This MINUTE could last you a lifetime: An investment thesis for a period of secular economic instability
We are living in times where a confluence of several secular and cyclical factors are resulting in a profitable rise of capital requirements for, and allocation in, the Materials, Industrials, Non-cyclicals, Utilities, Technology, and Energy (MINUTE) sectors.
“Well we know where we’re goin’ but we don’t know where we’ve been.
And we know what we’re knowing’ but we can’t say what we’ve seen.
And we’re not little children and we know what we want.
And the future is certain give us time to work it out.
We’re on a road to nowhere come on inside.
Takin’ that ride to nowhere we’ll take that ride…”
- Road to Nowhere by Talking Heads
The inexorable quest for “more”…of everything:
It is safe to assume, everyday, almost all of approximately 6.9 billion people wake up wanting more than they already have. Some aspire for more luxuries; others seek more necessities; a vast under-class, just struggles for more dignities.
Global commerce is an agile, pragmatic force transforming more and more lives than ever before. Thanks to the forces of globalization, we are witnessing a free-er flow of goods, services, capital, and people around the world. Also, largely thanks to globalization, every year tens of millions of people from a wide variety of emerging and frontier markets are joining the growing global mainstream of what broadly constitutes as “middle-class consumers.” This somewhat loose grouping of “middle income” consumers already constitutes roughly half of the world’s population.
More food is needed, produced and eaten. More clothes are bought, sold and worn. More property is being built and inhabited. More cars and trucks are being manufactured and driven. More oil, gas, coal and other conventional energy sources are being harnessed, distributed and consumed. More alternative energy sources are being discovered, produced and commercialized. Trillions of dollars of roads, railways, power plants, transmission networks, dams and bridges are being built and utilized. More paper is being used…and forests felled. More minerals are being mined, processed and used in a wider variety of industrial and consumer applications. More manufacturing is being done and absorbed – on a net global production basis.
It is an insatiable, inexorable quest for more…and more…and more from a planet that has its very real physical limits.
Resources are limited.
Demand is rising. Supply is not. In fact, supply is diminishing for a wide variety of natural resources.
It is that simple.
The real, the tangible, the substantial: The World is Pyramidal
Imagine Maslow’s hierarchy of needs represented in a world that isn’t round, ovular, or even flat.
The world is a four-dimensional pyramid of time, population, demand, and supply.
Due to the enormous pressure on resources owing to a rising global population and various other sub-plots, our times are characterized by exceptional change or instability underpinned by the triumvirate of: uncertainty, ambiguity, and complexity.
What is also undeniable is: because of – or in spite of – globalization, the individual or family is much more disconnected from a social support structure. During earlier times in more settled communities, this support structure was taken for granted. With professional certitude and financial stability petering out, the individual or family is much more vulnerable to the financial consequences of the high-velocity change we experience today and can anticipate to experience for the foreseeable future.
By mixing in the notion of rising demand and declining supply of natural resources, the concoction we have is a period that harkens back to our pre-historic ancestors’ times of operating in a hostile, uncertain, ambiguous, high-risk, constantly-evolving environment.
It is only natural that a Darwinian “survivalist” instinct kicks in among us to seek safe havens.
Investors are us: You and I.
Quite obviously, our investment decisions are not disconnected from the complex interaction of our personal, social, economic, and financial imperatives and choices.
Therefore, what we find is a seamless connective tissue between our psychological makeup which may be in “survivalist” mode and our investment bias to seek a real, tangible protection from the real, intangible economic storm. It is this quest for the real, the substantial that has Gold breaching record highs on a regular basis. Silver is at a 30-year high precisely for the same reason. In a period of secular uncertainty and instability, Gold can be expected to continue to hold its status as the ultimate haven of safety and trust. A haven that has stood the test of time for its ability to act as a reliable medium of exchange and as a store of value (or wealth). Gold has also, unsurprisingly, held its purchasing power over several thousand years of human commercial history. It has, and continues to be: rare, valuable, and tangible.
Due to demand-supply constraints, prices for most commodities are on a secular upwards trajectory anyway. What, however, we are witnessing is something much deeper and more primordial. We have begun to witness a global, long-term, broad, social, “survivalist” quest (beyond just the investment world) for the physical security of the real, the tangible and the substantial.
This survivalist quest is a pragmatic quest.
Manifestation of individual and societal “tail” risks; particularly of the “fat” variety:
The quest for financial security and a steady income at the expense of higher-risk, dividend income (or capital appreciation) is the underlying driver for fixed income security markets booming in most parts of the world.
Baby-boomers in many ageing, developed economies of the West have had multiple setbacks in regards to their retirement savings and entitlements over the last decade. At the start of the millennium came the dot-com bust, shortly followed by the 9/11 attacks and the collapse of financial markets with a deep, ensuing recession. Barely recovering from that shock, the Credit Crisis came bringing along with it the worst recession since the Great Depression.
As a result, a significant number of boomers have seen their nest eggs shrink just at the time when they have been made redundant or have had to accept lower paying positions with fewer benefits.
Hence, the need of (and pursuit for) income security, reliability, and predictability is only going to strengthen in the coming years.
Leading up to the Global Financial Crisis, trillions of dollars worth of “intangible” securities had disastrously evaporated into thin air. During the ensuing global “Credit Crunch,” we were all rudely awakened to the notion of “tail risks,” i.e. Risks that lie outside the confidence interval of the expected range of outcomes on a normal distribution curve. Nicholas Taleb’s “black swans” do exist. In its aftermath, The Great Recession has also illustrated how our inappropriate or inadequate intervention (e.g. not intervening to save Lehman) of regular tail risks can allow them to morph into “fat tail” risks – unleashing a set of devastating, systemic, and inter-connected outcomes in what has come to be called The Great Recession.
Even if “fat tail” risks do not actualize (or not as severely or frequently as in the recent past), our time is still to be characterized by an acute awareness of the possibility of tail risks in general, and “fat tail” risks in particular. Whether at the micro-economic (individual and family) level or at the macro-economic level, the notion of tail risks can be expected to play a significant role in the economic lives of nations, going forward.
A future flush with capital: Sovereign Indebtedness & Fiat Currency Debasement
Post-Global Financial Crisis, whether due to genuine commitment towards the welfare of their constituents or due to political expediency or some combination thereof, governments (particularly developed economies) have demonstrated a renewed sense of purpose to generate employment by investing in “energy security” and “infrastructure upgrade” projects for their respective economies. These investments are expected to be made through various fiscal measures such as:
a) shifting budgetary priorities away from defense, space and entitlements to sectors like energy and infrastructure projects,
b) launching deficit spending measures to invest in new infrastructure projects, and
c) raising taxes as well as growing the tax base, among other measures.
The ironic upshot of the Global Financial Crisis is to add more fuel to the fire that created all the havoc and instability in the first place. Further loosening of monetary policy and expansion of sovereign credit have been used as levers to stimulate economies out of the “credit crunch” that resulted from a crisis of confidence in the financial markets — which to begin with — was induced due to lax and expansionary monetary conditions sustained over an extended period of time. Since the Great Recession began, central banks across most of the developed, and several of the consequential emerging markets, have progressively eased interest rates to near zero. In fact, the prospect (and reality) of additional rounds of quantitative easing by central banks has been another favored recipe to further increase money supply in the global financial system.
Quantitative easing (or sovereign debt and other fixed income asset purchases by central banks through new fiat currency issuance) can continue for some time before inflationary pressures start to seep in to the real economy. As these sovereign credit purchases by central banks expands their balance sheets, ever larger proportions of their respective treasuries’ revenues have to go towards servicing this debt. As the costs of servicing this debt grows, the central bank has to print more money. It becomes a vicious circle.
In essence, all that such quantitative easing measures are doing is to leave sovereign treasuries more indebted, fiat currencies more debased, and asset prices inflated (primarily in nominal terms).
Asset price inflation is, however, very real for the ordinary citizen on Main Street. The component of asset price inflation that is over and above nominal levels owes its increases to rising demand for these assets by a growing number of consumers around the world. Further, one can argue that the “real rate” of inflation, based on fundamental demand-supply dynamics, is also magnified by market speculators betting on directional moves on asset prices thanks to the cheap money available within the financial system. As cheap money floods in from the financial economy to the real economy, the increasingly “financialized” world has begun to show ominous signs of expansive, unintended consequences being unleashed upon the broader society. The Global Financial Crisis, that began to show its first material consequences on the world economy in 2007 (and most will argue is still underway), can be expected to be only the first of many global “events” that will send shock-waves across the global economy for years to come before some sort of global “reset” will have to occur when the collective pain of the debtor nations and corporations gets too unbearable to prolong any further.
Private sector credit creation: A growth imperative for banks in a de-leveraging environment
Meanwhile, proprietary trading is on the way out for the money center banks and investment banks. Therefore, fee-based investment and corporate banking will become ever more consequential for generating profits for these institutions. This reduction and eventual evaporation of trading revenues will entail an aggressive pursuit for increasing lending and underwriting activities among the banks. We are entering a period where, on the one hand, there is a concentration of capital in the financial economy among the hands of relatively few banks. On the other hand, there is diffusion in the real economy where innovation happens and jobs are created. Hence, despite the enormous monetary stimulus programs rolled out by governments, bank lending has tended to remain tight and expensive to a majority of businesses. At some point in the imminent future, however, all the build-up of excess liquidity on bank balance sheets will have to be put to work in the real economy. At that point, despite Basel III compliance obligations, there is a likelihood of banks and other lending institutions expanding their loan books and loosening their lending requirements to win business.
In addition, non-bank, private sector players such as private equity firms, asset management firms and hedge funds are also expected to pursue their profit motive in this new phase of monetary expansion.
Inorganically created trillions of dollars of capital (fiat currency) is about to chase limited real resources and organically growing investment opportunities. The result: value of “hard stuff,” i.e. real, tangible assets (metals, commodities, natural resources, plants and machinery, infrastructure and real estate) is to grow over a secular trend line for the foreseeable future – albeit with a higher degree of volatility. The “hard stuff” also can be expected to out-perform the “soft stuff” (Software & Technology, Media, Entertainment, many parts of Financial Services, Hospitality, and other Services sectors, among others).
Hence, most of the world’s reserve currencies (US Dollar, Euro, UK Pound Sterling) are to come under pressure in this monetary expansionary environment.
Most currencies, in this period, can be expected to face a downward pressure but a few are also likely to stay resilient or appreciate due to the “flight to safety” phenomenon or because they belong to countries that are net exporters of raw or finished goods and services. Currencies that can be expected to strengthen are:
- currencies that have sound macro-economic fundamentals and fewer, more insulated fiscal and monetary variables to contend with (Swiss Franc, Swedish Krona); or
- currencies that are issued by large net exporters of natural resources or finished goods (Canadian Dollar, Australian Dollar, Brazil Real, Russian Ruble, Norwegian Krone, Chinese Renmimbi, Korean Won).
Pursuit of yield and the resulting fixed income bubble:
It may not seem like there is a profusion of liquidity in the general economy, yet the waves of capital are building up around the world and liquidity has already begun to creep into certain parts of the global economy such as a wide array of fixed income securities and emerging markets equities.
There are already signs of a bond bubble building up on the horizon.
Furthermore, central banks around the world are likely to continue to sustain a posture of extremely low interest rates to promote an increase in money supply thereby making a tight lending environment an unattractive proposition for banks and non-banking financial institutions. Government and corporate borrowings, on the other hand, will become ever more attractive to lending institutions’, corporations’ as well as institutional investors’, burgeoning balance sheets. The “promise” of a long-term steady yield would aggressively chase down returns in an otherwise uncertain environment. Therefore, fixed income instruments – whether sovereign debt, municipal bonds, or investment-grade (even high-yield) corporate debt – will increasingly become popular in this environment. Popularity, however, is not going to ensure high returns. Risk of a strengthening investor bias towards bonds is very real. Spreads – between high-grade and the enlarging pool of high-yield (aka junk) bonds – is expected to grow. Spreads – between fiscally austere and responsible governments vis-a-vis spendthrift economies, states and municipalities – is also expected to widen.
In pursuit of yields, investor appetite for high-yield fixed income securities has reached enormous proportions. This ravenous demand for high-risk fixed income securities, so recently after the Great Credit Squeeze, does not seem to abate even when it comes to high-risk sovereign debt such that of countries like Greece, Spain, Ireland or Portugal.
It is for the same reason why even the convertible bonds asset class can be expected to perform better than pure equities across many industries – particularly, the services-oriented industries. It follows that various forms of capital structure arbitrage opportunities are expected to present themselves in abundance during this period of dislocation and change.
It is in this setting that large, old-world behemoth corporations with steady cash flows and dividend payouts are expected to gain investor favor in the equity markets.
It is also noteworthy that, in early autumn of 2010, various Central Banks are still trying to fend off deflationary pressures both in word and in action – across many parts of the developed world.
The Fed, for example, is indeed in a fix. On the one hand, the US economy remains sluggish despite interest rates near record lows inching closer to zero. On the other hand, unemployment rates continue to trend upwards over – what can now be considered – a secular trajectory rather than a cyclical one.
Safety is the theme du jour: Defensible (not necessarily just defensive) industries that get “hands dirty”
So, how can we confidently utilize the above analysis to:
a) preserve capital;
b) grow capital.
It is quite straight-forward, really.
One way is to listen to what legendary investor Jim Rogers professes in terms of the merits of investing in “hot commodities.”
What companies would benefit from the “hot commodities” theme?
Metals & Basic Materials Producers: BHP Biliton (NYSE: BHP), Rio Tinto (NYSE: RIO), Vale (NYSE: VALE), Newmont Mining (NYSE: NEM), Barrick Gold (NYSE: ABX), Freeport-McMoRan (NYSE: FCX), Vedanta (LON: VED), Xstrata (LON: XTA), and so forth.
Energy Producers: Chevron (NYSE: CVX), ConocoPhilips (NYSE: COP), Exxon Mobil (NYSE: XOM), LUKOIL (PINK: LUKOY), Petroleo Brasileiro (NYSE: PBR), Royal Dutch Shell (NYSE: RDS.A), ENI (NYSE: E), among others.
What is noticeable is that a commodities boom will entail alternating cyclical demand for “risk on” assets such as oil, coal, gas, copper, etc. on the one hand and for “risk off” assets such as gold on the other. From a secular growth perspective, however, we are already in the midst of a bull run for both “risk on” and “risk off” commodities.
Capital flows, and consequent capital appreciation, can be expected to occur in miners, producers, harvesters, distributors and traders of commodities. We can fully expect for producers and manufacturers of consumer staples (particularly those with a global reach), basic and intermediate materials, and various energy sources — to see a significant increase in capital allocation as well.
In a multi-year period of de-leveraging across some of the highest consumption-driven (developed) markets, consumer staples can be expected to remain one of the few relatively stable sectors of the economy. Within the food and consumer staples space, companies like Kraft (NYSE: KFT), Nestle (VTX: NESN), General Mills (NYSE: GIS), ConAgra (NYSE: CAG), H.J. Heinz (NYSE: HNZ), Syngenta (NYSE: SYT), Monsanto (NYSE: MON), Bunge (NYSE: BG), and Archer Daniels Midland (NYSE: ADM) are likely to do well during this period. If agricultural commodities traders such as: Glencore, Cargill, and Louis Dreyfuss go public, they would be an attractive companies in which to buy equity as well. Their debt would also be an attractive way to gain exposure to the “food security” theme. Companies like Proctor & Gamble (NYSE: PG), Unilever (NYSE: UL), Johnson & Johnson (NYSE: JNJ), among others are expected to show resilience in the consumer non-durables space.
Our times, however, are not just characterized by rising values of “hard assets” such as: physical commodities, basic materials, and energy sources. Our times are not just about molecules found in nature. Our times will also re-discover the value of hard-to-replicate, “get your hands dirty,” industries like: infrastructure, industrials, utilities, telecoms, distribution and transportation.
The Industrials (Building Materials Suppliers, Construction and Heavy Equipment Manufacturers, etc.) would be attractive investment destinations. Leaders in this space will continue to demonstrate their dominance: Alcoa (AA), Lafarge (LFRGY), ArcelorMittal (MT), POSCO (PKX) are all positioned well to benefit from global growth in infrastructure and real estate development — particularly within emerging and frontier markets for years to come.
Utilities and Distribution industries would benefit from a “flight-to-safety” phenomenon. They would also be viewed as defensible businesses that are hard-to-replicate overnight. Utilities like Pacific Gas & Electric (PCG), E.ON (EONGY), RWE (ETR: RWE), GDF SUEZ (GDFZY), Gas Authority of India (532155) are bound to perform well in an environment of rising energy consumption and high barriers-to-entry for a new energy producer/distributor to replicate the extensive production, distribution and transmission network that these enormous utility companies have laid out over decades.
The Tech (and Telecoms) sector can be expected to retain resilient levels of demand and investment.
In a world of rising telecommunications usage coupled with dramatic adoption rates of first-time users in vast expanses of the developing world, those companies which have a head-start in their respective telecoms (particularly mobile telephony) markets are poised for significant upside. Examples that come to mind: Bharti Airtel (532454), Reliance Communications (532712), Brasil Telecoms Participacoes (BRP), VimpelCom (VIP), Turkcell (TKC), Vodafone (VOD), among others.
In each of the above mentioned sectors, the companies (and their securities) of the following types are expected to do well:
- clear and diversified market leaders, or
- the ones which have significant exposure to emerging or frontier markets, or
- the ones with dominant or monopolistic rights over raw materials, or
- those which are well-managed, low-debt, low-cost structures.
Fundamentals of companies in the ‘MINUTE’ space will point toward the best-performing equities and corporate debt — as long as — their securities are not over-priced vis-a-vis classic valuation metrics.
Fundamentals, at the end of the day, will differentiate the winners from losers even in the highest-performing sectors.
It is against this backdrop, that investors can generate superior risk-adjusted returns by investing in industries encapsulated within the ‘MINUTE’ theme.
“Welcome to your life
There’s no turning back
Even while we sleep
We will find you
Acting on your best behavior
Turn your back on Mother Nature
Everybody wants to rule the world
It’s my own design
It’s my own remorse
Help me to decide
Help me make the
Most of freedom and of pleasure
Nothing ever lasts forever
Everybody wants to rule the world…”
- Everybody Wants to Rule the World by Tears for Fears
Power Shift from West to East: Potential for Trade Disputes, Currency Wars and Protectionism
These are times characterized by structural changes in the global economy as the clichéd economic weight of the world shifts back from the West to the East (for fifteen of the past eighteen centuries, such has been the status quo).
These structural changes have only accelerated since the Global Financial Crisis.
Since the ensuing Great Recession, United States – the wealthiest country in the world – has now approximately one in five of its citizens living in poverty. Unofficially, 16% of the workforce is unemployed or under-employed. United States continues to run enormous trade deficits vis-a-vis China. China is buying American treasuries and United States is buying Chinese consumer products. As of now, it is in both countries’ interests to continue this policy of “mutual engagement.” The situation, however, is untenable.
Hence, the question is: Who will blink first?
Meanwhile, the UK is squeezed from many sides: rising unemployment, surging entitlement requirements, declining tax revenues, increasing need for economic stimulus, falling industrial competitiveness, and a general economic malaise. The country has elected its first right-of-center government (with a leftist coalition partner) in over a decade that is pushing through sweeping austerity measures to curb its out-of-control budget deficit.
Portugal, Ireland, Italy, Greece, and Spain are all dealing with enormous fiscal problems threatening the very existence of the European Monetary Union. There is a good possibility that we have not heard the last or the worst of the Greek fiscal woes or the Irish banking crisis. Default from either one of them cannot be ruled out.
Even hitherto fiscally robust economies like Austria and Belgium, are showing signs of economic strain.
The historically liberal, left-leaning post-World War II Western Europe seems to be building up a rising appetite for anti-immigration, right-leaning, populist tendencies. Nationalistic, anti-immigrant sentiments are beginning to manifest in electoral politics as well as in government policy across liberal and/or socialist heartlands such as France, Germany, Sweden, Denmark, and The Netherlands.
All of these are developed economies. All of these are some of the wealthiest societies in the world.
In this environment, overt or covert forms of protectionism are only a matter of time. Such protectionism, however, tends to help those industries more which are resource and labor-intensive — where jobs cannot be exported over a broadband connection. On this go around, however, there are fewer manufacturing jobs to protect in the West. As it is, the global manufacturing supply chain is extraordinarily intertwined where the component suppliers may be head-quartered in China, Taiwan, Malaysia, Indonesia or India. The final, branded consumer product, however, is – more often than not – designed in the US or Western Europe. Import tariffs, therefore, are not likely to trigger significant changes in global trade flows until and unless, the West brings about structural changes in its economies to support indigenous manufacturing to compete with cheap imports from Asia and elsewhere — particularly, those imports that are more competitive due to lower cost structures as well due to artificial currency depreciation. Any such structural change itself would take at least a generation to show marked effects in global trade flows.
The Eastern governments, for their part, would have to stop (or at least reduce) meddling with their currencies in order keep their exports artificially attractive in global markets.
Meanwhile, the currency row between the US and China is not just indicative of a growing tension between the Western (consumer) economy of the US and the Eastern (producer) economy of China. This currency row is a thinly veiled manifestation of the power struggle and transition we are witnessing from the West to East.
Ultimately, societies that “create” stuff (largely the West) should have more leverage than the societies that “make” stuff (largely the East). Intellectual property rights, however, cannot be as directly and completely measured, enforced and monetized as manufactured value addition. Hence, the West is being viewed as more profligate and less productive than the East and vice versa.
In fact, in very real terms, global trade and savings imbalances are partly due to this very phenomenon where the West is not being compensated in full — for its innovations in hi-technology, bio-therapeutics and conventional medicine, automotive, aviation, distribution and logistics, financial services, media, telecommunications, among other industries. The West is doing the innovation “heavy-lifting” only to see the East create a cheaper, faster, more mass-market version of the product or service that is sold across the globe without much (if any) financial compensation or intellectual acknowledgement offered to the original Western innovators of that product or service.
Meanwhile, the East is now beginning to move up the innovation value chain where it may, increasingly not only produce the products and services of the future, but may also originate the innovations of tomorrow.
As this shift occurs, power will be transitioned — from the West to the East – much like before in the history of civilizations in spasmodic, discontinuous bursts of instability and discord (if not all out combative military interventions or wars).
Global scarcity of resources, birth of new nations and a period of secular economic instability:
Historically, the world has dealt with scarcity for most of its existence. Make no mistake, despite armed conflicts in the past several decades not being as devastating or multi-lateral as World War II, the quest for resources continues to intensify among nations. In fact, one can argue that beneath all the cultural, religious, and linguistic differences that are offered up as the key bases for the independence struggles of various minorities, the central (although not always overtly stated) raison d’etre for new countries being carved out of existing ones is the notion of safeguarding ancestral, “sovereign” economic interests of a minority residing in a resource-rich territory within an existing nation.
Right from the mid-twentieth century – when former South Asian British colonies became independent as India, Pakistan, East Pakistan (later Bangladesh) – the pursuit of economic self-determination has been as much a factor as the desire for political autonomy or social equity and liberty in all independence struggles. Obviously, such a dynamic is not uniquely pertinent to the British empire either, the French relinquished their control over Indochina to give birth to three new nations for a similar set of reasons – Vietnam, Laos, and Cambodia.
Self-determination of political, social – and crucially – economic interests was the common thread across the founding fathers and the indigenous populations that catalyzed the break-down of the Soviet Union. Since the Communist union’s dissolution, a slew of new nations (many of which resource-rich) have come into being: Russia, Ukraine, Moldova, Armenia, Azerbaijan, Belarus, Estonia, Latvia, Lithuania, Georgia, Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan.
East Timor became independent a few years ago fuelled by its quest for religious, cultural and economic freedom.
As a matter of fact, there have been rumblings for independence in resource-rich Kurdish Autonomous Region of Northern Iraq (popularly known as Kurdistan) for quite some time. Yet another example of economic drivers playing a significant part in seeking autonomy and independence, many in the Flemish region of Belgium want to separate from Wallonia – in large part, due to the economic disparity and dispensation structure of state-provided welfare benefits.
North and South Sudan may go their separate ways as early as January 2011. In addition to all the ethnic violence that has culminated in the proposed referendum for independence, South Sudan sits on over five billion barrels of proven oil reserves. Economics, again, becomes a critical consideration.
If we peel all the layers of the onion, as it were: Through the centuries and across geographies, the ongoing march of societies staking claim to resources they consider are rightfully theirs, has led (and continues to lead) to conflicts.
We are entering an era where, again, the quest for basic resources is expected to form the basis for many a major and minor future conflict — not just among nations but even within them.
As the sense of scarcity rises and the gap between ‘haves’ and ‘have-nots’ widens: anger, resentment and strife can be expected to follow. Recent strikes by workers in Greece and France over raising the retirement age and reducing entitlements, collective unrest in Pakistan and Haiti over the slow and inadequate response by their governments in the wake of natural disasters, as well as food riots in Mozambique are but a few manifestations of public anger boiling over. Despite those episodes not yielding the desired results for the ‘masses,’ we haven’t seen the last of them. Au contraire, if anything, we can expect to see more such collective manifestations of economic tensions brewing at the international, domestic, community, family unit and individual levels.
The writing is on the wall is: We are entering an era of secular economic and geo-political instability.
Hence, these times are about valuing the basics that sit at the bottom of Maslow’s hierarchy of needs: Food, clothing, and shelter.
“I close both locks below the window
I close both blinds and turn away
Sometimes solutions aren’t so simple
Sometimes goodbye’s the only way
And the sun will set for you
The sun will set for you
And the shadow of the day
Will embrace the world in grey
And the sun will set for you…”
- Shadow of the Day by Linkin Park
Once upon a time there lived two orange farmers in sunny Florida.
They were called: Jack and Steve.
They both were friends, came from the same town, similar age, socio-economic background and skill set.
They both worked hard for their co-operative. They both were hungry to progress in their line of work. They both were ingenious in the way they approached their work. But there was ONE vital difference between the two: Jack and Steve had completely different outlooks on business.
Jack was good at ensuring every last drop of juice was squeezed out of the oranges he used for their co-operative’s juice-making facility. However, Steve was more intrigued by the idea of how he could produce more oranges and sell them to new sets of customers in different product formats and through wider distriution.
Jack continued to come up with innovative ways to squeeze out the last drop of juice in the oranges that were grown in their co-operative’s orchards. It gave the orchard a handsome 10% increase in juice yields.
Steve, on the other hand, had no immediate results to show for his efforts in experimenting with crop yield improvement techniques. He tinkered with new innovations in how his co-operative’s oranges could be used in other products and categories — food & beverage (non-carbonated drinks, soda, candy, etc.) and personal care (soaps, facial creams, etc.), among others. He even engaged with new distributors from across the pond in Europe to sell more of his product. All of these efforts amounted to very little as most of these initiatives resulted in marginal marketshare gains but significant expenses over the short-to-medium term.
While Jack was delivering measurable “results,” Steve was been criticized and chastised for apparent lack of pragmatism and bottom-line results.
But one fine day, Jack realized he had reached the limit of squeezing every drop of juice available in an orange and could go no further. Meanwhile, right about this time, Steve’s non-fizzy, special orange and mixed fruit juice blend began to take off. Over the next few quarters, the drink gained national popularity.
In that year alone, sales went up by 35% and margins approximately: 20%. And there seemed to be no stopping the popularity of the drink — which a major beverage company was interested in licensing for US$ 300 million for an exclusive, multi-year agreement to produce and distribute the drink. This would be 10 times the annual US$ 30 million turnover of the entire orange co-operative and 100 times greater than the US$ 3 million extra margin improvement that Jack had painstakingly operationalized by improving juice yields from their orange stock.
Moral of the story: Yield management and cost reduction have their logical limits. Growth and diversification, on the other hand, is only limited by the resourcefulness and creativity of the people involved.
What company are you?
Jack — the cost-squeezing innovator with a natural limit to your value creation capabilities…or Steve — the relentless strategic innovator with boundless value creation capabilities.
What is your outlook on business…and life?
The Great Moral Squeeze
Is it just a global credit crunch we are facing; is it merely a crisis of confidence?
Or have we stopped valuing values?
In reality, isn’t it that we are in the midst of a global “moral bankruptcy?”
And, does a strong ethical framework foster a healthy economic environment?
Finally, what can we do to regain some semblance of normalcy?
Note: This essay discusses a wide variety of ideas and draws from several bodies of knowledge. Therefore, it ought to be read with the cognizance that an in-depth exploration of the topics covered may warrant a volume in the future – of which this essay could form the underlying foundation.
Monday, September 15, 2008: Lehman Brothers files for the largest bankruptcy protection in U.S. history. The US government refrains to intervene to save the failing investment bank.
Tuesday, September 16, 2008: U.S. Federal Reserve presents $85 billion rescue package to the insurance behemoth: AIG. The move is made in order to avert larger, systemic shocks to the global financial system. The same day, Merrill Lynch, the third largest investment bank in the world is sold to Bank of America in a fire sale.
Sunday, September 21, 2008: In order to shore up their toxic balance sheets, two of the most venerable names in the investment banking world: Goldman Sachs and Morgan Stanley dropped their much vaunted investment banking status to become bank holding companies.
October 6-10, 2008: The Dow Jones Industrial Index falls 1874 points (18%) to record the steepest weekly fall in its history of 120 years.
Friday, October 31, 2008: UK’s second largest bank: Barclays announces a £7.3 billion investment from Middle East sovereign fund investors for roughly a third of its ownership.
Monday, November 24, 2008: US government and Citigroup together identify $306 billion in distressed assets on Citigroup’s balance sheet. Citigroup would absorb the first $29 billion in losses and various US government agencies would pick up most of the remaining tab. The Treasury Department also commits to a total $45 billion infusion into the bank.
Thursday, December 11, 2008: Former Chairman of NASDAQ, Bernard Madoff is arrested on a securities fraud charge that is estimated to be worth a historic $50 billion.
There’s plenty of other bad news to recount. But you get the picture.
Safety in Numbers
“We go by the major vote, and if the majority are insane, the sane must go to the hospital.”
– Horace Mann
The word on the street was: if a sufficiently high number of people would be on the wrong side of the issue, the rule of safety in numbers applied. Well, the numbers part did apply, and the safety part did not.
During the boom times, “free markets” were given as much a free rein to benefit from the growing “investor class” of wealthy high net worth individuals, investment bankers, hedge fund managers, asset managers, and private equity firms, among others. Millions of less than sophisticated investors got caught in the current financial crisis through one product or another – whether through an unrealistic home mortgage, or spiraling credit card debt, or a derivative investment, or a home equity line, or one of the other cheap credit-fuelled products. Now, tens of millions of average Joes and Janes through their savings, 401-K’s, IRA accounts, and mutual fund and common stock holdings are bleeding hundreds of billions of dollars. Somewhere along the way, the financial services sector (purveyors of easy credit-fuelled products) got too smart and too greedy for everyone’s good.
Ultimately, bad karma had to catch up.
And how has bad karma caught up?
Seemingly sophisticated financial market participants (investment banks, insurance companies, hedge funds, asset management firms, etc.) have suffered, and in certain instances, succumbed to what Warren Buffet calls, “weapons of mass financial destruction.” And now, expectedly, everyone – the perpetrators and the victims – are in that clichéd state of: fear, uncertainty and doubt.
Doesn’t history have a way of repeating itself?
In fact, there are several parallels between now and The Great Depression. On the back of years of easy credit, speculation was rampant across several asset classes such as equities, commodities and real estate then, just the way it was on this go around. There was a “trust” (investment firms that were publicly traded) securities bubble then just the way there was a derivatives (fixed income securities, commodities futures, etc.) bubble this time around. The role of investment banks in creating and selling new, arcane, and insidious financial instruments, was central then just as it has been in this crisis. And an unfettered financial markets regulatory environment and a damagingly loose monetary policy regime that spawned the market distortions then are strikingly similar to the “market fundamentalist” economic policy framework that has given rise to the current financial meltdown today.
Whether folks are aware of the parallels between now and the Great Depression or not, markets are spooked by the inability of the financial services sector to self-correct the excesses of its own offspring, i.e. products of financial engineering.
And therefore, markets find themselves underneath a cascade of events from housing price collapse, to home foreclosures, to personal and corporate bankruptcies, to the ever-growing sub-prime crisis, to millions of job losses, to an unrelenting colossal liquidity crunch, to historic stock market crashes, and to a potential US financial markets failure, and a globaleconomic meltdown…and possibly the invocation of The D word?
So, how did we get here?
The Moral Argument
If we scratch just beneath the surface, we will see that it is not just a “credit squeeze” we are in, it is actually a dual and interconnected squeeze. The squeeze in credit is really a symptom of a squeeze in confidence. But, it does not stop at that either: Loss of confidence originates from a more fundamental place. It originates from a lack of trust.
And needless to say, lack of trust is one stop away from the root cause – often dismissed as an irrelevant and antiquated notion in the modern, pragmatic world of business, economics and finance – ethics and morals.
“Greed, for a lack of a better word, is good. Greed is right. Greed works. Greed clarifies…”
– Gordon Gekko (character played by Michael Douglas in the 1987 movie: Wall Street)
Trust, one may argue, is better. Trust unites. And, trust liberates. Most of all, trust elevates.
Trustworthiness earns us the entitlement of being called human and civilized.
It is the glue that ties individuals – businesses – communities – societies – in fact all relationships together. It gives us a symbiotic construct within which to co-exist with fellow humans.
One may argue, it naturally waxes and wanes with the continuously changing cycles of how much integrity or “moral equity” or “ethical capital” there is left in a society at a given point in time.
The disturbing state we find ourselves today is: trust is running dangerously low.
In the continuous cycle of peaks and troughs of honor and integrity, and yes, consumer and investor confidence, our times and our societies are experiencing for themselves what comes out of violating universal values. These universal and timeless values are deemed sacrosanct and inviolable for a civilized society to function with some semblance of order and certainty. It is those values which are considered the most basic, common denominator that have been, and should be, considered a given. It is these values that aggregate to what we commonly refer to as our moral compass.
It is our moral compass that protects us from giving in to Gordon Gekko’s “greed is good” mantra.
It is our moral compass that steers us clear from mistaking a healthy dose of Rand-ian Objectivism (the operating philosophy of legions of Wall Street bankers and Corporate America’s CEO’s) with a “tunnel vision” and perverse pursuit of Chicago School economics agenda.
It is our moral compass that provides a degree of certitude to the other (whoever that other might be) that regardless of what we stand to gain or lose, we will honor our commitment to deliver on our promises (whatever our promises might be).
It is our moral compass that navigates us through life’s numerous temptations.
It is our moral compass that guides us to do the “right thing” – for the right reasons.
It is our moral compass that through hundreds, thousands, millions of big and small interactions and decisions keeps the society’s trust intact.
“…Pay my respects to grace and virtue,
send my condolences to good,
give my regards to soul and romance,
they always did the best they could,
and so long to devotion,
you taught me everything I know,
wave good bye, wish me well,
you gotta let me go,
are we human…”
– From the song “Human” by The Killers
Could it be that what we are really facing is a colossal “moral bankruptcy?
Glamorous, effective, and even practical as it appears, unethical and immoral behavior leaves the perpetrator and the victim impoverished. It is intoxicating but temporary. It leaves societies and economies stagnated or regressed. And it strips us of much that makes us civilized, cultured, and yes, human.
Governments, of course, cannot legislate morality. They can, to varying degrees of success, regulate business practices. Few would disagree that the numerous regulatory institutions and their complex and arcane control mechanisms in mature and emerging economies such as US, UK, France, Germany, Japan, China, India, Korea, among others have been able to regulate their markets to varying degrees of success. That was true until the current financial crisis began.
Governments can punish irresponsible, unethical or immoral behavior. Perhaps, through certain policy measures, they can even marginally incentivize ethical and moral conduct. Consider trading of carbon credits as an example.
With a clear sense of ethical direction, even companies can competently regulate their business conduct through governance standards, through audit committees and internal audit departments, through risk management departments and their policies and procedures, through their auditors and consultants, among others.
Ultimately, though, it is individuals who constitute these organic, evolving societies – who have to live by certain organizing principles that are governed by a broader social and moral code as well as a narrower administrative, legal and legislative framework. And if individuals do not or cannot self-govern themselves with a clear and broad set of rules of engagement, then the government can only do so much through its regulatory levers. But that does not mean it should forego its social responsibility and absolve itself of its moral obligation.
Erosion of Independent Judgment
“A man of great common sense and good taste is a man without originality or moral courage.” – George Bernard Shaw
Could it be, that America – and for that matter – the rest of the world is losing its capacity to appreciate and exercise clear-eyed, rational, and independent judgment?
Has group-think taken over to the point where critical thinking has become a novelty to marvel at rather than a skill to develop and employ?
Or is it that, in addition to the above, there is something even deeper at play here: We, as a modern, civilized society have stopped valuing values?
Simple, classic, timeless values.
It is societies, after all, that rise and thrive by values – or decay and decline for lack of them.
And therefore, governments, companies, and societies together have to pay the price for the wayward conduct of its citizens – regardless of the industries in which they operate.
Just the monetary price tag on this go-around for our transgressions: $14 trillion and counting…
$8.5 trillion in various US Federal government bailout and stimulus packages (a detailed list is available upon request), $2.5 trillion and counting that governments around the world have infused into the financial services sector to shore up the global capital markets so far, and $4 trillion of losses incurred in capital markets since the current global financial meltdown began starting spring of 2007.
In light of these staggering losses, the question arises:
Is moral conduct a naïve and polyannish aspiration for a utopian world, or is it a realistic and practical imperative for a healthy, functional society and economy?
Switching gears then, so where does the trail lead us back to?
Uncertain Livelihood; Unstable Life
There could also be a lot of stress, pain, and suffering with the millions of job losses. There is unimaginable financial strain one goes through with a job loss and unconscionable insecurity that one experiences – especially in those economies where there is no safety net. Beyond those great misfortunes that no man or woman should have to face, there is a more fundamental loss. The loss of one’s identity that comes from being rendered unproductive and seemingly irrelevant to society. It is this loss that bends, and unfortunately sometimes, breaks the strongest, most resilient of wills. It is this loss that leads to crime. It is this loss that runs against the most basic principles of human dignity and honor. It is this loss that needs to be defeated with absolute resolve regardless of how derisive the label ascribed to the individual, company, or society fighting for the rights of the silent majority. Those could range from socialist to communist to liberal to progressive, and so on.
What also often goes unexplored is the socio-economic ecosystem that bred selfish, greedy, short-sighted, and socially deleterious behavior by which we are all affected. As Los Angeles Times columnist Tim Rutten eloquently points out: “Long before the financial system melted down, American business’ share of the social compact melted completely away.”
Long before toxic assets had hit the balance sheets of Wall Street, toxic motivations had begun eating into the fabric of society. The unspoken rules that hold us together in a social compact of honor, decency, and fairness had been discarded to the junkyard of values.
A vast majority of the current bankers’ generation – Generation X – is likely to have experienced first-hand how their families’ economic and social stability came crashing down by the loss of the bread-winner’s job. The beneficiaries of this disruptive market mechanism extolled the virtues of its “Darwinian” ethos. As the Austrian economist Joseph Schumpeter called it: the “creative destruction” of capitalistic forces. But there was a cost – a heavy cost borne by the families and their young, impressionable ones – who went on to live by the cynical interpretation of the Darwinian code of “survival of the fittest.” The interpretation was one of a twisted, brutal, and severely political ethos covered by a thin veneer of civility and political correctness. The moment they stepped out into the public domain, it was each man for himself, each woman for herself.
Such an insecure, uncertain, and unhealthy environment gave rise to the toxicity that we live and breathe today.
One may wonder: where is the civility in this value system?
Where is the humanity?
In a setting like this, where there would be only negative consequences for not being a “team player” – regardless of how morally vacuous the “game” was, voices of integrity would not have much of a chance. The reward of “fitting in” was too alluring, and the price of not doing so, too heavy.
And hence, here we are: In this global financial and moral crisis.
What could happen next?
“Brother, can you spare a dime.” – Yip Harburg (sang by Bing Crosby), 1932
Business is the lifeblood of an economy. However, capital is the oxygen of an economy. Capital is what oxygenates business – which in turn ensures economies survive and thrive. As we speak, the world financial markets are sucking out oxygen, i.e. capital of the markets. And out of businesses. They feel wronged and, therefore, are in a punishing mood. It doesn’t matter whether they punish Main Street for the sins of Wall Street or vice versa. After all, it is hard to single out any impeccably innocent party to this party.
Looking beyond the debate over the extent of their impact, it is entrepreneurial businesses that are one of the prime engines of economic growth in Western-style capitalistic economies around the world. In the ensuing corrective process that is already underway across the globe, the thriving market for ideas and innovations is getting squelched. In a knee-jerk reaction, the capital markets that trade in “paper” may intentionally or unintentionally stifle real entrepreneurship (regardless of whether it resides in a large enterprise or small). As it turns out, real entrepreneurship creates real value for the real global economy. And by the way, that real value produces real jobs and generates real wealth.
So, how do we get out of this mess? What should we do now?
“Get busy living, or get busy dying.” – Ellis Boyd “Red” Redding (character played by Morgan Freeman in the movie Shawshank Redemption)
Keeping people employed fully is socially responsible. Utilizing their talents and skills optimally is economically profitable. Natural resources are scarce, human ingenuity is not. Zero sum games are applicable to the alternately dour and toxic, ruthless and vacuous world of politics. In sharp contrast, the world of economics is alive: pulsating with creativity, energy, and vitality. It is ever growing, morphing, and enriching.
It is time for us all to go to work. Find our passions and our causes. Ideas we believe in. We do not have a choice. We must go to work.
In this great adversity, there is great opportunity. It is an opportunity to re-evaluate and re-adjust what we value and what we reward as a society.
As a global society.
We, as a global society, are at a crossroads. Big and far-reaching as the current global financial crisis is, the threat to the ecology of our planet dwarfs anything on the horizon. It is, quite simply, a matter of our long-term survival as a species.
The good news is, there are also many time-tested ideas, frameworks, and philosophies available for us to seek our collective salvation (in a purely secular sense of the word). They range from financial to economic to political to sociological to psychological to philosophical to religious, and of course, to ethical. Given how enormous and sweeping our challenges, we may have to employ all of these levers to varying degrees across different peoples and nations. All of these choices as independent organizing philosophies, or in some combination thereof, will most assuredly have different intended as well as unintended outcomes. A fair, steady, and dispassionate approach to arriving at a consensus is paramount. Intellectual honesty, therefore, is also imperative. Each nation, town and community would have to come up with their unique, grass-roots recipe that works for them. And at the same time, due to our ever deeper global inter-dependence, each of them would have to ensure that their governing social, economic, political, and religious ideology integrates in some way, shape, or form within the larger global community.
Curiously, the moment the discussion veers towards policy (and heaven forbid) ethics and morality – some of us tend to tune out. One cannot blame those who do tune out. We live in a cynical world.
Nonetheless, we must effect numerous policy changes to fix the global economy as well as to resolve the “clash of civilizations” – and to regulate the capital markets – and to clean up the housing mess – and to reduce uncertainty in the job markets – and so on. One could even offer several socio-economic frameworks to sort out the world’s moral bankruptcy in the private and public domains.
Role of America
However, as Newsweek International’s editor, Fareed Zakaria, explains: we are gradually shifting to a period of the “post-American world,” where the “rise of the rest” will create new ethical, environmental, commercial, political and diplomatic opportunities and challenges. America, however, would still have the unique opportunity to set the agenda for powers across both the developed and developing economies. Despite the gradual shift to a multi-polar power structure, what America thinks, says, and does in the forthcoming decades would continue to profoundly impact the rest of the world.
And therefore, as the current crisis has made it all too clear, American public policy and personal ethics would play a central role in getting not just America, but due to its inter-linkages, the rest of the world out of this current economic crisis and moral squeeze. However, even America’s constructive role in a “Post-American World” would only be a necessary but not a sufficient condition for the world to get back on its feet. The solution set to today’s complex and long-term problems actually begins with a reminder of something much simpler yet bigger.
Back to Basics
“Leadership cannot just go along to get along. Leadership must meet the moral challenge of the day.” – Rev. Jesse Jackson
Progress has come to the world wherever the ennobling pursuit of one’s destiny has been rewarded.
Progress has come to the world whenever people have been proven right for believing “anything is possible.”
Therefore, it is time to ask broad and sweeping questions about whether we are achieving progress in a larger sense of the word; in a civilized sense of the world.
It is time to re-visit some of our long-held assumptions, hypocrisies, prejudices, and values by which we understand and respond to the world.
Now is also a time to re-discover an idea.
It is a basic idea. But a very big idea.
It is an idea for a fairer and more just world.
A world where leadership exists in thought and in action. And in every other sense of the word.
A world that is driven by a sense of purpose rather than by a sense of convenience.
A world that not only confronts tyranny but also embraces justice.
A world that not only fosters unity but also promotes diversity.
A world that not only has a taste for success but also an appetite for failure.
A world that not only reaches up for the pinnacle of power but also reaches down to the depths of compassion.
A world whose nations set their agendas – not just due to their military might, or financial strength but more so, because of their moral authority.
A world whose nations not only protect their land, sea, and air but also open their hearts, minds and souls.
A world that not only commits to a level playing field but also delivers on mobility for those who score a goal.
A world whose nations are not only honest to their peers but also to themselves.
And most of all, a world where our sustenance is not at the expense of the planet’s sustainability.
It is time to re-discover classic values…values of merit, courage, hard work, enterprise, innovation, self-reliance, collaboration, thriftiness, tolerance, resilience, perseverance, unpretentiousness, candor, decency, trustworthiness, generosity, loyalty, honesty, and sustainability.
It is time to value values again.
About the Author: Sahil Alvi is a management consultant and a writer. He presently works with a global management consultancy in Dubai, UAE. Previously, he has held management consulting roles with Ernst & Young and PricewaterhouseCoopers in the US. He can be reached at: email@example.com