrant.

Historical, political, and cultural opposition against business sector in France has led quite a few entrepreneurs to decamp for more business-friendly countries. The New York Times recently had a piece about entrepreneur flight to the United Kingdom. That Times article further cited Le Monde’s discussion on whether youth must leave France to succeed.

The Centre for Policy Studies recently released a paper that compared the propensity of a country to generate “SuperEntrepreneurs”. That is, not looking merely at the self-employment statistics, which could include your corner barber or your accountant. Rather, it looked at countries that had a large number of entrepreneurs building multibillion dollar global companies. In other words, those entrepreneurs who create most of the new jobs.

When they compared incidence of high-impact entrepreneurship they found, “The lowest share is found amongst nations with French legal origins, which is less than one-fifth of that of nations with English legal origins.”

When the stability of the rule of law has become uncertain due to the its co-optation by the political process, then executives think twice about doing business in that environment. That is, why go to France, when you can just go next door to Germany or across the Channel to England?

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