The Way and Its Power Print E-mail
“The Way and Its Power”



“Plan for what is difficult while it is easy, do what is great while it is small. The most difficult things in the world must be done while they are still easy; the greatest things in the world must be done while they are still small. For this reason sages never do what is great, and this is why they can achieve that greatness.” This simple wisdom appears in the classic Chinese text, Tao-Te Ching, authored by Lao Tzu between two and three thousand years ago. It speaks to the virtue and value of foresight, anticipation and timely action. This philosophy reflects the leadership qualities that honor and preserve culture and civilization. Compare this to the faulty and disingenuous logic of Alan Greenspan who claimed that it is impossible to spot a market bubble before it bursts and better to apply a monetary salve after it has. Leaders need vision and fortitude.


Today’s America is listing, rudderless in dangerous seas. We got here after decades of spending and promising beyond our immediate ability to deliver. We fiddled with the laws of capitalism trying to alter its harsh nature rather than accepting it for what it is and preparing for the inevitable cycles. We manipulated supply and demand through misguided policies that pushed prices far from market values. The manipulations left only false wealth and air pockets beneath asset prices when markets reclaimed their domain. Our economy lurches forward and back because of decades of misdirected capital funneled to a finance sector that lined the pockets of too few and suffocated critical infrastructure, education and manufacturing. Far too many of us viewed resources, jobs and entire industries as disposable. We banked our futures and those of generations yet to come on the notions that our resources and strength are boundless, our character and virtue superior and our destiny to lead and shape the world in our image. The optimism, some might say arrogance that helped make America great has also made us vulnerable. We failed to appreciate the gravity of potential crises on our horizon, strolling confidently past opportunities to recognize and avert danger. Our competitors and enemies have grown stronger and we are falsely comforted that they are adopting the ways of the global market place. We have largely ignored the risks to our national security that comes from dependence upon others for debt financing, raw materials (some essential to military technology) and manufacturing capabilities.


 Somewhere along the line since the Second World War, America , the cash and carry, pay as you go nation transformed into a mass of senseless procrastinators pushing sacrifice and responsibility on to the next generation and the next. We became a nation that would prefer to borrow against tomorrow than pay in full today. We lost track of our leaders in business, banking and government. We couldn’t be disturbed from our busy work a day lives, E-trade accounts and conspicuous consumption to participate in the oversight processes that preserves democracy and prevents servants from becoming masters. We allowed problems to become great because we didn’t address them when they were manageable. Now we bicker about the unpalatable nature of the solutions. “A true conservationist knows that the world is not given by his fathers but borrowed from his children.” John Madison      





Let Them Eat Cake



After decades of mismanagement, moral hazard and the myopic afflictions that accompany great national wealth we find ourselves searching for a pleasant solution to a financial crisis that need never have occurred. We have wasted years gridlocked in political paralysis, losing ground as others fill the void we have left.  A global revolution empowers emerging nations and enemies to wrest the torch of leadership and power from America . Our business leaders see no farther than the next quarter, the next bonus or the next bailout. Billionaire Charlie Munger, the vice chairman of Berkshire Hathaway and long time sidekick of the affable Warren Buffett spoke his mind to a group of University of Michigan students on September 14, 2010. Andrew Frye, Businessweek reporter caught the exchange. His article appeared in the September 20th edition. While defending the bank bailout Charlie told tomorrow’s leaders they should “thank God” for the bank bailouts, they “shouldn’t bitch about a little bailout” and that the bailouts were “required to save your civilization” and “should have been bigger”. When asked if the general population should have gotten a bailout Munger replied people in economic distress should “suck it up and cope” and that if everybody else gets a bailout the “culture dies”. Berkshire Hathaway is the largest shareholder of Wells Fargo & Company stock and owner of $5 billion in Goldman Sachs Group, Inc. preferred shares. Wells received $25 billion and Goldman $10 billion in taxpayer funded bailout money. It has occurred to many observers less conflicted than Munger that a viable solution to the banking industry’s missteps might have included wiping out the risk taking equity shareholders before putting taxpayers on the hook. It is difficult to tell which comes first, the moral hazard of government protecting wealthy investors or the sense of elitist entitlement that leads some among us to believe that American culture and civilization exists to serve their financial interests.



“The true meaning of life is to plant trees, under whose shade you do not expect to sit.” Nelson Henderson



Our leaders are engaged in a high stakes tug of war that has far more to do with extending their political careers than the future of the nation they serve. Their vision extends to a horizon limited by the election cycle and access to campaign contributions. The idea that they might take action to alleviate threats to America ’s culture and standard of living even when unpopular is unfathomable. Vast sums of money flood the coffers of both major parties while the sources of these funds are harder to trace than ever. Financial lobbyist guided career politicians to water down legislative attempts at financial reform that most likely make America vulnerable to another, larger crisis. On October 11th the Wall Street Journal reported that pay on Wall Street is on pace to set a record high for the second consecutive year. As for too big to fail- Wells Fargo has doubled in size since the financial crisis and many of the largest banks have seen similar growth attributable to crisis driven shotgun weddings greased by taxpayer funds. The increased concentration of wealth, power and risk only hints at the extent of the failure of America ’s leadership. The idea of stabilizing the institutions and then reducing the concentration of risk that holds taxpayers hostage and emboldens speculators has fallen quietly by the wayside. The real power resides in the canyons of Wall Street. Will leaders arise who put the future of the country ahead of personal and partisan gain?



The Hour Glass and the Maze



I have often written of the inspirational words of accomplished leaders worthy of our admiration and respect. I use these words as springboards to reflective thought in these quarterly musings.  While I keep collections of the great axioms and speeches that resonate across generations only two simple images are fixed above my desk. These symbols have been with me since my earliest days as an entrepreneur.  One image is of an hour glass; the sand peeling away reminds me of the irreplaceable and ephemeral nature of time. The hour glass is accompanied by the image of a maze, a puzzle that challenges me to get from entrance to exit with accuracy and efficiency. Combined these symbols remind me of the need to innovate and create value, to find solutions before my time is up. Capitalism, by design, requires a sense of urgency. Competition requires participants to be lean and smart and anticipatory. We must steel our focus on the task at hand but always have an eye on our vision of the future. Victors anticipate change and cultivate change within. And all the while we are navigating the maze we must be keenly aware that the sands of time are passing from future to present, to past. At no time has the urgency of global competition been so great or the maze so demanding for America .


The Rise of the Rest



We have heard plenty about the role “creative destruction” plays in economic development and evolution. The waves of innovation can swamp stagnant companies and countries that fail to anticipate change and act wisely. In a competitive world full of hungry people striving for a better life the man on top is the target. The champion is rarely as hungry as the challenger. And when complacency sets in we become lazy and our senses become dull. We take time off to enjoy our success. It is amazing how quickly flab replaces lean muscle and shortcuts substitute for hard work.


America came to accept that financial innovation was superior to manufacturing innovation and that sophisticated debt instruments were a substitute for earnings power and increasing net worth. As we bought into this set of equivocations our competitors and enemies were observing keenly. They grew the infrastructure, education and manufacturing platforms that would generate real wealth. They applauded our consumption and used our dollars and manufacturing jobs to build muscle. Hell, they lent us the money to party on and hoped that in the haze we wouldn’t notice them gaining ground. Any fighter will tell you that it’s the punch you don’t see coming that does the most damage.


Before 1960 not a single “developing nation” enjoyed a faster growth rate than the United States . Between 1960 and 2000 30% of the “developing nations” grew faster than America . This rise provided welcome stability and an improvement in the standard of living in some of the world’s impoverished nations. But from 2000-2008 the pace of growth in developing nations accelerated at a rate suggesting a sea change. The rich western nation’s stagnated and 85% of the world’s developing nations enjoyed growth surpassing America ’s. This disparate inertia will be difficult to reverse. The G-7 wealthy nations grew at a 2.1% rate from 2000-2008. Assuming current rates of productivity and continued trends in demographics wealthy nation growth is expected to decelerate to 1.4% in the coming decade according to the IMF. This would be the slowest rate of growth since the end of World War Two when the mantle of leadership passed from the British Empire to America .


A broken financial system does not allocate capital efficiently. An extended period of misallocation of resources can have big long term consequences. In the years leading up to the financial crisis productivity growth or output per worker was flat to slower in the G-7 nations while it soared in the developing world. Worker productivity is a key ingredient to growing wealth. It is not coincidental that while America shaded capital toward the financial sector and away from education, research, manufacturing and infrastructure our opponents did exactly the opposite. While we accumulated debt and trade deficits and tilted toward weakness they built cushions against economic downturn while laying the foundation for future strength. It is imperative to resolve the conflicts of the financial crisis and revamp the broken system to prevent a repeat and to restore efficient capital distribution. Domestic consumption can only exhibit permanent growth when accompanied by increasing real net worth.




The Art of War



Over 2000 years ago Sun Tzu taught his disciples that war is won before it is fought. It would serve American leaders well to supplement the words of Machiavelli’s The Prince with the tactics described in The Art of War. While the principles are too numerous and complex to do justice here it is important to know that the ideas of Sun Tzu permeate the strategy of our greatest competitors from Asia . The Chinese manufacturing behemoth Foxconn is a company every American should familiarize him/herself with. The company is run by a self made billionaire, Terry Gou, who borrowed $7500 from his mother and embarked on a journey that is helping transform his country. Gou is said to be worth nearly $6 billion though he claims not to keep track. Gou says he is not interested in “how much I have. I am working not for the money at this moment, I am working for society, I am working for my employees.”(Not to belabor the point but contrast Gou’s comments to those of Charlie Munger quoted above). China is following the familiar path of industrialization and urbanization experienced by Europe and America , only on a scale unknown in history. Foxconn employs 920,000 Chinese workers, mostly 18-25 year olds. Foxconn is a major supplier to IBM, Cisco, Microsoft, Nokia, Sony, Hewlett-Packard and Apple. This is a man and a nation on a mission. Make no mistake that China is in this capitalist game to win and Gou lacks none of the cut throat competitiveness, intelligence or confidence of the greatest western industrialists. Terry Gou is China ’s Henry Ford.


Gou says of Warren Buffett, “he is too famous, too old. He doesn’t understand Chinese private companies.” He believes most MBA degrees are worthless, “you can’t learn to swim by reading a book.” Gou says he forced Steve Jobs to produce a business card and mocks Wall Street bankers who “look out the window at the Hudson River and say, I am king of the world.” Clearly this Chinese capitalist defers to no American icon. His self-assurance may be exceeded by the determination and discipline on his young workforce. Foxconn taps into the Chinese culture and the ideas of Sun Tzu to guide its troops. According to an article in the September 19th edition of Bloomberg/Businessweek Gou has placards prominently displayed throughout his factories that read, “work is a type of joy ,” “a harsh environment is a good thing, “hungry people have especially clear minds,” study your opponent, “use foreigners’ rules of the game to fight, “an army of a thousand is easy to get, one general is tough to find, and “Mainland China is not the only one globalizing.”


Executives at Foxconn joke that in 20 years everything will be made by Foxconn and sold by Wal-mart. By the end of 2011 Foxconn aims for 1.3 million employees, 25 factories in 12 countries and seeks 15% annual growth for this industrial giant. Gou has plans to expand into the retail market in his native land and to expand production at his Houston, Texas plant where he employs 1000 Americans.


All is not roses for Foxconn employees. The pay stinks by western standards at $176/month, the working conditions are brutal. An Army of 300,000 workers eat, sleep and work in a Longhua factory in the provincial city of Shenzhen (a small fishing village in 1970, a city of 9 million today). Eleven employees jumped to their deaths in suicides this spring, presumably due to the stresses and dehumanization of assembly-line work. Foxconn employs an around the clock staff on its Crisis-Help-Line Desk and has strung 3 million square meters of suicide nets to catch jumpers. But Foxconn pays on time, pays over-time and has lines of willing employees seeking the opportunity Gou offers.


It is certainly not my intent to glorify Chinese manufacturing but instead to provide a glimpse of our competition in this global struggle. America would do itself a great disservice to underestimate the power of Foxconn, the Chinese version of government directed capitalism or the rest of the developing world’s firepower. “Be extremely subtle, even to the point of formlessness. Be extremely mysterious, even to the point of soundlessness. Thereby you can be the director of the opponent’s fate.” Sun Tzu





At the Heart of the Currency Debates


A Race to the Bottom



Global trade imbalances are difficult to sustain for lengthy periods of time. Nations that have long term net trade deficits eventually become debtors and may even suffer a credit crisis. It is difficult to consume more than you produce, to spend more than you make. The rich western economies including the US are living proof of that.


When a global depression seemed possible many of the world’s leaders put national self interest aside to work together to rebalance trade and shore up the financial system. The global recovery has proven sluggish and uneven but the disaster scenario has moved to the back burner for the time being. So has international cooperation. This is most evident in the currency markets. When nations look for the quick fix to economic weakness such as slack consumer demand due to high unemployment or a credit crunch they look first to exports. Exports boost demand and support jobs until an ailing economy can get back on its feet. And nothing helps exports like a cheap currency. Just ask the Chinese. If the US wants to grow exports its best bet is to put US goods “on sale”. We accomplish this not by discounting prices per se but by discounting the dollar. But as logic dictates all nations cannot simultaneously export their way out of recession nor can all devalue currencies in concert in an exchange market where, for one to fall another must rise. In the real market it’s a bit more complicated than this but logic still holds. This race to the bottom is no solution and certainly no substitute for a true realignment of trade.


As fiscal austerity tightens its grip on the floundering global recovery a currency tiff will become more likely. And because currency wars are mostly futile they have the propensity to devolve into protectionist trade wars. Let us hope that Washington recalls the lessons of Smoot-Hawley and resists the temptation of trading votes for economic disruption. The trade issue cries out for an international solution. There is more to this global conflict than China and America . A gradual global rebalancing of trade is preferable to a devastating trade war. Unfortunately China and other surplus nations are building wealth and infrastructure and are not yet willing to shift financial resources to worker’s compensation, social safety nets or environmental controls. The Chinese labor force is gaining some bargaining power in the form of wage concessions and improving conditions. But the Chinese consumer is still a long way from pulling his weight at the global shopping mall.


Here At Home



Persistent economic weakness and partisan gridlock threaten America ’s rebound from the financial crisis and recession. The political battles may even heighten the risks of a second recession or another asset bubble. With fiscal stimulus off the table we have laid the responsibility for recovery at the door step of the Federal Reserve. Despite the harshest of lessons we have learned so very little about the limits and evils of loose monetary policy.


The Federal Reserve has an inadequate bag of tricks to boost growth in a structural downturn. They can manipulate short interest rates and they can manipulate money supply. With interest rates at zero they rely on “Quantitative Easing” to lower the cost of borrowing. The Fed will likely engage in a second round of asset purchases, buying Treasury notes and bonds, to flood money into the financial system and further depress long rates. The hope is that this action will spur borrowing, refinancing, spending and ultimately hiring. There is a good chance a second “Quantitative Easing” will accomplish less than expected, further inflate stocks and remind businesspeople, investors and consumers how bad the economy really is.


America is not Japan but…



America’s sluggish recovery and failure to respond to stimulus to date has spurred comparisons to the plight of Japan . Our economy is far larger and more diverse. Our demographic trends while negative are nowhere near as dire. But America is still subject to the whims and laws of market capitalism. One of capitalism’s critical dynamics is hard to quantify. It can’t be measured by an economist, built on a factory floor or counted on a warehouse shelf. What Keynes labeled “Animal Spirits” exist in the hearts and minds of businesspeople, investors, consumers and lenders. Without animal spirits there is no spark to ignite the flame of industry.


Japan was the original Asian powerhouse pumped up by perhaps history’s most spectacular speculative bubbles in stocks and real estate. Japan was on a trajectory to dominate the global economy. In 1991 economists predicted Japan would overtake America as the world’s largest economy by 2010. Japan ’s GDP has not grown since.  When the property and equity bubbles burst in the late 1980’s they extinguished the flame of animal spirits in Japan . Neither enormous deficit spending nor a flood of easy money and low interest rates could reignite the flame. Japan has been trapped in a deflationary spiral and anemic growth for a generation. Consumers refuse to spend; businesses don’t make capital investments, banks hoard cash while buried under bad loans and predictably, final demand collapsed. This lack of confidence produced a negative feedback loop breeding generational tensions, cultural pessimism and reduced expectations for the future. America should think in terms of the hourglass and the maze.  


A Governor Who “Gets” Government


Jennifer Granholm, Michigan



Comparisons with Japan while frightening are premature. But the time for vision and innovative leadership is now. Washington is hobbled. Change will come from leaders at the state and local level. A great example of innovative leadership comes from Jennifer Granholm, Governor of Michigan. Her keynote presentation at the Brookings Institute Hamilton Project for Economic Recovery Proposals earlier this month was inspirational and informative. No state has been hit harder by the structural change of the Techno-Global Revolution and to my knowledge no governor is fighting harder or smarter for recovery in his/her state. The Governor understands how to integrate the needs of local economies with the tools available through the State and Federal government. She also pounds the pavement to bring home foreign businesses to Michigan, showing global companies how to succeed in America while expanding opportunity in the Wolverine State . The Governor creates jobs while diversifying her local economies and tax base.


Low rates are not the answer and not without consequences. Low rates may exacerbate the sluggish recovery by slowing spending and increasing savings. Consider that with rates low pensions and savers require greater investment to build a nest egg. Those already retired receive less income from investments and spend less. This cycle represents the classic economic “paradox of thrift” and has the potential to do great damage to consumption and “animal spirits”.   





The Bond Market



Interest rates have marched steadily lower since our last quarterly report. The biggest decline has occurred in the belly of the curve, the five and seven year maturities. Markets are expecting a second “Quantitative Easing” with the Federal Reserve buying Treasury notes in the belly of the curve and have front run the action producing a strong rally.


The yield curve remains steep with Fed Funds pegged near zero but the belly of the curve has flattened with five and seven year maturities dropping 72 and 67 basis points respectively.


Spreads on Agency and Corporate securities have tightened to Treasuries as investors seek yield, squeezing much of the value from these asset classes.




Investment Strategy



With interest rates at historic lows and spreads very tight ICM has turned recent investments to US Treasury securities. During the quarter we have employed a strategy know as “riding the yield curve”. This strategy takes advantage of the steep yield curve and the Federal Reserve pronouncement that the Funds Rate will remain low for an extended period of time. Properly structured callable agency issues offer “yield to call” returns that are relatively attractive and have been added to portfolios where appropriate.


Until the economic picture improves market interest rates are likely to remain in current ranges. The risk to this scenario comes from three sources. First, if the Fed disappoints the market with a less aggressive purchase plan rates could rise in maturities ranging from 2-10 years. Second if there is a marked improvement in economic data signaling that the Quantitative Easing will be short lived rates could rise in a similar fashion. Finally, any borrower dependent upon foreign investment during times of currency market unrest is always subject to wavering demand and thus higher borrowing costs.


ICM has chosen Treasury securities for their liquidity and tight bid to offer spreads. We are following both domestic and global currency and bond markets for signs of reversal and economies for signs of improvement. We will make great efforts to respond in timely fashion. As always we will apply a conservative approach to maximizing returns in these highly uncertain and volatile markets.