The next boom starts in ... 2014?

I don't normally share or post my speeches - I prefer to just talk rather than read - but I wrote my speech last night for a dinner presentation and thought I would share with you a shorter version here. 

The speech disappointed a few folks as it forecast two years of flat or negative growth to 2011, three years of slow growth to 2014, and then another boom period from 2014 onwards.  They wanted the boom forecast to be more like 2010 (a year away?) but hey, I could paint nice rosy pictures to make you all feel happy, but what the heck, I'd just be lying.

Anyways, I have a long and in depth presentation that justifies this view, but here's the speech:

Good evening ladies and gentlemen,

The briefing I had for this evening is to start with telling you a bit about what the CEO’s are thinking, so I’m going to explore this for a while, by looking at this crisis, its roots and its solution.

You will have heard of Northern Rock by now, and this was the first we really knew of the crisis.

It all began back on 9th August 2007, known as Blackberry Thursday as most bankers and hedge fund managers were sitting on beaches with just their Blackberrys at hand to communicate back home.

A month later Northern Rock collapsed after the first bank run in Britain for over a century. The bank run was sparked when the bank went to the Bank of England, as lender of last resort, and the news was released into public domain.

This was a serious embarrassment. I would meet my French colleagues, and they would go “so, the Northern Rock eh, heh, heh”. Thank goodness only a few weeks later I was able to reply, “and yes, the Societe Generale eh, heh, heh”.

Unfortunately, I can now go “the Bear Stearns, Lehman Brothers, HypoReal Estate, Fortis and even Iceland”.

The core issue of August 2007 was the subprime crisis created by derivatives that were fatally flawed. These derivatives, also known as Structured Investment Vehicles (SIVs), were being traded as debt that was collateralised by mortgage-based assets. That’s why they are Collateralised Debt Obligations (CDO).

When Northern Rock collapsed it was because the ability to borrow on the wholesale funding markets to service mortgage debt disappeared, as people realised that mortgages were not assets but liabilities. Northern Rock traded £3.50 to every £1 on deposit through mortgage debt, so it was like pulling a rug from underneath them.

Back then, the general consensus was that around $350 billion of such mortgage debt existed worldwide. As the strangulation of wholesale funding continued, the strain was demonstrated on more and more occasions by the likes of IndyMac Bank, Fannie Mae and Freddie Mac in the USA, and by the collapse of overinflated property markets, such as Spain, in Europe.

By April 2008, the International Monetary Fund increased their forecast of the debt issues globally to around $1 trillion, but the strains worsened and finally, on September 15th, we saw the worst scenario explode with the collapse of Lehman Brothers. The result was that, in October, the Bank of England increased the amounts to be written down to $2.5 trillion and, today, Merrill Lynch analysts are forecasting that Europe’s write-downs alone will be over $5 trillion.

Why did the Lehmans collapse exacerbate the losses forecast so much, and why was this so different to the end of mortgage based lending and the subprime crisis?

Basically, Lehman Brothers collapse pulled the rug on any trust left in the lending and credit in the markets. That’s why AIG began to show cracks with $85 billion required from the Treasury to begin with, exploding to over $130 billion in short order.

In the same week, Merrill Lynch was pushed into a shotgun marriage with Bank of America, as was HBOS and Lloyds TSB, and various markets imploded. Even countries viability disappeared, as we all know what happened to Iceland.

Why has the situation become so extreme?

Because all belief in the credit markets disappeared as Lehman Brothers collapsed.

Lehman Brothers you see, were at the heart of the markets for Credit Default Swaps (CDS). CDS are another form of derivative that allows you to secure the likelihood of debt being unpaid through a company’s collapse by hedging it using a derivative backed by a AAA rated security, such as Lehman Brothers.

If Lehman brothers could collapse, then many believed this market for CDS was worthless, and so all trust went out of the markets and down the drain.

And the market for CDS is valued at $55 trillion, so this is not something that’s trivial.

It does not mean that we lose $55 trillion on these contracts, as each of these contracts has a winner who gets paid and a loser who pays. What it does mean is that banks globally suddenly felt unsure of their exposure to that $55 trillion bill, and hence they all inverted and stopped lending.

In order to resolve this, as you know, governments globally have been desperately trying to sort it out.

The USA has pledged almost $2 trillion, the UK over $1 trillion, Germany around $700 billion with more to come, and the ECB over a trillion. Iceland’s bankrupt, and many say that Ireland is one character change and six months from being another Iceland. Spain’s property market has crashed as have their jobs, and Greece is seeing riots over the euro. Germany’s unemployment rates are breaking records, whilst the rest of Europe wonders what is happening.

These are all the things we are wondering about today, and we are all trying to find some security and confidence.

Now I don’t want to get you guys down, as this is going to be over soon, but the real cause of all this angst and misery is mismanaged derivatives contracts that were mis-valued, mis-sold and mis-understood.

These are, as Warren Buffet calls them, “weapons of financial distribution”. These weapons saw bankers creating financial instruments that were fatally flawed, regulators with zero comprehension as to what they were regulating, and management driven by profits and greed.

So what will change now?

Well, we’ve had lots of crashes before.

I can remember financial crashes and busts, from Asia to Latin America, from the dotcom bust to the negative equity markets of the early 1990’s.

In fact, there have been 139 financial crises in the 24 years between 1973 and 1997, 44 of which were in high-income countries, compared to 38 between 1945 and 1971.

So we have had many crashes in the past, just that this is a big one. Probably as big as 1929, the Great Wall Street Crash.

And whilst banks and investors have no confidence, neither can business.

But this will get sorted.

The urgent three priorities right now, for example, are to get rid of bank’s bad debts, help banks to lend again, and to resurrect banks’ wallowing share prices and Tier 1 Capital ratios.

This is being addressed and will be resolved through new regulations and new business structures.

In particular, I believe that the G20 meeting in April will come up with some form of global fund that will provide relief for the banks. In other words, this over-heated market and crisis will have the pressure released by summer at the latest.

But the issue is that it will then still take about two years to resolve, and about five years to get back to strong growth.

So you’re looking at an economic cycle of two years of flat or negative markets, and three years of low growth thereafter.

That’s not great news, but there are ways to manage through such times.

What does it mean for your CEO’s and firms?

Well, banks are returning to domestic focus and reducing overseas exposures, so first of all find a bank that is domestic who you can trust ... if there is one.

Find one with strong capital bases too, and there are a few of those.

Meantime, make sure you’ve got cash. Cash will be dominant as we work through these issues.

If you haven’t got cash, then sell non-core assets and cutback on all unnecessary expense straight away. Convert anything you’ve got into cash, and make those asset sales now as markets are going to go down more this year.

Once you’ve got the house in order, there is one key thing I then commend to you.

Invest in technology.

Technology is the one thing today that is cheap, powerful, and simple and can be easily deployed for revenue generating purposes.

Now I’m not saying that because I’m speaking at a technology conference.

I’m saying it because it’s true.

Just look at my business.

If I had started this business a decade ago, all of my costs would have been wrapped up in brochure production, postal costs and photocopying.

To reach the people we reach today, we would have to mail out a newspaper or equivalent, every single day and mail that to over 10,000 people.

The costs would easily be around £3,000 per day.

Five years ago, we moved to a website, but the website was all in flat HTML.

We could now reach 10,000 people per day via email, so the cost overheads were reduced, but we had to do that on a dialup line and it took hours. The daily telephone costs were around £30 per day.

On top of that, to get the website to look anything like how we wanted, we spent around £40,000 / $50,000 per year. So it was costing us £30 rather than £3,000 per day, plus the rest.

Today, I blog and email and run the website using standard web tools and services.

The cost is £20 or $30 per month for access to the internet over high speed broadband.

From £3,000 per day to £30 per day to less than £3 per day.

That’s how easy it is to run a business now.

And these businesses can appear to be global, even though it’s just someone sitting at home blogging and emailing.

That’s the power of today’s technology.

What bothers me though, is that most firms don’t get today’s technology.

For example, the London Stock Exchange just spent around £40 million on a new system and has over 1,000 staff in London.

They’ve got new competition from new exchanges that only spend a million on their technologies, or less, and have fewer than 50 staff.

But they are just as effective.

The message is that technology combined with understanding can reinvent business models, innovate services and create revenue opportunities at zero incremental cost.

But most people don’t get it.

By way of example, I was at a major conference in 2006 when the head of one large firm stood up and said that he had been shocked by the acquisition of YouTube by Google for $1.65 billion in October 2006.

Not because of the deal, but because there was a firm out there worth $1.65 billion that he had never heard of.

So he called his executive team in, and asked who had heard of YouTube.

None of them had.

So he put “YouTube” into his PC and the message came back “access to this website is not allowed through the corporate firewall, please contact your systems administrator if you believe this is incorrect”.

That was the CEO of McKinsey!

In 2007, I spent most of the year trying to explain what Facebook was to bankers. None of them knew anything about it because they could not access Facebook whilst at work, and it was the last thing they wanted to mess about with when they got home.

So the issue is that most executives are firewalled out when it comes to this technology stuff.

How can you understand your future channels if you cannot see them, access them, connect with them or use them?

And just as we get these archaic businesses wedded to old style technology investment catching up with this socially networked global village, it’s all changed again.

We are on the cusp of moving from an internet that was pulling and downloading to one that is pushing and intuitive.

The semantic web, where everyone’s electronic devices are connected, tagged and sorted into a relational database, means that we will soon have everything begin pushed towards us based upon our preferences.

Tell me if I should stick with my current bank, telecoms provider, gas and water supplier, stationery firm ... you name it. The web will find it and make sure you are optimising your lifestyle.

So we go from a cut and paste lifestream to a cut and thrust lifecycle.

The semantic web – only five years away or less – will fundamentally change the way we think, buy and deal with each other as individuals, and as businesses.

And note, that the semantic web therefore is going to be the big deal when we get out of this economic mess.

Five years I said for this next generation web and five years to get back into a growth cycle.

There is a perfect storm of good business and good technology on the horizon, which all comes together in 2014.

For two years we will be in flat or negative growth, for three years slow growth and then, in 2014, fast growth supported by a boom of new web technologies.

So if your management does not get the next generation technologies. If your management does not see the fact that business models are being created with technologies that cost 1/1000th of your costs, tell them that some companies are running businesses for £3 per day that would have cost them £3,000 per day a decade ago.

Wake them up by telling them that Facebook had only 6 million users in 2006, 60 million in 2007 and, today, has over 140 million.

Tell them that YouTube generates more hours of viewing for most people, than traditional TV.

Tell them that some bloggers report and manage more news with more distribution and readership than some newspapers.

And that anyone can create these global reach capabilities from their homes.

Therefore, sticking to old tried and tested structures and operations was good for businesses when businesses were slow to change, but will kill businesses in the next five years as business is now fast cycle change.

In 2014, we will be in another growth cycle. A more sombre one, with very different financial instruments and services, and with banks that are far more checked and regulated than ever before, but it will be another growth cycle.

Those firms who harness the power of the network will be the ones that achieve the fastest growth in that next cycle.

On that note of optimism for 2014, I’ll leave you.

Thank you and goodnight or should I say, goodnight and good luck.

Comments

[Makarand Jadhav]

Hi Chris,

Very thoughtful article, shows a lot of research behind this and logical sequencing of the points presented are really good.

Thanks

Makarand

[Jeremy Kidd]

Great analysis, Chris.

[Michael Brown]

Hi Chris,

An interesting speech and certainly relevant for financial services businesses but "invest in technology" is not a solution for real firms that actually make things. You can't make a BMW by sitting at home with a PC or writing a blog. You can have all the technology in the world but without the physical things (computers, comms infrastructure, buildings etc) that back it all up you have nothing. An economy without companies that make tangible assets is just a load of hot air.

The current crisis happened exactly because of complex derivatives which were ever further removed from the real physical assets that backed them up. In many ways, the technologies you speak of so highly are to industry what SIVs, CDOs, and CDSs are/were to mortgaged properties.

Regards,
Michael.

[Chris Skinner]

Michael

Interesting, and thank you for agreeing with me rather than arguing an alternative point.

In particular, I am not saying that all businesses run from a bedroom, just that some can. Technologies such as those to which I refer, are changing the economic model of all businesses that depends upon 'knowledge workers' as those workers can now work from home.

Second, I write about financial services which make no physical goods but sell promises which are digital based upon those very knowledge workers. Therefore, telling banks to invest in tech makes 100% sense.

Third, BMW or any other business invest massive amounts in tech too, to improve their physical supply chains and to innovate. A BMW without the technology on board today, would be a Model T.

Fourth, you mention the physical things that back things up and again you are talking about technology services. So you agree with me.

Finally, if the technologies I speak of so highly are the SIVs of industry, why are you saying you need the comms and computers? They are those technologies?

Chris

[Marc]

Hi Chris,
I really enjoyed reading this speech, and liked how you tied together what is currently ailing the world economy as well as how the banking landscape will fundamentally change (as will the healthcare landscape in the USA) as the result of decreasing technology costs (coupled with increasing access to said technology). On this topic, however, it will continue for start up firms to accomplish more than the establishment due to the legacy system costs. Most companies get hung up on the integration of new technology into an older platform, which results in costs ballooning (as you illustrated with your example above).

On the note about the crisis being caused by CDO/CDS exposure - I couldn't agree with you more. Michael Lewis has a great article in Conde Nast magazine, as does Christopher Whalen in the Nov 2008 Seeking Alpha edition.

One of my core beliefs is that the question is more important than the answer – ask a wrong question, get a wrong answer. I don’t think that the way out of the housing meltdown is to prop up banks – I think the way out is to deal with the main issue that has caused all this pain – the CDS contracts that backed all this debt. You’ll recall at dinner that I view these contracts as a form of insurance fraud (as there really wasn’t any intent by the party selling the contract to actually live up to it), and my solution would be to somehow invalidate these contracts.

As you stated above, there is over 55 TRILLION in CDO/CDS exposure - and while that doesn't equate to 55 Trillion in losses (as there will be some winners), the amount of exposure is simply something that can't be addressed by adding liquidity - the world just won't have enough (or won't be able to work together to provide enough).

The approach of using liquidity to address this issue is to me like trying to build a wall to protect against a Tsunami - it is unlikely that you'll be able to build a big enough wall to hold back the tide.

In the case of the Tsunami, the way to address the issue is to accept that there will be devastation, and then rebuild once the waters have receeded.

In the case of CDS/CDO obligations, I think the solution is the same - find a legal means to eradicate the CDS obligations so that the phantom "55 Trillion" obligation is drastically reduced to something manageable - so that the rebuilding of the financial system can begin.

What are your thoughts about this approach? Why exactly can't we deal with the true problem - the CDS/CDO swaps?

[Monevator]

Your points about the cost of technology coming down are well made.

I wonder though if there are other costs related to technology that will ramp up as a consequence.

Now companies no longer have to spend say your £50,000 per annum on web development, the barriers to entry have been dramatically lowered and the playing field leveled.

Given all websites are to *some extent* equal, I wonder if companies will now be spending that £50,000 a year instead on Google advertising, SEO research and building their brand through traditional marketing so consumers find and stay with their site, and not a rivals?

[trade show booths]

Very interesting Chris. Your analysis seems probable. I along with many will be watching how everything unfolds over the next 5 years.

[Jack W Plunkett]

Chris, excellent, vital thoughts. Thanks for sharing them. You talk about a perfect storm coming together in 2014 or so, and you're absolutely right. However, there are even more factors invoved in the coming tech boom--much of it will involve nanotech, biotech and remote wireless sensors. Also, there will be considerable convergence between technologies (moving everything toward smaller, better, faster, cheaper). People interested in this line of thought will enjoy my new book The Next Boom, released in January 24 (see amazon, or see the Plunkett Research website for sample champters and related videos). Best wishes, Jack W. Plunkett