Cent of Fear

I was intrigued by the recent press around Renaissance Technologies, the ambitious quantitative trading fund run by the inscrutable Jim Simons. While numerous heuristic (meaning based on a series of empirical rules) quant platforms operate in the market, few have achieved the legendary status of Renaissance. Operating with an opacity characteristic of the engineers who create them, these funds buy and sell not based on performance of enterprises but on the trading behavior of the markets per se. Not surprisingly, Renaissance and some of its aspiring ilk, are well endowed with physicists, mathematicians and engineers with backgrounds in linguistics, encryption, intelligence and related unstructured data fields. Those who are interested in learning more about the man behind the legend will enjoy reading Jim’s work on topological quantum field theory.

Peter Brown and Robert Mercer, the two PhDs who have stepped in as co-CEOs of Renaissance have an interesting background. Both contributed to IBM’s natural language research effort before being spirited away to join Simons. Much of their work was on modeling the “next effect” in words – trying to rationalize what the next word in a communication sequence would be based on the pattern preceding the predicted. Simply put, their work on n-gram language models assumes that the words you’re reading are not random in their inclusion or order. Rather, they are perplexingly, predictable. They, perplexingly rather, are predictable. Predictable, they rather perplexingly, are. You may be missing my point. You see, language is an encoding process, an encryption if you will, which loads meaning not merely in words but also in word-order and context. Before Drs. Brown and Mercer could crack the real nut – how to handle metaphoric expression – they followed the sirens to a quant fund and started making money. And here’s why I find the three people’s stories interesting. Because their performance actually unveils a fundamental human limit – the “cent” of fear.

From Babylon in the 18th BCE, to 7th century CE Roman “benevolent societies” which offered to pay death benefits to “insured”, to today’s most advanced insurance enterprises an irony emerges from looking at Renaissance performance and what seems to be an improbable industry comparable. At their peak performance, they hit very similar limits of blended returns, between 35-40%. Why is it that death and automated trading both capitate their performance at 40%? I think that the answer is that we have a human constant that I would call the “Fear Premium”. Now some of you might prefer that I call it uncertainty but I don’t for a simple reason. The motivation that makes Renaissance money is the “n-gram” of the next predicted event. They have modeled a human response that they train machines to detect and trade accordingly. Insurers constantly push the margin on how much the market will pay for the perceived “control” of fundamentally uncontrollable events (like death). In both cases, the uncertainty is skewed and the skewness is around the fear of loss.

Ironically, as I’ve begun to look at this dynamic, I have come to observe the Fear Premium in numerous historical and present capital models. Over the coming weeks, I will be highlighting several of these. One of my favorite which must be mentioned is the Basel II reserve capital spread between “investment grade” credits and “junk” credits where the Fear Premium charged to banks for reserve capital is, you guessed, the same number.

At the core, what does this mean? I believe that Renaissance is not necessarily anything more than a canary in a coal mine. Equity and bond traders are letting a few people (and the number of beneficiaries appears to be shrinking as Brown and Mercer look to close the doors to more outside capital) take their money by behaving predictably. If equity and bond traders stepped away from their addiction to impulsive trading and actually began investing based on, God-forbid, actual analysis of corporations or bond issuers, the helium that is maintaining the illusion would dissipate and the game would be over. If we didn’t live in an era where dying in debt continues to justify the dizzying levels of life insurance that we buy, making sure your death doesn’t cost your loved ones would lose its cache and the Fear Premium would be exsanguinated. In short, being free from fear would put at least another 40% of money in your pocket. It would let you spend 40% more time with your family and friends. It would let you relieve 40% of your stress.

As evolved as we pretend to be, it is ironic that in our present age, we still are gazelles on the savannah living with the certainty that there must be a lion out there somewhere. As evidenced by the recent nonsense that was marketed as “health care” debate in the U.S. (a harbinger of the love fest just around the corner in the U.K. and Australia), we had conservative Christians and political activists up in arms about – God forbid – the government caring for those less fortunate. I can’t wait for the first such activist group to waive their government authorized non-profit status, operate a homeless clinic in honor of their spiritual patriarch, and then talk about the irrelevance of government. You know why they won’t do that? Guess what the taxation rate would be on an activist group that didn’t have non-profit status… You guessed it, the Fear Premium.

Fools Gold

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It is not by injustice, therefore, that you hold what you have taken, rather it is through your own human kindness that the citizens are allowed to keep whatever they do retain.

Yet I foresee that if we betake ourselves to the life of indolence and luxury, the life of the degenerate who think that labour is the worst of evils and freedom from toil the height of happiness, the day will come, and speedily, when we shall be unworthy of ourselves, and with the loss of honour will come the loss of wealth.

- Cyrus the Great in CYROPAEDIA by Xenophon

I am perplexed. As I read the Federal Flow of Funds data, I’m struck by what appears to be a simple irony. In the FY 2009, consumer spending and debt have shrunk significantly and persistently (debt down $112 billion in FY 2009). During the same period of time, Federal debt has continued to balloon ($1.4 trillion in FY 2009). At its peak in 2006, consumer credit – the engine of the consumption addicted economy – rose to a high of $1.17 trillion.

The past 4 quarters have seen commentators and politicians describe their assessment that the economy is showing signs of recovery. However, this propaganda is, well, just that, propaganda. Here’s why.

First, the only thing that is contributing to economic activity is the Federal government’s spending of borrowed funds. In the most inefficient means of stimulating the economy (tax incentives) the Federal government is spending other people’s money to stimulate the automotive, housing, and manufacturing sector. As I said for the past four years, if you removed the premium of Federal spending (particularly in the indirect support of the war efforts in Iraq and Afghanistan) leading to S&P profits in defense, aerospace, materials and energy, we were in a recession before the “banking crisis”. Our GDP during the Bush administration was inflated and it’s even more so today. However, even the most casual observer can see that the Federal government doesn’t get the same economic return on its dollar spent as did the American consumer.

Second, we’re still living in the illusory world of an antiquated employment statistic. The fact remains that we have a growing number of Americans who are contributing nothing to the economy. We have more people who are beyond the 12 to 15 week without a job window who are either not working at all or are working in temporary situations or are otherwise under-employed. In the most recent March data, under-employment is over 20% and unemployment (U6 Figures) is still around 16%. Simply, this means that over 1/3 of the American population is not contributing to the economy. This cannot and will not last.

The myth that this is acceptable because “productivity” is higher is – well – just that, a myth. We are not more productive. Just because those who are employed are working longer hours and their marginal production per employee appears to be growing, this statistic fails to capture the fact that we’re riding an artificial wave of “value” inflated, to a large extent, by Federal government wage premiums. With more of the labor force working longer hours for real-dollar less wages, the Bureau of Labor Statistics is, once again, contributing to the consensus illusion that we’re making progress. We’re not. Paying fewer people less does not create an economy, it stimulates the French Revolution.

Cyrus the Great had it right. The day has come, when our carelessness about productively engaging our society to focus on real value creation in lieu of phantasmal “service” and “knowledge” businesses that supported consensus illusions as we saw our consumer addiction dealers off-shore the manufacturing of our intoxicants, must be reckoned. We must once again find honor not in the acquired wealth from others but in the honor of productive engagement. We must celebrate the industry that creates rather than blindly waiting to be served by those from whom we’ve taken so much. The drug is wearing off and we need to see clearly that creativity and production, supported by ethical exchange of value, is not a whimsical aspiration but rather the only way into a future with living.
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No Other Gods

In his first Papal Encyclical, Deus caritas est Joseph Ratzinger – then Pope Benedict XVI – spent considerable time discussing the role of the church in social justice. He stated:

“The direct duty to work for a just ordering of society, on the other hand, is proper to the lay faithful. As citizens of the State, they are called to take part in public life in a personal capacity. So they cannot relinquish their participation in the many different economic, social, legislative, administrative and cultural areas, which are intended to promote organically and institutionally the common good.”

In an encyclical that is built around discussing the relationship between love and social justice, the Pope made concluding reference to St. Martin of Tours who is the iconic representation of justice and charity. In an act of profound (and capital) consequence as a Roman solider, he took the property of the State (his uniform’s cloak) and gave it to a beggar. This act of giving State property to a beggar was a violation of Roman law and could have cost St. Martin his life. Instead, it became the foundation of his canonization. Pope Benedict XVI makes a clear declaration that “service of neighbor” is inextricably part of the mandate of the faithful and of the church.

So as Europe was aflame with the church’s tireless abuse scandal over the past week, I was in East New Britain and New Ireland provinces in Papua New Guinea – the Metropolitan Archdiocese of Rabaul. Established in 1844 as the Apostolic Vicariate of Melanesia and promoted to Archdiocese in 1966, the church was established in its current incorporated state with the Roman Catholic Archdiocese of Rabaul Act of 1969. And, while I thought I was going to write this week’s blog about the horrific scourge on humanity’s legacy (once again, fully capitalized, aided and abetted by the Toronto Stock Exchange and its willing investors) – Simberi Mining Corporation (TSX-V: SAU) – where an entire village’s food supply has been jeopardized by a failed re-routing of a river, I find myself compelled to address a more insidious injustice. That is the violation of the Papal Encyclical referenced above.

For those of you who don’t travel to the Archdiocese of Rabaul, it is hard to appreciate the depth of injustice represented by the land holdings of the Catholic Church. In a land where property rights did not exist in our current understanding, the church’s land holdings are vast. Much of the productive agriculture supply is controlled by the church and offered to locals (original stewards of the land) for leases. In a land of abundance, in the name of God, the faithful are charged for access to the creation that has been the heritable land of millennia. The Pope’s reference to the “common good” in his first encyclical is constantly violated by the perpetuation of exerting “ownership” of land that was taken from those who had no knowledge of what land ownership meant. In Kokopo, the prime commercial real estate is owned by the church. On the coasts, fertile farmlands are owned by the church. If the Pope was serious about his encyclical, why doesn’t he put himself in line with the very saint he holds as iconic and return the land to those from whom it was taken? Rather than entering history as the Pope on whose watch the church foundered on more sexual abuse, why doesn’t he actually become the first Pope to explicitly evidence that the church’s God is not mammon?

And the Catholic’s are not the only ones displaying conflicted messages in East New Britain and New Ireland. No church has been more clearly evidenced in promoting family values and the importance of social order than the Church of Jesus Christ of Latter Day Saints – the Mormons. I have been amazed at the church’s expansive presence throughout the Pacific and have been constantly impressed with the tireless efforts of the church to build communities which provide education, recreation and numerous other benefits.

However, this same church that has worked so hard to promote the highest and most laudable social values as an expression of a genuine belief, has two amazing contradictions which cannot conflict with the very values that they promote. First, Zions Bancorporation (NASDAQ: ZION), the bank founded by Brigham Young, and other asset management arms associated with the church have active presence in the global gold market. This church, which promotes the value of family and stewardship could use its presence in the Pacific to call for accountability in gold mining. In a part of the world where Barrick (ABX.CA), New Guinea Gold (NGG), Simberi (SAU), Lihir (LGL) and the oceanicidial Nautilus (NUS.TO) operate with lack of environmental, social, or legal transparency, where is the church’s voice to defend its faithful against loss of land, ecosystem, dignity, and wealth? Regrettably, it is largely silent. Apparently gold is more important than people.

And who can forget the fact that Brigham Young University has patented biodiversity and indigenous knowledge from Pacific Island healers without naming the providers of the information in their patents? Where is the church when violation of international intellectual property law is done in its name and held in its institutions? Regrettably, here too it is silent.

You see, a great prophet is quoted as having said that you cannot serve God and money. However, whether it is in the colonial annexation of lands held in trust and Commons for millennia, or in the coin of comfort in times of fiscal uncertainty, it seems that communities of faith seem to lose their prophetic voice when it comes to the wealth upon which they count their blessings. And this, in the final analysis, is a failing more insidious than those that grab the headlines. Because they undermine the very values that are promoted as divine.

It’s time for those who seek to shepherd those who live in the abundance of creation to actually genuinely care for those who have turned to faith as their guide. It’s time for morality and justice to go all the way to the bottom line. Otherwise, the world will see the true identity of the god that has been deemed supreme.

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Why We Don’t Build Pyramids

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On Wednesday, March 10, 2010 I was a guest lecturer at Atenisi University in the Kingdom of Tonga. Atenisi University is an enigma in every sense. Seldom have I met people more profoundly dedicated to the cause of freeing minds for deep inquiry. Seldom have I seen students more animated when a perspective blows its way to the island kingdom that sits on the first ray of dawn each day. Nowhere is the dawn more possible than the place where every day begins first.

Now, the next three paragraphs are weighty but I ask you to indulge me them as they reflect a theme that I’ll explain later. And yes, I know that taking what I’m trying to say to heart, may mean that you need to take a couple bites at the apple. Think of it as poetry if you must…

I gave three lectures at Atenisi. The first was in Philosophy, the second in the macro-economics integral to the French Revolution, and the third in Clinical Psychology.

I hypothesized that Pythagoras’ conviction of the essence of truth manifest in numbers may have been deeply influenced by Persian moral philosophy. His attempt to forge a new understanding of humanity’s consequence in the cosmic scale may have been inspired by the stories of Cyrus the Great who stands alone in our present understanding of history as a master of tolerance and social discourse. [It is plausible that Xenophon, a soldier and student of Socrates, chose to write the Cyropaedia because of its centrality to the evolution of Greek philosophy.] I went on to suggest that the Pythagoras known to students of mathematics and philosophy has been characterized primarily by “Truth is Number” as an apology for our modern obsession with numeric reductionism. In plain English – that the only thing that matters can be counted and the only thing worth counting is expressed, in its most generic form in money. How rare it is to hear about Pythagoras’ spiritual inspiration from Orpheus, that great mythical failure who inspired his men past the Rock of the Sirens not by debating the merits of being seduced but rather, simply playing a sweeter sound.

My proposition regarding the macro socioeconomic dynamics behind the French Revolution was rather blunt. I suggested that the revolution was not as much revolution as it was a coup d'état. My thesis was built around the observation that the combined rise of Central Banks (replacing Church and Crown treasuries) and limited liability corporations needed to galvanize a public to be distracted by the opulence of the monarchy. This public furor rallied a populace while the Corporate Banking interests assumed sovereignty – an act consummated during the Napoleonic Wars and, famously, with the functional privatization of the Bank of England following Waterloo. Few historians adequately address the fact that it was the ability to levy taxes that galvanized “revolutions” and, after the revolutions, the one thing that remained more intact than ever was – you guessed it, taxation. I suggested that the faux banking crisis of 2007-2009 is, in fact, the first substantial evidence that the coup has committed the fatal seduction of coups – when the robbing of the national treasury winds up involving stealing from yourself. Now, the only thing left for central banks to do is trade with each other as they’ve become entirely detached from their underlying national economies. In short, Act I of the French Revolution is over – on to Act deux!

And in Clinical Psychology – where the discussion was on Learning – I discussed my observations that what we call learning is more accurately described as consensus patterned behavior. Building the argument around the concept of Orderly Organic Synchronization (the process of building shared consensus views on observations and inputs which support socially acceptable narratives), I pointed out that most of what we do when we educate and train is to actually encode patterns that make communication within a subset of humanity efficient while explicitly isolating those who we deem “outsiders”. In its most egregious form, we suggest that language is a means of communication failing to realize that by selecting to encode in one language, we expressly identify our audience and subconsciously exclude those who encode using different encryption.

Off to an interview with the national news in Tonga and then an evening lecture on Poverty.

Now, aren’t you glad we’re through that? So, let’s click the lens back a notch and see what is behind what I’m saying in these three “parable” lectures. And what is the message that is communicated by linking what appear to be three disparate themes. Here goes.

I’ve written before about our collective, unimaginative system of denominating “wealth” and “poverty” based on a simplistic monetary metric. Those who “have” are those with monetary wealth and disposable access to consumption. Those who don’t have access to disposable monetary resources are “poor”. We rationalize our Orderly Organic Synchronization (learning) by reinforcing this message. We “know” (because is our synchronized, accepted belief) that if a country has a small GDP, it’s poor. If a country is being robbed of its minerals and resources by those with monetary power, it’s still poor. Isn’t it ironic that many of the world’s “poorest” nations actually have much-desired resources in abundance? And isn’t it convenient that, by focusing on their absence of monetary strength (labeled as “poor”), we co-opt them into letting their resources be exploited without consideration for people, the environment or the future. The Greek philosophers who gave us our concepts of “truth” and “substance” are misapplied when they are used to rationalize behavior that counts dollars but not trees, gold, clean soil, and fresh water.

A few months ago, I worked with courageous leaders in East New Britain, Papua New Guinea to notify the Toronto Stock Exchange that one of their listed companies (New Guinea Gold, TSX:NGG) was reporting revenues of gold sales to the public while failing to disclose or pay royalties for those sales under their obligations to the nation of Papua New Guinea. Further, the subsidiary shell corporation set up by NGG in which local landowners hold partial interest, was being charged accrued debt expenses without receiving any revenue. The company pressured the local media to renounce a newspaper report of its own securities filings. And TSX Compliance did nothing. You see, apparently, Canadian securities regulators only count what their listed companies report. And shareholders, drunk on gold fever, have no knowledge, interest, or will to know that their company is operating at the expense of a country.

Now we can sit back and rationalize that, after all, Papua New Guinea is a long way away and so oversight is impractical. However, it’s not so far away as to prevent Canadian investors from misappropriating the assets of a country. You see, you can take money from Papua New Guinea gold in Toronto, but you can’t take information.

I was recently asked by a French socialist academic if I really believed that ethical capitalism is possible. In a diatribe worthy of a wooden crate in 1917 in Moscow or Paris, I was informed that labor and resources are necessarily exploited in capitalism. Really? You can’t build common wealth by engaging productive people to a mutual benefit? You can’t open the aperture to accommodate that STAKEHOLDERS (including workers, managers, and shareholders) all need to benefit if the ecosystem is to be viable in the long term? Which leads me to the coup d’état.

If, as rational human beings coexisting on this planet, we share common aspirations for sufficient living conditions in which there is enough for all and even wealth for a subset, why is it that we’ve ignored the notion of Liberty and Fraternity – the rallying energy for the Greeks, the French, and yes, present? The answer is simple. Society has manifested a fear of those who control the coin of the realm. We seem to be incapable of considering that it is the hegemony of debt-based currency which is the cow to sacred to challenge. Is the bailout of reserve banks any different then Marie Antoinette’s “Let them eat cake”? Is Toronto’s indifference to flagrant abuses of its own ethical and legal standards any different to the tyranny of willful ignorance that plagued Versailles?

We the People, in Order to Form a More Perfect Union can actually begin operating in Liberty and Fraternity without being forced or cajoled into these ideals. In fact, I think we only get there by actually living the way we’d like to see the bigger system operate.

Start with a simple exercise. Take a look at your retirement account or your stock portfolio. Examine the companies in which you hold equity. And then, take a quick look at the company’s last quarterly filing. See the locations in which they operate and then look at the news for those locations using the company’s name in your search. For example, type the terms “SAIC” and “Greek Olympics” into a search engine. You choose your companies and see what you see. You’ll find one where to maximize profit, a city has collapsed with a plant closure so you could get your investment profit. You’ll find one where the reason why a jurisdiction is selected is because they have “favorable environmental operating conditions” which is politically correct for the ability to pollute without consequence. You’ll find one that paid fines for bribing officials in procurement efforts. And when you find that company, sell the stock. But don’t just sell it. Go on and write a letter to the investor relations manager explaining that, as a shareholder, you will no longer support what they’re doing. Then, take the proceeds of that sale – your gain – and contribute it to a cause you believe in.

You see, when you build your retirement on a foundation that includes a passivity which authorizes bad behavior, you insure that the coup persists. As soon as you start living the way you wish the world would work, little by little, you’ll help turn the tide.

So, how do we get from Cyrus and Pythagoras, to the Bastille, to Psychology, to Papua New Guinea, to Toronto, to our retirement account? Actually, quite simply. If we want “things” to “change”, we must actually begin manifesting the world we wish to see. Waiting for someone else to begin, when that is the unifying consensus of everybody, means nothing will get done.

Which is why we don’t build pyramids. We don’t build pyramids because we don’t believe that it can be done or that those people in Egypt or Meso-America could have done it. However, I know how the pyramids were built. It started with someone starting. So… let’s get started. And, by the way, a bunch of you read this blog, think big thoughts, and then go on about wishing that something could happen. So why don’t you send this blog to 25 of your closest friends, get together, and figure out how to do the exercise suggested in this post together? You never know, you might actually change your world.


P.S. If you want, you can use your blog-inspired proceeds to help Atenisi University offer more scholarships to students in Tonga. This country, while fifth from the bottom of the global country “wealth” chart, has a university that offers full tuition waivers to any citizen. If you want to make a difference, get in touch and I’ll connect you with something worth doing. Their budget could use about $80,000 to open up a whole new program in Ethical Innovation Finance.

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All Debts Public and Private

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I was walking in Manhattan this week in the midst of an epic journey. The company I lead, M•CAM, is looking to establish a market solution to the current market’s greatest challenge. We are working to create a transparent means of linking human creativity to human enterprise in a way that rewards innovation and aligns capital and enterprise to shared objectives. You see, what has passed for financial innovation over the past three decades has grossly contorted the capital system and has decoupled capital from productivity. Having entered into dialogue with many of the market’s most sophisticated minds stewarding the largest aggregated pools of capital, the daunting realization was that, when confronted with systemic paradigm shifting opportunities, the people you might think are on the frontiers of financial sophistication are truly paralyzed by the reality that the hype about economic recovery is, well, just that – hype.

I’ve written about this before but I’m pretty sure that most people still don’t get what’s wrong at the core of the economic system. And while I’ve tried to highlight a number of components of the disease that still plagues our economic system, I think that I’ve been ineffective at communicating. And in a world where the market “responds to good news” about the slowing of the rate of job loss (because we’re continuing to shed the hopeless – now well over 2 million people – who have not found work from the official count) and sees this as indications of a “recovery”, at some point you must confront the fact that the same media that didn’t see the recession/depression coming are equally incapable of reporting on market recovery.

Let’s revisit some basics. I’ve called your attention to the difference between debt and credit before. Debt focuses on the cost of money and its use. Those with capital – which in their own hands earns nominal interest in, say, Treasury bills – can provide that capital to others as long as their cost to hold the money and their return to lend the money are sufficiently spread. Debt, whether it’s in the form of your mortgage, or bonds to pay for a highway, or pay for an out-of-control government (like the fiscally delusional U.S.) seeks neither productivity nor equilibrium. It seeks its own return and requires perpetual growth. In modern times, debt is resolved (as many of us know) by taking out more debt – politically correctly known as refinancing. If you contemplate debt in its extreme, debt is antithetical to productivity. Three hundred years ago, debtor’s prisons ironically put the debtor in prison extending the usurious reach of obligations to family members and friends while rendering the productivity of the debtor impractical and impossible. In modern times, debtors now find themselves having to take more time away from family with a second or third job, leave children unattended to pay off obligations, etc. In many parts of the world, including the U.S., debtors wind up literally enslaved. Human trafficking, now at an all-time high, is a direct consequence of debt.

There was a time when credit – an entirely different concept – was more commonplace. In its simplest form, credit is best exemplified with a seed. If I have seeds in abundance, I may offer 10 seeds to a farmer and charge him 15 seeds in exchange. This works because I know that each seed I provide will yield 100 seeds – more than enough for him to keep seed for the next year, feed his family, and pay me 15 seeds. While cartoon in its simplicity, this example is quite vital to understand energetically. Unlike debt which seeks its own return divorced from the underlying enterprise, credit takes into account an alignment of all interests. First, as the provider of seeds, my bet is with the farmer and with nature. Second, my return is based on fruitful productivity. Third, my role as seed provider is not necessarily perpetual. In fact, I may work myself out of a job and may need to move on to other forms of credit if a market is fully functional and crops are productive. In short, as the provider of credit, I am betting with future productivity, not a perpetual illusion of capricious returns. And yes, I will lose sometimes. And that’s o.k.

One of the main reasons we are in the economic failure we’re in right now is because we don’t understand credit anymore. And in failing to understand credit, we give no thought to the fruitful ecosystem. Let’s look into this deeper.

In credit, I look to the ecosystem of the seed-farmer-soil-rain-harvest-market dynamic and understand that, to make a functioning system, I need to make sure that my credit works within a closed loop that may or may not have finitude. I need to look at the raw material-production-assembly-distribution-marketing ecosystem and make sure the capital costs fit inside the fruitfulness of the ecosystem. In short, I need to understand the foundations of productivity and then integrate my capital within a viable cost structure therein. In short, my returns – high or low – are directly a consequence of the ecosystem productivity.

Debt, on the other hand, has made capital ignorant and lazy (euphemistically described as “efficient”). I spoke to several people about collateral. Collateral is a form of commitment that says that, if for any reason, an obligor fails to perform on repayment of an obligation, a secondary source of payment in the form of disposable assets, can be monetized to defease the obligation. Collateral has taken on enormous meaning lately as, in its absence, cash-rich banks are unable to lend because their reserves are adjusted based on their creditors’ collateral adequacy. With investment-grade collateral, a bank needs to hold 8 cents in reserve for every dollar lent. Without collateral, the same bank must hold up to 53 cents in reserve for every dollar lent. Most of the American and European public fail to understand that the reason why cash-laden banks are not lending is because they cannot. Technically they cannot because they do not have collateral adequacy in their credit assets. Operationally they cannot because they have no clue how to assess the collateral in today’s market – most of which is intangible. Your home, used as collateral for your mortgage, does not create value and, when real estate markets fail, its loss of value actually puts you in greater debt.

Ironically, during this administration’s rush to stabilize our economy and put it on the road to recovery, it has continued to overlook a comic irony. Intangible assets, intellectual property and innovation are all part of what’s called a “General Intangible Lien” – a collateral instrument holding hostage all corporate innovation from effective deployment. I use the term hostage because, unlike traditional tangible collateral – like real estate – that at least has some form of value, intangible collateral is taken under liens, restricted from use, but assigned NO VALUE. In other words, banks now hold America’s and Europe’s innovation assets, ascribe them NO VALUE, and with real estate and traditional assets loosing value, have no way to unleash their value without worsening their already collateral-insufficient position.

In short, our love affair with debt – mortgage or commercial debt – has enslaved the seeds of future productivity. When I was in Saudi Arabia speaking with people associated with SABIC – the buyers of GE Plastics – they were shocked to learn that many of GE’s patents on critical plastics technology were not expressly conveyed in SABIC’s purchase. Many of them, post the acquisition, were still held in liens taken by banks with whom GE had lending agreements. Companies including electronics, telecommunications, pharmaceutical, and energy enterprises and others, have vast intellectual property holdings which are tied up in senior liens rendering their use limited to non-existent. In the case of one photographic technology company, their patents are expressly prohibited from use in licensing transactions by the bank that holds their debt. And, during my stroll through the banks of New York, I was amazed that nobody seems to realize that we need to fundamentally change. More of the status quo is NOT the solution and will continue to inflame the sores that we've bandaged poorly of late.

I highly recommend deeper exploration of the debt conundrum expounded by my friend and colleague James Quilligan. James writes and speaks about the centrality of debt and capricious interest in the present economic system failings. I will spend more time on this as well. In the meantime, we need to actively decouple our debt dependency and actively work to create fruitfulness-aligned capital systems. This means that when we’re working on building ecologically viable communities in St. Louis, we need to examine every element of our retrofits. The water systems in buildings need to be financed using the future value of potable water and be paid for using water credits. Sanitation systems need to be financed using off-grid commitments where developers can be compensated for reducing or eliminating their reliance on municipal water and sewer systems and where organic waste can be captured, processed and turned into a fuel source. Rather than seeing waste as a cost, we need to see biomass as energy and compost. We need to realize that the private sector – not the government – must lead the way to link capital to future productivity. In a world where our government has reduced its economic empowerment tools to interest rates and tax incentives, little more than the failed status quo can be possible.

And on an unrelated note: Did anyone in Congress EVER run a business? To grow a business, you must invest. To invest, you must use present profits to plow back into enterprise. So, when stimulus bills get passed that provide tax relief (that only is useful if you are creating profits) does ANYONE realize that this only creates loss carry forward positions which make small businesses desirable tax sinks for larger – less employment friendly companies? I’ll write more on this one too.

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Distrito Federal – Brasilia to the World

An Open Invitation to President Lula...


Patents are social contracts between the public and inventors. In exchange for sharing enabling disclosures on inventions with the public, the inventor may receive a limited-time market restriction around third party commercial exploitation of the invention. For two decades, a fundamental misunderstanding has been promoted by industrialized countries – most robustly supported by the WTO and its TRIPS agreement – focusing on the rights of patent holders. Galvanized around the treatments for HIV/AIDS, marginalized countries have been coerced into debating these presumed rights while offering no attention or voice to the other half of the social contract – namely, the public interest. Every patent is required to contain the disclosure – the recipe if you will – for how a skilled person can replicate the invention. If it does not provide such clarity, it is not a legal patent and any untaught claim is unenforceable. Pharmaceutical companies have extorted vast sums from marginalized countries under the “compulsory license” concessions derived from costly battles around patent estates. In most instances, the combatants in the battles waged on drugs, technology, communications, and defense, have overlooked two glaring omissions.


First, with few exceptions, the platform compounds for most key pharmaceuticals are NOT patented in worldwide patent filings. In the most notorious cases of HIV/AIDS drugs, the core compounds were protected in the U.S. and parts of Europe alone. While pharmaceutical companies did file patents on production methods after the fact (and often with complicit patent offices turning a blind eye towards rules of patentability), the core compounds (together with its original production processes) were entirely unrestricted in the majority of the world. The patent thickets constructed by pharmaceutical companies DO NOT limit the use of the compound. They simply restrict the distinct processes of manufacturing in the countries with protection. While the Doha Declaration and other uses of Article 31 of the TRIPS Agreement have co-opted the debate around patents into the nefarious faux concessions for public health interest, all of this sound and fury obscures the real point. In most instances, the countries impacted by patent allegations have an open source alternative to create domestic solutions. These open source alternatives are derived from: 1) failure to file original patents in countries thereby rendering them public access from the first year after filing; and, 2) expired, abandoned or otherwise public domain alternatives which provide freedom to operate alternatives to branded product claims of proprietary positions. Countries from Brazil, to India, to Thailand, have been seduced into debating an untested presumption of rights which must immediately be informed.


Second, as evidenced in the recently-released Global Innovation Commons (debuted in Florianopolis, Brazil in October 2009), hundreds of thousands of patented technologies are described in patents which do NOT enjoy international enforcement rights. If a patent has not been filed in a country, that country is free to use the information for its own market use and can enter into international commerce around the patented invention provided that no commercial activity whatsoever is done in countries of enforcement. Companies selling patented technologies to countries in which the patents enjoy no protection are not capable, under patent law, to defend any unprotected element of technology. [Note: There are instances where companies, realizing their patent filing failures, impose patent-like restrictions by contract.] When resolving Trade Credit Offset obligations, hundreds of multi-national companies seek to receive offset credits from technology transfer however, in most reviewed cases, the patents transferred to countries like China, Brazil, India, Korea, Taiwan, etc. DO NOT EXIST. There is a common misunderstanding around patents. Just because someone has a patent in Europe, for example, does not give them any market restriction rights outside of Europe. A patent is only enforceable in jurisdictions where it is filed. A user of patented technology in other markets is not “stealing intellectual property” (an allegation frequently made by the U.S. Commerce Department on behalf of companies who forgot to protect their assets in emerging markets); rather, it is salvaging an abandoned property option. A patent holder cannot, by virtue of a transfer of a patent, create an asset around something that was not first filed and enforced in the recipient country. A U.S. patent – not filed and in good standing in Brazil – cannot be transferred to Brazil for any value other than value for the Brazilian recipient to limit use in the U.S. market. The patent has NO effect in Brazil and has no restriction on third party use in Brazil.


Brazil’s President Lula has been seen, by many, as an advocate for the world’s marginalized states in the area of WTO’s TRIPS matters. Coming out of the Doha round of WTO negotiations (and I use that term loosely), he was willing to stand up and use the tools that the incumbency had provided him – namely ethical use exemptions for public health under Article 31. However, as he is now coming to the close of his dynamic presidency, I would strongly recommend that he take a game-changing approach. I would suggest that Brazil make an explicit statement that FULLY honors the TRIPS agreement in a way that the industrialized authors of WTO never anticipated. Practically, I would recommend that President Lula:


1. Immediately lay Commons Claim for the public benefit to ALL intellectual property records of patents filed by EVERY patent holder in the world which did not seek Brazilian jurisdiction status;

2. Immediately distribute these Global Innovation Commons patents to academic institutions, state-sponsored research laboratories, small and medium sized enterprises, and nationally domiciled corporations for immediate use in:

a. Domestic research, development, deployment, and commercial use;

b. International commerce between countries in which the same protections were equally ignored;

c. Resolution of Trade Credit Offset obligations (over $13 billion in current obligations associated with foreign technology procurement at present) by inviting foreign patent holders to receive partial offset credit if they teach Brazilian companies how to use their technology and agree to subcontract with the same for production, assembly, or advanced research and development; and,

3. Extend the logic of the Article 31 concession to ALL technologies under the argument that NO right should restrict the use of technologies if the holder is not actively operating in the market. In short, no patent holder should be free to block technologies to clean energy, health care, water, or infrastructure if they are not actively offering the same in the market.


It is time for credible voices like President Lula to frame a global standard that is not merely the best that can be done with the flimsy arguments offered by incumbents – like the compulsory licensing façade built on the untested presumption of validity of patents – but to raise the standard to say that the world now stands to take seriously the public interest in the patent contract. We the people, in exchange for true disclosures of technologies that advance our well-being, will offer limited market protections to those who disclose true advances and make those disclosures to all humanity. If the patent holder ignores any country or its people, the social contract not only is not enforceable there, but the ignored places must unite to use the open source created by arrogance and ignorance and create the Generic Innovation Industry – a new force for economic transformation in a new global economy. And if Merck, and its monopolistic allies, fear that this will provide a “chilling effect on research” (http://news.bbc.co.uk/2/hi/americas/6626073.stm), then they are clearly not the right company to address the world’s greatest challenges. I trust that President Lula uses his final months in the Presidency to fully unleash Brazil’s creative engine for global transformation. By this summer, we should see Open Source cellulosic ethanol production, Open Source desalination; Open Source agro-industry; Open Source bio-technology; Open Source high speed transportation; Open Source everything.

The World needs this leadership at a time when the industrial incumbents are now alleging hollow patent estates blocking climate, food, water, communications, power, and health technology deployments. If we're going to be serious as a human race about our intractable challenges, we must have accountability for the fact that most of what we're looking for is already here - just buried out of sight by those who profit from the perpetuation of the status quo.

Give Chance a Hope

I just spent the last several days in Rio de Janeiro. Selecting the days of Carnival for a business trip to Rio has its positives and its drawbacks but I can assure you that the positives far outweigh the distractions (not to mention that many of the distractions are quite positive). I was a guest of APEX, a critical component of Brazil’s economic development and engagement strategy and, as a result, was treated to a first class trade promotion experience. True to form, observing events wasn’t enough for me – I had the amazing experience of being invited to dance with one of the best samba schools in the Carnival parade!

As I interacted with public and private sector influencers in Brazil, I was overwhelmed by a single observation which is the subject of my post this week. The observation is complex and I’m sure it will leave more than a few puzzling but, here goes.

The stated purpose of our visit was to carry forward conversations about the use of Trade Credit Offsets as an accelerator for enterprise creation and financing in Brazil. While experts from around the world come to Brazil loudly promoting investment in Brazil, this cacophony has masked a huge reality – I think intentionally. Let me explain.

Business is built on the interaction, and value exchange, between a steward of resources or goods and those who have use for those resources or goods. The nature of the value exchange may take the form of commerce with money or it may take the form of defined mutual benefit. However, in Brazil, the desire to create equity-based capital markets – encouraged by experts from abroad and reinforced by influencers within – provides the context for a deep systemic failure. Clamoring for “access to capital” to create the next “Silicon Valley” illusion is en vogue. When a person like me asks about cash-flow, revenue, or value exchange, I’m viewed as an anachronism. You see, in our promotion of economic development around the world, we’ve not promoted business – we’ve promoted usurious capital markets where it’s about investment returns, not enterprise. Stop and think. How many of you actually KNOW the business of the companies in which your pensions are invested. Get it?

A Trade Credit Offset is a function of market asymmetries. When a country buys a fighter plane or a hydroelectric power plant, the economic imbalance created by a net outflow of money from a country to a company is excessive – many times representing significant fractions of GDP. To address this imbalance, most countries impose Trade Credit Offsets which act a bit like a rebate. If, as a company, I sell a billion dollar power plant to a country, I am required to create $300 million dollars of market with the country in return. Historically this took the path of purchasing commodities, raw materials or components. Offsets can range from 25% to 100% of the nominal value of the contract and must be satisfied before the company can recognize the revenue on its balance sheets.

Over time, companies began setting up local subsidiaries for component manufacturing, assembly or service creating employment value which, in many instances helped deal with offsets. More recently – and most substantially used by China – technology transfer and know-how have become increasingly desirable by countries increasing their industrial efforts. Multiples are put in place to incentivize things like technology transfer which, in many instances receives a 10 fold multiple on its value as the offset satisfaction.

In fiscal year 2009, we identified over $5.2 billion in unsatisfied Trade Credit Offsets in Brazil. This number is staggering on a number of levels. First, what it means is that while Brazilian economic development professionals are running around looking for equity capital, they’re ignoring the LARGEST capital source in Brazil, created by Brazilian procurement and waiting to be deployed. Second, it means the supplier companies providing goods and services to Brazil are likely holding large amount of contingent revenue on their books (up to $20 billion) which cannot be recognized until satisfied. Third, it means that while creating offsets, Brazil is not effectively using this program for the fulcrum it affords. Brazil is paying premium price for less than they should be getting and they’re leaving untapped billions on the table.

So, I explained this in my meetings in Rio. Not surprisingly, people connected with Brazil’s largest corporations got it immediately. In many cases, their response was informed by the fact that they have suffered cost overruns and huge expenses from being overbilled by foreign companies who are passing along offset risk in proprietary pricing and financing. But regrettably, and to the round-about point of this post, the people in the public sector were frozen in disbelief. Their first response was, “I can’t believe what you are saying.” Frequently that response was followed by, “Why hasn’t anyone ever told me about this?” And then, my favorite, “Do you have a white-paper on this?”

I guess this is the point where I had my mini-epiphany of the week. A white-paper! Really?

If you had gone for three days in the desert without water and I handed you a bottle of water, would you first ask me to explain the chemical structure of water? Would you debate the importance of water and your lack of clarity around whether water is really as important as others say it is? And as you’re dying of dehydration, would you convene a committee to explore the merits of taking water given the possibility that it might be from the tap versus from a mountain spring in France? No. You’d drink the water.

I guess what struck me was the irony that people looking for investment – when confronted with capital far in excess of their wildest imaginations of capital for business development – chose to continue to pursue the proven failed model and walk past the largest capital asset the country has at its disposal. Which leads me to the title of my post “Give Chance a Hope”. It’s time that we give ourselves the permission to trust our observation of facts rather than rationalize consensus thinking in the face of wholesale evidentiary dissension.

Our current economic and social paradigms are heavily biased on propaganda. The controllers of the message become the arbiters of truth – even when all evidence stands in direct contravention. They are the hypnotists of those charged with leadership. In Papua New Guinea, I presented the Provincial Government of East New Britain with data from a mining company’s PUBLIC FILINGS on the stock exchange. This data explicitly said that the company was taking gold out of the country and not paying their required royalty. The mining company successfully prevailed upon the local press to publish a retraction of a report of the company’s own public filings. The Provincial Government cowered in the face of pressure from the mine. At no point did the government ever independently verify the news published by the mine on the company’s own website which confirmed their abuse. And the Toronto Stock Exchange, when informed of the same information, has taken no action against incontrovertible evidence of legal and financial violations.

Over 100 countries have been exposed to the Global Innovation Commons – a repository of open source innovations available for immediate deployment in the fields of carbon-alternative energy, agriculture and soil management, clean water, and tropical diseases. The vast majority of those who encounter the repository of OPEN SOURCE data remain convinced that they cannot use the information because it was once patented. Think about it. The very system which Thomas Jefferson established to SHARE information with the general public has been so thoroughly abused that the very basis of the social contract has been rendered unimaginable by the same general public. Over $2 trillion dollars of innovation, available for free, untouched!

Where’s the problem? Is the Government of East New Britain corrupt? Are economic developers in 100 countries corrupt? No, I think not. As a matter of fact, I think that the true failure is summarized most honestly by a gentleman representing my generous host in Brazil who had the decency of acknowledging, “We didn’t even know we could know.”

In the face of the self-proclaimed “knowledge economy” it is a moral failure to accept “not knowing” as a justification for the perpetuation of mineral rights abuses, inefficient energy technology legacies, contaminated water, food shortage and land degradation, and rampant disease. My friends in Brazil, Papua New Guinea, and over 100 other countries are not the problem – we all are. We must act to educate. We must inform ourselves and commit to sharing information with others. Start by getting the messages in this blog out to your friends and colleagues – look at the referenced data – draw your own conclusions and ACT.

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