Post-Newtonian economics

In spite of the fact that recent US economic data has shown new home sales increasing strongly (latest report showed a 9.6% increase in January new single-family homes), strong numbers on business investment in equipment (growing at a 10.5% annualized rate according to today's US GDP revision data), and strong corporate profits (recently making a new all-time high), investors and the general public at large continue to demonstrate angst over the economic outlook and to express concern that somehow any recovery since the 2008-2009 crisis has been entirely engineered by the Fed and could collapse again at any moment.

As an example, after Fed Chair Janet Yellen addressed a Senate panel yesterday (article here) and said that it is difficult to determine whether recent "softness" in economic data was related to exceptionally cold weather over the past few months or whether it could indicate that growth was slipping for another reason, many observers took it as evidence that the Fed might soon consider putting a temporary hold on the "tapering" of quantitative easing -- and financial markets rallied at the prospect!

We have said many times in the past that we do not believe that good investing is based upon an ability to predict the next move in the economy, and we have also said that we have never held ourselves out as being able to predict the next move in the economy, either (see for example here).  We also do not have much confidence in anyone else's ability to do so. 

However, we can say for certain that we do not believe that the economic recovery that has taken place since the 2008-2009 recession -- as weak as that recovery has been, for a variety of reasons -- has been due to the easy-money policies of the Fed or its quantitative easing.  Neither do we think the economy will suddenly collapse again if the Fed keeps on tapering, or even if the Fed raises interest rates.  In fact, we would argue that the Fed's extreme policies have actually been part of the reason that the recovery has been less robust than it should have been.

This is because we believe that economies are actually driven by something very different than what most people mistakenly believe drives economic growth.  We do not believe that economies tend to fall apart without government care or central bank micro-management.  We do not believe that various forms of "stimulus" are necessary to prod and poke people into spending money or starting businesses or trying to improve their own situation -- or even trying to improve the situation for other people around them.  In fact, we believe that these things tend to happen by themselves, as men and women use their talents and creativity to come up with new ideas and to experiment with solutions to problems.  It is government tinkering that tends to be the problem, not the solution, although a big economy composed of enough men and women trying to solve problems can resist an awful lot of government tinkering without breaking down (as evidenced by the economic growth over the past five years).

In light of this view, we would like to introduce into the discussion some extremely important statements made by George Gilder in a recent talk (video here), in which he expounded upon the revolutionary economic views he published in his new book, Knowledge and Power. In that talk, he explains that the economics of Adam Smith -- as positive as Adam Smith's contribution has been to economic thought -- were really a reflection of Newtonian physics, and the view of the human being as a kind of atom in a world of other atoms, responding to the incentives and pressures and scarcities and resources that he or she encountered (see the portion of the video between 3:00 and 4:00).

This view, Gilder explains, in many ways reduces men and women (in the eyes of economic theorists) to the equivalent of a chicken in a "Skinner box," reacting to this or that stimulus.  Such a view invites governments to try to create the perfect set of conditions, adding or withdrawing stimulus here or there, trying to prod the poor homo economicus this way or that, in order to steer the economy into growth.  George admits that even supply-side economics (of which he has been a champion in the past) falls into this fallacious view of mankind (see the portion of the video between 4:00 and 5:00).

Instead, George offers a radical new view of economic theory -- one that may perhaps be called "post-Newtonian economics"!  He argues that an economic system is "a knowledge system, not an incentive system."  In a knowledge system, knowledge is gained by performing a series of falsifiable experiments, in order to gain information and ultimately form conclusions.  This, George argues, is what entrepreneurs do at all levels (from the largest businesses to the smallest): they try different solutions to see what works.  It is the entrepreneur or innovator who comes up with a new solution, who introduces the key element of surprise into the world, who actually creates economic growth. 

This is a very different model than the "incentives-driven" view of economic growth.  We have touched on this important insight of George's previously here as well.  If he is correct, and we believe that he is, then that means that investors should spend a lot less time worrying about the level of Fed stimulus, and a lot more time analyzing which companies are creating "successful experiments," so to speak.  Which companies are offering some new solution, a solution which may have been a surprise when they first brought it out, and which solutions are gaining traction as people or businesses like that solution and find value in that solution. 

Businesses which we believe are doing that can be found all over the economy, even in the economic conditions we are facing today.  They may be creating new solutions in surgery, by using robots; they may be creating new solutions in transportation, by matching up carriers with shippers in more efficient ways; they may be creating new solutions in data networking, by using software to do tasks that previously required dedicated hardware; they may be creating new solutions in ways that we haven't even noticed yet, but which you have noticed in your own business activities or daily life!

We believe George Gilder's new, post-Newtonian way of looking at economic and entrepreneurial activity is truly world-changing.  And we believe that adopting that mindset can be very beneficial for investors and economy-watchers alike.

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The Truth About the Minimum Wage

One would have thought by now that in a country as advanced as the United States, a debate about the merits of minimum wage laws would be unnecessary.  Anyone who has a rudimentary knowledge of economics knows that if you increase the cost (price) of something, you tend to get less of it.  Therefore, if the goal is to lessen the availability of lower paying, low skilled jobs then mandating that the provider of such jobs increase the wage (cost) that it must pay to employees in those positions could be considered a sure-fire way of lessening their availability.  

It is a shame that the recent politicizing of this issue has caused it to become considered a viable option for improving economic growth.  However, given that there are those who apparently believe that increasing unemployment benefits are also acceptable methods of fostering economic growth, perhaps we should not be surprised that views on the minimum wage are surfacing in the manner that they are!

Fortunately, there are still voices of reason and truth out there who are able to put the nonsense in its proper place.  Economist Scott Grannis in his Calafia Beach Pundit blog, offers some excellent data on the reality of the minimum wage in this country.  The "money" statement from Scott regarding the minimum wage is "....Raising the minimum wage would therefore benefit only 1-2% of the population, but it would probably make life miserable for young and inexperienced workers, who could find that the jobs available to them have vanished because the minimum wage has been set at a level which exceeds their productivity."  We completely agree.  Kudos to Mr. Grannis!

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Have you heard of this company? QUIK

Over the years, this blog has highlighted companies as examples of the type of growth investment we look for when allocating investment capital and which embody the business characteristics we write about on this forum.  We have previously explained in some detail that we look for companies which we believe exhibit two fundamental characteristics: "capable, dynamic management operating in fertile fields for future growth" (see for example this and this previous post). 

Previous companies we have discussed which we believe exemplify these two broad characteristics have included TSCO, RMD, and EZCH.*

Another company we believe to have "capable, dynamic management operating in fertile fields for future growth" is programmable semiconductor designer QuickLogic (QUIK).* 

QuickLogic is currently a small company, with a market capitalization of only a little over $200 million.  The company designs semiconductors which can be used in consumer electronic devices to perform a variety of tasks in conjunction with the main processor (or apps processor) to enhance the device's overall performance while at the same time reducing power consumption and extending battery life.  These two characteristics (enhanced performance and reduced power consumption) are extremely important to designers of mobile devices, for obvious reasons. 

Having another processor, such as those sold by QuickLogic, handle certain tasks rather than making the apps processor handle them typically saves power, because running the apps processor consumes a lot of power. 

Also, apps processors by their nature are typically "general purpose" -- they are designed to be able to run all manner of applications, from helping you find your way with turn-by-turn navigation to allowing you to play Angry Birds, and everything in between.  Therefore, the apps processor does not really enable makers of consumer devices to easily differentiate their product in the highly competitive markets in which they compete.  Many of their competitors will be using the same (or similar) apps processors, and the consumer will only notice a difference when one processor is noticeably faster or more powerful than a competitor. 

QuickLogic's products, however, are designed to provide very distinctive features that enable device manufacturers to differentiate their devices.  For example, one product category offered by QuickLogic enables better visibility of a display screen in conditions of bright sunlight, while at the same time providing savings on power consumption (because QuickLogic's solution runs algorithms to optimize aspects of the image and contrast, but does it outside of the apps processor using Quick's inherently low-power logic).  This capability is an example of the kind of differentiation which makers of consumer electronic devices desperately need in the highly competitive race to produce the next popular smartphone or tablet.

Another important category of products, newly announced by Quick and discussed in the video above, is a processor designed to monitor sensors. The number of sensors on mobile devices is growing rapidly; sensors can be anything that is designed to measure and monitor the environment or the device's position in three-dimensional space, and include cameras, microphones, thermometers, accelerometers, gyroscopes, compasses, and other tools. 

Devices in general and mobile devices in particular are becoming more and more aware of their environment, and will soon be able to tell whether they are riding in a car, or being pushed in a baby stroller, or accompanying their owner in a pocket.  They will be able to tell if their owner is looking at their screen at the moment, or not, or if he or she has gone to sleep.  Some devices are already capable of some level of awareness, and some applications developers have already created apps to be able to take advantage of this awareness.  Examples include games that can be controlled by tilting or shaking your smartphone or applications that count how many steps you take during the day and which give feedback on calories burned.  Indications are that the number of sensors on mobile devices (and virtually every connected device in the "internet of things") is about to grow exponentially, as will the number of applications written to take advantage of all the new awareness these sensors will provide.

One of the challenges that all these new sensors will pose, of course, will be the potential for a massive increase in power consumption.  If your phone's apps processor is required to constantly monitor the level of ambient light, the surrounding temperature, and whether the phone is at rest or in motion, that will create a major drain on the battery.  QuickLogic's solution is to offer a separate processor (sometimes called a "co-processor") which is far more energy-efficient than the "speedy" but power-hungry apps processor, and to use this processor to monitor all the sensors in the device.  This co-processor in charge of all the sensors is sometimes referred to as a "sensor hub."  The sensor hub can wake the apps processor up if it is needed, based on input received from a sensor, but otherwise it can let the apps processor rest in a low-power state while the sensor hub monitors the surrounding environment.

This type of capability can enable tremendous differentiation for makers of mobile devices.  For example, perhaps some consumers would like to have a phone that can tell if their user has put the phone inside of a purse, so that the phone can know to ring louder when it receives a call or a text while it is in the purse.  Or, as described in the video above, perhaps a phone with an app that is supposed to count steps taken during the day could tell if it is being pushed along in a jogging stroller, so that it could continue to give credit for those steps too, instead of thinking that it is sitting still and therefore not giving its user an accurate count. 

The possibilities for sensors and the apps that developers can come up with are endless, but if the device's big, power-hungry, speed-optimized apps processor had to monitor all the sensors all the time, most of those possibilities would never see the light of day, because they would be too taxing on the battery.  QuickLogic's solutions are extremely power-efficient, and (as described in the video above) are the first sensor hubs which use less than 2% of the battery power.  In fact, Quick estimates that their processors use about one-thirtieth of the power of other processors that have been put forward as possible sensor hubs by competitors so far.

Another important aspect of QuickLogic's products is the fact that they are programmable.  This aspect is also extremely important to device designers attempting to differentiate their products in a competitive and rapidly-changing marketplace.  Programmability enables equipment designers to customize a chip, and to do it much more rapidly than the non-programmable alternative which can be time-consuming and expensive.

In fact, QuickLogic has a long history competing in the programmable-logic market, which is dominated primarily by two much larger companies, Altera (ALTR) and Xilinx (XLNX).**  QuickLogic's approach was far more power-efficient than that of either Altera or Xilinx, but in the era before the recent mobile-device revolution, that approach was not a significant differentiator in most large markets, and Quick eked out its living servicing a few very niche markets. 

However, as CEO Andy Pease explains in the first part of the video above, when he was hired to lead the company, he assessed the company's key strengths and focused their efforts on addressing the areas where Quick's unique capabilities could provide the most value to their customers.  It just so happens that the ongoing mobile-device revolution, and (we believe) the upcoming sensor-driven revolution, play right to Quick's strengths, a fact which tends to validate Andy Pease's vision for Quick's future and the decisions he has made since joining the company in 2006.

This point brings us back to the first important characteristic in the classic growth formula: not only must the company be positioned in front of fertile fields for future growth, but it must also be characterized by capable, dynamic management.  Our interactions with the company so far, and the company's history since Andy Pease took the helm, indicate that QuickLogic is extremely well-led.  His recent decisions to develop re-programmable technology in addition to Quick's traditional one-time programmable technology, very important for navigating the rapidly-changing environment as the sensor revolution unfolds, and to establish an "office of the CTO" in order to make his Chief Technology Officer more of a strategic executive steering the company's future technology course, are both briefly discussed in the above video and both support the conclusion that Andy Pease is an insightful leader capable of making tough decisions necessary to position the company for the future.

We believe that investors can learn a lot by studying QuickLogic as an example of a classic "Taylor Frigon growth company" that typifies capable dynamic management positioning their business to address fertile fields for future growth.

* At the time of publication, the principals of Taylor Frigon Capital Management owned securities issued by Tractor Supply Company (TSCO), ResMed Inc. (RMD), EZchip Semiconductor (EZCH), and QuickLogic (QUIK).

** At the time of publication, the principals of Taylor Frigon Capital Management did not own securities issued by Altera (ALTR) or Xilinx (XLNX).

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Hundredth Anniversary of the Federal Reserve: We "get by" IN SPITE



On December 23, 1913, one hundred years ago yesterday, Woodrow Wilson signed into law the Federal Reserve Act, which had been passed in the House on September 18th the same year by a vote of 287 - 85 and which had been passed in the Senate on December 18th by a vote of 54 - 34. 

The creation of a central bank in the US meant that the supply of money could now be controlled by a central planning body, in contrast to the previous basically laissez-faire systems (the US had experimented with several different systems with varying levels of government interference during its history prior to 1913), in which money and credit were not directly under the control of the government and banks could issue their own notes, and during some periods could issue their own scrip in exchange for deposits. 

The contrast between central banking and free banking is admirably contrasted in Breaking the Banks, by Richard M. Salsman, published in 1990 and available from the American Institute for Economic Research.  He characterizes central banking as follows:

[. . .] we describe central banking as any and all forms of government intervention in the banking system, specifically a legal tender monopoly on the issue of bank notes, a lender of last resort, mandatory deposit insurance, and the regulation and/or ownership of banks.  16.

The ramifications of the creation of the Federal Reserve have been profound.  One of the most important negative aspects of the central banking system has been steady erosion of the purchasing power of money, which over time has had a catastrophic effect on the people's ability to trust their money as a store of value.  The long-term impact of this erosion of purchasing power has been far greater than most people recognize, as we discuss in several previous posts, most notably in "Stand still, little lambs, to be shorn!" which itself is the title of a study published periodically by the AIER.

Perhaps not coincidentally, 2013 is also the one hundredth anniversary of the establishment of a federal income tax in the United States, via the ratification of the 16th Amendment to the Constitution in February of that year.  After the Constitution was changed to allow an income tax, Congress got to work writing income tax law, which was enacted in October of that year.

 

Both the income tax and the erosion of the purchasing power of the money in the US have together caused tremendous harm to the individual's ability to keep his or her own property and to increase it through productive labor.  It is very important for investors to understand the history and impact of both the income tax and inflation / loss of purchasing power on their money and ultimately their wealth.

 

Further, the creation of the income tax and the establishment of the central bank led directly to the ability of the federal government to grow tremendously in size and scope since 1913.  While a thorough critique of the performance of the Federal Reserve since its founding is beyond the scope of this writing, there can be no doubt that the ramifications of the existence of such an entity has been significant in its impact on the US and global economy.  While it can can be argued by reasonable people (certainly Milton Friedman was one) that the benefits of central banking outweigh the negatives, it is our view that the concentration of such power into the hands of a few must be handled very carefully and well articulated "rules of the road" must be followed in order to limit such power.

 

Regardless, here at Taylor Frigon Capital Management, we have always believed that individual men and women, as well as the country at large, have gotten by in spite of what we believe to be  often questionable actions by the bankers at the Fed.  See for example the previous post entitled, "We get by in spite," published December 23, 2009. 

And on that positive and hopeful note, we wish all our readers a very Happy Christmas and a Prosperous 2014!

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Back from the New Telecosm Summit, 2013

We recently attended the New Telecosm Summit, which was the latest in a series of Telecosm Conferences inspired by the vision set forth by author and thinker George Gilder.  This year's event took place on December 3rd and 4th in New York City.

The concept of the "telecosm" refers broadly to the world unleashed by abundant information-processing capability coupled with abundant networking capability: the technologies which make information processing and sharing so inexpensive and plentiful that massive amounts of high-definition video data can be shared almost anywhere, even while mobile (not requiring people to use devices that are tethered to the network by a physical cord).  

The possible applications for such super-abundance are literally unlimited, since the human imagination is essentially unlimited, and we have all seen the impact of the creative applications that people have found for these new capabilities over the past ten or fifteen years, and the ways they have transformed numerous aspects of human life.  These transformations, and the technology that makes them possible, constitute the concept of "the telecosm."

This year's Telecosm conference featured talks on the progress of this paradigm, and some of its far-reaching ramifications as we can envision them today, as well as presentations by some of the individuals and companies who are working on ways to apply the capabilities of the telecosm to different areas of human life (including medicine), or on ways to expand those capabilities to new heights.

Of course, event chairman and Telecosm pioneer George Gilder gave the opening keynote, and during his remarks he laid out the powerful vision that he believes underlies the entire paradigm.  He notes that the incredible advances in information processing and information sharing on global networks during the past several decades was made possible by the "information theory" articulated primarily by Claude Shannon, who declared (in George's words during the talk) that "information itself is surprise, and creativity is surprise."  

This concept underlies the inevitable gravitation of information towards the electromagnetic spectrum, because the waves of energy in the electromagnetic spectrum behave in a very unsurprising and predictable way, making them an ideal carrier for information (unexpected blips in the predictable spectrum can then be used to carry coded information, in just the same way that puffs of smoke signals against a clear sky can be used to carry coded information).

George then explained how this concept has ramifications that go to the heart of the profound question of how economies grow and how innovation and creativity can flourish (these are both the same question, of course).  Most of those who have tried to examine this question of how to enable innovation, creativity and growth have focused on incentives of some sort, whether those incentives came in the form of government "stimulus" (a typically "Keynesian" or "demand-side" approach) or in the form of reducing penalties or obstacles to growth such as taxes or regulations (the typically "supply-side" approach), but George explained that the application of Claude Shannon's information theory to this question came as an epiphany to him, and enabled him to see that innovation and creativity are actually forms of surprise, and therefore forms of information!  

This insight enabled him to see that a healthy economy that enables the always-surprising creativity and innovation of individuals is really a knowledge system (because it is based on information), rather than an incentive system, in which those in power try to provide incentives to behavior as if they were guiding a chicken in a Skinner Box.   George explains that trying to manipulate humans using the Skinner Box method has failed miserably, but that by realizing that knowledge accumulates in very specific ways, and by seeing the economy as a knowledge system or a learning system, we find an entirely new perspective that has not been appreciated before.  

"A learning system operates differently from an incentive system," he said in his talk.  Specifically, learning and knowledge are accumulated through a series of "falsifiable experiments" -- and in the world of business innovation this means a series of "entrepreneurs creating falsifiable experiments" that may succeed or they may not.

George develops this important new approach to understanding creativity, innovation, and economic growth in his most recent book, Knowledge and Power.

Unfortunately, the temptation of those in power is and has always been to interfere with the critical series of "falsifiable experiments," by picking winners and losers.  One of the sub-themes of the conference this year was the degree to which the unpredictability and interference introduced by government officials and their cronies in various areas of business has created major disruptions to the promise of innovation and creativity over the past two decades.  

Thus, this year's Telecosm presented a tempered message that was balanced between the promise of innovation and creativity -- which in many ways have reached tremendous heights -- and the caution and uncertainty which still threaten both the telecosm and the wider economy.  We believe these concepts are very important for investors (and all participants in the economy and wider society) to understand and consider carefully.

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