In my last blog I wrote about the immediate need for helicopter money and coordinated fiscal stimulus from governments around the world. Since then the US administration announced a $850bn stimulus package. I would like to share some numbers to put the figures being proposed by US political leaders into context.

The GDP of the United States was $21.4 trillion in 2019. This means that on average, the US produced a GDP of $1.8 trillion/month in 2019. Obviously, even with all the measures put in place in response to the coronavirus, we are very far from having shutdown the entire economy. But what percent of the economic output has been impacted by the partial shutdown and economic disruption?

To give us an idea, we can actually use the latest economic data shared by China yesterday. According to the National Bureau of Statistics, industrial output in China tumbled by 13.5% in the first two months of the year. As per the Financial Times, the same data also showed that retail sales plummeted 20.5 per cent year on year in January and February, and fixed asset investment fell 24.5 per cent. Services production also declined by 13 per cent in the first two months, and coupled with the industrial production figure, Capital Economics estimates that Chinese GDP contracted by 13 per cent during the first two months of the year. (Source: Financial Times, Chinese economy suffers record blow from coronavirus.)

However, while the data above suggests a 13 per cent drop over two months, it is important to note that China only went into full lockdown on January 23^rd. Considering that February is a shorter month, the contraction primarily corresponds to a period of thirty-seven days. Putting this into monthly terms, a reasonable assumption is that China’s economy contracted by 10.5 per cent on a monthly basis during the lockdown period.

Taking this 10.5 per cent number and applying it to the US monthly GDP of 1.8 trillion, we see that the GDP impact of going into shutdown for one full month is about 190 billion dollars, or close to one percentage point of annual GDP each month the shutdown is in place. This sort of math is of course way too simplified, but it helps give a directional understanding, and it seems to imply that by proposing a $850bn stimulus package the current US administration is looking to make up for about three to four months of lost output from slowing down economic activity in response to the coronavirus.

What the numbers do not take into account is follow on disruptions that may be caused as people lose their jobs or companies have to go out of business permanently. It also does not take into account any disruptions from stress building up in the financial system such as the repo or commercial paper markets. Nonetheless, one can only hope that it will inject markets and people with a sense of stability. The delivery mechanisms will also be key, as the stimulus needs to reach the people and businesses that need it most in an expedient manner.

The most important thing to note here however is that the US is far from the only country impacted by the coronavirus. The GDP of the EU is close to $20 trillion, and their economic output have certainly been exposed to the same sorts of unprecedented shocks. Hence, it will be very important that other governments continue to take similar fiscal measures in the coming days, and do so in a coordinated manner.

We are living through unprecedented times. Never before has the global economy been this interconnected, and never before have the seven billion plus souls that inhibit this planet changed their collective behavior so suddenly and so dramatically.

The global wave of fear that the COVID-19 virus and the associated media coverage has unleashed has created a tsunami of reactions, with borders closing, factories shutting down, and both the demand and supply side of the economy going into what can best be described as shock.

The health and safety of the world’s citizens should be priority number one, and I would first and foremost like to express my eternal gratitude to the nurses, doctors and medical workers who are working on the frontlines of this pandemic to the point of utter exhaustion, putting their lives at risk on a daily basis to save ours. We are deeply grateful, and words are not enough to express the importance of the work that they do for all of our collective safety.

As for the global political response, I am neither a scientist nor an epidemiologist, so I will not get into the controversial topic of whether the response from the various national governments of the world has been an overreaction or an underreaction.  I would however like to point out that in times of crisis, coordination and solidarity is paramount, as is staying calm and levelheaded. Politicians globally face no easy choices in the coming weeks. It is the job of our leaders to make these incredibly difficult choices, always putting the good of society and the health of all the world’s citizens as the top priority. Sometimes the right choice might not be the most popular one, and it is the job of the leader to make that right choice in light of scientific knowledge and the long-term welfare of society. Open and honest communication that also prioritizes keeping the population as calm as possible will be key.

While nothing can be more important than preserving people’s physical health and wellbeing, I would like to focus here on the economic consequences of what we are going through. I will not go into the numbers here, but the analogy with regards to the global economy that comes to mind is a big airliner that has shut its engines in midflight. We now need to restart the engines and land the plane safely.

The Fed has announced that it has cut its rates to zero percent, so it is fair to say monetary policy is stretched to its maximum. However, while this will undoubtedly help, it will likely not be enough.

Given that the global economy faces an unprecedented challenge, global policy makers now need to focus on unprecedented economic responses. Given that the shock is driven by both the supply side (factories shutting down, supply chains breaking down) and demand side (consumers not spending money and postponing most purchase decisions), governments will have to take swift steps to address both sides.

One such step would be what is known as “helicopter money” a term attributed to a thought experiment performed by Milton Friedman, where a helicopter drops money that is directly picked up by the people. One key condition of his thought experiment is that everyone is convinced that this is a unique event that will never be repeated. This thought experiment has since been picked up by economists as an alternative (or supplement) to monetary policy including quantitative easing. Its proponents argue that it can be a very efficient way to increase aggregate demand, especially in what is known as the liquidity trap – or central banks reaching the zero lower bound on interest rates.

The proponents of this tool include Ben Bernanke, who has in the past stated that helicopter money should be on the table as an alternative of last resort.

In practice, there are clearly many ways in which helicopter money can be implemented. The spectrum can range from tax credits to individuals and small businesses (the mildest form) to actually transferring money directly into their bank accounts (basically a sort of temporary Universal Basic Income for the duration of this crisis).

Given the severity of our current crisis, I think policy makers need to immediately start assessing the various delivery mechanisms and preparing an action plan as soon as possible. The best option in today’s circumstances is likely to be one where small businesses and consumers get money put directly into their bank account. While the cost of this will undoubtedly be high (using a simple example, giving forty million people GBP 1,000 per month equates to a cost of forty billion pounds for each month that the policy is in place).

However, if the benefit is to prevent a total breakdown of the economy, the cost may be very worthwhile indeed. The delivery mechanisms will also be key, and alternatives that help small businesses stay solvent also need to be considered. This can take many forms including a forcing mechanism to direct the helicopter money to be spent immediately, or other direct assistance to small businesses, including payroll support where the money in effect gets delivered via business payroll. One big benefit of this would also be to give consumers one less thing to worry about. Everybody is clearly very worried about their physical health and wellbeing, and adding financial worries on top of this only increases the level of stress.

Finally, it is also important to point out that one big benefit of helicopter money is that it would create less inequality and would thus help maintain social stability and cohesion in trying times. Quantitative easing primarily gets delivered via the banking system and tends to flow towards house prices and stock prices, which then tend to leave behind people that cannot afford to own a home or buy stocks.

We need to remember that (God willing) this too shall pass, and once it does, we want to wake up to societies that have made it through these troubling times with their heads held high, in solidarity with their fellow people and neighbors, and without sacrificing the fundamental values on which we have built our civilization.

In my last blog, I mentioned the slightly disquieting and amusing fact that your money does not exist. People usually have one of two reactions to this statement. If they are an economist or a student of the modern banking system, they say “Yes, so what?” whereas if they are part of the remaining of 99.9% of the population the reaction is usually a mixture of “What have you been smoking?” and general disbelief.

The easiest way to prove the point is to use a simple example, and here it goes. To illustrate that this is not directly related to the digitalization of money which is a separate issue (i.e. paper vs. digital money), let’s consider a bank in an economy that only uses paper banknotes.

In this paper money based economy, imagine Customer #1, who now goes to a bank to deposit her $1,000 in banknotes. The bank happily accepts her money and gives her a little paper ledger that shows an account balance of $1,000 (effectively the bank now owes her $1,000). Our trusting Customer #1 may be thinking of her banknotes living a comfortable existence deep down in a secure bank vault, the equivalent of money heaven.

However, in reality, the bank is much more than a simple safe or a vault for locking up banknotes. The bank needs to make money as well, and to do so, it takes the vast portion (let’s use 90% for illustrative purposes) of Customer #1’s money and lends it out to Customer #2.

Now, Customer #2, who we can imagine to be a bread maker, takes the $900 the bank lent him, and sets out to use his $900 to buy himself a new bread oven for his soon to be opened bakery. Hence, Customer #2 goes to Customer #3 (who happens to be a bread oven maker) and gives him the $900 in exchange for the latest model bread oven.

Customer #3 who sells bread ovens has no interest in putting his money under his pillow either. Hence, he takes his new $900 and goes back to the bank and deposits it. The bank gladly accepts the money and gives Customer #3 another paper ledger that shows his account balance with the $900 on it (so the bank now owes him $900).

Let’s take a little break here and consider how the situation and all the various ledgers look. The bank only has $1,000 in its safe, but Customer #1 has a ledger that tells her the bank owes her $1,000 while Customer #3 has a ledger that tells him the banks owes him $900. If they both were to go to the bank to withdraw all their funds (a total of $1,900) the bank would have to tell them that all the money is not there.

So what gives – where is the money? Of course, the short answer is that the bank has $1,000 in cash, while Customer #2 (the bread baker who took out a loan), owes the bank an additional $900 that he will pay back with the profits from his soon to be opened bakery shop.

Of course it does not stop there. Once Customer #3 (the guy who sold the bread maker the oven) puts his $900 into the bank, the bank once again lends out a big portion (let’s again use 90% as an example). Hence the bank takes $810 and lends it out to Customer #4 who uses the money to buy bricks to build herself a new house, etc.

I’ll spare you the math and the repetitive examples, but when all is said and done, the bank is left with $1,000 in capital (cash in the vault), while the sum total of all the money in the customer’s ledgers is actually $10,000. In other words, Customer #1, Customer #2, Customer #3, etc. all collectively think they have $10,000 of cash in the bank, whereas the bank in reality only has $1,000. Hence, the bank has created $9,000 of “imaginary cash” that does not exist, except as a collective belief. (My math here is only directionally correct, as the real-life computations are complicated by centuries of banking and accounting regulations and customs.)

One implication of this this is that banks are vulnerable to “bank runs” that occur when people for whatever reason believe a bank is no longer trustworthy (this kind of panic can occur for any reason but usually involve rumors about the bank’s viability). This creates a self-reinforcing herd behavior where all the customers go to the bank to get their money out simultaneously. As even the healthiest of banks would not actually have all this money as we saw above, long ques form up in front of the bank which make the bank run worse, resulting in a vicious cycle that ends with the bank going bust, and the depositors losing their money.

It is for this reason that government support and the associated regulation is crucial for banks. To prevent bank runs (which otherwise would occur quite regularly), the government steps in and informs everybody that they guarantee everybody’s money up to a certain amount (the money still does not exist by the way, but the government has the power to print new money if push came to shove – this of course would create inflation but that is a whole other story). But at least the government guarantee inspires confidence and makes bank runs less likely.

So what is the relevance of all this for entrepreneurs and operators in the fintech space? One big implication, especially for those longing to one day become regulated banks, is to realize that they cannot become one without accepting the protective embrace of their respective governments and bank regulators. And that protective embrace can easily turn into a smoldering bear hug if the regulators think the bank is not being run as it should be. Hence, while becoming a bank may sound tempting, know that it comes with the full weight of history and banking regulation behind it.

After all, everything, even creating imaginary money, comes at a cost.

Speaking to my friends that work for some of the big multinational banks, a comment that I have heard on more than one occasion is that they do not want to become the “dumb pipes” on which the financial system runs. For those of you outside of fintech and banking circles, the argument goes something like this: “Banks are getting bigger and increasingly more regulated, open banking is yet another regulation that forces us to give access to our customer data, enabling others to build products on top of our infrastructure while we become the pipes of the financial system, leaving banks to do the plumbing while fintechs steal our customers and capture all the riches and glory.”

While I cannot speak on behalf of big banks, looking back at history I am not sure that being the piping is such a bad thing. In fact, going back no further than the start of the last century, we can see that just like today’s headlines are dominated by the monopolistic power of big tech, the most pressing business issues in the early 1900s were around the dominance of the big “robber barons” that literally controlled the rails and piping of the emerging modern economy.

The first example that comes to mind is usually John D. Rockefeller, widely regarded as the wealthiest American of all time, (and possibly the richest person in human history) with his wealth worth nearly 2% of the US GDP at its peak. And while controlling 90% of the US oil and kerosene market in one of the most infamous monopolies of history was the key in paving his way to such riches, Rockefeller was equally focused on controlling the pipes through which this oil would flow. The first pipeline to carry oil was pioneered in 1863 by Samuel Van Sycle (the importance of this quickly became apparent to the Teamsters union who proceeded to try and destroy the pipeline which would take away their jobs) and it was not long after that in 1872 that Rockefeller had already bought United Pipe Lines, and by 1876 Rockefeller already controlled half of all the pipelines in the United States.

So Rockefeller certainly did not think of pipes as being “dumb” and neither did some of the other robber barons of the gilded age. In fact, when Rockefeller moved to New York in 1884, his 54^th street residence was next to the mansion of William Henry Vanderbilt, whose father Cornelius had built up a vast family fortune with their railroad empire (not quite at 2% of GDP, but close).  

There are clearly analogies here for our data driven economy almost two centuries later, and I am not just talking about the odd similarity between the oversized moustaches sported by the robber barons and Super Mario, the smart plumber of the digital age.  The twenty-first century economy runs on data, and those who control the rails and pipes on which data flows can exert huge profits and influence. Whereas oil was referred to as the “black gold” of the gilded age, data is now the “cyber gold” of the information age. The importance of this is very clear in everything from Angela Merkel’s focus on how Europe is lagging behind the US and China on data platforms, to the fact that Mark Zuckerberg is making increasingly frequent trips to Capitol Hill. It is worth noting that over the last couple of centuries Zuck seems to have replaced the moustache with a hoodie, but the lack of gender diversity has not changed as dramatically as fashion has in the top billionaire ranks.

So how does this relate to the world of fintech and banking? For one thing, if I were a bank, I would be much more worried about not being the pipes versus vice versa. And rather than worrying about customers controlling (and being able to grant access to) their bank data with fintechs building new and innovative products using that access, I would worry about big tech companies such as Google or Tencent becoming the new pipes that power financial transactions.

The other lesson that banks today can glean from Rockefeller’s playbook was that in addition to his focus on using the pipes to gain a competitive advantage, one of his other business strategies was to standardise the kerosene and oil that he sold. (He did not name his company Standard Oil for nothing!) In fact, the combination of owning the pipes and gaining huge economies of scale resulted in the price of kerosene dropping by nearly 80% over the life of his company, while the standardisation resulted in improving the quality of the kerosene.  

Standardisation has huge benefits, and just like the advent of containerisation dropped costs in logistics (moving the same amount of break-bulk freight in a container is about 20 times less expensive than conventional means), the advent of APIs today enables data to connect faster and orders of magnitude cheaper. In fact this sort of API-fication of data transmission is a leading driver of newly emerging fintech businesses such as Railsbank and Fidel API, both innovative companies founded in London with a global reach, and both very much happy to be the pipes that drive the innovation of other fintechs.

Bringing together banking and pipes in a final anecdote, I’d like to share a story that used to circulate in New York some years ago. In this story, a wealthy banker from Manhattan is organising a big party in his Hamptons weekend house, and hours before the guests are due to arrive, the plumbing in the house breaks down, flooding all the bathrooms. Desperate to get it fixed quickly, the banker calls a plumber who shows up immediately but gives him an astronomical quote to fix the pipes in short order. Shocked, the banker tells the plumber, “I am a banker and even I don’t make this kind of money!” To which the plumber replies, “I know, I used to work on Wall Street as well, but I decided to become a plumber.”  

One does not have to browse for too long in today’s news headlines before encountering a story about how machines are replacing a lot of the jobs that used to be done by humans. These stories usually come with dramatic headlines, and for an avid reader of science fiction such as myself, it feels like the next step may actually be Isaac Asimov’s vision of humans starting to develop romantic relationships with robots, or robots taking over the task of raising and nurturing our children (arguably some parents have already started taking this leap with iPads).

While it is hard to predict when the first romantic relationship between a human being and a machine may occur (for the record, in a story that he wrote in 1953 Asimov predicted that the first self-driving car would be created in 2015, and romantic relationships were just a few decades behind – so watch out!) it is clear that machines have already started to take over a lot of the jobs that people took for granted, and this has clearly caused a profound level of stress in people that are being replaced by efficient (and more effective!) machines.

As an investor in technology driven companies, I have to admit that this triggers two conflicting emotions in me: On the one hand, it is impossible not to worry about all the disruption that society will be going through with this tsunami of technological change, while on the other hand one gets quite excited about all the new possibilities that the new technology enables.

So, will we ever be able to constructively deal with our own creations becoming better than us at what we do? In an attempt to gain some insight, I decided to read a book that I thought would be relevant in this context: “Deep Thinking” by Garry Kasparov, which is a first-hand account of how the then reigning world chess champion Kasparov came to terms with being beaten by a chess playing. With the whole world watching intently, Kasparov was decisively crushed by IBM’s Deep Blue in 1997, and thus became one of the most well documented case studies of machines trumping humans.

Based on Kasparov’s public statements after the match, as well as the general media coverage back then, it would be all too easy to conclude that Kasparov did not take the defeat very well!

However, with the benefit of twenty-two years of hindsight, it is amazing to see how Kasparov has come to terms with his loss. Everybody should certainly read his book to find out for themselves, but one key insight that stands out is that humans can actually partner with machines to beat computers at their own game. In his book, Kasparov has some rare tidbits, one of which includes Kasparov’s Rule: Weak Human + Computer + Strong Process is better than Strong Human + Computer + Weak Process. In other words, we as humans can beat just about anyone as long as we know how to employ data crunching computers on the one hand and smartly designed processes on the other hand.

So how does this all relate to the world of finance and fintech? While Kasparov was a very publicized example, it turns out he was merely the canary in the coal mine, as what happened to him soon started happening to others. Brokers, traders, accountants and all sorts of finance professionals started being impacted, not to mention other industries such as travel agencies and organized retailers. The accounting example in particular is interesting for us at QED, since we believe that there is great opportunity in the midst of all this disruption in an area we know particularly well: small business lending.

Just as Kasparov was able to see the silver lining for the world of chess in his defeat, cloud accounting software and bookkeeping automation has opened up new horizons for the accountants of the world. Rather than seeing a job being taken away, they can now see it as an opportunity to start focusing on how to devote their energies on advising their business clients on other important finance related questions beyond just balancing the books. Obviously, the most important such question is to how to grow their business, which in many cases relates to funding, something that is not always easily accessible for a small business.

One of our investments in particular, a London based fintech startup called Capitalise, has tackled this opportunity head-on, by creating a platform that connects the hundred thousand plus accountants in the UK with finance providers, hence enabling these accountants to do what community bank branch managers used to do fifty years ago – advise entrepreneurs how to fund and grow their business. And the timing could not have been better! As bookkeeping was being automated, thousands of bank branches were shutting down, leaving their small and medium sized business clients with nobody to talk to on important questions like what kind of funding solution to use to finance the future growth of their business.

Hence Capitalise takes the challenge created by what seems like a disruption and turns it into a win-win-win solution: Accountants can focus on providing higher value-added corporate finance advisory solutions while machines do the bookkeeping, the small businesses that had nobody to talk to about growth & funding (with neighborhood bank branches closing down) can now talk face to face with their trusted accountants, and all the alternative finance providers and banks that have less branches or a reduced physical presence can now access thousands of small businesses via trusted accountants that help create positively selected loans (i.e. much less risky loans – it turns out Capitalise accountants consistently create loans with much better credit quality). And while doing all this, Capitalise is certainly adhering to Kasparov’s Rule, utilizing smarter processes as mentioned above.

So here is yet another example of how one technology platform can help mitigate some of the disruption that other technologies are creating. While an automated bookkeeping software can only tell you how much money you spent exactly last month, a human accountant, supported by Capitalise’s platform, can actually help a business owner ask the right question: What kind of financing is right for my business?

To take a quote from Pablo Picasso that Kasparov also references in his book: “Computers are useless. They can only give you answers.” Only truly empathetic and intelligent beings know which ones are the right questions to ask.