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Tuesday, October 21, 2008
Financial Turnaround - Getting It Right
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Building The Real Equity Again

As the global financial markets take a short break from the chaos of the last 6 months, it is important not to lose sight of what needs to be the long-term plan towards their recovery. What has become apparent from initial investigations of the root cause of the financial mess is that there were numerous elements contributing to the financial demise that we now find ourselves in. It wasn't just sub-prime mortgages and CDO's at Lehman Brothers or the other investment banks that caused the turmoil - it was a disintegration in the financial values associated with real capital or equity, and also a disintegration of morality and truthfulness in the representation of facts and risks in both finance and politics.

As the world pushes for a financial solution, there is really only one end game and that is the integration of financial reforms with an ultimate goal to save our one and only planet's environment. Humanity from every latitude and longitude needs to rapidly address the deteriorating natural environment with capital growth incentives that promote restoration. The immediate need is to stabilize markets, and this can only be done by driving honesty back into them. The world needs real capitalism and not some version of 'who wants to be a millionaire in a day.' Looking at the foundations of capitalism from the early 1900's, it is evident that capital growth was built upon hard work and effort by the industrialists of that era like Ford, Edison, and Carnegie, who built products, processes and company values using the collective efforts of many, and delivering equity capital growth to the investors and jobs for the people.

Since the dot-com crash of 2000, and then the winding down of Enron, there has been an irresistible need to replicate the annualized returns of 30% or better to support the notion that only this level or greater can be considered an excellent return. Growth expectations like these are what fuelled the excess behaviour of the investment banks to push aside their risk management for an all or nothing grab at a one-sided jackpot using virtual money instruments to keep their earnings rolling. Unless you are in a rapid growth industry, like we had with IT in the nineties and now IP Communications, and Zero Emissions Energy today, an excellent return by a well managed company is really instead an annualized profit of 15% after expenses and taxes.

One of the misnomers in finance is that derivatives provide long-term liquidity growth. In reality, this is false because derivatives derive their existence from real equity growth and cannot be absolutely virtual and independent financial instruments unto themselves. The problems in the financial markets that we see today are associated with too much leverage in virtual positions without any real equity that backs it up - hence the negative cash balances and the failures of financial institutions when the opposite side of the deal started materialising. Derivatives markets must be aligned to an associated real equity foundation and derivatives trading volumes need to aligned to real equity asset trading volumes in magnitude and immediacy.

The alignment of derivatives trading volumes with real equity would be best accomplished using a network of international derivatives exchanges that provided full disclosure and real-time accounting against the true summed volume of derivatives traded against the real equity volumes. Additionally, a regulated derivatives float volume probably needs to be established that limits derivatives volumes to a regulated percentage of the average daily volume of real equity trades in a given financial instrument (equity, commodity, or currency). This will help ensure that the real capital structures are not distorted by the virtual ones which is one of the elements of the financial chaos today.

Critics argue against any regulation, but one need only look at the number of  companies that asked to be protected from the 'shorters' during the last month's events to realize how crazy the impact derivatives can have, and still have on real viable companies or the currencies of small nations (Iceland). The only reason United Airlines stock took a drastic one-day plunge of 75% on September 8, 2008 was based upon an invalid report being magnified by the 'torpedo' sinking effect that derivatives have on increasing pricing volatility in markets. The same scenario is what torpedoed Northern Rock in the United Kingdom.

A company in 'play' under derivatives short-selling will, in the worst case scenario, deliver just one single cash flow of liquidation to a few people, whereas a functioning company will have a much higher combined multitude of annualized cash flows providing jobs for many people within the economy. Derivatives in their current form are too easily used as implosion instruments that feed off historical real capital until there isn't any left. Warren Buffett has an acumen in determining value and he was right to call derivatives weapons of mass destruction. So what then is the impact that the natural environment plays on the financial world and visa versa?

If we assume that there is only a small window of time left in which we can turn the health of the Planet around (some say only 60 months to reverse course), then the first element of reversing the environmental downward spiral we are in is to rapidly decrease the unsustainable pollution throughout the globe. Its not about how wonderful our current life is; its about whether our children will live through the mess we are creating for them, and whether we should be so audacious as to believe that we are more valuable than polar bears, or any other species for that matter. In reality we owe our existence to the functioning of the global ecosystem and currently most of us are doing our best to make sure that it doesn't work anymore.

There is an immense amount of money to be made in restoring the planet, and society needs to get the global formula right, aligned with supporting financial structures to clean up the planet. The oceans and seas and marine life need urgent protection from overfishing and pollution. Humanity needs to get absolutely intelligent to save itself and absolutely appreciative of the natural environment that has been given to it. Our current over utilisation of plastics and the discarding of them is insane. Plastics use is completely unsustainable and unfortunately needs to be rapidly reduced to a minimum in a very short period of time. Conservation needs to become the next growth industy where the global formula is that everything conservation makes a profit. You need only look at the global wind turbine industry to see an excellent example of this, with returns on investment of more than 20% annualized over the next fifteen years or greater.

Humanity must also become absolutely honest with high levels of integrity if it is to survive. There is too much work to be done to repair the planet and the world cannot allow progress to be diminished by the scams that we have recently seen in the financial markets. Additionally, we must improve the integrity of commerce and communications on the Internet. A 'wild west' mentality of anything goes currently exists within the Internet, where copyrights are consistently violated, commercial transactions distorted, and fraud allowed to flourish without penalty. Today, monopolistic technology based scams restrict competition and innovation. Nobody will develop further content if it is being stolen by the heavyweights to support corporate balance sheets with misappropriated advertising revenue and hits. The world needs to ensure the integity and security of the Internet, otherwise it too will flounder like the financial markets and trust will be lost.

There is so much work to do to repair the planet and everyone, every race, colour, religion must work together at the task of repairing our home for the future generations. The investments we need to save the planet are 25, 50 and as much as 100 year projects, and finance must build the supporting structures that emphasise long-term capital growth in environmental investments. Long-term investment is not a new concept. Henry Ford,for example, did not build the first Model 'T' just to retire on; it was Ford's first mass produced product, and he created a foundation for capital growth in the Ford Motor Company that today has been producing cash flows and employing people for more than 105 years.

In short, the world needs as much zero emissions wind, solar, geothermal, and wave energy as it can build and as soon as possible. Additionally, industries of conservation, conservation technology, new sustainable materials, new zero emissions transport, new efficient working and transportation behaviours are essential. Products must be durable, repairable and upgradeable so as to reduce unnecessary waste.

Throughout the world in many places we also need to restore the sense of community, town halls, town centres, and at the highest level build a much stronger community of United Nations. The world must work together with urgency on global finance and global environment restoration in a true partnership of humanity. The challenge for everyone is to drastically reduce waste and pollution, and improve the environment for our fellow animals, plants and micro-organisms. Every little human being who is taking their first steps in this life must have a future here, and it is up humanity to ensure this outcome! 

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