Too Many Holes in ‘Balance’ Sheets

I’ve been asked many times to explain my rationale behind not following consensus practices of reporting corporate performance with ‘traditional’ accounting.  “Yeah, I get that you do unusual things but just show us the financials that we’re used to seeing,” I’m asked by people who have just determined that the businesses that I’ve created are among the most fascinating and innovative they’ve seen.  I used to be amused and now I’m just vexed by the illogic of such a request.  The field effect of what I’ve done around the world is visible.  The powerful technology I’ve architected and deployed is working and continually proven.  The countless ventures around the world that have launched, revitalized, or restructured using a unique methodology are bearing fruit.  Then I’m asked to explain this unprecedented effect using a metric that was never a component of its manifestation.

I am reminded of my frustration as a member of the radiology faculty at the University of Virginia when we were working with technologies enabling digital mammography and use of gamma emitters to detect early stage breast cancer in young women.  One of the FDA’s leading advisors from a famous northeastern medical school in the U.S. (also on the advisory payroll of one of the largest medical device companies making conventional mammography machines) convinced the agency to require newer, better, technology to be tested for equivalence against inferior conventional technology.  “Substantial equivalence” was required to take precise instruments and sub-optimally run them to prove that they were “as good as” an antiquated standard.  This industry-endorsed (and funded) malpractice and wilful illogic cost the lives of many young women who suffered from aggressive cancers invisible to inferior x-ray technology.  Threats to incumbent infrastructure could only be eradicated by proving that the measured out-performance was “not equivalent”.  People died.  Hospitals and doctors were essentially bribed into acquiescence.  And the band played on. 

Russia and China look like they’re about to execute a 30 year Russian natural gas supply agreement “worth $400 billion”.  This proposed deal makes sense – reportedly – for China as it solidifies another critical energy source for its growth objectives.  It fulfills Russia’s desire to find a cash-rich buyer alternative to the contentious European buyers who have been a constant complexity made worse by recent events in Ukraine.  But I find it fascinating that both China and Russia seem to be ignoring the fact that this $400 billion deal is not going to cost or be worth what is alleged at present.  Why?  For the simple reason that a thirty year anything will not be what is proposed.  Ukraine has been independent since 1991 – a short 23 years.  From the 1654 Treaty of Pereyaslav and the 1686 territorial dispensations in the “Eternal Peace” between Russia and Poland which was neither eternal nor peace to 1991, over 10 million Ukrainians died in wars and famines directly caused by their benefactor caretakers.  Not surprisingly, the cost of pumping natural gas from Russia to Europe across Ukraine did not factor in the nearly 350 years of pent up animosity resulting from abusers carrying many flags.  Is it reasonable to assume that 1.34 trillion cubic feet of gas will flow from Russia to China for the next 30 years without political or social upheaval?  Absolutely not.  Do we know the true cost of Ukrainian transshipment of gas?  No!  But we do know that it’s cost hundreds of lives, the frail global economic cooperation of the former G-8 (now G-7) and G-20 (now G-19?), and massive energy price ambiguity harming manufacturing and employment across the Eurozone.

What is the price of political risk?  What is the price of social upheaval?  Is it simply the collapse of purchasing power parity or gross domestic product?  No.  Can the much ballyhooed risk premium in commodities and utilities “price” the certain instabilities built in short term impulses with long term malignant consequences arising from neglect of knowable instabilities?  Absolutely not.  And can business and finance credibly offer extensions of current accounting models that adequately describe current realities and future opportunities and threats?  The fact that we’ve been globally incapable of emerging any economy post-2008 into a robust intervention-free actor is evidence that our metrics fail… Empirically! 

Therein lies the irony.  Using our consensus metrics, we can see that our metrics are insufficient.  Yet we still press on as though their use will somehow manifest their adequacy.  Central bank intervention has provided ‘cheap money’ to enrich the paper wealth of a few and push a greater proportion of the celebrated ‘middle class’ into retrograde.  The economically poor?  Forget about them.  Their ranks are growing and their voices are being strangled.  While high end retailers like Tiffany and LVMH grew at 9% in the first quarter of 2014, sales of the bottom 99% of homes in the U.S. fell by 7.4%.  Elitist retailers like Walmart saw sales fall by nearly 5% while discount retailers at the lowest price points grew over 7%.  The middle of the distribution is getting weaker while the tails are getting stronger.  In other words – the economy isn’t working for the economy. 

So back to my opening.  Why would I build a business that is predicated on, or assessed for performance on a system that does not work?  How much did it cost me to uncover the fact that Rio Tinto and its closely held corporation Bougainville Copper Ltd is seeking to defraud Papua New Guinea of over $50 million?  It cost: years of plane fares, days of interactions with citizens of Bougainville including ex-combatants that multi-lateral peace keepers refuse to engage, three years of direct opposition and discouragement from members of my own organization, courage of my family in the face of ostensible security threats, creative economic modeling and years of forensic accounting, joyful community engagements, a partnership with a great business partner, and countless other inputs.  And in over 30 years, did anyone with any budget do the same work?  Absolutely not.  How much did it cost to build a financial structure that could flow billions of dollars of capital to business by rationalizing their intangible assets in a fashion that banks could understand?  Was it millions of dollars of investments?  Was it tens of millions of dollars of revenue?  No!  Others tried the same and have come up discredited and empty.  It took bold initiatives in the public arena, ridicule and celebration for taking a contrarian stance against the propaganda of mainstream economists, the tireless effort of loyal members of a team who saw their professional colleagues taking lucrative shortcuts to personal enrichment at the expense of the mission, advanced computational analytics that are unrivaled in any industry – analytics that actually outmaneuver super-computers that cost taxpayers in excess of $300 million each year and bureaucracies on both sides of the Atlantic that cost industry over $4 billion each year.

In a few weeks, my quantitative equity fund will celebrate its first year anniversary of active trading.  Measuring corporate stewardship and quality of innovation alone, we have outperformed the large cap equity markets in a year where the same markets have reached their all-time peaks.  In short, we’ve beat the best at their own game.  And by a considerable margin.  Does that make our metrics right?  Absolutely not.  But what it does show is that the market is not measuring what drives it.  And this incomplete view directly harms wealthy and poor alike.  Public dollars are spent chasing ephemeral objectives rather than addressing legitimate social and infrastructure needs.  Countless illusions are created around businesses that will never bear fruit.  From crowd-sourcing to Goldman Sachs, the measurable ignorance premium is growing and we’re the worse for it.

It’s time to account for it ALL – the stuff that we use, the frameworks around which we organize our impulses, the wisdom that we integrate, the capital we use to empower our efforts, the tools we use to build and propagate our impulses, and the success or failure we celebrate or shun!  A more complete embrace of reality will have a quantifiable effect.  Let’s throw out the sheets that no longer service us and recalibrate our world.