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It is December 3rd, 2021 at game 6 of the World Chess Championship where challenger Ian Nepomniatchi is taking on Magnus Carlsen. Game 6’s are known for being explosive and iconic, but this game began rather innocuously with a conservative opening from the world champion. During the midgame, Ian felt that the position might be slightly favored for him, but the computers and everybody watching saw the game as a dead draw; everyone except Magnus Carlsen. On move 25, Magnus sacrifices his queen for both of Ian’s rooks, a sharp, but advantageous trade. Still, the computer believes it is a dead draw. What followed from this point was several hours of frankly unremarkable chess until move 115 where the last of Ian’s pawns is traded off leaving just his king and queen. Magnus at this point has no queen, but he does have counterplay with two pawns on the e and f file as well as a knight and a rook.

One thing to note about this position is that it is solved, meaning that we know what the result should be with perfect play. In this particular position, the way to make a draw is to position your queen on the long diagonal in order to cut off the pawns and prevent them from reaching the end of the board. This is the one and only way to for Ian to make a draw. Ian plays out the endgame without knowing this and so, with each move he makes, he leaves less drawing options for himself on the next move. Maybe at move 115 there are 8 possible moves that could lead to a draw, but by move 130, there are just 2 moves that draw, and Ian plays neither of them. Magnus Carlsen ends up winning the longest game in World Championship history by squeezing water out of a stone and pushing a completely even endgame into a victory. 

There are many interpretations of this game, and it deeply pains me to skip over the intricacies of the middlegame, but the lens that I see this game through is the economic lens of path dependency. Yes, it is true that even with the difficult endgame position, Ian had chances to draw, but the decisions that were made earlier in the game complicated the drawing chances. Of course, it is easy to criticize the 130th move that Ian made as the losing move, but if the early, middle, or early late game were played differently, Ian wouldn’t have been dependent on finding the only drawing idea on the board. The decisions that were made previously affect the decisions that need to be made, or can be made, in the future. History matters.

Path dependency is the idea in economics that the decisions made in the past have a sort of inertia which carries into the present day. How we arrived to the present determines how the future plays out. For example, when it comes to technology adoption, humans find it difficult to replace currently used systems. While it might be true that a currency that exists entirely on the blockchain would be more efficient and easier to use for the average consumer, we have a certain inertia that makes the decision to use cryptocurrencies a dubious one. Decisions in the past to adopt a hard gold standard, then a soft gold standard, and now a fiat standard, have affected the way that money is thought about today. In fact, the currency example is a very telling one because most people do not think deeply about the currency they use. We have decades and decades of precedent for using dollars without thinking about them, making dollars a completely entrenched system. I have used dollars my whole life, so have my family members, and so have the members of my community. The information that I have interacted with about currency is rather limited, and none of it has been able to override the entrenched feelings about dollars that we are all used to. 

If there is one human who must deal with the concept of path dependency the most, it is likely Chair Powell who has the final say on Fed policy and how the agency plans to tackle inflation. For those of you who read or listen to Chair Powell’s words, you will know that he speaks ad nauseam about making sure that inflationary expectations do not entrench themselves in the economy. Why? Because, in the same way that use of dollars has been entrenched in our minds, so too can the expectation of rapidly increasing prices be entrenched, making the task of squeezing inflation completely out of the economy next to impossible. The Fed also must deal with the reality of path dependency in their own decision making as well. A so-called “soft landing”, in which the Fed successfully calms inflationary pressures while not plunging the economy into recession, is very unlikely. But, why? Just like Ian Nepomniachti made decisions in the early game of his chess match that made his endgame more difficult, the Fed waited too long to raise rates at the beginning of this saga, limiting the wiggle room that they may have been able to enjoy. When the stimulus first rolled out, there were hundreds of possible soft-landing paths available, three months into the inflationary period, perhaps there were still 50, at this point, there may not be any paths left to avoid a recession. 

One of the pet topics of this newsletter is the phenomenon of the bank run. Before this last wave of bank runs, we covered the concept in the context of "tulipomania" in The Netherlands, and through the first banker to suffer a bank run, Johan Palmstruch of Sweden. Since then we saw the run on FTX, as well as runs on real banks like Silicon Valley Bank and Signature Bank. The Silicon Valley story has some very close ties to this concept of path dependency because it is the story of hubris and risk. The prevailing idea around SVB’s bookkeeping was that the inflow of investment dollars into tech startups would never end. As many of you will know from our last newsletter and from the plethora of articles about this collapse, the liquidity issue stemmed from the bank’s position in US treasuries that they took using deposits. Of course, the sophisticated bankers of SVB knew that, as interest rates rose, the value of these treasuries would go down, so why did they take these positions in the first place? The answer is that they did not see the mass withdrawal of deposits as a possibility. From their perspective, the venture capital investments would just continue on forever and no short term market volatility would stop that. Of course, this was completely false, and we should not let this story go without learning some valuable lessons. In this case, evaluating the balance sheet of SVB without the rose-tinted glasses would lead to a different conclusion that if those rose-tinted glasses were planted firmly on the bridge of the nose, which it appears that they were for the entire executive team. Again, the past matters and inertia is important. 

Now to direct the attention back to our mission here at Peak 15 to add value to the world around us, and our vehicle for that, our co-gp fund. With path dependency in mind, and the understanding that our decisions today might limit possible decisions tomorrow, we must be mindful of both the velocity of capital, and the velocity of deals. Let me explain. While our fund is open, we do not believe it would be advantageous to raise the entire fund, and then hold the money in waiting for deals to pencil in. Furthermore, we do not want to raise too little capital such that the velocity of capital is too slow to capitalize on great opportunities. Remember that the whole point of the fund was to take advantage of the velocity of capital to meet the velocity of deals. From our point of view, even though our Willow Park acquisition (which you will hear more about in our communications later this week) is an amazing asset and we are so glad to have locked it up, the great wave of fantastic deals is still several months away. Yes, we want to be ready with capital when that time comes, but there is real danger in raising too much capital too quickly and feeling pressured to deploy it. That would be a case of past decisions altering future choices. So with all of this in mind, we are pressing forward in our balance of velocity of capital, and velocity of deals with the understanding that the past matters to the present, and the present matters to the future.

Keep Climbing!

P.S. - As I briefly touched on in this month’s piece, there is absolutely more news about Willow Park and our entire experience coming this week. To summarize: we closed on the asset on Friday and we couldn’t be more excited to take on this project. To those of you who have supported us for a long time, thank you for your support. For those of you who invested in this asset through our co-gp fund, congratulations. We look forward to sharing in this incredible cash-flowing asset with you. Keep a lookout for that update coming later this week.