Getting Real

With the Super Bowl coming up, I thought it might be fun to use football to illustrate one of the big themes Kris and I are working on at Research 2.0. The theme is the convergence of the real and virtual worlds, something we call RealVR. The convergence of the real and virtual worlds promises to profoundly reshape the global economic and financial landscape. The investment implications of RealVR are significant, particularly when viewed in conjunction with the migration of applications to the Cloud.

We can illustrate the convergence of the real and virtual worlds by looking at the evolution of Electronic Arts’ popular computer game, “Madden NFL.”   The first version of the game – titled “John Madden Football” – appeared in1989 for the Apple II series of computers. In 1991, a version was released for Sega’s Genesis machine. The picture at left is a snapshot from that game. Note the crudeness of the playing field and players. Suffice it to say that Madden NFL in 1991 was not realistic at all.

If we fast forward a decade to 2001 and look at a snapshot from that year, we can see that the graphics of the Madden football game have taken on a more realistic appearance. The team colors and logos are clearly visible (in this case, the Raiders and the Rams). We can see the images of the players are beginning to resemble real football players. The playing field looks more realistic as well.

It is evident from these two snapshots that during the first decade of Madden NFL, there was a significant increase in the realness of the game. We can jump ahead another decade (well, almost) and compare the realness of the 2001 game to today’s Madden NFL. Nearby is a snapshot from this year’s version of the game. Note there has been another large increase in the realness of the game. The players are beginning to resemble themselves (pictured in the snapshot are Arizona Cardinal wide receiver Larry Fitzgerald and Troy Palamalu of the Pittsburg Steelers, participants in last year’s Super Bowl).  The current version of Madden NFL makes the 2001 version look like a joke. There is no comparison.

The evolution of Madden NFL over the past two decades clearly shows the ongoing convergence the real and virtual worlds. Put simply, things are getting real. Given where we are today it is pretty easy to see that things will become even more real and life-like in the coming decade amid exponential growth of computer power.  We are moving into an age where increasingly, it will become difficult to discern real from virtual.

We can imagine in the not-too-distant future a time when our appearance in a virtual world like Second Life or Teleplace will resemble who we are in real life. Several of the companies we have spoken with over the past year are incorporating life-like avatars into their enterprise virtual worlds technology. The avatars are crude today, just as the football players were in the early versions of Madden NFL. But you can bet they will get more realistic in the years ahead.

As RealVR continues to evolve in exponential fashion, there will be many new opportunities for established as well as emerging technology companies. Much of the research Kris and I are doing today involves identifying the biggest potential beneficiaries of RealVR.  It is an important piece of our investment strategy today and ripe with potential. We believe the convergence of the real and virtual worlds will profoundly alter the dynamics of corporate growth and profitability and create some fantastic investment opportunities in coming months and years.

Speaking of RealVR, football, and the Super Bowl, it won’t be too long until Madden NFL will be available in 3D and people will be able to watch the real Super Bowl in 3D – in their living rooms or on their smartphones.

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3D Reality

“ 3D will never be much more than a gimmick.”
-       Erik Sofge (Popular Mechanics, January 14, 2010)

One of my favorite books is called “The Experts Speak,” written by Christopher Serf.  The book is full of famous pronouncements by so-called experts that look ridiculous in hindsight. Here’s a gem from the book that appeared in Popular Mechanics back in 1949:

“Computers in the future may weigh no more than 1.5 tons.”

Another favorite of mine from the book comes from Ken Olson, President, Chairman and Founder of Digital Equipment Corp., who in 1977 stated:

 “There is no reason anyone would want a computer in their home.”

As I sit in my home office writing this blog post on a computer that weighs less than 4 pounds, I am thinking that Erik Sofge’s statement about 3D never amounting to anything more than a gimmick will end up looking as silly in the not-too-distant future as these two pronouncements.

As Kris and I have noted in our research with GigaOM, we are at the very early stages of a (r)evolution in 3D computing. Advances in digital computer technology are making it possible to render dazzling life-like 3D images and environments. Driven by powerful computing architectures, we are moving headlong into an era that will more resemble what we saw in the movie The Matrix and on Star Trek: The Next Generation with its Holodeck.

No disrespect to our friends at Popular Mechanics, but we believe 3D will amount to much more than a gimmick. In our view, 3D will become the de facto standard in computing. Looking out into the future, we find it difficult to say what won’t be 3D. We can already see seeds of the 3D (r)evolution that will make today’s 2D internet and web look like antiquated and crude technology. 

That’s not to say that there won’t be booms and busts along the way. To expect otherwise is not to understand the nature of technology and markets. We’ve seen a large flow of 3D announcements over the past year – from new 3D LCD HDTVs, computer displays, glasses, movies, software, TV programming, etc.  More capital is being invested in 3D technology and content and we expect this trend to continue in the months ahead. The fact that 3D movies have generated over one billion dollars in the past year during a difficult economic time is enough to raise a few eyebrows in executive suites around the world.

There is no doubt in our minds that a fair amount of investment activity in 3D will not generate a favorable return on capital and will be curtailed and shut down (witness Philips N.V. decision to pull the plug on their autostereoscopic display research lab not too long ago). Some 3D technology will be over-hyped and lead to disappointment. This goes without saying.

From our perspective, we are in the very early stages of 3D digital computing. This is a key point that should not be lost on investors. There are powerful advances in digital computer technology and software ahead that will create rich, immersive environments that we have never experienced before. These advances will make it possible to render far more life-like images and environments than we have seen to date. Mental Images’ Reality Server, OTOY’s Lightstage, and James Cameron’s Avatar are impressive, but they are just the tip of the 3D digital technology iceberg.  There’s much more to come.

I suspect there are a few kids right at this very moment envisioning a fully immersive, 3D future that would blow us all away.  And when they are grown up and have achieved billionaire status from pursuing and realizing their vision, they might discover the January, 2010 issue of Popular Mechanics on the 3D web with their 3D computing device, read it, and have a good laugh.

Glasses-Free 3D

Given what we saw at CES 2010 and based on the research we’ve done, it’s clear 3D is gaining momentum in the marketplace. Today we published an interview we conducted with Dr. Craig Summers, founder and CEO of 2D-3D Video, Inc. Craig is an innovator in 3D technology. An ex-Apple employee, he has developed a way for viewing 3D content without the need for special glasses and equipment.

In our interview, Craig tells us about his glasses-free 3D technology and explains how it works and compares to other products in the marketplace. We also explore where and how content can be viewed, how close we are to be able to convert 2D content to 3D in real-time, as well as what markets are driving most of the new demand for 3D content.

There is no shortage of competing 3D technologies in the marketplace. What makes 2D-3D’s technology attractive for users is that 3D content can be viewed on conventional technology, whether it be smartphones, netbooks, smartbooks or LCD TVs. No special equipment is required.  The company also has the capability of converting 2D video into 3D in real time. Needless to say, real-time 2D to 3D video conversion has the potential to change the content landscape.

Readers can download the interview for free at the Research 2.0 website (registration required). Readers may also be interested in the free photo software Dr. Summers recently released that allows users to create 3D photos. The software can be downloaded at this link:

http://www.2d-3dvideo.com/NewSite/download.html

Also, iPhone and iPod Touch users can download 2D-3D’s mobile video player for free at iTunes at this link:

http://itunes.apple.com/us/app/2d-3d-video-player/id305666560?mt=8

Skype Everywhere

We’ve been big fans of Skype since the service was launched. We were pleasantly surprised when eBay acquired the company several years ago thinking they could make hay with Skype’s technology. We subsequently became dismayed many months later when eBay failed to capitalize on what we viewed as a golden opportunity with Skype. We were delighted to see a group of seasoned private investors last year acquire a majority of Skype shares from eBay. Under the right ownership and management, we continue to believe there is plenty of upside ahead for Skype.

Skype has over 500 million users currently. The company employs a freemium business model.  Skype-to-Skype calls are free no matter where you are located. The company derives revenue by charging competitive rates for people to call regular phone numbers and for add-on services like voice mail. Increasingly, Skype has been used for video calls. The company says video chats account for 34 percent of calls on the service today.

Skype has been thus far confined to computers, smartphones and iPods, but the application will be moving into family rooms in the near future. Two major manufacturers of TVs – Panasonic and LG Electronics – recently announced they are integrating Skype into their Internet-connected TVs (so called NeTVs). According to the folks at Insight Media, over a million NeTVs were sold last year. That’s just a trickle compared to what we are likely to see in the years ahead.

Skype’s CTO Jonathan Rosenberg notes that 2010 is the year when NeTVs will start to take off. He believes every TV that ships in the near future will have built in Wi-Fi, webcams and microphones. NeTVs will be equipped with web browsers, and widgets will used by TV networks to integrate their delivery models with NeTVs. Put simply, TVs will become part of the network in the home.

According to Skype, the service on a TV will work much as it does on a PC, but with some limitations. A TV program will stop playing once a Skype call is made or answered. Apparently, the processors in TVs are not yet powerful enough to allow people to chat while they watch a show. We expect this situation to change in the future with the development of more powerful processors.

It may take a while for NeTVs to penetrate family rooms in a significant way. That said, there is no doubt in our mind that NeTVs will become the norm in the future. We think Skype’s strategy makes a lot of sense. It will be fun to watch how this space evolves.

In terms of the bigger picture, we see NeTVs playing a growing role in the evolution of the RealVR Cloud.  NeTVs will be a gateway to deliver more immersive, 3-D viewing experiences in the home. This will open the door to more technological innovation and new products and services in the years ahead.

We are hearing that Skype may file for an IPO this year. If that’s true, we’ll be taking a close look at the deal.  We believe it could be a great investment opportunity at the right valuation.

Broadband v Cable

Steve has touched on the some of the issues facing cable companies like Comcast in the past.  However new pressure from the content providers and studios on the cable companies is forcing them to raise already-too-high prices for consumers in what will be a key battle for the home in the next ten years.

Of course the cable companies are aware that this is coming and they have entered the broadband business which will keep expanding with WiFi and other mobile options so they can complete with communication companies like AT&T and Verizon.

But they still have a broken pricing model when it comes to their core business of TV.  They provide hundreds of channels of content and charge a fixed fee for it (at different levels of course) versus charging you just for what you want.  This model works up to a point but when the numbers of channels reach a certain point *and* the cost per channel goes up, the model breaks down.

This is happening because most of the individual channels like The Food Network and others are look for a few more cents per user per month.  Individually the numbers are small, say going from $0.08 to $0.20, which a fan of the The Food Network would be happy to pay.    The problem the cable companies have is that shifting to the per-channel pricing model means they would have to reengineer their business model and in the near-term would create a bit revenue drop, so they are fighting hard to avoid this by adding services like broadband and/or VoIP and creating a “bundle” of service that tries to protect their cash cow.

But with the overall price of basic and enhanced cable going up, more consumers are going to opt for a broadband solution where they can simply pay for what they want to watch via iTunes, Hulu or other Internet content providers.  The reason this part of the cable model is doomed is that the increase of content is now exponential and the a “pay for everything” model cannot work.

About 10 years ago I did a personal analysis of all the programming available on cable back when there were fewer than 100 channels.  In round numbers this was 2,400 hours of programming available.  About 0.5% of the content was remotely of interest to me personally.  So that’s 12 hours to chose from for my 1 hour of potential TV-watching time per day.  The highest cost channel for the cable provider is ESPN at $4-5/user/month.  [This in itself illustrates the main issue since I don't watch ESPN but it's considered a "must have" channel that drives the cost of the monthly service.]  however most channels are far less, let’s say 20-50c/user/month with an average of 25c for the sake of simplicity.  That makes the 100 channels cost the cable company $25/month so they can still have a good business charging me $35-40/month for their service.  If I watched an hour a day of TV and can use a DVR then my cost for content is about $1/show which seems fair.

However cable companies are already charging on $75/month on average for basic cable and this will be increasing due to higher prices for content.  The question becomes at what point to consumers realize that by paying for what they watch they can cut their bill in half?  And who will offer that service?  Netflix is closest on the movie front now that they have instant watch.  It’s harder to see a solution for sports or news but the pieces are out there with streaming technologies becoming more scalable.

For our household the $75/month fee was already high enough to justify a “all Web” strategy with iTunes, Netflix and Internet streaming.  So far the cable companies have not experienced anything like a broad movement away from paying for basic cable as the phone companies did with the accelerating slide of land-line phone subscriptions.  But as prices escalate and demand for more granular pricing models intensifies those that are not prepared could end up losing substantial market share and revenue.

Adding to the pressure will also be mobility.  As monthly subscriptions escalate it becomes harder to pay them if watching that programming will not be possible due to travel or time constraints.   Again the cable model is not prepared for the eventuality that people will want to “take their content with them” and/or not pay for what they can’t watch.  Compare the cable model to Netflix which allows users to watch content from any browser, change their address for receiving DVD’s and  suspend their membership when they will not be able to use it.  With cable users pay every month, home or not, watching or not.

The all-you-can-eat pricing model for TV is not going to disappear.  In fact that model is just fine as long as some of the content can be excluded from the price.  For example I’d be happy to pay the cable TV company a monthly free for a bundle of channels I select and even give them a 50% gross margin on it.  It might be less revenue but possibly more profit for a visionary cable company to shift to this model ahead of everyone else and actually win the game!

Is anyone out there that bold?

If It’s Broke, Fix It!

Our friend Mark Anderson at the Strategic News Service (SNS) pointed out recently there are some serious issues facing all citizens in the U.S. and other western nations.   Here is Mark’s list of what’s broken in the West:

4. Western Systems Remain Broken:

After all the blather and bother, almost nothing has been done to fix U.S. and other Western systems. Almost all major systems are broken, either becoming dysfunctional or with costs running wildly out of control. A partial list would include:

a. Congress: Reelection costs are obscene, and bribery is commonplace. The system is corrupt.

b. Healthcare: Both premium and operating costs are completely out of control. Nothing done in Washington will help either problem.

c. Higher Education: Both tuition and operating costs are wildly out of control, growing at almost the same rate as U.S. healthcare costs. Liberal arts students are getting BA degrees and $100k debt loads on graduation.

d. K12: Teaching and Learning: In the U.S., in real dollars, we have about tripled per-student spending since the early 1960s without any increase in performance, and the system has so much immunity built in that no one can touch it.

***************

I wanted to share Mark’s observations with readers because I whole heartedly agree with them. Being an optimist by nature, I think they can be fixed.  But fixing them will require a change of heart, a lot of work, patience and positive energy.

I would like to wish all of our readers a very Merry Christmas and a happy, healthy and prosperous New Year. Thanks for taking the time to read our blog posts and share some of your thoughts with us. We look forward to more of the same in 2010.

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3D and 4G

Kris and I published a report on 3D mobile technology today with our friends at GigaOM (subscription required) ahead of the release of James Cameron’s “Avatar,” which opens in theatres on Friday. We are seeing a burst of innovation in the mobile space, led by companies like Apple, Google, Nvidia, Qualcomm and others.  We believe it is in mobile computing where we will see increasing convergence between the real and virtual worlds (what we call “Real VR”). Is it any wonder why Google and Apple are banking large fortunes on mobile technology?

With 3D mobile technology, augmented reality will become totally immersive and spawn new applications and services we haven’t seen before. A host of new software and services  will pop up  as if out of nowhere (how many people knew Twitter existed 18 months ago?). The Cloud will become a pervasive force in mobile computing.  Supercomputing, once the domain of expensive laboratories, will be available in the palm of your hand through the Cloud in the not-too-distant future.  Could the Singularity be too far away?

One of the issues we did not address in our 3D Mobile technology report was the state of mobile bandwidth and its impact on the evolution of 3D mobile technology.  There are over 4 billion wireless subscribers globally, and there has been a significant increase in mobile data usage. Mobile data accounts for over 20% of carrier revenue globally. The increase in the demand for mobile data poses some important strategic questions for the mobile operators who need to figure out a way to deliver mobile data more economically and efficiently.

Third generation (3G) is the predominate technology used by wireless carriers, but we will see a migration to more powerful fourth generation (4G) technologies in the future amid rising demand for wireless data applications and immersive mobile experiences.  The two leading 4G technologies are LTE (Long Term Evolution) and WiMAX (Worldwide Interoperability for Microwave Access). Both 4G technologies help reduce the cost per megabyte, increase efficiency and decrease latency through flat all-IP infrastructure, and provide a rich framework to innovate new applications and services across multiple platforms.

Most major mobile carriers in the United States and several worldwide carriers have announced plans to convert their networks to LTE. The LTE specification provides downlink peak rates of at least 100 Mbps, an uplink of at least 50 Mbps. LTE can deliver the same MB at  less than 25 percent of the cost compared to Wideband CDMA (WCDMA) and at less than 50 percent compared to HSPA (High Speed Packet Access, a 3.5G technology). WiMAX technology lies at the core of mobile pioneer, Craig McCaw’s company, Clearwire. Sprint is an equity owner in Clearwire and is building out a 4G network using WiMAX. Whether WiMAX 4G can pull Sprint out of its tail spin remains to be seen.  We have our doubts.

Many analysts expect LTE to become the dominate 4G wireless technology in the future and that looks like a reasonable bet to us.  Whatever technology prevails, it is clear that there will be growing demand for high speed wireless broadband as 3D mobile technology and applications proliferate.

3D and 4G go hand in hand.  The more bandwidth, the better the immersive mobile experience.  Who are the likely winners in 3D and 4G mobile technology?  What companies should we be investing in today? For answers to those questions, you’ll have to sign up to and become a Research 2.0 client. Membership has its privileges.  :)

(Disclosure: The Research 2.0 Technology Model Portfolio has positions in Apple, Google, Nvidia and Qualcomm; clients have full access to the portfolio and its managers).

The Perfect ‘RealVR Cloud’ Storm

I was recalling a time back in the mid-1990s when I was up in Canada giving a talk on investing to a group of financial advisors.  I was speaking about the coming wave of technological change associated with the Internet and World Wide Web that our research had uncovered and recommended taking a position in a little, largely unknown company called Amazon.com. Most of the people in the room had no idea what I was talking about, but there was one guy in the room who came up to me after my talk and said, “That talk was terrific! What was the name of that company you recommended?”  For the most part during my travels, I felt as if I were speaking to the deaf since few had done any research on the internet or web or even heard of the technology.

Fast forward nearly fifteen years. There’s a perfect storm brewing in technology – one that promises to bring about a tidal wave of creative destruction in the months and years ahead.  A wave of economic change that could rival what we observed in the mid-1990s.  That storm is something Kris and I call ‘The RealVR Cloud.’  There are two pieces to this storm: RealVR and the Cloud. Together, they represent the next major opportunity for technology companies, businesses and investors alike.

RealVR captures one of the biggest trends we have ever seen in our careers and may see in our lives – the convergence of the real and virtual worlds. It encompasses the 3D internet, 3D web, augmented reality, and virtual reality. It cuts across every sector of the global economy from consumer, to business and government. Together with advances in cloud computing, which is the catch-all phrase for networked computing which promises to change computing as we know it, Cloud computing is ushering in a host of different computing architectures, mobility and new applications requirements.

All of the established technology companies – Apple, IBM, Hewlett-Packard, Microsoft, Dell, Sony, Google, you name them – are making a massive push into the the Cloud. Together, Real VR and the Cloud promise to unleash a massive wave of technological change – a virtual Cambrian explosion of innovation. You can think of The RealVR Cloud as the next evolution of computing, the internet and web.

Just as during the Cambrian explosion in biology, which wrought millions of new species and incredible biological diversity, there are thousands of emerging companies operating beneath the surface and invisible to many observers. These companies have been slowed down by the financial crisis, but there’s still a heartbeat and they are intent on finding a way to create innovative products and services associated with the RealVR Cloud that will challenge incumbent technologies and established business practices in much the same way Amazon.com, eBay, AOL and Yahoo did in the 1990s. Not all will succeed, of course. But some will, and they will appear as if they came out of nowhere. Such is the nature of exponential change in technology.

The RealVR Cloud is being enabled by extremely powerful, nano and quantum-enabled technologies. We are entering a period of innovation that will usher in new 3D chip architectures, powerful chips, including Graphic Processing Units (GPUs), Multi-core CPUs, 3D Virtual Worlds software platforms and applications for increased collaboration and productivity, sensors and software to enable touch, voice and vision to make technology more human-like.

The RealVR Cloud storm will reshape industries and businesses around the world. There will be new products, services and applications emerging out of the RealVR Cloud for energy, transportation, medicine and health care, consumer products,  and any other industry or sector you can name. Put simply, the RealVR Cloud is nothing less than the next (r)evolution in information and communications technology. As Kris says, there’s no more important space in tech land. The Real Cloud is likely to represent an overwhelming share of technology market growth in the decade.

Amid the perfect RealVR Cloud storm that is brewing, we see a growing inefficiency in equity markets. More and more investors seem intent on chasing daily or monthly returns. Miss the quarter by a penny and issue conservative guidance, and investors dump the stock and run away. This is creating new opportunities for those investors who see value beyond the quarter.  The perfect RealVR Cloud storm that is rolling in is not a quarterly phenomenon. It will evolve over the course of years and well into the next decade and beyond. To try to capture this tidal wave with investment processes intent on targeting daily or monthly returns is foolhardy. We’re fully in agreement with my fellow Morgan Stanley colleague Andy Kessler, who after sizing up the latest trading scandal on Wall Street summed up nicely what Kris and I believe at Research 2.0. Andy said:

“Information now travels at the speed of light. The edge to human traders is mostly gone, arbitraged out by fast computers. Near-term blips in stocks will always be driven by those with industry contacts, legal or illegal. The only way to truly beat the market long term is to use your head, think out long-term trends, figure out where productivity and therefore wealth is being created in the economy, and invest alongside it. This might include investing in wireless commerce, gigabit broadband, personalized prescription drugs, oil shale extraction, or electric smart grids that can better allocate power to where it is needed.

Some investors will make money trading daily and a few will get news that gives them an indication of where to invest before everyone else. But the edge of focusing on the next mountain to be climbed, while fast money chews up the foothills directly in front of us, is the surest way to make money over the long run.”

Kris and I believe the RealVR Cloud is the next mountain to be climbed. Our technology analysis at Research 2.0 is intensely focused it. It is our mission to help businesses and investors understand the perfect storm in technology that is brewing. Those that don’t are likely to up like George Clooney and his crew in the movie. Suffice it to say, we hope that is not you dear reader.

The Battle Ahead: Deflationary Boom vs. Inflationary Bust

Earlier this week, I wrote a blog post on the impressive performance of productivity in the U.S. business sector (see “More Like a Deflationary Boom”). I noted that business productivity growth was rising sharply again and this was a recipe for disinflation and outright deflation. Companies have been restructuring aggressively to cope with harsh economic conditions, and the restructuring, amid increasing liquidity in the global economy, is beginning to pay dividends in the form of higher productivity and profitability. Accelerating productivity growth is great news for the economy and for financial markets.

While the private non-farm business sector has been busy restructuring and getting back into shape, the same cannot be said for the U.S. public sector.  From the looks of things today, it appears that the public sector is in dire need of restructuring. Let’s have a look at the numbers, shall we?

Over the next year, the U.S. Treasury will have to refinance $2 trillion in short-term debt and, in addition, raise another $1.5 trillion to finance the government deficit. That’s $3.5 trillion or nearly 25% of U.S. nominal GDP. Some analysts have looked at these numbers and argued that bankruptcy is around the corner.  We believe that is too harsh of an assessment. That said, given the daunting figures, one wonders where the money will come from to finance the multi-trillion dollars of U.S. government debt in the year ahead.

Overseas investors have been large buyers of U.S. government debt. Foreign investors own over 40% of U.S. government debt. As it stands today, the U.S. currently has insufficient reserves (gold, oil, and foreign currency) to cover the $880 billion the U.S. government owes foreign creditors so they may be  reluctant to continue buying large amounts of Treasury securities at current interest rates and exchange rates. That remains to be seen.

Meanwhile, back at home total domestic savings are in the range of $600 billion. They are not sufficient to cover the government shortfall. Warren Buffett, Bill Gates, Larry Ellison and all the other billionaires and multi-millionaires in America don’t have the funds to finance the U.S. government. A major tax hike is also a possible solution to help finance the deficit, but such a move right now risks aborting the economic recovery. In all likelihood, a major tax hike right now would be the equivalent of economic suicide and lead to the demise of the current administration.

If foreigners become increasingly reluctant to finance the debt, and domestic private savers don’t have the wherewithal, where is the money going to come from to finance it? Chances are, it will come from the U.S. Treasury and the Federal Reserve. The Treasury will print cash and the Fed will purchase government debt in the open market. In other words, the old fashioned printing press will be used to help keep the federal government in business. When strapped for cash, simply print more money!

Of course, there is a cost to having the U.S. Treasury printing more money and the Federal Reserve purchasing the debt in the open market. The cost is inflation. The excess liquidity from the printing press first finds its way into financial markets, which boosts the prices of financial assets. Interest rates remain low and equity multiples expand. Over time, the excess liquidity finds its way into wages and the prices of goods and services. As it does, inflationary pressures build. As inflation rises, the relative value of the dollar declines in the currency markets and investors flock to gold and other hard assets viewed as a hedge against future inflation.

Not surprisingly, many Federal Reserve officials have been arguing the need to keep the federal funds rate low for the foreseeable future. Lower short- term interest rates will keep U.S. government borrowing costs down, helping to keep the government’s deficit from rising further. Currently, 3-month Treasury bill rates are at 0.06% – just above zero. Also not surprisingly, the value of the dollar has been declining and the price of gold has risen. This is pretty much what one would expect from resorting to a printing press solution to financing trillions of dollars of government debt.

Whereas performance of the private sector in the U.S. appears to be consistent with a deflationary boom scenario, performance of the public sector is screaming inflationary bust. From our perspective, and I imagine the perspective of foreign and other creditors, the U.S. federal government is in serious need of restructuring – both financially and operationally. It has expanded beyond its financial limits. Privatizing GM, AIG and restructuring the mortgage market, which is on the docket, would be a good start. But much more restructuring is needed.

Absent a serious restructuring of the federal government, the burden of debt will become highly inflationary and act to erode the value of financial assets and offset the efficiency gains in the private sector, perhaps akin to what we experienced back in the 1970s or even worse. Needless to say, such an environment will not be conducive to a bull market in equities.

Whatever conclusions one wishes to draw from the U.S. government debt figures, and I certainly don’t have all the answers, it seems plain to see that now is definitely not the time for the current U.S. administration to consider expanding the size and scope of the federal government. America simply cannot afford it and to think otherwise is sheer delusion.

Come to think of it, I can’t remember a time when there has been such as large a divergence between U.S. private and public sector performance. One can think of it as a battle: Deflationary Boom in the private sector versus Inflationary Bust in the public sector. Who wins the battle will tell us a lot about how financial markets will perform in the future. I’m inclined to bet on the guys running the printing press, but I am pulling for the private sector to prevail. Holding gold and Google might be a good investment strategy as the battle rages on (Note: this is not an investment recommendation, although as a disclosure the writer holds positions in GGN and GOOG currently).

The Spirit of Creative Destruction

A friend of mine sent me to a link to a YouTube video titled “Did You Know?”  After viewing it, I thought it captured beautifully the spirit of this blog. I hope you enjoy it as much as I did.

As for what it all means, figuring that out is what keeps Kris and I busy during the days and evenings.