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Do you know

It’s what you know.

It’s not what you know, it’s who you know.

It’s not who you know, it’s who knows you.

Knowledge, networks, and branding.

You have to start somewhere, and the logical starting point is to acquire knowledge. Society understands the importance of this, which is why primary and high school education can be obtained for free in pretty much all developed countries. And in many countries, university is also heavily subsidized.

But hold on a minute, you might be thinking, many high schools are not free. In fact, they can be very expensive. Think of schools like Eton, public schools in the UK, or private schools in Australia.

It’s true that many schools are expensive, but there is a good reason for this. The parents at these schools are buying something in addition to mere knowledge. They understand the importance of surrounding their fortunate child with other fortunate children. And they are willing to pay big money for the privilege. Friendship networks are a valuable resource that can open doors to a more prosperous and enjoyable life.

However, in a world where knowledge is increasingly commoditised and friendship networks can provide counsel and support but not definite opportunities, the truly important factor is to become distinctive.

The best schools understand and educate their students in the importance of finding an interest and standing out. In Australia, I was fortunate to attend St Aloysius’ College. It was a school run by the Jesuits where students were encouraged to partake is sports, music, cadets, drama, the Duke of Edinburgh program, and all manner of other extra-curricular activities. These activities were fun but they also gave the students a unique experience and story that we could tell about themselves. A brand that the boys could continue to build at university and beyond.

I am currently teaching at a university in China, and the students also seem to have an intuitive sense that branding is crucial. While extra-curricular activities may not be quite as important as they are in Australia, the students will do almost anything to obtain an ‘A’.

Nothing could be more devastating than a ‘B+’.

Of course, after the dust has settled and the exams are finished, the student who earns the ‘A’ doesn’t necessarily know or remember more than the student with the ‘B+’. But in a country with 1.3+ billion people, the costs of failing to distinguish oneself can be high – less chance to study abroad, fewer career opportunities and, perhaps worst of all, diminished prospects for a favorable marriage.

Knowledge is mandatory and networks are helpful, but branding is key.

[Side note: Congratulations to my alma mater, Oxford University, which was ranked #1 in the latest Times Higher Education World University Rankings, which judges the performance of 980 universities across 79 countries.]

(Image Source: Flickr)


levered-monkeys

As Oxford’s poet-philosopher Ludovic Phalippou once put it, “we are all just levered monkeys!”

What did Phalippou mean by this comment?

Well, as I explained to my corporate finance students this week, the use of debt by companies is called “financial leverage”. That is, debt acts like a lever which can magnify the size of both gains and losses.

Imagine that you are the CEO of Apple Corporation and require a return on investment of 10%. There is a new venture you can undertake that will generate a return on assets of 2%, but you can currently borrow money at an interest rate of 0%, and so you can use debt to help you achieve your required return.

You decide to go ahead with the project, and the numbers look something like this:

Venture     – Debt           = Investment
$1 million – $800,000 = $200,000

EBIT        – Interest = Income
$20,000 – $0           = $20,000

ROI = Income/Investment = 10%

Bravo!

In this very simple example (which ignores things like taxes and capital gains), you have successfully used debt to increase your return on investment from 2% to 10%.

As I mentioned in an earlier post, central banks in some of the world’s major economies are keeping interest rates at record low levels. And in a few places (like Japan, Europe, and Switzerland) interest rates are negative.

Since debt can be used to magnify investment gains, central banks are no doubt hoping that businesses will take advantage of lower interest rates to increase investment and thereby stimulate the economy.

However, record low interest rates can’t last forever.

When will central banks return interest rates to more normal levels?

This past week there was talk about whether the Fed would raise interest rates in September. Jamie Dimon, CEO of JPMorgan Chase, argued that the Fed should raise rates sooner rather than later. However, Goldman Sachs reduced the chance of an interest rate hike in September from 40 percent to 25 percent; while at the same time increasing the odds of an increase in December from 30 percent to 40 percent.

Nobody knows exactly when central banks will start to increase interest rates again, but it seems that it could happen in the not too distant future.

As the CEO of Apple Corporation, you had managed to achieve your required rate of return of 10%, and you were feeling pretty pleased with yourself. However, imagine now that the central bank decides over the course of a few short years to increase interest rates back to a more normal level of, say, 4%.

What happens to your return on investment?

Venture     – Debt           = Investment
$1 million – $800,000 = $200,000

EBIT        – Interest  = Income
$20,000 – $32,000 = -$12,000

ROI = Income/Investment = -6%

Bazinga!

As a result of rising interest rates, the return on investment for your venture has fallen to minus-6%. This is below the return on assets of 2%, and even further below your required return of 10%.

What can we learn from this simple example?

Well, one of the goals of central banks, in keeping interest rates at record low levels, is to stimulate the economy. This should work because lower interest rates reduce the required rate of return, as we saw in our example. However, by encouraging business leaders to undertake projects that offer low returns, it may be that central banks are sowing the seeds of the next downturn.

They have to raise interest rates at some point, and when they do, businesses who have taken advantage of financial leverage to pursue projects with low returns will have their losses magnified.

The more debt a business has used, the more pain it will feel.

Silly monkeys!

(Image Source: Flickr)


capital-for-you-and-meThis past Friday marked the 40th anniversary of the passing of Mao Zedong, the founding father of the People’s Republic of China.

Most notable here in China was the absence of discussion or commentary.

This is perhaps understandable since it is Chinese government policy to celebrate past leaders’ birthdays rather than the anniversary of their passing. However, it also seems to be quite telling. According to the Wall Street Journal, one Weibo user contrasted the occasion to the 2014 anniversary of the death of Communist Party leader Hu Yaobang for whom “all kinds of media and officialdom [paid] unbridled tribute. But this year on the 40th anniversary of Mao’s death, it’s this quiet. Especially today, you don’t even see a few comments here or there.”

Why the silence?

Well, for one thing, Mao was a communist revolutionary responsible for the Great Leap Forward and the Cultural Revolution. Putting the merits of communist theory to one side, it could be argued that these initiatives were not exactly a run away success.

The Great Leap Forward (1958 to 1961) aimed to transform China by establishing agricultural collectives and pursuing rapid industrialisation, and ended up causing a period of economic decline and tens of millions of deaths.

The Cultural Revolution (1966 to 1976) aimed to maintain the communist ideology within China; a decade of violence and instability ensued.

Despite all of this, Mao remains a complex historical figure, widely regarded as the greatest Chinese figure of the 20th century, and the official government line remains that Mao was “70 percent correct and 30 percent wrong”.

It is understandable though if China’s government may want to distance itself from Mao as the years go by.

For one thing, Mao was a revolutionary, and the Communist Party would prefer to maintain stability and growth.

Over the last year, China’s GDP grew by around 6.7 percent; slow compared with historical growth rates over the last twenty years but still more than three times America’s GDP growth rate. At the current rate, the size of China’s economy will double in around ten years. This will open up new opportunities for Chinese workers, and help to lift millions of people out of poverty. At the same time, however, there are suggestions that China’s growth is being fueled by increasing amounts of debt. This could mean that current growth is unsustainable, and that lower growth and higher unemployment may be likely in future. The Communist Party are wise not to inspire a revolutionary sentiment.

Mao was also a communist, and advocated collective ownership and ideas like the removal of the class system; policies which sought to alienate people from capital assets like land and social status. These policies would have made it difficult for people to be productive or creative, resulting in economic stagnation.

China’s current growth and development depend on it embracing quite a different philosophy, one that allows people to develop and accumulate capital (whether it be intellectual, social, financial, natural, physical, or technological capital).

There is a common misconception that if China embraces the value of “capital” in helping people become more productive and creative, then it will need to adopt the American free market version of capitalism. This is of course not true. Germany and the Nordic countries have their own unique versions of capitalism. And China has embraced a version of state capitalism which seems appropriate given its culture and historical perspective.

Capital for you and me (and the state).

(Image Source: Wikipedia)


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