Friday, December 26, 2008

Visions of the Future: Fred Wilson sees commerce, I see war

As a VC, Fred Wilson is focused on the entrepreneurial opportunity in the commercial part of the spectrum. His take on what sort of interregnum we're in is therefore essentially positive, because within the bounds of that arena, it's clear that this historic ongoing dislocation means that opportunity abounds:
This downturn will be marked in history as the time where many of the business models built in the industrial era finally collapsed as a result of being undermined by the information age. Its creative destruction at work. It's painful and many jobs will be lost permanently. But let's also remember that its inevitable and we can't fight it. Technology and information forces are unstoppable and they will reshape the world as we know it regardless of whether or not we want them to.

'Spectrum' is a good way of thinking about what is going on, and let's call the commercial aspects of the current interregnum and coming change the 'green' part of the rainbow, nicely positioned in the heart of ROYGBIV.

Over there on one edge of the spectrum of the future, I'm spending a lot of time worrying about Red, the color of Mars, god of war.

'Arena' is a word chosen carefully, because commerce is a game played within set rules. The larger struggle is how, and by whom, those rules are set; and that combat both has no rules, and is about to become much more intense. Frail Mercury may sit on the sidelines, or hide in the cellar, while fiercer fights take place.

Why do I feel so strongly that this is imminent? Unrealized to many of us in the west, the beneficial outcomes of the current 'game' of commerce have now been disproven in the eyes of many. Seeing the newly revealed artificial nature of progress and prosperity in the West, does anyone in Nigeria, or Pakistan, or Brazil, or Russia, Malaysia, truly believe that their ladder up through the stages of global capitalism actually has rungs?

If they stop believing that, they stop playing the game, and move on to more fundamental maneuvers. And one of the precepts of those maneuvers is that they must be responded to, which means that only one party's decision is required to set them in motion.

Caught between fundamentalism abroad, fundamentalism at home, and a more prosperous despised neighbor to the east, the current generation of Pakistani leaders no longer believe that they can even rise to the level of prosperity enjoyed by India. What is their next logical move? We're all about to see.

Sunday, December 21, 2008

Bob, the word you're searching for is 'Interregnum'

Robert X. Cringely, in his last PBS column:
The world is unsettled. It's not just this damned financial nightmare we have to deal with but also a sense of between-ness, like something has just ended yet still lingers slightly though it is obvious that something new is about to arrive. But will it be a good something new? That's hard to tell.
In past eras we used to have interregnums between the reigns of kings. These days, we see them in the pauses between empires, hegemonies, and technology-driven waves of infrastructure. We're there.


I'll try to get some thoughts posted on waves of technology and deflation over the Christmas holiday. It won't be fun, but it may be interesting.

China May Fall: The Next Big Problem Is Political Risk

We're finally to the point in this unfolding economic crisis where most people are seriously willing to engage with the topic of whether this recession is of the magnitude and danger of the Great Depression. That's far cry from a year or even six months ago, when depending on the skepticism of your listener, using such terminology either raised eyebrows or placed you straight into the tinfoil-hat brigade.

That's a good thing, because once we can talk about something, we can analyze it, manage it, and possibly mitigate it in ways that are really difficult to do when we're in a state of absolute denial.

I continue to be puzzled by how many people view market movements as abstracted from real-world events, as if markets are some pure reflection that has little or nothing to do with the facts on the ground. These sorts of arguments are common when people say, for instance, that the fact that the S&P is now trading at or slightly below its long-term "fair value" means that it's unlikely that stocks will go down further. This is a slipshod presumption because there are whole huge categories of risk that have yet to really be taken into account, just as one year ago, the very real risk of systemic defaults on structured finance obligations across all debt classes had not yet been taken into account.

The thing that is scaring me on an almost daily basis is political risk, and I am amazed that this is not a much larger part of the discourse already. One of the few exceptions that I have seen is Gary Shiller's recent discussion of the possibility of regime change in China. Does anyone remember what happened right after the Great Depression? The answer is World War II, and it's worth remembering that World War II was made up of a number of interlocking wars, with the Japanese, Germans, Soviet Union, British Empire (including India), United States, the French Empire, China, Italy, and many other secondary players (the list is endless but includes most of Asia, all of Europe, and most of North Africa as well as our good friends the Canadians, Australians, and New Zealanders) all throwing their entire military and productive capacity into a struggle of resources, ideology, economic systems, power, and race that the world has not seen before or since.

It is my sincere belief that both the Great Depression and World War II were the direct outgrowths of the protracted collapse of the British Imperial economic order, which first started to crumble with the Boer War in South Africa circa 1900, and whose final death knell was sounded in the late 1950s and early 1960s with the effective end of colonialism. A huge swathe of actual and abstract infrastructure needed to be swept away to prepare the world for a new economic and political system, as the illogical remnants and deep-seated contradictions and flaws of the prior order were exposed, exploited, and exploded. It was an era where the myth of white supremacy was as outdated as the battleship, and in ten years of global struggle (1936 - 1945) and megadeath, the foundations were cleared for what came next.

We are now twenty years since the end of the Cold War in 1989, and we are due for a big war or two. We can get lost in the metaphors of whether what may come would be the equivalent of World War I or World War II. What worries me is that it is coming, and it is coming for both a long-standing reason and a proximate reason.

The long-standing reason is that we have hugely illogical and remnant pieces of global political and economic structure. When the Cold War ended, there was still no effective difference between a telephone company and a national government; paper was still the major form of bureaucratic communication, advertising, and information dissemination; petroleum's energy supremacy was unquestioned; and the vast majority of the world's economy was composed of the US, Western Europe, and Japan.

The core structures of our natural resources extraction, global shipping and trade, transportation systems, energy systems, information systems, and military makeup haven't really changed that much. Tanks, jets, and aircraft carriers still dominate the modern military, though their conceptual resonance with armored knights on horseback in the emergent era of the first firearms grows stronger by the day. Vertically managed corporations still rule the economic landscape, though their resemblance to discredited socialist bureaucracies is as strong as ever. Factories may have moved to China but largely still run just as they did thirty and fifty years ago. Pensions, retirement funds, education, healthcare... the list goes on. The world has changed, and our systems cry out for a reboot. Such rebirth - renaissance - turning of a new leaf, the turning of a globe, revolution - is inevitably painful, miserable, and destructive. I'm not calling for it; in fact I fear it -- but I am predicting it.

That is the general cause.

The proximate cause is quite simply poverty. Material poverty, poverty of spirit, and poverty of ideas. In perilous times, rulers fall; and rulers who may fall will do anything that they can to maintain their tenuous grip on power. The most logical move in the world is for a ruler to focus inward anger outward; to create or highlight a wrong or an enemy, and unite a populace against that cause. The wrong may be true, or it may be constructed; there may be a valuable prize to be gained (such as resources) or war may simply drive domestic political benefit. But as sure as the sun rises, right now, threatened rulers in many halls of power are contemplating wars of many kinds. In retrospect it becomes a difficult question whether the rulers led the people to war, or whether the populace demanded rulers to lead them there; once a politician puts himself at the head of a parade, who is to say whether a pull or a push is in progress?

But in either case the war happens.

The political risks of our current crisis are practically immeasurable; they are easily as profound as those extant in the decade leading up to WWII.

* China faces domestic unrest that may cause it to implode.
* The EU faces internal schisms that may cause it to break apart.
* Africa faces an existing tide of lawlessness and poverty, and spark-points such as Zimbabwe, that may draw much of the continent into varied forms of bloodshed
* I will be shocked if India and Pakistan don't have a war in the next decade, and relieved beyond expression if that war doesn't go nuclear
* The United States will face its own serious domestic discontent, as it has the most to lose from the dissolution of the current world order
* A nuclear-armed and belligerent Russia is about to be impoverished by the collapse of oil prices. The last time that happened was 1989, and the Soviet Union fell.
* The many petroleum-fueled autocracies of OPEC face similar threats - and many are well-armed
* South America has large states with little petroleum -- Brazil, Argentina, and Chile -- and small states with a great deal of petroleum -- Colombia and Venezuela.

Even leaving aside additional sources of potential stress such as drought and declining food and water supplies brought on by climate change and overfishing, there is such ample opportunity for global disaster here that it's hard for me to imagine that the coming decade will be peaceful.

In terrible recessions, markets don't trend 50% below their "fair value" for abstract reasons. They do so because the outlook for the future at those dark, bleak times is truly terrifying.

I fear that we will see those times again.

Sunday, December 07, 2008

Calling All Pirates!

An article I read on Bloomberg today sent of all of my "looming unintended consequences" radar into turbo overdrive. It's about the spread between current and futures oil prices, apparently called Contango, and the fact that this spread is so unusually large right now -- $41 current price vs. $55 December 2009 futures contract, so $14 per barrel -- that it's actually cost effective to:
a) rent a supertanker
b) borrow enough money to buy a Buh-Buh-Billion dollars worth of oil
c) anchor said tanker offshore somewhere and
d) physically deliver the oil a year hence.

Some Oil Dude in London is reliably quoted as saying that this strategy should deliver 11% profits over the forthcoming year, which looks pretty darn tasty when Ye Olde Worlde is ending all around us, and Treasuries are paying less than 1%.
pirate oil money flag
The reason that my looming disaster radar is going Beep! Beep! Beep! is because as sensible as it sounds, this is just the sort of nothing-can-go-wrong "auction off our lottery and our turnpike" sort of thinking that has gotten us so deep into our current financial crisis.

So for those who habitually stomp through graveyards, the foolish of all stripes, and investment bankers in particular, here's a short list of what could go wrong with this strategy, from the likely to the formerly absurd:

* Bankruptcy and/or default of whoever is sitting on the other end of that billion dollars worth of futures contracts. I can certainly imagine that entity either having gone under in the normal course of business 12 months from now, or seeking bankruptcy protection to avoid paying what could literally be $500 million worth of additional costs, if oil is at $28 instead of $56 when December '09 rolls around. Since every contract we can imagine has turned out to be worth the equivalent of toilet paper over the past 12 months, what's to say that oil delivery futures contracts won't suffer the same fate?

* Storm and/or other damage and destruction of the tanker and the oil. Sure, there's insurance against such things. Insurance companies are just SO financially stable these days, and happy to pay billion-dollar losses rapidly and fully, don't you agree? (cough) AIG (cough).

* Pirates and terrorists, oh my! The article goes on to say that as many as 16 supertankers may be booked for such use; which means that they'll be sprinkled around the globe in all sorts of locations, ripe to be hijacked, blown up, spirited away, or other malfeasant use.

Seriously, what really gets my hackles up (in fear not in anger) is that this sort of stupidly rational strategy is the height of "the system works" thinking, which assumes that a long complex interlocking string of contracts will be honored. Let's look at the string here:
* A current contract to buy a billion dollars of oil
* A loan to finance a billion dollar purchase
* Rental of a supertanker [and crew?]
* Insurance on the tanker and the oil
* Some sort of anchoring rights [or the knowledge where to anchor in international waters]
* A futures delivery contract for the oil

Think that anything could go wrong here? See any arcane interconnection of previously uncorrelated financial instruments and indices? Worried about the odds that at least one single thing in this long chain will go slightly wrong, in a world where Things Going Wrong has lately proven to be the approximate statistical equivalent of the sun rising in the east?

Nah. Count me in. Pirates be damned -- 11% sounds awesome!

PS. 2:1 leverage for 22%? Anyone? Hello, calling 2006... anyone?