Entrepreneurship, Economics and Emerging Markets

David Merkel is the first of the “guru bloggers” that I follow and respect to call it a depression:

I’m going out on a limb here, and I’m going to suggest that we have already entered a depression. The concept of a depression is even less objective than that of a recession, but some suggest that a decline in real GDP of 10% or more is the criterion, which we have not attained yet.

I don’t think a 10% decline in GDP is the right threshold. Depressions are different because of their widespread nature, often coming through financial systems that are in danger.

As it is now, many things are happening that are depression-like. Here we go:

1. Record high levels of total debt to GDP
2. Many go hat in hand to the government.
3. The spreads of the bond market are at record levels since the last depression, and maybe comparable.
4. There is policy paralysis and confusion. No one knows what to do or leave alone, they act blindly or cower in fear.
5. Ultrasafe investments have record low yields.
6. Banks don’t trust each other.
7. GDP is shrinking, and unemployment is increasing at a rapid rate.
8. Financial businesses are failing and shrinking at high rates.
9. The government comes in to “help” the markets, and ends up replacing the markets.
10. The security of banks and other financial entities is open to question.

The Aleph Blog » Blog Archive » It’s Called a Depression

(Image credit: tonythemisfit, license)

Now that we’re staring into the abyss for stocks again, I thought I’d check to see what the recently launched Yahoo! Glue had to say on stocks.

Stocks are devices used since medieval times for public humiliation, corporal punishment, and torture. The stocks are similar to the pillory and the pranger, as each consists of large, hinged, wooden boards; the difference, however, is that when a person is placed in the stocks, their feet are locked in place, and sometimes as well their hands or head, or these may be chained.

Everything about stocks - Yahoo! Glue

Even the most articulate of the bears would not have been able to put it better. And you thought the algorithms were dumb.

Here’s a screenshot for posterity (click to zoom)

With new lows on the S&P and the Nasdaq, and from what I’m hearing from other investors, it does feel like we’ve entered the discouragement phase in the sentiment cycle:

DISCOURAGEMENT AND AVERSION

After a long price slide, the area where churning takes place is between the Discouragement and the Aversion phase, after a significant decline has already taken place. Often, this appears as a head and shoulders bottom, a cup and handle or a saucer dish pattern. As the public continues to dump stocks, short sellers become bold and bearish. Their views are supported by bad news and poor economic data. Prognostication of lower prices to come is undoubted. This is when everyone knows that the market cannot ever go up again, and that anything, even cash, is preferable to owning stocks.

The Investor Sentiment Cycle : InVivoAnalytics.com

One of my most profitable investment tools has been an understanding of why sentiment can often produce counter-intuitive results. Consider this statement by the Indian Finance Minister Chidambaram:

“Hotels must cut tariffs; airlines must cut prices; real estate must cut rates of apartments and homes they sell; car makers and two-wheeler makers must cut prices,” he said, while addressing industrialists at the Indian Economic Summit being organised by the World Economic Forum and the CII in New Delhi.

FM asks realty firms, airlines to cut prices

Of course the Finance Minister wants GDP growth at the cost of profitability, especially in an election year. Every economic transaction adds to the GDP, even if it is loss making for the parties involved. You could boost GDP by paying half of the unemployed workforce to dig a ditch, and the other half to fill it up (yes, India actually has a program along those lines.)

But the deeper question is - why don’t these industries (especially real estate) cut prices to get inventory moving ?

The answer lies in sentiment - real estate is not supposed to go down. Realtors have sold the emerging markets this marketing drivel for too long. A normal market would attract buyers as prices go down. But in today’s sentiment-driven world, reducing prices actually might scare away buyers who see something that “isn’t supposed to happen”. Realtors worry (correctly) that a precedent of lower prices will encourage buyers to wait even longer.

So now we wait for the ongoing credit crunch to force the realtors to sell sell sell, and for the sentiment to turn. And you can bet the market will overreact on the downside too.

Many people are underestimating the tidal wave of demand destruction that is looming over our heads.

Deepak Shenoy gets it almost right:

What’s the buzz word this time? Energy. This boom has fuelled an enormous amount of money into energy - from research to discovery to exploration to production. There’s now solar and wind energy coming up. Nuclear’s picked up steam unintended. In India, coal and gas fired plants are coming up - mega and ultra-mega who coined that? power projects. There’s investment in distribution and transmission. And most of this has already gone in, in the hope that power will sell for a lot.

Will it? I honestly doubt that. We in India cannot imagine “too much” power. I think that’s what we in the cities will have - because no body has yet figured out how to make people in the villages pay, and no one is yet thinking of drawing lines to them. Too much power means it will become cheap - and I mean in five to ten years, not tomorrow.

This, I think, is the next boom, come 2014 or so. Businesses built on the back of seemingly unlimited power supply - from refrigeration to recreational vehicles - will start to benefit the most. And the biggest will probably come from an area I cannot yet imagine, but I’m sure it will start becoming visible in the next few years

The Indian Investor’s Blog: Excess Power - the next boom, after five years? >> Investing in Indian Stocks, Futures and Options

The only correction I’d make to Deepak Shenoy’s thesis is - We already live in a world designed for “seemingly unlimited power supply”! There will be excess power in the future - but that will be because there will be very few avenues to deploy the power that is coming online.

And before you start thinking of “China and India”, let me just say this - it doesn’t matter how many emerging market citizens yearn to live western lifestyles - the only thing that matters is whether they can afford to pay market prices for that energy and the products that depend on it. And right now, even at these depressed prices, the answer is - they cannot.

So - suggesting that cheap energy prices will create a new boom industry is like saying that cheap paper will create a new boom industry. Ultimately it is demand that pulls industry, and not the cost of raw materials. Hence any prediction on what the “next boom” will be must define clearly where both the demand, and the ability to pay will come from.

Image credit: criminalintent (license)

Those of us in software understand the concept of fragmentation all too well. But can the same concept apply to ownership of resources like real estate, wireless spectrum and patents ? Yes, says Professor Michael Heller of Columbia University.

And from Ethan Zuckerman comes an interesting book summary/review of Michael Heller’s new book “The Gridlock Economy“.

Heller believes that a common thread in all of these cases is the disappearance of a tight linkage between ownershpi and use. In the past, there was little distance between the patent and the product, the land ownership and the property development. But innovation these days is about assembing resources. You need multiple pieces of protected property to achieve innovation in semiconductors, drug discovery, software or telecoms. It’s true in the arts as well, with the rise of the maship, and illustrated by the difficulty of releasing documentary films. See the difficulties regarding the docmentary Eyes on the Prize, due to copyright issues.

To describe this situation, Heller has coined the phrase, “The Tragedy of the Anticommons”. This is in contrast to the tragedy of the commons: when anyone can use a resource, it’s likely to get overused. With too few owners, overuse is a common outcome, because rational individuals will prioritize their needs over collective goods. This was a critical insight for environmentalists in the 1960s, helping unite a large number of environmental problems into a common phenomenon. Private property was often prescribed as a solution to tragedy of the commons solutions, assuming that a property owner would consider long-term implications of development for her property rather than permitting overuse.

Heller argues that, in many cases, we’ve skated right past private property and into anti-commons, characterized by underuse. If we’ve got too many owners, there can be too little use of a resource. We don’t see the anti-commons tragedy as clearly, as it’s characterized by the absence of innovation. “Where do you go to protest that a drug didn’t come to market or to complain that your cellphone is so poor?” With this new concept, Heller hopes to rope together a set of disparate problems with a similar set of ownership structures.

…My heart’s in Accra.

When I heard that Sun was planning to lay off 6,000, the first question that popped up in my head was - Does Sun even have 6,000 employees? (Actually 6000 is just 15% of their workforce.)

Sun is a company of extremes - they produce some of the most accessible and usable open source software in the world. But their hardware products are far from accessible and affordable for most small and mid-sized companies. Most of the startups I interact with (including my own) use Sun’s open source OpenOffice and also Java extensively. But sadly for Sun none of those startups uses Sun hardware.

So in many ways Java and OpenOffice seem to have a bigger brand than Sun itself (Of course, Sun admitted as much when they decided to change their stock ticker from SUNW to JAVA).

But Dana Blankenhorn asks a more important question - what will be the impact of Sun’s woes on open source ?

Dave Rosenberg is worried about Sun, a question discussed here last week.

“If it fails,” he writes, “Sun will be the harbinger of sorrow for the rest of the open source world.”

The open source business, yes. The open source world? Not so much.

Open source is a fact of life. Gartner Group estimates all large businesses will be deploying it within a year. Linux is extending its reach from the server to the client. Open source applications like Firefox are highly competitive.

On the other hand, the open source business model is not doing so well. It’s not bringing in the green. When given something for free and then asked to buy support, most customers say “thanks, but no thanks” especially when times get tough.

Open source is not all about the money | Open Source | ZDNet.com

I have a slightly different take on open source. I submit that there is an excess of software talent in the world - and that this talent cannot be soaked up by the corporate world. This “excess” talent manifests itself in the form of open source. Anecdotally I might even suggest that 30% of the developers that I have worked with are underemployed relative to their ability.

Writers write because they can’t help it - and developers code because they must. So while the open source business model will be cyclical along with the rest of the economy, the torrent of software will prove to be resilient.

And as for Sun - its days as an independent company might be coming to a close. And that will be a big loss to the open source world, because it is hard to imagine that any new owner of Sun will be as sympathetic and inspirational to open source as Sun was.

Image credit: jvetterli (license)

(Originally written for VentureWoods - India’s leading venture capital and startup blog)

The following paragraph jumped out from something I wrote in 2005.

U.S. real-estate slowdown will have global consequences: Interest rates, U.S. bond prices, U.S. consumer confidence, dollar exchange rates (and hence the offshoring business), combined with the huge (and increasing) U.S. trade deficit are all pieces of a fragile domino game. This game could easily turn ugly if the U.S. real estate market accelerates its slowdown, or even worse, turns out to be a bubble. Bad news in the U.S. housing market could trigger a global recession.

(From Predictions for 2006 from an Indian perspective on VentureWoods, emphasis added)

This seems all remarkably prescient and oracle-y now, and I almost made a suitably massive upgrade to my ego. But like recent Sensex rallies my ego quickly came crashing down when I read some of my other predictions - e.g. Yahoo will start catching up with Google (Hope is eternal, and I might yet come back to gloat).

But lets get back to more important things:

There seems to be a tendency amongst many to regard a recession as a finite event, associated with a numerical reduction in GDP or stock market values. Business writers seem to compare a recession with a winter, where you hunker down (”cash is king”) and hibernate on minimal life support - after all, spring is just around the corner.

That might be a useful survival strategy, but it misses the bigger point - recessions (and especially this one) are discontinuities with totally unpredictable consequences (gosh I sound like a Nassim Taleb fanboy). To continue my useful but terribly flawed nature analogy, recessions are not like winters, but more like the Ice age that made the dinosaurs extinct. Like the Ice Age, this recession has already essentially destroyed the US Investment Bank business model.

What other changes will this Ice Age bring? I see a few possibilities:

1. Currency changes - The hegemony of the US financial industry (and the financial industry in general) is over. As I write this, the G-20 is meeting to discuss what could very well be the birth of Bretton-Woods II. A covert agreement to safely achieve a massive devaluation of the US Dollar is not out of the question (what will the Rupee do ?). Nor is it impossible to envision the emergence of an alternate reserve currency (or more likely a basket).

2. Consumer changes - We have lived, learned and grown up in a world where the world (now mostly China) manufactures and the US consumes. That world has changed. The US consumer is now on life support. She might live for a long while more, but that vitality and voracious appetite is unlikely to return. For the sake of my mental well-being I prefer to not imagine the consequences of this to the Chinese economy.

3. Fiscal policy changes - The ghost of Keynes is stirring - World governments will unleash the mother of all fiscal (deficit) spending rather than allow deflation to take hold. This sort of worldwide government stimulus is unprecedented, and its implications (or even its effectiveness) are unknown at this point. Will all the stimulus go into productive areas of the economy or will it be gambled away ?

4. Political landscape changes - The current bonhomie between nations and “global co-operation to solve the crisis” is very fragile and based on mutual fear. The Doha talks fiasco shows that developing nations are no pushovers now. There is a real chance that this “united in fear” sentiment could morph into a very ugly blame game. The parallels of the current situation to the Nixon Shock (when the French demanded gold from the US in return for dollars) are eerie and very scary.

So my question to the readership of this blog is this - does anyone see these changes too ? And more importantly, what other seismic shifts do you see occurring in our economic and business landscape ?

(Originally written for VentureWoods - India’s leading venture capital and startup blog)

In a world where government statistics seem to come from an alternate universe, regular folk like us are left grasping for honest anecdotal evidence of the times we live in. From Terri Lonier comes a classic - the haircut index.

As a microbusiness owner, however, I’ve found one reliable index that won’t show up on most economic forecasts, one I’m calling the Haircut Index. Let me explain.

In my small town in New York’s Hudson Valley, there’s a hair stylist who is known for his impressive talent with haircutting shears. Walk in with a shaggy head and after a brief time with Sean’s nimble work using scissors or razor, you’ll leave crisply styled. As a result, his appointment book is always full, often months in advance. While I’m delighted every time he cuts my hair, I’m usually too disorganized or haven’t planned far enough in advance to get a spot on Sean’s calendar.

The other day I called his salon, hoping to snag one of his rare cancellations (self-employment does have its scheduling benefits). Imagine my surprise when the receptionist said, “Terri, next week Sean has an opening on Wednesday at 11, and two on Thursday at 2 and 4. Which do you prefer?”

It was then that it hit me: the economy had truly changed. For Sean to have three openings in the coming week signaled a major shift in demand.

Sitting in his chair the following week, I chatted with Sean about the rarity of his availability. Was this a fluke, or a significant economic signal? “It’s a reflection of the economy,” he said. “When things get tough, people will forego buying a pair of jeans or going out to eat, but still invest in a good haircut, because it’s something they live with every day.” But the recent instability in the overall market has brought a whole new level of uncertainty, he added. “When I see this many openings in my appointment book, I know the financial concerns are deeper than usual.”

One-Person Business

Image credit: malias (license)

From the “Report on Business” comes this interesting tidbit:

Mr. Saji noted that 65 per cent of China’s bank lending is secured by real estate, and that long-term leaseholds represent up to 20 per cent of revenues for many regional governments - leaving both at risk in the slumping real estate market. On top of that, he said, many Chinese have borrowed money from banks “under the pretense of buying a home” but spent the money on cars and stocks instead. “This suggests that China actually has its own brand of subprime loan problem,” he said.

reportonbusiness.com: China positioned to unleash global deflation

It was all very well to be for the Chinese government to support free markets on the way up. But now that loan defaults, deflation and a possible depression is upon us, will the Chinese government stay committed to the free market ? Or will we see a “reversion to the mean”?

Image credit: paogao (license)