What Would Warren Buffet Do? Big Tech vs Productivity

When Warren Buffet speaks, people listen. In 2017, 42,000 showed up for the annual Berkshire Hathaway meeting and another 17 million streamed the event online. While it is his views on cryptocurrency (he hates it) that grabbed the headline this year, I believe his bit on productivity (from 2015) below is far more relevant, especially in the current environment, which has many calling for breaking up big tech and universal basic income.

“Too few Americans fully grasp the linkage between productivity and prosperity. To see that connection, let’s look first at the country’s most dramatic example – farming – and later examine three Berkshire-specific areas. In 1900, America’s civilian work force numbered 28 million. Of these, 11 million, a staggering 40% of the total, worked in farming. The leading crop then, as now, was corn. About 90 million acres were devoted to its production and the yield per acre was 30 bushels, for a total output of 2.7 billion bushels annually. Then came the tractor and one innovation after another that revolutionized such keys to farm productivity as planting, harvesting, irrigation, fertilization and seed quality.

Today, we devote about 85 million acres to corn. Productivity, however, has improved yields to more than 150 bushels per acre, for an annual output of 13-14 billion bushels. Farmers have made similar gains with other products. Increased yields, though, are only half the story: The huge increases in physical output have been accompanied by a dramatic reduction in the number of farm laborers (“human input”).

Today about three million people work on farms, a tiny 2% of our 158-million-person work force. Thus, improved farming methods have allowed tens of millions of present-day workers to utilize their time and talents in other endeavors, a reallocation of human resources that enables Americans of today to enjoy huge quantities of non-farm goods and services they would otherwise lack. It’s easy to look back over the 115-year span and realize how extraordinarily beneficial agricultural innovations have been – not just for farmers but, more broadly, for our entire society. We would not have anything close to the America we now know had we stifled those improvements in productivity. (It was fortunate that horses couldn’t vote.)

On a day-to-day basis, however, talk of the “greater good” must have rung hollow to farm hands who lost their jobs to machines that performed routine tasks far more efficiently than humans ever could….The answer in such disruptions is not the restraining or outlawing of actions that increase productivity. Americans would not be living nearly as well as we do if we had mandated that 11 million people should forever be employed in farming.”

In other words, society should welcome progress, but also help those left behind. Buffet’s maxim is simple enough, but do monopolies and the speed of disruption complicate things? Is there a case for breaking up big tech because it actually hurts progress and productivity?

Investors have always recognized and valued productivity. As a result, the market rewards technology stocks with high valuations even if they make no money. Today, investors have become even more enamored with them. Given the monopolistic positions companies have built using their network effects and ecosystems, Apple, Microsoft, Amazon, Facebook, and Alphabet (Google) now have a market cap of $3.78 trillion dollars (March 12). These five make up of 15% of the S&P’s market value, more than the entire financial, health-care, or industrial sectors. Taking a step back, one finds that the tech sector’s 25% share of the S&P is the highest since the dot-com bubble, when it peaked at 35%.

A big question now is if these companies are monopolies, what are their implications for productivity? Do they help productivity in the short-run, but harm it in the long-run? Would they resist the temptation to buy out competitors and hike prices on consumers in the future? On the other hand, is it possible that they keep their disruptive spirit and drive productivity gains? Just as Amazon is entering into healthcare, is it possible that it will upend the DMV and save the day too?

Another big question is whether the technological disruptions today are any different for their effects on the labor market. While the farmers who were put out of work by machines may have found other jobs, is it possible that future disruption will be so widespread that the farmer equivalent today will not be able to find any job? This is presidential hopeful Andrew Yang’s view. He says that “we’re going to have a million truck drivers out of work who are 94 percent male, with an average level of education of high school or one year of college.” In other words, self-driving trucks “will be enough to create riots in the street. And we’re about to do the same thing to retail workers, call center workers, fast-food workers, insurance companies, accounting firms.” To play devil’s advocate, one can then ask whether technology actually improves productivity if it puts a large part of the labor force out of a job. If people are constantly asked to re-train their skills because technology keeps on making them obsolete, then maybe society’s productivity has not improved much after all.

In response to these questions, I am sure Warren Buffet will hold his ground, but I do not know the answer to these questions. Maybe it is inevitable that information technology’s network effect produces large companies and only they can be productive given the high fixed costs. Maybe savvy consumers, activist shareholders, and conscientious employees can prevent big tech from doing evil. Maybe robots will takeover, but people will find something else to do like people have always done.

One thing I do know is that when big tech takes over the market, may be the only active management left will be for tech analysts (sarcastically). 

Source - WSJ graphics 

Don’t Buy What You Don’t Understand: ETF for Millennials and Finance Nerds.

What is an ETF?

With the rise of robo advisers such as Betterment and the word of mouth praises for how cheap and good it, more and more have dabbled in ETFs, but many may not know much more than what the acronym stands for and how it is a stock that buys a basket of stocks. Here is my ETF primer for my fellow millennials and finance nerds.

According to Bloomberg analyst Eric Balcunas’s ETF origin story, one of ETF’s inventors Nate Most said the idea of ETFs came from commodity warehouse receipts. Given it is costly and difficult to move commodities around the globe, commodity traders keep them stored at the warehouse and trade the warehouse receipts around. ETF does the same thing, except the commodities are stocks and they are stored at a custodian bank rather than in a warehouse.

ETFs are essentially the same, except slightly more complicated. To begin, the ETF issuer finds a fund custodian to store the basket of stocks. The ETF shares are created off of the basket of stocks stored at the fund custodian. Then, the ETF issuer finds a broker dealer bank to serve as the authorized participant (AP) to help manage the size of the ETFs and the basket of stocks stored at the custodian bank. For instance, if people want to buy more shares of ETF than created, the AP may buy stocks and exchange them for newly created ETF shares and sell these ETFs to the investors. Thus, the AP helped increase the size of the ETFs and the basket of stocks stored at the custodian bank. Similarly, if people want to sell their ETFs, the AP may buy ETFs and exchange them for stocks from basket of stocks stored at the custodian bank. Thus, the AP helped decrease the size of the ETFs and the basket of stocks stored at the custodian bank.

If this again sounds like gibberish, here is an analogy that might help. The basket of stocks is gold, the ETF is gold standard British Pound, the ETF issuer is the Bank of England, the custodian bank is Bank of England’s vault, and the AP is the Bank of England’s bankers. During the gold standard era, one could theoretically go to the Bank of England to exchange one’s British Pound into gold from its vault. As a result, gold and British pound are interchangeable (this requires the ridiculous assumption that there is no fractional reserve banking and there is enough gold to cover all the British pound). Similarly, the ETF and the basket of stocks are the same because one could theoretically exchange one’s ETF into the basket of stocks from the custodian bank. Also, when Bank of England has more gold, it can issue more British pound, which is no different from the ETF issuer creating more ETFs when it has a bigger basket of stocks. This is how ETF works.

What are its risks? (More for finance nerds)

First, what if the gold in the vault is impure or fake? In that case, the people who bought British Pound for the gold would have lost all faith in their British Pound. They will rush to the bank to exchange whatever pure or real gold in the vault and sell the rest of their British Pound. This could happen to ETFs. Since many ETFs hold financial derivatives that mimic the value of the basket of stocks rather than the actual stocks, it is possible that when investors rush for the exit one day, the financial derivatives will fail to mimic the value during extreme periods, leading to panic. Second, what if Bank of England changed British Pound’s conversion to include silver because it ran out of gold? In this case, people may also lose faith in their British Pound and rush to the exit. This could also happen to ETFs. There have been instances where too many people wanted to buy ETFs and not enough stocks to back them up. In this case, the ETF issuer decided to add other stocks into their basket of stocks so that they could keep on creating and selling ETFs. Third, what if many new countries are formed and they all start creating their own precious metal backed currencies? How will it affect the normal mining and trading of precious metals? The liquidity of ETFs and stocks are now called into question as ETF continue its explosive growth both in terms of size and number.

What are the implications of its risks? (definitely for finance nerds)

If the financial derivatives that back up many ETFs fail or lose value unexpectedly, many will take big losses. This may be just another market sell-off like the dot com bubble or it could lead to a bigger financial crisis where large systemically important financial institution are challenged. One reason to feel downplay this risk is that the global ETF market is only about $3 tn compared to the $240 tn total wealth worldwide and it is unfeasible that all ETFs will suffer big value losses due to the unforeseen risks mentioned above. However, one must also refrain from being complacent. The supposed infallibility of Mortgage Backed Securities led to the massive credit default swap bets on the side. While the MBS market at the time was only $8 tn, the notional value of the CDS was around $60 tn! It is often difficult to see the risks lurking in the shadows until it is too late. Lastly, even if it is unlikely ETF will be a trigger of a financial crisis, it is possible that ETFs’ explosive growth in terms of number and size have introduced changes to the market ecology that increase the system’s vulnerability.