Will the EU survive a Brexit?

A recent poll by a Dutch newspaper suggested that 53% of Dutch voters would like to have an ‘in/out’ referendum similar to ours. On reading this it struck me that there has been too much emphasis on the impacts to the UK leaving the EU and not enough on the impacts to the other party. There will clearly be implications for both the EU as an institution and for the wider European economy.

All the economic arguments against Britain leaving the EU also apply to EU member countries access to the UK market, and perhaps more so given that the EU exports more to the UK than the UK exports to the EU. There is a counter-argument in that in the event of an exit vote there could be a flock of organisations leaving the UK to manufacture and provide services within the trading block itself. In other words the losses that Europe would face would be offset by the gains from organisations leaving the UK and moving to other locations on the Continent. It is impossible to make a forecast on the degree to which this position can be substantiated as all we seem to have are reports from various groups of economists and forecasters who, as a profession, are notorious for getting it wrong. It may well be that there will be some who could eventually make a decision to de-camp, but it is equally likely will be a very long period of ‘consideration’ as the politics and economics of an exit start to settle down. The negotiations on cross border tariffs will be more than interesting to watch given the current EU import/export situation and there is little doubt that there will be some furious lobbying in Brussels and Westminster.

Should there be a Brexit vote there will undoubtedly be volatility in the foreign exchange, debt and equity markets as traders and investors realign in accordance with where they think their interests will lie. Attention however could soon switch to Europe, possibly within days of the vote as the European political and economic worlds collide into uncertainty.

The Europe question really falls into two broad but linked areas: its economics and its politics.

I have to confess to being surprised by the ability of the ECB to hold the Eurozone area together. Back in 2011 I was convinced that within a couple of years the Greek debt problem would have torn the EZ apart. My mistake was to underestimate the political willpower in Brussels and Frankfurt to ‘do whatever it takes’ to maintain the integrity of the currency area. With an alphabet soup of ECB initiatives and some prodigious write-offs a bail-out deal was struck with Greek lenders and the debt substantially moved to the European taxpayer. All those French and German banks were helped out of their predicament and lived to lend another day. Greece then effectively voted to say in the EU via the rather convoluted political means of a referendum on whether to accept a ‘plan of agreement’ negotiated with the Troika. The deal done the Greeks now have a debt of over €353bn, a GDP of €168bn and nearly forty years of ‘austerity’ ahead of them, mostly driven by its onerous repayment schedule. What could possibly go wrong?

Meanwhile, over in Spain unemployment has edged up to 21% at the end of Q1 2016; not quite as high as the 24.1% in Greece but getting there. Italy sits at 11.7% and Portugal 12.4%. Overall the Euro are currently stands at 10.2%. Growth in the Euro area as a whole was 0.6% but this masked a negative performance in Greece of -0.5%, a barely measurable 0.3% in Italy and 0.2% in Portugal, and an improved outturn of 0.8% in Spain. Germany, Europe’s manufacturing powerhouse, managed 0.7% GDP on the back of a very respectable 4.2% unemployment metric. Two other useful indicators are the inflation rate and interest rates. For the EZ as a whole these were -0.1% and 0%. Blighty is not quite the land of economic wonders that some parts of the political ecosystem would have us believe but the United Kingdom did manage to deliver 0.4% GDP and recorded unemployment at 0.5%.

The Brexit referendum has naturally focused on the impacts to the British economy of an exit but what about the impacts on Europe and the EZ in particular? If we take April 2016 as a reference point, the UK’s exports to the EU were £12.0bn and EU imports were £19.1bn. Thus, as the HMRC states in its April report: ‘In EU trade the UK was a net importer this month, with imports exceeding exports by £7.1 billion.’ These figures obviously fluctuate but overall we import more from the EU than we export to it. In other words the EU would be taking a mighty big risk if it sought to exclude the UK from Europe via the imposition of tariffs. Let’s be more specific. The EZ is not in a healthy state. GDP is moribund and is arguably only above zero because of the largesse of the ECB and its current €80bn/month QE programme.

Which brings me over to the politics. The EU has an enormous challenge at the moment to assuage the feelings of millions of EU citizens on the state of their respective economies. There seems to be an increasing unwillingness from the citizens of Northern member states to continue funding Southern member nations. But it has more recently started to morph into the immigration minefield. Freedom of movement for EU citizens may be just about acceptable for Northern EZ voters but mass migration from outside the EU is entirely something else. Thus we have a conflation of issues all over the EU and the finger of blame is pointing at the institution itself. Southern states don’t want the austerity that the EU imposes and Northern states don’t want to continue to face the financial and social implications of a financially dysfunctional EZ area.

The results of an Ipsos Mori poll carried out earlier this year carried out in nine EU countries, suggested that 45% of those polled wanted an in/out vote like the British. This was led by 58% of Italians and 55% of the French contingent. In the same poll 33% of the 6,000 surveyed indicated they would actually vote to leave. This still suggests a majority still in favour of keeping the EU intact but it’s hardly an overwhelming endorsement.

There is some ‘domino theory’ type thinking associated with the Brexit vote. Britain leaving the EU could mark the start of a more member states leaving and this of course raises the question of whether the institution could remain intact. Since 2010 the EU/ECB has been able to ‘whatever it takes’, or perhaps it should be ‘whatever it wants’ to hold the EZ together. But the inconvenient intervention of voter dissatisfaction has now ascended the political agenda. In the absence of voters, the EU/ECB has had free rein to use diplomatic and financial levers, but in the immediate future they may well have to face challenge of millions of unhappy citizens and one or more in/out referendums. The odds may well be stacked against them this time.

The economics and politics of the EU and the EZ are inextricably linked. In the absence of any EU activity the ECB has used its full capability to try and kick-start the economy back into life. It hasn’t really worked. At best QE has prevented some disinflation and arguably deflation, but there have been costs to this. The European debt markets have entered the Alice in Wonderland world of negative interest rates with German bunds the latest casualty. In essence the ECB has bought up too much of the EU sovereign debt with the residual element now fought over by institutions desperate to park their short term money somewhere. The Italian banking system and more than a few of the French and German banks are undercapitalised, whatever the ‘stress tests’ suggest. One serious shock and the whole European banking system spins into a turmoil, a turmoil that raises the risk of a 2008 style panic. The whole European system looks less than stable.

So where does that leave the EU on a majority Brexit vote?

With a conundrum and a lot of economic and political risk. The conundrum is whether to play hard ball with Britain and risk the integrity of exports to the UK. In the face of a wave of political discontent would the EU want to undermine what is already a moribund economic performance? The political risk is of course all about those other anti-establishment political initiatives and their own drive for a membership plebiscite. However the EU might spin a UK exit, it will in effect establish a precedent, and a very dangerous one.

Betting against EU survival has been a losing position over the past few years but that was before the not-so-timorous Brits decided they wanted to make a decision. The rest of the EU are now watching and I have no doubt will be as glued to the TV set as the British in the early hours of June 24th. If the British vote to stay my belief is that it will settle many voters in the rest of the EU; the cries for refere

ndums will fade. On the other hand if the Brexits are the majority my sense is that a wave of ‘we want one too’ will sweep across much of Europe. After a week or two of market volatility negatively affecting UK markets and the GBP, attention will soon turn to Europe, its markets and economy. While we in the UK may well have to deal

with another Scottish question the real action will be across Europe as the political implications and economic realities are evaluated. There appears to be little sense of panic or urgency in Europe at the moment but that is likely to change within hours of an exit vote. The first real cracks in the sclerotic EU infrastructure could start to appear before the year is out.

We shall see.

EU crack2

A few references:






A framework for transformation

In late 2014 during a ‘quiet’ period I set myself the task of writing what I thought would be a short deck on change management. Perhaps about 30 or so slides positioning a 60 to 90 minute presentation and discussion; something I could potentially use in an early client meeting.

It didn’t take long to fail on that one.

Four or five weeks and around 250 slides later it still felt like an incomplete work. The 30 or so slides had evolved into a two module seminar covering aspects of both change management and business performance improvement. No longer 90 minutes it would take a couple of days to go through it, and even with this amount of time the topics could really only be covered in a cosmetic, overview sense.

The problem is that change management is such a vast subject. Where exactly do you start? An academic or general management consultant might use John Kotter’s work as a logical point of origin, but I have my own ideas. For my part you can’t really make sense of change at the micro-organisational level without a pretty robust understanding of the macro-economic, financial and social factors extant at the moment. I have a firm belief that the ‘big’ issues and trends in the world have a pretty direct and causative link to what happens, or should happen, at organisational level. Organisation strategy, or the considered reaction to these elements, then becomes the link between your work as a senior transformation agent, your industry context and the world as a whole.

So that becomes a starting point in designing a transformation programme. We need to understand what is going on within the organisation’s industry, and the relevant macro factors before diving head first into the detail. Digital is clearly one of the most important trends around at the moment but there others also in the arena. It makes sense to undertake a strategic review of all of them, and perhaps prioritise by impact before attempting to position a corrective change in direction.

With a broad understanding of the global and industry factors we can take a more informed look at the organisation itself. It could be that some immediate action is required. Certainly with many of the companies I have worked with there has been a need to react quickly to a shift in market conditions. Technology changes have become particularly important in recent years as new entrants and competitors have identified and exploited cutting edge capabilities and functionality. The net result has been that revenue streams are often negatively affected for those that fail to recognise the opportunities. They have not reacted quickly enough either operationally or strategically. Thus, we are left with the classic situation of a cost base being out of step with a revenue base: costs must therefore be reduced.

A ‘transformation programme’ is a common reaction. Most organisations have not yet become used to the idea that transformation is now a perpetual need and that improvement should be continual. Operational line managers don’t generally raise a cheer when transformation programmes are launched due to a combination of ‘me’ issues and their disruptive effects on business as usual activity. My view is that they can live with them because they still see a transformation as an ephemeral activity; in other words it will go away at some point, at which point life can resume as before….

Putting the cultural reactions to one side, how should a transformation programme be approached? Fifteen to twenty years ago I entered the world of change management through a senior strategy role. The concurrent integration of four telecoms companies had created opportunities for cost saving synergies and a need to reduce the recurring cost base. There was no need to explore broader market factors or global trends; that had already been done. What we needed to do was to work out how to cut the organisation’s costs without impacting service levels.

I worked as a junior operational strategy director at the time but had already come into contact with the rigours of management consulting. As a senior manager I had been seconded into a number projects and programmes led by a succession of the big management consultancies. All were useful and have helped shape the approach I now take towards transformation work.

A simple and obvious concept soon adopted was that of finding ‘method improvements’ to help address the challenges of restructuring. Even today the boards of companies and other organisations in distress will simply apply an arbitrary reduction to current budgets. In the desire to remove cost there is often little thought applied to the implications for service quality, of a reactive and often ill thought out directive. On the face of it a 20% cut in costs looks like it will directly translate into a 20% saving in cash. This is rarely the case. Work cannot simply disappear without some consideration about where it will go. Method improvements are the necessary means for eliminating the work that will still be needed in order to deliver goods or services. It is vital to identify the required method improvements or a transformational restructuring will not be sustainable. In the absence of careful planning, people whose jobs have previously been made redundant will need to be re-hired to address the inevitable backlogs and customer complaints that tend to arise when service levels are not effectively maintained. Cost savings are therefore at risk of becoming transitory.

Method improvements addressing the removal of work can include all sorts of initiatives. A decision to withdraw from a market because it is no longer profitable will clearly destroy work, thus the removal of any associated resource becomes a rational and justifiable action. Cost savings relating to removing these activities will be sustainable. Process improvements can also remove unnecessary work. Lean Six Sigma techniques eliminate both the steps in processes and improve the efficiency of those steps remaining. After undertaking such exercises lower levels of resource are usually needed to undertake the work. Likewise, automation has clear and obvious advantages. Manual labour is reduced and work can usually be undertaken at a faster pace and with improved quality. Digital thinking can foster an environment where the end customer can be persuaded to undertake some of the required work, and its presentation can often be an improved customer experience. Centralisation and outsourcing are likewise options which can often help rationalise a proposed reduction in budgets. The need to match resource capacity with demand has also increased in recent years. A reduced down time or increased utilisation does not necessarily destroy any work but it can help an organisation work with a lower level of resources.

The key from a transformation perspective is to undertake a comprehensive review of the challenges ahead and options available before attempting to build that MSP plan. A transformation programme could include multiple initiatives ranging from developing demand/capacity plans, establishing shared service centres, outsourcing, manual process improvements or a comprehensive digital/IT project. An initial analytical and evidence based review should set the scene, the options, benefits and preferred route to achieving the objectives. Only then can the actual transformation programme be designed and later implemented with any confidence of success. First analyse, then implement.

By definition a transformation programme is finite. It has a beginning, middle and an end. However, the process of transformation is not finite. Organisations have always changed but the difference today is the pace of change: when one programme stops another one is usually around the corner. The real challenge at the moment is to get organisations to think in terms of continuous and unavoidable transformation. It will never stop, nor will the pace slacken. Whether led by a ‘Chief Transformation Officer’ or a ‘Chief Digital Officer’ the goal must be to force the pace at which the organisation moves from 20th Century approaches towards addressing 21st Century imperatives. This means a cultural shift in thinking, a move from dealing with change as a ‘one-off’ initiative needed “every three or four years” (a quotation from a CEO whose programme I was once assigned to) to something that will always be there. At programme level the disciplines of analysis and then implementation will still be required, but the whole process of transformation needs to become a business as usual production line.

There is little choice if organisations are to survive and thrive.

Digital transformation

I listened to an HBR webcast not too long ago which posed the question as to whether larger organisations should now be appointing a ‘Chief Transformation Officer’ (CtrO), or a ‘Chief Digital Officer’ (CDO). It’s an interesting subject for a couple of reasons. A ‘C’ level title obviously has gravitas and seniority associations with it but it also might suggest something of a more permanent nature, somewhat distant from the project or programme director nomenclature more commonly used in transformation leadership. Somewhat more important is the discussion about the function and role a CTrO or CDO might fulfil. Where exactly would it fit in the panoply of organisational structure, governance and control?

Many organisations still see ‘transformation’ as something ephemeral, a project or programme which moves the organisation from an old paradigm to something shiny and new. It could be anything from an organisational restructuring exercise to launching a new operating model, or developing and rolling out a new IT platform. In the past it has often been seen in a project context with a beginning, middle and an end. A concept is developed, business case funding and objectives approved, a plan created and implemented, and the whole thing is handed over to operational ‘business-as-usual’ people. Job done; transformation complete!

This is no longer a tenable approach. Transformation is now a continual challenge. Not only is it perpetual in nature but it is occurring at an ever-shifting and accelerating pace. Business models that have worked for years or decades are at risk of being blown out of the water by competitors that are more fleet-of-foot, and who have a better grasp of the benefits of the latest technology and customer experience requirements. Organisations must therefore embed a culture of transformation into their DNA to survive. Leadership and direction is now a constant need, which does indeed suggest some single unifying force is required to help pull together the vision, strategy and execution on an ongoing and constant basis.

So what exactly would the function of a CTrO or CDO be?

As few, if any, actually exist at this time we need to define exactly what need such a function would address. We already know a lot about the broader issues it would face but we still need to work out exactly what the role it would play in resolving these challenges. Central to the role would be leadership in the vision of how organisations are able to adapt to the challenges and opportunities of technological change. It is not however purely strategy, nor is simply an extension of IT or entirely focused on the change management implementation aspects of transformation. It is a blend or synthesis of all three. Leadership and vision is required but a good understanding of technology is also required, as are some sound capabilities in the execution area. A CtrO would need to work with IT, strategy and senior functions to both contribute and help translate the broader longer term strategy into actionable plans. It would need to help source new ideas, internally and externally, and leverage the capabilities of IT and other support functions in constantly re-imagining and helping shape and re-build the operating model, using the best technologies available. Above all it is a unifying force, one that strives to help strip away silo thinking and working. In fast track world of the second decade of the 21st Century, it could well be the most important role that doesn’t exist.

I am writing this listening to the latest Radiohead album, streamed on the Amazon Prime service. The hard copy CD version is not due out for another month but the tracks are already available, for a fee… Amazon are a pretty solid case study of how end to end digital thinking has managed to improve the digital customer experience. It is a far better service than I have had in the past and it started me thinking about what exactly is meant by a ‘digital transformation’.

‘Digital transformation’ is something of a misnomer as it’s really about far more than the IT aspects of digital. It is about speed, vision, capability, culture, change management, working together, unification and integration. It is about technology stretching into all parts of the organisation with the objective of creating an agile, continuous improvement focused culture, one which strives to create the ultimate customer experience. But it is also even more than this. It can also be about process improvement, perhaps achieved by digitising processes, enhancing the ability of employees to work, or general performance improvement. ‘Big Data’ and robotics are likely to play an increasing role in this space as will the ‘Internet of Things’.

Organisations who master the art of perpetual incremental transformation will naturally evolve their business operating models as their markets and customer requirements change. Digitally constructed organisations will constantly re-shape their internal control structures. New products and possibly whole business areas become far easier to identify, develop and launch. The technology platforms are the glue that binds together the vision with operating model and customer delivery experience. Decisions become easier in the sense that they become more data driven rather than trial and error guesswork. Organisations who successfully integrate discrete systems into single seamless delivery platform have a far greater chance of meeting the ongoing threat of market challengers. Not only are they able to defend themselves but the development opportunities are almost endless. The challenged become the challengers.

Which brings me back to Amazon. Having crushed competition in the consumer goods space what is there to stop them making some serious inroads into the world of services? They epitomise a digital leader and clearly have the skills, vision and capability to exploit an obvious world class fulfilment platform. Amazon Prime TV may be an early example of what is to come. What, for example, would stop Amazon applying for a banking licence, making inroads into insurance services or having another go in the travel area? How would these sectors respond?

Technology is constantly offering both opportunities and threats, but it is how quickly organisations are able to adapt that will define an incumbent’s chances of survival. Perhaps above anything else digital transformation is about the speed organisations can adapt to changing and more demanding customer requirements.

Reporting Changes

I am always on the lookout for subjects that might have an impact on my professional world of business performance improvement and change management. The ‘Management Control Cycle’ or ‘Management Operating Framework’ refers to the way in which organisations forecast, plan, undertake work and report on work. Most operate the cycle although more from an intuitive approach rather than structured method. I tend to think of it as a four quadrant cycle, linked but with a specific theme and application in each.

The ‘Reporting’ quadrant is where performance is measured and it’s here you find the KPIs (key performance indicators) and what I like to term OPIs (Operational Performance Indicators). OPIs are essentially useful indicators that help manage the business but which are not the main drivers i.e. they are not the high impact KPIs. Reporting is obviously of critical importance to any organisation because as we all know, if you can’t measure it you don’t really have much control.

Enter the EU.

A couple of years ago a new EU sponsored ‘Non-Financial Reporting Directive’ (the ‘NFR Directive’) was approved targeted at businesses with more than 500 employees. The intention is that in December this year it will be passed into UK law with a view to its regulations taking effect from January 2017. The directive basically creates an obligation for these larger entities to provide additional information to the ‘extent necessary’ for an understanding of the undertaking’s business, its social, employee and environmental circumstances, bribery and anti-corruption related matters and human rights.

A ‘non-financial’ statement will be incorporated into the management report and will include information on the company’s business model, policies, outcomes and risks relating to the NFR Directive and any relevant non-financial key performance indicators. Additionally listed entities will be required to outline their diversity policy relating to age, gender, education and professional backgrounds, and explain the absence of a policy if relevant.

To some extent parts of these requirements have been in place under various bits of law for some time but this looks like a kind of aggregation or consolidation regulation. Its implications are obvious in the sense that organisations are going to have to find ways of improving their tracking of a new set of ‘relevant’ KPIs and they don’t have much time to work it out. Creating appropriate policies may be a fairly straightforward process but developing meaningful KPIs on bribery, anti-corruption, human rights, ‘social and employee’ related matters and the environment are not without challenges. Some organisations may have been recording this data for some time but the difference between the past and next year is the formality of regulation and of course the fact that the results (currently) look like they will need to be published in the annual report.

There might be a debate on whether some or all these new KPIs can be published on a website, or secondary report, rather than within an annual report but until that is resolved we probably have to assume that the rigors and accuracy standards of financial statements will apply.

This may not be a performance improvement issue in the productivity sense but it’s certainly part of the ongoing impact of regulation on the change management environment. At organisational level the accountabilities for tracking and reporting on this data need to be determined as do the associated processes, formats and data capture mechanisms. It’s yet another example of how macro-level drivers affect the micro-world of change.



Peak Oil redux

According to Goldman Sachs global oil supply went into deficit during May 2016 which probably explains the speculative behaviour on the paper derivatives markets. Oil prices in both WTI (West Texas Intermediate) and Brent rose during March, April and May, anticipating equilibrium later in the year. After an extended period of declining and low prices it looks like oil prices will lurch upwards, no doubt followed by prices at the pump.

During 2015 an unbelievable number of oil analysts were predicting many years of low prices, apparently confusing short term politically driven oil output policies with the fundamentals of the oil industry. They seemed to compound their errors by extrapolating US shale production forecasts using the sort of assumptions only appropriate to conventional onshore oil production. Anyone who knows anything about the economics of fracked oil knows that increasing or even maintaining production depends very much on establishing an increasing stream of new wells. Fracked wells typically peak in output in year two of production which is why we may well see some significant falls during 2017 and 2018. Even a significant increase in price may not be enough to stimulate the sort of production levels seen in recent years.

Short term it looks like oil prices will moderately increase but it’s the 2020s we ought to be preparing for. In true Spinal Tap fashion Saudi Arabia may have recently turned up the output dial to eleven in its strategy of containing Iran and hurting the US shale industry. But this policy can’t last given the unintended consequences of dismantling OPEC and depleting its foreign currency reserves at an alarming rate. It will need to scale output back not only for its own immediate domestic budget reasons but also because it doesn’t have infinite supply. Saudi has been increasing production in a world where current reserves are simply not being adequately replaced, not just in the Middle East but globally.

Peak conventional oil production is generally accepted as having occurred in 2006. Which is why there were many articles about Peak Oil during the 2006 – 2010 period. For a time it did look like all types oil, onshore, offshore, tar sands etc. might peak between 2012 and 2015. Oil market speculation pushed prices up to $140bbl in the period leading up to the global banking crisis in 2008 and the financial world took a breath. The US FED’s reaction to the credit issues in the banking sector had consequences for the oil industry. Trillions of US dollars were printed to bail out the banks but it was inevitable that some of this would find its way into the oil sector. An estimated $350bn helped finance the technology and infrastructure that made US shale happen. With prices between $80 and $120 hedge funds queued up to invest in aspirational US shale companies and an inevitable boom in output transpired. US shale has bought the world some time. A fortuitous set of circumstances and the profit motive added perhaps ten years to the Peak Oil window originally forecast for 2012 – 2015. Few are brave enough to forecast a new timeline but one thing for sure is that it will happen, and probably in our lifetimes.

Peak Oil is not about oil running out. There are billions and billions of barrels of the stuff all over the world, both discovered and undiscovered. Peak Oil is about output, price and EROI (Energy Return on Investment). Peak Oil is therefore about the affordability of oil in terms of its uses. We may have billions of barrels of oil offshore and in the Canadian tar sands but can we afford to extract it to run cars with? Can we afford the ongoing costs of cleaning the Canadian environment after the water and energy intensive process of converting it into usable energy? What is the point of having tens of billions of oil reserves if the energy we get from it equates to the energy we have to deploy to get the stuff out? This is what Peak Oil is really about. It’s not about running out of oil per se, but is about running out of affordable oil. Thus, as is suggested by recent price action we have probably already run out of oil at $30bbl. Even an artificially induced supply glut could not force the price below $30bbl for more than a few days.

A point also missed by the many oil analysts conditioned by the artificially induced supply glut of the last eighteen months is indeed whether we have actually run out of $60 or even $80 oil. If $60 to $65 is the break-even level for US shale then perhaps this this really the current Peak Oil price level. On the other hand most of OPEC oil producing nations and Russia need oil above $80bbl in order to meet their budget and social welfare commitments. Venezuela, for example, is generally recognised as having the largest oil reserves in the world and yet is edging perilously close to failed state status. While the nominal cost of actually producing oil in Venezuela is reputedly less than $15bbl, the implications of its social programmes suggest that ten times that amount is needed to keep its government and economy above water. Perversely its output has dropped by 300k – 400kbbls/day in the last twelve months, just at a time when it needed income the most. Theft, lack of maintenance and electricity problems have all contributed and are all aspects of an economy that doesn’t work when oil prices are too low.

The point here is that the current price of Peak Oil is not necessary set by a large volume producer such as US shale. Without an increase in prices Russia could be the next Venezuela, or perhaps even Saudi Arabia. Neither economy is working effectively at $40 to $50 oil; both are depleting reserves to keep their respective government and social programmes intact. Both need prices to rise before they effectively run out of reserves. With a prolonged period of low prices there is more than a chance that they will be forced to either borrow substantial amounts or face a Venezuela style meltdown which could have similar and concomitant impacts on oil output.

Where then is the actual 2016 Peak Oil equilibrium price? We know that it is above the $25 – £30bbl range; the market has already told us that. But when we factor-in all the political and economic dynamics of the oil market, is it actually $60, $80 or even above $100? Notwithstanding shale it is clear that the recent surplus is anomalous and artificial. Not only has output and pricing strategy created short term difficulties but it has also sown the seeds of a more structural supply deficit in the 2020s. The oil business appears to need prices in the $80 – $100 zone to justify ongoing investments in exploration and field development and to keep OPEC economies afloat in 2016. Unfortunately, not only have the low prices of the last eighteen months curtailed shale oil investment but conventional and offshore E&P (exploration and production) has also plummeted. This recent lack of investment in E&P will have consequences in the early 2020s and possibly even sooner. Watch for the headlines to switch from forecasts of oil at $25 (even $10bbl!) to oil at $150 or even $200bbl.

So why do I as a change and transformation specialist take such an interest in oil? I see the oil industry as something of a nexus point. Oil remains our most important commodity and still provides the energy that powers the world. Significant changes in the availability and price of oil have dramatic and often fairly immediate consequences for economies and organisations working within those economies. A global shortfall in output of a two or three million barrels of oil per day will have a major impact on its price and the price of everything that relies on oil for its production. A one to two million excess of supply over demand had the effect of reducing price from over $100bbl to nearly $25bbl at one point. A deficit will not only reverse this but when availability is an issue could well power the price way beyond that reversion point. Shale output may start-up again but the investors who recently lost money on their original investment are likely to be a lot more circumspect about pumping even more billions into such a volatile industry. Iran, seen as potentially a gap filler also needs billions of external investment before it could offer the sort of output extant before UN sanctions were imposed.

Thus it is not beyond the realms of possibility that prices will be back in three figures in the coming years and potentially higher than the $140 reached a few years ago. In the absence of a shale-like saviour these prices will have major implications for how organisations will operate. They will have transform themselves to work within a new oil energy restricted paradigm. Alternative energy investment will need to be accelerated, other operating costs reduced and alternative models of operating developed. Oil stands at the nexus of business strategy and change and will continue to do so until the world truly develops an alternative energy infrastructure that significantly reduces our reliance on this highly volatile energy source.

There are many Peak Oil sceptics around but I am obviously not one of them. Shale has bought the world some time and tens of billions of E&P investment might buy us some more but from where I am standing in 2016 that doesn’t look very likely. Peak Oil may not be a ‘now’ issue but I would be surprised if we get to 2025 without it hitting the financial headlines again.

Getting more from your sales incentive framework

Towards the end of 2015 I was asked to undertake a review of the sales incentive framework of a large international organisation. The review extended into most of the world’s geographic regions and covered almost 650 sales account managers and specialists. In retrospect it was probably one of the most interesting and challenging reviews, and brought back memories of the time I spent in B2C and B2B sales environments in the mid-1990s and early 2000s.

With the help of another member of the team undertaking a survey, some external benchmarking and data analysis, the review was delivered and recommendations broadly accepted. During my tenure in performance improvement consulting I have produced quite a number of reviews and, at least for me, a key component of a review is to have a good understanding of best practice, or my new preferred term: ‘sound and reasonable practice’. In other words if you are to undertake a review you really need to undertake it against some form of exemplar framework. This may not always be possible, as proved the case a few years ago when working on a local council strategy report. In the absence of a tried and tested exemplar framework defining sound and reasonable practice, researching and reaching an understanding of alternative options, or how others work might be a second best approach. But I digress.

The most interesting part of the review was in fact validating my understanding of what sound and reasonable practice in sales compensation actually is. With some background in both business and consumer sales functions, and indeed having had accountability for a sales commission function I did think I knew a bit about it. This proved to be only partly accurate. In the last ten to twenty years some aspects have in fact changed but others have not, and it is also necessary to consider the context of the sales function, its size and industry.

The premise of the review was that sales performance could be improved and costs potentially reduced by identifying changes to the incentive framework. Over time it had evolved and become more complex than it needed to be and more challenging to effectively manage. Its market had also moved on. Many opportunities to improve were identified and the client was provided with a roadmap towards evolving the incentive framework in a direction that was more likely to meet its cost objectives and market needs.

This particular client was far from unique in omitting to validate its sales incentive framework on a fairly regular basis. In the ten years I spent in sales functions I don’t actually recall any external review of the sales commission schemes. Changes were made regularly but usually originated from the ‘good ideas’ department of the sales function or imported by sales people joining the organisation. Costs were certainly challenged by Finance but these challenges were often fought-off by germinating fears about sales performance. In other words cut incentive costs and sales performance will fall. A growing sales force and increasing scheme complexity had to be met with automation. One member of the support team’s role was just to develop the sales commission scheme. His Excel modelling was first class but I’m afraid there was probably far more trial and error than there ought to have been.

My recent foray into the world of best or sound and reasonable practice has established that these ‘exemplar’ reference points are available. As suggested earlier, due consideration should be made of nature of the sales function (B2B/B2C), the industry within which it operates and, to a degree, its size. I qualify this last point because all sales functions, no matter what their size, ought to have a good grasp of good practices one of which is to ensure that the schemes in operation are written down, as simple as possible and easily communicated and understood by the people to whom it applies.

This is not exhaustive list but some other sales incentive areas to look at would include thresholds, quota, pay-mix, upside potential, payment frequency, complexity, caps, performance measures and eligibility. Then of course there is the administration, system and cost aspects to consider. Governance and change control are also important. How do schemes change, why and who actually authorises these changes? We are now far further forward than we were twenty or thirty years ago and sound and reasonable practices are better defined than they used to be.

In conclusion, it may already be self-evident for those working within sales but the incentive framework and schemes adopted are not the only driver of sales performance. Sales culture and leadership both play their parts as do the standard of communications, training, coaching, data quality and general leadership. However, the right approach to remuneration is still key. You can have the best of everything else but if the incentives don’t work for the sales teams or it is too costly for the organisation then there probably isn’t a long term future for the business. Both cost and ‘sales excitement’ objectives need to be met.

Feel free to get in touch if you think your organisation might benefit from a review of its sales incentive framework against internationally recognised sound and reasonable practices.

Is change resistance a myth?

A couple of weeks ago a Harvard Business Review article appeared in my inbox which contended that ‘resistance to change’ was a myth because ‘people like change’. People do indeed like change but the logic was a little specious in that the connection between change resistance in corporate environments is not really related to change we create ourselves.

A vacation is a pleasant change of scenery, something most of us look forward to as a change of routine. A new car, gadget or an entertainment experience are all changes we enjoy. They are the sort of change we have control over and actually seek to create. Thus people do like this sort of change and it is highly unlikely that there will be any ‘resistance’ to what are intended to be pleasant experiences.

We contrast change situations which we have created ourselves and where we have some control over with the sort of change which does typically invoke active or passive resistance. I have encountered some form of resistance in all of the many change and transformation programmes I have been involved in. A change in organisational structure or the introduction of new processes is always disruptive in some way. Fear of the unknown is a natural response and employees will seek ways of mitigating personal risk to their status or power base. Imposed change is rarely seen as a positive at an individual level. What may be seen as a necessary response to changing financial and market conditions at a corporate level often translates into a personal threat at an individual level. This sort of change is not typically something we have created ourselves and not likely to be a pleasant experience. People generally don’t like this sort of change and will frequently seek ways of resisting it.

Overt change resistance is not something you tend to come across very often. Managers know that if they are seen as not following the programme there is a fighting chance that a target will be placed on their back. A reputation as a trouble-maker is not something you want in an environment where changes have to be made, especially if those changes involve organisational restructuring.

Resistance to change is far more likely to be covert and disguised. Lip service may be paid to the goals of the corporate change but underneath the ‘words of support’ there is no real drive or energy behind making things happen. Meetings are delayed or poorly attended. Key issues may be deferred or the implementation plan poorly designed. Agendas can be hijacked by items that are peripheral to the core challenges and less ‘streetwise’ team members might be encouraged to generate ‘issues’ which delay an implementation or distract attention. Targets can be made unrealistic in their ambition, virtually ensuring failure before the programme has really got underway. Business-as-usual can be prioritised drawing essential team members away from their change programme tasks and back into daily routines. There are dozens of ways a programme can be set-up to fail and all of them add up to the kinds of change resistance we see in both minor and major transformations.

So there are two forms of change. There is the sort of change that we create ourselves, the change that we enjoy and seek to repeat. Then there are the changes that are often imposed extraneously. It is this latter case where both active and passive resistance tends to occur. People do like change but only in a limited set of circumstances. They generally don’t appreciate the change required by corporate needs and will in many circumstances develop innovative ways of resisting it.

Change resistance is not a myth.


I think it is fair to say that most people in the Western world don’t actually understand what gold is all about. Over the past fifty years we have been inculcated into believing that it is a material used for personal adornment or perhaps as a minor industrial application. Very few now think of it as money.

My own interest in gold started around the mid-2000s, a few years before the 2008 banking crisis. Ironically the article that actually piqued my interest was about silver rather than gold but the two are usually referenced as behaving in a similar manner. I had some funds to invest and had started to undertake some research into potential targets. My journey through various funds, investment trusts, equities, bonds and all the other potential resting places for a substantial but not life-changing pot was often punctuated, or perhaps diverted, by discussions about gold. And so it started.

When Nixon reneged on the U.S. commitment to maintaining a gold-backed currency in 1971 the West effectively entered the modern era of ‘fiat’ money:


There are currently no currencies directly backed by gold which is one of the reasons why we often see some dramatic volatility in their relative values. What a currency is worth is driven by a whole host of factors, the sum of which equates to traders’ perception of its value. The US dollar (USD) has increased in value by 15 – 20% over the past eighteen months against a basket of currencies, while the GBP has dropped five or six percent against the USD in recent weeks. There are lots of reasons for these moves but they all add up to a view that the USD is a ‘safer’ store of value at the moment while the Great British Pound (GBP) is seen as a ‘risk’, partially down to Brexit nerves. Without gold as an anchor, a fiat currency can and often does go to zero. We have also yet to see the impacts of the estimated $13 – $15 trillion of ‘printing’ that has taken place since 2008. True, much has been offset by general shrinkage in the global credit markets but the fact remains that there are still trillions of freshly printed currency sitting as ‘excess reserves’ at the U.S. Fed or swilling around the financial system. In virtually every other instance of currency debasement, deflation precedes a period of inflation so we may yet see some turmoil of the inflationary kind.

Which brings me back to gold which is often seen as a bet against price inflation; Kyle Bass, a famous hedge fund manager, has also suggested that: “buying gold is just buying a put against the idiocy of the political cycle. It’s that simple!” Gold haters tend to draw attention to the fact that gold doesn’t usually pay any interest. This is true but has become a somewhat academic point in Japan and parts of Europe where ‘negative interest rates’ are paid. A bar of bullion is a far more attractive prospect than a commitment to pay the bank interest for holding your money. Thus the ‘war’ between the fiat ‘paper bugs’ and ‘gold bugs’ has started to switch direction.

A few years ago Ben Bernanke, the former U.S. Fed Chairman, was asked by libertarian congressman Ron Paul whether gold was money:


His response was both entertaining and illuminating. Entertaining in the fact that the subject of gold is taboo in central banker circles and illuminating in the bizarre nature of the response. Bernanke did not believe that gold was money and yet admitted that the 8,000 tons or more held at Fort Knox and West Point is held as a matter of ‘tradition’. This tradition has been more than kept alive in recent years by central banks in Russia, China and other Asian states who seem more than happy to exchange their US dollar treasuries for a ‘harder’ asset like gold. On a net basis since 2008 central banks have actually increased their gold reserves with China reputedly acquiring multiples of the amounts they have actually declared. So although ‘officially’ the USD remains the most liquid and ‘hardest’ of fiat currencies if you want to preserve wealth and value for the longer term then gold would seem to be the only option, especially in a world where a few billion Indian and Chinese people hold a slightly more traditional view. Paper currency may be OK to buy the groceries but if you want to preserve wealth for the next generation, gold is the only game in town, even land and property is secondary.

Whatever its appeal fully investing in gold is just as much of a risk as going ‘all-in’ to any asset class. The better known investors will usually suggest that a proportion of your portfolio should be invested in gold. This proportion seems to vary from around 5% to a maximum of 20 – 25% at the more extreme end. None suggest anywhere near 100%. The gold element of my own retirement fund is a fund itself, investing in the ‘majors’ (mining companies) in the gold sector. Since reinvesting my portfolio in the latter half of 2015 it has outperformed all of my others (up 27% in six months) and forms a disproportionate element of the overall fund, which now requires some realignment. After 3 – 4 years of appalling performance we seem to be seeing a new bull market, at least in the mining stocks themselves. Nonetheless you have to look at it in context. Gold increased more than six fold between the early 2000s and 2011 but then dropped by over 40% subsequently. Even today it is still 36% below its 2011 peak.

As with most other major commodities gold is priced in US dollars. Thus a miner operating in South America will substantially benefit if the USD moves up against a local currency. For example, a producer in Chile incurs costs in Pesos but will benefit from gold revenues priced in USD. In recent years the Peso has decreased in value from around 450 to 730 to the USD.


Furthermore, the price of oil has decreased from over $100 to around $40bbl. It is not therefore surprising to see the large gold miners show some dramatic increases in prices over the last six months, despite the fact that gold still languishes in the $1200 – $1300 band. The ‘smart money’, the early movers, have already identified the potential and have taken positions; the institutions are no doubt checking the sector out and a year or so from now perhaps the ‘retail’ investor will take notice. Even now the gold sector is still down about 80% from the highs of a few years ago, when gold hit $1900/oz; it trades at around $1220 as I write this.

One aspect of gold that causes considerable distress to the ardent gold bug is that COMEX, and to some extent the LBM paper markets. Most gold today is traded as a contract rather than as a physical transaction. What this means is that ‘paper gold’ can be created at will to meet market demand. The market seems to work on a fractional basis or leverage. So long as there is enough physical gold to meet the claims of those actually wanting physical, the market can continue without any significant disruption. In the past year the ratio of claims to actual physical has been in the 350 – 400 region which obviously creates a certain amount of risk for participants. Commercial traders appear to remain unconcerned about this situation and continue to take short or long positions in the commodity, mostly rolling over these contract positions like clockwork on a monthly basis. It is entirely possible that this situation could be maintained for months or even years, that is until some extraneous instability elsewhere in the financial system ripples through to the gold market. In which case all bets could be off and a rather dramatic re-pricing could be in order.

I don’t expect drama during 2016 but it does look like the four year bear market in gold has ended. There will be ‘ticks’ both up and down during 2016 but it does look like the theme of an increasing price is slowly taking hold. As at the end of March / early April 2016 the gold buying season is still some months away and yet the ‘correction’ after the Chinese New Year celebrations has been muted compared with the last few years. There will be some volatility as speculation increases on whether the FED will add another 25 basis points its rate in June although beyond that it looks unlikely that there will be any more tinkering prior to the US presidential election. A combination of a new gold buying season starting in August and a few speculation free months on the US FED funds rate should translate into a fairly robust performance in gold in the latter part of the year.

Whatever your views on gold, both on its status as a currency and on its expected performance over the next year or two, it remains unwise to ‘over-invest’, whatever the prospects. It may also help to regard of it as a form of money, whatever Ben Bernanke declares in public, rather than as simply another asset. An ounce of gold will still pretty much buy what it could in Roman times. You can’t say that for either a USD or a GBP which have both depreciated by well over 90% in the last century.

The gentleman pictured is called Datta Phuge. In 2013 he was reported as ‘splashing out on a £14,000 gold shirt in the hope that it would attract female attention’.



Not sure if it worked…..

The costs of cutting

As the grey storm clouds of a global economic recession make their slow progress from the East, smarter organisations will already be formulating plans and strategies to combat its implications. Taking steps before a downturn, in the ‘good times’, can help avoid the sort of reactive and damaging decisions many will make when finally forced to do so. It is these reactive and forced decisions that often cause lasting damage to a company’s reputation and can impact its operational effectiveness and financial results for some years.

Having been involved in many transformations and restructuring programmes I have seen a number of approaches for dealing with income shortfalls. A classic mistake that most organisations will make when under pressure is to issue an edict to all budget holders instructing that they cut costs by a set percentage, perhaps 5% or 10%, or in the most severe cases 20% to 30%. On paper it works. The budget is slashed by the desired amount, operating revenues and costs fall into line and all is well with the world.

But is it?

From an accounting perspective, on the ‘plus side’, an organisation will take a one-off hit for restructuring costs but in theory will receive the benefits of a reduction in the overall recurring payroll operating cost. Discounted to present value the net of the one-off cost and ongoing savings should create, or should I say ‘protect’, overall shareholder value. So financially it seems to work but it is at the operational level that we often start to see problems, and hidden costs.

If there has been a structural change in market conditions you have a good argument for suggesting that work has effectively been eliminated and that the restructuring initiative is simply an exercise in balancing the cost base with declining revenues. Work previously required is no longer needed so we need fewer people. A cyclical change in the market which drives revenues lower creates a different kind of challenge. In this scenario you may still wish to maintain an operating capability but at the same time address a short term need to reduce the cost of the payroll.

It tends to be the cyclical changes in conditions where the issues arise. Many organisations will not distinguish between the two situations and will apply the same solution, a uniform % reduction in the budget. If the expectation is that conditions will improve over a two or three year period most organisations will expect their operational functions to maintain their capability but with less staff to do the work. The work has not gone away, it’s simply a case of there being fewer people to do it.

The pattern is always the same in these situations. Budget holders try to shift work around to other functions, work does not get completed or if it does its quality or timeliness suffers. Ultimately, it will impact on the service provided to customers.

It is vital therefore to rationalise a cost cutting exercise. A 10% or 20% reduction in headcount will indeed save ‘hard’ costs but it will likely impact in other ways. It may not be immediate but a poorly executed cost reduction initiative could ultimately impact revenue generation, the transmission mechanism being poor customer service. Operational managers may lay the blame on the cost reduction exercise but drops in revenues 18 or 24 months after the initiative will rarely get much of a hearing as a significant cause.

To cut costs sustainably and to minimise impacts of revenue generation it is essential to create a plan that allows the business to maintain its capability and service quality. The plan should manifests itself as a series of method improvements. These method improvements are designed to either eliminate work or ensure that it can be undertaken with fewer resources. Method improvements could include withdrawing from supporting certain markets. Quitting a market will obviously eliminate the need to support work in that area; in other words work is eliminated. Process improvements ensure that work is undertaken more effectively and efficiently – more work is undertaken by the same or fewer people. Technology can often be deployed to automate work previously undertaken manually. Organisational restructuring does not of itself save costs unless it is associated with another improvement initiative such as the creation of a shared service centre or perhaps an outsource arrangement. A new organisation structure is an output of a considered cost reduction plan; the elimination of work and improvement in the way it is carried out has allowed the organisation to administer itself with fewer managers and staff.

Closely associated with an effective cost reduction plan is some consideration of the impact on customer service. Organisations suffering from a major change in its markets may well be prepared to make some decisions about the service levels it wants to provide in the future. In this case if the method improvements do not in aggregate add up to the required cost reduction then a discussion on service levels must be had in order to address the gap. Though unpalatable, an exercise to define service levels across the operational functions should be undertaken so that senior management can take appropriate actions. Thus the plan for both a specific function and the business as a whole may well consist of a suite of method improvements and possibly an acceptance that certain functions will no longer be able to provide a level of service previously delivered.

Reducing costs is always a challenge. However, it is far easier and far more sensible to undertake a review of the operational cost base before a recession arrives than afterwards. From the perspective of early 2016 we are already being warned by international financial institutions, the BIS and IMF amongst others, about the impacts of a deflationary wave sweeping across the world. Another recession in North America and Europe may not yet be at our door but the leading indicators and forecasts are not encouraging. Smarter organisations ought to be undertaking strategic reviews of their operations today rather than in 2017. Will yours be one of them?

Are we back in 2008?

I have recently seen a number of articles suggesting that 2016 could in fact be a re-run of 2008. In other words a financial storm is brewing but most of us just don’t realise it, or maybe don’t see it yet. As a manager of my own SIPP (Self Invested Pension Plan – a bit like a 401k if US based) it matters to me. It does to you as well although the distance between you and retirement and the distance between you and your ‘managed’ pension plan probably makes it feel somewhat remote.

I started taking a far greater interest in the movements in world markets about ten years ago. With a background in accountancy I have never really been uncomfortable with numbers, and PE ratios, EPS and dividend cover have been familiar concepts for many years. Alas it’s not really enough if you are going to directly control your own financial health, you really need to gain an understanding of the fundamentals of investing and the dynamics of markets, and possible even an insight into technical trading. I have also found it useful to try and better understand the movements of financial markets work and revisit a number of basic economic theories. On this latter point most economists have been trained in the Keynesian paradigm so the views you tend to get are filtered through Keynes economic theory. Our global banking system is also pretty much managed by Keynes followers so if you can get your head around some basic Keynes principles it is far easier to take a guess at the sort of policies they will follow when conditions change.

Central bankers were mentioned deliberately. In recent years it has become obvious that the markets have reacted, Pavlov style, not just to their policies but even to their ‘jawboning’. A newspaper article by Jim Bullard, a US FED president (St. Louis) can move markets. When the US markets react they frequently influence the European markets, sometimes even more than our own indigenous British or European central bankers. In other words there is a fairly tangible link between a US FED member opining on a local US issue and the value of my SIPP. It therefore makes sense to keep an eye on what is taking place outside the UK, in Europe, China, Japan and US.

The theme of this blog is 2016 vs. 2008. ‘History doesn’t repeat itself, but it does rhyme’ as Mark Twain is often purported to have said. This is also true of 2016 in that the US sub-prime derivative catalyst is unlikely to be the source of any problems later this year. In 2008 many of the US banks had miniscule capital ratios and the regulatory framework severely weakened. This is not the case today in that the US banks are far better capitalised, regulation is somewhat improved and the world of MBSs (Mortgage Backed Securities) is far more controlled. I would also like to think that there have been some cultural improvements in the banking system, although that of course we can’t really know until the next crisis emerges.

I do think that we have to look outside the United States for a catalyst. There are many potential candidates ranging from stability in the Eurozone banking system to Japan or China’s lacklustre economic growth story. It could be one or all of these things interacting with each other or perhaps it will be something taking place in the sovereign bond markets or instability in currencies.

Many of the change, transformation or performance improvement projects and programmes I get involved in involve identifying or improving KPIs (Key Performance Indicators) or what I call OPIs (Operational Performance Indicators), the latter being important but not key indicators. I like to apply this analytical framework to economic conditions and the markets as an aid to helping make decisions on what and where to invest.

The markets are not the economy but there is obviously a link between the two. When you get central banks interfering with markets the link is weakened but not eliminated, a good example being the QE (Quantitative Easing) fuelled extended bull cycle the US S&P has experienced until recent months. Irrespective of these interventions the bankers cannot delay the influence of fundamental economic conditions forever, so it’s useful to work through a number of global indicators to get a sense of context.

World GDP (Gross Domestic Product) is obviously a good ‘world KPI’ but it is limited in that it’s a lag indicator. It is a reasonable measure of what happened last year. More useful KPIs are those that track current activity, and two that I occasionally take a look at are the ‘Baltic Dry’ and the global PMIs (Purchase Managers’ Index).

The Baltic Dry provides a sense of world trade which is something of an analogue for global economic activity. It is not entirely reliable on a historical sense in that the boom years of the early 2000s resulted in an increase in shipping tonnage; in other words an increased supply of ships. Nonetheless, despite this distortion acting as a drag on freight pricing the index is trading at historically low levels. At its peak in 2008 the index exceeded 11,500 while today it has struggled to stay above 350.

Notwithstanding additional capacity, there has still been a massive drop in world trade, particularly in East –West import and exports.

The Markit PMI Index tracks PMI in 30 countries. It tracks output, orders prices and employment metrics and is closely watched as an indicator of forthcoming economic conditions. 50 is set as the benchmark with anything above this level suggesting better times ahead while results below indicates potential recessionary conditions. January 2016 data confirms the bear market in basic materials but still suggests that world financials and technology are still in positive territory. However, performance in in consumer services are showing signs of decline, particularly in the US:


Which brings me to the US. The US is still the largest economy in the world despite the economic assault of China. Whatever happens in the US economy has set the tone for world activity for decades so it’s a good idea to be knowledgeable about what is happening ‘over there’. There have been some improvements in US conditions in last few years, particularly in U3 unemployment numbers and growth. This could be changing. Notwithstanding retail, housing and car sales holding up there clouds are starting to appear on the horizon.

The US dollar may be (very slowly) fading as the premier currency in the world but it still remains the only option as world reserve and the size of its bond markets underpins its role as a safe harbour in a sea of volatile currencies. The enthusiasm for US dollar in the last couple of years can be seen in the DXY, a measure that tracks its performance against a basket of other currencies. The DXY has rocketed from 80 in 2014 to nearly 100 today:


In other words it has increased in value by almost 25% in a very short space of time. This looks like it may be beneficial to the US but it has a cost. Most of the larger US companies trade overseas and have experienced a drop in earnings as a result of local currency translation into USD. Central banks like to use the currency devaluation tool so the US FED are not likely to be particularly pleased with this situation. Import prices have dropped which means price deflation, another frustration in that the rationale for increasing interest rates is undermined. Long term it’s even worse. US debt is not only heading for $20 trillion but the value of that debt (purchasing power) is not eroding – most central bankers like to increase inflation to 2% or more as a contribution towards reducing its purchasing power. Its nominal value may be increasing but its buying power reduces if you can create ‘healthy’ inflation.

China’s growth is slowly reverting to the lower more ‘normal’ levels experienced by developed economies. It really is too large to generate the double digit growth of the past, especially when the structural impetus is to migrate from a manufacturing into a service based economy. It will be spending less on ghost cities and extravagant infrastructure but there still major initiatives such as the new ‘Silk Road’ which is attracting spend. It needs to eliminate surplus manufacturing capacity but it can’t achieve this overnight, the political risks of a social reaction to industry closures mean that it will take time to restructure.

I don’t really think that the catalyst for the next crisis will be in changing economic conditions, my guess is that it will occur in the markets. Deutche Bank’s $60 trillion derivatives book combined with its low capitalisation rate has recently been cited as a major risk to the European and therefore world banking system. Its president recently had to reassure markets about the robustness of its balance sheet while at the same time going back to the market to raise more capital. Deutche may be a risk but it’s a known risk and doesn’t yet look like the next Lehman. The markets move quickly but it probably deserves a pass at this stage.

It is the unknown or little publicised risks that are the real concern. Credit spreads, the difference between any bond and a sovereign treasury have widened over the past year. This is a concern. Wider spreads mean growing risk and they are on the rise. We are not yet at 2008 levels but we are close to dotcom bubble levels and seem to be on a clear trajectory upwards. The US FRED charts are a useful tracker, using the benchmark 10 year bond as a reference point:

credit spread

Liquidity is also an issue in the sovereign bond markets in that the central banks have been buying up government debt across the world at an unparalleled rate. Perversely, the policy of central banks buying up sovereign debt and sucking liquidity out of global markets may in fact become a catalyst for a crisis. Japan’s bond market is one to watch with this in mind.

I believe that gold is really a currency despite the PR of the last forty or fifty years. It still trades as a currency pair and is still stored in the vaults of most central banks as part of a country’s currency reserves. In recent years most central banks outside of the West have been buyers of gold, particularly China, whose gold reserves are officially less than 2000 tons but unofficially estimated at anything up to 30,000 tons.
It is not the price of gold that I track as an indicator but the gold/silver ratio. In the past when the gold/silver ratio has got to 80 or more we have had some form of crisis. In 2008 the ratio hit 83, in other words one ounce of gold bought 83 ounces of silver. Panic in the markets drove investors into gold so its value relative to other commodities rapidly increased to crisis levels. Silver is a form of money as well but it also has an industrial aspect and it’s this aspect that manifests itself when crisis conditions are apparent; gold is the behavioural driver of the ratio.

The worrying point at the moment is that the gold/silver ratio is almost at the 2008 peak:

Gold silver ratio

It closed on Friday at 83.04 vs. the 2008 high of 83.86. If it were the only indicator of stress on the credit markets we would already be in a crisis situation. Fortunately, it is not a widely used indicator and is usually reactive to conditions rather than a driver of behaviour. At the moment I see it as a fear indicator, and perhaps the reaction of disaffected currency holders in nations where negative interest rates reign. Gold is often cited as not paying any interest but it’s a far better investment than a bank account in a world where you have to pay a bank to hold your cash.

So, in summary I don’t see an imminent Lehman type moment but there are concerns both in the fundamentals of economic activity and in some of the market indicators.

2016 may not be 2008 just yet but then again we are only two months into the year, and there is that small matter of a Brexit vote which could make things very interesting in May and June. Volatile markets look like a certainty this year, whether or not associated with a true crisis.