Western Downward Drift and the Olympics

Welcome to guest blogger: Dr Michael Power - Investec Bank:

For the marketing and the sheer entertainment value - the Beijing Olympics exceeded even the advanced hype. But, as the images fade, we should remember that this contest was not the only one of Olympian proportions to be playing out in the world at the time. There is also an economic marathon taking place between runners in the West and those in the East, a national relay race that will eventually see the baton of economic primacy being carried – symbolically having been dropped by the US Team in the 4x100m relay race in Beijing – by China. The final medal table of the Beijing Olympics may yet come to symbolise the start of this hand-over process.

Many in the West probably still think – and the lazy love of the familiar more than brute logic is often the father of their thoughts – that the West’s current economic malaise is nothing more than a very bad case of cyclical flu. In such a context, aspiring Western politicians will continue to peddle promises to build a better tomorrow: witness Barack Obama and his “Yes, we can!” pledge. By contrast, few will dare articulate just how structurally passé the West’s current model might soon be and therefore just how difficult delivering on those electoral promises could become.

Final Medals Tally Total:
China 100
United States 110
Russian Federation 72
Australia 46
Korea 31

Canada 14

Overriding the forebodings of that small clique of Westerners not in denial, the ‘yes we can’ apologists for the West still dominate the airwaves of CNBC and Bloomberg. Those daring to suggest that something more seminal might be happening are usually dismissed as the economic equivalent of doomsday merchants wearing “End is Nigh” sandwich boards.

I believe profoundly that the essence of what makes mankind such an optimistic species is our dogged faith in the idea of “hope springs eternal”: indeed Obama’s book captures this determination in its title, “The Audacity of Hope”. For it is humanity’s pre-disposition to dream of a better tomorrow that is the source of that river of human endeavour that irrigates the seeds of a brighter future. And so powerful can be this flow of sweaty optimism, it can cut valleys through granite mountains of counter-logic in forcing its way towards the greener pastures of progress. But hope alone cannot guarantee progress and the wellspring of industriousness that feeds the West’s river is not nearly as plentiful as it used to be. Instead, today’s sweaty optimism rises most abundantly where the sun also rises: in the East.

In this game-changing world, a few commentators – George Soros, Marc Faber and Jim Rogers – have suggested that the West is in its worst financial crisis in 30 years precisely because the economic baton is being passed from West to East. As the great economist, Joseph Schumpeter, might have noted, perhaps we are at a crossroads in history where Western destruction is now being offset by Eastern creation. In our far from decoupled world, the West’s economic yin cannot change without impacting the East’s economic yang, and vice versa.

On the one side, the West (and especially its Anglo Saxon heart), by living way beyond its means on the chimera of easily available credit, ever rising household indebtedness and ever increasing fiscal and current account deficits, has enjoyed many decades of prosperity. And, even in the wake of the credit crunch, most Westerners still believe that this model of prosperity is both soundly-based and sustainable. The last year has proved to us it is not.

On the other side, the East (and especially its Chinese heart), by living well within its means with a high domestic savings ratio (45% in China compared to a negative rate in the US), regularly running current account surpluses and maintaining high levels of foreign exchange reserves (the Greater China Club – China, Hong Kong, Taiwan and Singapore – now have over $2.5 trillion) has deferred consumption today and, by funding investments from these savings, set about building a better tomorrow. At the same time, a not insignificant portion of the East’s savings have also been diverted to plug that savings gap in the West and especially in the US.

By postponing consumption for well over a decade, the East’s hoped for tomorrow has now started to materialise in a better today – Beijing’s splendour is evidence of that! And despite the desire by some of the East’s Old Guard to extend its era of abstinence, many Asian governments are now encouraging their constituents to enjoy a bigger share of the fruits of yesterday’s labours. This suggests that the Asian model – one based not upon self indulgence but rather self denial – was ultimately not sustainable either.

Dragons' Den recommends Money Magnet

CBC is kindly featuring Money Magnet on their blog for the terrific reality show - Dragons' Den.
As you know, I have written about the show in this blog and have included a special section in Money Magnet for the contestants.
For those entrepreneurs interested in braving the Dragons' hot breath in order to fund their companies, I have covered off the questions the Dragons want answered before opening up their cheque books.
There is also a summary of the winner of CBC's competition, Trent Kitsch, and his perceptions of raising money before and after Dragons' Den.
If you are a business owner and are contemplating how to grow your business, do pick up a copy of Money Magnet as it will change your perspective on what is possible.
Do not rely on traditional banking for your business because it is just like smoking - it stunts your growth.

How financial tools destroy your capacity to do things

A recent HBR article from January 2008 Harvard Business Review has a provocative piece by innovation guru Clay Christensen and a couple of colleagues called "Innovation Killers: How financial tools destroy your capacity to do new things." I have the greatest of respect for Clay Christenson who does hit the nail on the head every time with his analysis of business. His critique of the limitations of DCF analysis is applicable to private equity deals, hence my interest.
Since my MBA and time at Deloitte, I have always been skeptical toward financial analysis and the reverence to which it is held.
While DCF analysis has its place, its limitations should be recognized. One problem is that fact that most DCF models are built on status quo assumptions (or growth projections) that don't account for the strategic and competitive curve balls. I would add that there is also the issue of garbage-in, garbage-out: the less you know about what's likely to happen (as is the case with new lines of business), the less reliable the output of your DCF model becomes.
I see the problem to be that instead of acknowledging this limitation, many finance geeks embrace the modeled output as Holy Writ. Besides being a false data crutch, it squeezes out consideration of other "softer" factors (like my favourite - non-quantifiable synergies)that are every bit as worthy of consideration. Pick up my book, Money Magnet, which deals with all of this in far greater detail.

War and Private Equity

Last week, Private Equity Hub's Dan Primack interviewed Michael Bleyzer, CEO of Ukrainian-based private equity firm SigmaBleyzer, to discuss the impact of the conflict in Georgia.  Though Mr. Bleyzer admits that the Georgian market has not drawn much of his interest, he does point out that an aggressive Russia cultivates politically-driven volatility in the large country that remains unattractive to him.  Naturally, he advises to stay away from sectors vulnerable to political or oligarchical influence, (i.e. energy, defense, etc.).  British Petroleum can attest to this, of course.  However, he does mention that though the "Bear" may be winning the fight to expand its regional sphere of influence, this is raising moral considerations for investors when considering to put their money in the country.

These sentiments do contradict reports from big institutional investors, such as Credit Suisse, on Russia (a member of the famous BRIC nations) but it is difficult to argue with a professional that is "in-country", operating in the region, looking to make returns from the best risk/return opportunities.

Private Equity Update

Banks have been in fashion for some time now.  A rare thing.  Papers are filled with glamourous headlines announcing the latest billion dollar "Writedown" or "Loss".   A year ago it was billion dollar "Deals".  It would seem that the bank's cousin, private equity funds, is also suffering from the same bad press.  Many in the newspaper business are assuming that because of the lack of credit, private equity is at a stand-still, licking its wounds from failed projects. This is not true.  

Private Equity's strength is its versatility.  As the banks began shutting the door to LBOs in late 2007 and selling debt at a discount to shore-up some cash, private equity funds abruptly changed course and bought much of that debt, and continues to do so today.  

Currently, some of the most activity is focused on infrastructure.  Around the globe, 71 funds are raising US$90.8 billion to invest specifically in infrastructure, a particularly stable investment with steady cash flows.  Private equity professionals are looking to outmaneuver any market volatility by preparing to support the CAD$150-billion that must be invested over the next 20 years to meet Canada's growing demand for electricity.  

It would seem, then, that the industry of private equity is never so much under attack as it is remobilizing and assessing new fronts of opportunity.  The only thing that is permanent now for these bankers and fund managers is having to cope with being splashed all over the front pages.  If David Rubenstein is any indication, it seems they will be able to adjust to this as well.