There is a reason we do not have enough baby milk, Siracha sauce, peanut butter or German Beer.
There is a reason our railways in the West are so antiquated while those in China are so swish.
There is a reason that energy prices are so high.
There is a reason why your washing machine no longer lasts 20 years.
There is a reason why President Putin wanted to hoard Ukrainian wheat and deprive the world from getting it.
It’s one reason. It is because we decided, in the West, to only invest in software/SAAS (Software as a Service) or in keeping share prices rising. It is because we avoided investing in anything real. It’s time to get real about this trend. The primary driver of this trend has been pure greed. The rates of return on software-led businesses have been massively higher than on real things. The view was that you could make a piece of software and sell it over and over. Here’s the first hard truth. This is no longer true. Software is copied faster than a Gucci handbag these days. Hardly anybody even writes original software anymore. It’s all cut and paste. Yet, Silicon Valley continues to primarily fund software SAAS ventures. It’s a known formula with better returns that the hard business of hardware.
This is one reason that investors would not touch hardware for the last two decades. But institutional investors still seem to be operating on outdated assumptions. They still seem to think the Chinese will copy anything physical. That may be true but China’s capacity to build a global brand or to get its product into Western markets is now severely impaired by a lack of quality control and by intense geopolitics. Investors also seem to think that there is no money to be made in making a thing. But, that’s wrong too. The most valuable things are the ones that combined great hardware and great software. A bicycle is a thing. A Peloton is a thing. But, it is also software and a community. But, even a bicycle as a thing has a market value in a world where China and emerging markets specialized in making things cheaper but not better. There is a mile-long waiting list for a hand-made Brompton Bike. That waiting list is funding their expansion into “a revolutionary new manufacturing facility with one aim – to build the kinds of bicycles that allow humans to move around cities better and more sustainably”. As Wired wrote in 2018, The Vehicle of the Future Has Two Wheels, Handlebars and is a Bike. But, who is funding Brompton’s expansion? Venture capital? No, customers are funding them.
Food is a hard, real economy investment too. Food seems pretty mundane unless it is under the banner of a brand that attracts customer loyalty. Investors understand Kraft Heinz and McDonalds. But most food investment is in food technology rather than in food itself. Investors want the tech, not the output. AgTech attracts capital but old-fashioned food production does not. After all, how many brands of baby milk, hot sauce, and peanut butter are there? Too many. This is why VC investing into Farm Tech accelerated faster than investment into food itself. But, who wanted to invest in Mexican Chillies when drought could kill the crops? This is exactly what happened over the last 18 months. Our inability to solve the hard problem of water in a place like Mexico meant the drought bit into chili production and hot sauce got killed by the heat. The baby milk and peanut butter shortages were caused by a more nefarious problem known as concentration. In short, there are too few producers. Why? Because capital likes monopolies and encourages their creation. Money will back a firm that owns the market. Competition is loved by economists but hated by investors.
Then there are major corporations. Instead of investing in the future through capital expenditure, they spent their money in recent decades buying back their own shares. They did not invest in new LNG terminals so the world could turn to US gas in this global energy crisis. They did not invest in new oil refineries or new rare earth metals refineries needed for modern manufacturing. They did not invest in new production facilities for baby milk or hot sauce or peanut butter. Share buybacks have been immensely popular for years. See the FT’s chart on this here. They lift the share price but do nothing to build out the economy.
The Chinese got around these problems by creating a public policy that was committed to infrastructure called The Belt and Road Initiative. Instead of buying Treasuries, they decided to recycle their savings into buying and building the critical infrastructure and assets needed to grow the economy. They built railways, roads, and ports not only inside China but across the world. In theory, they secured access to raw materials through this process. “We will build you a port if you give us 30 years’ worth of fill-in-the-blank with bananas, oil/gas, protein, etc. This worked until emerging markets began to realize that the deal required that they go deep into debt and failure to repay the debt meant China could seize these assets. Witness the deal where Uganda had to surrender its only international airport to the Chinese. China’s leverage was in the fine print. Maybe this was China’s plan all along? Confiscation is one way to build a global military infrastructure. Notice that China has just announced that the People’s military now has a “pink slip” to protect such assets with “military operations other than war” so that China can secure “property, and maintain(ing) national sovereignty, security, development interests, and regional stability”. The point is that this option is not available in the West. The state cannot direct the private sector to build what it needs. But it can ask. That is exactly what the US government/military is doing.
The US Defence establishment has been focused on “getting real” for quite some time. DARPA and other branches of the US Military have been seeking to foster homegrown products and innovation. For example, in the drone space, they realized that they could not and should not depend on Chinese-made drones. Why? Because there was a good possibility that all the data might make it back to Beijing. So, it was decided to foster US-made drones. The strangely named entrepreneur Palmer Luckey sold his Occulus Rift to Facebook and started making drones for the military. His firm, Anduril is now worth $8b. The defense community is increasingly driving private sector investment given the need for defense new technologies like hypersonic capabilities and quantum computing. Perhaps it is telling that President Biden invoked the Defence Production Act to deal with the baby milk shortage? Is the government going to increasingly take a command/control approach because private investors can’t and won’t touch anything but software? It’s happening with rare earth metals. It wasn’t that long ago that nobody would finance the expansion of Lynas, the world’s leading expert in rare-earth metals. Who is financing them now? The Pentagon! Why? Because you can’t make a fighter jet or a tank or an iPhone without rare earths. The sector is a national security issue.
Maybe beer-making will also begin to fall under the rubric of national security as well? Somehow, I can also imagine the new German military spending some of that 2% of GDP on beer production given the core role beer plays in defining Germany’s national interest. By the way, the real problem causing the German beer shortage is driven by high energy prices and a shortage of glass bottles to put the beer in. It’s the hard part of beermaking that’s causing the problem not the liquid part. But who wanted to invest in bottling? The Guardian reports that Carlsberg is looking at bottles made of “wood-based fibre shell and a plant-based polyethylene furanoate (PEF) polymer lining”. A whole 8000 of them will be made available to customers throughout Europe. (that should be sold out in about 10 seconds. I am guessing customers will fund this undertaking too rather than investors. As for high energy prices, notice that militaries everywhere are starting to commercialize long-existing energy-generating military tech. Solutions we’ve had for years are suddenly going to be made available to the public. But not because investors brought these possibilities to life but because militaries decided to declassify them.
One reason that energy prices are so high is that the US has not managed to build the LNG Terminals that are needed to move natural gas to the rest of the world. In theory, the US could displace Qatar as the biggest supplier of Natural gas in the world. But this requires the right infrastructure. As it stands, a recent fire at the Freeport LNG liquefaction facility in Texas brought about 17% of the market to a halt. Prices jumped. Why don’t investors want to build these physical facilities? Fear of litigation (especially after the damage and judgments arising from Deepwater Horizon)? Fear of accidents? Why did Deepwater Horizon happen in the first place? Some say it was the skimping on maintenance costs in order to keep the share price up. Once again, the financial performance drove hardware into a disastrous outcome.
This is what happened to washing machines too. They used to last 20 years. Today, the redundancy is inbuilt. Why? Because the financial performance pressure forced them to sell more machines that were less well built at cheaper prices. This was fine when we thought resources were limitless and China made ever-cheaper household appliances and the markets mainly went up, so we all thought we’d be richer. But all this has unraveled. Now we realized washing machines don’t last. Worse, they’ve been designed, like so many appliances, so that they can’t even be repaired. Most hard goods cannot be repaired these days. The vendors want you, indeed need you to buy a new one. This is also why so few people know how to make anything anymore. Remember Albert Einstein learned a huge amount about physics and hard real things from working in his Uncle’s appliance repair shop fixing broken things. Today there are no repair shops. Automakers seal car engines so you can’t play around with the engine and learn about it anymore. Kids are told that coding and software is the future.
But software is not the future. If anything, shardware is the future. This means goods or processes that require both hardware and software to function properly. That means all robotics, all buildings in the future, all cars, trucks, bicycles trains and planes that will have software systems needed to run and track them.
The problem should be obvious now. No amount of software alone is going to get that 20 m tons of wheat out of Ukraine and onto the global market. The world would be better off if their grain silos were shardware and we could track the condition of all that wheat instead of guessing that it’s ok. Pestilence and mold are as old a time and remain the greatest enemies of raw grain. Does war make it easier for pestilence and mold to attack grain? Yes. Nearly 5m tons are already at the ports. Some grain is already on some 84+ ships that are stuck in the harbor. Are the rats having a field day? I don’t mean the Russians. I mean actual rats! Of course, the Russian military may have a field day blowing that grain out of the water with missiles too. All this is why the White House just announced the intention to build temporary silos along the Ukrainian border and in Poland. My guess is that this may be the first serious modernization of grain silos in Ukraine in decades because nobody wanted to build modern grain silos when they could invest in software. Food is now a national security issue that warrants spending from the defense budget.
One thing that the collapse of the global supply chain has taught is that the world cannot run on SAAS and software alone. It’s time to get real. That means a world where capital and talent get on their bikes and start making hard stuff.
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Brilliant. I picked up a dog-eared cottage copy of FutureShock(1970), and found the chilling boast that America was poised to become the first country in the world with more white-collar workers than blue-collar. Included in white collar? Retail and other service workers. In the blue? People who actually made things. That this was considered the pinnacle of success 50 years ago explains in part how we got where we are. Terrific analysis here. Do you think money will shift from funding SaaS?
The reason why US LNG capacity is currently constrained is price volatility. Except for Golden Pass LNG (owned by XOM & Qatar), no US liquefaction capacity has been built on speculation (i.e., owners take all price risk). Except for this project, no liquefaction capacity has been built without buyer commitments. From 2015 to 2019, global oil and gas prices were exceptionally low, due to surging US tight oil production and the resulting price war with Saudi Arabia. Virtually no European gas buyers (except for Poland) were willing to make financial commitments to US LNG because Russian gas was relatively cheap. As European utilities could not pass the cost of supply security on to their customers, they could not afford to diversify. Without government support, buyers had to buy the cheapest gas, which was from Russia. The trap Putin was creating was obvious, particularly for those of us trying to sell US LNG capacity. But it was impossible to persuade buyers to bear the financial risk, until the risk became tangible.