The Bear’s Lair: Ferment brings us the future

Large organizations are almost never innovators. You can quote the occasional exception, such as the Manhattan Project, but even in space exploration the ability of Elon Musk’s SpaceX, on a tiny budget, to outdistance NASA in rocket design, shows that big is generally intellectually barren. Throughout history, the periods of greatest innovation have coincided with the periods of market chaos, with a myriad of small competitors and no established standards. We need to figure out a way to encourage such periods.

As has been well documented, the last decade has seen a dearth of start-ups. On Census Bureau data the establishments entry rate has declined from around 15% of existing establishments in the late 1970s to around 10% in the years to 2014, with the drop occurring in two stages in the years of Bill Clinton and Barack Obama. Even up to 2017, while single-person company formation has held up fairly well, the formation rate of companies with more than a tiny number of employees has dropped quite significantly in the last 20 years, given the increase in the population.

At present, the California tech sector has shown signs of increasing maturity, even senescence. Long-established venture capital companies fund round after round of private financing for companies that rarely go public, while the very largest tech companies have in less than two decades become true behemoths, with Google and Facebook having over 60% of the online advertising market between them, for example, and tending to buy out or squeeze out competition.

The rate of innovation has declined, the industry is showing signs of a stultifying conformism, especially in political matters and real estate has become impossibly expensive for new entrants to the business. Industries can carry on like this for a great deal of time (though there must surely be a weeding out of the perennially unprofitable in the next downturn) but you would not expect great innovation to come from such a milieu. Google and Facebook are very similar to the 1950s General Motors, concentrating innovation on tail fins, lobbying like crazy, celebrating conformism, and declaring that’s “What’s good for General Motors is good for America.” That kind of industry produces the Edsel and loses market share to imports.

The truly innovative business environments are very different. In the early Industrial Revolution the textile companies employing the new steam technology were tiny, generally just a few thousand pounds in capital, with large companies not appearing in Britain until the 20th Century. Even when a company became substantial, like the elder Sir Robert Peel’s Peel, Yates (which became the largest cotton mill in the world) the partnership was dissolved on Peel’s retirement in 1817 with the assets distributed to partners; there was no attempt to create a long-standing institution.

Likewise, in early 20th Century America the automobile market was fragmented and chaotic until Henry Ford consolidated it after about 1912. In both cases, the level of innovation was very high, but it was coming from individual entrepreneurs trying new things, not from within large corporations. Even though some makers of bicycles or wagons diversified into automobiles, they were mostly not sufficiently cutting-edge in the new technology to be successful.

Conversely, Bell Laboratories until 1982 was a famous center of technological excellence, with untold billions devoted to it by A.T. & T., and it came up with the transistor in 1948, but even in an era when venture capital money was almost non-existent, it did not pay for itself and most of the innovators left. Likewise, the Xerox PARC laboratory in the 1970s came up with most of the architecture that would be used for the next three decades by the PC industry, but failed to do anything commercially useful with it, eventually having its IP ripped off by Steve Jobs. Even when large organizations devote billions to being innovative, they are very bad at it. See, in more recent decades, Hewlett-Packard’s sorry track record or the non-search bits of Google (which admittedly could still come up with things to justify their cost, but don’t currently seem likely to do so.)

The dot-com boom of the late 1990s was a quintessential environment of chaos, competition and creativity. Most of the dot-com companies were mayflies, lasting less than a decade. Even when a company had apparently become dominant in a sector that was to be important, like Ask Jeeves, Webvan and Friendster, their dominance dissipated when new competition came along. Many medium sized fortunes were made, but the entrepreneurs, even super-wealthy ones like Steve Case of AOL, did not become leaders of major businesses; instead they sold out and lost much of their importance by doing so. There were no 1990s equivalents of Eric Schmidt of Google, Mark Zuckerberg of Facebook or Tim Cook of Apple, dispensing leftist creativity-destroying wisdom to the masses and spending huge fortunes on lobbying governments to secure the deep moats around their businesses.

Today’s tech sector has become a slow-moving behemoth dominated by large companies, with a symbiotic link through lobbyists to the government, reciting conventional pieties while very little innovation takes place. However, there is one sector where the buzz, chaos and creativity of early textiles, early autos and early dot-coms is rampant, that of crypto-currencies. Crypto-currencies are disruptive, as were those earlier innovations, but in this case they are disrupting the lethargic world of government-mandated fiat currencies.

Ned Ludd was displaced by the textile mills, the buggy-whip companies were bankrupted by the early automobile industry and the fax machine manufacturers were put out of business by the dot-coms. Today the world’s central banks, who have done such an abysmal job since 2008 of preserving the value of money and the integrity of capital markets, are under threat as never before by new stores of value, uncontrolled by governments. As in other embryonic markets, the environment is chaotic, the systems do not work properly, there are a myriad of tiny competitors. However, also as in other embryonic markets, the speed of innovation is blistering and ferocious competition is bringing massive technological gains.

It is not clear where the future of crypto-currencies lies, just as it was not clear in 1995 which dot-com projects would succeed, in 1900 what the automobile could do, or in 1810 what steam power could do for the textile industry (let alone elsewhere). Yet the most important thing is the atmosphere in the sector; huge amounts of money are being made, there are no dominant players and all kinds of different ideas are being tried. Just as the handloom weaving business was overwhelmed by the textile mills, so some sectors of business, probably including the centralized Internet and very possibly including the world’s monetary system, will be overwhelmed by the crypto-currency revolution. It is an awe-inspiring prospect, which will be most awe-inspiring if cryptos cause us to re-invent money itself.

Paul Singer, of the hedge fund Elliott Management, told his clients that crypto-currencies would be seen as one of the most brilliant scams in history. As a hedge fund manager, Singer will doubtless have seen many scams. Yes, of course there is fraud in the crypto-currency sector, but that does not make the entire sector fraudulent. But fraud exists in much better-established sectors, too, especially when government is involved.

For example, for some years we have known that scientists in the “global warming” sphere bent the evidence to suit the politically attractive result. However according to researcher James Delingpole, it now appears that the National Oceanic and Atmospheric Administration may be spuriously adjusting the temperature data, making the “deep freeze” of early January this year appear only an averagely cold spell and the winter of 2014 in New York state appear only 0.9 degrees colder than that of 1943 when it was in fact around 3.3 degrees colder. If this is true, the level of deception involved in the “global warming” mania far exceeds that of the average crypto-currency promoter. “Climate change” may not be the most brilliant scam in history – there are no giant intellects involved – but it is very probably the largest.

One final danger in crypto-currencies, increased by attitudes such as Singer’s as well as the very real frauds that occur in the space, is that governments, probably acting globally through the G20, will seek to ban them. This has been attempted before. In May 1820 the well-respected Whig leader 4th Earl Stanhope (1781-1855) proposed in the House of Lords a bill banning the use of machinery in manufacturing, on the grounds that it was throwing people out of work. For crypto-currencies, the forces seeking a ban are much stronger, and the forces resisting one are much weaker than the economically sophisticated and determined Tory government of Lord Liverpool.

Before you support the banning of cryptos, just think for a moment of where we would be today if Stanhope had succeeded!

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)