Inflating Bubbles and the Coming Pin Prick

Recent conversations about inflation, consumer price index and confidence, and “recovery” in much of the G-20 have been fascinating and terrifying at the same time. I remind myself that the economists currently assessing the state of recovery are the same ones who “didn’t see” 2008 coming. I guess that may contribute to the terrifying side of the equation. The fascinating side is the lack of recollection of 1986 – 1994 negotiations around the General Agreement on Tariffs and Trade (GATT) which led to the 1995 creation of the World Trade Organization (WTO) on January 1 that year. One of the anchor tenants of the WTO was the non-discrimination objective on trade for products and services. Plainly, what this means is that no country is allowed (though they all violate the rule with countless caveats to the rule) to purchase based on favorable biases that which can be supplied by another at a better price. As we moved to a service industry, this meant that, to be competitive with qualified international bidders, companies in Occidental markets needed to reduce their cost of labor by reducing the average wage to one that reflects international competitor wages. However, as the recent wage dispute in China has brought into sharp focus, WTO failed to realize that this non-discrimination impulse (a major factor in justifying out-sourcing of labor to artificially deflate competitive pricing) would actually create a hyper-inflationary bubble that is about burst.

Some background will be helpful. If we had a Keynesian system working in a vacuum, labor, wages, productivity, consumption and monetary supply would all work in an utopian harmony. Consumers – both laborers and the public sector – would be constantly choosing to spend or save based on wages or revenue available to spend and the products and services that they would be purchasing would reflect an aggregate value compromised of cost of production plus a variable profit. However, a factor that serves as a spoiler in this utopian ideal is debt-based consumption both on the sovereign and personal level. For the life of the WTO, we have had an anomaly building which is coming to a terminal end. Occidental consumers (both public and private) have been consuming far greater amounts than would be appropriate in a properly functioning system under the myth that inflation has been held in check. And, devoid of any sense of consequence for future economic parity, have been deluded into believing that this hyper-consumption can be done on debt. However, there is a huge problem in this line of thinking purely on economic terms.

The Chinese labor pool, not unlike the Singapore miracle of 20 years ago, is beginning to seek greater wage parity with the consumers who are buying its products. Not surprisingly, this impulse is coming at the exact same time as the Chinese government is realizing that its exposure to U.S. debt is at an unacceptably high level. Further, it knows that its greatest threat to its very existence is the fact that millions of Chinese want to see direct benefit for their willingness to labor for the benefit of their collective debtors. In short, China is left with no option but to further invert their historical export activity to supply a greater number of domestic consumers. The recent increase in wages in China will accelerate a major global economic instability. By increasing wages, local purchasing power will increase. Revenue from taxes will also increase adding to the Chinese government’s economic reserves. Savings – especially those associated with pension programs will increase the amount of money held within the country for investment. This investment is already driving greater Chinese ownership of its own production base as well as the ownership of supply chains around the world. And ironically, this is where the bubble pops.

As early as 2004, reports of labor shortages were coming from China. That’s right. In a country of 1.3 billion people, there were labor shortages. These were not based on a holistic economic ecosystem however. The shortages were in labor willing to work for paltry sums to supply the Wal-Marts of the world. The Chinese workforce, highly motivated, educated and a bit pissed off by the fact that they were supporting a consumption orgy in the West, were seeking better paying jobs. For a few years, the Chinese government did little to respond. However, in the current 5 year plan, that’s changing. The manufacturing base in China is rapidly being transformed to compete on big ticket, high technology items. China just agreed to a $12 billion railroad project in Argentina. China and Siemens recently signed a joint venture on steam and gas turbines. And the list goes on in Pakistan, Africa, South America and Europe.

I recall a conversation that I had with President Bush’s Commerce Secretary Donald Evans’ staff before is farewell visit to China. Secretary Evans was going to do what U.S. Commerce Secretaries are famous for doing. He was going to go over the China and, with typical impudence, deride the Chinese for their lack of global respect for trade policy, intellectual property protection, and currency policy. I strongly recommended that his speech be modulated for fear that one day it would be used against us. That day has come. And inflation is just around the corner. However, that’s not our biggest worry. We’ve got far more at stake and all the inflation talk is a nonsensical diversion masking a much bigger monetary seismic shift.

In the coming few months, we will see that the U.S. economic interest in the People’s Congress is on the wane. One of the tell-tale signs of the coming change is the grossly misreported comments made by State Administration of Foreign Exchange. “Any increase or decrease in our holdings of US treasuries is a normal investment operation,” has been interpreted to mean that the Chinese are not going to pull the plug on our dollar. However, the $2.45 trillion of U.S. exposure sitting in Chinese reserves is going to be dumped at the precise moment when it is in the “fiscal benefit” of Chinese economic policy. And here’s where we come full circle to the GATT / WTO bubble.

Let’s assume that major power or infrastructure projects are going to be put out to tender. And, let’s assume that a Siemens / Shanghai Power joint venture is competing with, let’s say GE. Negotiations bounce back and forth and prices get within +/- 5% of each other. Concessions are being made and all the FCPA rules are being strictly monitored (oh, there I go being utopian). And just at the moment before a key award is announced, China dumps some U.S. Treasuries. This instantaneously adversely impacts GE’s cost of capital totally inverting the viability of the deal. China wins, U.S. loses. I wonder if our Commerce Secretary will be advising GE to suck it up and play by the rules when the best technology and price is on the other foot. Do you suppose that the U.S. Commerce Secretary will tell the U.S. public markets that we’re really happy to see China achieve the great objective of the WTO – poverty alleviation – as we watch the rest of our manufacturing infrastructure crumble into irrelevance? And when we realize that we forgot to protect U.S. intellectual property in Argentina because it was not a “viable market,” do you suppose our government will chasten the U.S. company’s oversight?

And inflation hits….. well, let’s see. I think that I have finally seen why the Mormons recommend storing up for a 10-year famine. I guess I didn’t realize that the dark horse of the apocalypse wears a yellow smiley face button under the “Welcome to Wal-Mart” moniker. We’ve got a fundamental day of reckoning coming. This judgment day is far less dramatic than the world ender’s would like. We’re getting to pay for 15 years of deflationary labor abuse and we’ll get to do so in very short order. We should have realized that our consumption cannot come on the backs of the world’s economically disenfranchised. Maybe we’ll learn to not repeat this mistake again.

Let’s stop worrying about nonsense economic metrics of an illusory past and wake up to what really matters – namely, our role as ethical, non-discriminatory members of a global market.

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What’s In Your Wallet?

I spent the past week in London, Zurich and Amsterdam. From a monetary and market evolutionary perspective, these three cities are synonymous with international capital exchanges, fear and uncertainty based risk management, limitation of liability behind corporations, collectively and respectively. While many monetary historians will lay credit or blame for today’s economic utilities at the doors of Italian bankers and traders, there can be little doubt that this week’s destinations did more refinement of our current capital dependencies and artifacts than all others when viewed over time and consequence.

My motivation was to write extensively on all three themes in this week’s post but I decided to simplify my thoughts around one theme. That theme presented itself in each of four specific moments of my trip – currency. Arriving in London from Washington D.C., I rifled through my foreign exchange stash that I carry with the vestiges of travels past. Thankfully, I found my £20 note which was adequate to buy our day pass on the Tube to get from Paddington Station over to Farringdon. However, the London transit authorities had not posted signage in such a way to alert a buyer of tube fare that none of the Circle Line or Metropolitan Line trains were in operation so, once spent, Colleen and I had the privilege of getting as far as Kings Cross and then walking several kilometers to get to our hotel. Having committed to a transaction that was meant to provide an expected utility my behavior changed and blisters on both of our feet were the consequence.

We stayed next to one of London’s great architectural artifacts of the Templars and I was reminded each day of the development of their demand notes that served to inspire the notion of central reserve backed currency. The building’s presence served as a point of reflection all week. I found myself reflecting on the fact I have come to use one of the most anonymous manifestations of their innovation realizing that, at the end of four days in London, I had used less than £100 in cash resorting to credit cards for nearly every meal, hotel, and cab. So, arriving in Switzerland, I had a wad of pounds and pounds of coins which I dutifully converted to Swiss francs – barely enough to get from the airport to downtown. I had to find an ATM at UBS near the Paradaplatz to get an equal sum for our airport return later in the day. I got Zurich’s currency bet almost right and left with CHF10 in the form of two large coins. In Amsterdam, I left the same way I came with the exact €5 note in my pocket having paid for everything there on plastic.

Spending a week in four currency zones gives you an opportunity to think about, well, currency. And if you’re like me, you can find yourself first amusing over the craziness of it all. For example, what genius came up with the idea of the £1 coin which is smaller than most of its pence brethren? Why do the Swiss have such an obsession with color on their notes? However, my reflections, courtesy of the ghosts of the Priory, went much deeper. In the final analysis, what does currency actually mean and what could I learn from this week’s destinations to think about currency assumptions?

Here goes. First of all, I think that currency, at its core, is a manifestation of the disintegration of community. When value was exchanged between suppliers and finished good producers, there was an implicit need to know the person with whom you were dealing. To succeed, you needed to establish, and be worthy of trust. And to be a surrogate of the transactions of others, you need to have the highest integrity of all. Beyond the mere recording of debits and credits, you needed to have a moral character which placed you above the seduction of holding and transferring the wealth of others. To be engaged in commerce or banking, you need to commit significant time to reputation – a phenomenon that has its highest value in community.

Reserve-based currency has given us the lazy, disintegration impulse to anonymize our transactions. When we hand someone a note or coin, one of the social messages we are communicating is a statement of finality. “By virtue of this payment, we’re done,” we are saying. We don’t have to remember what we may owe or be owed. In a tragic irony, we once exchanged things that had social value – gold, silver, or commodities. For close to two hundred years, we saw these be replaced by something with less permanence and no intrinsic value – paper. In our highly evolved state, we further reduced the exchange to a magnetic impulse using a legacy of the Third Reich – the linear magnetic tape. And now, a sizable number of transactions occur without so much as an artifact at all. Whether you’re ICAP trading $1 trillion of credit default swaps or you’re AIG holding counter-party risk, the exchange of most face value on Earth has been reduced to an entity-less phantasm.

On a recent flight across the United States, I was intrigued by what I believe could be an illegal announcement in light of U.S. inter-state commerce laws. If you wanted to eat or drink anything other than 100mls of Homeland Security approved toiletry liquid, you needed to “buy onboard”. But, we were informed, the airline no long accepts anything but credit or debit cards. We are living in a world which is rapidly moving towards an insidious phase in which the access to a bank card – which obviously necessitates a monopolistic mandate that every person MUST use a bank – is a precondition to engage in commerce.

Some of you may not get the message I’m trying to communicate but I hope those of you who do get it make a point to circulate this blog post or at least explain it to others. Our value exchange system has actually crossed an immoral and unethical tipping point. Currency advocates argued that currency itself liberated international trade and created a mode of access to markets. And, to some extent, while never done with equality of access, this had some evidentiary truth. However, in a time when the public taxpayer has had to pick up the tab for the anonymous greed of the bankers who control the utility of exchange with monopolistic insolence, the simultaneous reliance on plastic and e-commerce together with the ever restrictive fee based behavior of the banks is unacceptable. And don’t think for a moment that the recent financial regulatory oversight transiting the lobbyist oiled halls of Congress has improved the situation in the least. To the contrary, Congress has strengthened the monopoly stranglehold and has insured market hegemony for those who have earned no respect from what once was community.

Today it is time to change. We need to reconnect with the roots of impulses which acknowledged that trust is built on accountability and community. Whenever and wherever we can, we need to regain our willingness to participate in transactions of trust. You think you can wait for someone else to figure out this systemic failure? Think again. While I was in Papua New Guinea three weeks ago, I saw a community exchange cultural tambu (strings of shells) which have been transacted for over 20,000 years and, in the process, I saw tons of produce move between two communities. At the exact same time, a thunderstorm in Charlottesville took out power to most of the city and, for three days, most stores and businesses ceased to operate because the electronic payment and communication system failed. You tell me, which system works? You tell me, which system allows for equal access? The bottom line is simple. We’ve been blindly led into a system that enriches the fewest in history at the expense of all. Enough!

So your challenge this week is to actually do something that creates value for another and accept nothing but a promise of a future return from the beneficiary. See if you can. Most of you who read this will view my recommendation as a nostalgic utopian illusion. However I’m recommending this for a very good reason. Over the past several months, the U.S. and European governments have been vastly expanding the deployment of electromagnetic pulse (EMP) shielding in defense and communications installations. If our governments – once allegedly of, for, and by the people – are now protecting themselves from electromagnetic radiation (which could come from a detonation of a high altitude nuclear device or a burst of electromagnetism) – it means that our e-commerce system is on a collision course with a nefarious outcome. So we MUST learn how to operate now in a manner that shows that we the people will not be victims of the insanity of those who perceive they control power. Get practice now and, in so doing, you may be part of the humanity that actually creates a more honorable, humane system. At worst, you’ll start building trust and community.

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After the Fireworks – then what?

Some combination of gunpowder and metal was concocted about 1,000 years ago in China to ward off undesirable spirits. One thousand years later, it’s a bit ironic that the same country that gave the world this invention is once again on the verge of reclaiming its role as global economic super-power. Three short days after the last spark vanishes in the night sky over the Potomac River fizzling as it hits the water, the Agriculture Bank of China will finally price its Hong Kong and Shanghai IPO setting the world’s record for the largest IPO in history. It’s notable to realize that the record being broken is also Chinese – the 2006 IPO of the Industrial Commercial Bank of China (ICBC) – where approximately $21 billion was raised.

There are several factors about this IPO that are particularly notable. And I’m not referring to the fact that this record is being set by the bank that has been the iconic legacy of the Communist Party’s half century of countering the notion that capitalism is the only mode for economic prosperity. After all, this bank, established under the auspices of Mao Zedong in 1951, has not made its money through fiscal shenanigans and investment banking fees. A significant amount of its strength comes from the simple fact that there are more customers in AgBank than there ARE Americans. That’s right, this bank’s customer list actually eclipses the entire population of the United States.

More intriguing, however, is the list of investors in this IPO. A significant participation in this watershed event is coming from the Middle East – including reported interest from Qatar as a primary buyer. To be sure, the global interest is diverse including Temasek from Singapore as well as Singapore’s Government Investment Corporation, Standard Chartered PLC, Kuwait and Abu Dhabi Investment Authorities, along with Rabobank, Daiwa Securities and several Chinese household name stalwarts who are coming together to celebrate a clear global message about the bets being placed on the future. This IPO comes on the heels of the unveiling of more evidence that the much-hyped “recovery” in the U.S. and Europe was, as I’ve reported for several months, a façade supported exclusively by excessive government spending. With banking, manufacturing, and building life rafts inflated by careless monetary policy and reckless spending in Washington, the patches on the tires that were supposed to be our “road to recovery” vehicle have come off and we’re now on the side of the road.

For the record, we’re not going to come back. And, for the record, I’m thrilled about that. As Mao’s legacy is toasted in Shanghai and Hong Kong, we now have a moment to sit on the sidelines and take an honest stock of where we are. Ironically, in a desperate effort to evidence matriculation into the market control club, this IPO may be an indicator of hope for an even larger transformation – one that won’t be claimed by any “ism”. You see, the AgBank IPO means that China is following the too-big-to-fail path that led the U.S. and Europe into 2008 calamity. And it’s doing so at the same time that China is going to establish policies to encourage spending rather than savings. The legacy of individual savings – a policy and social phenomenon that helped grow Chinese banks – is going to shift to spending as global export demand weakens. Internal demand is going to expand and internal consumption – supported by recently upwardly adjusted wages – is going to increase. In short, what made the AgBank so successful to date, is a dynamic that was unsustainable.

To be clear – a lot of people are going to make a lot of money on this IPO. And, AgBank is likely to continue to persist as one of the world’s most powerful banks. However, the Chinese economy generally is repeating a systemic risk that contributed to the failure of the U.S. and European banking infrastructure. The Chinese banking environment is well-suited for agriculture and manufacturing businesses where hard assets are the core of productivity. However, as China has shown from its decade-long failure to effectively deploy its compulsory technology transfer assets (required from multi-national corporations seeking to sell technology to the Chinese government), it is ill-equipped to transition to an innovation-based economy. China holds more of the world’s cutting edge technology rights than any other country. However, the National Development and Reform Commission still has no clear visibility on what it has and how to put it to use. In fact, in the 11th Five Year Strategic Plan of the Communist Party of China, they officially promote “independent innovation” as a core objective in a world where collaboration has been proven to out-perform proprietary impulses at every turn.

So, on this July 4, 2010, we can watch our tribute to China flash against the darkening skies. We can puzzle over the irony that we picked a Chinese invention to mark our self-proclaimed but never fully actualized “independence”. And then we can wake up tomorrow and realize that an era has ended. And as with every end, this merely means that there’s a new beginning. Not only will the AgBank IPO possibly set the largest record – it may also be one of the last of its kind. Like world-records when the world went from yards to meters, some records aren’t broken because the measurement changes rendering the old metrics irrelevant. And that’s the time we’re in right now. The measurement which allows a Mao legacy bank to eclipse all capitalist-generated IPOs is comic, ironic, and evidence that change is upon us. The real challenge for us is to have the courage to walk away from the pointless metrics of value that led to vast wealth disparity and begin constituting reciprocal knowledge networks that perpetually benefit whole communities. And when we begin that journey, we’ll be less interested in independence and more tuned into interdependence. We’ll be less motivated to burn gunpowder and metals and we’ll be more motivated to see an unpolluted sky. Maybe when it’s done setting capitalist records, China will become a land that fosters a new experiment – one that collaborates on a more integrated future where people and their ecosystem can thrive.

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On Second Thought

I left Brisbane this morning and landed in LA four hours before I left. During my flight across the expanse of the Pacific, crossing the dateline and the Equator in relatively close proximity, I read R. Buckminster Fuller’s And It Came to Pass – Not to Stay by the light of the nearly full moon. This treatise concludes with the following:

“Special-interest sovereignty will always
Attempt to monopolize and control
All strategic information (intelligence)
Thus to keep the divided specializing world
Innocently controlled by its propaganda
And dependent exclusively upon its dictum.

Youth have discovered all this
And is countering with comprehensivity and synergy.
Youth will win overwhelmingly
For truth
Is eternally regenerative
In youth.
Youth’s love
Embracingly integrates,
Successfully frustrates,
And holds together,
Often unwittingly,
All that hate, fear, and selfishness
Attempt to disintegrate.”

My trip concluded the second year of our internship program – the Heritable Innovation Trust – during which we expanded our work in Mongolia and Papua New Guinea with the bold contribution of seven young people. Ken Dabkowski worked with Ts. Enkhtuya and me in conducting initiation visits in the South Gobi and Arkhanghai provinces in Mongolia. Katie Martin, Caitlin Boyd, Lewis Caskey, Shannon Augustine, Rod Jackson, and Elspeth Missel worked with Theresa Arek and the team expanding the PNG Heritable Innovation Trust in communities throughout East New Britain. From ice waterfalls in Three Beauty Mountains in South Gobi to the summit of Tavurvur – Rabaul’s active volcano – youth won! And in the next several days, the Heritable Innovation Trust will once again replace ignorance with intelligence enabling more of the world to engage with itself decreasing dependency on the propaganda of special interest sovereignty.

Having two days in one gives me considerable time to reflect on this week’s post. There is so much about which to write. I could fill countless posts with each day’s experience. However, I wanted to briefly share with you our day at the volcano for in this day are countless parables.

Before dawn, the stilted house shook with one of the many earthquakes that dance under Matupit Island. This one was over 5.0 on the Richter scale. Not that scales matter too much when everything is built on forgiving meters of ash. An earthquake rolls along rattling the few windows which have not been replaced with layers of plastic vainly attempting to block the ever-present ash. A glance into the dawning light revealed a plume of steam rising from the caldera. Silently.

The boat came and with it a flood of young children wondering what 7 strangers were doing waking up in their village. After all, since the eruption, the villagers have been told to leave their homes and move to relocation centers. Visitors from the outside – from America – don’t stay the night in Matupit. They stay in the resorts a safe distance away. But this morning, 7 strangers woke up from a moon soaked night in a village where life persists as it has since before there was history.

Our first stop was at the southeast side of the volcano where 8 brightly colored dugout canoes were beached. Their occupants were up in the ash fields digging Megapod eggs. The Megapod birds – barely larger than a chicken – lay eggs that are buried at depths of two meters in the volcanic ash. Incubated by the volcano’s geothermal dynamism, no shortage of birds or eggs here! The eggs are substantially larger than a chicken’s – more like a big duck egg. And the yolks are immense – filled with protein and fat – making them ideal food for the local community.

After being told how to identify a fresh nest, I was invited into a hole that measured about 1.5 meters across and about 1 meter deep.

“Start digging,” was the simple instruction.

About half a meter further into the ash, a side wall of the hole caved in burying my legs to the knee.

“Sometimes the diggers are buried in these holes and die,” I was advised.

Not necessarily the most comforting thought but, with five people standing around the hole, I took some reassurance that they’d at least know where to dig to find me if I succumbed to the shifting earth. And then, closing in on two meters down, it happened. I removed a spade full of ash and there was a glorious egg. I was elated. No Easter basket ever held such wonder as a Megapod egg at 2 meters below the surface of newly formed earth. Before long, four eggs were sitting on the surface. Four eggs which could feed a family for a day. Four eggs which could be sold at the market for 8 kina or about $2.50. That could buy a tin of meat or a small bag of rice.

“We don’t touch the birds,” explained Oxy. “They care for us and give us plentiful food so we honor them. Our people know that these birds are here to give us strength.”

From the depth of the nest, we were invited to climb the volcano. To the summit! At first, the climb was up a modest slope heavily rutted by deep gullies. Then the grade increased. At times the combination of the steepness and the ash and pumice made hands as effective as feet in scrambling past sulfurous vents. A massive swarm of bees nested by a steam vent about two thirds of the way to the summit. The sun-drenched black ash and rock was relatively cool compared to the golden crystalline earth where steam intermittently burst from the ground. On bare feet, the nature of rock, ash, and heat were acutely evident.

And then the summit. Standing on a narrow ridge and looking to the south one could see the vibrant colors of minerals, ash and mud in the Rabaul harbor. Across the water was the greening blast zone where life is beginning to take root in the ashes of years of eruptions. At the base of the mountain, diggers persisted in their quest for eggs. Perched high on the lava flow, the Megapod birds sat and called to each other. To the North…

Plumes of steam rushed up the crater wall depositing minerals as they raced towards the azure sky. Iridescent colors – yellows, greens, and bluish whites – highlighted the contours. Beauty everywhere!

Experts will tell the people of Matupit that they should leave. After all, they live in a geologically active zone. “It’s dangerous,” they’re told. However, if you sit at night around the fire in Matupit you hear a different story. It was the grandfathers and grandmothers who knew to leave the island before the cataclysmic eruption when all the seismologists and geologists were saying that there was no need to move. Their movement – not modern scientific “knowledge” – saved thousands of lives. They know what sound in the earth portends a destructive eruption and, if you live with them for a night in their homes, they share this information with you. The community knows when the fish spawn and when millions of fry can be netted to provide much needed protein. The community knows how to live in a place where others would perish.

Like the nomadic camel herders in the Gobi Desert, the people of Matupit are not victims of a natural disaster. Rather they are keepers of a knowledge that we all need. Whether its climate change and desertification or a super volcano in Yellowstone, humanity should see wisdom keepers rather than victims. If we were wise, we would learn the elegant simplicity of finding the abundance in violent changes and learn the lessons of grateful adaptation. By naming a volcano a disaster, we rob it of its ability to teach. By seeing those in its reach as victims, we blind ourselves to the grace of evolution which is an inextricable part of humanity’s development. Sure, we could abandon Matupit and in so doing lose the capacity to think again. Or you and your friends could work with us to create humanity’s classroom at Matupit and, in so doing, insure a future for humanity in the face of coming change. Think again, maybe for the first time!

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Questionable Democracy – In ? We Trust

Mongolian President, the Honorable Ts. Elbegdorj addressed the Fair Mineral Development Roundtable hosted under the auspices of his office and the World Economic Forum this week. Would that more heads of state have the ability to articulate sovereign and public interest with the clarity and pragmatism evidenced in his remarks! Rarely have I seen as concise and unqualified a statement from a public servant than the remarks made by the Hon. D. Zorigt, Member of the State Great Hural and Minister of Mineral Resources and Energy when commenting on the mineral laws of Mongolia. In both instances, the refreshing clarity centered on the stated recognition that “best practice” laws drafted over the last 20 years, in consultation with foreign interests, have exposed Mongolia to significant disadvantage. Only now are Parliament members and the public and private sector realizing the full extent to which the laws were drafted to favor mineral and energy extractors to the detriment of the public interest.

For readers of InvertedAlchemy, the irony will not be lost that, during the same time as my meeting with the leaders of Mongolia, BP’s CEO was foundering in his testimony before Congress on the nature of liability and responsibility of the extractive industries when things go poorly. Further, the government of Australia is fanning populist flames to support their proposed revised tax scheme on mining companies which, according to analysts from Morgan Stanley, will jeopardize many future developments. And, I’m currently writing this entry from Papua New Guinea where the Prime Minister (yes, the same one that’s been heralded as a hero for his REDD campaign to placate CO2 polluters) pushed through an amended environmental law that greatly reduces accountability for polluting the sea. It’s almost beyond belief that the government of Papua New Guinea, under the glaring light of the BP global brand debacle, would choose such poor timing to make rules less stringent.

Four years ago, I stated that my analysis of the global markets indicated that by 2010, the U.S. dollar would be in such weak condition and the euro would be inadequate to pick up the slack so as to open the possibility of a move by China to push a commodity basket-backed reminbi. Well, the International Herald Tribune today, Friday, June 18, 2010 loudly confirmed that analysis. Chinese leaders are warning the G20 not to bring up currency at the upcoming meeting or face “serious global economic consequences”. The U.S. and Europe have finally awakened (albeit, too late) to the error in the Jack Welch era out-sourcing wave. You see, the “we’ll always be the innovator” thesis that justified the risk of outsourcing manufacturing assumed that resource scarcity would be controlled by Western markets. However, quite suddenly, the tables are turning. Beryllium, cobalt, copper, gallium, indium, germanium, gold, graphite, magnesium, platinum, tantalum, tungsten, and uranium – all minerals that were safely controlled by post-Bretton Woods arrogance are now controlled by China, Russia, Congo, Brazil, Mongolia and others who were left out of the club for the last 50 years. It would not be surprising to see China reinstate a gold or hybrid metal standard as it seeks to manage its risks on dollar and euro historical exposures. And when a key infrastructure development project to what could be the world’s largest gold / copper operation in Oyu Tolgoi in South Gobi, Mongolia is a 105km road to the Chinese border, it doesn’t take a PhD in geopolitics or economics to realize that commodity control is about to take a serious and unquantifiable turn.

It was, however, at the Ulaanbaatar roundtable this week, when I saw galvanized a series of critical information failures which led many in the roundtable to revert to basic questions about the adequacy of representational democracy in countries rich in minerals and energy resources. Questions of nationalization vs. “free-market” were met with NGO mistrust in the transparency of asset dispensation. “Trust” and gold, copper, and coal, seemed to make poor bedfellows.

I will summarize five themes where I observed situations in which the “wrong” questions and assumptions gave rise to heated debate around the “wrong” answers.

First, lack of understanding of the cost of equity. As presented in the meeting, the Mongolian government purchased equity in the Oyu Tolgoi LLC (“OT”) mining operation. The equity was purchased with debt which is running up interest well in advance of any productivity. Not unlike several of the Papua New Guinea and other national cases where we’ve seen government equity purchases debt financed by the likes of the Commonwealth Development Corporation, the European Investment Bank, and the World Bank and its sister organizations, the belief is that somehow equity means benefit sharing. Nothing could be more misleading. Few things could do more harm with respect to mal-aligning public expectations and actual outcomes. Mongolia’s interests are in the LLC operator – not in the corporations which will manage the profits and see their stocks rise on the back of the country’s extracted wealth. Ivanhoe Mines and Rio Tinto – and their shareholders – will see their stock price appreciate many times while the LLC remains an illiquid debtor / operator. Everywhere I went, I heard the public perception that Mongolia was going to start reaping the benefit for its equity far sooner than possible. And remember, if their shares ever do have value, the first beneficiary is the debt financiers, not the people.

Second, lack of understanding about “local investment”. Like many other cases around the world, the OT investment agreement called for significant employment and contracting revenue to come to the citizens and Mongolian corporations. However, if one examines how much of the billions of dollars that are being “invested in the country” are actually building wealth for Mongolia, the numbers tell a very unfortunate, tiredly predictable story. Chinese, Korean, Russian, European, Japanese, and American companies will see their revenues rise as they contract services and supplies. Further, much of the “local” attributed expenditures are actually the employment of expatriate consultants and contractors engaged in projects for community benefit. Their compensation (usually at a salary plus hardship premium) is often attributed to country benefit even though the actual compensation flows out of the country. OT made a laudable commitment of up to 90% local employment which represents a larger commitment than most. For this, they are heartily commended. Mongolia could have been better served by asking for a proportion of compensation – not body count – as the local labor force typically represents a miniscule fraction of the expat executive compensation. Body counts are one thing; actual compensation is the true economic metric.

Third, lack of visibility regarding corporate structure and accountability. In every country where we’ve worked, neither the local level nor national government seems to take sufficient time to understand how far removed their subsidiary corporate counter-party is from the actual control of profits and operating decisions. While the media and general public hear about the multi-national entity whose name is attached to the project, there is a general lack of clarity on the fact that neither the listed company’s nor the capital provider’s success in the broader market have any bearing on the direct benefit flowing to the country. Board decisions, control of disposition of assets, and allocations of revenues to generate dividends are typically made well outside the operating corporate structure in which the country has participation.

Fourth, lack of capital markets visibility. The money to be made in mining is far removed from the mine. The promise of the “largest” gold and copper mine creates wealth in public equities like Ivanhoe, BHP, Rio Tinto, and others in listed share price appreciation – not their balance sheet. Infrastructure finance benefits bond issuers and traders through fees and commissions on trades – not in-country businesses or the public. Once in production, it is commodity traders – not the suppliers – who make the most traded wealth. Yet time after time, countries are lured into believing that somehow their ownership is going to create a pathway to wealth creation. In the absence of the ability to participate in equities and bond liquidity-based trading, countries are saddled with debt-financed, encumbered equity, operating liabilities and pro rata financial obligations, and very disillusioned citizens.

Finally, lack of market-appropriate tools. Most countries have little more than license, royalty, and tax as means to capture some benefit for the loss of extracted minerals or energy. When they realized that they’ve been disadvantaged, they revert to the globally unpalatable (though popularly expedient) actions like nationalization of licenses on producing properties. And if they raise taxes, demand more royalty participation, or nationalize incompletely considered and illegitimately granted licenses, they are penalized as not being stable business environments thereby diminishing standing for foreign investments and partnerships. All too often, the rule of law is eclipsed (as it has recently been in Papua New Guinea) by expediency where the short term empty promise of benefit concedes lax regulatory environments where public interest is subordinated by misinformed public officials to placate unethical demands from corporations.

Against these challenges, most paths lead to the decision to succumb by a few public sector officials who are co-opted for their own personal gain while they abandon the public interest they’ve been elected to promote. Corruption, beginning with multi-national corporations who see uninformed governance as a weakness to exploit, is a frequent utility in this expediency-driven model.

Could there be a different path? Would it be possible to get it right?

Yes. Countries and their mineral and energy ministers could demand that the counter-party in benefit sharing be the listed company or demand a equity tracking benefit that would allow for monetization of the early equity appreciation immediately post announcement of resources and immediately post the granting of production licenses. Countries could demand that they are compensated on the applicable market appreciation in the equity, bond, and commodity markets attributable to their market contribution. Countries could demand that their counter-party signatories be the senior listed company (the holding interest) rather than the shell subsidiaries from which benefit can be easily shielded. Countries could set compensation and contract REVENUE requirements rather than relying on the antiquated body-count requirements. Countries could demand the implementation of Trade Credit Offset equivalent programs for competitively bid contracts where local businesses could be nurtured and grow into scalable suppliers and partners with capacity building, training, and technology transfer. And, are you ready for this? Investors could actually demand that the companies in which they invest are held accountable for misleading and unethical business behavior including fraud in negotiating, contracting, and environmental and community accountability.

What has been historically labeled as sovereign risk could be cured by actually placing indemnity issuers in mineral and energy rich countries so that the financial incentives of contract stability are actually aligned with all actors. By linking financial and risk management business – required by any multinational corporation’s shareholders to the country in which business is being done – economic literacy and benefit can grow and the operating environment can be stabilized.

And, it’s important that we get this right. You see; if we don’t actually take responsibility across the board – investors, corporations, and countries – we will galvanize a public response that is already fueled with mistrust built on expectation misalignment and abusive experience. Democracy is not possible when the public is not informed of all the facts. Those who promote democracy but insist on the preservation of secrecy and willful ignorance are simply insuring their own demise and accelerating the same. If we’re going to see constructive international market development in the coming years, the only thing we’ve got left is an attempt to innovate ethics into our capital markets. If we don’t, expedient actors who are resource hungry will innovate their own model and we all will be the poorer.


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The Poverty of Nations and the Visible Hand...of?

Boarding the plane in Dalanzadgad for our return flight to Ulaanbaatar, I ascended the stairs behind an Australian who was sporting more corporate logos than entirely necessary. On his shirt was the logo for Mitsui Coal, on his coat, Hitachi and on his carry-on, a mining company.

“Whatcha doin’ here?” he asked.

“Working with the local camel herding communities to understand their connection to the regional and global market and ecosystem, and the local groups that are working to deal with desertification on the Gobi by re-planting Gobi trees,” I responded.

“Ha,” he scoffed. “We’re just here diggin’ holes like we do everywhere. We’re not much worried about trees.”

I settled into 8C on the Saab prop plane for the 500km flight back to Ulaanbaatar and watched out the window as we taxied down the runway and lifted off into the setting sun. Looking out of my window, I saw the horses, the spring and lake where Batbayar (“Baidi”) and his wife Jaagaa are planting 20,000 Gobi trees and the endless steppe (see the Heritable Innovation Trust Post from today). I saw the horses pasturing in the lush green of the water that dots the vastness and I reflected on my first trip to this amazing land.

To the rest of the world, South Gobi is a land of untapped potential. Coking coal, gold, copper and other metals are the generous legacy of the once forested land where trees, dinosaurs and vast seabeds once covered the land. Out in the Sand Mountain region to the west of Dalanzadgad, the plain is broken with huge cliffs and canyons where you cannot help but step on fossil after fossil – each footstep a decision between one piece of coral still layered in the fossil record and one that was washed out with the last rain. Every now and then you find yourself encountering lava and evidence of the volcanism which brought huge mineral deposits near the surface.

In this land - quite similar to Utah or parts of Colorado - humanity is replaying its predictable, tired addiction. A land of “natural resources” has evoked the Adam Smith impulse to see the value of this place by the sum of its subtraction. President Elbegdorj has seen countless other countries fall into the Resources Trap (referred to in an earlier post from Paul Collier’s work) and has chosen to take a different path that includes more domestic benefit for the country’s resources. I wonder if the Parliament and the President of Mongolia are willing to take an even bolder step. I wonder if they would have the willingness to lead the world into a new capital system where people actually live without extracting the last ounce of gold and ton of coal.

What we know is that the story of BP in the Gulf of Mexico – now day 50 – is the unifying story of the last 234 years. As I type this post, CNN International stated that BP is considering all options to cap the hemorrhage of oil – including the nuclear option. And we, the willing, gullible consumers of 24 hour news are supposed to sit by and accept as we are hypnotized into the belief that somehow or another bombing the seabed is an option? And whether it’s a nuke on the seafloor or the growing use of cyanide and heavy metals to feed the gold addiction that is now toxifying some of the most scarce water resources on the planet in the Gobi desert, we rush on.

For the record, the two volume publication of Adam Smith’s work in 1776 was titled, “An Inquiry into the Nature and Causes of the Wealth of Nations.” His “invisible hand” was a reflection of the state of moral philosophy which gave rise to revolution in the Americas and the challenge to monarchists in Europe. His work was social commentary – not a declaration of truth. And so for us to respond to the Pavlovian glockenspiel in seeing Mongolia as the place where mining companies and their technological minions (like Caterpillar, Hitachi, Mitsui, and others) supply the last syringes in the crack house of our addictions are the winners is fitting on a day where we also see a tactical nuke on the seabed as an acceptable option for containment of an oil disaster in the gulf!

Are we better than this? Are we willing to stop wringing our hands in Washington D.C. and Louisiana about oil slicks and actually do something? Like, stop all BP equities trading so that the company knows that it must apply all of its efforts and resources to stop the leak and, until then, it’s quarantined? Like identify every deep water well or extractor and immediately require retrofits to insure that this cannot happen elsewhere? Like requiring all stock exchanges to list only those companies in compliance with International Council for the Exploration of the Sea guidelines and have sanctions, including full financial liability and profit disgorgement, for those who are in violation BEFORE they toxify the seas?

See, if we actually priced in the cost of the consequences of actions – like the cost of water extinction in the Gobi desert – we’d realize that Adam Smith was wrong. Sanctimoniously calling “greed” the “invisible hand” doesn’t make it better. It just makes it palatable for a moment. We are better than this. We can transition to another reality – not through activism but accountability. I can’t wait to see the first mine that actually honestly reports all costs, discloses all benefits, and spends as much time thinking about the extinction of the resource as it does about quarterly profits. And I can’t wait to see a commodity market in which trading premiums flow to those products sourced from Accountable Commodity suppliers. Transparency is the first step and action is its corollary. And rather than waiting, we’re going to see if it can be done. More on that later.

When I’m back from the remote western regions of Mongolia, you’ll hear from me again. In the meantime, share this and last week’s post with those you know and let’s start moving to another future. The hole has been dug deep enough! Let’s start planting new seeds.

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Tradewinds, Gates Foundation, and Black Gold: Follow the Money

“A commitment to excellence in all that we do.”
“Integrity and respect in our dealings with our clients, colleagues and business partners.”

These are a few of the principles promoted by Tradewinds Global Investors. With a reported $27.6 billion of assets under management, I was intrigued by these principles in light of the places where Tradewinds’ “integrity” has placed their money. The reasons I found Tradewinds Global Investors interesting is both their stated Core Values and the company they keep. Their reported positions include two notorious environmental nightmares – BP (NYSE:BP) and Barrick Gold (NYSE: ABX), one of the major owners of the Allied Gold (ASX: ALD; AIM: AGLD).

In fairness, I should point out that a current review of BP’s ownership includes quite an interesting fraternity including: Wellington Management Co., State Farm, T.Rowe Price, Bill and Melinda Gates Foundation, Vanguard Funds, Fidelity Diversified International and several banks. Wellington, Fidelity and State Farm share the fraternity of owning Rio Tinto (NYSE: RTP) along with TD Asset Management. Under another arm of TD – this time TD Securities - Barrick’s ownership fraternity includes Blackrock and Capital Research Global Investors.

As we approach the 50 day mark on the BP oil spill, I wonder if anyone finds it ironic that Nautilus Minerals (TSX: NUS), at their May presentation to the Offshore Technology Conference in Houston TX celebrated the “minimal” impact risk of offshore extraction. They proudly announced that, “Nautilus Minerals Inc ("Nautilus") is following the lead by the offshore oil and gas industry to tap vast offshore resources.”

As I sit here in Ulaanbaatar, Mongolia, I find myself amused by the observation that the Capital Market System that appears to be failing at present, if the truth be told, really never worked at all. You see, somewhere between 401(k)s, insurance and bank reserves, stock exchanges, and operating businesses, we made it o.k. for people to assume that they’re making investments which, in turn, build wealth. However, what we’ve really done over the past several decades (at least) is insulate those who are “building wealth” from any visibility into the costs of that wealth. While residents of the Gulf coast in the U.S. are rightfully upset as millions of gallons of oily sludge wash up on their beaches, are any of them connecting the dots and demanding that their retirement fund managers STOP pouring money into companies that operate in a careless fashion, indifferent to ecosystems in the interest of making the bottom line as fat as possible?

In an era where we hear about “financial reform” and “increased transparency” in the capital markets, where are the calls for stock exchange regulators to assist the public in getting to the truth about how their profits are being derived? And you, the reader, where are you in demanding that your investment intermediaries actually abide by their lofty public relations and marketing “core values” while they continue to support companies who operate with indifference to humanity and the ecosystem? When Warren Buffet has the audacity to dismiss the economic crisis as an undetectable market anomaly (save for, in his words, “a few Cassandras”) where is the U.S. Congress’ or the White House’s resolve to actually inquire of the Cassandras as to where, when and why they saw the big one coming?

You see, I think that we’ve gotten lazy. And worse than that, I think we’ve decided that our comfort – built on an illusion of our insular, sterile world – is more important than actually finding out from whence our comfort comes. I think that we’ve gotten quite content to let our discount electronics consumption ride on the now suiciding labor force in China where working conditions are so detestable that employees find killing themselves more desirable than making the next HP or Apple product - a situation that Steve Jobs reportedly finds "very troubling." Really?

I had the chance to meet with some of the community development team of Rio Tinto’s mining operations here in Mongolia. While many people mistake me for just another activist opposed to extraction on principle, what we did this week is to have a discussion about how things could be changed here so that mining and social values could co-exist. Am I convinced that the ground water will be more preserved, that communities will gain greater benefit, or that the environment will be spared? Not yet. But what I did reconfirm is that when people sit down and learn from each other – actually listening and conversing – productive steps are possible. More importantly, I confirmed that, if an average human being actually wants to gain more visibility into what a company is doing, it’s possible. It involves getting off your couch and going to see the impact that your money is making.

I don’t know the folks at Tradewinds. I have no idea whether they are indifferent to human values or whether they’ve just made investment decisions based on quantitative inputs in impersonal matrices. I don’t know if they’ve spent time on the Gulf coast helping clean up the oil spill or whether they’ve been pressuring BP to still declare a dividend and get on with making money. I don’t know if they’ve seen the villages displaced by Mark Caruso’s water diversion in Simberi (Allied and Barrick Gold) which has turned the airport into a flood plain and has turned local gardens into swamps. I don’t know if they know that their “community relations” budget included the employment of mercenary paramilitary assets to deal with community relations. But I do know this. If we are ever going to turn around the insanity that blights our current state of humanity, we better get involved in who is putting our money wherever it’s going.

Any of you who want to ask specific questions about where your money is being invested and who are willing to do so in the comment section of this blog, I will be more than happy to share with you my experience on the ground (and invite others to do the same). Even a gold mine can operate with ethical principles if those who put their money into it make “all-in” value a priority for management. We can do better, and for the sake of the world, we must. While we watch China expand its reach over the control of the world’s resources, we can lay the foundation for earning the accountability that we’ve neglected far too long. If we wish to have any moral authority to offer commentary on what has already been behavior defined by expediency, we better earn that voice.

Wake up!

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