5 min read

Frequency Analysis #2


The big headline, if not news, this week was Fitch Ratings agency downgrading US Debt from AAA to AA+. If you read the press release, you can see their reasons (governance, deficits, interest rates, recession risk) are not anything new. The logical question is then, why now? What everyone is saying is that it's political, but what nobody is saying is that the timing was apolitical. We are just under three weeks from the first primary debate. Big news stories tend to last one week. Anything Fitch does in the next two years will be deemed an attack on the incumbent or a statement about the president elect.

The non-news is precisely the news here. Pundits, government officials and journalists were up in arms about the downgrade. The fundamental complaint is that Fitch made a binary decision (publish or not) about a continuous problem (deficit grows a bit each year), but as everyone knows, frogs hop out of boiling water. Turns out they don't, and that's exactly the problem! If you drop a frog into boiling water, it dies. The frog in hot water needs to make a binary decision (hop or not) before a continuous process (heating water) becomes a binary one (phase change). Lots of risks are binary, and our warning systems require a threshold, even if its an arbitrary one. The bigger question is, "You're a frog in a hot bath. You look around at the other pots. Should you hop over?"

Compare the US economy with any in the world, and then tell me you're worried about the Fitch downgrade. Jamie Dimon, CEO of JP Morgan, is getting a lot of coverage for calling the downgrade "ridiculous," but he also makes the point that countries with AAA ratings, like Germany, Norway and Singapore, all rely on the American security guarantee. He actually calls it the "American enterprise-military system," which is a great turn of phrase.

So do I think Germany, Norway and Singapore are more likely to pay back their debts than the United States? Yes. These are countries that fetishize rule-following to an extent that they have rules for when not to follow rules. Do these countries depend on the American enterprise and military? Certainly. Is it the job of rating agencies to raise concern and ask uncomfortable questions. Absolutely. Everything is working as expected.

If you need any more confirmation that Europe has not been a better investment than the US, here's a story about the 14 year low in European IPOs. The war with Russia in Ukraine has clearly put a cloud over European markets, but this isn't just a story about geopolitical risk and an economic systems in decline, it's also a capital markets and technology story.

First, it's a capital markets story because there are European IPOs, just not in Europe. British chip maker Arm notably picked the Nasdaq for its listing earlier this year. Arm, one of Europe's largest technology companies (about half as big as German enterprise software firm SAP, which is half as big as ASML a Dutch robotics supplier to the semiconductor industry), is the rare exceptional tech company.

Arm is so rare in European tech circles, that it the exception that proves the rule. A company born of scientific enlightenment, with few natural resources and people, but globe spanning in influence, Arm is an apt analogy for the U.K. The company traces its roots back to a collaboration between Apple Computers and Acorn Computers, a British competitor with a leg up in chip design, but an unhappy Italian owner. So Apple helped Acorn exit the computer business and get into the chip design one. In one sense, Arm is just coming home after a long European vacation.


Speaking of semiconductors, Citi released it's Quantum Computing report calling the 2020's the decade of quantum advantage. They predict that by 2025, useful quantum computing (QC) applications will emerge. They base this on the continued compounding of Moore's law and recent software advances to tune the highly unpredictable output of QC. They claim that quantum advantage will mean such sweeping changes in machine learning, optimization, cryptography and simulation, that we must begin preparing now.

This is likely true, and like the Fitch rating news the threshold is arbitrary. The paper has some great interviews and examples of what it all means for fields like AI, cybersecurity, energy storage and risk management. Still, it feels like this report has been in the works for a while with Citi waiting for a news story to break.

The potential superconductor LK-99 is just such a story. One of the most obvious applications of a room temperature superconductor is cheaper and easier QC, among energy, transportation, and many other utopian uses. I alluded to this possible breakthrough in my piece on progress, earlier this week, saying I'm no expert on materials science, and three days later... I'm still no expert. So like Fitch and QC, I'm facing a binary outcome (LK-99 works or not) with a continuous amount of data mounting day by day. One way to infer a threshold is to look at betting markets:

Was the discontinuity in August real or a false alarm? July 25th shows a highly volatile market, likely due to few traders. Then a slow build up (did people know something others didn't?) until the pop of August, exactly timed to this viral tweet linking to a paper giving theoretical weight to the experimental claims:

The betting market it still substantially elevated, but well off the highs of August 1st. I'm cautiously optimistic, and the more I read, the more I am aware of my physics ignorance. Between the doomers and the viral videos is one outcome that seems to be most likely to me, the experiment is real, but commercialization will be hard. Empirical evidence (true or false), papers (accepted or rejected) and tweets (viral or not) are binary, but utility is mostly the continuous effort of many over time.

One area the QC and LK-99 story would have big pros and cons is cryptography. On the pro side, we'll have much more powerful computers and new algorithms that will greatly improve accuracy and descriptiveness of anomaly detection in network traffic, device behavior and fraud. The big con is the weakening of current encryption technology, but keep in mind that the bad guys use encryption too!

One way bad guys use encryption is ransomeware. My standard take on ransomware is that, like national defense, it's too big a job for any company and should be provided as a public good. Recent efforts by the US Federal government has born that thesis out with ransomware attacks down across the board. While it may be good news on the whole, it appears that ransomware targeting critical infrastructure is up. With QC, the resources and capabilities required for defense will be the domain of nation states, making it even more necessary for public defense.

An increasingly related risk to ransomware, is bioweapons. As labs, knowledge and know-how become more and more decentralized, bioweapons become more like cyberweapons. One example of this is the recent shuttering of an unlicensed bioweapons lab in central California. Not much is known about the lab and the organization running it, but China is suspected, which makes the news even more alarming.


On the front lines of the American enterprise-military system are Ukraine and South Korea. It makes sense then that the South Korean defense industry is benefitting greatly from weapons sales to NATO countries. As nation state technologies like QC and superconductors bring great new benefits and risks, decentralization increases the number of threat actors. Strong states therefore are becoming even more crucial to maintaining stability.

One such counter example to strong states is Niger, where a recent coup may be causing greater regional instability. Russia is accusing France and the US of propping up the previous government for energy and defense purposes, respectively. The irony is that some of the coup leaders were US trained, although this is far from the first time the US has been bitten by the mouth it is feeding.