Sunday, December 28, 2014

Great Leader Chair

If your actions inspire others to dream more, learn more, do more and become more, you are a leader - John Quincy Adams, 6th US President

Leadership is an amorphous concept. The oxford dictionary defined leadership as, “The action of leading a group of people or an organization, or the ability to do this.” The concept of leadership has been oft debated in recorded history from Plato’s Republic to modern day research. And, given its enduring importance I set out to discuss it once more.

The Prime Minister of India governs by the force of the mandate given by the people of India. This social contract is based on the evolutionary need of the populace on the time, which in a democracy evolves and finds representation much faster. But different states differ in the manner they provide legitimacy to their leadership to govern. For example in Saudi Arabia, the power is shared between the Al-Saud and Al Shayk family (descendants of Muhammad ibn Abd al-Wahhab founder of Wahhabi form of Sunni Islam). The Al-Saud family governs the country politically while religious institutions owe their allegiance to the Al Shaykh family. "This oasis is yours, do not fear your enemies. By the name of God, if all Nejd was summoned to throw you out, we will never agree to expel you" said Ibn Saud. Muhammad ibn Abd al-Wahhab replied, "You are the settlement's chief and wise man. I want you to grant me an oath that you will perform jihad (holy war) against the unbelievers. In return you will be imam, leader of the Muslim community and I will be leader in religious matters." The ulema (Muslim law scholars) exert wide spread influence in turn reinforcing the legitimacy of the Al Saud family. When the Soviet Union collapsed, Eastern European states which were governed by Moscow without their ‘will’ splintered. Similarly, Iraq or Syria having a population with divided identities will struggle for decades to produce a legitimate leader. These countries have and will with their current geographies be governed by force alone thus producing cycles of instability – force will define legitimacy. Consequently, legitimacy of leadership is the first leg of the Great Leader Chair.

All politics, from organizational to international, is a struggle for power. The accomplishment of ultimate aims of leader is determined by the power he individually and the state he governs possesses. “Of the gods we know,” to quote Thucydides, “and of men we believe it is a necessary law of their nature that they rule wherever they can.” Mughals established their rein over India, the Nazis wanted to colonize the world or Wilson wanted make the world conducive to democracy. Finally, the efficacy of the power possessed defined the outcomes. One of the critical goals of the Chinese state is to avoid general dissent in the core Han population or in restive provinces of Xinjiang, Tibet or Inner Mongolia, thus, keeping the state as one. The Communist Party (and currently Xi Jinping) maintains this order through the power wielded by the People’s Liberation Army. Narendra Modi through his personal charisma won the BJP a majority in parliament thus giving the country a majority government after 30 years. This gives him immense personal power over this party, therefore, governing India and in turn the ability to project that power internationally. At the Potsdam conference in 1945, Churchill, Stalin and Truman entered the room from 3 different doors at the same time to emphasize equality of their power and prestige! Power, thus, is the second leg of the Chair.  

In 1813 in Dresden, after the disastrous defeat of Napoleon in Russia, Napoleon was threatened by a coalition of all of Europe. In a discussion which is estimated to have lasted 9 hours Napoleon, acting like the emperor of Europe, tried to restrain Austrian Chancellor Metternich from joining the coalition against him. After a stormy session, Napoleon dropped his hat expecting Metternich to pick it up. Metternich pretended not to see it; at that point it should have been clear to the Napoleon, who had earlier had a decisive victory against Austria in Austerlitz, the situation had changed. He was decisively defeated in Leipzig. When China entered the nuclear club, India went to the UN asking for abolishment of nuclear weapons, as a non-nuclear state its bargaining ability was zero and the international conflict between the US and USSR ensured that this would never come to pass. Good intentions give assurance against bad policies but they are no guarantee of political success, similar has been India’s action vis a vis Pakistan time and again. Great leaders understand the advantage of timing and use it to ensure successful outcomes.

Abraham Lincoln had a moral end when he wanted to abolish slavery. To this extent he dealt with the southern states making compromises and in the last year of the civil war accelerated the bombing of civilians to bring a quick end to the war. In the short term, it meant killing people but in the longer run saved more lives by ending the conflict. Similarly, Churchill and Roosevelt engaged with Stalin to end the Nazi terror. In his acclaimed book “The Great Terror: Stalin’s Purge of the Thirties,” Anglo-American historian Robert Conquest said: “We get a figure of 20 million dead [under Stalin], which is almost certainly too low and might require an increase of 50 percent or so.” When Bangladesh was liberated, while it violated the principles of honouring the sovereignty of Pakistan and against significant international opposition, it was a moral project of liberating an oppressed populace. Moral Compass, thus, is the fourth and final leg of the Chair. The examples I have outlined are international in nature where gap is the widest as there are no rules that govern the behavior of nations except constraints (behavior of other nations, geography, military power etc) and history. At the microcosm of an organization, the distance between action and morality is minimal, as not only an ethical and moral code has evolved between participants but there are codified rules which govern behavior (i.e. equality of opportunity or hazardous employment).

In my view ultimately it’s a delicate dance between these four critical attributes – Legitimacy, Power, Timing and a Moral Compass – that defines a great leader and statesman. Konrad Adenauer was 73 when he became the first chancellor of West Germany post WWII and then led it for 14 years. He had opposed the Nazis and then went on to set up the CDU party post the war to unify Catholics and Protestants. His views on Germany’s role in Europe were strongly influenced by the two world wars and the century-long animosity between Germany and France. He, therefore, focused his attention on promoting pan-European cooperation leading to European Coal and Steel Community in 1950 and also the later treaty for the European Economic Community in 1957 which laid the foundation for the European Union, thus, embedding German success in European success. While he is blamed for cementing the division of Germany, he understood that it was the unification of Germany eight decades back under the genius of Bismarck that became the key cause for the wars. It demanded incredible courage and statesmanship to guide a stricken nation. Similarly, Mustafa Kemal Atatürk did post the breakdown of the Ottoman Empire guiding Turkey to its independence and modernity.

A statesman acts based on constraints imposed on his action and by the burden history imposes upon him. But it is only post outcomes that people begin to attribute foresight; he simply doesn’t know at that point in time, given the multiplicity of influences, the consequences of his action. Thus, I have excluded foresight as a critical attribute. Lincoln admitted, “I do the very best I know how, the very best I can, and I mean to keep doing so until the end. If the end brings me out all right, what is said against me won’t amount to nothing. If the end brings me out wrong, ten angels swearing I was right would make no difference.” 

Saturday, December 13, 2014

Dollar rises, Oil falls, World shivers

Raghuram Rajan yesterday said ‘Make for India’ in addition to ‘Make in India’. The underlying message in the statement was the world is not prepared to absorb the capacity India may set upon building. It rather feed its own demand and in turn creates an ‘isolated’ virtuous cycle. The world suffers from a lack of aggregate demand resulting in declining GDP growth across all markets except the US. The other aspect has been his action of stepping up intervention in the foreign exchange market to enhance dollar reserves to protect from adverse impact of dollar increase or shortage. Third, has been to push the government to expand domestic savings to increase the investment rate in the economy

As the dollar rises it will tighten financial conditions for all markets especially emerging markets. USD credit to all non-banks in emerging markets has steadily stepped up since the financial crises, moving up from ~USD4trn to ~USD8trn, the fastest growing segment. Emerging market index of exchange rates has already witnessed a decline of 20% since 2012 impacting unhedged exposures. This enhancement in USD credit has come along with longer maturities with average maturities now exceeding 8 years. While this mitigates roll-over risk but magnifies duration risk for investors, as now non-bank credit (i.e. asset managers) dominate the credit market. In the post Bretton Woods world, twice the dollar has rallied for a long duration both times it has caused a crises, in the 1980s in Latin America and the mid-1990s the Asian Financial Crises.

The dollar’s rise seems inevitable. Key thing to understand is currencies trade against one another and commodities trade in USD terms. The Yen has declined from 80 to almost 120 against the dollar and Euro from 1.40 levels to 1.25. These two large currency adjustments have happened against the USD. China is likely next year to follow with its own depreciation given the impact of lower yen on competitiveness, a sharply declining factory production and increasing real rates. Shale gas finds is enhancing US oil production potential manifold changing the current account structure in turn reducing the USD circulation globally and adding further to USD strength. Further, US Fed seems to have created a market perception of increasing rates based on unemployment levels boosting the USD against other currencies. This data has been strong with historical backdrop of low price of oil further enhancing job creation. Past Fed studies found negligible long run spill-over from oil prices into core inflation, whereas employment elasticities this decade suggest a 40 per cent fall in the oil price adds a million jobs. My view as I have earlier stated as well, the US Fed will always in its pricing action surprise the market on the upside given the levels of Fed balance sheet but in turn create volatility. The Fed has between now and 2018 to normalize rates as then we may see the next round of fiscal pressure due to social security liabilities.

In this context, decline in oil prices is creating an alternate dynamic of deflation in already low inflation or deflationary world. In addition, decline in oil prices will create credit risk:
  • Global inventory value of oil has declined at USD60/barrel by almost USD400bn. Sovereign and large corporations like Exxon will absorb that loss, what about the rest?
  • 18% of US high yield is dominated by energy.
I have already discussed the geopolitical and economic impact of oil in my previous article. Since then, global demand estimates have been further lowered as a reflective impact of low prices on oil producing countries. One of the leading global e-commerce company CEO last week told at a conference said pricing for ecommerce is typically 75% of offline prices – another driver of deflation. Maybe OPEC is selling at a discount to get e-commerce valuation!!

Some thoughts on what this portend for the world:
  • Yen which has already declined from 80 to 120 is now being discussed at 145 levels. This could push up inflation materially leading to BOJ losing policy control. The Nikkei which has almost doubled since this new policy started could be staring at a nightmare. But in the short-term there is more gains;
  • The Chinese look almost certain to devalue next year for the reasons mentioned above creating significant pressure on South-East Asian countries;
  • The Aussies have had a great run with the commodity boom. Their GDP growth will continue to decline and may end in deflationary territory. Hedged Aussie bonds are a good place to be. It will be good time for tourists in Australia with the lower currency;
  • Turkey, South Africa and Latam have high current account deficit and commodity dependence and Turkey particularly high short-term external debt. They would be difficult markets;
  • Euro-zone’s last bastion Germany is bordering deflation and recession and its ‘first bastion’ Greece is in the throes of another bond crisis with 10-yr reaching 9.15% while the 3-yr is almost 11%. If the USD shakes the high yield market the pressure will increase. It is likely that we may begin to see the disintegration of the union in the next 2 years as economies struggle to re-adjust given the Euro’s shackle;
  • To the Russians, it will seems like the late 80’s and 90’s, one which broke the Soviet Union and the second where Russia defaulted and devalued;
  • UK nightmare of London property price decline may come true;
  • The US is the cleanest shirt but with countries exporting deflation via the currency and commodities declining, US reversion to trend growth and Fed target of inflation will be difficult.
From an investment perspective globally, owning staples / healthcare delivery / utility / Japanese exporters equities, hedged developed market bonds like Australia and emerging market bonds like India and Mexico, agricultural commodities and oil at these or lower prices are the best options for 2015. The world will see consumption gains in oil and commodity importing countries but they will be marginal given household leverage across most market. 

India will benefit massively from commodity price decline (at $115 per barrel we consumed 6% of GDP and now it’s ~$60 per barrel) but key is policy action to increase growth capacity. Retail plastic goods, chemicals, lubricants and cement stocks will see profit enhancement from energy price reduction. But for policy action we wait and watch…