America, From Sears To Google (Or Why Silicon Valley Is Set Up For "The Mother Of All Government Smack-Downs")

Authored by Peter Zeihan via Knowledge Leaders Capital blog,

Today’s story begins with the once-behemoth that is the American retail firm, Sears. In the last week of September Sears’ stock dipped below $1 a share, reducing the company’s market value below $100 million. Sears may still linger on a bit, but when a big firm falls into penny-stock territory, its outright liquidation is a foregone conclusion.

Sears (originally Sears, Roebuck and Company) is the iconic store of the American modernization experience. As a relative latecomer to the world stage, Americans got in on the industrial revolution significantly after most Western European nations. The vast majority of Americans lived on farms until late in the 19th century. Urban Americans had access to manufactured goods, but in rural regions most people made their own clothes and tools – or tapped the expertise of craftsmen in local towns. Most of these in-town purchases were managed via general stores where managers, knowing farmers had no alternatives, gouged on pricing, credit terms and selection.

Enter Sears.

Sears sourced manufactured goods from American cities (and abroad) and built a distribution network deep into every nook and cranny of the American territories. Starting with luxury goods in 1886 and rapidly moving into everyday products, by the turn-of-the-century Sears’ 500+ page mail order catalogues had become ubiquitous not just in cities, but in farmhouses. It was Walmart and Amazon all in one. Sears completely overhauled what Americans considered to be centuries-old economic norms and pushed cheap, high quality manufactured goods into every single home. Sears quickly became America’s largest firm and largest employer. Quite unwittingly, Sears started the United States on the long path to urbanization, the industrial age, and the destruction of the local retail store.

(Incidentally, when the British Empire brought its manufactures to German lands, the economic dislocation helped start a German civil war. So anytime you think Americans can’t handle transformative economic stress, please try to keep it in perspective.)

Sears’ near-death today is part of a similar economic transformation. Just as Sears was a physical manifestation of the Industrial Revolution, Sears’ end is part of the Digital Revolution. Gathering, processing and distributing information has been the bugaboo of corporate systems as long as there have been firms with a reach further than they could see. The steamship and telegraph obviously helped, but managing anything big first and foremost requires an information system.

The Digital Revolution thus far has reduced the cost of storing information to nearly zero. In the early 1980s storing a gigabyte of data cost roughly $500,000 and I think that’s without accounting for inflation (economists and techies don’t always have the best relationships when it comes to data comparisons). Today storing that same volume of data costs roughly three cents. Information transfer costs follow a similar path (part of why all publicly available email clients are available at no-cost).

With information now being in effect free, the biggest restraint on industrial expansion became … humans. Someone still needs to analyze and distribute the data, and then check up on the results. Humans in the data chain have become the general store managers of our time, gatekeepers to the consumers that escalate prices. Enter algorithms, designed from day 1 to remove humans from the data management equation. With the elimination of those pesky human barriers, the Digital Revolution reached out into the real world of sales and distribution and killed the job-destroying monster that preceded it. That’s remade how we design, order, manufacture, transport and warehouse goods. It allows us to instantly transmit architectural plans, military orders, payroll, and cat videos as well as get two-day (or less) deliveries for free.

The problem with algorithms is twofold. First, we have yet to figure out how to program in value judgments and ethics. Second, anything that introduces a hiccup into the information flow – say, fact-checking – increases the cost to something above zero. Just as Sears’ systematically cut out costs, algorithms and the human decision-makers who design and manage them see the human element as a block on progress. Something to be ruthlessly excised.

Photo courtesy of Peter Zeihan

That has set up Silicon Valley for the mother of all government smack-downs.

Let’s divide the American political spectrum into four rough blocks: the center-left, center-right, populist-right, and populist-left – and then look at how their view of Silicon Valley has radically shifted during the past three years.

America’s center-left originally adored Silicon Valley because they were corporate titans with social agendas that matched the center-left’s general political views – particularly when it came to social policies on issues such as education, gay rights, and multiculturalism. The center-left – epitomized by politicians such as Chuck Schumer and Diane Feinstein – saw Silicon Valley as remaking corporate America from within.

But as information transmission became free, this happy marriage collapsed. Silicon Valley resisted anything that might infringe upon information flow, including flows that harmed issues the center-left valued. For example, Russian attempts to spawn race riots or shift the direction of a presidential campaign, or the ISIS live-streaming of executions, or disinformation campaigns blaming train derailments on Hilary Clinton after she lost the election. Consequently, the center-left hasn’t simply dropped its support for the Valley, it now sees the Valley as a threat to democracy itself. The Valley’s chronic misogyny in the age of MeToo doesn’t help the Valley’s case with the center-left either.

America’s center-right – represented in Washington by folks such as Paul Ryan and Mitch McConnell – similarly were wedded to Silicon Valley’s aura. In the Valley the center-right saw a heavenly manifestation of what could be achieved with American know-how and new technology and a spirit of entrepreneurship in a low-regulatory environment.

This happy marriage has also ended. At first it was about politics: Valley CEOs started to get a bit too public with their enthusiasm for left-leaning issues, and charges erupted that some in the Valley were censoring right-leaning political viewpoints on platforms they controlled. But the center-right’s concerns soon deepened to something much more fundamental: much of the Valley committed to never working for the American government – most notably the intelligence community and the Defense Department. But Valley services remained fully available for sale so their work could benefit other government’s programs.

The idea that the political liberalism of Silicon Valley is better served by allying with Xi Jinping’s dissident eradication systems or Vladimir Putin’s systematic repression than the U.S. military requires mental contortions the center-right considers unfathomable. The center-right now doesn’t merely question the Valley’s ideology or even its patriotism, but its sanity. The most pro-business part of the American political spectrum is now firmly anti­-Silicon Valley. Concerns about cybersecurity and the regulations those concerns will likely spawn is only the icing on the cake.

But as much credence as there is to the points of America’s centrist politicians, the concerns of the American populists are actually more valid.

The populist right started out furious with Silicon Valley. Whether the politician is Ted Cruz or Donald Trump, the Main Street verses Wall Street discourse is not only a powerful one, it is broadly accurate. The current manifestation of Silicon Valley is fundamentally designed to remove as much human labor from the economy as possible. It – statistically – is the greatest job-destroying machine in American history.

The populist left is, if anything, even more angry at the Valley. Algorithms and robots don’t pay taxes, but their profitable outputs still accrue. This concentrates the income of what used to benefit human laborers to the operators and designers back in San Jose. Politicians like Bernie Sanders and Elizabeth Warren are fundamentally correct when they assert this is a leading reason for America’s deepening economic inequality.

All four factions are correct.

All four factions are edging toward policies that would revoke the Valley’s unlimited license via some sort of constraining regulation.

Photo courtesy Peter Zeihan

Tesla is probably in the greatest danger. Technically, Tesla is a car firm, but its valuation and finance-raising systems mirror Silicon Valley rather than Detroit. That gives it access to ridonkulous amounts of cash – something necessary to pioneer fundamentally new technologies – but lands it with the metrics of a conventional automotive firm. Therein lies the rub.

When it comes to evolving ethics in a dynamic regulatory environment, most investors go with what they know. They know Tesla is a badly-run company that has yet to figure out how to move metal around its own factory floor. They know Tesla has almost never met a production goal. They know Tesla cannot break into the mass market (the cheapest available Model 3 is at fifty grand, with the subsidy). They know Tesla’s technology and materials science is insufficient to its goals. They know Tesla faces stiff, rising competition from more experienced market players.

They know Tesla is led by a CEO whose social media strategies mirror a broadly-disliked president. They know Tesla’s CEO has bet the firm’s future on a political ideology that provides subsidies that will not last. They know Tesla’s CEO sees no problem cross-subsidizing the firms of family members. And they know Tesla’s CEO has settled with the SEC on charges of stock manipulation which cost the firm that has never made a profit $20 million. There is no shortage of preexisting business norms and regulations that could bring Tesla down. Should the investment community ever believe Washington is coming for Silicon Valley, they will ditch the weak players first. It doesn’t get weaker than Tesla – ergo why the short-selling of Tesla is already so intense.

Facebook comes in second, and not simply for the role they’ve played in Russiagate. The firms’ unfettered and enthusiastic raping and selling of customer data has not simply shown no ethical constraints, but we now know Facebook actively markets its user data to scammers. Not via the web – dark or otherwise – but by sending sales reps to scammers’ convention and closing deals in person. The public trust has been lost. The question in my mind isn’t will Facebook be eclipsed and displaced by a rival, but will there be prison time for some of its executives?

Twitter may have a brighter future. Unlike Facebook, TeamTwitter admitted the role it played in Russiagate fairly early on and has taken steps to roll back the damage. Such public admissions combined with a sense of genuine regret – or at least a reasonable digital facsimile of regret – stand in stark contrast to Facebook whose grudging, plodding steps have the feel of a six-year-old who thinks moving a single pair of underwear to the hamper has cleaned up his room and thus should be allowed to go back outside to play. Are Twitter’s actions and contrition deep and fast enough? That’s a political question, but I give points for effort.

One likely path forward in regulation is the modification of Section 230 of the Communications Decency Act. To make a very long and technical legal explanation short, Section 230 stipulates information technology platforms are not publishers, and so are not responsible for any content they pass along. Without 230 we’d not have an Internet economy since all our infotech platforms would be liable for the accuracy of everything in every web page, blog post, pop-up ad and email.

To date, there have only been three carveouts: copyright infringement, child pornography and sex trafficking. Silicon Valley fought those carveouts tooth and nail, asserting first-amendment rights issues, but mostly being concerned about costs. The hilarity of deliberate inaccuracies currently punctuating American political information systems – Russiagate being the prime example – are pushing many political factions to consider a fourth carveout for foreign election interference. And while with some very skilled coding an algorithm can be taught to look for prostitutes, I’m guessing that determining whether an ad that slams or celebrates Hillary Clinton or Donald Trump is accurate will require the sort of judgement call only a human can make. And humans don’t work for free.

Amazon probably faces less pressure, and probably has more time. Yes, Amazon Prime and related subsidiaries are a very visible part and parcel of the whole job-destroying ethos that motivates Silicon Valley. But three issues pop up:

First, the damage to American retail is largely done. A stiff roll-back at this point would probably be counterproductive. And this is hardly the first American retail revolution: general stores to Sears to Walmart to Amazon. At each step the process is more capital intensive but less labor intensive with slimmer margins. Where do you draw the line? Do you draw a line? (A change to how Amazon is taxed, however, is an excellent idea).

Second, Amazon would operate in the red if not for a single unit that has nothing to do with getting a hairdryer to you: Amazon Web Services. AWS is the data management portion of Amazon which is wrapped up in nearly every data flow for every business in the country. It is well-run, faces competition, and has next to nothing to do with the retail arm. Splitting the two so that the wildly-profitable AWS cannot cross-subsidize the barely profitable (and until recently, unprofitable) Amazon Retail makes a wildly great deal of sense for all players. It would certainly preserve the value-added portion of Amazon that generates lots of new sources of economic activity rather than gutting old sources.

Third, Amazon is everywhere. I don’t say this to imply U.S. government entities cannot bring it down, but instead that Amazon’s retail activities are in every American county, complete with dozens of distribution centers and tax relationships. Should the regulatory floodgates open the result will be a thick, self-ambulatory tangle of regulations at the city, country, state and national level. It will be a rancid mess that Amazon leadership will be able to exploit to buy time and – most importantly – to shape in a way to mitigate end-impacts upon the firm.

Of the big boy digital firms, that leaves Google, whose recent actions put it into a category all its own:

Recent defections from Google’s development teams have exposed the firm’s work on a project they call Dragonfly, a search engine product for the Chinese market. Allegedly, Dragonfly tags certain search terms the Chinese government chooses that it thinks might indicate dissident behavior such as “how do I get a Canadian visa?” or “what happened in Tiananmen Square in 1989?” or “what is Falun Gong?” It then packages the request with other search data on the person in question, complete with IP and physical addresses and phone numbers and forwards the information on to the Chinese state. It’s a degree of privacy violation and government monitoring of civilians that would have disgusted Orwell.

If – and I emphasize the word “if” because I do not have a Dragonfly-style program covering Google HQ – Dragonfly is real, Google is in serious trouble. Collaborating with a dictatorship that is sliding into a cult of personality so complete Hitler would have salivated over the program violates every ethical and political norm of every political faction in the United States. Anything that puts Elizabeth Warren and Ted Cruz on the same side during Senate hearings should get everyone’s attention. And Google’s executives’ refusals to confirm or deny Dragonfly’s existence while under oath before Congress tends to shift my thinking that this is less bureaucratic bungling and more greed so all-consuming it constitutes treasonous behavior. It is exactly the sort of massive corporate miscalculation that has triggered catastrophic government crackdowns on major American firms in the past. The breakups of Standard Oil and Bell come to mind.

And it would happen under President Donald Trump. Make no mistake. Trump is no longer part of the party of the businessperson. Things in America have changed in politics too...