Watch the Bottlenecks!
(March 19, 2009)
Dear Subscribers and Readers,
In engineering, a bottleneck is defined as a component of a process or system that has the lowest capacity or performance within that system. By definition, the performance of the entire process is limited to the performance of the bottleneck. Examples of everyday bottlenecks may include congested freeways, long checkout times at the grocery store, or the amazingly slow customer at the local Starbucks drive-through window. Within your PC or laptop, this component is usually the read/write times of your (traditional) drive. In one of the most significant stories to hit the laptop market this year, Samsung has gone on record predicting that the cost of a solid state hard drive (on a per GB basis) will reach parity with traditional hard drives sometime in the next few years. When we first started covering this development on our discussion forum in December 2006, many (including both enthusiasts and the CEO of Seagate) thought that SSDs would remain a niche area for years to come. Not only have SSDs started to reach the mainstream laptop market (one can buy a laptop prepackaged with a 128 GB SSD with a decent speed at only $100 over the price of a 7,200 RPM 400 GB traditional hard drive), the demand for them should literally explode over the next 12 to 18 months. As traditional hard drives have typically been the bottlenecks in both PCs and laptops alike, the proliferation of SSDs across both the business and retail markets will significantly increase the productivity of the “creative class,” including programmers, graphics/animation designers, and the heavy users who are always traveling (SSDs are more durable as they consist of no moving parts). I don't know about you – but I long for those days when Windows could boot up in half the time or when I no longer have to wait ten seconds to open a large excel file. As someone who gets frustrated with long waiting times (yes, I am impatient), a 60-second wait for my laptop to reboot could easily turn off my creative juices and turn into a half-hour exercise in procrastination.
In a broader sense (and on a more serious note), the concept of a bottleneck/constraint on the part of the entire system is also applicable to the US and global economy. For example, whether the US economy can sustain its impressive economic growth over the last 200 years or so would depend on factors such as the quality of our educational system, the quality and affordability of modern-day healthcare, the state of our physical infrastructure, and of course, the ability of our financial system to fund new innovations, ventures, and businesses. Over the last few years, we have discussed the many bottlenecks that are now clearly evident, including our access to cheap energy, the sad state of our government-funded secondary educational system, the failure of both our political system and ourselves to put science at its rightful place as the highest of our priorities, as well as the deteriorating state of our physical infrastructure. As the eminent historian, Arnold Toynbee wrote decades ago, whether the US economy can move on to the next boom or the next stage of her progress would depend on our ability to meet our major challenges, including resolving the current bottlenecks in our economy. Almost always, it is the “creative minorities” that tend to derive solutions to these challenges – while others in positions of power then follow. The current crisis has also brought with it significant opportunities – as it has clearly showed the American public that our previous lives were not sustainable. The financial crisis (and the energy crisis last year) has also got many Americans thinking of our vulnerabilities and the inevitable problems that we will face in the next 20 years. This has in turn resulted in a new political/general will to invest more in the future – whether it is in alternative energy, healthcare (e.g. stem cells research), or nanotechnology. In a recent TED talk, Juan Enriquez, the former founding director of the Life Sciences Project at Harvard Business School, discusses the current state of the human evolution experience. Topics include recent breakthroughs in bacterial engineering, tissue engineering, and robotics (including fusing robotic technologies in order to make our lives better, such as allowing the deaf to hear and the blind to start to see). Many of these developments are not only happening in laboratories, but are actually being implemented in real-life situations. This presentation is a must-see.
The canals were the early enablers of the US capitalist system in the early 19th century. The expansion of the railroads in the 1850s and 1860s allowed for a more substantial expansion of the American population and the further accumulation of wealth. The success of the first transatlantic telegraph table in 1866 linked the US and the UK on a close-to-real-time basis for the first time in history, allowing for a much more rapid dissemination of information across the world (in a matter of minutes, as opposed to more than ten days by ship just ten years earlier). The rise of the electrical industry (first in New York) in the 1890s increased productivity and acted as a basis for further innovations to come. The steel industry revolutionized the bridge-building industry and led to the construction of our first skyscrapers. Then came the automobile industry in the 1920s (along with the adoption of the assembly line in many of our manufacturing processes), the radio, the aircraft, the interstate highway system in the 1950s, the computer in the 1950s to 1970s, the PC in the 1980s, and last but not least, the proliferation of the internet in the 1990s. All of these technologies acted as bases for further economic growth – whether they were productivity enablers, or served to disseminate information or knowledge more quickly. The trend of our ability to seed more life-changing and productivity-enabling technologies has not changed. For example, I fully expect cellulosic ethanol to be commercialized sometime in the 2010 to 2012 timeframe (assuming crude oil averages $60 a barrel or above). I also expect better battery systems to be developed and deployed into plug-in hybrids that will allow them to run solely on electricity and to recharge very quickly. As Juan Enriquez's presentation implies, I highly expect the biotechnology industry to come up with major solutions to solve the ills that would result from a much large older population, such as Alzheimer's and physical degeneration. Today, approximately five million Americans suffer from Alzheimer's, at an annual cost of about $80 billion to Medicare and Medicaid. The loss in productivity (both direct and indirect) is estimated to be approximately $75 billion. Left untreated, more than 7.5 million Americans will be suffering from Alzheimer's by 2030. This is not only a detrimental blow to the US economy in terms of direct treatment and care giving costs. Since so much of our knowledge (and investment) capital lies with our older workers, it would be a shame to see this “go to waste” (literally) and to do nothing about it. While long-term forecasts are, almost by definition, wrong, I also expect some kind of effective cure for Alzheimer's sometime in the next 10 to 15 years, given the current rate of research progress and given the amount of significant impact the disease has on society.
In the meantime – the greatest detriment to the long-term growth of the US economy right now is the fragile state of our financial system. Yesterday's announcement by the Federal Reserve to purchase $300 billion of Treasuries, an additional $750 billion in agency MBSs and $100 billion in agency debt would go a long way to restoring the health of the US financial system, especially since the announcement was not expected. Goldman Sachs had previously estimated that a $1 to $1.6 trillion of Fed balance sheet expansion is equivalent to a 100 basis point cut in the Fed Funds rate under “normal credit conditions.” To that end, the Fed's announcement yesterday to expand its balance sheet by $1.15 trillion comes close to a 100 bps conventional easing. This was no doubt required, as US households have collectively “lost” $13 trillion of assets over the last 18 months. Since there were no major earthquakes, fires, war, or other disasters, and since the long-term earning power of the workforce and US corporations has not changed, I highly doubt this will have any significant impact of our long-term inflation outlook. As a matter of fact, the recent financial crisis and recession has only spurred our scientists and entrepreneurs to work harder than ever. Physicists and engineers are either getting PhDs or working as post-Docs - as they have seen their Wall Street dreams shattered. Such creative innovations should bring down the long-term outlook on CPI expectations. Make no mistake: The Fed is merely providing liquidity to the financial markets and the US economy at this point, as this $1.15 trillion balance sheet expansion is a mere drop in the bucket. More importantly - since this is not part of a political process (strictly speaking) - all these facilities could be quickly unwound after the economy stabilizes, simply by selling the agency MBS's and Treasuries back into the open market. The Fed was also very careful about purchasing long-term Treasuries. If it did not work to bring down interest rates, there was no doubt that the move would have backfired and caused a further erosion of confidence. Most likely, the Fed looked at the Bank of England's experience and determined it was a risk worth taking. Now that the Federal Reserve acted with force, I highly expect the US Treasury to follow with their Public-Private Investment Fund (PPIF) sometime in the next couple of weeks.
In the short-run, investors will be focusing on General Electric's update on their financial business (GE Capital) later this morning. This update should dictate the tone and action of the financial markets in the next few days. Even though both Treasury yields and mortgage rates have come down significantly yesterday, corporate yield, CDS, and CMBS spreads are still at or close to record high territory. My guess is that many institutional investors are still sitting on the sidelines either waiting for the implementation of the TALF or for some stabilization in the housing market. With the Federal Reserve providing an effective guarantee to TALF investors, it may actually make more sense to participate in the TALF as opposed to buying corporate bonds, even though the latter are trading at a very attractive value. For now, the best thing the US Treasury and the Federal Reserve could do is to make sure the TALF is implemented quickly and effectively, since the results of this will greatly shape the market action over the next couple of months.
Henry To, CFA