Sunday, May 11, 2014

Sleeping Pygmies


The only way to not just survive but thrive as an entrepreneurial enterprise is to destroy fixed costs and labor overhead... The way to destroy fixed costs and labor overhead is to pay no business rent, own no vehicles, have no employees, owe no debt, own your own tools/means of production and nurture human and social capital. Charles Hugh Smith
A friend mentioned in passing recently that it seems impossible for anyone in business to make money any more. He was talking about a favourite coffee shop that now has several new competitors. We see it all the time, a business enjoys a temporary period of success, which in turn attracts new competitors who sometimes force the previously successful enterprise out of business. It's a classic example of Porter's fiver forces of competition (illustrated above - from an interesting post on the advertising agency death spiral).

Such is the normal cut-and-thrust of free market capitalism (not that it's ever really free, market-driven or capitalist these days in an age of bailouts and cronyism).  But of course there's more at play than your standard, textbook competition. First of all there is deflation: price levels are stagnant or still falling in many retail, service and export sectors (and so therefore is the turnover of entire sectors of the economy). Deflation + debt = death for many businesses (and ultimately, a few governments as well).

Beyond deflation there is the problem of our banks. Not only is lending continuing to fall as households and businesses scramble to pay off old loans rather than take on new ones, but even the money supply is stagnant or declining - in particular the M2 measure (historically highly correlated with the value of GNP and hence the size of the economic cake to be competed over).

The banks, of course, have their own problems (bad debts, upcoming stress tests and then Basel III). In reality, it would suit them to get their house in order and then get back to business as normal. But we won't be getting back to normal any time soon - or ever, for that matter. As the quote above from Charles Hugh Smith reminds us, the combined forces of competition, deflation and broken banks (and not just in Ireland) mean that the level of demand for bank loans from businesses and entrepreneurs will remain subdued and will likely shrink further as rising loan rates create even higher hurdles for businesses and investors facing falling rather than rising prices.

Throw in alternative currenciesartificial intelligence and new business models that don't require capital, equipment or even staff and our banks look less and less like sleeping giants... and more like sleeping pygmies by the time they're 'back to normal'. But not before loan rates go a whole lot higher, whatever the ECB does.

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