Investor. Any references to securities are not recommendations or solicitations to buy or sell anything. I may have positions in securities mentioned.
Greed and Capitalism
What kind of society isn't structured on greed? The problem of social organization is how to set up an arrangement under which greed will do the least harm; capitalism is that kind of a system.
Meet China’s New Top Stock Market Watch Dog -- Former Beijing Police Chief Stalking “Malicious” Short Sellers
by Bloomberg Business
The high-ranking cop who brought down one of China’s top Communist Party
officials has been put in charge of a corruption probe of the
securities industry in the wake of a summer stock crash, said a person
familiar with the matter. The appointment of Fu Zhenghua underscores the
importance that President Xi Jinping has given the investigation into
possible securities fraud linked to the $5 trillion wipeout in June and
July… Read more »
The careers of
superstar CEOs Bill Gates, Andy Grove, and Steve Jobs offer important
lessons about how to become a better strategist.
Many discussions of strategy revolve around companies. But what about the people who develop corporate strategies? How can executives develop their skills as strategists?
There’s no better way than to learn from the masters. That’s the idea behind a recent book by David B. Yoffie, the Max and Doris Starr Professor of International Business Administration at Harvard Business School, and Michael A. Cusumano, the Sloan Management Review Distinguished Professor of Management at the MIT Sloan School of Management. Both men are experts in business strategy — they’ve been teaching the subject for nearly 30 years at Harvard and MIT, respectively. What’s more, Yoffie and Cusumano have studied or worked closely with some of the world’s leading technology executives. In their book, Strategy Rules: Five Timeless Lessons From Bill Gates, Andy Grove, and Steve Jobs (HarperCollins, 2015), Yoffie and Cusumano explore strategy insights drawn from the careers of the former CEOs of Microsoft Corp., Intel Corp., and Apple Inc.
MIT Sloan Management Review editorial director Martha E. Mangelsdorf spoke with Yoffie and Cusumano about what executives can learn from Gates, Grove, and Jobs about mastering the art of strategy. What follows is an edited and condensed version of that conversation. MIT Sloan Management Review: Your book “Strategy Rules” looks at strategy lessons from three iconic CEOs from the computer industry: Bill Gates, Andy Grove, and Steve Jobs. What made you choose those three CEOs to write about?
Yoffie: There are several reasons for choosing these three. First and foremost, all three of the companies they led — Microsoft, Intel, and Apple — became the most valuable company in the world at some point. We were looking at three companies where we believed it was undisputed that the three individual CEOs had accomplished an extraordinary amount over their careers.
Second, we had spent a lot of time working with or observing all three of these individuals. We knew them, their records, and their companies extremely well. And by identifying three executives whose legacy as CEO was complete — and where the companies they led had continued to perform well after their departure — we could capture a more complete picture.
Like
most people who buy recreational vehicles, Warren Buffett made his
decision quickly. He heard about Forest River in the summer of 20051 and bought the company just seven days later.
Today,
the purchase seems particularly sage. The Recreational Vehicle Industry
Association projects that North American manufacturers will ship
369,100 machines this year at an average price of around $37,000, which
would be a 52 percent boost in business from five years ago and make
2015 one of the industry's best years on record. With a dominant market
share of close to 40 percent, Forest River is in pole position.
"The
sun, the moon, and the stars are all lined up," said Doug Gaeddert,
general manager of Forest River's RV business. "A lot of folks who made
this purchase are doing pretty well right now."
Buffett’s
timing wasn’t even that great. Just a few months after getting into the
RV business, the industry began its peak year. After 2006, the
home-on-wheels industry drove into the crisis, almost disappeared, and
has since been slowly accelerating back to cruising speed.
Forest
River, however, fared better than the industry at large. Despite some
bumpy years, it steadily drove annual sales from $1.6 billion in 2004 to
$3.8 billion in 2014.
A lot of factors are fueling the recent
boom, including a surge in interest from bored baby boomers, relatively
cheap gas, and even cheaper financing. More than anything else, however,
the business rides almost entirely on the economy at large. A consumer
needs to be feeling fairly sanguine to think: "Wouldn't it be cool if we
could drive somewhere with our bed and flat-screen TV in a $400,000 rig?"
A
lot of those consumers happen to be among the more than 10,000 U.S.
baby boomers retiring every day. Roughly 10 percent of RV owners are
over the age of 54, according to the RV Industry Association2.
But younger cruisers are buying in as well, in part because the
industry's major players pour about $15 million a year into a collective
marketing budget that has been sending caravans of big rigs around to
college campuses and music festivals.
Gaeddert
said there is a 50 percent chance that the industry will sell more than
400,000 RVs next year, even factoring in a slight uptick in interest
rates. "That would absolutely be a milestone number," he said.
Oaktree Capital Group co-Chairman Howard Marks discusses how emotion
and human nature play into investing. He speaks on "Bloomberg ‹GO›."
(Source: Bloomberg)
The US investment bank predicts the ruble will be on the list of
good performing currencies next year along with the US dollar and the
Mexican peso, Bloomberg reports.
Goldman Sachs recommends buying Russian and Mexican currencies over South Africa’s rand and Chile’s peso.
This week, the ruble has grown three percent, but seems not strong enough to continue the trend in 2015.
“Ruble
assets have found useful support over the last week on a perceived
rapprochement between Russia and the West. This relationship may,
however, will be tested over the coming days and weeks as fundamentals
continue to be weak, oil prices remain under pressure and a December Fed
liftoff seems increasingly likely,”
Ivan Tchakarov, economist at Citigroup told Bloomberg.
Goldman
Sachs also said the greenback would grow in value in 2016 against the
euro and yen. In 2015, the dollar has been growing compared to all of
its peers, as the US Federal Reserve gets closer to hiking interest
rates and the European Central Bank and Bank of Japan continued monetary
stimulus.
Ruble will make 'Made in Russia' a global brand – World Bank economist http://on.rt.com/6vjf
Ruble will make 'Made in Russia' a global brand – World Bank economisthttp://on.rt.com/6vjf
The
Financial Secrecy Index ranks jurisdictions according to their secrecy
and the scale of their offshore finanical activities. A politically
neutral ranking, it is a tool for understanding global financial
secrecy, tax havens or secrecy jurisdictions, and illicit financial
flows or capital flight.
The index was launched on November 2, 2015. Shining light into dark places
An estimated $21 to $32 trillion of private financial wealth is located, untaxed or lightly taxed, in secrecy jurisdictions around the world. Secrecy jurisdictions - a term we often use as
an alternative to the more widely used term tax havens - use secrecy to
attract illicit and illegitimate or abusive financial flows.
Illicit cross-border financial flows have been estimated at $1-1.6 trillion per year: dwarfing the US$135 billion or so in global foreign aid. Since the 1970s African countries alone have lost over $1 trillion in capital flight, while combined external debts are less than $200 billion. So Africa is a major net creditor
to the world - but its assets are in the hands of a wealthy élites,
protected by offshore secrecy; while the debts are shouldered by broad
African populations.
Yet all rich countries suffer too.
For example, European countries like Greece, Italy and Portugal have
been brought to their partly knees by decades of tax evasion and state
looting via offshore secrecy. A
global industry has developed involving the world's biggest banks,
law practices, accounting firms and specialist providers who design
and market secretive offshore structures for their tax- and
law-dodging clients. 'Competition' between jurisdictions to provide
secrecy facilities has, particularly since the era of financial
globalisation really took off in the 1980s, become a central feature of
global financial markets.
The problems go far beyond
tax. In providing secrecy, the offshore world corrupts and distorts
markets and investments, shaping them in ways that have nothing to do
with efficiency. The secrecy world creates a criminogenic hothouse
for multiple evils including fraud, tax cheating, escape from financial
regulations, embezzlement, insider dealing, bribery, money
laundering, and plenty more. It provides multiple ways for insiders
to extract wealth at the expense of societies, creating political
impunity and undermining the healthy 'no taxation without
representation' bargain that has underpinned the growth of accountable
modern nation states. Many poorer countries, deprived of tax and
haemorrhaging capital into secrecy jurisdictions, rely on foreign aid
handouts.
This hurts citizens of rich and poor countries alike.
What is the significance of this index?
In
identifying the most important providers of international financial
secrecy, the Financial Secrecy Index reveals that traditional
stereotypes of tax havens are misconceived. The world’s most important
providers of financial secrecy harbouring looted assets are mostly not
small, palm-fringed islands as many suppose, but some of the world’s
biggest and wealthiest countries. Rich OECD member countries and their satellites are the main recipients of or conduits for these illicit flows.
The
implications for global power politics are clearly enormous, and help
explain why for so many years international efforts to crack down on
tax havens and financial secrecy were so ineffective, it is the
recipients of these gigantic inflows that set the rules of the game.
Yet
our analysis also reveals that recently things have genuinely started
to improve. The global financial crisis and ensuing economic crisis,
combined with recent activism and exposure of these problems by civil
society actors and the media, and rising concerns about inequality in
many countries, have created a set of political conditions unparalleled
in history. The world's politicians have been forced to take notice of
tax havens. For the first time since we first created our index in 2009,
we can say that something of a sea change is underway.
World
leaders are now routinely talking about the scourges of financial
secrecy and tax havens, and putting into place new mechanisms to tackle
the problem. For the first time the G20 countries have mandated the OECD
to put together a new global system of automatic information exchange
to help countries find out about the cross-border holdings of their
taxpayers and criminals. This scheme is now being rolled out, with first
information due to be exchanged in 2017.
Yet of course these
schemes are full of loopholes and shortcomings: many countries are
planning to pay only lip service to them, if that -- and many are
actively seeking ways to undermine progress, with the help of a
professional infrastructure of secrecy enablers. The
edifice of global financial secrecy has been weakened - but it remains
fully alive and hugely destructive. Despite what you may have read in
the media, Swiss banking secrecy is far from dead. Without sustained political pressure from millions of people, the momentum could be lost. The only realistic way to address these problems comprehensively is to tackle them at root: by directly
confronting offshore secrecy and the global infrastructure that
creates it. A first step towards this goal is to identify as
accurately as possible the jurisdictions that make it their business to
provide offshore secrecy.
This is what the FSI does.
It is the product of years of detailed research by a dedicated team, and
there is nothing else like it out there. We also have a set of unique
reports outlining detailed offshore histories of the biggest players in
the game. Click here for the full 2015 ranking. For further questions, click here.
By Tyler Durden at ZeroHedge
Today, U.S. fast-food workers will strike across 270 cities in a
protest for higher wages and union rights that they hope will catch the
attention of candidates in 2016 elections, organizers said.
The walkouts will be followed by protests in 500 cities by low-wage
workers in such sectors as fast food and home and child care, a
statement by organizers of the Fight for $15 campaign said on Monday.
The protests and strikes are aimed at gaining candidates’ support
heading into the 2016 election for a minimum wage of $15 an hour and
union rights, it said.
The strikes and protests will include workers from McDonald’s,
Wendy’s, Burger King , KFC and other restaurants, the statement said.
And while we sympathize with their demands for higher wages, here is the simple reason why they will be very much futile.
Dear fast food workers of the US – presenting you nemesis: the Momentum Machines burger maker.
According to a recent BofA reported on how robotics will reshape the
world, San Francisco start up Momentum Machines are out to fully
automate the production of burgers with the aim of replacing a human
fast food worker. The machine can shape burgers from ground meat, grill
them to order with the specified amount of char, toast buns, add
tomatoes, onions, pickles, and finally place it on a conveyor belt.
The robot is shown below. It occupies 24 square feet, and is much
smaller and efficient than most assembly-line fast-food operations. It
provides “gourmet cooking methods never before used in a fast food
restaurant” and will deposit the completed burger into a bag. It does
all of this without a trace of attitude.
According to public data, the company’s robot can “slice toppings
like tomatoes and pickles immediately before it places the slice onto
your burger, giving you the freshest burger possible.” Unlike human
workers, the robot is “more consistent, more sanitary, and can produce
~360 hamburgers per hour” or a burger every 10 seconds.
Furthermore, future generations of the device “will offer custom meat
grinds for every single customer. Want a patty with 1/3 pork and 2/3
bison ground to order? No problem.”
As the company’s website adds, “our various technologies can produce
an ever-growing list of common choices like salads, sandwiches,
hamburgers, and many other multi-ingredient foods with a gourmet focus.”
But most importantly, it has no wage demands: once one is purchashed
it will work with 100% efficiency for years. And it never goes on
strike.
As the company’s co-founder Alexandros Vardakostas told Xconomy his “device isn’t meant to make employees more efficient. It’s meant to completely obviate them.”
The company’s philosophy on making millions of fast food workers obsolete:
The issue of machines and job displacement has
been around for centuries and economists generally accept that
technology like ours actually causes an increase in employment.
The three factors that contribute to this are
the company that makes the robots must hire new employees,
the restaurant that uses our robots can expand their frontiers of production which requires hiring more people, and
the general public saves money on the reduced cost of our burgers.
This saved money can then be spent on the rest of the economy.
This is a major problem for the US economy, which once built on a manufacturing backbone, has seen the fastest jobs growth in recent years for workers employed by “food service and drinking places” i.e., fast food workers, waiters and bartenders.
Finally, for those complaining that there will be no “human touch” left to take the orders, robots have that covered too:
And now it’s time to calculate how many tens if not hundreds of
billions in additional welfare spending these soon to be unemployed
millions in low-skilled workers will cost US taxpayers.
The buyer who shelled out $170.4 million for Modigliani’s Nu Couché—the
second-highest price paid at auction, ever—has been revealed as a
Chinese billionaire with an irresistible rags-to-riches story: Liu
Yiqian is a former taxi driver turned investing magnate who reportedly
pays for his historic auction purchases on an American Express
Centurion, meaning he can fly wherever he wants, whenever he wants.
Liu has already established himself as a major buyer of Asian art
with a knack for scandalously ostentatious displays of the wealth he
amassed investing in the stock market. After paying $36.3 million for a
Ming-dynasty ceramic cup at Sotheby’s Hong Kong in July 2014, Liu
scandalized the art world when a picture of him gleefully sipping tea
from the 500-year-old object once owned by emperors surfaced. If that
let-them-eat-cake moment wasn’t enough, Liu also paid for the cup with
his American Express card, swiping 24 times and racking up almost 422
million rewards points, according to Bloomberg.
Just a few months later, he paid $45 million for a 15th-century
Tibetan tapestry—again with his Centurion. He used his points to fly
with his family to New York, where, according to Bloomberg, Liu drew
attention for posing for a photo in his underwear in their St. Regis
hotel room, assuming the pose of a Tibetan yogi statue he planned to bid
for at an upcoming Christie’s New York auction. He won it at a price of $4.9 million.
Courtesy of Christie's.
This appears to be Liu’s first major purchase of Western art; he told The New York Times
of the sensual reclining nude, “This work is relatively nice compared
to [Modigliani’s] other nude paintings.” He added that he plans to
display the work at one of his two Shanghai museums: “It will be an
opportunity for Chinese art lovers to see good artworks without having
to leave the country, which is one of the main reasons why we founded
the museums.”
Liu has not confirmed whether he paid for the Modigliani with his
American Express card, but we can only guess what kind of splash he has
in store to celebrate
If you need evidence that Wall Street is a financial time bomb waiting for ignition look no further than the recent meltdown of Valeant Pharmaceuticals (VRX). In round terms, its market cap of $90 billion on August 5th has suddenly become the embodiment of that proverbial sucking sound to the south, having plunged by nearly two-thirds to only $34 billion by Friday’s close.
No, Valeant was not caught selling poison or torturing cats during the last 90 days. What is was doing for the past six years is aggressively pursuing every one of the financial engineering strategies that are worshipped and rewarded in the Wall Street casino.
Indeed, Valeant’s evolution during that period arose straight out of financial engineering central. That is, it was a creature of Goldman Sachs and the various dealers, underwriters, hedge funds and consulting firms which ply the Bubble Finance trade.
At the end of the day, the latter have turned the C-suites of corporate America into gambling dens by attracting, selecting and rewarding company wrecking speculators and debt-crazed buccaneers to the top corporate jobs.
In this case, the principal agent of destruction was a former M&A focussed McKinsey & Co consultant, Michael Pearson, who became CEO in 2008.
Pearson had apparently spent a career in the Dennis Kozlowski/Tyco school of corporate strategy. That is, advising clients to buy, not build; to slash staff and R&D spending, not invest; to set ridiculously ambitious “bigness” goals such as taking this tiny Canadian pharma specialist from its $800 million of sales to a goal of $20 billion practically overnight; to finance this 25X expansion with proceeds from Wall Street underwriters, not internally generated cash. He even replicated the Tyco strategy of moving the corporate HQ to Bermuda to slash its tax rate.
Pearson’s confederate in this scorched earth corporate “roll-up” enterprise was Howard Schiller, a 24-year veteran of Goldman Sachs, who became CFO in 2011, and soon completed the conversion of Valeant into a financial engineering machine.
During their tenure, Pearson and Schiller spent about $40 billion on some 150 acquisitions. And exactly what common expertise and value added leverage did these far flung acquisitions in contact lenses, ophthalmological therapies, dermatology, cosmeceuticals, anti-aging creams, Botox equivalents, acne fighters and much more bring to the table?
Well, what they brought was an opportunity to slash thousands of jobs, eliminate R&D, fund massive amounts of goodwill and intangible assets with cheap debt and, most especially, to fill Valeant’s purchase accounting cooking jars with fulsome amounts of reserves that can henceforth be used to cause inconvenient integration costs to disappear, as needed.
Indeed, Valeant not only failed to acquire any significant pharmacuetical synergies, but actually went in the opposite direction. That is, it has militantly eschewed investment in drug research and development in an industry who’s very purpose is the development of new drugs and therapies.
Yet the alternative strategy they peddled to the occupants of the hedge fund hotel that became increasingly crowded with VRX punters as its shares soared skyward was downright nonsensical and economically vapid. It could only have thrived during the late stages of a Bubble Finance mania.
In essence, Pearson and Schiller claimed that the rest of the industry was infinitely stupid, and that tens of billions of market cap could be created instantly by the simple expedient of buying companies with seasoned drugs and then jacking up prices, often by orders of magnitude.
In fact, Valeant has acquired a reputation for ferociously raising prices. In one year alone the company jacked-up the price of 81% of the drugs in its portfolio by an average of 66%.
The point here is not to echo the Hillary Chorus in favor of government drug price controls. Quite the contrary. Despite a crony capitalist inspired patent regime and the endless legal obstacles thrown up by the Big Pharma cartel, the drug market is not immune to the laws of economics.
Raise the price of drugs radically enough and you will attract competitors into the market with new formulations that circumvent the patent; or get greedy enough and generics will swamp you on the patent’s expiration.
Nor does that truth completely exempt even small volume or so-called orphan drugs. In those instances, it takes massive price gains to move the aggregate revenue needle. That is, exactly the kind of egregious increases that stir a political firestorm among users and providers and bring the Hillary brigade charging toward the TV cameras.
Accordingly, Martin Shkreli’s 5000% increase in the price of Daraprim went dark even faster than his company Twitter account.
Stated differently, what seasoned industry executives know that may have escaped the attention of 32-year Wall Street hot shots like Shkreli, or the spreadsheet jockeys who congregate in the hedge fund hotels, is that massive, wanton, overnight price escalation is not a business strategy that builds sustainable value and reinforces brand equity; it’s a scalping tactic that works in the casino, but not the real world.
At the same time, Pearson and Schiller slashed staff and chopped down R&D spending to a comically low 3% of sales. That compares to an industry norm of 12% to 18%.
Finally, this Wall Street witches brew was stirred together in pro forma financials that assumed these predatory price hikes would be permanent and that these back-of-the-envelope cost savings would be immediately realized in full.
The resulting profit projections, of course, had virtually nothing to do with the company’s actual results, but they did conform to sell-side hockey sticks like a hand-in-glove.
As the New York Times noted in an piece over the weekend:
Looking at Valeant’s real earnings compared with its make-believe ones exposes an enormous gulf. Under generally accepted accounting principles, the company earned $912.2 million in 2014. But Valeant’s preferred calculation showed “cash” earnings of $2.85 billion last year. That gap is far wider than at other pharmaceutical companies presenting adjusted figures.
Needless to say, it did not take long to turn Valeant into a veritable debt-mule. Its debt outstanding rose from $400 million in 2009 to $31 billion at present, and that’s the rub.
To wit, Valeant has been a veritable cash burning machine during its Wall Street driven M&A spree. So it has no possibility of making ends meet under a continuation of the maniacal M&A campaign crafted by the Wall Street wise guys.
Indeed, its demise is a near certainty. On the one hand, it was destined to blow-up if it kept “growing” via debt-fueled M&A. Contrariwise, its peak stock market value at 100X GAAP earnings was destined to implode if it stopped doing deals and triggered a mass exodus by the punters who inhabited VRX’s hedge fund hotel.
It goes without saying, of course, that these Bubble Finance deformations have resulted from the lunatic cheap money and wealth effects levitation policies of the Fed. Financial repression and QE deeply subsidize corporate borrowing to fund financial engineering deals, thereby reducing the after-tax cost of even sub-investment grade debt to low single digit levels.
Likewise, ZIRP is the mother’s milk of Wall Street speculation. It enables hedge funds and other fast money traders to build-up positions in rocket ships like Valeant at virtually no cost through the options and dealer financing markets.
Indeed, as VRX’s market cap grew from $14 billion to $90 billion in just 36 months, it generated a daisy chain of rising “collateral” value that enabled leveraged speculators to chase its stock to an ever more absurd height relative to the company’s GAAP financials.
During the 12 months ending in September, for example, VRX generated only $2.54 billion of operating cash flow, but spent $14.3 billion of cash on CapEx, M&A deals and other investments.
Nor was that an aberration. During the 27 quarters since the end of 2008, VRX has generated a mere $7 billion in operating cash flow, but has consumed nearly $26 billion of cash on investments and deals. Stated differently, it was a Wall Street Ponzi pure and simple.
Likewise, during that 27 quarter period, which roughly tracks Pearson’s tenure, the company has posted rapidly rising sales—-with the top line growing from $757 million in 2008 to $10 billion in its most recent LTM report.
But it has been an absolutely profitless prosperity—–not unlike the typical financial engineering driven roll-up. Thus, over this 27 quarter period as a whole, sales totaled just under $30 billion, but its cumulative net income amounted to a miniscule $130 million.
That’s right. Over the last seven years, Valeant’s GAAP profits have amounted to just 0.4% of sales.
So why did Valeant’s market cap soar from $1.2 billion, when Pearson arrived in 2008, to the recent peak of $90 billion during a period when the company has generated hardly a dime of profits?
It was just another case of Wall Street financial engineering and speculative hype at work. The entire story has been based on pro forma, ex-items forward looking Wall Street hockey sticks, and not the least those published by Goldman Sachs.
Yet there is no mystery as to why these financial engineering scams happen over and again in financial markets which have been corrupted and disabled by the Fed and other central banks.
Namely, because the deal fees from financial engineering are so lucrative; and because the checks and balance of a healthy free market in finance——such as short-sellers, heavy hedging expense and meaningful carry costs for debt financed speculations—–have been destroyed by the central banks.
Thus, a few years ago Valeant’s predecessor company was a backwater player on the Toronto stock exchange, but in the last three years it has become the fifth largest payer of investment banker fees on Wall Street.
In fact, thanks to its rapid acquisition-driven and debt-financed expansion Valeant’s investment banking fees have totaled $500 million since 2012. This means that only General Electric Co, Allergan Plc., AT&T Inc. and Dell Inc have paid more, according to data from Freeman and Co.
Needless to say, financial engineering scams like Tyco and Valeant would never happen in an honest free market. Short sellers would shut them down long before they reach egregious levels of over-valuation; and the cost of honest downside market insurance (i.e. S&P 500 puts) and market driven carry cost would dramatically reduce the profitability of speculation and the amount of punters and capital in the casino.
In today’s broken markets and corrupt regime of central bank driven crony capitalism, however, bubbles inflate in individual securities, as well as in broad sectors (e.g. biotech, social media and junk bonds) and the market as a whole, until they reach egregious, self-correcting extremes. Then they violently implode, creating immense waves of collateral damage in the process.
Recall that Tyco’s market cap dropped from $125 billion to $25 billion during just the final six months before Kozlowski was finally forced out in June 2002. Likewise, during the last 90 days nearly $250 billion has evaporated from the 150 companies in the NADAQ biotech index.
Viewed in the larger context, therefore, Valeant’s $55 billion implosion in recent weeks is just a preliminary tremor. On a worldwide basis, the mother of all financial bubbles is just beginning to fracture.
Accordingly, in the US alone there is probably another $15 trillion of bottled air waiting to be released. Perhaps then the American people will learn that Yellen & Co have actually been in the un-wealth effects business for way too long.
OPEC or U.S.: Who Blinks First in Oil Market Flood?
The
oil price was near its lowest in more than a decade, cash reserves were
being depleted, emerging markets were in turmoil and Saudi Arabia was
beginning to panic.
“It was a very scary moment,” said
Khalid Alsweilem, former head of investment at the Saudi Arabian
Monetary Agency, the country’s central bank. “And luckily at that point,
oil prices started going up. Not by design, by good luck.”
That was 1998, and now Saudi Arabia’s fortunes
threaten to turn again. This time, luck might not be enough as the
government tries to protect the wealth of a nation whose economy has
swelled by five times since then. The bastion of conservative Sunni
Islam also is paying for an expanding role in regional conflicts in the face of a resurgent Iranand Islamic State extremists who have bombed Saudi mosques.
Economists
are predicting a budget deficit of as much as 20 percent of gross
domestic product and the International Monetary Fund forecasts a first
Saudi current-account deficit in more than a decade. Reserves at the
central bank tumbled 10 percent from a year ago, or by more than $70
billion.
As a result, bets on the devaluation of the riyal
are surging. The Tadawul All Share Index lost 18 percent in the past
three months and dragged stocks down across the Gulf region. The
benchmark’s moving averages made a so-called death cross on Aug. 18, a sign to some investors that more losses are ahead.
Patient Saudis
The
Saudis have “played a waiting game,” Robert Burgess, Deutsche Bank AG’s
chief economist for emerging markets in Europe, the Middle East and
Africa, said from London. “The budget for next year is going to be a
very important milestone that the markets are going to be focusing on
quite intently.”
With oil prices down by more than half over the past 12 months to below $50, Saudi Arabia faces many of the same financial problems it did in 1998.
“There’s a long list of things that Saudi officials can do before touching the livelihood of ordinary Saudis”
Waseem Obaidi/Bloomberg
The
difference is the sheer cost of maintaining the state as an employment
machine and guarantor of the riches that Saudis have become accustomed
to since the last squeeze. Subsidized gasoline costs 16 cents per liter
and while there’s the religious levy called zakat, there is no personal
income tax in the nation of 30 million people.
“The
Saudi government can’t continue to be the employer of first resort, it
can’t continue to drive economic growth through the big infrastructure
projects and it can’t keep lavishing on subsidies and social spending,”
said Farouk Soussa, chief Middle East economist for Citigroup Inc. in
London.
Taking Action
That’s not to suggest Saudi
Arabia is headed for the kind of spending cuts and tax increases more
familiar to austerity-hit Europeans. The government, for instance, could
first freeze the expansion of two mosques in Mecca or tax wealthy
landowners, Jamal Khashoggi, a former media adviser to Saudi Prince
Turki al-Faisal, said by phone from Riyadh.
“There’s a
long list of things that Saudi officials can do before touching the
livelihood of ordinary Saudis,” said Khashoggi. “Yes, it’s a difficult
time and maybe it could have been much better if we did what we’re doing
today a couple of years ago when the price of oil was in the $100s.”
Fuel subsidies alone will cost Saudi Arabia as much as 195 billion riyals ($52 billion) this year, or 8 percent of GDP
Photograher: John Moore/AP Photo
During those good times, King Abdullah,
who ruled from 2005 until his death in January, increased social
spending as the Arab Spring uprisings toppled leaders elsewhere.
It’s
also not like Saudi Arabia has no control over its destiny. Oil
rebounded after 1998 – the price of crude advanced in 11 of the 16
calendar years since then – not least because the Saudis used their
clout as the de facto leader of the Organization of Petroleum Exporting
Countries, or OPEC.
What Crisis?
The country has declined to cut production and lift prices over the past year to gain market share from the shale industry
in the U.S. and other producers with higher expenses, even if that’s
come at a cost to its finances. Saudi Arabia still has $664 billion of
net foreign assets, equal to almost 90 percent of the economy, and
little debt.
“I wouldn’t say there’s any kind of crisis
or even a crisis on the near horizon,” said David Butter, associate
fellow at Chatham House in London. “They’re in the oil business. They’ve
had it pretty good for quite a long time and that’s not typical.”
Even so, the IMF recommends
that Saudi Arabia control its growing wage bill, make changes to
government subsidies for fuel and electricity and bring in more non-oil
revenue through taxes. The country’s breakeven oil price – the point at
which it can balance its budget – is about $100, said Soussa at
Citigroup.
Deputy Crown Prince Mohammed bin Salman
Hassan Ammar/AP Photo
Fuel
subsidies alone will cost Saudi Arabia as much as 195 billion riyals
($52 billion) this year, or 8 percent of GDP, Riyadh-based Samba
Financial Group said in an Aug. 18 report. Central bank Governor Fahad
al-Mubarak already has called for a review of price subsidies.
A
new economic council headed by Deputy Crown Prince Mohammed bin Salman
could help make the changes if it can move quickly, said Alsweilem, the
former investment chief who is now a fellow at Harvard University’s
Belfer Center.
While less per capita than in smaller
energy-rich Gulf states Qatar and the United Arab Emirates, the relative
wealth of Saudi Arabia means the government might need to tread
carefully. Any adjustment will be “jarring,” said Soussa.
“These
are things that are absolutely politically explosive,” he said. “You’ve
gotten accustomed to a certain lifestyle and that lifestyle is far in
excess in terms of luxury that was prevailing in 1998.”
Alive
