Fallout from the Bailout: A Crisis of the Commons?

The $700 Billion Bailout:
A Crisis of the Commons!

By

Thomas Schinkel, Ordinary Citizen

September 22, 2008

In the midst of yet another spectacular crisis allow me to step back and take you to a small community way up in Northern Maine. The name of the town is Millinocket.

Background

It was early 2002, not more than five months after 9/11. The fellow who shared an office with me in an office building close to downtown Boston came in to see me. A practicing bankruptcy attorney, he had received a call from a colleague, a respected lawyer in Bangor, way up in Northern Maine. My colleague had known me for several years and he was familiar with my work in the office products and paper industry. That is why he wanted to talk to me.

Bankruptcy!

What was the call from Bangor all about? A giant problem had erupted in one of their wilderness communities in the North country. It was in the middle of an unusually cold, harsh winter, and The Great Northern Paper Mill of Millinocket had been forced to file for bankruptcy! The question he had, were there any consultants in the Boston area who could help figure out what to do? Oh, and don’t look for anybody to expect any big fees because we are all stressed to the max up here!

During the next twenty minutes, my neighbor briefed me on what he had learned. At the end of his pitch, he asked if I had an interest going up there with him to see if there was anything we could do. At various intervals in my own career I had come up against the forestry and paper industry but never from this angle. Not knowing what to expect, I figured that – if nothing else – this might be a good learning opportunity. To make a long story short, the next day we called the Bangor attorney, told him of our intentions and started driving North. The attorney in Bangor in the meantime, made several appointments for us so that we would make good use of our time while there. Eight hours later we checked into a motel in the center of Millinocket, getting ready for meetings the next day.

Pandemonium!

I tell you, it was pandemonium. Millinocket is a tightly knit community of 5,000 that had managed to maintain a culture of independence and self-reliance in a way I had never seen before. Without exaggeration I met some of the most wonderful people you will ever meet in your whole life. However, it was obvious that disaster had struck with the large paper mill that had dominated the town for over a hundred years, being pushed over the cliff. The repercussions for the population were devastating. Schools, hospitals, the library, the grocery store, the hotels, you name it, everyone was affected. Worse, the pension money that had been tied up in the fortunes of the company had been lost as well. The descendants of ten generations of people who had lived comfortably off of skills they had honed in harmony with nature, saw their fortunes go up in smoke.

What Happened?

My first inclination was to try and understand what had happened. Get a fix on the recent history of the paper mill, and what challenges they were confronted with that had overwhelmed them. In a nutshell, two decades ago, the mill had been embroiled in a wave of consolidation within the paper industry. Then, several years ago, there had been a leveraged buy out. To pay for the transaction, one of their prime assets and a steady source of revenue, an entire network of hydro-electric dams across the Great North Country had been sold off. No sooner was the transaction completed, or they started to notice new competition. From Singapore. From Indonesia. From Brazil. From paper mills in Georgia.

It’s Globalization!

Unbeknownst to the people in Millinocket, some of those new competitors had invested in massive new technologies that had cost hundreds of millions of dollars. Now, Great Northern was forced to follow suit. On top of the leveraged buyout they were now forced to borrow another $100 million for the acquisition of a huge new piece of machinery from Finland. Absent the global wherewithal of some other companies in that industry, they did not realize they were just about the last party in the world making that investment and that all the other investments in this new equipment had caused a massive glut around the globe of exactly the kind of products Great Northern had been living off of for generations. Various qualities of newspaper print, you get the picture.

There was nothing I could do!

After listening to this story for an hour or so, I realized there was absolutely nothing I could do. I had no magic bullet to share with them that could get them out of the fix they were in. No way, and I told them so. The people I met must have thought “Oh, for heaven’s sake, another one of those city boys”, but no, they were very nice to me, and we started what even today I believe was a useful dialogue.

Except, ask a few Questions. . . .

What, I asked them, is your primary asset, your primary strength. Well, they said, we know everything there is to know about forest residue. It turned out that the State of Maine has the highest density of forest in North America, together with stretches of land in Canada. Remembering a conversation I had had a year earlier with a ‘clean energy’ scientist from Arizona, I asked what they knew about converting forest residues to energy. The Arizona scientist had been particularly enamored of the opportunities that could result form converting natural resources such as forest residue into hydrogen.

Peter Drucker

Plain and simple, the question I left them with was “what could they do with the assets they had and deploy them in a new and creative way”. Following Peter Drucker’s mantra that a problem properly defined was half solved, could they redefine the business they were in and instead of thinking they were in the paper conversion business, which led them to one way of reasoning about their future, could they start thinking of themselves as being in the clean energy business and get on a different course of reasoning altogether? This might open up entirely new avenues for raising capital, for recruitment, training, and business development. Conversations over, the next morning, my attorney friend and I drove back to Boston, saddened by the economic tragedy we had just witnessed first hand.

More than a bit intrigued. . . !

I could not shake the story and - using my newly acquired internet skills - I went on a research spree into all matters related to clean energy. Fairly quickly, I stumbled upon an obscure story about a small island nation way out in the Atlantic, Iceland. Many years ago, I learned from this e-news clip, the Icelanders had made a decision to wean themselves off of fossil fuel by embracing their only asset, geothermal energy that they had learned to convert into hydrogen. In fact, their first hydrogen-driven public transportation bus had just been inaugurated and pressed into service.

Off to Iceland! Why?

Thinking that there might be bits and pieces of information useful to the folks in Millinocket, I decided to investigate what this was all about. By sheer coincidence, one of my pilot friends was well acquainted with the situation in Iceland, and she made an introduction for me. Before I knew it I was seated across the table from Bragi Arnason, the father of the Iceland Hydrogen and Energy Independence idea. Frankly, I could not believe my ears! Being much closer to nature than we are, they had figured there was no way they would survive as an independent people if they continued down the road of dependency on fossil fuel, domestic or foreign. They had come to this conclusion by the early 1990’s, mind you!

Good Thinking over there in the Land of the Blue Lagoon

Not only that, they actually had arrived at a consensus among various political factions that this was the right way forward! Explaining the purpose of my mission, they were very helpful and left me with several suggestions that could be helpful for my project. On the way back to Boston from Reykjavik, I kept thinking to myself that maybe this could be a model in some form for my new friends in Maine and in Millinocket. Having done some more research on projects around the country, it was now time to go back to Maine. Was there an opportunity to start a “Government-Business-Consortium” – I asked - that would look into the Iceland model for Maine in general, and for Millinocket in particular? What would it take to get such a consortium off the ground?

A Consortium?

Several talks with the governor’s office and various government agencies later I got a sense that there was a lot of potential support for this idea. But what about the corporate sector? Who could sponsor this? Introductions were made to representatives of the only sector that was known to be flush in cash: the Oil and Gas Industry. Meetings were arranged, presentations made. The reception was polite. Now, mind you, it was in the middle of the winter, the demand for natural gas in places like New York and Boston was sky high and I could not help but notice that the people I spoke with were totally preoccupied with what they called an important ‘peak pricing’ cycle, a seasonal opportunity for selling their own energy products at higher than usual margins due to the cold temperatures that engulf the Northeast region every year.

No Money!

Several follow up calls later it became overwhelmingly obvious that they had absolutely NO interest in a consortium of any kind, let alone a consortium that would address an “off-the-reservation” subject like hydrogen. Get out of town, and don’t come back!

To make a long story short, what seemed to be a perfectly sensible idea, a public private consortium to start thinking about a new way of using forestry resources for the benefit of creating new sources of prosperity came to naught. The government did not have the money. Millinocket did not have the money. And the only people in Maine who were flush in cash did not have the money!

Here is my question.

Millinocket in and of itself is a non-event. Some of the problems were self-inflicted, no question about that. With the benefit of 20/20 hindsight, the leveraged buyout was probably a bad idea. Investing in that new machinery so late in the innovation cycle was probably a bad idea. I realize that. But there are at least five such communities in the State of Maine. Perhaps more. And there are at least five of these communities in every state of the Union. Overwhelmed by Globalization! No support. No help. No money. No nothing. That is at least 250-300 communities across the land. Probably more. What about them? How come there is no money to support them in the struggle to reinvent their lives?

Of Roads, Bridges, Prisons,
Pre K education and elementary schools

There are two million prison inmates in our country. Eighty percent of them
have something in common that landed them in jail. They were doing drugs. Another thing they have in common is that they never went to pre-school, and they missed out on a good, standard quality elementary school education. The reason? No money! For almost a decade now, there has been no money to help a process going of rebuilding roads and bridges, let alone renovation and reinvention! Not even petty cash! No money for education. No money for diplomacy.

Capitalism at its finest?

How come there is never any money? Capitalism at its finest? Purification by fire? Survival of the fittest? Creative Destruction at Work? Perhaps.

BUT WAIT, WAIT. At the drop of a hat, we can find $700 billion to bail out a bunch of Wall Street executives who have been allowed to make one mistake after another! With the benefit of 20/20 hindsight, how about their errors of judgment. How did that come about? Where did that money come from? Whatever happened to all those promises to eliminate earmarks? Is this not the biggest earmark of them all?

The Great Rebate of 2008

Do you remember the U.S. Treasurer’s check you got earlier this year? The check that helped the economy going again? First of all, what you got there was your own money to begin with. But here comes the whopper. That check you got represents approximately one seventh of what is being proposed now. In other words, for every ONE dollar the government just returned to us they now want to take back SEVEN to fund the rescue a bunch of high-rolling gamblers on Wall Street. Seven hundred billion dollars – that is SIX percent of our Gross Domestic Product. That is the size of our entire Trade Deficit for 2007, and that is ballooning out of control. Help me out folks, am I missing something here?

Or socialism for the Rich?

Contrasting Millinocket with Wall Street, is this beginning to look like Socialism for the rich - Capitalism for the poor? Hmmm. . . .! Time to ask a lot of questions. I mean . . a lot of questions! While our pundits are talking up a “storm of distraction” on that that Great American side show called Sarah Palin - her hair, her voice, her glasses, her lipstick (sic), her thoughts, her dresses, her shoes, her children, her interview with Charley Gibson, ‘is our money being hoisted out the backdoor?’

What is the Difference, anyway?

When a person in Millinocket writes a toxic check, he or she goes to jail. Desperate or not. We all know that. But what about that Mississippi river of toxic loans written by the Wall Street crowd? How come the Treasury Department is all over the case, but the Department of Justice is nowhere in sight?




An ounce of Prevention?

That the paper industry was in some sort of trouble has been known since the 1980’s. What if the government had worked out a strategy together with the employers and the unions in that industry (and so many others for that matter), to arrive at an orderly transition over a period of two decades? Identify the weakest links in the chain and provide some support, financial, expertise and otherwise for the communities that were known to be the most vulnerable? This could have prevented a lot of the problems in the 500 communities swept away by the Tsunami of Globalization that has enveloped our world since the Fall of the Berlin Wall in 1989.

Energy Independence?

And what about Energy Independence? When you think about it, here are some obvious examples. Take Brazil, that tired old country mired in poverty and violence down South - During the 1970’s they conceived a plan to become energy independent by cultivating fuel from sugar cane. Today they reap the benefits. Not bad for a third world country in South America. The example of Iceland is obvious. What else can be learned about governance from cases around the world? Of course, in America we have a massive economy and we would have to come up with our own solutions. But I have a hunch that the cost of such an approach would be a tiny fraction of the $700 billion we now need to shell out in a hurry to bail out a few!

Crisis of the Commons

It seems to be exceedingly clear from the numerous symptoms of distress that plague our society, that we are suffering from a Crisis of the Commons. It is an inability or unwillingness to reach out among various groups and invest in long-term solutions even if the pay-out does not appear in the wallet during the next three months. The skill sets needed to look at our behavior from various perspectives and judge our actions on the basis of their impact on the common good seem to have been diminished if not completely lost in the rush towards material gain for the immediate term.

That the request for a bailout of this magnitude comes from the same people who did everything in their capability to help destroy the perspective needed for the creation of a common prosperity is the quintessential insult added to injury. My sense is that Millinocket and the 500plus communities that have suffered so much from globalization are first in line.

What about that old cliché that an ounce of prevention is better than a pound of cure? Next patient: Detroit!

Thomas Schinkel
617-818-8783
Thomas.schinkel@gmail.com


PS: What should the Government do? What should Congress do?
To provide stability in the market, my sense is that they should create a new bank, fund it with whatever it takes – i.e. $1.0 trillion – and direct those funds at providing relief to the American citizens who have been caught in the mess created by the financial institutions. And they should leave Goldman Sachs and Morgan Stanley to their own devices. Let them file for bankruptcy. There are plenty of other banks and institutions that can fill the void.

America: Export Nation?

America: Export Nation?

How Currency Imbalances and the High Oil Prices may transform a
Consumer-centric Economy into an Export-centric Nation

by

Thomas Schinkel

August, 2008


The other day I was watching a news program on PBS where several oil industry experts were asked why the price of oil was so high. Very quickly they pointed to the two main culprits. One was the US Federal Reserve, which had made the fatally flawed decision to lower interest rates, starting in August 2007. The other culprit was that new wave of speculators, financial institutions that had started investing in oil futures without knowing how to do it. In passing, these oil industry experts noted that the dollar was low, which was causing problems for the oil markets too.

What the experts did not address is WHY the dollar was so low. In today’s business environment, if you are charged with figuring out the long-term direction of your enterprise, no doubt these twin questions about currency imbalances and oil prices are at the center of your concerns.

And if you are thinking of selling your company, these issues are equally important, since they may dictate who your buyers will be and what country they come from.

A leading question in all of this, of course, is whether the combination of high oil prices and a low dollar is structural and therefore lasting in nature, or just a temporary condition that may fade away with a few clever policy decisions the Federal Reserve Bank could implement with the stroke of a pen. But whatever the answer to this question, the result of this current combination may be a major transformation of the American economy from consumer-centric to export-centric. I’ll explain, but first, we need to step back for a little perspective on our current situation.

How We Got Here
To gain a sensible perspective on these related issues, let’s take a quick look at a long-term historic view of some of the most fundamental trade imbalances in the American economy. (See graphic, below.)



Prepared by Thomas Schinkel from data provided by the U.S. Department of Commerce




Trade imbalances between the US and the rest of the world are nothing new. In nominal terms it does not matter much whether you have a trade deficit of $100 billion or $500 billion. What matters is the size of the deficit in relation to the country’s total economic output.

So, a key measure is the trade deficit relative to the US Gross Domestic Product (GDP). For example, from 1989 to 1991, the trade imbalance between the US and the rest of the world actually declined from 2% of GDP to 1% of GDP. During the 1990’s it rose again to approximately 4% of GDP. But this trade imbalance ballooned to 7% of GDP in 2006, more than tripling in just ten years. The two main drivers were energy imports (mostly petroleum products), and manufacturers accelerating their shift of manufacturing facilities from US shores to the Far East.

What do we notice when we refract the US Trade Deficit into these two major components, the Energy Deficit between the US and the rest of the world, and the US Trade Imbalance with China? The US is importing so much more of its energy needs than it exports, again not just nominally, but relative to the size of its economy.

In 1991, the energy deficit was the single largest component of the US trade deficit with the rest of the world, mushrooming to 60% of the total trade deficit. But throughout the 1990s there was a sharp correction in this imbalance, and by 1999 it stood at a mere 20% of the total trade deficit.

Meanwhile, the imbalance in the trade relationships between the US and China kept growing, not just in nominal terms but relative to the size of the US economy as well. Today, China accounts for over 30% of the total trade imbalance between the US and the rest of the world.

Ever since China’s acceptance into the World Trade Organization in 2001, this trade imbalance has widened, again, not just in absolute terms, but also relative to the size of the US economy.

The Road Not Taken
One of the consequences of this never-ending and largely unmanaged saga of growing trade imbalances is that the Chinese, Japanese, and other governments were ever more flush with dollars which they routinely re-invested in US Treasury bills, with the expectation of steady returns on their investments.

With this backdrop of the growing trade imbalance between the US and the rest of the world, let’s go back to the question of why the price of oil is so high and the value of the dollar is so low. If, in August 2007, the Federal Reserve Bank had chosen to raise interest rates instead of lowering them, this might have bought some time for the value of the dollar, encouraging foreign governments to hang on to their T-bills just a bit longer.

This in turn, might have helped slow the rising price of oil, which is traded in dollars. The overseas oil producers argue that if the value of the dollar falls, so does their purchasing power, forcing them to raise their price to make up the difference.

But the consequence of an August 2007 interest rate rise would have been an avalanche of real estate-induced bankruptcies throughout the country far larger than what we have seen to date. With the trade deficit remaining out of control and with no policies that are credible (in the eyes of our creditors) to stem the tide, the Federal Reserve Bank seemed to be caught between a rock and a hard place at this time last year.

How to Get Back on Track
Pulitzer-Prize winning author and journalist Tom Friedman of The New York Times argues for trying to get a comprehensive fix on the structural imbalances in our trade relations with the rest of the world. More importantly, he argues, we need to get our energy deficit under control.

After all, he seems to say, you cannot have 1) a trade deficit, 2) an energy deficit, 3) a government budget deficit, 4) a wholesale shift of manufacturing jobs to overseas destinations and a strong dollar, and low prices for imported energy and have this continue ad infinitum. Come to think of it, those are not the ingredients of a virtuous upward cycle but of a negative, downward spiral. And that is what we seem to be in right now!

To break out of this spiral, Friedman argues for a Federal tax on all those conventional energy carriers that make us more dependent on foreign sources. First off, the collected tax would end up in the US Treasury’s coffers instead of other countries’. Such a tax would help stimulate the introduction and lasting integration of clean energy sources such as wind, solar, and hydrogen.

American Metamorphosis
When the crisis is over, many assumptions about the US economy may have been turned on their ears. One of those assumptions is that without that seemingly all-important “Consumer Spending” there would be little left of the US economy.

The silver lining in these gathering storm clouds is that American manufacturers with innovative and leading-edge, high-quality products have a splendid opportunity to gain and regain world markets. Indeed, if present trends continue, my sense is that within the next five years the US will be going through a metamorphosis from a “Consumer-centric Society” to an “Export-centric manufacturing nation.”

This after all, is the only real way towards finding a new equilibrium in a world economy that has allowed major imbalances to accumulate as part of a set of policy assumptions that date back to the 1950s and 1960s.

For those of you whose manufacturing facilities are still stateside, and who have been thinking of moving off-shore, perhaps it is wise to hold off on the decision for just another bit. (Some of you might want to move those facilities back to the US in a few years!)

In closing, what is your worldview? And how do you let it influence your planning for survival and prosperity?

Tom Schinkel
Business Adviser

Thomas Schinkel is an internationally recognized business expert who works with chief executives of large, medium, and small businesses on a broad range of strategic issues. He does this through coaching, consulting, writing, training, meeting facilitation, and speaking engagements at conferences. Clients also include venture capital firms, trade associations, and individual investors. Tom is particularly passionate about three intertwined issues, namely:

• Business Opportunities resulting from International Trade,
• Growth through Acquisition, and
• Customer Relations Management.

Tom works and lives in Boston, Massachusetts. He can be reached via e-mail at Thomas.schinkel@gmail.com or via telephone at 617-818-8783.
www.thomasschinkel.com