The best thing I read this decade

Things don't go in a straight line, which was somehow news to me

Welcome to I’m Late to This, a newsletter about things I haven’t stopped thinking about. 

If you haven’t yet, make sure to sign up so you don’t miss an issue. I’ll be publishing once a week on Saturday or Sunday mornings.

And now, the best thing I read this decade. 

In 2015, venture capitalist Jerry Neumann published a blog post titled “The Deployment Age.” In keeping with the thesis statement of this newsletter, it is something that I have not stopped thinking about since I came across this post in the spring of 2016. 

And while I’ve argued before that people should be reading more fiction and less news — mostly because fiction, unlike the news, is true — Neumann’s post, for me, enjoyed the biggest element any written work needs to connect with a reader: timing and luck. (Also: his post is not really news, so I will say my take holds!)

Now, in the spring of 2016, the U.S. economy was doing okay. Not great. Not good. Just okay. The global economy, as Adam Tooze outlines in his latest book “Crashed,” had just come through its most perilous period since the eurozone crisis five years earlier. 

Robert Gordon published his book “The Rise and Fall of American Growth” in January 2016. The book’s central argument is that many of the innovations which lead to rapid increases in worker productivity and overall economic prosperity during the 20th century won’t be repeated. We’re talking things like electricity, universal indoor plumbing, microwave ovens, and so on. It’s a compelling thesis. I always thought it was wrong. But the Gordonian worldview colored a lot of conversation about where the economy was headed. I think it still does today.

And so in 2016 the general consensus agreed that secular stagnation had won. Larry Summers was right: better things were not possible. The economy had been and would be fated to a lower-growth trajectory. 

Neumann’s post, for me, re-framed the secular stagnation debate as one that put the 2010s at the beginning of a new part of the same cycle that had begun decades earlier. His argument borrowed heavily from the work of Carlota Perez and unlocked for me a way through the frustration of seeing Boomers declare that only they could enjoy the good times. And not to be all “Fourth Turning” about it, but I think it had just not really occurred to me before reading Neumann’s piece that we experience time linearly but reality unfolds cyclically. I guess I thought the whole Rust Cole thing was just a bit. 

And so at the risk of oversimplifying Neumann’s thesis, “The Deployment Age” argues that economic cycles operate over long arcs and in two phases: installation and deployment. The current cycle is centered around info tech. The installation phase has passed and we are currently in the deployment part of the cycle.

The turning point of all cycles is a bubble. The tech bubble and the real estate bubble that lead to the housing crisis are, as we get further away from them, clearly not events that stand alone. It’s called a “lost decade” for a reason. These events were merely two phases of one bubble. We’re now on the other side.

The exciting part of Neumann’s thesis implies we’re at the beginning of a potentially 20+ year cycle during which we will realize the full potential of all the tech we’ve seen hyped over the last few decades. The early returns on this idea are things like Uber and Lyft changing transportation, Spotify giving you access to basically every song ever made for $10/month, and Instagram creating an on-demand mall. These services are unlocked by the ubiquity of internet-connected phones. Technology that was built during the 1990s tech bubble is being efficiently and effectively deployed 20 years later. 

(Footnote: I think this probably bodes poorly for the AI/ML/AR/VR crowd because that is a kind of leap forward this cyclical thinking would indicate isn’t going to happen until the next cycle.) 

The less exciting part (for some, at least) of the deployment age is that we’re now entering a period where innovation is iterative, not transformative. As thesis statements for what this shift means goes, I think this brief passage says it best:

The zeitgeist changes from creative destruction to creative construction. Financial capital pulls back and production capital takes over the funding of innovation.

“Financial capital” can be loosely defined as “hot money” or just “investor capital.” This is money looking for returns on capital, not business success. During the current cycle this goes from junk bonds to the rise of LBOs in the 1980s, then morphs into retail investors speculating in tech stocks in the ‘90s and adult entertainers becoming house flippers while banks turn their balance sheets into Jenga towers of derivative risk in the 2000s. 

Then it unwinds. 

“Production capital,” in a (sort of) contrast can be loosely defined as “company money.” Neumann defines production capital as that which seeks, “predictable innovation: classic sustaining innovation, not the riskier exploratory innovation. This period, when production capital starts to take control, is a period of synergy, with less technological volatility, fewer business failures, more (and longer-lasting) employment, and less income inequality.”

Or as Neumann writes:

The distinction between ‘financial capital’ and ‘production capital’ is key to Perez’ explanation, but it took me a while to figure out exactly what she meant by it. My long-ago operations research textbook had a cartoon showing one MBA talking to another: “Things? I didn’t come here to learn how to make things, I came here to learn how to make money.” This is the view of financial capital. The view of production capital is exemplified by Peter Drucker: “Securities analysts believe that companies make money. Companies make shoes.”

In the wake of the crisis the first forms of production capital deployed are the cash balances mandated by the Federal Reserve to be held on bank balance sheets so that solvency doesn’t become an acute issue again. But longer-term, production capital ultimately seeks the entrenchment of the new economy’s winners. We see this clearly today. 

In 2018, Microsoft, Amazon, and Google spent a combined $68 billion on capital expenditures. This was good for a 5% share of the entire U.S. economy’s non-residential private fixed investment during a year that saw investment surge because of tax cuts. The deployment age thesis says this is just the beginning. 

The next leg of innovation in this cycle is Amazon and Microsoft and Google providing incremental value to their customers through massive investments to solidify their market-dominant positions. There is no imminent “next paradigm” in tech — the paradigm is just big companies getting bigger, better, and more deeply integrated into our habits. Amazon Prime goes from two-day free shipping to one-day free shipping. It is an amazing convenience. But it is not a flying car

And so it is no surprise that the largest companies in the stock market this year saw their collective value increase by over $2 trillion. The top five were the tech giants we know — three of them are mentioned above, plus Facebook and Apple — and that are now beyond any reasonable doubt The Establishment. 

The next biggest is a bank. Recall the first deployment of production capital after the crisis.

As Neumann writes:

In 1953 the establishment believed that what was good for GM was good for America; it’s not a stretch to say that over the next 20 years the establishment will begin to believe, and act, like what’s good for Google, Facebook, and Apple is good for America.

We hear a lot of hand-wringing from the investment community about the “regulatory risks” that face today’s tech giants. Politicians from both parties seem to not like most of them very much.  

But real regulation, in the form of a breakup or onerous new capital regulations or something similar, will likely only follow from a crisis. Politicians are talking what I think is at best a medium-sized game about the role of Facebook, Google, Amazon, and Apple in our society. 

And as has been well-documented, the current antitrust paradigm is poorly equipped to address the challenges these companies pose because on a consumer welfare basis, these are four amazing businesses. These companies’ massive investments in their businesses are designed to keep customers (and constituents of these somewhat-disgruntled politicians) so happy they don’t care that when it comes to competitive practices, we are having a discussion that is a lot less friendly. 

Neumann concludes his argument by outlining something he acknowledges was obvious back in 2015, is still obvious in 2019, and is still not appreciated: the economy is not static. 

And by “the economy,” he means the ways we learn in Econ 101 about how the economy is measured and sorted and what that idea says about current cycles. Because the textbook says we will revert to some equilibrium of growth and prosperity, etc., and provides the backing for views that argue growth is being “pulled forward,” as if economic well-being is zero sum. “Secular stagnation” says that equilibrium growth is lower than previously forecast. Assuming the equilibrium is the first mistake.

And it’s because of this thinking that people still argue interest rates must go up and still think stock prices are too high. But there is no level of rates or stock prices or home prices or the cost of televisions or computers or clothing or food that must hold: the price is the price. That is economic reality. 

Neumann writes:

People have always had a penchant for thinking that now is the end of history, whenever now was. Whatever just happened will continue happening; however we’ve learned to deal with problems are deep underlying truths, not just contingent responses. But if things are always changing, then there is never an end to history, and many of the things you’ve learned as deep underlying truths are actually subject to being overturned at any time. Everything you’ve learned in your career has to be re-examined every once in awhile to see if it will be as true in the future as it was in the past.

Some things we’ve learned over the past 30 years — that novelty is more important than quality; that if you’re not disrupting yourself someone else will disrupt you; that entering new markets is more important than expanding existing markets; that technology has to be evangelized, not asked for by your customers — may no longer be true. Almost every company will continue to be managed as if these things were true, probably right up until they manage themselves out of business. There’s an old saying that generals are always fighting the last war. It’s not just generals, it’s everyone’s natural inclination.

I am as excited about this idea now as I was more than four years ago. 

I remember where I was when I read this post for the first time and I remember the immediate need I had to tell someone about it. I was driving from New Jersey to North Carolina with my parents to attend my youngest brother’s college graduation. I remember telling my parents — or, for sure my mother, but I don’t know why my brother and father who were also in the car wouldn’t have been the audience for this — about the post. Or maybe it didn’t happen that way: such are the perils of memory. 

I worry, of course, about what this all says about me. Does thinking that a VC’s blog post is really great mean I’m actually an idiot? (Surely enough people thought that before this post anyway.) 

Am I supposed to be lauding a Zadie Smith essay or some deep reporting from George Packer instead? What about a novel? Shouldn’t I be humble-bragging about some long book I actually finished? And how was I not steeped in the history of economics literature that probably spelled out everything Neumann said like a hundred years ago? 

But like I said at the beginning, reading, re-reading, and remembering Neumann’s piece is probably just about timing and luck. For all I know Jerry Neumann has forgotten about this post, or didn’t think it was that great, or has completely changed his mind.

And in the end we don’t really get to choose what we find interesting. And we don’t get to decide when and where we find it.

Thanks for reading I’m Late to This. Have a great holiday and a Happy New Year. We’ll be back with a new edition in 2020.

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