Archive for the ‘Leadership Challenges’ Category


A New Monetary Order?

June 28, 2012

A few short years ago it was sensible to assume that the global economy was stable and reliable; today we must adjust to a world of financial instability. Consider the following warning from Bill Gross, Managing Director of PIMCO in his June 2012 Letter to Investors:

“The global monetary system…(is) fatally flawed by increasing risky and unacceptable low yields, produced by the debt crisis and policy responses to it. “

The International Monetary Fund (IMF) has downgraded its forecast for world economic growth twice in the past few months, while leading economists debate whether 2012 marks a return to growth, or 1932 all over again.

Monetary Crisis

At the base of today’s debt problems lies a global monetary crisis that cannot simply be wished away. When sovereign debt approaches a critical threshold, generally 80% of GDP, red flags are raised, bond markets and rating agencies start to get nervous. Today, although Greece, Spain and Portugal gather all the headlines, the sovereign debt crisis extends far beyond these nations. Consider that ALL European nations including Germany exceed their own legally defined limits of sovereign debt.

The fatal reality is, levels of debt (sovereign, corporate and personal) through out the  global economy today are rapidly approaching the breaking point, due largely to an inbuilt paradox in the present monetary system.

The entire capitalist monetary system generates interest-bearing debt as a matter of course. Money creation in all its forms, whether vertical (central bank generated currency and related money) or horizontal (bank loans) triggers interest from its inception, and as a result, is subject to the iron laws of compound interest.

The monetary paradox is simple, but deadly. In straightforward terms, the productive capacity of the economy grows arithmetically (in the 2-4% range), debt, however, grows faster, obeying the abstract laws of exponential progression. Compounding interest rates on debt exceed economic growth rates even in good times, and are doing so today despite massive central bank intervention to keep rates at historic lows. Eventually, compounding debt must exceed the system’s ability to meet even the minimum requirements and the system collapses.

“Even if we lived on an infinite planet, the interest rate on a debt-based monetary system could not exceed the growth rate of the economy (both measured in real terms) over the long term without inevitably causing a major default on debt.” (Minsky 1986).

Who knows what will happen ultimately, but what I can tell you for certain is a new monetary regime will emerge as the global economy reacts to these important developments.

While many authors and authorities are speculating on this subject, history demonstrates clearly that monetary regimes are not established from the top down, by rational discourse and planning. Rather they are established from the bottom up by new and better management of credit systems.

The historic Gold Standard was not designed, it simply became common practice as paper currencies came and went during periods of economic crisis and war in the past. As a universal currency, transferable across national boundaries, golds appeal was obvious. Yet, its monetary role evolved from the bottom up, rather than being designed for purpose.

Our present Central Bank managed monetary regime was born by accident in 1971, when U.S. President Richard Nixon took the United States and the Western world off the Gold Standard (implemented at Bretton Woods in 1944). The monetary vacuum created by the abandonment of Gold was filled by Central Banks, based on the (idealistic) theories of Monetarism and the science of economics.

The present monetary system is intellectually exhausted, presenting policy makers with a ‘Hobson’s choice’ of austerity or Keynesian monetary expansion; neither of which has proven capable of driving sustainable growth. A new monetary regime must solve this dilemma, directing society’s plentiful resources to the productive heart of the economy.

The principles that will govern this new monetary order will likely be the following:

1.  A new monetary system must break the cycle of systemic, interest-induced crises, evolving toward a sustainable regime based on value

2. The ultimate goal of monetary policy will settle on societal well-being, abandoning the present goal of economic equilibrium (base balancing of GDP growth and CPI-related inflation metrics).

3. There is no return to a Gold Standard, but money supply must be backed by the productive capacity of the nation. Asset-based money supply will emerge as the only viable alternative to the present Central Bank managed system.

4. The productive assets underpinning the money supply will expand with the introduction of new classes of assets. Total Assets, whether traditional or newer non-traditional assets, whether socially owned or privately owned, will be the bedrock value standard upon which money supply will be rooted.

5. Vertical money supply (currency and related derivatives) created by governments will be backed by the total stock of assets of the nation based on the five capitals, while horizontal money (bank deposits and related derivatives) will be backed by privately owned assets, defined much more broadly than today.

6. The new monetary regime will need to factor in a nations natural and human capital, moving beyond simple exchange value definitions to encompass a full appreciation of the utility value of all asset forms.

We’re in for a wild ride, with no shortage of pain in the short to medium term; however given the growth in new assets and the (presently invisible) undocumented asset potential in all economies, early movers could gain significant advantage on the rebound.


A Marshall Plan for Greece?

February 23, 2012

According to London’s Financial Times leading industrialists in Germany have recommended a new Marshall Plan for Greece, involving both private and public investment.

This is the best (and maybe the only) good news to come out of Europe for many a month. The Marshall Plan, for those too young to remember, was one of the most remarkable initiatives of the Post War era, unprecedented in modern times.

Under the Marshall Plan (named for the Secretary of State George Marshall) the United States committed substantial funds to the reconstruction of war torn Europe. Total investment by the US in the immediate post war period, including the Marshall funds, totaled $25 billion almost 10% of the US GDP. The funds were used to rebuild civil and industrial infrastructure in a devastated Europe.

The Marshall Plan, which was in operation from 1947 to 1951, was surprising in its generosity; victors in war are not noted for their willingness to invest in the vanquished. More importantly the Marshall Plan presented a vast contrast to the hard-nosed tactics employed on Germany and its allies by the Great Powers after World War I.

The success of the Plan contributed materially to the recovery of Europe, which led to the creation of the NATO alliance and (later) the European Union. More importantly it helped heal Europe and put bread on the tables of millions and millions of people. No small accomplishment.

If (and it’s a big IF) the present debt crisis in Greece is going to stabilize somewhere short of default, it must have an upside. Lenders are imposing severe restrictions; Greece is expected to endure crippling austerity, falling lifestyles and real restrictions on its democratic systems and sense of self-determination.

Greece needs a positive future; more than being a wiping boy for global bond markets. The fact that this initiative is emanating from Germany is terribly important, for it is the Germans that are taking the hardest line in this matter. An act of generosity on the scale of the Marshall Plan could not only help the Greek economy, but also heal the wounds that have been inflicted upon the tender sensibilities of modern Europeans. They are badly in need of repair.

Let us hope that this suggestion is acted upon enthusiastically and delivered in the same spirit as the original.


Winds of Change are Blowing, Beware

November 12, 2011

WASHINGTON — The Obama administration, under sharp pressure from officials in Nebraska and restive environmental activists, announced Thursday that it would… delay any decision about the Keystone XL pipeline until after the 2012 election.

An election year politician doesn’t really need any more incentive to delay an unpopular decision than thousands of protesters parked in his front garden.  That’s a political no brainer.

But, realistically, if a few thousand activists were the extent of it, precedent suggests that a politician is home-and-dry supporting ‘Job Creation’ activities, particularly in tough times.

Unfortunately for TransCanada Pipeline (and by extension, Oil Sands developers in Alberta) there is a large and growing backlash against ‘Big Business’ in the United States that’s altering the strategic landscape profoundly.

“The public outcry has just continued to get louder and louder, stronger and stronger,” said Annette Dubas, a Nebraska state senator. The issue for Nebraskans is complex.  Although they are a ‘red’ state, supporting business and right-of-center causes consistently, they is growing concern that the XL pipeline will contaminate the Ogallala Aquifer, a crucial source of water in the Midwest.

For TransCanada, pipeline sponsor, this is an unexpected surprise. The company has been developing this project for years and has sailed through its governmental reviews and environmental impact studies with flying colors. Their astonishment at recent developments was made perfectly clear by spokesman Shawn Howard, “A lot of people would stand back and say, ‘If this was such a concern, where were you three or four or five years ago?’ ”

Shawn’s surprise is typical. But how do you know you’re in the middle of a revolution? Answer: you don’t. Not until it’s too late.

Our societal tectonic plates are shifting. The “Occupy Wallstreet” movement marks a turning point. It is the radicalized thin-edge of a giant wedge of public resentment that has been building for many decades. The establishment is unaware that a volano of middle class anger is about to erupt Vesuvius-like over the business landscape. The speed and violence of this explosion will simply overwhelm the established way of doing things. What does a business leader do in such situations: act now to strengthen the company’s most valuable asset, the ‘Social License to Operate’.

Most hard-nosed business people pay lip service to the idea of social responsibility, and, in this, they have lots of institutional support. No less an authority than economist Milton Freedman laid down the law: “…there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits….”.  Making profits and (secondarily) providing jobs IS the social responsibility of business; it’s no wonder that many businesses take their Social License for granted.

However the winds of change are blowing. American banks, authors of the ‘sub-prime’ mortgage disaster, illegal foreclosure practices, and serial incompetence are leading the way, The oil industry, although not free of embarrassing public gaffes, is still reeling from the Gulf of Mexico fiasco and a host of pipeline problems.

What should be clear from recent events is that the status quo is dangerous. Much more will need to be done to win back public trust and confidence. A good start would be a sober analysis of the situation, and a willingness to understand businesses’ ‘relationship with the public’ is damaged and needs repairing – fast.


New Assets, Bankers Still Don’t Get it

October 26, 2011

I had a conversation recently with a banker friend of mine, who’s skeptical about the ‘new’ economy (“there is nothing new about the new economy”, he claims). While I’m ranting on about great opportunities and how the new assets are essentially ‘invisible’ he interrupted and said: “But Robert we can’t bank that stuff, there‘s no intrinsic value there. Its not real like land, or plant and machinery.”

After that, I had to stop and catch my breath for a moment. Apart from the horror of absorbing this shocking statement, I was beginning to see how difficult it is for many knowledge-rich businesses today to get banking facilities – they might just as well be talking to a brick wall.

David and Goliath

After I recovered my composure, I said, “Matthew, let me tell you a little story about how attitudes just like yours almost destroyed the most powerful company in the world.”

I don’t know of you remember at all, but during the ’60s and ‘70s IBM owned the computer business. It was the biggest and most powerful technology business on the planet. IBM began its life in the 1880’s as International Business Machines, and had grown up during the 20th century as a machine-maker ‘extraordinaire’. By the late ’70s, IBM was unsurpassed in terms of technology development, but was even more dominate in reputation, in the power of its brand. It was often said in those far away days “nobody was ever fired for buying IBM.” In other words they were, and were perceived to be, the best in the business. They owned the computer market by virtue of their brand reputation and the excellence of their hardware, selling frighteningly expensive mainframe computers.

With success came a kind of arrogance and complacency, a fatal flaw very evident in their negotiations with start-up software pioneer Bill Gates. Bill was so young and Microsoft so small in the late ‘70s that neither registered on IBM’s radar screen. Good fortune, however, was just around the corner. Early in 1981 Microsoft was approached by IBM to produce some operating software for IBM’s ground breaking, soon to be released PC, the Personal Computer.

As it happened Bill and Microsoft didn’t have a ready operating system to sell to IBM, so they went out and purchased a basic operating system from software developer Tim Paterson for $50,000 and adapted it. The renamed version eventually became IBM’s PC-DOS.

New Approach to Software

Developing software and selling it outright to customers was standard operating procedure in the software world of that day. Remarkably, in Microsoft’s case, something quite amazing happened. Bill recognized that his simple operating system was more than a toss away service for IBM’s hardware; his software had great utility and value. Bill Gates pondered on how best to sell his operating system to IBM, but also retain the right to sell it to other customers as well.

Bill Gates launched Microsoft and (almost accidentally) created the modern software industry by ring-fencing his computer code with a legal agreement and licensing its use to IBM instead of selling it outright. Under the agreement Microsoft retained the right to independently develop and market its own version of PC-DOS under the brand name MS-DOS. Signing this agreement was a colossal blunder for IBM, a mistake that in very short order catapulted this titan of industry to the point of ruin; meanwhile Microsoft, a global superstar, was born.

The lesson for bankers today is this. The launch of Microsoft might never have happened if IBM had not brought an antiquated industrial mind-set to the negotiating table.

IBM, of course, played by the existing rules of business; they KNEW that only ‘real‘ tangible assets were important.  For IBM, software was unimportant; it was simply an expendable service. As a result of this blindness IBM didn’t see the opportunity or the danger and therefore did not object to the licensing arrangement.

Microsoft KO’s IBM

In the stoke of a pen, IBM abandoned two of the most valuable (if non-traditional) assets of the 20th century; simply left them on the boardroom table. And (bankers take note) what were these assets: the MS-DOS software assets, and more importantly a relationship-based customer equity asset that would dominate the world of computing for the next quarter century.

Ownership of the MS-DOS software platform soon paid handsome profits for Microsoft. With its unique capabilities MS-DOS helped launch IBM clones, competitors to IBM in (clone pioneer) Columbia Data Products, Eagle Computer, Compaq and others. This however was only the beginning, soon MS-DOS became Microsoft Windows and the world had a ubiquitous new software operating system for a generation of personal computer users. Microsoft’s ownership of this non-traditional asset, one of the most profitable assets of the 20th century, was – ironically – only made possible through ignorance and neglect: software-as-asset being a contradiction in terms for IBM.

But MS-DOS was not the biggest asset IBM left on the table that day. Customer equity, the magic ingredient that catches customers’ desires, that informs the ‘Why of the Buy’ for computer purchases soon passed from IBM’s hardware to customers’ familiarity with the Window’s operating system. PC buyers were loyal to Window’s (and to a lesser degree Apple’s) operating system, not the hardware platform. Armies of computer buyers flocked to Microsoft based computers regardless of the hardware platform. (Note to Microsoft, today customer equity is moving to Apple’s platform, beware!).  This customer equity asset was, until recently, the most valuable asset in the history of computing – more than anything else it created the myth of Microsoft and almost cratered IBM as a viable business.

So, Matthew, there is something new about the new economy, value is driven in new ways, from unfamiliar, intangible sources that most bankers don’t understand. How can bankers hope to keep pace with all these changes? I don’t know but burying your head in the sand and pretending that nothing has changed won’t help, that’s for sure. “


Getting out of Technology Jail #2

September 16, 2011

In the past few decades there has been a veritable explosion in innovation, accompanied by exponential growth in important technology drivers, including Internet bandwidths, the performance, the speed and RAM power of computers.  As a result of these and other changes, the engine of growth in our economy has migrated from its traditional industrial base to something substantially different.

Today nontraditional assets, new ideas, patents, software and other forms of intellectual property underpin many of the most exciting businesses in our economy.  Needless to say, these new sources of wealth do not appear on the company’s balance sheets, and sometimes not even on their management’s radar screens.

Despite the fact that these new assets form the largest part of our economy now-a-days, important institutions including business schools, banks, accounting professionals, securities and exchange commissions have not kept pace with these changes and as a result do not know how to interact with the new innovative businesses that have emerged from all this.

With Western economies failing rapidly, there is a desperate need to bridge this yawning gap. What’s required is a means of translating the institutional standards, management disciplines, operational processes and leverage of traditional assets into this rapidly developing knowledge driven ‘new asset’ space.

This means treating nontraditional assets like traditional assets.

Essentially the first step is for management to properly identify and capitalize the nontraditional assets on its own balance sheet on an historical cost basis – which will at least identify the important value drivers in the business. This is NOT traditionally done in the normal course of business, but does conform to a rapidly evolving GAAP (Generally Accepted Accounting Principals)

As important as this step is, its does not extract the full ‘enterprise’ value from innovation.

So… what is enterprise value? If you’re fortunate enough to own traditional assets, developable property for instance, accounting standards allow you to estimate the property’s value on a ‘best use’ enterprise basis.

Highest and best use, or highest or best use (HBU) is a concept in real estate appraisal that shows how the highest value for a property is arrived. HIGHEST AND BEST USE is calculated optimistically on the reasonably probable and legal use of property, that is physically possible, appropriately supported, and financially feasible, and that results in the highest value.

This enterprise value will very often be many times the purchase price. This kind of valuation technique allows property developers to accelerate their businesses through increased financial leverage.

Translating these traditional valuation concepts into nontraditional assets assumes a ‘best use’ valuation of the intellectual property with all kinds of caveats and assumptions. Enterprise valuations tend to be larger than standard values at play in the market today because of many factors, including optimistic assumptions about:

(1)  Access to capital and other resources of all kinds

(2)   Management competency and skill, and not least

(3)  Globalization’s impact on Market Size calculations.

So why is Enterprise Value so important?  In a word… LEVERAGE

Leverage the Assets at Full Value: traditional businesses take full advantage of leveraging their assets on a best use basis. For instance owners of development property are able to use the full develop-able collateral value of their assets to attract bank finance, to establish valuations when going public, doing joint ventures etc. Enterprise valuations unleash this best use value of nontraditional assets so they can be leveraged in the same way, commercially and in the stock market. 

By identifying the asset strength, bolstering the company’s balance sheet and structuring properly, it is possible to greatly increase the Net Worth of a company, preparing it for investment, increasing the bargaining power in real financial terms.

What’s the benefit of Enterprise Value: Now, it is possible to fit a substantial investment into the company without punishing dilution.

Things to Think About:

  1. Unfortunately it is very difficult – if not impossible  – for your ordinary accountant to obtain Enterprise Value for nontraditional assets in the originating organization. Specialized GAAP accounting techniques (it really is brain surgery) are required to accomplish this goal.
  2. If you’re interested in more details on how to accomplish all this, write a summary of your new asset business in the comment box below and I’ll see that someone contacts you.

Technology Jail #2: Wall Street Wolves

July 1, 2011

According to a recent University of Maryland study, the United States economy is generating (annually) trillions of dollars of undocumented intangible asset wealth. This wealth is literally invisible; it does not show up on company balance sheets, in GDP statistics or other national economics measures.

Interestingly this new wealth is, to a large extent, accumulating in the vast army of innovative small to medium sized businesses (SME). Unfortunately, because we don’t (at present) manage, account or securitize these sources of wealth properly or consider the assets ‘real’ we’re creating unnecessary hardship for SME’s and society at large.

Technology Jail (see last months post), handicaps knowledge-rich businesses and vastly increases their cost of capital but, also, in a real sense contributes to the relative decline of the West in global economic terms.

Many SME’s today, lacking solid bankable assets, chose to ‘Go Public’ early to gain access to the capital they so desperately need.  But going public in this way is expensive and is loaded with unexpected perils. Indeed the markets are filled to the gunnels with bright young companies essentially locked in the ‘Penny Stock’ wing of Technology Jail.

Andy Kessler, a financial journalist and writer, being interviewed on NPR recently said: “You know IPO’s are capitalism’s carrot, right, they’re hung out in front of entrepreneurs as an incentive for them to work hard, pull all-nighters, chug ‘jolt’ cola and change the world.”

But Andy also pointed out a few home truths for the audience.

What most people don’t know is that in an IPO process the management of the company fly’s around the world meeting institutional investors, meeting with the Fidelity’s, Janus’s the mutual and pension funds in a process of whipping up excitement for what they do. And then the underwriters, Goldman Sachs or Morgan Stanley go around and say ‘how many shares can we sign you up for”.

So it’s this funny kind of auction (that takes place)… You know the management of the company, the employees of the company and certainly the venture capital investors of the company do well when the company’s goes public – they can’t sell for six months by the way. But the ones who do best are the ones who get allocated shares on the deal and if it doubles in the first few minutes… you know they do quite well”.

What’s wrong with this picture Andy?

The company sweats bullets for years to get something worthwhile off the ground; the management then go around and ‘drum up demand’ for the shares. Then the guys who have done the least, the bankers and their favorites, load up on fees, divvy up the tradable shares and ride the initial demand to great profits while the company, including the guys who pulled all-nighters, are stuck.

What’s the out come of all this at the end of the day? Unfortunately not all companies are lucky enough to be a ‘Linked-In’ with huge brand recognition and earnings. Today the NASDAQ – OTC Bulletin Board and the Pink Sheet Board are littered with broken deals – public Companies with partially developed technology, trading at pennies and struggling to keep current with their SEC filings.  The SEC’s response to this is to make the filing requirements even more stringent. Unfortunately, It’s not the filing system that is broken; it’s the presence of so many un-bankable intangibles and a predatory finance industry.

The process of ‘Going Public’ is so distorted, the incentives so misplaced today that it reminds me of “Little Red Riding Hood.” You know how the story goes: an innocent little thing in her red cape is on her way to grandmothers house in the dangerous woods. When she (i.e. the high tech SME) arrives at the offices of her financial savior, she notices her ‘grandmother’ (broker dealer/investment advisor) has an odd look in his eye while he promises the little ‘darling’ cupboards filled with bread and cookies. Little Red Riding Hood then says, “But grandmother, what a big investor network you have!”. “All the better to fund your deal my dear…” This eventually culminates with Little Red Riding Hood saying, “But grandmother, what big teeth you have!”, to which the wolf (broker dealer/investment advisor) replies, “The better to eat you with my dear,” and swallows her whole.

Most truly innovative companies gain very little in real terms from going public this way; unfortunately, apart from being fleeced by their broker dealers they find themselves burdened with a host of free trading shares and absolutely the wrong (short term, opportunistic) shareholders chosen not by themselves but by underwriters.

Its a short sellers dream; welcome to Penny Stock land.


Navigating the Age of Volatility

January 14, 2011

How did your organization cope with the Financial Crisis in 2008? If the answer to that question is “not as well as we should have” then ask yourself the following question:

  • How are we going to manage a future crisis that will be twice as deep and twice as long?
  • Will we even survive?

 The World has Changed

 The world of business is in the midst of a paradigm shift that is changing the economic reality profoundly. Consequently, the global economy has entered the Age of Volatility; a faster pace commercial environment that shifts gears suddenly and unexpectedly.


[The diagram above is a graph of global crude steel production over the course of the past century. Crude steel production, tied to industrialization and urbanization, is used as a global growth and GDP indicator. It reveals a succession of roughly 30 year growth patterns that have characterized the economy over time.]

 What it Takes to Succeed Today

In a global economy as volatile as today’s standing still is not an option. The question is what steps should a leader take to ensure success?

Ultimately successful companies need to be more adaptive, resilient and strategic. However, this scale of organizational change doesn’t happen overnight.  In the meanwhile there are some measures you can take immediately to prepare your organization for disruptive change, whatever its origin.

  1. Improve your Situational Awareness, most people today are finally starting to relax, they’ve come through the recession of 2008, business is returning to normal and, as far as they can see, no storm clouds are on the horizon. Don’t follow the complacent crowd, develop a High Altitude Mindset. In other words operate in what appears to be a normal world with the attitude that crisis could strike at any moment.
  2. Do not delay, develop options NOW. You have a plan, now is the time to stress test it and build in greater resiliency.
  3. For instance, rationalize your corporate finance, renegotiate terms on your debt if necessary to provide you the flexibility to manage through a sudden spike in interest rates sometime in the next five year interval.
  4. Strengthen your balance sheet, identify and sell non-essential assets, pay down debts prepare your organization for ‘heavy weather’.
  5. Raise awareness within your leadership teams and begin contingency planning. Revisit foundational assumptions; revise your strategy where necessary. Every departmental VP should have options laid out for a variety of futures, with tactical plans ready for implementation at short notice.
  6. Begin planning for the kinds of business you’ll be able to do profitably during and after a major correction; identify the necessary plant and machinery, core employees and supply partners that you’ll need.
  7. Prepare the board and shareholders, make them aware of the risks and brief them on your heightened level of preparedness.
  8. Where possible practice executing your options – remember fear and panic could cripple your organization’s ability to act in a crisis situation – it’s why we do fire drills.

Consider that you may not be able to survive on your own. Once you have examined your own situation and have a clear idea of the weaknesses and strengths, start having conversations up and down your supply chain. It is the entire supply chain that is potentially at risk, work with your partners to:

  •  Identify important areas of commercial interdependence, remember your customers tend to be adversarial in good times, but they would definitely not want to see their vital sources of supply disappear in a crisis.
  •  Be creative in your joint planning, even a deep downturn must end sometime – plan accordingly. For instance you could agree emergency business minimums with important suppliers, emergency sales volumes with important customers, all with terms agreed in advance to ensure your mutual survival.

Remember that volatility is not necessarily a bad thing; it’s really only a problem for the unprepared. With proper planning and appropriate timing you could gain significantly market share and competitive advantage if you are ready and your competitors are not. 

Never forget the old adage,  flexibility is priceless in a crisis



July 1, 2010

Climbers face many challenges, particularly in extreme zones like the summit of Everest. Apart from being physically demanding, the highest peaks are oxygen depleted, which means at the very moment when you require extra energy, you are deprived of the sustenance you need to perform effectively. Climbers call this is the Starvation Zone, and many excellent low altitude climbers are simply incapable of managing the physical and mental challenges of high altitudes.   

Credit is the oxygen of business; it courses through the system feeding the body and animating the limbs of commerce. Over the past decade we’ve been operating at low altitude, a credit rich environment but business leaders beware, you’re about to enter a Starvation Zone of your own.

The extraordinary period of Keynesian stimulus ended at the Toronto G20 summit. In future governments have agreed to rein in their stimulus spending and are obligated to half their operating deficits by 2013.

It was also agreed that banks must significantly increase the quality and quantity of their capital assets. Capital requirements act as a kind speed-limit for banks, increasing capital levels has a real cost as it makes credit both more expensive and less available. Every extra dollar a bank holds in capital equates to at least $15 that it is unable to lend.  

If that weren’t enough, The Bank for International Settlements warned on Monday that central banks must raise interest rates even before their respective economies are clearly in recovery.

All this of course is sensible and prudent economic management from the macro level, but for business in the short to medium term it spells falling demand and a rapid contraction of credit at a time when the global economy is far from healthy. It’s as if, having almost broken our backs getting to base camp, we decide to push on to the summit of Everest in poor health and lacking oxygen – good luck.

Things to Think About

  1. The past is NOT a reliable guide for the future; going forward you’ll need MUCH better teaming and what we call a High Altitude Mind Set to succeed in this difficult environment.  
  2. Successful High Altitude climbers manage the Starvation Zone by preparing in advance, acclimatizing their bodies, adjusting their pace, strengthening their internal fortitude. Its time for businesses to do the same. Begin now to condition your organization for far more challenging times than you’re experienced to date. (for details on how to accomplish this see (


June 9, 2010

Many not so casual observers, including Queen Elizabeth II, have wondered why economists did not anticipate the recent Financial Crisis. The reality is most economists were stunned when the Crisis arrived, panicked at its blinding speed and can only recommend ‘the same old, same old’ going forward. There’s two principal reasons they didn’t see it coming. One, economists weren’t looking broadly enough at the economy to see the problems developing in the first place, and second, what evidence was available (and there was plenty) tended to be discounted or ignored for ideological reasons.

The Dismal Science

Economists, despite being highly respected and sophisticated scientists, have been on the defensive for centuries. Truthfully, the study of economics was in difficulty even before Thomas Carlyle leveled his famous ‘dismal science’ charge in 1850. Perhaps the one nagging criticism  that stings most strongly these days is the charge that economists are so infatuated with the wonder of their theory that they ignore practical reality.  

Why should the rest of us care? It’s a serious issue because economics matters. The management of a modern economy, the decisions and actions undertaken by politicians, senior policy advisors, Chairmen of the Federal Reserve Bank, business leaders, Wall Street investment bankers and others, are derived from an underlying body of economic thought; today those underpinnings rest largely on the shoulders of neoclassical economics, the foundation stone of modern capitalism.

Neoclassical Economics

Although neoclassical economics is a foundation, it is by no means a unified body of theory. However modern economists working within the neoclassical paradigm tend to agree on both a quantitative approach to economic analysis and a field of study centered on the exchange process. Neoclassicism is a mathematical system of thought concerned with market related phenomena, particularly the determination of prices, outputs, and income distributions.

This is quite a change from the past. A century ago the great Alfred Marshall could say of economics: “Political Economy or Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing. Thus it is on one side a study of wealth; and on the other, and more important side, a part of the study of man.” These days you’ll find a much less ambitious definition for economics, generally along the following lines: “Economics is the social science that examines how people choose to use limited or scarce resources in attempting to satisfy their unlimited wants.” …a dismal science indeed.

So, where did it all go wrong?

It all happened a long time ago, in the horse and buggy days of the Victorian era. Mid-Victorian capitalism was facing a mountain of trouble. Marxism and the rising working class movement were galloping forward on the left; on the right there was a looming – cataclysmic – breakdown of laissez faire, which eventually launched an era of vicious protectionism and hyper aggressive imperialism. According to economic historian Eric (Lord) Roll, in these confusing times there was a strong desire among classically minded economists to produce a more scientific study of economics and – ideally – find a way to side-step the theoretical challenge of Marxism once and for all.

The Marginalist Revolution of the 1870’s provided just such an opportunity. The marginal utility theories of Jevons, Manger and Walras revolutionized economic thought and with it the entirety of economic study.  Neoclassical economic theory, which emerged as a consequence of the Marginalist Revolution, introduced important new concepts into the economic lexicon, particularly a theoretical perspective that the value of goods is determined subjectively “in use” by the end-user (classical economics had assumed that goods had a hard, objective value, which was equal to the amount of labor applied in its development – the so called labor theory of value).

However, neoclassicism also introduced fundamental changes in the study of economics; its explicitly scientific approach introduced a mathematical bias into economics, which has grown significantly over the course of the past century. Unfortunately, mathematical precision has come with a hefty price tag: the Marginalist Revolution reduced the scope of modern economic analysis considerably. By drawing a ring-fence around the exchange process – forevermore the ‘legitimate’ area of economic inquiry – neoclassical economics retreated into a narrow, quantifiable definition of economics, where the larger (messy) questions were simply ‘out of bounds’. And although economists gained much greater mathematical certainty and logical consistency in adopting neoclassical principles, the Marginalist Revolution placed significant limits on the boundaries of economic study, stifling inquiry of those economic inputs that lay outside the narrow confines of the exchange process.

It was this reduction in scope, this retreat from the larger study of political economy, undertaken over a century ago that created the ‘boundary’, the theoretical wall that defines the limits of economic analysis; the presence of which leaves economists as mere spectators in critical elements of the economy. It is one of the reasons why so many of them didn’t see the storm clouds gathering in the first place and still can’t.

Economist’s counter these charges by pointing out that their market focus is reasonable, given that every meaningful economic activity that takes place outside the boundary eventually winds up in an exchange transaction, which they believe, essentially, brings the outside world to them on their (quantitative) terms.

Yes, economists do consider ‘out of boundary’ inputs, but lumber them into a broad undifferentiated category they call externalities. The practical consequences of this approach, however, distance economic analysis from the primary sources of economic activity. For instance most economics are unconcerned (and presumably unaware) of the nature of new asset classes in an emerging knowledge  economy or more importantly, just how these new assets impact economic risk assessment over time. In other words, economists are left to examine only the derivative (quantitative) effects of economic phenomena rather than their primary causes.

The Ideological Force of Monetarism

Unfortunately, this confusion between cause and effect has been greatly magnified by the late 20th century rise of Monetarism. Like many theoretical considerations in economics, monetarism was controversial and applied carefully within the profession; while outside in the world of finance and business it was swallowed whole, hook, line and sinker. Unfortunately monetarism became more than a new set of economic principals, it morphed into an ideology, a faith like belief in the purity of markets. The practical effect of market purism has been to undermine traditional checks and balances perfected over the ages to preserve the integrity of capital. As a result capital management practices collapsed across the board when it became popular to believe that markets purified the economy of all risk. This ideological sedative infected all aspects of economic decision making, undermining the culture of banking, accounting, credit rating, management and economic policy making.

Modern Economic Thought

Modern economics, despite being an important theoretical advance on the past limits economic thought in several ways. Firstly its dedicated mathematical approach limits the very process of economic analysis, for it implies strongly that anything that is not quantifiable simply doesn’t count. Secondly its constricted focus means it looks at the economy through a microscope rather than a telescope – in other words its missing the capitalist forest for the statistical trees. These reductive forces contribute to the fatal combination that blinded many economists in the run up to the Financial Crisis and are, even now, limiting our ability to put the economy back on a sound footing.


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.

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