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Eating A Mountain of Credit
We are living in a golden age. There are many cultural and social similarities between today and the enlightenment era of the 1600s. We have food, housing, entertainment, confidence and more. But there is a darker side to our prosperity as there was 400 years ago. The apparent wealth of the world remains vested in a few people which makes it impossible for resources to be shared, even if they are common goods (like clean air, water, energy, ...). And the ability of our world to adapt to satisfy the needs of the majority of humanity is impeded by a culture that finds it difficult to share.
The system change that our planet needs is within us all, but it is repressed. The X-culture that dominates global systems is born of a belligerent history. The softer-side of humanity has been repressed by the need to feel secure. Ironically, now that we are secure - we have the technology and resources to satisfy all life's needs - we continue to behave like primitive beasts.
Why should that be so? It is because at the margin of experience we compare ourselves to our peers, but our comparator is not the family next door, it is the family in the media. We imagine that our peers are the Hollywood stars that pretend to live our lives. Or the executives that we read about are simply a step away from us. Or the holiday advertised should be ours. Or the cosmetically enhanced features of a model should be our goal too. It is so difficult for us to withdraw from the social hologram and realise that the illusion of success is unattainable, that happiness comes from integrity and that having stuff means having responsibility not freedom. We have enough. We have more than enough. But we want more.
The age of prosperity that we are enjoying is underpinned by capitalism, or money. Money is simply a reflection of our values. Our value of food, goods, services, work, and so on. It simplifies barter in a community which can understand this idea. Credit is a derivative of money. It still represents our values for stuff, both physical and meta-physical, but it also reflects our value of time (interest) and our value of risk (of our barter counterparty). The phenomenon that has fuelled such rapid growth globally is the rapid expansion of credit, both in developed markets where credit cards, sub-prime loans, margin accounts and so on have spread through the population, but also in emerging markets, where credit is being introduced for the first time to many people, including those at the bottom of the pyramid.
The result today is a massive increase of the number of people with credit and the amount of credit people have. For all of these people, the story is the same: a person who has had little, has few savings and scrapes together the rent each month. has suddenly been given credit. The credit gives the person the opportunity to fulfil their dreams and pay for it later. This may be buying a house for the first time, a new car, a stock portfolio or a sewing machine. The willingness to accept the obligation to repay the debt is based on the person's own confidence in their own ability to repay, which may be enhanced by the sales patter of the creditor or the behaviour of their neighbours or media characters. If parts of that illusion fall away, the fantasy must crumble. If confidence lapses, people stop exchanging goods (they prefer to horde rather than trade), and this decline in activity means that debtors can not do enough to fulfil their obligations. And that small default quickly avalanches through the population of creditors. People lose face, lose confidence and may even lose their sanity.
To many this mountain of credit must seem like a delusion in itself - how can there be more money than stuff? But that excess is simply the value of time (quantum capitalism again). And everyone values time. It is misguided to claim that interest is unethical unless the claimant places no value on their continuing life. (The only people that may be said to have recognised the unity of space-time and do not inherently value their own lives are enlightened "gurus".) In fact, it is more likely that as people are given credit, they place a higher value on their own life and thus time.
Whether humanity chooses to engineer a world in which our values respect nature or not, will determine whether or not this mountain of credit can be maintained or not, for two reasons. First, simply, if the credit is used to invest it may be repaid, if the credit is used to consume, which is not nature friendly, it will not be repaid. Unfortunately, much of the credit created in the past 5 years has been consumer credit and has been consumed.
Secondly, the natural dynamic of planet earth is driven by energy, originally from the sun. On a planetary scale, energy is the currency of life. If our values reflect the values of life, the biosphere will survive, and money will reflect the natural flows of energy on this planet. If we do not value life, we will simply destroy it. This is not a doomsday scenario, simply a fact of nature which is only relevant when the dynamic of human values (money) has a direct impact on the biosphere. It is not relevant at the level of a car, or a litterbug, or a dirty factory. It is relevant on the scale of impact that humanity as a whole has.
This perspective is relevant today because we have extended our credit well beyond historical norms both at a simple financial level, but also from the perspective of the biosphere. The financial markets will be the first to crumble. This is absolutely necessary in order for humanity to learn from experience. If we do not, the decline of nature will be far more painful. The decline in credit must occur because it has been built on optimism, rather than reality. The next time we build global credit so quickly, we are likely to be more careful in our scenario planning. And it is certain that our values will have enlightened. We will value clean food over convenient food. We will value community over virtual reality. We will value authenticity over advertising. We will not compromise on our ethics because "others" do, or because we can. We will be responsible for ourselves, rather than blame the "system" for our problems.
In the meantime, to lessen the pain of an economic or natural slump, eat less. At the base of our pyramid of demands is food. And while many people exist on a modest diet, most of us consume far more than our bodies want. And our food is cheap because we subsidise it heavily. And these subsidies underpin an insidious corruption of the market mechanism for distributing food. If we stop subsidising food in Europe, the US and Japan, our consumption habits would almost certainly become more healthy, our appreciation for food would match its worth and our agricultural practices would change. These changes must come in the coming decade if our food resources are to remain bountiful. As research increasingly shows, the degradation of land and the reduction in its productivity is a global phenomenon that can not be exported.
And as we improve what we put into our bodies, our souls will be nurtured. It is evident that a lower calorie intake, and in particular a reduced flesh intake, improves vitality and extends longevity. Appreciating the source of the morsel ingested improves the eating experience. Perhaps it all seems a little far fetched, but our own little empirical experience supports this, as does science. While the time to change political minds will be long, you can help yourself improve body mind and spirit now - eat less, and a lot less flesh.
Investment, Finance & VC
The US Dow Jones Index of closed above 13,000 for the first time in history, powered by strong corporate results. The broader Standard & Poor's index reached a six-year high of 1,515, not far off its all-time high of 1,527 recorded in the dot.com boom of 2000.
While good corporate results have pushed up the US markets, more than anything perhaps, the optimism shown by markets may be underpinned by liquidity. An excellent big picture view of global liquidity by Jeremy Grantham has been shared by John Mauldin here (page down). As Grantham notes, bubbles are based on human behaviour, and the mechanism is simple: perfect conditions create very strong "animal spirits," reflected statistically in a low risk premium. Widely available cheap credit offers investors the opportunity to act on their optimism. Sustained strong fundamentals and sustained easy credit go one better; they allow for continued reinforcement: the more leverage you take, the better you do; the better you do, the more leverage you take. Most interesting is his observation that bubbles, like internet stocks and tulips, go through an exponential phase before breaking, usually short in time but dramatic in extent. And I think we're in that phase now. Look at charts with at least a one year rear-view and decide if you too see an accelerating uptick since December, whether US, Europe or China. The conclusion: super returns are available for a few weeks more, but when the tide turns make sure you are out, or can liquidate painlessly and fast, or you don't mind holding for 10 years.
And, for finance people, to illustrate how the risk-return perception has become imbalanced see this chart, again from John Mauldin. A downward sloping efficient frontier? We prefer to take more risk for a lower return? Something does not add up, so watch for cracks in the pyramid of credit ...
Certainly, the Bank of England considers markets to be more liquid than during the dot-com boom of the late 1990s. This liquidity is enhanced because transaction costs are low. Increasing interest rates have not reduced liquidity to levels that make a difference. While the market buoyancy is welcome, the risk of a turnaround if the virtuous circle of liquidity dries up is high. In the US, where many look for signs of changing trends, the slowdown has so far been mainly in housing and manufacturing. If it extends to consumer spending, the consequential knock-on could accelerate and spread internationally. Recent GDP numbers suggest this might be happening. Perhaps the avalanche will begin when job creation slows. In the meantime the demand for labour will put pressure on inflation. But an event outside the US may well be the trigger to rebalancing global economic balances. We've identified a couple of sources: the Chinese stock market and Spanish and Irish property.
What about China? The government has implemented numerous measures to moderate the economy, yet growth continues to be rapid. It appears that the traditional methods used, such as interest rates, which have been raised 4 times this year, do not have the same effect because the propensity to save is much higher in China. In other words the growth is principally from new participation at the bottom end of the spectrum as more people get access to capitalist systems, rather than expanding middle and upper income growth. In fact private consumption as a share of GDP has fallen in China over the past 5 years. The propensity to spend carefully on assets, rarely spend on convenience and invest in education and infrastructure will build a strong economic foundation for the future, even though growth is fast today.
That is the big picture. But there is a growing frenzy to "play" the stockmarket in China. It is accessible to more people, because the amount required to play is lower, and recent returns have been spectacular. Accounts at brokers are being opened at a rate of 200,000 a day. In the first four months of the year more new accounts were opened than in the whole of 2005. Many of the new players are young and eager to share in the gravy train. With the index racing this year, significant gains have been seen in a short time and no-one considers risk. The consequences globally will only be significant if the decline catalyses a change of sentiment in other markets, which it nearly did at the end of February. Another wobble in April did not translate in to a rout. But the next might. This bubble will run out of steam and then there will be tears.
Turning to Europe we noticed a couple of ripples in Ireland and Spain. While Ireland is a tiny economy (population only 4 million) it may be a weather vane for the winds of fortune. Certainly Ireland has boomed over the past 2 decades and is now one of the richest countries in the world - the standard of living is excellent. And property underpins current economic energy with a construction boom ongoing that contributes a quarter of the country's GNP, 2x the normal contribution. Much of the demand has been fuelled by first time buyers and investment buyers at the low-medium end of the sector. And these buyers, spending 60% - 80% of their monthly income are highly exposed to interest rate increases. The other exposure is exports to America which also account for a large part of the economy. The ECB rate has nearly doubled since mid-2003 (2% to 3.75% now), when a large proportion of these mortgages were taken out, and another raise or two can be expected this year. American industrial investors, most of whom staked their investment a decade or so ago, will be facing high labour cost increases as well as some exchange rate exposure. ECB rates are now beginning to pinch. The risk of a market and export slowdown is high. If the Irish economy slows it will be painful, and will be global news and may precipitate further weaknesses around the world. While there are many vested interests, both political and economic, it is increasingly difficult to paper over cracks in the economic balances. Perhaps the most telling sign of the top of the market is that in 2006 Irish banks in Dublin sold and leased back their operating properties and real estate agents sold out to foreigners. Ireland may be insignificant to the global economy, but it may be a straw that breaks the camel's back.
And in Spain, Astroc, a property company based in Valencia, saw its shares fall by 65% in what looked like a response to tighter planning regulations in the region. The worries have spread to other property groups, where shares fell by 20%. Having been floated last May, Astroc's shares had risen tenfold before the crash. Share prices of other leading property companies, such as Colonial, Metrovacesa, Fadesa, Urbis and Inmocaral, also soared last year. Worries spread wider into construction stocks such as Ferrovial, Acciona, ACS and Sacyr Vallehermoso, and banks such as Santander and BBVA, knocking the Ibex stockmarket index off by 1.7% in the week up to April 25th. On that day it was partially pepped up by reassuring noises from government officials and bankers. However, the trouble will not be restricted to Spain - many foreign individuals, especially from the UK and Ireland, are exposed to Spanish property. If these tremors reverberate in the coming months, the knock on to other markets will occur.
In fact, I got nervous enough to liquidate a number of stocks that I felt were overexposed to a potentially sharp drop. But we're not 100% cash and there are businesses less exposed to downside risk, because of fair pricing or better fundamentals. While reviewing your portfolio consider banking and energy stocks which are not overpriced.
News on US housing market was not good. Sales of non-new US homes fell 8.4% in March, the sharpest month-on-month drop for 18 years. The National Association of Realtors data also showed the number of homes sold was at a near-four year low. The latest figures showed an 11.3% fall in existing home sales, compared with a year ago. About 6.1 million existing homes were traded in March, the lowest figure since June 2003, while the average price of a house is now $217,000, down 0.3% on 2006.
One of the causes of growing liquidity (as well as sub-prime lending) has been more credit cards in issue . Mastercard released performance data after its first year as a listed organisation. The amount spent on Mastercards grew 16% against a year ago, while there was a 19.4% rise in transaction numbers. Latin America, the Middle East and the Asia Pacific region were particular targets for new business. About 5% of Mastercard's total revenue in the period came from a restructuring of its fees to charge customers for making overseas purchases with US-issued cards. And about 2.5% of its income was attributed to the movement of the euro against the dollar - with the dollar recently hitting an all time low against the Euro.
Last month's review reflected on Quantum Capitalism leaving open the question of how the quantum phenomenon affects markets. Since then the following notes by John Mauldin on the decline of LTCM and more recently Amaranth illustrate the particular phenomenon that makes predictive modelling inherently weak - the influence of the market on itself complicates the ability of models to resolve unknowns. It is in these situations that intuition can succeed where black boxes fail.
"The Nobel laureates associated with Long Term Capital Management had run extensive risk analysis on all the historical data. These were not wild gunslingers. They were clearly convinced that they had covered the risks. And they had covered all the risks that were in the historical databases. However, there was one piece of data that was not in the historical numbers, and that was the effect of Long Term Capital itself. LTCM became the market and the connection between markets that had never shown any correlation. As they had to sell seemingly unconnected investments to meet margin calls, the pressure on all of the markets ratcheted up simultaneously. And the more they had to sell, the worse it got.
The same thing with Amaranth last fall. They had PhDs running around doing analysis on risk, based on historical data, but someone forgot to factor in what it means when you become such a large part of a relatively small natural gas market that you can no longer meaningfully hedge or exit a losing position. They were averaging down into a losing trade, which is nearly always a mistake, but their market activities were of such size they distorted the market signals. Before they realized, they were getting margin calls, and the size of their own trades to raise cash was making the market move against them."
An in-depth study of responsible investment approaches of international pension funds was released by UNEP FI’s Asset Management Working Group and the UKSIF SSP: "Responsible investment in focus: How leading public pension funds are meeting the challenge".
A SIRAN-KLD study shows that nearly Half of S&P 100 Index Companies Now Report on Environmental, Social, and Governance Issues; over one third using the Global Reporting Initiative’s “Sustainability Reporting Guidelines”.
Investor Insight published a review of sustainability investing which will be valuable to those newly investigating this investment focus.
BP CEO John Browne resigned prematurely at the end of April as a newspaper won a court battle to print details of his private life. This increases the possibility that there is more deceit in the organisation than expected. While Browne's private life might be immaterial to the business, his misstatements about them, perjury and the private affairs expensed to the company all paint an unsavoury picture of the integrity of the head of BP and BP itself. BP is not an Enron, but, if the culture of deception at the top perpetrated the whole organisation, there could be some litigious skeletons in the closet. Notwithstanding that, Browne and BP have handled the affair very well, and the share price is up. BP has suffered problems in recent years including oil spills in Alaska and an explosion at one of the firm's US refineries in 2005 in which 15 people died.
Private equity continues to be a dominant theme of the financial pages as they finance massive buyouts. Our cautions about exaggerated optimism of last month remain.
The Business in Development Challenge 2007 is open to start-up or established entrepreneurs with a business proposal for a new, or the expansion of an existing enterprise in a developing country. For criteria, timeline and other info please visit www.bidnetwork.org
Q1 venture capital data for the US showed venture capital investing reached its highest level in six years, with over $7.05 billion disbursed.
Climate Change Capital, a leading carbon investment bank, has acquired Quality Tonnes, a Washington, D.C.–based carbon consultancy, methodology developer and project originator. No financial terms were disclosed.
Biofuel Energy Corp., a Denver-based ethanol producer, set its proposed IPO terms to 9.5 million common shares at between $16 and $18 per share. It had originally filed to raise $300 million, and plans to trade on the Nasdaq under ticker symbol BIOF. JPMorgan, Citigroup and A.G. Edwards are serving as co-lead underwriters. Shareholders include Greenlight Capital, Third Point Partners and Cargill Inc. Biofuel Energy initially plans to construct five large dry-mill ethanol plants on corn-belt sites where Cargill has a strong local presence and, in most cases, adjacent to grain storage facilities owned by or affiliated with them.
Imperium Renewables Inc., a Seattle-based biodiesel producer, is planning to file for an IPO later this year, according to VentureWire. The $200 million-$300 million offering would value the company at over $1 billion. Imperium is run by former venture capitalist Martin Tobias, and has raised funding from such firms as Nth Power, Technology Partners, Vulcan Capital, BlackRock Investment Management, Capricorn Management and Silver Point Capital.
Built-e Inc., a Seattle-based provider of green building materials, has raised over $5 million in first-round funding led by Catamount Ventures, according to VentureWire. The company operates under the name Environmental Home Center.
HowStuffWorks, an Atlanta-based online content company, has raised $75 million in private funding (mostly equity). It also plans to launch an instructional video offering, in partnership with ViTrue Inc. Participants in the round include Capital Research & Management, Chilton Investment Co., Carl Icahn and Chartwell Investments. Allen & Co. served as placement agent.
EctoPharma Ltd., a UK-based developer of a non-toxic pesticide for the treatment of head lice, has raised £2 million in VC funding led by Braveheart Investments.
PointOV Ltd., a UK-based e-commerce site that bills itself as an eco-friendly, fair-trade version of Amazon, has raised £800,000 in second-round funding from NorthStar Equity Investors and individual angels.
SustainableCircles Inc. (a.k.a. SustainLane), a San Francisco-based Internet media startup focused on green technologies, has raised around $3.5 million in Series B funding, according to a regulatory filing. No investor info was disclosed.
Topia Academy Inc., a South Korean private after-school tutoring company, has raised $20 million in growth capital funding from The Carlyle Group.
For those in or interested in family business, there is a colourful story of the father-son relationship in Arcelor Mittal, where Aditya and Lakshmi Mittal's power sharing works.
Interest Rates and Currencies
Data from the US Commerce Department show the US economy grew at its weakest pace for 4 years during 1Q 2007. The news pushed the dollar to record lows of $ 2 per GBP and $1.36 per €. US GDP grew at an annual rate of just 1.3% in the first three months of the year, down from 2.5% in the previous quarter, andconsiderably worse than earlier forecasts of 2% . Separately, the University of Michigan consumer sentiment index also fell, but not as much as had been feared, to 87.1 in April from 88.4 in March, which was the third fall in a row.The final result was boosted by optimism about the current rally on Wall Street - a self-reinforcing illusion perhaps? US exports declined at a rate of 1.2% in the January to March quarter, while imports rose 2.3%, helping to drag output figures lower. Also, the Fed's preferred inflation rate, which strips out volatile food and energy costs rose 2.2% during the first three months of the year, up from 1.8% in the previous quarter. Employment remained robust in March with 180,000 new jobs, in a sign the US economy remains durable. The labour department report showed job growth was stronger in both January and February than previously thought, and March unemployment rate also dropped to 4.4% from 4.5% in February.
In the UK, there is a more sanguine view of economic imbalances and some analysts are already saying that interest rates 'could reach 7.5pc'. Inflation is pushing up and the breakdown by economic group is more worrying than the headline number. UK prices are now rising at their fastest rate for 16 years. Inflation reached 3.1% in March - as measured by the Consumer Price Index - up from 2.8% in February. Governor Mervyn King was obliged to send an "explanatory letter" to the Chancellor, for the first time in the MPC's 10-year history, discussing the aberrant inflation numbers. The more trusted Retail Price Index, which includes housing and fuel costs, is also a cause for concern. RPI inflation rose at 4.8% last month - its highest annual rate since July 1991.
Japan has kept its key interest rate on hold at 0.5% amid fresh concerns about deflationary pressures in the economy.
Trade and FDI
The US filed what appear to be frivolous WTO cases against China. They are said to be aimed at persuading Beijing to tear down barriers to US goods and to criminalise piracy. But they are said by some to be the most legally contentious ever filed by the US against China and seek to force politically sensitive changes to cultural laws and the judicial system. They appear to be time and relationship wasting tactics encouraged by US lobby groups. The effort to liberalise the audio-visual market will meet serious resistance, as Beijing sees the importation of foreign and particularly western culture as a political rather than economic policy decision. The US demand that China throw pirates in jail rather than issue fines would also require changes to the criminal code. China "expressed great regret and strong dissatisfaction at the decision" saying that it was "not a sensible move for the US government to file such a complaint" at the World Trade Organization. "By doing so, the US has ignored the Chinese government's immense efforts and great achievements in strengthening intellectual property rights protection and tightening enforcement of its copyright laws," said the Intellectual Property Office commissioner Tian Lipu. It is ironic that coincident with these WTO filings, the US is raising tariffs on coated paper from China, using an anti-subsidy law for the first time in two decades. In this particular instance the US Commerce department move was encouraged by private equity groups which own US based paper businesses. These actions by the US seem characteristic but nevertheless surprising - I would have thought that the US, with its tremendous intellectual and multicultural resources, would have a more appropriate strategy for relationships with next decade's global superpower.
The Japanese finance ministry noted that China has overtaken the US as Japan's biggest trading partner for the first time since World War II. Japan's total trade with China totalled 25.43 trillion yen ($ 215 billion) in the year to 31 March, driven in part by Japanese firms shifting manufacturing work to China to take advantage of cheap labour costs there. (The figure for the US in the same period was 25.16 trillion yen.) Japan's trade surplus widened 74% from a year earlier to a record high for March of 1.633 trillion yen last month, buoyed by a weaker yen and exports to China.
And Toyota has overtaken General Motors to become the world's biggest car maker - Toyota sold 2.348 million vehicles in the first three months of 2007 while GM is estimated to have sold 2.26 million cars and small trucks during the same period. Non-US car makers have been boosting foreign sales and making gains in the US, the world's largest car market, as consumers look for fuel efficiency. Toyota has enjoyed strong sales on the back of the success of its pioneering petrol/electricity hybrid, the Prius, and new models of popular car ranges like the Camry Sedan and Corolla.
In the vein of the "cost of a BLT", the BBC reports on the true cost of cotton.
The Global Trade Protection Report 2007, featured in the Financial Times, is available at www.antidumpingpublishing.com.
Activities and Media
April was sunny! The warmest and driest April that many of us in Ireland can recall. While it put pressure on seedlings and budding plants in the garden, we all enjoyed the summer weather, especially over Easter holidays. But we also checked our irrigation systems in case they become necessary later in the summer!
We also enjoyed a rollicking time as stock markets shot up. But the roller coaster ride made us a bit queasy so we reacted rather bearishly and harvested some gains.
The overarching theme of the month for us though had to be education. Catalysed by decision time for our children, we focussed on sensitive issues like boarding or not, bilingual or not, and curriculum. I encourage you to browse the news reports in the education section above, though our reflections always come back to the natural methods of education and this is where our R&D will continue to focus.
The Bloodless Revolution has been an enjoyable read. It is surpising to learn of the luminaries from Bacon to Newton to Rousseau to Einstein that strongly advocated a softer lifestyle based on yogic principles. Their various rationales for their unwillingness to kill for food is surpisingly broad covering science and philosophy, including Christian rationalisation. An entertaining look back into to the history of enlightenment.
The Global Campaign For Education brings attention to the gross education deficits around the world. We draw your attention to this subject because education is by far the most effective and lasting solution to poverty.
FringeHog Tags the World is a collaborative media project designed to build an interactive database of photographs and images that illustrate emerging ideas and trends impacting the future.
You can get access to Ethical Markets TV, founded by
Hazel Henderson, by downloading and installing their toolbar
here. A great media resource for those focussing on SRI, CSR etc.
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