In trying to make sense of economic uncertainty, it pays to look beyond conventional wisdom for an explanatory theory of the hidden fundamentals that can drive or hinder growth. Hence this interview.
Mark Anderson is the editor, publisher, and chief correspondent of the Strategic News Service newsletter, one of the most incisive publications in its field. Ostensibly about the future of the computer and communications industries, it covers a broad range of factors that affect and are affected by those businesses: everything from technological advances to capital flows to government policies to educational innovations to advances in physics.
Anderson argues that the root cause of the crisis of 2008–09 was excess liquidity: too much money seeking rapid returns, subsidizing too much production for too few customers. That bubble burst, no subsequent engine of economic growth has proved sustainable, and the excess liquidity remains, driving some prices up and others down, and splitting the world even more dramatically into economic haves and have-nots. Three critical measures, in Anderson’s view, need to be put into place before serious recovery can get under way. The first is better protection of intellectual property. The second is the specific type of financial reform that would prevent “jackals” (short-sellers) and “vampires” (sophisticated investors who take profits without contributing either market balance or information) from dominating the market as they do today. The third is a rebuilding of the manufacturing base of the industrialized world, including an accelerated transition to green energy and technologies.
This interview is adapted with permission from a conversation conducted on May 13, 2010, before the audience at Anderson’s annual Future in Review conference. Anderson, a former venture capitalist and founder of two software companies and a hedge fund, is known for his knowledgeable readers (who often contribute to the newsletter) and his prescience: He tracks his published predictions and claims a 90 percent success rate. In this interview, he goes out on a limb. He believes that human beings, flawed though their decisions may be, have the will and the ability to avoid further crisis — or at least to bounce back from crisis in the long run.
The Lesson of Liquidity
S+B: How do you interpret the divergent points of view about where the global economy is going — the view that we’re heading for deflation and depression and need more government stimulus versus the view that our greatest dangers are inflation and deficit spending?
ANDERSON: The largest problem facing our economy in 2010 was going to be hyperinflation. All the central bankers and policymakers understood this. But a funny thing happened: The damage was so great from the meltdown this time that the time frame changed. The threat of hyperinflation is real, but it’s a long-term threat. It may come in five or 10 years; no sooner than five.
In the meantime, we are all still dealing with the consequences of the meltdown. For example, in a very strange way, the low interest rates that still exist because of the meltdown are assisting in the economic return of some parts of the economy. The economic stimulus from 2009 could never have been enacted except for the knowledge that there would be no hyperinflation in the short term.
Keep in mind — and there are still very few people who get this — that the crisis did not start because of American banking practices or subprime loans. It started because of the doubling of global liquidity over a five-year period in the 2000s. The world’s annual investment capital, the amount of money seeking rapid returns, went from US$36 trillion in 2002 to $72 trillion in 2007, just five years later. That’s what led to all the inflation we saw in real estate prices, all around the world.
If you saw that pattern early enough — and I saw it in 2007 — then watching the financial system was like being inside a warehouse where someone has poured gasoline all over the floor, and there’s a guy smoking at the far end. You know something’s going to happen. It’s just a matter of when. There were 50 different problems that could have triggered the crisis.
The key to the crisis wasn’t in the balance sheets, which were lies. Even today, bank balance sheets are lies. Nor was it the usual GDP numbers, which are made up. It was in the fund flows. The big lesson is that for the future, we’d all better start watching fund flows.
S+B: What are the fund flows telling us now?
ANDERSON: I don’t know. The worst part of this story is that people don’t measure them. They’re very hard to track, and no one’s in charge of measuring them. The numbers I just cited for 2002 and 2007 came out a year after the collapse. Even in 2007, I didn’t have them. I saw symptoms of this money flow through the price rises in petroleum markets, and through the “carry trade,” where speculators borrow in one currency to invest in another. There were trillions of dollars of “hot money”: money seeking quick returns. Where would that get invested? In stocks, bonds, commodities? A lot of it went into real estate.
S+B: These billions in hot money were funding lots of efforts to provide quick returns…
S+B: …which were producing many goods and services that no one wanted or needed…
ANDERSON: Or that were bogus.
S+B: And creating a kind of bubble of asset bubbles through the 2000s, in stocks, real estate, financial instruments…?
ANDERSON: Absolutely. That’s right.
S+B: And did all of those bubbles fully burst, or is there more to come?
ANDERSON: Oh, no. All those asset bubbles burst. Real estate, stock, different countries, different markets, they all burst.
But the hot money is still with us. Today, instead of only one country, Japan, providing the near-zero interest rates that enable a carry trade, we have almost every nation except Australia competing for the interest-rate bottom. This has produced huge flows of hot money into the global liquidity pool. Although I haven’t seen any figures published, the amount of available capital, despite a slower economy, is likely to be equivalent to the totals of 2007. When the damaged parts of split economies begin to come back, this liquidity will likely create a whiplash effect, throwing countries into hyperinflation before they can respond effectively.
That is the fear of every central banker in the world, and the threat is more than plausible; it seems inevitable.
Protecting Intellectual Property
S+B: What other important trends are shaping the economy right now?
ANDERSON: The first is the conversion of the world’s abject poor to consumers, and that’s more important than the birthrate. Around the world, the next 1 billion consumers are coming online really fast — for the most part in India, China, and Southeast Asia, but also in South America. Even the poorest of these people will have cell phones and some access to technology. The “cloud” of cloud computing will be serving them, too.
Meanwhile, it’s becoming brutally clear that the economy is not going to be what it was. We’re going to return, not to normal, but to reality. There will be a war between two systems: that of the mercantilist countries, which seek to make money by obtaining foreign intellectual property (IP) and regulating trade for the sake of competitive advantage, and the free market, free trade countries: India; Australia; and those of North America, Europe, and most of South America. Most businesspeople in the West are not emotionally prepared for this war.
S+B: By mercantilists, do you mean only China?
ANDERSON: No. Japan was the original expert mercantilist, even before World War II. After World War II, the Japanese refined their model, the South Koreans refined it further, and the Chinese learned from both. Today, the Chinese model is probably more advanced than the other two. The Chinese didn’t want to wait 40 years. So whereas some Japanese and South Korean companies obtained IP in nefarious ways, only China made the acquisition of intellectual property a serious government program. It was required in the contracts of American companies doing business in China that they give away their patented designs, processes, and innovations as part of the right to trade.
The Chinese also allowed huge amounts of investment, even though they prevented outright ownership of companies by outsiders. This was clever. In effect, the Chinese said, “We will take your money and IP in exchange for access to our market — but it’s faux access. You’ll be able to sell cars and airplanes here until our companies are ready to compete, and then we’ll cut you off.” A lot of people got fooled into thinking that it was either an open or partially open market. In fact, it was just a very well-designed mercantilist program.
In the mercantilist model — which, by the way, is a very intelligent way to build a fast-growth economy — you bring together business and government leaders and set up a deliberate trade policy. You list the industries you’re most interested in and target them one by one. Cars are important because they use steel and involve a lot of employees. One test for the effectiveness of mercantilism is the number of outside products sold in that country; for example, only a handful of American cars are sold in South Korea and Japan.
The indicators so far are all in favor of the mercantilist countries winning over their free market counterparts. And as the United States and Europe lose manufacturing and intellectual property, and as we find that the return on investment for IP starts to decline, how do technology companies fare in that environment? It’s tough to make a $2 billion investment in an operating system if it shows up on the street for a dollar 10 days later in Hong Kong. This is a big problem that hasn’t been fixed.
S+B: How will free market countries try to fix it?
ANDERSON: There are only a couple of choices for the governments of the West. Choice A: Keep going as is. In that case, the value of IP will disappear. With limited returns, the whole world, essentially, will stop investing in innovation.
Choice B: The governments of the West focus on protecting IP — in trade agreements, other policies, and their public talk. There has to be almost a cultural shift, where people recognize that civilization — the discoveries, cures, drugs, chips, and advances that we’re most proud of — are all forms of intellectual property. We’ve already created geographical alliances for trade, such as the North American Free Trade Agreement. Having trade alliances based on intellectual property would make a lot more sense; countries should only trade with others that have similar protections in place. India saw this coming. After having a very loose environment for a long time, it passed one of the strictest sets of IP laws.
S+B: Could India’s approach become a model for other countries?
ANDERSON: I think it could. The idea of moving research and development to India looks better and better to companies that have been burned a few times in other countries. India is now a healthy competitor. Its people are very smart. A lot of Indian Institute of Technology (IIT) graduates are brilliant programmers. The government leaders very much want to have their own industries. India will be a real player among global high-tech competitors.
Jackals and Vampires
S+B: What kind of impact will financial regulation have?
ANDERSON: When you look at financial meltdowns, you have to consider the role played by financial jackals, as I call them: short-sellers, unrestrained by oversight of any kind, who pile on and make money when there’s a sign of impending shortages. That’s why Bear Stearns lost $33 billion in value in two days — over a weekend, mind you, when no one was even trading. George Soros did the same thing to Britain in 1992. This year, the breakdown in Greece is another form of the same story. The central bankers of Europe didn’t understand this in the same way that American financiers did, because the U.S. has more experience with jackals.
The shorts have such an effective technique and so much power that the truth, whatever it might be, about real economic value and prospects doesn’t matter. Maybe Greece only needed €25 billion [$34 billion] to avoid default, as was said in February, or €45 billion [$61 billion], as the European Union offered in April. The amount is unimportant. What’s important is, Did you and I and 13 of our closest friends pile on and short this thing? If we did, it’s going down. Foreign exchange rates — the legitimate trading of currencies — is unimportant compared to the pressure brought by shorts.
We saw the great potential danger of this behavior in 1997 during the Asian financial crisis. Those collapses of currency didn’t occur because the countries had suddenly overreached. The jackals were simply picking off the weakest, one by one. We have to fix this problem somehow.
S+B: In other words, regulation of trading is more important than regulation of the banks.
ANDERSON: Yes. More precisely, regulation of traders would be a more effective way to regulate the big problems that exist right now in the markets. I hear Wall Street guys say with a straight face — and I think they mean it — that, “Shorts are a part of the natural order. There’s a long, and there’s a short. It’s that simple.” In other words, a short trade is just a deal where you buy an option on a falling price, and they should be allowed to continue.
But I don’t think that’s how the world works. In a short deal as it works in practice, you buy options against the share price, and then you call your friends, and they call all their friends, and then you call the press, and you tell everyone lies about how bad the company is. Then the stock goes down. And that’s not right. It’s an extremely damaging, destructive practice that has no real place in the economy.
The answer would be to either eliminate shorts altogether, which probably won’t happen, or to put back some serious restrictions such as the uptick rule. [The uptick rule, established by the U.S. Securities and Exchange Commission in 1938, restricted the short selling of a stock when its price falls. This rule was removed in 2007.]
S+B: Realistically, though, how much regulation of short selling will happen? The SEC has been publicly considering a reinstatement of the uptick rule since April 2009.
ANDERSON: Sure. Don’t push it. “It takes time to do these things.” Seriously, it’s hard to believe that we’re having a debate about whether to regulate some forms of trading. After seeing the collapse of the global economy, and having come close to the edge of destruction for all that we know and hold dear, some legislators are still arguing with a straight face that we don’t need any fixes.
We do need fixes. I hope they bring back the uptick law and institute the Volcker Rule [barring banks from proprietary speculation]. Right now, the larger banks are lobbying against this. That’s one example of why we cannot rely on lobbyists to come up with the right policies, for either the health of the economy or the health of their own industries. I recently met someone who led the banking industry’s lobbying effort, during the Clinton administration, to have the Glass-Steagall Act revoked. They spent $1 billion in cash. They’ve spent easily that much fighting the current wave of proposals.
I don’t know if we will get regulatory assistance, but we definitely need it. There is a strong possibility that it won’t get passed, or that it won’t be tough enough, and then we would go right into another financial crisis, but 10 times worse and without any remedies for the government to provide this time. How much extra debt load can the U.S., the U.K., or the E.U. take on right now?
S+B: What prospects do you see for investors in the current financial system?
ANDERSON: I think that investors ought to be very careful. Stocks in this market can move in ways that most investors couldn’t possibly anticipate. A few companies, like Goldman Sachs, have become so good at what they do that the game they’re playing isn’t the same as the game an ordinary investor plays in the market.
A few months before the crash, I was watching Goldman, and I realized that these guys were doing something in that building that nobody else did. I’m not talking about anything illegal — it didn’t have to be. For example, Goldman locates its computer servers within a small distance from the trading servers because they need the extra microseconds of transmission time. I don’t play that kind of game; very few investors can. In May 2010, the Goldman Sachs quarterly reports came out, and said they had 35 days with profits over $100 million; 78 percent of their profits came from trading. And every day was better than the day before. That pattern of profitability never happened before.
S+B: You’re saying that Goldman is the corporate equivalent of the mercantilist governments. They’re all such sophisticated financial players that they change the game for the rest of us.
ANDERSON: Yes. You can’t blame them, because they’re playing by the rules — I think, at least mostly. But the rules may have to change. If someone gets to be that good, then they become vampire investors: “I’m just going to take some blood but I’m not going to give you anything back.” That kind of trading is destructive. It doesn’t help anybody; it doesn’t correct imbalances in the market. In fact, it ensures that markets won’t work.
An estimate by Vanguard Group founder John Bogle two years ago put the amount extracted at that time at about $600 billion per year, directly removed from the American economy. Well, what if it becomes $1.2 trillion? Or $5 trillion? At what point do we wake up? Or do we just lie there with the spigot in our veins and never wake up at all?
Rebuilding the Manufacturing Base
S+B: What will happen in the general economy in the U.S. and Europe?
ANDERSON: Already, we’ve seen the economies of the U.S. and probably Western Europe split cleanly in half. Some people will be wealthy beyond their wildest dreams. They will be the people in global commerce of some kind, probably with most revenues coming from offshore.
At the same time, a lot of people will have lost their jobs forever. At the age of 35 or 45, they have lost jobs that they dreamed of retiring from, and they’re not going to get them back. For kids just out of school, the job market is so oversaturated that it could be 10 or 15 years before that gets fixed.
This kind of severe split between haves and have-nots has not happened any time before; not in the Great Depression, or in the crashes of 1987 and 2001. The time delay before a broad job market returns will be a big problem for the bottom half of the economy, and it will be difficult to see clearly because it will be clouded by averages in the statistics. The unemployment rate will be 10 percent overall, but that will mean 40 percent in some sectors and zero percent elsewhere.
S+B: Why would it take so long to fix this problem?
ANDERSON: It has two causes, and both took a long time to develop. They’ll take a long time to unravel. The first is the rise of offshoring over the past 40 years to cut costs — a strategy that is backfiring now. Companies in the West are bringing jobs back to their home countries, not for patriotic reasons, but because they found out either that they needed their expertise in-house or that part of the offshoring machine didn’t work very well. Distinguishing what to offshore versus what to produce at home has become a major business question.
The second cause was the loss of the U.S. manufacturing base as companies elsewhere outperformed American companies. Automobiles are a pretty good example, and there are some great books written about this. See, for example, Eamonn Fingleton’s In the Jaws of the Dragon: America’s Fate in the Coming Era of Chinese Hegemony [Thomas Dunne Books, 2008]. These manufacturing jobs went to Japan or South Korea, which occasionally then offshored them to China and Vietnam. The same happened with electronics. The U.S. has one DRAM [dynamic random access memory] semiconductor company left, but essentially all the others went away.
In the coming years, more Asian and Latin American companies will open plants in the U.S. and Europe, but mainly to avoid trade retribution. That, too, has been going on for 30 years. For instance, in the late 1980s, Japan was named an “unfair trading partner” under the “Super 301” U.S. tariff laws. This happened after Intel filed a complaint about semiconductor competitors from overseas, and Toyota’s top executives worried that cars would be the next product type in line. So they immediately put all their manufacturing plants for cars sold in America into the United States. It wasn’t because they loved America; it’s because they didn’t want Super 301 brought against them, too.
The U.S., in particular, is vulnerable to this problem. It should decide not to allow foreign nations to sell cars in its markets, if there is not equal access for U.S. cars overseas. The same ought to be true for steel, televisions, consumer electronics, and other categories that the U.S. has been frozen out of in trade with mercantilist nations. Why should my citizens be allowed to buy your cars, if you won’t let your citizens buy mine?
Hope and Expectation
S+B: If you looked at these trends separately, none of them would strike you as a good thing. But given the way they fit together, where do you look for hope?
ANDERSON: There is some reason for hope here. Learning how to protect IP is our only path forward. Whether you’re making movies or chips, the sooner that happens, the better.
The emergence of all of the new consumers in the world is exciting. If we got some basic things right about trading, there would be lots of growth available for everybody. China, the U.S., Japan, India, and Europe could all grow. It would be a very exciting story.
S+B: How does the environmental imperative play into the growth? For example, we’re trying to boost economic growth, bring billions of people into the middle class, and stay within the carrying capacity of the planet at the same time.
ANDERSON: Like [University of California computer science professor] Larry Smarr, I call myself a long-term optimist. And I don’t see people as a threat. It seems to me that the largest businesses available — as the Chinese would tell you, and I think a lot of Americans understand — are in clean energy, alternative energy, and green technologies.
We need a big problem to solve right now. Climate change is like the next war — in fact, it could have all the economic impact of a war without being a war. It’s obvious what to do, the requirements are clear, and it couldn’t be more important. Let’s do it.
I miss Winston Churchill. I wish we had a Roosevelt. I would love it if Obama would stand up and make the kind of case those leaders might have made: “I’m very sorry, I’m going to hurt your feelings now. I’ve recognized the importance of this problem, and I’ve talked to [U.S. Energy Secretary] Steven Chu. As of today, we are not going to build another coal-fired plant ever again. All plans are on ice. Forget it. Moreover, for every existing coal plant, we’re going to put in either a natural gas or a nuclear plant. That’s a five-year program. In 2015, we’re turning off all the coal plants in America. Period.”
That would buy us 20 years of time in which to curb emissions more thoroughly. He might go on to say something like this: “Between now and 2030, we’re going to test all the other technologies: algae, solar, wind, whatever. Everybody gets a shot, and we’ll let the market figure it out. But we will invest and have tax policies that encourage this stuff to happen. At the end of that 20 years, we’re going to turn the switch again, and probably no more nukes. And guess what, by the way, Yucca Mountain is open for business [storing nuclear waste], and if the people of Nevada don’t like that, we’re going to send the troops down there and open it forcefully because this isn’t an opt-out kind of situation. That’s the plan. And we’re not voting on it.”
That’s the kind of leadership we need right now in many countries. I think people would love it.
S+B: Your primary audience has been technologists. What do you say to them about doing well while doing good in this environment?
ANDERSON: The generation that’s coming up right now is so cool. I recently heard David Gergen from Harvard’s Kennedy School of Government say, “The only way we can go wrong is to discourage these kids. They are set to go. They’re smart. They’re motivated. They understand the problems. They are engaged.”
I think that’s true. I believe the baby-boom generation has done a medium-to-poor job of recognizing the problems and dealing with them. But this generation is set. I’m totally encouraged about the idea of, “Here’s the baton, sorry about the mess, please do better,” and I think they will.
- Art Kleiner is the editor-in-chief of strategy+business and the author of The Age of Heretics (2nd ed., Jossey-Bass, 2008).