A decade's focus on digitalisation leaves physical assets vulnerable.

Venture capitalists are being schooled in the realities of hard power.

While software has been “eating the world,” in Marc Andreessen’s memorable editorial in the Wall Street Journal a decade ago, and making VCs rich, at the heart of everything remains the atoms and molecules formed when two or more atoms chemically bond.

Bringing the right atoms together is difficult, especially when so much relies on a tiny proportion of them – namely, the rare earths, which are a group of 17 metallic elements, such as Lanthanum, which can be used to convert raw crude oil drawn from the ground into gasoline and diesel, and Neodymium that has magnetic properties.

China is currently home to the world’s biggest rare-earth reserves, holding approximately 37% of the global total, but produces about 63% of the global total used in 2019 by importing more. Between 2016 and 2019, the US imported 80% of its rare earths from China, causing geopolitical concerns.

China has leveraged its rare earths supply not only to attract foreign manufacturers, but to strengthen its own manufacturing power and use it as a bargaining chip in trade talks, according to Foreign Policy in April. Demand for lithium, dubbed the new “white gold” because of its use in batteries for electric cars, is also racing ahead of supply.

Now, Russia, which has spent the past 20 years building its financial reserves from the sale of atoms, mainly hydrocarbons, is massing troops on the border of Ukraine. Whether it cuts off gas supplies to the European Union is driving political concern but relatively little attention has been paid to what Ukraine has that could, in VC Peter Thiel’s book, Zero to One, help bring pricing pressure on other staples through a more monopolistic position.

Ukraine’s largest export are cereals, worth $9.4bn in 2020 (19.1% of its total exports).

For those, like Russian president Vladimir Putin, who remember the days of the USSR when the soviets imported record amounts of wheat – 55m tonnes in 1984 – the ability or otherwise to feed population tends to cause political turmoil.

After all, Soviet president Leonid Brezhnev in 1981 described food as “the central problem” in economic planning. The Financial Times before the current border tensions between Russia and Ukraine said: “Thirty years after the collapse of the Soviet Union, Russia has transformed itself into a global wheat powerhouse, accounting for almost a quarter of the world’s exports. It is the top supplier of wheat to Egypt, as well as Turkey and Azerbaijan.”

Wheat prices are part of a general rise in the prices for atoms affecting particularly western markets (rice harvests have meant limited price rises for that staple in China).

The price of crude oil, which this month hit a seven-year high of $96.16, was likely to stay elevated, the International Energy Agency said, and with Europe’s gas storage facilities only a third full natural gas contracts for next-month delivery jumped 12% to €83.41 per megawatt hour, the FT noted.

“This is the most extreme inventory environment,” one analyst at Goldman Sachs told the FT. “It’s a completely unprecedented episode. There is no supply response.”  Supplies of aluminium — the price of which hit a 13-year high — are also low, as smelters in Europe and China cut capacity because of surging energy prices.

The impact, along with other supply chain disruptions and money creation from central bank and government responses to the pandemic, is surging inflation, which in turn pushes more people to want to buy the sorts of commodities produced by Russia and Ukraine.

As noted investor Ray Dalio said in his latest book: “When the creation of money sufficiently hurts the actual and prospective returns of cash and debt assets, it drives flows out of those assets and into inflation-hedge assets like gold, commodities, inflation-indexed bonds, and other currencies (including digital). This leads to a self-reinforcing decline in the value of money.

“At times when the central bank faces the choice between allowing real interest rates (ie the rate of interest minus the rate of inflation) to rise to the detriment of the economy (and the anger of most of the public) or preventing real interest rates from rising by printing money and buying those cash and debt assets, they will choose the second path.

“This reinforces the bad returns of holding cash and those debt assets. The later in the long-term debt cycle this happens, the greater the likelihood there will be a breakdown in the currency and monetary system.”

Breaking the dollar as the global reserve currency is an important objective to weaken the US’s projection of power around the world. Capitalising on the turmoil to strengthen your own state is a nice upside.

But whether Monday – after the closing ceremony for the winter Olympics – or before the Spring thaw sets in brings a Ukrainian invasion or not a central plank of a strategy is clearly in place. Hard power works especially when allied to the “four discords” of military operations laid out in the Wuzi text, which argues:

If there is discord in the state, then you cannot deploy the army;
If there is discord in the army, then you cannot organize your formations [
];
If there is discord in your formations, then you cannot join battle [
];
If there is discord in battle, then you cannot achieve victory.

If the objective is a reordering of a US-led global political order in favour of autocracies and dictatorships then capitalising on the hard power realities of using atoms and drugs while leveraging the opportunities of using bits in digital parts of the economy to steal or apply discord.

Elisabeth Braw, a fellow at the American Enterprise Institute, a think-tank, wrote in the FT: “We should not lose sight of the fact that states seeking to intimidate and punish their adversaries are much more likely to use non-military methods, from cyber attacks to intellectual property theft to stealthy acquisitions of companies developing sensitive technologies. This so-called greyzone aggression, which falls below the threshold of formal conflict, takes place every day. Increasingly, companies are the target.”

She quoted a new survey by international insurance broker WTW, due out next month, that found “nearly three-quarters of companies expressed concern about state-sponsored cyber attacks, while over half are worried about government-led retaliation against private companies in international diplomatic disputes.

“Just under half reported concerns about growing use of sanctions targeting private companies or individuals. (With the renminbi increasingly able to compete with the dollar, Beijing will soon be able to follow Washington’s path and impose sanctions on companies of its choosing.)

“In total, 40% worry about state-sponsored theft of intellectual property [IP], and 31% fear state-directed acquisitions of sensitive technologies.”

Even more than a price rises on their coffee beans, these sorts of attacks on IP threaten the VCs’ day job.

Note – see the February issue of GCV for more on the US-China challenges.