“[Bitcoin] won’t end well, it’s a fraud…worse than tulip bulbs…[but] if you were a drug dealer, a murderer, stuff like that, you are better off doing it in bitcoin than U.S. dollars,”
— Jamie Dimon: CEO, JP Morgan
Headline: JPMorgan Guilty of Money Laundering, Tried To Hide Swiss Regulator Judgement
— via Cointelegraph
Given the current, latest successive series of spikes to all time highs for Bitcoin, the detractors are working overtime to make the case that the crypto-currency is a Ponzi, a scam, a phantasm or at the very least, a bubble. Oddly, many of these same detractors spend a lot of time cheerleading “the other bubble”, that everything-bubble, stocks, bonds, real estate, even ETFs of ETFs, you name it.
It’s easy to make superficial apples-to-screwdrivers comparisons about why Bitcoin is doomed to fail. Until you really take some time to look into it. When first was exposed to the idea back in 2013 and researched it, I realized that “this really is different”, and the reason why was because of something John Kenneth Galbraith had once written which (until then) had invariably held up as true. In “A Short History of Financial Euphoria” Galbraith said:
“The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version. All financial innovation involves in one form or another, the creation of debt secured in greater or lesser adequacy by real assets.”
When one looks at the history this accurately maps every financial bubble from Tulipmania (which we will debunk as a suitable metaphor for Bitcoin shortly) right up to 2008 and beyond.
However one place where it isn’t applicable, is to the phenomenon of Bitcoin. Crypto-currencies, at least at present, have no leverage and are near impossible to purchase on credit. In other words, if asset bubbles get that way largely through leverage, and there is comparatively no leverage in Bitcoin, then something else has to be driving it.
Granted, at the moment it’s a very exciting sideshow for those who are on the train. A long time customer emailed me as I was writing this asking “at what point has easyDNS’ profits from accepting and holding bitcoin exceeded the actual operating profits of the company?” I had never considered that but some quick math revealed that even after cashing a chunk out to buy gold (not my greatest trade), that happened last year.
But the price action around this isn’t what is exciting about Bitcoin and the crypto-currency revolution. What is exciting is that the centralized, bankster controlled monopoly over the issuance of money itself is finished. It’s over. Even if they successfully manage to co-opt some major crypto-currencies or issue their own, Gresham’s Law will assert itself as capital managers will select a truly decentralized crypto-currency wherein they control, or have the option to control, their own private keys to safely store their wealth while they’ll use the government version to pay taxes, etc.
Whatever state issued “digital cash” comes out in the near future, I’m suspecting it will be centralized with mandatory key private key custody or escrow. When that happens it shouldn’t even be called crypto-currency, call it something else like “pseudo-crypto” or “fauxcoin” to differentiate.
Given the mostly bad analogies and unfounded criticisms being levelled at Bitcoin, let’s first take a serious look at what Bitcoin isn’t. Then in Part II we’ll look at what it is and why its different.
This is the goto criticism for people who simply don’t understand that crypto-currencies are based upon mathematics, zero-trust, open-source and consensus. They think that bitcoins can simply be created “at will” and are backed by nothing.
They also say that as if the world’s reserve currency, the US dollar, isn’t, literally, “backed by nothing” and hasn’t been since 1972; and as if can’t be created at will, which it most certainly has, with a vengeance.
Indeed as Galbraith continued in our earlier passage:
“This was true in one of the earliest seeming marvels: when banks discovered that they could print bank notes and issue them to borrowers in excess of the hard-money deposits in the banks’ strong rooms”.
All fiat currencies today really are backed by nothing and can be created at will (that’s what the word “fiat” actually means), and perhaps unbeknownst to many we are right now in a protracted, global currency war. Every nation is “racing to the bottom”, trying to devalue their currency against their trading partners so they can:
This is why everybody’s purchasing power is going down despite tenured academics and central bankers incessantly complaining about “low inflation” and political spokesmodels always talking up a “strong currency”.
Bitcoin isn’t: “Backed by nothing”
What is? The USD and every other fiat currency in the world.
The idea that Bitcoin or most crypto-currencies are “a Ponzi” is easily debunked by understanding what a Ponzi actually is.
As observed in CryptoAssets (Burniske & Tartar, 2017), it’s very simple: new investors pay old investors.
It is important to realize that in a Ponzi, the earlier investors are literally paid with funds being injected by the new investors in a “flow through” fashion (as distinct from later investors having to pay higher prices to earlier ones to induce them to part with an asset).
As long as the number of new investors and thus the influx of funds is growing at a rate faster than the payouts to the earlier investors, the Ponzi scheme thrives. When the expected payouts exceed the rate of input, it dies.
One doesn’t have to look very far to find mechanisms that fit the definition exactly: Social security programs are all classic ponzis. The demographic reality today is that with the entry of the “Baby Boom” generation into retirement, given that the subsequent generations are so much smaller in size, additionally penalized by falling real wages, rising or multiple taxation, decaying purchasing power on their money and returns on any savings they can eek out suppressed into negative nominal yields; this Ponzi is in its terminal phase.
(Given that these exacerbating headwinds which face later generations can be summed up with the phrase “financial repression”, it is only logical that capital would “flee” to some asset or currency which appears resistant to them.)
Granted, the current ICO craze probably includes some ponzis. The Cryptoassets book describes the OneCoin Ponzi as well as how to spot a ponzi in crypto-currencies. I would have been hesitant to even call OneCoin a crypto-currency at all. It wasn’t open source and had no public blockchain.
In Bitcoin or other true crypto-currencies, early holders are not receiving bitcoin from later entrants. In fact, quite the opposite is happening. Later entrants must entice earlier ones to part with their bitcoin. Since Bitcoin cannot be created at will, it must be mined at a rate that drops over time (this year approximately 640K new bitcoin will be mined, about 3.8% of the total supply).
Demand for bitcoin is simply outstripping supply of new coins being mined (for reasons we will discuss in Part II). If said price action rises dramatically (like for example, Bitcoin suddenly became the highest performing asset class in the world) then a feedback loop would occur. Ever higher prices would be required to induce earlier holders to sell.
Bitcoin Isn’t: A ponzi
What is: Social Security
What is described above is the same dynamic that occurs in any “bull market”, as buying begets more buying, and “fear of missing out” kicks in. It is said one of the most accurate gauges of “happiness” correlates closely to how much wealth one has when compared to one’s brother-in-law. Alex J Pollock describes it in “Boom and Bust: Financial Cycles and Human Prosperity”, as “The disturbing experience of watching one’s friends get rich”.
The trick would be to have some understanding of when a strong bull market has crossed into Bubble territory. One of the more popular analogies for Bitcoin is Tulipmania: the financial bubble that occurred in 1630’s Amsterdam with none other than tulip bulbs. Bitcoin is compared to Tulipmania so often I decided to take a closer look at Tulipmania to see if the comparison was valid.
What I found was that it most of what we know today about Tulipmania is superficial and self-referential, deriving primarily Charles Mackay’s chapter on Tulipmania in his seminal “Extraordinary Delusions and the Madness of Crowds” (1841). It is a scant 9 pages and is purely anecdotal, describing ridiculous prices paid by the otherwise pragmatic and level-headed Dutch and then it all just blew up like all bubbles do.
Finally I found Anne Goldgar’s Tulipmania: Money, Honor and Knowledge in the Dutch Golden Age, which is the most in-depth investigation to the rise and subsequent fall of Tulipmania extant today. In it we learn about the circular references that went on to inform our present time about Tulipmania:
“If we trace these stories back through the centuries, we find how weak their foundations actually are. In fact, they are based on one or two contemporary pieces of propaganda and a prodigious amount of plagiarism. From there we have our modern story of tulipmania.”
She traces the lineage of MacKay’s chapter:
“Mackay’s chief source was Johann Beckmann, author of Beytrage zur Geschichte der Erfindungen, which, as A History of Inventions, Discoveries and Origins, went through many editions tions in English from 1797 on. Beckmann was concerned about financial speculation in his day, but his own sources were suspect.
He relied chiefly on Abraham Munting, a botanical writer from the late seventeenth century. Munting’s father, himself a botanist, had lost money on tulips, but Munting, writing in the early 1670s, was himself no reliable eyewitness. His own words, often verbatim, come chiefly from two places: the historical account of the chronicler, Lieuwe van Aitzema in 1669, and one of the longest of the contemporary pieces of propaganda against the trade, Adriaen Roman’s Samen-spraech tusschen Waermondt ende Gaergoedt (Dialogue logue between True-mouth and Greedy-goods) of 1637. As Aitzema was himself basing his chronicle on the pamphlet literature, we are left with a picture of tulipmania based almost solely on propaganda, cited as if it were fact.”
Goldgar helps the reader in pursuit of truly understanding Tulipmania by rewinding to the late 1590’s, when there were no tulips in what is now Holland, or in fact Europe. Gardens were purely functional, for growing food, herbs or medicinals. Then tulips and other curiosities began coming into the country and Europe from merchant vessels trading in the Mediterranean and Far East.
The “flower garden” arose for the first time, and it was spectacular – giving rise to an entire movement of collectors and aficionados, whom in the early days were as a rule well-to-do and affluent. In later years, more people sought out, and then speculated in the tulip trade to not only profit, but to lay their own claims on what they perceived to be a higher economic class or status.
At the risk of over simplifying her work, the Tulip trade became intertwined and inseparable from, art.
“The collecting of art seemed to go with the collecting of tulips. This meant that the tulip craze was part of a much bigger mentality a mentality of curiosity, of excitement, and of piecing together connections between the seemingly disparate worlds of art and nature. It also placed the tulip firmly in a social world, in which collectors strove for social status and sought to represent themselves as connoisseurs to each other and to themselves.”
The more I delved into understanding Tulipmania, the more I couldn’t escape thinking that the analogy was much more applicable to a different “asset class” which did enjoy a momentous bubble in recent times, but it wasn’t bitcoin or crypto-currencies. To belabour my point, Bitcoin was impelled not by art, beauty or any semblance of collectibility but emerged primarily as a resistance to financial repression.
Something that was driven by uniqueness and fostered an aristocratic in-club all it’s own and until recently enjoyed stratospheric price action, was the aftermarket in domain names. This isn’t the place to conduct a post-mortem on that bubble, but suffice it say that the distinct characteristics of domain names more closely resembled that of tulip bulbs than Bitcoin does. (For the reader interested, I have written at length about the domain aftermarket here and here).
Bitcoin isn’t: Tulipmania
What was like Tulipmania? Domain names.
If Bitcoin isn’t a digital fiat backed by nothing, nor a ponzi nor Tulipmania, then what is it? Why has this come out of literally nowhere to become the strongest performing and fastest growing asset / currency in the world?
When I started writing this post I wasn’t sure myself. I had to go back through my library and look at history and try to find some historical antecedent for what was happening. After looking back through the origins of money itself and working forward I still wasn’t any closer to a mental model that “worked”.
Then around 2am the other night I woke up with the idea that I was looking in the wrong place, and it hit me with such force that I had a hard time getting back to sleep – even though I had made an “off the cuff” tweet that captured the basic idea of it a few weeks earlier (which I can’t find now).
I’ll take you through it in Part II. (Hope to have it up soon). But in the meantime, I’ll leave you with another megabank CEO who’s take on all this is very different from Jamie Dimon’s. Goldman Sachs’ CEO Lloyd Blankfein here muses on why it’s entirely plausible that money may evolve from being based on fiat to being based on consensus. Some truly extraordinary remarks coming from a man in his position.
The Transition Town phenomenon is a self-organizing movement to create resilient communities that can prosper in the oncoming era beyond cheap oil.
I was drawn to this concept when I first encountered it and was pleasantly surprised to find out that I lived not far away from one, Dundas Ontario is just a few miles away from my home in the west end of Toronto, Canada.
Even still, the prospect of pulling up stakes and moving there wasn’t practical when I came across the idea. But thinking about it made me realize that there was a community that I was already a part of, had been working closely with for nearly 20 years and was populated by people who held a lot of these “transition values”. Most of us are health conscious, long-term thinkers and independently minded. A few of us already source large portions of our food from a nearby farm, and we had collectively eschewed the “groupthink” of mainstream economics and politics, of perpetual “growth for growth’s sake” and ever expanding debt, and seeing it as for the most part leading society to what will prove to be counter-productive.
That community of course, easyDNS the company I had co-founded back in 1998. So while I realize that maybe personally it would be unrealistic to buy a hobby farm anytime soon, it was entirely possible for the business to someday invest in one (we haven’t yet, but we could).
Out of this realization I began researching the premise of “The Transition Company” or the “Transitional Corporation” or just a “TransitionCo” for short.
While the Transition Town movement saw Peak Oil as the catalyst that would impel economic instability, I looked at the literature on the financial and business side of our current paradigm (people like Chris Martinson’s Peak Prosperity and Charles Hugh Smith’s Of Two Minds) and realized that we’re nearing “peak credit” or “peak debt”. Cheap, debt-based “money” was the “oil” that lubricates the New Economy and Globalization and we’re nearing the end of its sustainability. Even with interest rates at or below the Zero bound (which is in itself damaging the economy in incalculable ways) The Debt Supercycle will sooner or later end, and when it does, things will be very different.
The Transition Company concept is the idea to create companies that cultivate long-term resiliency in an oncoming era beyond cheap capital known as “debt”.
As the economic policies which have brought us here play out, things look to get worse before they get better for the middle class, for small to medium-sized businesses, for anybody who isn’t directly connected to the policy makers and the central planners at the nexus of the debt-built economy.
If one wants to survive this inexorable trend toward aggregation (bigger and bigger companies sucking up all the oxygen in a space) and centralization (a few gigantic walled gardens squeezing out all the independents), one has to compete on different terms.
In other words, to successfully compete against a world full of 800lb gorillas, one has to resort to a kind of guerilla capitalism, and the framework for that is what’s described below.
We are nearing the end of a global debt super-cycle which started not in 2009, in the aftermath of the Global Financial Crisis, not in 2000 after the Y2K scares and subsequent dotcom implosion, not even in (pick one) 1997 (LTCM), 1987 (crash) or 1971 (end of Bretton Woods and dollar backing by gold), 1933-37 (New Deal) but rather, 1913 with the creation of the US Federal Reserve Bank.
The era we know and experience as “the modern age”, “the information age”, which has become the theology of Globalism and “The Savior State” owes its early stage traction and then escape velocity to the twin waves of abundant cheap oil and ever expanding credit. Both of these are coming to an end, and informed elites as well as shrewd outside observers know it.
“By about 2010 we should see a significant increase in oil production as the result of investment activity now underway. There is a danger, that any easing of the price of crude oil will once again, dispel the recognition that there is a finite limit to conventional oil”.
–U.S Former Secretary of Defense James Schlesinger
“[The debt-financed growth model has reached its limits.] It is even causing new problems, raising debt, causing bubbles and excessive risk taking, zombifying the economy,”
— German Finance Minister Wolfgang Schäuble at G20 Finance Summit in Shang-Hai, 2016
“As investors, what do we think about the quadrupling of central bank balance sheets [“debt”], to over $13 trillion in the last 10 years? It certainly doesn’t make me feel any better to say it fast or forget that we moved ever so quickly from million to billion to trillion dollar problems”.
— Kyle Bass, letter to investors 2012. (Central bank balance sheets now pushing 17 Trillion)
“The debt growth model is over. There are no shortcuts only real reforms… We’ve been able to enforce an ‘Official Reality’ by throwing government financed money [“debt”] at it, to make things that aren’t economic look economic. And now that the debt growth model is over, that game is coming to an end. On an optimistic note, if the debt growth model goes away and we have to deal with an equity world, then fundamental economics get relevant again and some of this weirdness and bizarreness of ’The Official Reality’ goes away because it’s just not economic”
— Catherine Austin Fitts, former Assistant Secretary of Housing & Federal Housing Commissioner. (Solari.com)
The Transition Movement sees the end of the runway approaching and are attempting to position and build foundations for an oncoming era of turbulence and volatility spurred by contractions in both the availability of cheap energy and cheap capital (debt). “Transition Movement” is a pre-existing actual label when applied to Transition Towns but I am appropriating it here for the “made-up” follow-on concept of “The Transition Company”, “Transition Corporation” or just “TransitionCo.
While Transition Towns serve a community defined by the physical location of the residents, the Transition Company’s community straddles both physical and virtual realms. It also crosses old paradigm boundaries of where the stakeholder layers demarcate.
To put it simply: the Transition Corp. is organized along principles that structure a “community” that includes the shareholders, the employees (who are ideally shareholders) and the customers – many of which may also be shareholders.
When one accepts the notion that the debt growth model is truly over, then many pillars of conventional business theory are shown to be counter productive, even ruinous over long time horizons – these include:
As I once lamented in Debt. It isn’t what it used to be that “Debt used to be something you actually paid off”. But that isn’t the case anymore. Now it’s meant to be rolled over, perpetually.
It wasn’t my imagination, this had become an MBA level tenet; as I was once mortified to learn in an EMBA level course I was taking that “all short term debt eventually becomes long term debt”.
It wasn’t always like this, in fact this “tenet”; this pillar of our current economic model is actually an aberration.
It is worth repeating the excerpt I quoted in that earlier writing from a business textbook I found from 1949:
“Any corporation, private or governmental, that wishes to provide for a sound and equitable continuity of its business must take steps towards the systematic retirement of debt immediately after it has been incurred. Postponement of all payment for property or privileges by those who presently enjoy their benefits is calculated to bring uncomfortable consequences to them or those who succeed them.”
When people talk about “conventional wisdom”, this is the sort of thing that springs to mind for me. Actually retiring debt, not rolling it over forever. One course is mathematically sustainable in perpetuity. You could productively issue debt, use the capital to grow one’s concern, use the proceeds from that to liquidate the debt, rinse, lather, repeat and you could do that forever.
The other way, perpetually rolling over debt, you can’t. Even at near-zero interest rates, where we are as I write this, your debt service will eventually cannibalize all your revenues because notwithstanding the near-zero cost of capital, you’re still trapped in a cycle where you must increase the principle debt load in order to “grow”.
This is a universal phenomenon – companies are under pressure to post ever improving results – not annually, every quarter. Shareholders, for their part, express angst if the share price doesn’t go up fast enough, and if it doesn’t, they sell. The average holding period for public stocks has gone from 7 years post-world-war II to about 6 or 7 months now (that’s excluding High Frequency Trading, which makes up most of the trading volume these days and the bots typically hold their shares for about 11 – 20 seconds).
So the companies do whatever it takes to increase the stock price every quarter, forever. Because this is, when you take a step back and think about it realistically, an absurd and possibly pathological expectation, there is no way a business can actually operate rationally and meet these expectations. Nobody can.
A very wise and successful CEO friend of mine once created a company here in Canada that became a billion dollar entity. Not a unicorn, they were actually quite profitable. When it was a publicly traded company he was the only CEO on the TSX who refused to give quarterly guidance.
“If profits are ‘up 5 cents a share’ then presumably that’s going to bump our shares by 5 cents. They want it now, but I make them wait 3 months until it actually happens next quarter for that nickel. I do that because if I tell them today ‘it’ll be 5 cents next quarter’ and and we only come in at 4.5 then everybody reacts like it’s the goddamn apocalypse.
If we “miss” then everybody goes ballistic and I look like an idiot. Meanwhile we’re talking 3 months, and there’s another quarter right after it… This goes on forever. No thanks.”
Eventually an activist investor took them private (forcibly) and in hindsight, I think if that company had been left to run, a lot of long-term shareholder value would have been realized. This brings us to…
It’s been said that the difference between “investing” and “speculation” is that the former tries to capitalize on a perceived mismatch in valuation while the latter is trying to guess at the direction of the price action (usually hoping that the price goes up).
The majority of market participants are doing the latter. If a TransitionCo were to be publicly traded, it wouldn’t really care about the daily gyrations in share price. If the company’s share price is significantly above what management feels is the intrinsic value (“IV”), they can use the shares to acquire other assets. If the share price is below IV they can always buy them back.
The myopic obsession with the share price takes everybody’s eyes off the real ball, which are the normal course operations of the company: Love-bombing one’s customers and delivering overwhelming value. Share price fixation, especially when it’s driving executive compensation is extremely damaging because it pulls all future growth into the present, and iteratively cannibalizes it for the sake of “today’s nickel”.
If I can sum up the difference between a TransitionCo and what we have today it can be stated as “reversals” or “backwardations”. One of which we look at here is share buybacks. Companies today are borrowing money at artificially low rates to buy back their own shares, which are trading at or near all-time highs. The value investor in me finds that kind of stupid.
When I wrote this, the major indices were putting up a string of all-time-highs (but the underlying technicals like the advance/decline and insider selling look awful). But what a lot of people don’t realize, because the media doesn’t give it very much coverage, is that most of the earnings gains in the S&P (said earnings gains supposedly driving the p/e multiple expansion which is propelling it to new highs) are coming from stock buybacks.
In Q2 2016, share buybacks accounted for 72.9% (!!!!!) of the trailing 12 months net income of the S&P. Read that again. That’s not 72.9% of the earnings gains; it was 72.9% of the earnings. 72.9%! That means nearly ¾ of the earnings are all financially engineered, and most of the funds used to buy back all those shares is borrowed because of these ultra-low, artificially suppressed interest rates and credit expansion.
Out of the 500 companies in the S&P500 in 2016, 146 of them spent more on buybacks than they actually made in “earnings”.
That’s financial engineering. It cannot go on forever, but it will “work just fine” until it doesn’t. When that moment comes, it will be disorderly and there will not be enough chairs to go around when the music ends.
This is closely related to the aforementioned point. But at this stage it becomes the core ethos of the business: acquisitions (leveraged, of course), sale-leasebacks of any actually useful assets (usually a sign the company is doomed) and serial funding rounds (see below).
I look at some businesses in my space and their home pages are a never-ending litany of “tombstones”, companies acquired in rapid succession. Five a year, ten a year. It hearkens back to the Age of the Conglomerates, a 70’s era craze when companies rationalizing about “diversification” started buying up everything in sight and pretty well every single one of them ended up crashing back to earth into a heap of “goodwill”.
Acquisitions can be beneficial. Those are rare. Warren Buffet calls a sensible one “a fat pitch” and by definition, every pitch cannot be a fat one. We’ve done one in the entire history of easyDNS and we’ve been at this for 19 years.
A few years ago I had lunch with an SVP at one of the competitors who is always pestering me to sell out to them. I remarked that, given their explosive and even profitable growth (at that time) I was surprised that they had recently done their first VC funding round. I went on to opine that it probably would change the nature of the underlying culture there.
“That’s just a financial event” he dismissed it. “Doesn’t matter. There’ll be more”. And he was right, there were more after that. None of the founders are there anymore. Over time they were all drummed out by the people on the other side of those “financial events”. That’s what happens. The company in question has gone from the competitor I used to worry about the most – growing like crazy and making tonnes of money; to the one I now worry about the least – trying to keep growing like crazy and losing money. Now that a bunch of bankster-backed VC’s run the place, the problem will take care of itself.
A lot of this is captured under a Scared Cow that deserves to die called…
Milton Friedman once penned an op-ed in the New York Times1 opining that the single responsibility of the Corporation was to “maximize shareholder value”. I use the word “opined” because it was, after all, his opinion. The viewpoint expressed in that seminal article could be viewed as the culmination of a long secular shift in the theory around corporate governance. It finally took the long-standing primacy away from “the stakeholder” (which included the workers, their families, the community within which a business operated, and maybe the customers) and gave it to “the shareholder”.
I understand the sentiment behind Friedman’s op-ed. I don’t even disagree with it: the managers are very much the employees of the shareholders, and they should answer solely to them. (Experience may show, if TransitionCo’s actually flourish, that you will see elevated levels of insider ownership from amongst the executives, founders, employees and customers resulting in more stakeholder alignment; so that longer term mindsets and productive operations seem less like New Age woo-woo and more like strategy.)
What I would debate is whether the long term best interests of those shareholders really are best served by robotically juicing the share price. My point herein is that we are exiting a construct where that seemed viable for a while, and we’re entering into one where it isn’t. We’re still responsible to our shareholders, and socialism still sucks, but we aren’t going to sustain or prosper if we’re functioning along the shortsighted, artificially enhanced holodeck that passes for a free market today.
With the adoption of Keynesian economics and Friedman’s shareholder supremacy, the Chicago School of Economics had won total victory and secured a de facto lock on conventional economic thought that persists to this day (therein lies the problem).
Human nature being what it is, promptly bastardized both Keynes’ and Friedman’s tenets into unrecognizable claptrap2.
Their pronouncements shoehorned into short-sighted, self-serving policies have since become so distorted and mischaracterized that they contribute directly to a type of globalized “soul sickness” that now permeates every aspect of our economy and culture.
Friedman’s “shareholder value” premise has become so dumbed down that many people really think this means that companies are legally compelled to “maximize the share price”3, which is simply not true. There is no legal obligation anywhere to maximize the share price. It can be argued (in fact I’m doing so here) that even if one accepts that the corporation’s sole stakeholder of import is “the shareholder”, that boosting the share price is not synonymous with, and quite possibly anathema to, “maximizing shareholder value”.
For one thing, the premise is at odds with the concept of Corporate Personhood, another sacred cow of modern thought. Admittedly it’s one which I honestly have no opinion on other than “it’s handy”. The reason it’s at odds with the premise of Corporate Personhood is because trying to deliver shareholder value solely via perpetually increasing the share price ultimately cannibalizes the corporate host. You can’t have it both ways: in this sense perhaps we’ve found another key stakeholder who should be considered in our effort to re-ground corporate governance: The company itself.
The point of the Transition Manifesto is that shareholder value (if you want to call it that) is maximized by refuting most of these toxic premises and gimmicks and then by running a decent business yielding reasonable returns over a really long time frame.
It’s important to note that I’m not shooting down “shareholder value” from a Marxist or socialist “the business should benefit society as a whole” viewpoint. At the core I’m a free market advocate claiming that what we are operating in today are not free markets, but rather, rigged markets operating under very reckless and delusional assumptions, high on a financial crack known as “cheap credit”.
The “TransitionCo refutes these flawed premises above and instead adopts methodologies that will form the basis of long term resiliency and sustainability. Over time, with enough TransitionCo’s operating in the marketplace, society will benefit (why? Because it will become less sociopathic.)
We’ve looked at how things are, how they should not be let’s turn our attention to how a TransitionCo would actually operate in today’s business climate:
Transition Co’s have real businesses with real products and services that have relevance to what I’ll call a “first order” customer base. If you’re running a company whose entire raison d’être is to provide a plugin to a social network then when that social network goes the way of the dodo, so do you.
If your entire business model is click arbitrage or some other way of gaming the search engine algos then guess what, you exist at the whim of somebody else’s business process and you are literally one tweak away from irrelevancy.
Further, the business should actually be about normal course operations, whatever that is. These days too many businesses are in the business of financial events first, and the operations are just window dressing to support an inflated valuation in the Series Z round.
When companies can earn ROI for their backers through liquidity events and financial engineering rather than normal course operations, “focus on the customer” means something different entirely than the company that is striving to serve the customer.
It means surveilling the customer and mining their data. Many “unicorns” and wannabes have no revenue models that involve customers paying for products or services; instead they seek to acquire as large a user base as possible (free services) and then they systematically dismantle their users’ privacy and mine their data. As the old euphemism quips: “If you’re not paying for the product, you are the product”.
A closely related strain of company will charge their customers for products but they will be of dubious actual value to the customer (“vaporware”).
In these cases the essential customer attribute is one of ignorance and what is valued above all are the ability for lock-in and surveillance. The dumber the customers, the better it is for business.
The flipside of this are companies and businesses that benefit from customer savvy, where the more customers are aware and educated about the products and services at hand, the better it is for the business supplying them.
This latter approach is the core ethos of an emergent model of business activity called “Vendor Relations Management” (VRM)4. Think of it as the flipside of CRM (Customer Relations Management) – it isn’t about “managing customers”; it’s about managing the businesses that want to engage with, and do business with each individual customer.
The valued attributes in this latter type of business relationship are: privacy, security and reputation.
Operational Diversification means reducing vulnerability to any single external entity. If your startup was created and funded to provide enhanced services to MySpace, things probably looked pretty gangbusters for a while, and then not so much. Similar companies operate today, existing for the sole purpose of plugging into one, single external ecosystem. It means you are completely dependent on the whim of those ecosystems and they can literally put you out of business. You live with the ever-present prospect of betting on the wrong horse, and that ecosystem contracting, waning and losing relevance. Sure, Facebook may seem unassailable today. But so did Yahoo yesterday, and AOL the day before that.
Ideally you have at least two non-correlated revenue streams of approximately equal volume where one vaporizing overnight would not automatically kill the other one. In my example easyDNS is both a domain registrar and a DNS provider. Yes, we do web hosting and such as well but we don’t earn enough revenues from it to carry the business (yet). If we lost our ICANN accreditation tomorrow it would suck and it would hurt and could take away half our revenues within a year, which is one hell of a haircut, but we would survive. It wouldn’t be “game over” the way it is with many other companies who can go to zero instantly just because Google updates it’s search algorithm (anybody remember Geosign?)
Similarly, try not to have a single customer that accounts for more than 2% to 3% of revenues. Some businesses are completely built around one or a few enormous customers. Losing a customer is painful, it’s worse when it’s fatal.
If you look at the business textbooks or take many MBA courses they will probably tell you that if you do a couple of things with your balance sheet, “the street” will penalize you. Those are:
The rationale is “cash is useless, it just sits there” and that “debt is lubricant, it makes your company go faster”. What this is really is, is stupidity dolled up to look like cutting edge business finance.
You cannot have too much cash in the bank. (Well, with Negative Interest Rates spreading like rot, and “bail-ins” being an actual thing now, maybe you can have too much in the bank). But you cannot have too much cash, which we’ll define here as “counter-party-free liquidity”. Times being what they are necessitates spreading that liquidity and assets around. One may hold a basket of currencies to mitigate against inflation (or hyperinflation) and include things like precious metals and Bitcoin. This essay can’t get too far into the bizarroverse we find ourselves in with Central Banks and central planning gone wild. Suffice it to say I’ve written at length about it elsewhere and will continue to do so here.
Find any company who’s heading into a downturn, or been suffering through one for a few quarters and ask their CFO if they think “having too much cash” is a problem. I’m pretty sure they’ll wish they had more of the stuff just sitting there rotting in their bank account before their troubles started. Then ask them if all the debt they piled up for those share buybacks, for those serial acquisitions, for paying out those dividends was a good idea. They may not think so. Unfortunately the journey from cash to goodwill to write-downs is almost always a one-way track.
It’s the cash reserves and the unencumbered assets together with the absence of crippling debt are what separate the survivors from the statistics when the downturns hit. In a world where ‘Black Swans’ are becoming more frequent, it’ll be the balance sheet strength that saves companies or balance sheet weakness that sinks them.
I’ve modified this slightly from the value investor parlance of “GARP” – Growth At a Reasonable Price, wherein value investors are loath to overpay for “growth stories” but this is exclusively thought of in dollar terms. What I’m talking about it overall “cost” of the unrelenting impetus for “growth for growth’s sake” placed on companies by the market. This cost is paid in terms of soul for lack of a better term for it.
As a brief aside, because the topic is huge and covered elsewhere (see “Further Reading”) this point brings us face to face with another symptom of our current delusional economic model: inflation (which is deemed as good) is based on a perpetual growth model, because we’re using debt for money and if it stops growing it’ll feel like heroin withdrawal.
Deflation is toxic to debt-based money, but in reality is actually beneficial to the wider population. If a monetary system was designed by smart people with the well being of society at heart, they wouldn’t come up with a debt-based inflation driven monetary system, run by privately owned central banks who create money as debt and then “lend” it to the State at interest.5 It’s likely they’d come up with a deflationary system instead, like a crypto-currency such as Bitcoin, a gold standard, or some other inelastic, or hard backed currency model.
Back to the TransitionCo, which doesn’t chase growth but will grow along organic lines, when the time is right, at a cost that is acceptable or even beneficial to the concern.
The Great Law of the Iroquois was to think in increments spanning 7 generations into the future (roughly 140 years).
The idea behind the TransitionCo is that it’s going to be relied upon to provide liquidity, income, wages and act as a vehicle for storage of value (savings) for a long long time (multi-generational), because where we are headed is going to be a long, brutal, harsh slog. There probably isn’t a term for it yet, because it will be in many respects worse than The Great Depression but will have too much technology, infotainment and Soylent Green to be considered another Dark Age.
When Transition Corps are publicly traded it is motivated by providing liquidity to the community shareholders and to provide a vehicle to distribute dividends. It is not there to give quarterly guidance and obsess over the stock price. Executive compensation should not be tied to stock price performance but to more rational metrics: absolute returns on invested capital, adjusted returns on normal course earnings or some rational appraisal of book value.
Because we exist in a climate of widespread financial repression, most classical investment and prosperity strategies are hamstrung by over indebted welfare States who systematically:
In other words, all classical, rational long term strategies have been systematically sabotaged. Thus, the TransitionCo has to become the long-term vehicle of savings and income for its shareholders. That’s a big responsibility.
The ethos in business today completely reverses the emphasis on exit strategies. The obsession with “the exit” makes sense if you’re operating within a debt-based expansionary bubble.
Under such a paradigm, equity investors want out as fast as possible (sequential funding rounds at increasing valuations to cash out earlier stage backers) while any and all debts accumulated are assumed to be rolled over forever.
A TransitionCo flips this over, endeavouring to create an equity-based approach: the equity holders are cultivated that have a long-term time horizon, who aren’t already scheming how to “get out” before they’re even in. Debt actually gets paid off. The basis of “no exit investing” does have a track record in that this is what many “value investors” do.6
This is not to say that a TransitionCo will eventually deliver 100x returns over the long haul, or even aspire to that. What I am saying is that by functioning along the principles laid out herein, the TransitionCo will deliver consistent returns, quite possibly elevated, and over a longer time frame.
TransitionCo’s are, in celebrated business author Jim Collins’ phrase, “Built To Last”. This contrasts against today’s ethos in which most companies are quite literally on a suicide mission: hell-bent on being ingested by the nearest 800lb gorilla at the earliest opportunity.
Thanks for staying with me so far, we’ll close out with a table describing the key differentiators between a TransitionCo and “the other kind” which we’ll just term a “DinoSaur Corp” or “DinoSaurus” and finally what to do next if you find yourself intrigued by the concept.
“Invert, always invert!”
— Carl Jacobi (but frequently attributed to Charlie Munger)
What differentiates a TransitionCo from a DinoSaurus are the following set of rather striking reversals or inversions:
|Share Buybacks||Load up on debt at artificially low interest rates to buy back shares trading at or near highs.||Would buy up their own shares when trading at significant discount to assessed IV, either as a capital allocation strategy (using their own money) or if levered, would do so with a definite pay-down strategy.|
|Financial Paradigm||Debt based. ROI via liquidity events such as successive funding rounds, being acquired, celebrity IPOs.||Equity based. ROI derived from normal course operations, Return-On-Equity, dividends.|
|Investors / Shareholders / Backers||The equity investors want their holding times to be as brief as possible.||“No exit” investing: The shareholders are in it for the long haul.
|Debt||Debt rolls over and grows forever.||Debt is temporary used selectively and actually liquidated.|
|Share Price||Focused on it to myopic extremes, tie executive compensation to it in ruinous ways.||Selectively take action based on internal assessments of overvalued (use shares to buy assets) or undervalued (buy back shares while they are on sale).
|Purpose / Mission||Do one thing, eat the entire market, even if that means losing money and cannibalizing the ecosystem to gain primacy||Have a core competency deployed across multiple business units and revenue streams. Have an investment unit devoted to building up a gigantic rainy day infrastructure.
|Financials||Top-line Revenue growth on income statement, ignore expenses, negative cash flows. Deficits made up via serialized funding rounds.
|Revenues greater than Expenses (a.k.a “profitable”) Cash flow net positive, rock solid balance sheet.
|Cash||Too much cash? Pay it out! (Better yet, borrow some and pay that out!)||Dividends are nice. So is having cash cushions & liquidity. One never knows when a bargain may present, or when an exogenic shock catches you off-guard.
|Customers||The dumber the better.
Mine their data. Customers are the product.
|The smarter the better. Customer primacy.
Vendor Relations Management (VRM)
All of the above material could be distilled down into the following base concepts:
If any of this has resonated with you, or if you are already running or backing a business along these lines and feel like you’re in it alone, feel free to join the Guerrilla Capitalism mailing list.
By Peter Weissman FCPA, FCA, TEP who has been tirelessly advocating against the current administrations’ plans to “supertax” small business “passive income” at 73%. (I also wrote my own reaction to the hypocrisy of this proposal on my personal blog).
Concerns regarding Finance Minister Bill Morneau’s controversial July 18, 2017 proposed changes to tax rules for private corporations are still numerous and significant. Ever since the ill conceived proposals were announced, anxiety levels have been high. Some business owners have put growth decisions on hold while others have decided to move or fund growth outside of Canada. While the Prime Minister and Minister Morneau recently announced some retreat from their initial attack the devil will be in the details, none of which have been disclosed. The government’s attack on private businesses has villainized this back bone of our economy, created unnecessary anxiety and created distrust of our government and its motives.
Some of the anxiety and distrust could have been alleviated had Mr Morneau responded in good faith to the flaws and risks of the tax proposals that were identified by businesses and professionals. Instead, the government further undermined its credibility by the manner in which it chose to respond. Selfishly, the government made business owners wait while responses were announced without details, slowly, over the course of National Small Business Week. The governments choice to prolong business anxiety in order to market its climb down from some of the most controversial tax proposals we have seen in decades was insensitive and indicative of its lack of respect for small businesses.
As modern day Trojan Horses, Minister Morneau and Prime Minister Trudeau announced their intentions to continue their battle with small businesses from within actual small business venues.
On October 16, from a Pizzeria north of Toronto, the Minister announced he will simplify the income sprinkling proposals. All he actually did was state that the proposed subjective “reasonability” test will be based on a shareholder’s contribution to the business. Professionals have largely agreed that income sprinkling is an area that can be tightened up but have recommended the use of unambiguous solutions such as precluding income sprinkling to children until they are 25. These quantifiable or “bright line” tests are imperative in order to eliminate uncertainty, allow the CRA to audit efficiently and avoid overwhelming taxpayers and the already overburdened tax court with expensive litigation the use of subjective terms like “meaningful contributions” will create.
Yet the Minister has chosen to proceed with an ambiguous reasonability test. In his November 1 statement to the Standing Senate Committee on National Finance, the Minister stated that there are reasonability tests in other areas of tax so this is nothing new. This type of uninformed self-serving statement is infuriating. The general public might accept such a rational but tax specialists cannot let the Minister get away with this disingenuous comment. Reasonability tests exists with respect to items like salaries where there are comparables. There are no comparables to use for private company dividends and no jurisprudence to provide guidance.
The decision to abandon restrictions on the use of the lifetime capital gains exemption was good news but there are many unanswered questions. Will the exemption be available to inactive shareholders? Will gains above the exemption amount be re-characterized as high rate dividends, as is currently written in the July 18 proposals?
Missing from the October 16 announcements were any references to the most troublesome components of his income splitting proposals.
At this press conference the government also announced the reduction in the small business tax rate. Most Canadians don’t realize that the nominal benefits to businesses, from this change, will be offset by an increase in the personal tax rate on dividends. The benefits of a preferential small business tax are questionable and some professionals have even suggested eliminating the small business tax rate.
On October 18, from Hampton, New Brunswick, the Minister announced he will move ahead with plans to penalize private companies that retain capital with taxes totalling 73% if passive income earned is in a small business. An exemption for the first $50,000 of annual passive income was announced. Even with the arbitrary $50,000 exemption, these proposals are ill-conceived and should be scrapped. The necessity to accumulate capital reserves is undisputed and the ability to accumulate more capital keeps Canada a relatively attractive place to do business. In his testimony before the Standing Senate Committee on National Finance, the Minister acknowledged that the government has not even determined how much revenue the passive income measures will generate nor the economic impact they will have. It is irresponsible and mean spirited for our government to announce such a significant policy without even understanding the pros and cons.
Tax professionals have performed the analysis and the results are shocking. The value of a Canadian private business will be hugely impacted if the passive income proposals are enacted. Already, Canadian businesses do not grow to the same extent as companies in many other industrialized countries. The passive income proposals will further reduce the value of private businesses by millions of dollars. This effect is enough to make even the most patriotic of Canadians move, grow or build their businesses outside of Canada. By his own admission, Mr. Morneau is not aware of this reality nor does he have his own projections. For these reasons the passive income proposals must be totally withdrawn.
Finally, on October 19, from a farm in Erinsville, Ontario where the only person “out standing in his field” was the farmer, Mr. Morneau said he will not move forward with proposals that would have made transfers of the family business to the next generation taxable at almost double the rate of a sale to a third party. Mr. Morneau, however, made it clear that changes will come. He stated
“In the coming year, the Government will continue its outreach to farmers, fishers, and other business owners to develop proposals to better accommodate intergenerational transfers of businesses while protecting the fairness of the tax system”.
Protecting the fairness of the tax system is our government’s code for “increasing taxes on small businesses”.
Finally, no proposed legislation for the revised rules has been released but they will be effective on January 1, 2018. Further showing his contempt for small businesses, the Minister Morneau has stated that, despite the effective date of January 1, draft rules will not be released until mid to late January and won’t be tabled for approval until the spring 2018 budget.
Think about this. The government is forcing punitive tax measures on small businesses but won’t tell us the details until well after the clock starts. Why is there such a rush? This ominous uncertainty is unhealthy for our economy, has paralyzed businesses, and is unnecessary and irresponsible.
Private businesses are the most vulnerable to tax changes and can least afford what is being forced on them. Yet the government continues to tell Canadians it is only making our tax system “fairer”. Perhaps the Prime Minister and Mr. Morneau have been sampling edibles that will become legal in January.
The Minister, the Prime Minister and all Liberal MP’s should not misjudge the apparent silence from the small business community as approval for the state of these tax proposals. Our message hasn’t changed. The proposals, even in their apparent current form, are not acceptable. Prior to the October announcements the proposals could have been salvaged with appropriate modifications. The government ignored the feedback it received and has made the remaining rules even worse. At this point, the only responsible approach is for the proposals to be totally abandoned in favour of a fresh start, with proper collaboration.
Once again, I urge the government to slow down and get this right. Don’t mistake the business and tax communities’ silence as approval. We have not gone away. We’re just resting.
[ Originally published November 24, 2014 on the easyDNS blog and included here to build up some base material ahead of launch – markjr]
The 800lb Gorilla in your space has a Mission Statement. Possibly complimented by a Vision Statement and maybe even a Values/Ethics Statement for good measure.
These were either outsourced to a consulting firm or dreamed up in a series of team-building workshops.
They encapsulate values of ethics, morality, diversity, commitment to excellence, customer service and a dedication to quality.
When employees of the Gorilla hear the Mission Statement, their eyes glaze over. By the end of the Values/Ethic Statement they are comatose.
Most of the people inside the Gorilla company couldn’t tell you the Mission Statement if you asked them and none of these statements have any impact on what actually goes on inside the company.
By contrast, you are On A Mission. You have a singular purpose that drives your every move. It is what Jim Collins calls “your hedgehog concept”. It gets you up in the morning. It keeps you awake at night. You live and breathe your mission and you let nothing distract you from it. Your mission is your obsession.
Our mission easyDNS (my company) has always been “To Drive A Stake Through The Heart of Lock-In In All Its Forms”.
When my partners and I started the company back in ’98, “lock-in” was the perpetual bogeyman that made our lives, and the lives of our customers miserable. So we set out to kill lock-in. Nearly 20 years later almost every strategic move we make can still be reduced to that same core principle:
Does it set our customers free? Then we do it. Does it box them in? Then we don’t. That’s a mission.