Archive for May, 2010


Don’t Blame Greece, the debt problem is global

May 22, 2010

Reading the headlines these days, you’d think Europe (and Greece in particular) was solely responsible for the latest crisis. Unfortunately our financial problems are structural, more wide-spread than the headlines are suggesting. The source of our difficulties, the real villain was (and remains) a deep-seated confusion in monetary policy about the definition of inflation.

Federal Reserve chairmen, like old military generals tend to ignore changing realities; preferring to fight the latest war with the tactics and tools that made them successful in the past. The last time the US experienced a significant inflationary period was during the 1970’s when CPI (consumer price index) rose at an annualized rate of roughly 8%.  Gaining control of inflation during the period meant “tough love”, hard monetary medicine was imposed by the Federal Reserve in the United States. Interest rates were driven up to unprecedented levels to fight persistent inflation – causing great pain for business and homeowners.

The major lessons of that inflationary period are generally considered to be the following. One, union power and COLA’s (cost of living adjustments) played a major role in driving up prices. Two, 70’s inflation itself was less a monetary phenomenon that a cost-push phenomenon driven by wage growth that was believed to exceed productivity growth. Whatever the truth of those lessons, they are now ‘givens’, realities governing Reserve Bank behavior in the US and around the world. As a result of this belief system the definition of inflation migrated from its historical meaning, a debasement (devaluation) of the currency stimulating a general rise in prices (i.e. a greater supply of money chasing a fixed number of goods); to any general rise in prices (defined by the CPI) full stop. 

Our present dilemma is a direct result of those decisions made long ago. Over the past 30 years while cost inflation linked to the CPI (consumer price index) has remained fairly stable, rising only with a bounded regime, the broad money supply (monetary inflation) has exploded, driven not only by loose monetary policy but by financial institutions and the near banks of the ‘so called’ shadow banking system. The results have been dramatic, consider that in the late 1970’s, the total amount of credit available in most western economies was approximately equal to GDP: just prior to the 07 ‘Crash’ that number had risen to about 350% of GDP.

In other words, with the Fed and other monetary authorities looking the other way inflation ran wild. The global economy was literally swimming in easy credit and it was soaked up eagerly at all levels, sovereign, commercial and personal. Since 2008 the global financial system has stabilized thanks to quantitative easing (near zero interest rates) and massive government simulative spending (almost all of it in excess of revenues) which has sent sovereign debt into the stratosphere.  Although we have bought ourselves some time, these emergency measures have only added to the problem:  the world has essentially responded to a huge ‘debt drinking binge and hangover’ with a couple of cool ones in the morning.    

We’ve basically used a bandage to cover our wounds, but are still left with the underlying disease. The reality is, we’re carrying too much debt at all levels. Greece is everyone’s favorite wiping boy, but its only the tip of the iceberg. In fact we’ve woken to the real risks at play, and our risk tolerances have (essentially) fallen off a cliff.  The unhappy consequence, the debt carrying capacity of the system is diminishing rapidly with predictable outcomes for debtors – who are faced with three rather unhappy outcomes, default, restructure or get real creative and institute debt for equity swaps. Not happy outcomes for the global financial system.

This problem is much bigger than Greece or Europe – in fact it’s everywhere you look. Resolving this dilemma will not be easy or without pain.

Things to Think About:

  1. The one lesson that history teaches us over and over again, is that debt is (almost) never repaid. It’s rolled over, it’s replaced by longer term debt or inflated to a smaller manageable level. What does not happen is a country, corporation or individual sacrificing their present and future for the past. Doesn’t happen.
  2. The Crisis of 07 was only a warm-up the big one is coming and soon. Its belts and braces time for corporations and individuals.

Disruptive Changes in Global Trade?

May 4, 2010

“Unhampered trade dovetailed with peace; high tariffs, trade barriers, and unfair economic competition,  with war”     Cordell Hull, US Secretary of State, 1944

In July of 1944, almost a year before the formal end of hostilities in World War II, the Allied Nations gathered together at Bretton Woods, New Hampshire to design the post war world. On the minds of participants were the key lessons of the Great Depression and World War II: the need to dismantle tariffs and economic protectionism, limit the extremes of economic competition and to build a stable rule-based global trading regime.  Unfortunately, there is growing evidence that the post war order is beginning to unravel, resurgent protectionism is undermining international cooperation and with it the reliability of global markets.

History seems to be repeating itself. In 1860, Britain was the pre-eminent global power, the United States of its day. Britain’s energy consumption was five times that of the United States and Germany, six times that of France and 155 times that of Russia. Britain used its political and economic strength to establish an international economic system founded on the principals of laissez faire, or free trade. This system grew strongly, encouraging globalization (on a limited basis) and increasing accessibility to markets. 

Unfortunately laissez faire began to unravel with the rapid rise in mid  19th century of newly industrializing nations, the most significant of which were the USA and (and a few decades later) Germany. These new industrial powers greatly increased economic competition among the Great Powers. The erosion of cooperation increased protectionism (in the form of imperial preference) and a set off a late century period of aggressive imperial conquest, particularly in resource rich Africa (the so called ‘Scramble for Africa’). 

 The Darkening Strategic Outlook

Today, the rise of the ‘BRIC’ (Brazil, Russia, India and China) is putting enormous pressure on the global system. The severe trade and fiscal imbalances that exist in the international system and the realization of potential commodity supply limitations, coupled with recessionary pressures are having a similar effect. They are undermining faith in the reliability of markets, unleashing forces of neo-protectionism and triggering a modern day ‘scramble for resources’. 

What will replace the free trade regime if it were to decline? At best we will see gradual erosion of free trade principals and international cooperation; more likely a severe economic downturn would trigger  a  protectionist backlash unleashing a sudden disruptive change in the global trade regime. When this happens expect disruption and much greater political involvement in the global economy, including (eventually) closed markets and  ‘managed trade’ packs negotiated between major trading blocks.

 Return to a more self-sufficient, vertically integrated companies

All the major trends of the past 40 years including de-regulation, globalization, reliable global markets, efficient logistics etc. made a compelling economic argument for corporate dis-integration. The situation going forward, however, is much different from the recent past. Major industries are more and more vulnerable to trade and supply disruptions and/or massive swings in the price of basic commodities. Major industries can be expected to reverse course and bias supply chain integration strategies through acquisitions (real supply chain integration) and/or deeper supply chain partnerships (virtual supply chain integration) as a hedge against global uncertainty.

 Things to Think About

  1. Where does your company and its assets fit in the global network. Do your homework so that you’re prepared before major changes take place. For instance to ensure access to key global markets you should be lining-up strategically positioned acquisition targets or compatible supply change partnerships in advance.
  2. You should also be asking yourself, what risks your organization would face if access to your global supply base became compromised and what we can do to build more resiliencies into your business model.

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