It happens all around us constantly - however, the digitization of our interactions, mostly facilitated by the Internet, must've had the greatest toll on companies products or their business models. Schumpeter's creative destruction must be at play more today than at any time in society's history and every Company must now (more than ever) be on the lookout for its own demise 3-5 years out.
The latest casualty - which took over 100 years - is Kodak (Started in the 1880's). Being showcased today as almost becoming a penny stock, there is no doubt its days are numbered. What only 20 years ago were synonyms with photos and pictures - are both today non-existent in the ecosystem: Kodak and Polariod (Started in the 1930's). The digitalization of memory / event capturing for the masses has been taken over by other companies who's main business didn't even used to be building cameras or producing film. Most likely, the threat of cannibalizing their major businesses at the time was the major impediment in them fully embracing the newest forms of participating in the industry (which wouldve required full focus), i.e. not making money in the film itself, but, only in the hardware - which probably required the company expanding into other type of hardware. Another interesting element of disruption is how it migrates spending from components of an existing industry (buying film, develping film, for example) to another (hardware, but, most likely increasing disposable income to be spent somewhere else).
Kodak and Polaroid had their time in American industry and innovation, which will be crystallized in history. Its the amazing speed of development that we have seen in the last 50-60 years, and which has really accelerated in the last 15-20, what has consumed companies that are not forever-forward looking. Leaving nostalgia aside for any of these companies, consumers and society are significantly better off by these forces of creative destruction.
Tuesday, September 27, 2011
Tuesday, June 14, 2011
NFLX: A bbuster killer, a cord-cutter, a cord-shaver, or a network?
The advent of Netflix on the media scene has been one of disruption that moves along the value-chain spectrum of video entertainment. Its roots as a DVD distributor via mail showed it as a disruptor of who until then was the biggest distribution channel for DVD's from movie studios: Blockbuster... in a period of less than 10 years it completed its disruption having acquired a market cap of various billions at the time when Bbuster was filing for bankruptcy. A graph of the disruption in play: http://yhoo.it/kZKT0G... since I like the topic on disruption, here's another one of Apple vs. Nokia/BBerry: http://yhoo.it/k8vMBn, which has really hit in the last 24 months: http://yhoo.it/j9GJnO
Even before it completed its BBuster disruption, it was already seen as a potential disruptor to video distributors into the home as it digitized its content and set its sights on distributing via bband ("NET"Flix) - providers via cable or satellite... which made them move aggressively in two main ways: (1) expand themselves as multiplatform providers, and (2) seek additional control over the rights to content... despite all the talk about cord-cutting, the low price and long-tail strategy fit NFLX best as a cord-shaver that could live together with cable as an add-on, thus threatening premium tiers offered by these services... establishing that there are certain things valued by consumers that a NFLX would not be competitive in offering: news, sports, live events, plus the still (and probably ever) valuable elements of a curated list of branded linear channels (content), it situated itself as a basic-services add-on...
Having clearly defined its space and its value proposition within the cabsat space, but with its disruptive juices ever flowing, it then started experimenting along two dimensions: (1) original programming - thus threatening its own suppliers (and thus increasing its power within the value chain), and (the latest) (2) seeking to become a network within bband - arguing that not unlike people pay for cable to get certain channels, people pay for bband to use NFLX.
This last pt has been ridiculed by many arguing that people don't necessarily get bband to get NFLX (true), but, its also true that people don't subscribe to bband to get NFLX any less than they subscribe to cable to get some 2nd or 3rd tier channels... or along the same lines, NFLX might be more of a reason for subscribers to increase their download speeds (and spend more money on bband), than 2nd or 3rd tier channels would be in subscribers paying more for cable.
At the end of the day, NFLX's disruptive power will stop at some pt along the value chain, and I would argue it would never fully compete with networks - companies like Viacom have the knowledge and drive the necessary company culture to create the content that particular targets desire (or don't know they desire), and that's a special skill that not easily disrupted. The kind of disruption that NFLX did - was business first (dvd via mail) and then technological (SVOD via bband), where as talent/creative disruption is something not as accessible... Along the content axis though it will become an enviable competitor to simple "premium movie distributors" who today get a fee by delivering the svc via cabsat.
The NFLX story is one of disruption in our industry that is still being written... that led to the demise of some businesses and led other businesses (that thought they had barriers to entry) to have positive change.... the happy ending is that it has increased the amount of consumption of this great good that we call "branded entertainment"
Even before it completed its BBuster disruption, it was already seen as a potential disruptor to video distributors into the home as it digitized its content and set its sights on distributing via bband ("NET"Flix) - providers via cable or satellite... which made them move aggressively in two main ways: (1) expand themselves as multiplatform providers, and (2) seek additional control over the rights to content... despite all the talk about cord-cutting, the low price and long-tail strategy fit NFLX best as a cord-shaver that could live together with cable as an add-on, thus threatening premium tiers offered by these services... establishing that there are certain things valued by consumers that a NFLX would not be competitive in offering: news, sports, live events, plus the still (and probably ever) valuable elements of a curated list of branded linear channels (content), it situated itself as a basic-services add-on...
Having clearly defined its space and its value proposition within the cabsat space, but with its disruptive juices ever flowing, it then started experimenting along two dimensions: (1) original programming - thus threatening its own suppliers (and thus increasing its power within the value chain), and (the latest) (2) seeking to become a network within bband - arguing that not unlike people pay for cable to get certain channels, people pay for bband to use NFLX.
This last pt has been ridiculed by many arguing that people don't necessarily get bband to get NFLX (true), but, its also true that people don't subscribe to bband to get NFLX any less than they subscribe to cable to get some 2nd or 3rd tier channels... or along the same lines, NFLX might be more of a reason for subscribers to increase their download speeds (and spend more money on bband), than 2nd or 3rd tier channels would be in subscribers paying more for cable.
At the end of the day, NFLX's disruptive power will stop at some pt along the value chain, and I would argue it would never fully compete with networks - companies like Viacom have the knowledge and drive the necessary company culture to create the content that particular targets desire (or don't know they desire), and that's a special skill that not easily disrupted. The kind of disruption that NFLX did - was business first (dvd via mail) and then technological (SVOD via bband), where as talent/creative disruption is something not as accessible... Along the content axis though it will become an enviable competitor to simple "premium movie distributors" who today get a fee by delivering the svc via cabsat.
The NFLX story is one of disruption in our industry that is still being written... that led to the demise of some businesses and led other businesses (that thought they had barriers to entry) to have positive change.... the happy ending is that it has increased the amount of consumption of this great good that we call "branded entertainment"
The Euro - the beginning and end of it
A currency union can't survive by combining less competitive, smaller economies with more competitive, larger economies without a common fiscal/borrowing system and/or labor mobility across the territories. Before long, the currency follows the bigger more competitive countries, and the smaller less competitive ones are left with an ever decreasing ability to produce/compete/grow, thus resulting in employment loss, decreasing growth and ultimately stagnation. The only way out for these countries is to: (1) catch-up in competitiveness (not possible in the short-term), (2) for the smaller countries to coordinate salary deflation across public and private sectors at the same time (not possible outside of a brutal dictatorship), or (3) to devalue and adjust prices via the currency mechanism. In summary, the competitive adjustment needs to happen via the relative prices (if currency is fixed) or via the currency if its floating.
As such, the Euro's survival looks very bleak, unless Greece, Portugal, Ireland and Spain (And Italy) can catch-up in competitiveness... or most likely - they'll get out of the German straight-jacket.
I wrote two posts earlier on this:
http://jtolosa.blogspot.com/2010/05/euro-clock-is-ticking.html
http://jtolosa.blogspot.com/2009/04/spain-new-argentina.html
and its surprising to me how long it takes for the general consensus to agree to the above reality - which has been lived over and over again during the last 40 years.
The European dilemma was exacerbated because so much credit flowed into these weak countries which was put to work in unproductive assets, thus creating debt that was ultimately not able to be repaid (due to the asset bubble and the reality of the lack of competitiveness), thus, advancing the day of reckoning.
No matter how far the can is kicked, these countries will need to get out of the Euro because we were not all created equally competitive... and the difference in competitiveness needs to be reflected in relative wealth at some point... and the only democratic and equitative way of pushing through the difference in wealth (without people noticing) happens to be an exchange rate.... let exchange rates float, and the market dictate how rich or poor countries become... fixing currencies with larger and more competitive countries is like creating a vision of an oasis in the middle of the very dry desert...
As such, the Euro's survival looks very bleak, unless Greece, Portugal, Ireland and Spain (And Italy) can catch-up in competitiveness... or most likely - they'll get out of the German straight-jacket.
I wrote two posts earlier on this:
http://jtolosa.blogspot.com/2010/05/euro-clock-is-ticking.html
http://jtolosa.blogspot.com/2009/04/spain-new-argentina.html
and its surprising to me how long it takes for the general consensus to agree to the above reality - which has been lived over and over again during the last 40 years.
The European dilemma was exacerbated because so much credit flowed into these weak countries which was put to work in unproductive assets, thus creating debt that was ultimately not able to be repaid (due to the asset bubble and the reality of the lack of competitiveness), thus, advancing the day of reckoning.
No matter how far the can is kicked, these countries will need to get out of the Euro because we were not all created equally competitive... and the difference in competitiveness needs to be reflected in relative wealth at some point... and the only democratic and equitative way of pushing through the difference in wealth (without people noticing) happens to be an exchange rate.... let exchange rates float, and the market dictate how rich or poor countries become... fixing currencies with larger and more competitive countries is like creating a vision of an oasis in the middle of the very dry desert...
Monday, September 6, 2010
Housing: The Decision - Government or No Government
Finally somebody has said it like it is - Home Prices in this country are supported by the government and if government were to leave the mortgage market to private enterprise, the availability of credit to buy homes would suffer significantly and thus (like for any other asset) prices would fall in tandem with the adjusting of the credit availability.
This is what Bill Gross said after visiting Washington DC last week:
"The private market was nowhere to be found because they charged too much (during the last 12 months, when gov't has been responsible for 95% of mortgages). It was the cost of private origination and securitisation, perhaps more than any other factor, that justified government involvement. Prime, but non-conforming, mortgages (jumbos, insufficient down payments) were being purchased by PIMCO in the hundreds of millions of dollars every week, but at yields of 6, 7, and 8%. If that was the risk/reward tradeoff, compared to FNMA and FHLMC yields at 3.5–4%, how could policymakers pretend that the housing baton could be quickly and cost-effectively passed back to the private market? Few, if any, could afford a new home at those interest rates. If you were a believer in the dominance and superiority of private markets, how could you deny the signal that markets were sending – that the risk was too high given the substantial losses of recent years?... Americans now know that housing prices don’t always go up, and that they can in fact go down by 30–50% in a few short years. Because of this experience, private mortgage lenders will demand extraordinary down payments, impeccable credit histories, and significantly higher yields than what markets grew used to over the past several decades. Could an unbiased observer truly believe that housing starts of two million or even one million per year could be generated under the wing of the private market? In front of Treasury Secretary Geithner and the assembled audience, I said that was impractical. Let me amend that to “ludicrous.”.... Having grown accustomed to a housing market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey into the camp of private lending. The cost would be enormous in terms of yields – 300–400 basis points higher than currently offered, crippling any hopes of a housing-led revival to the economy."
I believe the adjustment we just went through is the first phase of what could be another large adjustment if the government decided to get out of mortgages. The adjustment in home prices is a reflection of removing all the loans that should not have existed in the first place: liar loans (no doc), no down payment loans, reverse amortization loans, interest option, among others - these loans were permitting people to buy homes they could not afford and because there was new demand for every particular price point, asset prices went up - we all felt rich, we all spent more, we all got more indebted, ultimately society created this bubble.
The second phase could be equally hurtful or worse - if government stopped guaranteeing mortgages, mortgage rates would go up significantly, and with them, demand for homes at any particular price point would also drop significantly. I don't think government will leave the mortgage market (guarantees, mortgage interest deduction, etc) for this specific reason.... which then leads to another question -> how can we create the right incentives as a society to stop so much investment into dead assets - i.e. homes. Homes don't deliver any economic growth - outside of providing an abode to those that do - at least not in the same fashion as investment in assets that are tied to the production of goods and services. The other negative effect of homeownership - in periods like today - is that it removes flexibility from the labor market. Owning a home does not allow people to move to find work as easily as if they were renting. Obviously owning a home provides many positives for people, famiilies, and society, yet this last argument is purely an economic one.
Going back to the beginning of the article - politics are playing a big part in the public's perception of the economic reality today - are future deficits good or bad? did an increase in government spending do any good for employment and growth? what would tax cuts do relative to spending? etc... and I have seen a lot of people denounce Fannie and Freddie and the government's involvement in the housing industry and a call to allow the private market to run its course... I question if these people are also willing to put the country into another 20-30% adjustment of home prices and the carrying risks to the financial systems that go hand in hand with that.
In the end, at a minimum, we should do everything we can to not allow ourselves to fuel these types of bubbles going forward because as we have seen its almost impossible to get out of them (at least in an optimal fashion).
This is what Bill Gross said after visiting Washington DC last week:
"The private market was nowhere to be found because they charged too much (during the last 12 months, when gov't has been responsible for 95% of mortgages). It was the cost of private origination and securitisation, perhaps more than any other factor, that justified government involvement. Prime, but non-conforming, mortgages (jumbos, insufficient down payments) were being purchased by PIMCO in the hundreds of millions of dollars every week, but at yields of 6, 7, and 8%. If that was the risk/reward tradeoff, compared to FNMA and FHLMC yields at 3.5–4%, how could policymakers pretend that the housing baton could be quickly and cost-effectively passed back to the private market? Few, if any, could afford a new home at those interest rates. If you were a believer in the dominance and superiority of private markets, how could you deny the signal that markets were sending – that the risk was too high given the substantial losses of recent years?... Americans now know that housing prices don’t always go up, and that they can in fact go down by 30–50% in a few short years. Because of this experience, private mortgage lenders will demand extraordinary down payments, impeccable credit histories, and significantly higher yields than what markets grew used to over the past several decades. Could an unbiased observer truly believe that housing starts of two million or even one million per year could be generated under the wing of the private market? In front of Treasury Secretary Geithner and the assembled audience, I said that was impractical. Let me amend that to “ludicrous.”.... Having grown accustomed to a housing market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey into the camp of private lending. The cost would be enormous in terms of yields – 300–400 basis points higher than currently offered, crippling any hopes of a housing-led revival to the economy."
I believe the adjustment we just went through is the first phase of what could be another large adjustment if the government decided to get out of mortgages. The adjustment in home prices is a reflection of removing all the loans that should not have existed in the first place: liar loans (no doc), no down payment loans, reverse amortization loans, interest option, among others - these loans were permitting people to buy homes they could not afford and because there was new demand for every particular price point, asset prices went up - we all felt rich, we all spent more, we all got more indebted, ultimately society created this bubble.
The second phase could be equally hurtful or worse - if government stopped guaranteeing mortgages, mortgage rates would go up significantly, and with them, demand for homes at any particular price point would also drop significantly. I don't think government will leave the mortgage market (guarantees, mortgage interest deduction, etc) for this specific reason.... which then leads to another question -> how can we create the right incentives as a society to stop so much investment into dead assets - i.e. homes. Homes don't deliver any economic growth - outside of providing an abode to those that do - at least not in the same fashion as investment in assets that are tied to the production of goods and services. The other negative effect of homeownership - in periods like today - is that it removes flexibility from the labor market. Owning a home does not allow people to move to find work as easily as if they were renting. Obviously owning a home provides many positives for people, famiilies, and society, yet this last argument is purely an economic one.
Going back to the beginning of the article - politics are playing a big part in the public's perception of the economic reality today - are future deficits good or bad? did an increase in government spending do any good for employment and growth? what would tax cuts do relative to spending? etc... and I have seen a lot of people denounce Fannie and Freddie and the government's involvement in the housing industry and a call to allow the private market to run its course... I question if these people are also willing to put the country into another 20-30% adjustment of home prices and the carrying risks to the financial systems that go hand in hand with that.
In the end, at a minimum, we should do everything we can to not allow ourselves to fuel these types of bubbles going forward because as we have seen its almost impossible to get out of them (at least in an optimal fashion).
Sunday, August 29, 2010
Deflation vs. Inflation Discussion
Lately, arguments on the future prospects of the economy have turned very confusing - so many people worried about the growing deficit and debt, and the potential implications on the currency and high inflation and yet so many other people calling for more deficits and monetary easing due to the fears of deflation. Aren't these two monetary phenomena diametrically opposed? and if they are, how can the market be arguing for the two extremes at the same time?
The answer is yes - they are opposed, and yes, the market has a right to be arguing for both at the same time. At a high level - very significant (fiscal and monetary) measures that could create some serious inflation need to be taken (or better said, need to be expanded) to make sure we don't fall into a deflation trap. Japan has been taking measures for twenty years that would spark fears of hyperinflation and lead to devaluations in most countries, yet, despite those measures, after all these years, its still dealing with falling prices and an appreciating currency.
In simple terms - I've beaten this horse to death - we borrowed significant amounts of money and invested them in non-productive assets. There is no difference between us having invested all the mortgage debt we took out (close to $10Tr to be exact) in homes or in statues (ok, there's a slight difference - we can sleep and eat in our homes, where we wouldn't be able to do it in statues)... yet, while we spent all that money in statues, we still owe the money - but our productive capacity to repay it is less than what its supposed to be... Since we owe so much money with limited productive assets to pay back, our individual decisions point to our savings to pay all that money back - which then puts the economy at risk, which leads companies to invest less, to get leaner, which leads to potential contraction and to potentially lower prices - starting a downward spiral... that also leads to an appreciating currency (because of the falling prices, which makes exports less competitive, despite all the printing of money)... that's the deflation trap we need to do everything to not fall into, its a very bad situation....
So, we will undergo all the practices possible to not fall into it - printing money, providing economic stimulus, etc (if our politics allow it after the elections) - which will ultimately lead to rampant inflation (too much money chasing too few goods) and currency debasing... yet its something we need to do to not fall into the trap above...
that's how we can be talking about inflation and deflation at the same time... we need to take inflationary measures to not fall into a deflation trap. this is all the result of the bubble we all lived through - facilitated by the Fed for so many years, as to how they let it become this way - its a function of another posting...
The answer is yes - they are opposed, and yes, the market has a right to be arguing for both at the same time. At a high level - very significant (fiscal and monetary) measures that could create some serious inflation need to be taken (or better said, need to be expanded) to make sure we don't fall into a deflation trap. Japan has been taking measures for twenty years that would spark fears of hyperinflation and lead to devaluations in most countries, yet, despite those measures, after all these years, its still dealing with falling prices and an appreciating currency.
In simple terms - I've beaten this horse to death - we borrowed significant amounts of money and invested them in non-productive assets. There is no difference between us having invested all the mortgage debt we took out (close to $10Tr to be exact) in homes or in statues (ok, there's a slight difference - we can sleep and eat in our homes, where we wouldn't be able to do it in statues)... yet, while we spent all that money in statues, we still owe the money - but our productive capacity to repay it is less than what its supposed to be... Since we owe so much money with limited productive assets to pay back, our individual decisions point to our savings to pay all that money back - which then puts the economy at risk, which leads companies to invest less, to get leaner, which leads to potential contraction and to potentially lower prices - starting a downward spiral... that also leads to an appreciating currency (because of the falling prices, which makes exports less competitive, despite all the printing of money)... that's the deflation trap we need to do everything to not fall into, its a very bad situation....
So, we will undergo all the practices possible to not fall into it - printing money, providing economic stimulus, etc (if our politics allow it after the elections) - which will ultimately lead to rampant inflation (too much money chasing too few goods) and currency debasing... yet its something we need to do to not fall into the trap above...
that's how we can be talking about inflation and deflation at the same time... we need to take inflationary measures to not fall into a deflation trap. this is all the result of the bubble we all lived through - facilitated by the Fed for so many years, as to how they let it become this way - its a function of another posting...
Saturday, June 5, 2010
Of Basketball, of John Wooden and of Life
I played basketball when I was young, I played a lot of basketball, at a competitive league, in school - elementary, middle school, JV, varsity; I spent hours on a daily basis on a basketball court. I don't play anymore, in fact I haven't played competitive basketball (other than pick-up games) since I turned 18 years old (I went to a Division I university, one with a pretty good basketball program - not that I would've had a chance in Division III anyway).
I always look back and think about what that time investment gave me... and today I believe it gave me a lot. Beyond the physical exercise and the camaraderie, competitive/organized basketball provides a lot of very good things for later in life. It taught me to be unselfish, to understand how far true teamwork can take you, it gave me enough experiences to understand that sharing success with others is better than sharing success by yourself. It teaches you the meaning of competition - that feeling of having an opponent yet knowing that their excellence is nothing more than a goal/target for yourself to improve; and for when that success is reached it then means so much more. It teaches you that actions have reactions- both in the good sense and the in the bad sense; the unwritten code of behaviour that says that everything we do is not in a vacuum and that it has consequences. Lastly, among so many other things, it teaches you that hard work gets you closer to any goal you may have, there is no such thing as a free lunch, hard work is as necessary in life as it is on a basketball court.
I could write for hours of the many things that basketball gives players or coaches...but, I want to get to John Wooden, the legendary UCLA coach who yesterday died four months before his 100th birthday. While I never met him and never saw him coach (I was born the day before he coached his last game at UCLA - winning the national championship against Kentucky on 3/31/75), I've read about him and followed him for quite some time. I always struck me how a nice and humble person had been so successful, in fact the most successful college basketball coach (arguably on any sport) of all time. Just scratching the surface of his thoughts provides a lot of insight as to how this man was so successful in trade and in life - I would say as successful in LIFE as anyone can be, here are some of his quotes:
I have no doubt John Wooden would have been successful in anything he set out to do - he was successful as a husband, father, grandfather, friend, basketball coach, author, lecturer, among others.... in the same way he would have been successful as a CEO or even as a politician (maybe not, he was too nice , :)).
May he rest in peace and may his teachings and examples which are applicable on the court as off the court (for basketball as in life) serve various generations in the future.
I always look back and think about what that time investment gave me... and today I believe it gave me a lot. Beyond the physical exercise and the camaraderie, competitive/organized basketball provides a lot of very good things for later in life. It taught me to be unselfish, to understand how far true teamwork can take you, it gave me enough experiences to understand that sharing success with others is better than sharing success by yourself. It teaches you the meaning of competition - that feeling of having an opponent yet knowing that their excellence is nothing more than a goal/target for yourself to improve; and for when that success is reached it then means so much more. It teaches you that actions have reactions- both in the good sense and the in the bad sense; the unwritten code of behaviour that says that everything we do is not in a vacuum and that it has consequences. Lastly, among so many other things, it teaches you that hard work gets you closer to any goal you may have, there is no such thing as a free lunch, hard work is as necessary in life as it is on a basketball court.
I could write for hours of the many things that basketball gives players or coaches...but, I want to get to John Wooden, the legendary UCLA coach who yesterday died four months before his 100th birthday. While I never met him and never saw him coach (I was born the day before he coached his last game at UCLA - winning the national championship against Kentucky on 3/31/75), I've read about him and followed him for quite some time. I always struck me how a nice and humble person had been so successful, in fact the most successful college basketball coach (arguably on any sport) of all time. Just scratching the surface of his thoughts provides a lot of insight as to how this man was so successful in trade and in life - I would say as successful in LIFE as anyone can be, here are some of his quotes:
- Success is peace of mind which is a direct result of self-satisfaction in knowing you did your best to become the best you are capable of becoming.
- Don't measure yourself by what you have accomplished, but by what you should have accomplished with your ability.
- If you're not making mistakes, then you're not doing anything. I'm positive that a doer makes mistakes.
- It isn't what you do, but how you do it.
- Never mistake activity for achievement.
- Success comes from knowing that you did your best to become the best that you are capable of becoming.
- Failing to prepare is preparing to fail.
- Be more concerned with your character than your reputation, because your character is what you really are, while your reputation is merely what others think you are.
- The main ingredient of stardom is the rest of the team.
- You can't live a perfect day without doing something for someone who will never be able to repay you.
- Consider the rights of others before your own feelings, and the feelings of others before your own rights.
- Be true to yourself.
- Make each day your masterpiece.
- Help others.
- Drink deeply from good books, especially the Bible.
- Make friendship a fine art.
- Build a shelter against a rainy day.
- Pray for guidance and give thanks for your blessings every day.
I have no doubt John Wooden would have been successful in anything he set out to do - he was successful as a husband, father, grandfather, friend, basketball coach, author, lecturer, among others.... in the same way he would have been successful as a CEO or even as a politician (maybe not, he was too nice , :)).
May he rest in peace and may his teachings and examples which are applicable on the court as off the court (for basketball as in life) serve various generations in the future.
Tuesday, May 11, 2010
The Euro - the clock is ticking.
As I established a year ago - its a matter of time for the less competitive countries in Europe (Spain in my example) to run into trouble within a common monetary system with more competitive countries. The inflow of money that comes with the anchoring of the monetary unit combined with the missallocation of credit (to non-productive uses) or simply the expenditure of that money ultimately leads to a situation where the country becomes uncompetitive, and will ultimately lose its ability to grow out of a recession.
Spain, Italy, Greece and Portugal (and Ireland) are in that predicament and no matter how much the ECB and its sister countries "throw" at the problem (i.e. to cover debt maturities in each one of these countries), its a problem that has no easy solution. The only way to solve the lack of competitiveness for these countries is to coordinate salary deflation across its public and private sector to regain the competitiveness it needs. Since we know from history and reason that is not possible, there is only one ending to this story: devaluation (and in most situations) default.
Let's take the two extremes: Greece - has an uncompetitive private sector and a bloated public sector + unsustainable debt levels - it will simply default, leave the euro, and devalue. For Spain the story is a little different - it has an uncompetitive (less in relative terms than the Greeks) private sector + a bloated public sector (less than Greece) + a sustainable debt level (At this pt). So, for Spain, while its still liquid, the engine that generates profits in that country is dead (within the Euro) - its like a company with little debt, yet, it can't make money for the foreseeable future, so its wholly dependent on creditors (who are happy to lend the hot potato at above market levels, knowing that there are certainly places where they can unload the debt at a partiucular pt in time). So, if Spain gets out of the Euro now, devalues, it might not have to default...however, reason and politics tell us that it will obviously stick it out and then devalue.
The lack of central taxing authority (to take care of most needs of the population) + the lack of mobility for people is what puts all the countries (who are not equally competitive) in this bind. A solution for the lack of competitiveness in these countries would have been: (1) to have a central authority take care of basic people needs (i.e. so there is no country-specific political turmoil - think a US state), or (2) for unemployment to have a high bar as people can easily move to other places with more work (Again, think the US under a common language - or taken to the extreme - think Puerto Rico, whihc has about 4MM Puertorricans in the US).
The better question is what then remains of the Euro if these four countries leave?
Let's see where this story takes us, as its not easy to exit these monetary unions.
Spain, Italy, Greece and Portugal (and Ireland) are in that predicament and no matter how much the ECB and its sister countries "throw" at the problem (i.e. to cover debt maturities in each one of these countries), its a problem that has no easy solution. The only way to solve the lack of competitiveness for these countries is to coordinate salary deflation across its public and private sector to regain the competitiveness it needs. Since we know from history and reason that is not possible, there is only one ending to this story: devaluation (and in most situations) default.
Let's take the two extremes: Greece - has an uncompetitive private sector and a bloated public sector + unsustainable debt levels - it will simply default, leave the euro, and devalue. For Spain the story is a little different - it has an uncompetitive (less in relative terms than the Greeks) private sector + a bloated public sector (less than Greece) + a sustainable debt level (At this pt). So, for Spain, while its still liquid, the engine that generates profits in that country is dead (within the Euro) - its like a company with little debt, yet, it can't make money for the foreseeable future, so its wholly dependent on creditors (who are happy to lend the hot potato at above market levels, knowing that there are certainly places where they can unload the debt at a partiucular pt in time). So, if Spain gets out of the Euro now, devalues, it might not have to default...however, reason and politics tell us that it will obviously stick it out and then devalue.
The lack of central taxing authority (to take care of most needs of the population) + the lack of mobility for people is what puts all the countries (who are not equally competitive) in this bind. A solution for the lack of competitiveness in these countries would have been: (1) to have a central authority take care of basic people needs (i.e. so there is no country-specific political turmoil - think a US state), or (2) for unemployment to have a high bar as people can easily move to other places with more work (Again, think the US under a common language - or taken to the extreme - think Puerto Rico, whihc has about 4MM Puertorricans in the US).
The better question is what then remains of the Euro if these four countries leave?
Let's see where this story takes us, as its not easy to exit these monetary unions.
Monday, April 19, 2010
The trading / buyer beware culture that doesnt add anything to society
The unfolding events for Goldman Sachs exemplifies the grotesque trading culture that has invaded our banking system. Its probably better suited to generalize the behavior by calling the responsibles traders as opposed to bankers.
You see, the banking function is supposed to allocate capital from savers to investors (look for best uses). In doing that, it performs a key function in society and in the economy - providing the funds that ultimately fuel our economic growth. That function if combined by agents who are aligned with their shareholders (i.e. management who is aligned with its shareholders), can never be speculative in itself, because the future of the firm depends on its investment decisions. Clients become sacred, and the reputation of the firm is its most important asset to maintain its going concern value.
In the trading culture that has invaded Wall Street through periods of excess, the agent as a trustee of its shareholders has broken down, and thus the clients also lose value. Its a fee-based culture, buyer beware culture that would lend itself to excesses, bubbles and busts.
When "traders" are motivated by the turnover of transactions (because that's what generates fees) as opposed to their end result, and when the short-term gains are greater than the lost trust from their clients down the road, human greed will lead to situations in which there are a few fee-based unscrupulous winners, and a lot of losers (usually society as a whole, as an example - the current housing bubble).
Furthermore, this behavior doesn't add any value to society. The synthetic securities that were created didn't add anything to society - they didn't provide any funding to new industries or companies - they simply were financial creations that allow a double-sided bet. The bad part is that in these creations there is usually one side that has full information, whereas the other side is "searched for" in any corner around the world (even if they are accredited investors). These securities didn't really have a reason to exist other than making some fully informed parties very rich, and providing very good returns for their fee-based bankers in the middle. That industry grew to a size it should have never grown.
Another example of the fee-based, buyer beware culture that permeates every bubble (with a lot of fee-based middle men in the middle), we can also simplify the housing bubble. The allocation of capital to buy homes went from a simple party to party transaction (bank to borrower) to one in which there could be up to X layers in between the actual lender and a borrower (the transaction was essentially created by the middlemen, otherwise it would not have happened). Lets assume a future borrower was looking for a home and is enticed into buying a bigger home (with a bad loan) by a mortage broker (middlemen #1 - who collect a fee if a loan is made), who then connects that borrower to a bank (mmen#2 - who collects a fee for selling that loan to a Wall Street bank, only way they make the loan), who then sells the loan to Wall Street (mmen #3 - who collects a fee for packaging a lot of these loans), who then sells the loan to the end investor (in some cases, who never had full information about how loan was made). There could be examples of other transactions with even more middlemen (conduits that take loans from smaller banks to wall street, etc). We could keep on writing - like writing about the ratings agencies and how they were paid by wall street, providing clear conflicts of interest in their ratings.
The point is that whenever there are a lot of middlemen in the financial industry and its combined with perverse (and large) fee-based incentives, thats trouble brewing for the economy and society. In the housing industry, in the stock market, in the bond market, in the sovereign market you name it.
A lot of the profits that have been made by the financial industry in the past decade are not tied to real economic growth, but, rather to the bad intermediation that usually resembled gambling.
Its time we focus on those elements of the financial industry that help fuel real and sustainable economic growth in society. The % of profits that the financial industry takes should hold relevance to the economic output of that country. Whenever it gets out of whack, its probably that some danger is brewing - they are getting their profits from promoting gambling behavior outside of their basic function of channeling funds from savers to investors.
You see, the banking function is supposed to allocate capital from savers to investors (look for best uses). In doing that, it performs a key function in society and in the economy - providing the funds that ultimately fuel our economic growth. That function if combined by agents who are aligned with their shareholders (i.e. management who is aligned with its shareholders), can never be speculative in itself, because the future of the firm depends on its investment decisions. Clients become sacred, and the reputation of the firm is its most important asset to maintain its going concern value.
In the trading culture that has invaded Wall Street through periods of excess, the agent as a trustee of its shareholders has broken down, and thus the clients also lose value. Its a fee-based culture, buyer beware culture that would lend itself to excesses, bubbles and busts.
When "traders" are motivated by the turnover of transactions (because that's what generates fees) as opposed to their end result, and when the short-term gains are greater than the lost trust from their clients down the road, human greed will lead to situations in which there are a few fee-based unscrupulous winners, and a lot of losers (usually society as a whole, as an example - the current housing bubble).
Furthermore, this behavior doesn't add any value to society. The synthetic securities that were created didn't add anything to society - they didn't provide any funding to new industries or companies - they simply were financial creations that allow a double-sided bet. The bad part is that in these creations there is usually one side that has full information, whereas the other side is "searched for" in any corner around the world (even if they are accredited investors). These securities didn't really have a reason to exist other than making some fully informed parties very rich, and providing very good returns for their fee-based bankers in the middle. That industry grew to a size it should have never grown.
Another example of the fee-based, buyer beware culture that permeates every bubble (with a lot of fee-based middle men in the middle), we can also simplify the housing bubble. The allocation of capital to buy homes went from a simple party to party transaction (bank to borrower) to one in which there could be up to X layers in between the actual lender and a borrower (the transaction was essentially created by the middlemen, otherwise it would not have happened). Lets assume a future borrower was looking for a home and is enticed into buying a bigger home (with a bad loan) by a mortage broker (middlemen #1 - who collect a fee if a loan is made), who then connects that borrower to a bank (mmen#2 - who collects a fee for selling that loan to a Wall Street bank, only way they make the loan), who then sells the loan to Wall Street (mmen #3 - who collects a fee for packaging a lot of these loans), who then sells the loan to the end investor (in some cases, who never had full information about how loan was made). There could be examples of other transactions with even more middlemen (conduits that take loans from smaller banks to wall street, etc). We could keep on writing - like writing about the ratings agencies and how they were paid by wall street, providing clear conflicts of interest in their ratings.
The point is that whenever there are a lot of middlemen in the financial industry and its combined with perverse (and large) fee-based incentives, thats trouble brewing for the economy and society. In the housing industry, in the stock market, in the bond market, in the sovereign market you name it.
A lot of the profits that have been made by the financial industry in the past decade are not tied to real economic growth, but, rather to the bad intermediation that usually resembled gambling.
Its time we focus on those elements of the financial industry that help fuel real and sustainable economic growth in society. The % of profits that the financial industry takes should hold relevance to the economic output of that country. Whenever it gets out of whack, its probably that some danger is brewing - they are getting their profits from promoting gambling behavior outside of their basic function of channeling funds from savers to investors.
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