What We’re Reading (Week Ending 31 July 2022)

What We’re Reading (Week Ending 31 July 2022) - 31 Jul 2022

Reading helps us learn about the world and it is a really important aspect of investing. The legendary Charlie Munger even goes so far as to say that “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” We (the co-founders of Compounder Fund) read widely across a range of topics, including investing, business, technology, and the world in general. We want to regularly share the best articles we’ve come across recently. Here they are (for the week ending 31 July 2022):

1. Matthew Ball – A Manual to The Metaverse – Patrick O’Shaughnessy and Matthew Ball

[00:09:15] Patrick: Can you just define what you mean by the metaverse and what you think a good working definition is that allows us to test things to say, is this thing that everyone’s excited about, or is it not? It seems obvious from our many conversations that the trend has been towards more digital engagement and participation. And that somehow, people think of the metaverse as the natural endpoint of this, where there’s more sensory immersion in some virtual world, there’s more navigability, there’s less walled gardens. How do you define the metaverse in its simplest definition so that we can all work off the same idea?

[00:09:50] Matthew: A live 3D version of the internet as we know today is the best and simplest way to think about this. Why? Because it not only explains how it’s a little bit different visually experientially. It keys into some of what you just mentioned, which is how it might be more intuitive. Of course, we didn’t evolve for thousands of years to tap glass, to interact with 2D interfaces, static information. We explore, we immerse in 3D. It’s a much better interface for many tasks. Far from all, but many tasks. But most importantly, we take for granted the interoperability of the internet and how important that is to everything we do and create. We don’t think about this question of the New York Times can’t link to Washington Post. We don’t even think about the idea that you can’t link directly to the specific piece of content on the Washington Post. We don’t concern ourselves with, “Darn. I took a photo on my iPhone that I stored to iCloud, and the file format therefore doesn’t work on Facebook.” You can take a photo, upload it to Facebook, right click save as, put it onto Snapchat, screenshot it on Snapchat, upload it to TikTok. So we have this vast network that manages hierarchy, communications, reference, the transference of data across different autonomous systems coherently, safely, consistently. And then file formats and conventions that run university. We have a lot of 3D stuff today. There’s a tremendous amount of time being spent in 3D platforms. What we don’t have is a scalable network that actually interconnects. And as we’ve learned from the global economy, world trade, as we’ve learned with the internet at large, the utility that comes from that is extraordinary.

[00:11:26] Patrick: Can you say a few words about the state of the engines behind three dimensional creativity or three dimensional output? You already mentioned Unity, and you already mentioned Unreal being the two dominant engines that people might be familiar with. But maybe paint a more vivid picture of the history here. And if 3D is literally in the definition of metaverse, it stands to reason that the engine that produces and allows people to produce beautiful 3D outputs is really, really important or central. Can you give us the details on the state of the world today as it relates to 3D engines?

[00:12:00] Matthew: Sure. I love this question. And let me actually start answering it by talking about the state of the world decades ago. I like to position the metaverse as a fourth era of computing and networking. The first was the mainframe era began in the 1950s for the most part, ran until the late 1970s. Let’s keep in mind, mainframe still exists. It’s actually a bigger business than ever. But it was largely superseded in the late 1970s, early 1980s by the advent of the personal computer, Apple, Microsoft, and TCPIP the internet. By the mid 2000s, we hit the mobile and cloud era. And now we’re starting to talk about the next era in the metaverse. What’s fascinating about the metaverse in contrast to the preceding three waves is where it seems to be starting. Seems to be starting as you’ve identified in gaming, consumer leisure. In a small segment in consumer leisure. People like to talk about gaming being larger than film. It’s a bit of a misconception. You’re talking about the theatrical box office. That’s about 40 billion, but of course the video industry’s over 600 billion, gaming’s still around 200. When you take a look at those prior waves, mainframes started with mega enterprises. The internet began with government. Most of the early adopters were again, large corporations. Mobile began with enterprise and government as well. Each of these waves either never came to consumer leisure as was the case in mainframes or came there last. YouTube 2005, Netflix 2007, streaming wars 2019. Consumer leisure tends to be last.

So why is it that the metaverse seems to be starting in the other direction? The answer relates to constraints. Constraints always define a technology from inception to its termination. The constraints for computing and networking in those prior waves was often processing power, broadband speeds, bandwidth, etc. And the result was you couldn’t do much live. You couldn’t share a photo with your grandmother. You couldn’t stream video. But certainly, you could send a Blackberry message in the early mobile era. You could send an unstructured data file or CSV if you were a banker or accountant. So we needed substantial improvements in bandwidth and processing power for these new technologies to have consumer applicability. But the constraints that affected simulation, real-time rendered simulation, game engines was fidelity. It didn’t have the bandwidth or the processing power to do a rich simulation. And what that meant is the government had very little use for it. You couldn’t actually do a military simulation with fake fire. But it was fine for pong. It was fine for space invaders, Legend of Zelda. So we’ve spent decades with the primary area of development of game engines, of real-time rendering and GPU chips coming from consumer leisure. What has happened in the past few years is we have reached a point where the maturing and sophistication of these game engines coupled with the wide deployment of powerful processors means that that applicability has expanded. Automotive companies as I mentioned are using Unreal so that you can help drive your car. You can use LIDAR to scan the environment around you in your Range Rover, understand how to navigate, and then actually pre-drive your vehicle. You can live simulate a building.

And what has happened is the companies that happen to have that expertise come from gaming. Nvidia’s Jensen Huang. Of course, Nvidia’s now the seventh largest company globally. Known to many investors for several years, but largely under the radar compared to most other top 10 companies was founded in the early 1990s, not long after Snow Crash was published. And Jensen has said they never wanted to be a video game company, but focusing on gaming was the best strategic choice they’ve ever made because it had three unique attributes. It was large, it was fast changing, and it was technologically intensive. Many industries like pharmaceuticals have two of those attributes, but they don’t change that quickly. So the mixture of the intensity of these problems, the rapid improvements per Moore’s law has meant that almost all these expertise sit here. Lastly, when you take a look at what this means for the metaverse today, Microsoft’s Activision Blizzard acquisition, the largest big tech acquisition in history, 75 billion in enterprise value. Satya’s press release, the final line of the very first paragraph says it provides the building blocks for the metaverse, the foundations for the metaverse. And a lot of that comes down to game engines.

[00:16:25] Patrick: If you think about the role of IP in the bootstrapping of the first metaverses, what comes to mind? I remember from our first conversation going really deep on Disney, and Marvel, and the incredible gravity and momentum that great IP universes allow for. And that very often, technology supports IP and not the other way around. That ultimately IP is the thing people show up for. They want to do something, they want to watch something, they want to be immersed in something. Activision Blizzard maybe is a good example here, but what is the role of existing or new IP as it relates to speeding up this change?

[00:17:01] Matthew: As with anything that we want to do, any place that we want to go, there’s a reason why Disneyland is more fun than six flags is. If there’s a place that we want to go, especially in a consumer leisure environment, it stands to reason that we want to go to the places filled with the stories and characters that we love. This has classically been Horizon World’s fundamental problem. It’s technically more robust than it is popular. It has better distribution than many other platforms. It doesn’t have content, partly because it doesn’t have as many developers, but in particular, the other platforms have been populated by produced in UGC IP for years now. If we’re to go to a fantastical place, want that to be the place populated with the things we love. This isn’t new. Of course, medieval gardens are adored with gargoyles and giant statues of lions because it provides immersion. We don’t just want to walk down hedgerows. We want to feel like we’re in the place we imagine. This is why many come to the inevitable conclusion that another medium full entertainment or another technological wave which has IP in it is naturally going to advantage those that have the most resident IP today. Disney does not have a gaming business. I think that remains a problem. Mostly because they don’t have the capabilities for it. Whether or not they publish their own titles is a different question, but we’re going to want to live in Disney IP…

…[00:26:53] Patrick: As I think about my own usage of Oculus, and I’m a person that wants all this stuff to happen. The idea of the Ready Player One haptic suit, and omnidirectional treadmill, and everything that goes into it, this full immersive experience just sounds fun. I was a video game junkie as a kid. Spent countless hours in some of these virtual worlds. I’m inclined to want to do it and be an early adopter of the technologies. I think I had one of the first Oculus. And when I put it on, what stands out as the Star Wars game, I’m forgetting the name of it. But really being blown away looking around like this is wild. And obviously, it’s only going to get more and more perfectly rendered. I had the problem of getting a headache or a stomach ache when I moved artificially, which I want to hear about what you think about that. But at the same time as blown away as I was, I really haven’t spent much time with Oculus on. And I’m curious if my experience as someone prone to want this to happen who tried it but really didn’t last, is that indicative of the broader experience so far with Oculus? What do you think the reasons for something like that might be?

[00:27:50] Matthew: I want to hit a few different points here, because I think we’re really talking about the suitability of alternatives that challenges with the current technology. And then the likely progression of said technology. Neal Stephenson, who of course coined the term metaverse. So he didn’t originate the idea that spans nearly a century, has talked about the fact that yes, his conception of the metaverse was primarily an AR and VR experience. And he highlights the fact that that was a reasonable, if not the best hypothesis at the time, especially in the science fiction community. But he’s highlighted that technology is path dependent. What we found out in the decade sense is that actually, hundreds of millions can adequately navigate 3D space with WASD on their keyboard. Forward, left, right, and back. Billions can navigate 3D space and choose to do so on a monthly basis using a touch screen. He says that he no longer considers that essential. It may be the best, most popular preferred way eventually. But it’s not a requirement. And if you see Tim Sweeney at Epic shows very little interest, at least today in those new devices. The second part is talking about the experiences that you’ve mentioned. We have a good sense of what is likely to be required for min spec, for mainstream adoption of VR hardware. And I go into this a lot in my book. We tend to think for example that we need a refresh rate of 120 hertz on a VR headset. That’s 120 frames per second. We probably need an 8K display. And I’m going to put aside other concerns for now like battery life, the weight of the device, the heat generated by the device, the number of additional sensors and tracking cameras we need, which constrain all available resources, but just 120 hertz and 8K display. Right now, the top of the line devices typically do 90 hertz and 4K.

So we need a roughly 3X increase in the number of rendered pixels per second, just to hit min spec where people aren’t suffering from nausea. You then layer in these devices have essentially late PS3, early PS4 graphics. Their computational load is much lower. Call of Duty: Warzone is limited to PC and gaming consoles only, but in exchange, the graphics are great. You can have 150 users. Fortnite plays on most devices, but as a result, you can only have 100 users. Free Fire from Garena is designed to work on all low end Androids. And as a result, it only has 50 players. Population one on the Oculus, their battle royale has only 18 players. So now we have a device that has half the resolution we want, two thirds of the frame rate that we want. It has PS3, PS4 graphics. And you can only have 18 other users. And then again, it probably has one eighth the sensors that we want, one third the battery life. It’s probably 25% too heavy. There’s a lot that we need to solve for these just to become min spec for nausea and usage. And then on top of that of course, we need these devices to be more than min spec. They need to feel better. The rejection of sensors, which is unique to VR. You can multitask on your PlayStation, you know whether or not your house is on fire. Your kids are upset. Your dog is getting into trouble. Probably raises that above min spec. We’re getting there. We’ve roughly doubled resolution density. We’ve doubled processing power since 2017. So those who say we’ve been here before, people don’t like VR don’t appreciate the headway that we’ve made in these devices. But it’s a lot like GPAs. It’s easier to go from a 3 to a 3.4 than it is to go from a 3.6 to a 3.8. And we saw this recently as medic kicked out their releases for AR devices again, for the third time this decade. This is a hard tech problem…

…[00:37:07] Patrick: This idea of everything talking to everything brings up one of the most interesting topics in all of this, which is the word interoperability. This word has gone from no one ever saying it to everyone saying it in five years. Both because of the metaverse and this next era of computing, but also because of blockchains, interoperability means a lot, is critical. No one really knows what the hell they’re talking about it seems like when they bring it up. But it brings to mind things like standards and protocols. Again, the boring base layer stuff that makes the modern world possible. Whether it’s visa, or TCP/IP, or SMTP it, some of these things you and I have talked about before. Can you talk about why interoperability gets its own chapter in your book, why this is such a key critical concept? And who might actually sponsor or start these things? Because many times in history, they’re not for profit. It’s a protocol. So walk us through this concept, because it seems like it’s at the bottom of everything.

[00:38:00] Matthew: The fundamental premise of interoperability is a little bit foreign to the average person because we take for granted how interoperable online existence is today. You have a common identity at least in some way, shape, or form that you can take into multiple different avenues. Your content, the content that you create is inherently interoperable because the file formats are relatively standard and embraced everywhere. Ping runs everywhere. JPEG runs everywhere. Every unit of content we create today essentially runs everywhere else. Your text, your audio, your video, not just an image can be uploaded to every different environment. And in fact, the worldwide web itself works because of elements of TCP/IP, but also other consortiums and working groups of feathers that maintain a cohesive hierarchy or IP address, the domain registrar system. This is important not just for the continuity of the web, the cohesion of your personal experience, the persistence of things done online. But they’re also important for competition. If you don’t like your web hosting company, you can just move your information to another. You can change domain all the time. So we should think of interoperability as important to content creation, as important to user rights, as important to the actual thriving economy of the internet. And you’re right to talk about the ways in which those are not managed by a central for profit body. But ultimately, we can reduce it to a simple idea. It’s expanding the network effects of everything that you do online, but that doesn’t exist in the virtual world. Roblox individual worlds can identify one another, but they have no ability to understand, least of all, even identify another virtual world. Be it in Fortnite, an educational forum, a training sample.

Communicating from one live services suite to another doesn’t really exist either. There’s no consistent way to store information. And least of all, the ability to take a 3D object whether it’s created for industrial purposes for a simulation. Northrop Grumman wants to test an engine and then see how it performs in a specific environment. They don’t really have a cohesive way to take that object from one simulation to another. So this question about interoperability is really about expanding the utility, practical applicability of everything in the metaverse. And I’ll drop this down to a simpler example. The world economy of course runs on standards, defacto and otherwise. And it’s essential to reducing the friction to all transactions to increasing the utility of all investments and purchases. What are those standards? USD is one. English is another. The metric system is a third. The intermodal shipping container. You’ll note of course that there are often many other standards. We also use the Euro. We also use German. There are multiple different types of shipping containers, not all intermodal. Metric and imperial sit side-by-side, often in the same country, often within the same business. So we shouldn’t think of interoperability from a panacea perspective. And this is one of the flaws I’m often asked, can we ever have interoperability? Yes, we’ll never have it perfectly, never have it exhaustively. The world doesn’t work that way. The internet doesn’t work that way. We still have private networks, offline networks. We still have paid and proprietary protocols. You often need an installer to access experience A or B, and there are often paywalls. But making it so that every 3D object, every experience, more purchases can move, can endure, have utility beyond that first creation is going to be key to actually building up this economy.

[00:41:45] Patrick: Help me understand how we can bridge that gap of something I build, own, earn, achieve in some place that I want to bring to some place else. If I think about games, and maybe that’s the wrong way to think about it. The object I win and spend hours looking for in Diablo is really not relevant in Fortnite, is really not relevant in Sims. It seems like even though there are all these great worlds, the idea of bringing stuff between them is hard to imagine because the worlds themselves are so different. So how do you think this happens? How does Roblox get connected to Fortnite? How far down do we have to go to build the bridge?

[00:42:23] Matthew: One of the challenges with interoperability discussions is that we often focus on the easiest to understand, but arguably the least useful example. And that is taking your Peely banana skin from Fortnite and bringing it into Call of Duty. There are so many problems with that. The engines of course are different. And I just want to highlight how different these engines often are. Unity and Unreal actually have different coordinate systems for X, Y, Z. They store information Y and Z differently. Now that’s easy for a computer to manage. You just have a translator. It works the same way that English to German does. You say let’s swap Y and Z. But if they have fundamental disagreements on coordinates, you can imagine how sophisticated some of the disagreements are. That naturally leads game designers in particular to say, “Why does that matter?” Putting aside the economic considerations, do you want to be appealing in Call of Duty? Is it cohesive with the aesthetic? Does it fit in a doorframe? Frankly, the Peely file format might be stored in a way that makes it three stories tall in Call of Duty. When you look at my metaverse definition, I talk about the continuity of data from 3D objects to entitlements, payments, communications, history. The object itself, the avatar is probably the least important element of that. We’re a little bit more concerned with when you do an educational exercise in school, 3D simulation in school is probably one of the most important innovations that we can see. We’ve learned that distanced education is terrible. We have long expected the advent of the internet and digital devices to see productivity improvements in education. Haven’t happened. We know that multiple choice is terrible, that playing a YouTube video is terrible, that Zoom school is terrible. But the ability to make real The Magic School Bus is intuitive.

I grew up making volcanoes out of paper mache, baking soda, and vinegar. Now, you can start to do that in realistic simulations where you are personally agitating the magma being ejected into the atmosphere, and seeing the time lapse implications on the environment. Building a Rube Goldberg machine to learn physics, rather than just watching a video of a NASA commander drop a feather and hammer on the moon. You can take that Rube Goldberg machine to the moon, to Mars and Venus. But of course, we believe that some form of interoperability or continuity of what you’ve done, and what that information is, and who you are is essential. We’re not going to have the same school pack for chemistry as for English. So it’s not as important that I take my banana skin from A to B, it’s more important that I can consistently manage my profile. But all of this requires formats, more importantly conventions, a whole bunch of other buzzwords. Frameworks of frameworks, systems of systems. But how does it emerge? It emerges in a well known way, the same way that USD and English did. It’s often network effects reiterated the incentives of changing systems. But again, never perfectly. Last week, we had the establishment by the Khronos foundation, the metaverse standards form 28 companies. Many notable omissions, Apple, Google, many other content providers. But Epic, and Meta, and so forth, Qualcomm all saying, “Let’s start to standardize our roadmap. We have to understand what we can build towards for the collective utility.” That’s the easiest step. No one has to make a sacrifice to their tech roadmap. No one has to pick a standard they didn’t like. But that formation period has already begun. And even Roblox has started talking extensively about their need for their developer economy to start to figure this out.

2. CRISPR Technology for DNA Editing Might Raise Cancer Risk, Israeli Scientists Warn – Gid’on Lev

But Tel Aviv University researchers are highlighting the risks of CRISPR, which stands for clustered regularly interspaced short palindromic repeats. The scientists examined how the technology affects the immune system’s white blood cells – T cells – and found that some of the patient’s cells had chromosomal truncations – a loss of DNA fragments, a characteristic of cancer.

The first trial approved for using CRISPR to treat people was done by researchers under Prof. Carl June at the University of Pennsylvania. The scientists removed T cells from a healthy donor and changed the so-called cell receptor on them to better identify cancer cells.

The researchers also used CRISPR to destroy the original cell receptor so that the engineered T cells wouldn’t recognize and mistakenly attack cells of the recipient and another molecule that cancer cells use to exhaust T cells. The engineered cells were injected into cancer patients whose cancers did not respond to any other treatment.

The results were published in 2020 in the journal Science: The engineered cells survived in the patient’s body for a long period and homed in on the cancer cells, even though they didn’t destroy the growth entirely.

The general consensus in the field was that after CRISPR’s excising of undesired parts of DNA, the cell carries out repair. In the new study, the researchers conducted a test to determine if indeed this repair mechanism works perfectly or that maybe repair doesn’t always occur, and when it does, it’s not always complete.

To examine the technology that presents this risk, the scientists reconstructed the trial conducted at the University of Pennsylvania. They used CRISPR to cut the genome of T cells in exactly the same places where June and his colleagues did: at chromosomes 2, 7 and 14. (Each human cells has 23 pairs of chromosomes.)

They then analyzed thousands of cells and found that up to 10 percent of the chromosomes that were cut did not repair themselves…

…With CRISPR, T cells can be made to better recognize cancer cells and prevent the recognition of normal cells. Furthermore, CRISPR can be used to remove the molecules that act as brakes on T cells, allowing the cells to exert their full killing potential.

Following the use of CRISPR, a mechanism in the cell repairs the cut DNA, but sometimes the cell fails to be repaired and might even lose large parts of the chromosome. This is serious because of the association with diseases including cancer.

In reenacting the research at the University of Pennsylvania, the Tel Aviv University scientists – aided by the students Alessio Nahmad and Ella Goldschmidt, and research assistant Eli Reuveni – sought to investigate CRISPR’s safety in general, not just in treating cancer.

“CRISPR only cuts and removes the DNA sequence at desired points. The natural mechanism of DNA repair in a cell is what’s fusing the cuts together and keeping the chromosome intact,” Ben-David says.“But sometimes the cell fails to execute the repair, and after this failure large parts of the chromosome – or even the entire chromosome – are lost. That creates a very serious situation because of aneuploidy – a change in the number of chromosomes.”

Ben-David says aneuploidy occurs in 90 percent of solid tumors; it’s the most frequent genetic change in cancer, more so than DNA mutations.

“In healthy cells, it never happens. There are always 46 chromosomes,” he says. “If in the process of genome editing via CRISPR, aneuploidy cells are generated and injected into the patient, this could be a serious problem. Until now, this problem hadn’t been examined in depth.”

3. Tails, You Win – Morgan Housel

Long tails drive everything. They dominate business, investing, sports, politics, products, careers, everything. Rule of thumb: Anything that is huge, profitable, famous, or influential is the result of a tail event. Another rule of thumb: Most of our attention goes to things that are huge, profitable, famous, or influential. And when most of what you pay attention to is the result of a tail, you underestimate how rare and powerful they really are.

Venture capital is a tail-driven business. You’ve likely heard that. Make 100 investments, and almost all of your return will come from five of them; most of your return from one or two.

Correlation Ventures crunched the numbers. Out of 21,000 venture financings from 2004 to 2014, 65% lost money. Two and a half percent of investments made 10x-20x. One percent made more than 20x return. Half a percent – about 100 companies – earned 50x or more. That’s where the majority of the industry’s returns come from. It skews even more as you drill down. There’s been $482 billion of VC funding in the last ten years. The combined value of the ten largest venture-backed companies is $213 billion. So ten venture-backed companies are valued at half the industry’s deployed capital.

There is a feeling, I’ve noticed, that this low-hit, high-stakes path is unique to VC in the investment world.

I want to show you that it’s not. Long tails drive everything…

…J.P. Morgan Asset Management published the distribution of returns for the Russell 3000 from 1980 to 2014. Forty percent of all Russell 3000 stock components lost at least 70% of their value and never recovered. Effectively all of the index’s overall returns came from 7% of components. That’s the kind of thing you’d associate venture capital. But it’s what happened inside your grandmother’s index fund.

You can drill this down even more.

Amazon drove 6.1% of the S&P 500’s returns last year. And Amazon’s growth is almost entirely due to Prime and AWS, which itself are tail events inside a company that has experimented with hundreds of products, from the Fire Phone to travel agencies.

Apple was responsible for almost 7% of the index’s returns. And it is driven overwhelmingly by the iPhone, which in the world of tech products is as tail-y as tails get.

Who’s working at these companies? Google’s hiring acceptance rate is 0.2%. Facebook’s is 0.13%. Apple’s is about 2%. So the people working on these tail projects that drive tail returns have tail careers…

…A takeaway from that is that no matter what you’re doing, you should be comfortable with a lot of stuff not working. It’s normal. This is true for companies, which need to learn how to fail well. It’s true for investors, who need to understand both the normal tail mechanics of diversification and the importance of time horizon, since long-term returns accrue in bunches. And it’s important to realize that jobs and even entire careers might take a few attempts before you find a winning groove That’s how these things work.

4. Speculation in 1980s Taiwan – Michael Fritzell

The financial bubble that gripped Taiwan in the 1980s is one of the greatest that the world has ever seen. Stock prices went up by more than 12x in less than four years.

At the peak of the bubble, over 5 million – one-third of all Taiwanese over the age of 15 – were actively playing the stock market.

This is the story about the boom and the bust of Taiwan’s little-discussed but spectacular stock market bubble, as retold in the book The Great Taiwan Bubble by Steven Champion…

…Before 1983, there wasn’t really any effective, legal way for an international investor to buy Taiwanese stocks. In the mid-1980s, however – the stock market was finally opened to foreign investors. Money started pouring in.

Capital inflows caused interest rates to plummet. Meanwhile, households felt loss aversion now that their bank deposits yielded almost nothing. So they sought higher in other financial instruments. Some of that money ended up in the stock market.

In 1985 – at an early stage of the bubble – the Taiwan Capitalization Weighted Stock Index (Taiex) was trading around the 700-mark. It had come off a bit from a previous high in 1984, but not many people were paying attention to the market yet. That would soon change.

An illegal lottery called “Dajia Le” (大家樂) was launched in 1985. It spread like wildfire through the nation, especially in Central and Southern Taiwan. For as little as 300 or 500 Taiwan Dollars, you picked a number from 00 to 99 and could get a jackpot of 15-19x – far more than any of the state-sponsored lotteries. It became a great success throughout Taiwan. Suddenly, just about everybody was into illegal gambling.

The reason why Dajia Le flourished was because of the economic slump in the summer of 1985. The unemployment rate increased to a decade-high of 4.1% and 320,000 unemployed Taiwanese were walking the streets in search of jobs. Many of them became disillusioned and turned to gambling.

After a few years, the government cracked down on these illegal lotteries. The state-sponsored Patriotic Lottery ended abruptly in 1987 and illegal lotteries such as Dajia Le were also shut down shortly thereafter due to government pressure.

Author Steven Champion described how hundreds of thousands of these gamblers were then in search of a new fix. He imagined that many of them must have turned into stock market speculation as an outlet for their lust for gambling.

The author worked as a fund manager in Taiwan in the 1980s. In 1986, he observed the market and saw it rise through the key 1,000 level. In his letters to investors, he opined that the market had become extended and suspected it was due for a correction. He just couldn’t imagine that it would rise any further.

Optimism was in the air though. In 1987, Taiwan officially became a democracy and many believed that the future was bright. Martial law was lifted, new political parties were formed and media censorship was eased.

There was scepticism throughout the whole stock market boom, but the scepticism gradually dissipated as bullish voice turned louder. Financial professionals were most nervous when the market bolted through the 1,500 and 2,000 levels but got calmer and calmer as prices went into the stratosphere.

The central bank issued new brokerage licenses and eased listing requirements. There was a huge increase in the number of licensed brokerages, from 27 in June 1988 to 297 in March 1990. Easily available but generally illegal, margin credit was provided through many of these brokers.

The new brokerage firms pushed stocks to retail investors. The larger cities Taipei and Kaohsiung were blanketed with new brokerage offices. The major firms then set up new shops in the secondary cities of Taichung, Tainan, Chiayi, Hsinchu and Changwha. When those reached saturation, brokerage firms finally opened up offices in even the most obscure country villages like Shalu, Fuhsing, Chubei, Huwei, Wuchi, and Huaton. Looking for new market niches, brokers established offices specifically targeted at housewives, doctors, farmers and students to lure more customers in…

…Suddenly, just about every single Taiwanese became involved in the market. An astonished foreign media jokingly started calling Taiwan “the Republic of Casino” instead of its official name “Republic of China”.

Students at National Taiwan University began to cut morning classes. Primary school teachers quizzed their students to see what stocks their parents were buying. High school girls desperate to accumulate savings to throw into the market turned to part-time prostitution.

60% of financial reporters owned stocks, and 84% of this group admitted their involvement in insider trading. When interviewed, 30% of those reporters admitted to considering abandoning their profession so that they could play the market full time.

In 1988, Taiex broke through the 7,000 mark – up over 10x since 1985. In brokerage offices, retail investors celebrated with champagne and happy faces…

…The market wobbled briefly in 1988 but quickly regained momentum. During that year, new president Lee Teng-hui appointed Shirley Kuo as Minister of Finance. To control the stock market bubble, Kuo announced a tax on gains derived from securities transactions. Taiex plummeted for 19 straight days, dropping from above 7,000 to below 5,000. Investors took to the streets and laid siege to the Ministry of Finance and Kuo’s residence. Fearful of losing next year’s elections, the government backed down and cancelled the tax. Stock prices exploded with renewed fervour.

It only took a few months to recover the previous high. As the market surged through the 6,000 level, then 7,000 and 8,000 stockbrokers held wild celebrations on their trading floors. Brokers offered free champagne, exploding firecrackers, balloons, buffet lunches and musical performances to their most loyal customers…

…The compounded return over the previous five years had hit international records. The Taiex had gone from 1,000 points in 1986 to 12,000 in 1990. Stock prices multiplied by more than twelve times in less than four years.

By the fall of 1989, the average price-earnings ratio on the Taiex was 100x – roughly double the already-high P/E multiple of 51x in Japan at the time…

…In early 1990, the market started wobbling. It looked like the market was taking a rest before scaling new, unchartered heights – just like it had done so many times in the past. But instead, the market entered into a vicious bear market that stunned most retail investors.

Many retail investors thought that the government provided almost guaranteed protection on the downside. The Kuomintang party had used the booming stock market as a slogan for their recent election campaign slogan, “Big Profits and Great Prosperity”. Many interpreted this as an implied guarantee against market losses. Yet despite continued optimism, the market drifted lower.

Trading volume reached new highs just after the crash, with traders doubling down on every single dip.

And then slowly, denial turned to anger, to depression and a gradual acceptance of the new reality.

Taiwan’s stock market bubble was finally over.

5. TIP466: The Bear Has Arrived w/ Jeremy Grantham – Trey Lockerbie and Jeremy Grantham

Jeremy Grantham (00:10:27):

I wrote a piece, Reinvesting When Terrified that by sheer luck came out the day the market hit its low and it said, “Get a policy, get a plan, present it to your committee or yourself and start to throw your money back into the market. You feel paralyzed, everyone always does and now’s the time to wake up, the market is cheap.”

Jeremy Grantham (00:10:46):

Of course, that happened in 1974 and ’82, which were classic lows and the market got down to seven PE and what I call terminal paralysis, sets in where you’re so frightened you can hardly move. You can hardly get to work, forget to buy stocks and that’s of course, as Warren Buffet would’ve said, that’s exactly the time you have to do it and it’s only 5% of the time, they are much quicker than the crazy bull markets.

Trey Lockerbie (00:11:11):

Now, I know you’re a huge skeptic of the Fed. Have the Feds rate increases and tightening efforts on the market or the market’s response surprised you in any way?

Jeremy Grantham (00:11:22):

No, I expect the Fed to be behind the curve, to be deep into optimism and it doesn’t really have a clue about market bubbles and the damage they do when they break. They’ve been eager now since early Greenspan to encourage bull markets because they help the economy, they really do and they always forget that the bear markets to go along with them hurt the economy at just the wrong time.

Jeremy Grantham (00:11:46):

If I’d been asked a bet, would the Fed get inflation wrong when inflation came along? At any time I would’ve said, of course they’ll miss it, they’ll be late, their responses will be pretty ill-judged. The Fed’s record is terrible. What is impressive is how much room they have been cut by the market. I mean the market is incredibly forgiving to the Fed. The Fed happened for 25 years to benefit from that amazing era as 500 million Chinese erased into the big cities and were plugged from marginal farming into highly profitable industrial system.

Jeremy Grantham (00:12:22):

Then they joined the World Trade Association and made everybody’s stuffed dogs and everybody’s iPhones for that matter. During that phase 500 million extra Chinese, 200 million Eastern Europeans plugging away from communism into capitalism. That was a golden era, Goldilocks if ever there was one and the Fed got to take credit for that.

Jeremy Grantham (00:12:46):

Prime Minister of England once, Mr. Wilson got reelected because England unexpectedly won the World cup in soccer and he got credit for it. I mean the president gets in the end credit for everything, good weather, he takes the shock for inflation. These things are all way bigger than the president of the United States, but the president and the Fed gets to enjoy the environment, so this Fed had a wonderful environment, they did nothing right, but they were seen to be presiding over low inflation and decent growth. The growth rate actually has slowed way down since Greenspan.

Jeremy Grantham (00:13:22):

It was averaging three and a half before Greenspan and averaging two and a half afterwards and today more like one and a half. It’s done nothing in terms of increasing the growth rate, but superficially it felt like a golden age because asset prices went up. Asset prices went up because inflation came down and rates were allowed to come down and in the end, rates were forced down and low rates make leverage cheap, make private equity deals wonderfully easy and profitable and they push up the price of real estate and they push up the price of stocks and that’s the way it was and the Fed gets the credit for that and it’s due none.

Jeremy Grantham (00:14:02):

D merit accrues from the fact that it kept on pushing down interest rates far too long and dangerously increasing inequality which is, I like to say the greatest poison in the system these days. The degree of inequality we have in the US now it does damage the strength of the economy and that is probably part of the reason why the growth rate has slowed and continues to slow.

Trey Lockerbie (00:14:27):

Now that inflation has arrived, there’s a lot of concern that we’re entering into a 1970s or eighties scenario stagflation. As a historian, could you give our audience an idea of what was happening during that period and how it resembles today?

Jeremy Grantham (00:14:42):

Well, every period is unique. The seventies had problems with the oil crises. You can call it one giant crisis or you can call it two or three, but in any case a triple, quadruple, quintuple the price of oil. In a hurry, we’d come off 50 years of fairly stable, low prices and they shot up and stayed up for a long time and inflicted enormous pain on the system. They lowered the growth rate. Why wouldn’t it? If you have to pay three, four times for your energy and it also, of course pushes up the price, so there’s nothing like an oil price increase to increase stagflation and it did. This time, if you adjust for the passage of time, the price of oil is not as high, but it’s still multiplied recently by three times and so that is imposing pain on consumption and is imposing inflationary pressure.

Jeremy Grantham (00:15:36):

Because of the invasion of Ukraine, we have had some extra spikes in the price of food, fertilizer and natural gas particularly in Europe. Interestingly, they are now almost all of them lower in price than the day before the invasion and this is a lovely example of how the stock market works. The start market is saying, “Whoops, there’s so much damage from commodity prices et cetera, et cetera, that we’re going to have a recession.” The recession isn’t bad news because the recession is going to get the Fed back in our camp of lowering interest rates again and helping stock prices and we’re looking out into the future and therefore that’s the good news, so the fear of a recession becomes wishful thinking about future interest rates and so the market gets a repressed for a while. It’s quite remarkable, but it’s fairly typical.

Jeremy Grantham (00:16:30):

That’s what we’re having now and that’s why we might have a bit of a rally for a few weeks, I think. Yes, what we should cover is how dangerous it is to get involved in a bubble that has more than one asset class, equities, growth stocks mainly. This time we’ve also moved into housing. Housing was chugging along okay, but last year it had the biggest advance, 20% in 2021 [inaudible 00:16:56] it had ever had in history and it went up to a higher multiple of family income, house priced divided by family income. Higher multiple than the peak of the housing bubble of 2006, it just means there’s a lot of value there that can be lost and it is dependent on interest rates. As you know when you’re paying a mortgage that the bottom of the mortgage was two and a half and it went up to 5.7, 5.8.

Jeremy Grantham (00:17:19):

This is a brutal increase in mortgage and means a lot of people will not move houses who otherwise would’ve done, which means a lot of people will not take a new job because they’re not prepared to double their mortgage payments. Everyone expanded to pay as much mortgage as they could afford, which meant that they put merciless pressure upwards on housing prices as the mortgage rates came down, so that’s a problem and then you have problems with a bubbly commodities market inflicting pain on consumption. As if that wasn’t enough, we have the lowest interest rates in 6,000 years as Jim Graham would say or Edward Chancellor’s written a brilliant new book, The Price Of Time. Of course, with the lowest rates in 6,000 years, you have the highest bond prices and that’s obviously been taken to the cleaners this year, too.

Jeremy Grantham (00:18:04):

You have bonds, housing, stocks and commodities. The only people who’ve tried that was Japan in ’89, they’re still not back to the price of the equity market. They’re still not back to the price of the land and the housing market from 89, that’s 33 years and counting. We did some of that in the housing bubble where the stock market came down in sympathy and that was brutal. They give you much greater pressure on recessionary forces and we are playing with fire this time, which was not anywhere near as obvious a year ago before that huge move upwards in housing.

Trey Lockerbie (00:18:40):

The interesting thing about the housing part to me is that with high inflation and to your point about expecting it to have inflation for the years to come, is that it seems like you’d want to own hard assets, so the demand should be there to keep propping up for the foreseeable future.

Jeremy Grantham (00:18:55):

Yes, in the long run, of course housing and stocks are very good protectors of steady inflation. The bad news is that psychologically inflation is associated with a negative, with a drop in PE from a psychological point and pressure on proper margins in the short-term and then it’s adjusts, but it’s very painful adjusting. Of course, it’s associated with a much higher mortgage, but once it’s adjusted, then of course you’re in much better shape.

Jeremy Grantham (00:19:23):

The world is much better off with moderately high interest rates. You get money on your savings, people don’t speculate as much, they don’t leverage as much, the risk in the system declines and you can afford to buy a house at lower prices and you can afford to buy stocks and build a portfolio.

Jeremy Grantham (00:19:40):

At the moment at the peak in December, if you’re young, you can’t get into the game. You can’t buy your first house, you can’t buy an equity portfolio. The yields are half of what they used to be…

…Jeremy Grantham (00:20:38):

I think in the longer term, forget the next few quarters who knows what happens really, but in the longer term, we are really running the risk that this is back to the seventies. We have problems with the availability of plentiful cheap resources and we have problems with plentiful cheap labor. The birth rate has crunched in every developed country except Israel and China.

Jeremy Grantham (00:21:04):

That’s a very, very important segment of the global economy to say the least. Every one of them has a population growth rate lower than replacement level so in the end, after accumulating lots of older people as a higher percentage, we start to actually have the population drop. Secondly, we’re 10 and 20 years in depending on the country into having smaller baby cohorts, so we know with absolute certainty, since they’re alive already that the 20 year olds arriving in the market will be fewer and fewer for the next to 20 years.

Jeremy Grantham (00:21:40):

We have not experienced this before. This has happened incredibly fast. China has gone from plenty of babies to a baby crunch almost overnight and a fertility rate that needs to be 2.1 is probably running about 1.4. Even in the US, the UK we’re running about 1.7. We’ve never seen levels like this, so we’re going to have a hard time getting enough labor. We’re going to accumulate old people who are very resource intensive. They need a lot of medical care, they need a lot of people care and we’re not going to have all that many people there.

Jeremy Grantham (00:22:14):

The supply of people to look after us old fogies is dropping steadily from now on for the rest of your life about, for sure. At the same time, I believe the correct interpretation of the commodity data is that it wasn’t only the China shock, the rapid growth rate for 30 years in China, but it was also showing signs that the best and cheapest, most plentiful resources had simply been mined or pumped and that we are running down into the second tier.

Jeremy Grantham (00:22:45):

If you look at the copper ore for example, King Copper is really important to the industrial system. Over 80, 90 years, the amount of copper in a ton of oil has dropped to a third of what it was, so you’re using an awful lot more energy and the energy also, which used to run for a hundred years at $20 a barrel in today’s currency, now runs at a hundred, so you’re spending five times the cost of energy to mine one third the quality of copper oil.

Jeremy Grantham (00:23:14):

You better believe technology can’t keep up with that. It did for a long time, it did very, very well but starting about 2002, the real price of the typical commodity has gone up a lot, it’s basically tripled.

Jeremy Grantham (00:23:27):

In a hundred years it went from… Starting at a hundred, it went down to 30, a brilliant help for getting rich and then from 2002 until today, it’s gone from 30 to 90, so over 122 years commodities are just about flat adjusted for inflation. Only 20 years ago, they were down at 30 cents on the dollar. This is a huge shift, hasn’t been nearly enough fuss made about it, but it’s the direction that is interesting to me. The direction is steadily up.

Jeremy Grantham (00:23:56):

Now, there’s a lot of volatility and commodities everybody knows. You produce an extra ton and the price collapses and your short a ton and the price triples, but if you look at the trend, the trend has been pretty reversed since 2002. My guess is it will continue to rise and that will pose real stagflationary pressure for a couple of decades and that’s why I fear this is re-entering the seventies and eighties…

…Jeremy Grantham (00:39:04):

I don’t want to get into wishful thinking, but basically as a society, we show all of the signs the failing societies in history have shown and the top of the list is Hubris, “Oh, you’ve been saying bad things for a hundred years and it didn’t work out.” You think the Romans didn’t say that? 400 years and so on and some of the civilizations down in central America where around for a thousand years and they built water storage, they built aqueducts and they had wonderful armies, but eventually they fall foul of a lot of failings and we check them all off.

Jeremy Grantham (00:39:40):

We look like a failing civilization book, but I’m hoping we have a little escape clause We have a couple of things going for us that have never worked before. One of them is population, that has never been a gleam in the eye of [Mouthes and the boys 00:39:54] even as we got wealthier that we would choose to have fewer children.

Jeremy Grantham (00:40:01):

This is remarkable and then adding on top of our choice is the fact that the world is getting so toxic, that even when you decide to have children it’s now getting to be much harder. One way or the other we are likely to have over the next couple of hundred years, a declining population and we have some chance that, that will be a great help. It isn’t a sufficient condition, but it is a necessary condition. The planet, under any circumstances could not support for the 10 billion that one reads about all the time for a hundred years, it can’t be done.

Jeremy Grantham (00:40:35):

We would need two and a half to three planets to cope with that. We can perhaps deal with a couple of billion and we might get there quite graceful. The other one of course, is technology and the rebuttal to the technology argument is that every wave of technology takes more energy back and it takes more complexity, which is a killer because complexity itself is a failing characteristic.

Jeremy Grantham (00:40:57):

It takes too much effort, too much manpower, too much energy itself and if that wasn’t enough, it increases your [inaudible 00:41:06] your overconfidence, every wave of scientific progress and so it can be quite deadly, but this time we have some open ended technologies.

Jeremy Grantham (00:41:15):

I call them, Get Out Of Jail Free cards and because they’re almost infinite fusion, geothermal and brilliantly cheap, effective storage any one of those three and we may get out of jail because that’s enough green cheap energy to in the long run take care of poverty if we chose to, for sure and take care of climate change. The thing about climate change is when we finish, we started 150 years ago with 280 paths per million carbon dioxide in the atmosphere. It’s only a little bit, but it’s a very powerful commodity. If we had no parts, we would be frozen at minus 20 to 25 degrees centigrade, a frozen ball with just bacteria around if we were lucky.

Jeremy Grantham (00:42:00):

It’s a very, very potent greenhouse gas. We started with 280 parts, a million we’re up to 420. That’s a bigger jump than the difference between the ice age, two miles of ice on Manhattan and the pleasant enough world that we have now. That’s a bigger jump, the ice age gap was just a 120 points and we have just gone up by 160 and we’re going to go up to about 525 and we need to go back to 300, so we’re going to have to get rid of 225 parts million of carbon dioxide as well as the methane.

Jeremy Grantham (00:42:31):

If you want to think about the carbon dioxide, that is 2 trillion tons or more, that is the absolute minimum. 2 trillion tons absolutely has to be taken out of the atmosphere over the next couple of hundred years and the Grantham Foundation, that’s all we do with our private investments, our venture capital. We have a team of half a dozen and all we do is focus on carbon dioxide extraction, biologically and every other method that we can get at, but that needs a huge amount of energy. However you do it, you’re going to need a lot of energy.

Jeremy Grantham (00:43:07):

One of our Get Out Of Jail Free cards would be very handy indeed. What are the probabilities? I think there’s probably 50/50 that fusion in the next few decades will come out with a viable engineering system, engineering and physics. The thing that I have doubt about is the cost. They’re going to be fairly costly plans, but 50/50 will have the technology and maybe it will be cheap and maybe it will not be cheap enough. Geothermal looks incredibly promising because the fracking industry has gone through the most amazing set of experiments, tens of thousands of wells, pushing, prodding, experimenting, shocking the rock using extra special mixtures of liquids to pump down and lateral drilling.

Jeremy Grantham (00:43:57):

It’s really been a revolution of engineering talent and if you could take all of that, which we can and apply it to geothermal and then start the same process with geothermal it would be almost surprising if we couldn’t, at least in some parts of the world have a really economically viable source of energy. The heat from the center of the planet here is more or less infinite, so that would do it.

Jeremy Grantham (00:44:22):

The third one would be a brilliant breakthrough in storage. We’ve come down to 10 cents on the dollar in the last 15 years. If we could come down, once again over the next 20 or 30 years to 10 cents on the dollar or even 20 would probably do it. We wouldn’t need a fusion or geothermal any one of those three will give us a chance of success. The problem is how much of the planet spirals out of control because of food problems, energy problems, creating fail states of the kind that we begin to see in Africa.

Jeremy Grantham (00:44:55):

If the temperature alone continues to rise, the whole Indian subcontinent, that becomes very questionable as to whether you could do regular farming. It has a wonderful share of the world’s arable land. If you see one of these maps, which is green for arable, you’ll see that India is one of the few places where practically the entire sub subcontinent is green. The problem is once you get over 35 degrees centigrade, which is about 95 Fahrenheit and you get humidity with it and you can’t stay out more than a few hours and they recently had 45 degrees centigrade for three weeks, as you probably read, the hottest they have ever had.

6. The Nightmare Scenario For Central Banks – Darlo Perkins

Officials feel utterly embarrassed about their “transitory” call in 2021, and you should never ignore the human element in policymaking. But the new bias goes deeper than that. It is also important to remember that the reason we have independent central banks is to ensure that the 1970s cannot happen again. So, we are talking about a risk that undermines the central bankers’ entire raison d’être, an existential threat. In fact, “price stability” is a prerequisite for everything else they do. It is the foundation of monetary policy. When investors ask about the pain central banks are prepared to tolerate, they are thinking about the wrong trade-off. The authorities are prepared to suffer a recession now because they fear a much worse recession in the future if price stability is lost. The trade-off, as officials see it, is intertemporal.

A recent report from the BIS outlines the nightmare scenario for central banks… The BIS analysis is largely statistical. It argues that there are two basic inflation regimes – “low” and “high”, each of which has its own self-reinforcing properties, although economies occasionally transition from one to the other. In the low-inflation regime, “relative” or sector-specific price changes are the dominant driver of the CPI. These tend to have a transitory effect, as they die out quickly. This is not a regime in which wage- or price-setters need to pay a great deal of attention to the overall inflation rate. Aggregate price pressures are subdued, and everyone takes this for granted. In the “high-inflation regime”, on the other hand, broader CPI developments start to have a much more discernible impact, with inflation itself becoming the focal point for private-sector decisions. This shift in emphasis leads, in turn, to behavioural changes that will cause inflation to become entrenched. In the high-inflation regime, even relative price shifts – such as spikes in energy prices – have persistent effects. And you know transitioning from a low inflation regime to a high inflation regime is under way based on the behaviour of prices within the CPI. Once they become more correlated, as they have over the past 12 months, there is a good chance – according to the BIS – that the economy is transitioning. 

7. Ben Clymer – Rolex: Timeless Excellence – Patrick O’Shaughnessy and Ben Clymer

[00:14:33] Patrick: Maybe before we go into the history, which is so interesting and really important, we could just do a level set for the audience on Rolex the business and just some basics like how many watches do they produce a year, the revenue that they produce a year, maybe say a little bit about their very unique business structure, which is certainly shocking to me and I think will shock some people too that aren’t familiar with it. Just level set us on the size and type of the Rolex as a business.

[00:14:55] Ben: And I want to be completely clear, and I’m sure Rolex will listen to this, so I want to be clear for them and for the audiences that they don’t communicate anything so this is all speculative. The information that I’ll provide and that I’m sure you read is completely speculative. We have a good idea of what they might produce and what the revenue might be. The assumption is is that Rolex is making just north of around a million watches per year with an average wholesale price of around $7,000. So you can do the math there to kind of give you an idea of size and revenue. And a million watches per year is a lot, but it’s not the biggest by quantity. Apple, of course, would be bigger than that. Arguably, if you included Apple, they would be an even bigger watch brand than Rolex, but different thing obviously. But if you were to combine, for example, the entire Swatch group, which ranges from Swatch to Breguet, including Omega, it would be a larger business than Rolex, in theory. But again, Swatch is a publicly traded company, you can see exactly what their revenue is, whereas Rolex is, as I think you’ve alluded to, Rolex is quite the opposite. Rolex is in fact run by something called the Hans Wilsdorf Foundation, which was founded in 1945 when the founder, Hans Wilsdorf, set it up to basically be effectively, a nonprofit run by a group of families that are still highly involved with the business today that have, I would say, effectively zero public interaction. I’m pretty close with Rolex and I’m pretty close with the watch industry you could say and I have met, I think, one board member, one time. That was not by design. I think I met him at a bar and I was like, “Oh, you’re so and so,” and he said, “Yes.” These people are in fact, the most powerful people in watches and nobody even knows their name. Nobody even knows what they look like. I happen to because this is my job, but most people have no clue who’s really pulling the strings at Rolex. There’s a wonderful CEO named Jean-Frederic Dufour, who used to be the president of Zenith, which is an LVMH brand and he is absolutely the base and brain behind much of Rolex, but there is a board there and like any board, they have a different kind of influence over the brand.

Rolex is effectively a nonprofit, some say one of the largest nonprofits in the world, which I would believe. There are dozens and dozens of rumors that you may have heard, such as they’ve got the largest private art collection next to the Vatican, or they own more real estate. They make more money in real estate than they do in watches. Any of those things could be true. What I can say with the utmost certainty is that they will never reveal any of that to be true, even if it is. They’re not the type of brand, type of company that will ever stand on the rooftop and shout about anything. I mentioned this in the story that I wrote in 2015, whereas most brands, they’re trying to create stories where there aren’t any, a lot of brands will say a watch is in-house and you manufacture it in-house when it’s not. Rolex doesn’t do any of that. In fact, what’s so remarkable and I found this out on my own, doing my own research for that story in 2015, they will make several updates to products at some significant cost to themselves and not change the retail price and not even tell anybody about it and the only reason that I found out was when doing research for that story, I spoke to an independent watchmaker who is in New York City and is one of the best watchmakers in the country, if not the world, and he said, he works on Rolex, as well as other brands. These are the changes that they made to their movements without anybody knowing. By the way, these other brands that are communicating about LIGA, which is a manufacturing technique that allows you to have frictionless gears, a brand sent out a press release about that. Then, he came to find out that Rolex had been doing that for five years. It was in half their watches already. That’s what’s so wonderful about Rolex is they just are so remarkably Swiss. They are so conservative and thoughtful in the way that they communicate. When I wrote that story in 2015, I was one of the first journalists who ever be invited inside Rolex’s manufacturing headquarters in Bienne, Switzerland, which is what movements are made. They just are not out there to talk about themselves really ever. It’s incredibly charming. The luxury world is so much about Instagram and influencers and people touting how prestigious any brand might be and Rolex is just quietly the most prestigious…

…[00:19:39] Patrick: Maybe you can give us the, I don’t really care how long it is, as long as you want to make it because it’s so damn interesting, the history of Rolex, the brand and the company, its founding and its key timeline milestones.

[00:19:49] Ben: Rolex is younger than most other brands. It’s younger than Omega. It’s younger than Vacheron by 150 years. It’s younger than Patek. In the Swiss watch world, I wouldn’t call it a baby by any means, but not one of these grandfathers. I mean, Vacheron was founded in 1755. That’s older than the United States of America. Rolex was founded by a guy named Hans Wilsdorf, who’s Austrian, but he was a total anglophile. He really just was obsessed with the United Kingdom in the early part of the 1900s. He goes into the UK and starts a company called Wilsdorf & Davis in 1905. Back then, you have to remember that, forget digital watch making. Wrist watches were not a thing. The wrist watch was really a product of World War I, which was guys and trenches, trench watches, were strapping pocket watches to the wrist so that they didn’t have to pull out of their pocket. It was a little bit more complex, but that’s it at a high level. Wilsdorf, in 1905, decides to focus on wrist watches, which is crazy. I mean, it was a little bit, frankly like Elon Musk focusing on EVs 10, 15 years ago. People just weren’t ready for it. He committed to doing the wrist watch in the early part of the 1900s, 1905, 1908 and in 1908, he creates a company called Rolex. Again, there’s lots of hearsay on why it’s Rolex. I think at the very least it’s safe to say that he chose that word because it’s the same pronunciation in all languages. Some people say it’s the sound it makes. There’s no confirmation on that, but effectively what he does is he’s just the distributor. He’s not making anything from 1905 to about 1908.

In ’08, he buys a movement, which is what powers watch from a company called Aegler, A-E-G-L-E-R, which we’ll get back to later. They’re still around today, buys a movement, puts it in a case made by himself and sends it off to, it’s called an observatory, but effectively what it is, it’s a testing facility, effectively a nonprofit that says, these watches or time telling devices, clock, Marine chronometer or whatever, are accurate within, we’ll say X and Y, effectively saying, these are the most precise time telling devices on earth, typically done for Marine chronometers and if you know anything about this history of longitude, like that is effectively how longitude was discovered. This is just paramount to basically all exploration of the time period. Up until that point, no wrist watches had ever even been submitted to this thing called the QA, which is a British testing facility at that point. In 1908, he does that with an Aegler powered watch. It’s a 44 day test and it is given the QA certificate. Again, nobody had ever done it. Some years later, about 10 years later, he submitted 136 movements back to the QA. I think 24 of them were cased in 34 millimeter gold cases and then another 112 were in what we call boy size, which is really very small. I mean, at this point, it would look like a nickel, but these are effectively the formula one cars of watch movements. There were other watch movements at the time that to you and me and most people, would look exactly the same, but these were high performance calibers and they did it with a special escapement. Escapement is basically how time telling was regulated. These were effectively the formula one cars of watchmaking and they were done in a way that was very, even back then, very Rolex. There was really no indication that these were anything special on a dial, besides it would say QA on them. They’re around. You can buy them today for really less than you might think.

Once he had been given the QA certificates for the first wrist watch ever, he decided really to focus on three tenants of watchmaking, which really were not at all prevalent in that day at all, because it was really about utility. The watch can tell you the time pretty well or it was about luxury. At that point, we’re talking the Cartiers, Patek Philippes, complications, really. History tenants of manufacturing, which remain true to this day, would be precision, accuracy, waterproofness, which didn’t really exist at the time, and then self winding. What I mean by that is ability to not have to wind the watch manually. Precision was done. We’ve covered that. These watches were based on QA. They came up with a new escapement to make them more precise. Waterproofness, I think, goes back to the question you asked about five minutes ago, which is, how did you get something that more people know about that basically can afford or confine? He created something called the oyster case and now almost all Rolexes with the exception of the Cellini line, use an oyster case. That basically just means a waterproof case. Nobody was doing it at the time. Omega had something that was pretty close and actually predates the oyster case, but never really took off in the same way. Instead of using seals, it was almost like a locking system. It didn’t really take off, but effectively there was this woman named Mercedes Gleitz, who was a typist, of all things, basically a secretary in the UK and she had swum the English channel successfully, the first woman to swim the English channel successfully.

Hans Wilsdorf, the founder said, “Hey, wouldn’t it be cool if this woman, A, she’s a woman, B, she’s doing this amazing feat that no one had ever done before. Wouldn’t it be cool if she wore the watch around her neck?” She didn’t wear it on her wrist to be clear. She put her around her neck and she attempted to swim the English channel. She actually didn’t successfully do it. She failed, but nobody really cared because she had already done it before. He took out an ad celebrating the fact that this watch was around this woman’s neck for 10 hours in the English channel and the time keeping was flawless. That solidified Rolex as A, a household name because the oyster case had been validated in the English channel with this early brand ambassador, I guess you would call her. That was a huge deal and I think one of the earliest examples of real marketing by any luxury brand or any brand really at all, and then the final tenant would be self winding, which is, I would equate it to the automatic transmission. When the automatic transmission came around, all of a sudden, driving a car became a hell of a lot easier. It just became wider accepted, et cetera. Prior to, I guess it was around 19, I’m going to say, 30 something that Rolex patented the first self winding movement. To be clear, there was somebody called John Harwood that actually had a different self winding movement first. I think that was in the twenties and his idea was to make a hammer. Some of them would bounce back and forth like this to continue to power the watch. Rolex said, let’s go a different array. Let’s create a rotor, so a weight that would oscillate around inner circle to power the watch.

That worked and Rolex had, actually I remember the date. It was 1933 because it had a 20 year patent on it and Patek Philippe, which was another stall watch of traditional watchmaking, saw this and said, “Oh shit, we need to do that too,” but they couldn’t actually release anything until 20 years later because of the patent. The Patek 2526, which is their first self winding watch that came out in 1953. That’s a different thing all together, but effectively, Hans Wilsdorf said, “I want the watches to be precise,” check with the QA. “I want them to be waterproof,” check with the oyster case, “And I want them to be self winding,” check with the perpetual. If you see oyster perpetual on any Rolex, which you’d see in all Rolexes now, oysters are waterproof. Perpetual is the self winding. From there, Rolex went out to make watches and they were doing things very much in a similar style to everyone else at that time until the early fifties. In the post-war era, post World War II era, they created their first sports watch. By sports watch, the technical term is professional watch by Rolex nomenclature. It’s the Submariner, which is the diver’s watch, which is 1953. It’s the GMT, which is the pilot’s watch, which is 1955. Explorer I, which is an Explorer’s watch or an all day everyday watch, which is 53 as well. Then, you had the Daytona in 1963. Later, you had the Sea-Dweller in 67, which is a beef up version of the Sub. Then, the Explorer II in, I guess, 1970 or so. Those are the watches that I think most people now think of when they think of watch. You see rotating bezel in most cases. You see a black dial in most cases. You see an oyster bracelet, which is a very wonderfully produced bracelet with an oyster lock bracelet. That is really when things change.

To be clear, Rolex was not alone. There were other brands doing it. Some would say earlier, some would say around the same time, but the Blancpain Fifty Fathoms is credited to 1953. The Omega Seamaster 300 and 120 are around the same time as well. They were not alone and you have to remember that even Rolex in the watch industry in that period, it was really a smattering of different suppliers. If you look at, for example, and I wrote about this several times over the past few years, if you look at, say the Rolex Daytona from 1963 and the Heuer Carrera from 1963, it uses the exact same movement and I’m saying the exact same movement, and that’s a Valjoux 72. Same case maker, same dial maker, same hand maker. What is the actual difference? The assembly was done by Rolex and the assembly was done by Heuer, but the product itself was really very similar. If you look at early Seamasters and early Submariners, a lot of similarity there. The difference was of course the oyster case, but that was how watch making was done. If you look at say, example of Patek Philippe 2499, that’s based on a Valjoux movement. You don’t think of that. You think of Patek as Patek. This is the holy grail, but up until really, I mean the 2000s, they were using what you call an Ebauche movement, which is just really movement blank and then, it would be finished by Patek or finished by AP or Vacheron or whoever. Rolexes were really, I would say, finished to a higher quality than most, but I mean, any good Blancpain or any good Omega would do much of what Rolex was doing. It was really not until much, much later in the seventies first when we had the Quartz crisis, which is effectively the creation of Quartz, which is analog time, but with a battery, which is dramatically more precise, I mean, dramatically more precise than mechanical watch making.

What is interesting to think about, and I give full credit to my old colleague, Joe Thompson, who’s the legend in the watch writing world, is the Japanese came in with Quartz, Seiko created it, effectively, came in and there was a war between Swiss mechanical watch making and Quartz analog timekeeping. To be clear, the Swiss lost. The Swiss lost by a country mile. All of a sudden, those guys that were buying a Rolex or Omega or a Heuer, because they were the most precise thing in the world just said, “You know what” why would I do that? I can buy a Quartz watch that is 10 times more accurate,” 10 times, and by the way, you don’t need to have good service. You just swap out the new battery or whatever all the time and that decimated the Swiss watch industry to a point where very, very few brands were producing things at a profit of any kind. Jack Heuer, whose family owned TAG Heuer before it was TAG. It was just Heuer at the time. In his biography, I mean, he talks almost going into bankruptcy. If you talk to Gerry Stern, whose father Philippe Stern and his grandfather have owned Patek for generations. In the late seventies, they had to borrow with their bank.

[00:29:53] Patrick: It’s existential.

[00:29:54] Ben: Yeah, this was real. It wasn’t just the smaller brands. Patek had issues. Heuer had issues. Rolex was really smart in that, through that period of real turmoil when, I would say, their chief competitor Omega decided to make some Quartz watches, decided to make some funky looking things, Rolex stayed the course, and yes, they did make Quartz watches. The Beta 21, which was a Swiss conglomerates answer to Quartz, is the most expensive Quartz watch ever made. I mean like thousands and thousands of dollars, they said, “We’re going to focus on what we do best,” and the focus went away from precision and accuracy and time telling to luxury. That is when you start seeing the gold Rolex on, I hate to say it, but the used car salesman and the gold Rolex became the thing, seventies and eighties, opulence, you understand what the eighties were, of course. It just changed what Rolex was, but by the way, it worked and it allowed them to continue to be relevant when everybody else being Omega, Patek to a degree, Vacheron, these brands really struggled. That is why so many of them ended up in conglomerates. In the eighties and nineties, when watches were, mechanical watches, were really not doing so hot, a lot of folks came in and bundled them all up. Richemont owns a bunch of the great ones, including Vacheron. Swatch owns everything from Swatch to Blancpain, Breguet, Omega. It was a time of great challenge for sure. Rolex, they struggled as well, never to the degree that the others did, but it was not great for them. Then, the nineties started to come around and Rolex had a CEO by the name of Patrick Heiniger. His father was actually also CEO too, to give you an idea of how things work at Rolex. And he said, “I want to take Rolex in-house,” and he was really the first to do, frankly well before Patek or well before anybody else. Rolex was using 27 different suppliers to make, say, Submariner.

After he was done with it, they’re using four and now, those four are completely owned by Rolex. There are four different production facilities, two in Geneva, one in, what I would call, Proper Geneva one and Plan-les-Ouates, which is a little bit outside and then there’s one in Chêne-Bourg, which does dials and there’s one in Bienne, which makes the movements. What’s so amazing is, Rolex, to me, the secret sauce is equal parts case, equal parts movement. The case is, you can reverse engineer if you’re a competitor and say, “Okay, what’s an oyster case? It’s got this. It’s got that. It’s polished there. Seals are done by X, Y, and Z.” Movements are a different thing entirely. And what’s amazing is Rolex Geneva, which is basically dials, cases, bracelets, all that stuff, and Rolex BN, which is up in the mountains in Vallée de Joux, had a handshake deal for 70 years. And I mean, an actual handshake deal that the calibers made by what was then called Aegler, who made the first movement for Hans Wilsdorf, that company was making movements solely for Rolex Geneva based on nothing but a handshake. And I mean that literally. There was nothing in writing up until 2004, which is just insane to think about. I mean, Rolex was certainly a multi-billion dollar a year business before then. And up until 2004, there was no contract in place to say that Aegler couldn’t make movements for Omega or TAG Heuer or whoever. And so in 2004, Rolex said, “You know what? Enough’s enough. Let’s get married here,” and they purchased the company. And so now Rolex BN is basically what Aegler was up in the mountains until 2004. And so Rolex now has four different production facilities. As I wrote that story, I was among the first to be invited inside the movement manufacturing, which is really the source of the IP. That is where the sausage is made, so to speak. Just remarkable. If you haven’t read the story, it’s on Hodinkee called Inside The Manufacturer: Visiting All Four Rolex Locations. It was remarkable. As I started out in that story, this was 10 years ago or seven years ago, I was a lover of watches.

I was a lover of Rolex and I had four Rolexes then than had anything else at that point. None of them were as old as I was. They were all considerably older than me. And it’s funny, I reread the story to prepare for this interview. And now since then, I’ve bought more modern Rolexes than I have vintage. And the world is just a different place. But once you see everything that Rolex does to a watch, and what I mean by that is the fact that they have their own foundry, even the steel, not just the gold and precious metals, even the steel on Rolex is proprietary and it’s made by Rolex. It’s 904L. It’s wild. They make their own gold. It’s called Everose if it Rolex gold. It’s just remarkable. And what I think is even more telling of what Rolex is about is that one of their facilities they actually have, and I mean this literally, more than two Nobel prize-winning scientists on staff working on watches. Think about what that must mean from a material science perspective. The innovation done by Rolex is just above and beyond anything I’ve seen. I’ve been to every watch maker in the world. I’ve been to several car manufacturers doing this. I’ve been all over. I’ve been inside Hermès. There’s just nothing like this. They create machines to test their machines that make watches. They have their own oyster test, which of course provides artificial pressure on a watch to know that it’s waterproof. They have a machine that can open and close a Rolex clasp a thousand times a minute, which is kind of amazing, because you actually have to open. It’s wild. So, you open this. It’s actually kind difficult to do. Imagine doing that a thousand times a minute. They invented a machine to do that. They have a machine in Chêne-Bourg, which is their dial and gem-setting location, to sort through all the stones that they’re given. First of all, Rolex only works with IF, which is internally flawless stones, which is obviously the most expensive, highest end. To ensure that the stones that they’re given, whether it’s diamonds or rubies or anything are real, they created a machine to sort them at scale and ensure that all of them are real. And I said, “Well, are bad stones or fake stones are real problem for you?”

They said, “No, not really. But we just want to ensure that every watch we sell is what we want it to be.” And I was like, “How often do you get a fake diamond or a fake anything?” And the answer was, “One out of 10 million.” To be clear, this machine was created either by them or they paid somebody to make it for them. This is their machine. It’s not like it exists outside Rolex. And this gives you an idea of what they’re about and how they do things. And it is so wonderful and so different than traditional luxury, which frankly, I may say, even as a purveyor of luxury items, is full of shit half the time. I’m into sneakers, but not in the way that I’m into other things. Why would a pair of so special edition sneakers sell for $5,000? Sneakers are made in China by machines. They’re hand- stitched here and there. It’s just designed. It’s artificial scarcity, et cetera. When you see what goes into a, really, any high-end mechanical watch, but in particular Rolex, you really start to understand. The Submariner, we’ll say, is 8,000 bucks. That might be a deal after you see what goes into this thing. And I mentioned in the story, several competing brand presidents had told me before I went on this trip that, “Oh, not a human hand touches a Rolex before it’s made. It’s all done by machine.” Which is effectively the most insulting thing a Swiss person can say, meaning that it’s void of character. It’s void of humanity. It’s like luxury should be about people. It should be about craftsmanship. And they’re saying, “Rolex doesn’t have any of that.” And I was like, “Oh, okay. That’s kind of a bummer.” That may have informed why I didn’t own any modern Rolex at the time. You walk into Rolex HQ in Geneva and you see hundreds of people finishing watches. And they’re not finishing in the same way Patek or Lange would, by hand with little pieces of wood. They’re finishing maybe six or seven Rolexes at a time on a polishing wheel, but they’re still polishing really the way that it should be done.

They’re assembling dials by hand. They’re assembling the bracelet by hand. There’s an incredible amount of hand work that goes into the most basic of Rolex, being like a Submariner or a Datejust. Beyond that, what’s so fun about them is they know exactly how different they are than everyone else. They also know that everyone wants to be like them. So, at at least two of their four facilities you might drive by and say, “Oh, there’s Rolex. It’s five stories high. It’s, I don’t know, a few hundred thousand square feet.” When you go inside, you realize that it’s actually 10 or 11 stories high, but five or six of those stories are below ground. And I just remember thinking, “Why would they do that? What’s the point of that?” And it was in fact to suggest to anybody that drives by that Rolex is smaller than they actually are. And I think if we had any idea of how big the foundation was, it would blow all of us away. I think it’s enormous. I think they’re probably producing more than a million a year, but that’s the generally accepted number. It’s who they are. And if they’re going to do something, they want to do things at the highest level. I’m a golfer and have been lucky enough to meet some of their players. And Adam Scott became a good friend and I asked, “Why don’t you sponsor X, Y, and Z?” or, “Why don’t you go grassroots?” Whatever. And they said, “This is Rolex like my golf. If we’re going to do golf, we only want to be involved with the majors. So, the US Open, the BJ Championship, the Masters, and of course the British Open. And that’s it.” If they’re going to do tennis, it’s going to be Wimbledon and the US Open. They don’t even want to mess with some of the other majors in tennis. It’s just remarkable how committed they are to working with the very best. It’s wild. It really is.

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