Ending the Era of Ponzi Finance

Ending the Era of Ponzi Finance

          
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Ending the Era of Ponzi Finance

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  • Negotiating the Fallout

    Implementing these ten steps is absolutely necessary to resolving the developed world’s Ponzi scheme. Everything depends on a fast and decisive solution to the debt crisis. Politicians alone will never be able to embrace this agenda on their own—as Jean-Claude Juncker, prime minister of Luxembourg and president of the Euro Group said recently, “We all know what to do, we just don’t know how to get re-elected after we have done it.” Therefore, they will need the active support of the business community and other stakeholders. Depending on how the elites of the developed world respond, there are four potential scenarios. (See Exhibit 8.)

    exhibit
    • If neither their debt problems nor their longer-term structural issues are addressed, the developed countries will face a secular crisis, with increasing social unrest and risks to democracy and the free market. Call this the Rome scenario.

    • If the developed world addresses its long-term structural issues but does not solve the immediate debt problem, then that debt will be a permanent drag on economic growth, resulting in reduced GDP per capita. This is the scenario of long-term economic stagnation.

    • If the developed world is able to eliminate the debt overhang in the near future but does not address its long-term structural issues, it will have missed an important opportunity. The result of this scenario of missed opportunity will be a sluggish recovery, increased social tensions, and reduced GDP per capita.

    • Finally, if the developed world both resolves the debt crisis quickly and undergoes a thorough structural adjustment, it will be able to return to a path of sustainable growth and social stability. Needless to say, the whole purpose of this paper has been to encourage the developed world to embrace this scenario of a return to growth.

    How can senior executives navigate this uncertain future? The initial reaction—particularly from those who run companies that are active in global markets—might be to acknowledge the facts described here but to see no immediate relevance to their own business and strategy. Some might even say that the current strategy of expanding in emerging markets is sufficient to weather the storm. Although regional diversification has to be part of the answer, it will not be enough. In order to deal with the implications of the necessary adjustments and to benefit from the changes, companies have to do much more.

    They have an enviable starting position. Despite the ongoing debt crisis in the developed world, companies in the U.S. enjoy record-high levels of profitability, with profits currently representing about 12 percent of GDP. Profit margins of European companies have increased since 2008, returning in 2011 to 2005 levels. Apart from 2006 and 2007, higher margins have not been recorded since 1981. It is only Spanish, Portuguese, and Greek companies that have been significantly affected by the broader macroeconomic situation.

    But for how long will companies be in a position to earn such high margins—especially when private households and governments need to deleverage? Either the economic crisis will worsen or governments will increase taxes to deal with their debt problems. High profit levels will not be sustainable unless companies also find ways to contribute to the solution by identifying and investing in new opportunities for profitable growth.

    Prepare for the new world. Management teams need to develop a point of view by developing a scenario of the coming years of change. Such a scenario should include, among other things, a two-speed economy with low growth in the developed world and higher growth in emerging markets; a greater propensity on the part of consumers to save and, therefore, to consume less; higher taxes; more cautious approaches to financing; and the paradoxical combination of low interest rates and high inflation risk.

    Only by assessing the implications of such an environment for their organization will executives be able to define the right actions to take. They must review and stress test the corporate balance sheet. Inflation is likely, but a company’s capital structure should also be able to weather a scenario in which severe constraints on financing return and demand falls, causing persistent low or even negative growth.

    Protect the core. It is most important to protect the company’s current position and competitive strength. The financial crisis is far from resolved, and the issues laid out in this paper will require significant action. Companies must reduce their vulnerability to shocks by reducing costs, creating a solid balance sheet with sufficient financial room to deal with another recession, and accelerating regional diversification to benefit from higher growth in other markets.

    Be part of the solution. It will not be enough to lower costs and participate in growth in other regions. Companies need to to play an important role in generating and supporting the required growth in the developed world.

    • New Products. Innovation will have to play an important role. The challenges of the future—increasing health-care costs, scarce resources, efforts to protect the environment—all require new answers and new products and services. Companies that contribute to the solution to these problems will be able to generate huge profits; they may even be part of the next industrial revolution.

    • New Business Models. The new world of less growth, less consumption, and older people will require new business models. There will be a need not only for different products but for different solutions to social problems. Companies should find ways to profit from economic and demographic trends. These trends will boost demand in some industries and change the demand structure in others.

    • New Ways of Doing Business. The changes described in this paper will result in new demands from the larger society. Companies should respond to these demands. For example, companies that adapt to the needs of older workers who have had to delay retirement will be helping to overcome the shortage of qualified labor and to increase workforce participation overall. Those companies that adapt first will have a competitive advantage when the shortage of labor becomes more acute. Companies also need to review their performance targets. Sustainability will gain in importance and should be translated into tangible business-specific goals against which the performance of top management is measured.


    The challenges described in this paper are far too big to be resolved by politicians alone. They require the whole of society to stand together, share the burden, and define the path forward. Company leaders must play an important role in this discussion. But they will have to look beyond their immediate business needs and shareholder interests. As the Ponzi scheme deflates, the only way to achieve a good outcome will be through cooperation.

    According to Thomson Reuters Datastream, EBIT margins for European listed companies reached 13 percent in 2010 and 2011.