The Frightening Reserve

The Federal Reserve is our nation’s central bank.  It, unlike other central banks of the world, is a body independent from our government (although its board members and chairman are appointed by the President and ratified by Congress).  With its establishment in 1913 it has a mandate to promote price stability, full employment, low interest rates; as well as regulate the commercial banking sector.

Their tools take the form of monetary policy actions, not fiscal policy actions.  In other words, they can influence interest rates and the money supply.  But they can’t spend and raise revenue through issuing debt or levying taxes.  Only Congress and the President through the Treasury can perform those latter.

The Fed’s most commonly used tool has been traditionally influencing higher (“tightening”) or lower (“easing”) the interest rate banks pay to borrow funds.  Raising those rates chills bank lending activity, if the Fed fears that the economy may overheat and cause inflation.  Lowering those rates tends to spur lending activity, if it has slowed from fear of recession.

That’s worked pretty well for most of the past century.  Until recently.  Commencing in 2007, when it became abundantly clear that we were heading into a severe and unprecedented credit crunch, the Fed began lowering rates toward an unheard of (just pretend Japan doesn't exist) zero percent.  It has since held rates near zero for almost four years now, and yesterday indicated that it will continue to do so until at least mid-2015.

In essence, the Fed has indicated that it will keep the cost of borrowing funds for banks free, for the better part of a decade.  Most easing cycles of the post-World War II period lasted for a handful of months to maybe a year-and-a-half.  Typically, our current unprecedented level and duration of low interest rates would have caused the economy, and likely inflation, to explode long before four or seven years had passed.

But that hasn’t happened.  Growth is weak.  Jobs are recovering at the worst rate since the Great Depression.  And broader indications of consumer inflation indicate that it has been hovering in a very benign zone of ~1.5-2.5%.

The reason that hasn’t happened is because we are suffering the deflationary effects of a depression - what the Fed is trying to avert.  The cost of stuff we buy might not have declined yet by virtue of the Fed's monetary stimulus to-date, but deflation nonetheless is finding ways into the system in the form of declines in wages, for instance.

A depression is different than your typical recession.  Recessions are caused by the natural ebb and flow of the business cycle.  Depressions are protracted and deeper than typical recessions, caused by a long period of society-wide debt pay down after an over-expansion of easy credit and leverage.

They simply take a real long time to work out.  And there isn’t much anyone can do about it.  But the Fed keeps trying, as the lack of any political fortitude has neutered any further fiscal action.  On top of years-long zero interest rates, the Fed has also been making outright purchases of securities in the market place.  This is their so-called “quantitative easing” (“QE”).

So what does that do?  In essence, it places cash directly in the hands of financial institutions.  In their conventional easing process of lowering short-term interest rates, the Fed literally purchases treasury securities with very short maturities from banks and other financial institutions.  The Fed is bigger than that market (as it has unlimited purchasing power, ultimately backed by the Treasury that can print money), so its actions influence market interest rates lower.

But once it pushes rates to zero as it has, that policy becomes ineffective – the so called “liquidity trap”.  So that’s when they resort to the unconventional QE.  With QE operations, the Fed purchases treasuries with longer dated maturities for cash.  This is more potentially inflationary than their conventional method of easing for a couple reasons.

Firstly, in their conventional method, they don’t really buy those very short term securities for cash.  They purchase them in exchange for a “reserve credit” that the bank can put on its balance sheet.  Think of it as a casino chip - it has value to the casino (to the Fed, that requires banks to keep a certain amount of funds relative to deposits), but no value outside of the casino.

Until the bank actually "cashes in" that credit and uses it to make a loan to someone that wants one, the Fed has not issued cash into the money supply.  And in case you haven't noticed, banks haven't been exactly tripping over themselves to make loans nowadays.

QE is different.  It is a direct purchase for cash of securities by the Fed, with money (at this point) literally printed out of thin air by the Treasury.  It immediately and directly expands the money supply.  And since it is purchasing securities that don’t mature for years – where in conventional easing they typically purchased securities that mature in days – it effectively expands that money supply for years longer than standard easing might.

Further, the Fed isn’t just buying treasuries (notes issued by the Federal government to borrow money).  But let’s just look at that for a second.  Through QE, the Fed is borrowing money printed out of thin air from the Treasury… to buy notes issued by the Treasury to borrow money.  In other words, through the Fed (as independent as it may be) our government is lending money too itself and in that process just printing money to keep the whole nation from collapsing into a deflationary spiral.  Nice.

So they’re not just buying treasuries, as I said.  They are also buying mortgage-related securities.  Remember those things?  That caused the financial crisis?  The Fed’s buying them because no one else wants to.

Which brings me to my point.  I have maintained for three or four years now that the financial crisis never really ended; that the crisis has just moved to different quarters; that the threat and risks are still with us, just manifested in a different manner.

Today, those risks of using excessive leverage to invest heavily in risky assets are being moved off of the private sector’s balance sheets and onto the Fed’s balance sheet (as well the Federal government's as weak economic activity increases its debts from lack of adequate revenue collection).  Pre-crisis, say late-2006, the Fed’s balance sheet was roughly $900 billion of assets and liabilities (the Fed typically maintains a “matched book”, where assets equal liabilities).

At year-end 2006, the Fed’s liabilities were mostly our checkable deposits, $779 billion (a good chunk of the money supply).  Their assets were mostly treasury securities, $741 billion.

Moving forward to today (latest report is through 31 March 2012), the Fed’s balance sheet is over triple what it was – now $2.9 trillion.  It’s never been expanded anywhere near this size before in its century-long history.  Their liabilities are now about $1.1 trillion of our deposits, and now $1.5 trillion in member bank reserve credits.

So with about $2 trillion of quantified Fed activity geared toward stimulating the economy, they have increased our deposits by a mere ~$300 billion.  In essence, ~15% effectiveness, if you will.

The rest of that “stimulus” – the $1.5 trillion of reserve credits (which was a scant $19 billion in 2006) – sits on bank balance sheets across the land not being lent.  Even though those funds for lending come free for the banks.

Which is why the Fed moved on to QE.  If the banks won’t use the funds to expand the money supply, the Fed will just eliminate that “middle man” and do it directly themselves by purchasing securities outright.  So now they own $1.7 trillion treasuries (up from $741 billion) and… nearly $1 trillion in mortgage-related securities issued by… the now since failed and nationalized Fannie Mae and Freddie Mac.  Because no one else wants to touch that stuff.

So when our Fed embarks on an experiment, never before attempted to this scale, and triples the size of its balance sheet, taking on $1 trillion of instruments no one else wants (that they owned $0 of in 2006 and before because they weren't allowed to), it might cause one to regard with concern the financial health of our central bank.

And yesterday, because all this activity has produced paltry results at best, the Fed announced that they are further going to buy another $40 billion of that stuff, each month, going forward into oblivion.  With money that we are creating out of thin air.

The crisis is still here.  But instead of destroying home prices, Countrywide, Fannie Mae, Freddie Mac, AIG, Bear Stearns, Lehman Brothers, Merrill Lynch, Washington Mutual, Wachovia, IndyMac, GM, Chrysler and the European PIIGS… now it merely threatens to destroy our central bank, the dollar and with that our full faith and credit.

Oh yeah.  And then we have that "fiscal cliff" coming up in a few months too.  That's a whole 'nother story.

 Have a nice weekend.

The Clear Choice

Well, both the Republican and Democrat conventions are finally out of the way.  A lot of people made a lot of speeches about how the choice is really so clear.  And they would be correct.  They would have us believe that one side screwed everything up; and the other side, the other.  And again, they would be correct.

This is, they tell us so emphatically, our clear choice.  What we have to choose from.

I believe that it is merely the illusion of choice, when the only effective options we have are between the same two parties that have at the very least presided over, but really are to me complicit in the affairs that have led us to our current dilemma.  Our "choices" are for one of two parties that have together shared complete control over this great nation since the early 1800s – making it effectively a bifurcated single-party state since.

And they spend too much money.  Both of them.  At least since I’ve been alive.  In my view, Republicans want to spend a lot of money on certain things by generally borrowing.  Democrats want to spend a lot of money on certain other things by generally taxing us instead.  And they would use these funds to effectively purchase votes from their constituents to tilt power between the two.

Both also spend a heck of a lot of time contrasting themselves with the other party.  But they are the same people.  And their rhetoric is growing more extreme, because we live in more difficult times.  Their respective party die-hard constituents absorb this rhetoric.  Through this, those constituents themselves grow more extreme, forcing politicians to follow that self-reinforcing spiral to our current intransigence.  (Only to pretend, as best they can, to be moderate for a small time between primaries and general election day to sop up the middle that hasn’t drunk their Kool-Aid.  Every damn cycle.)

It’s growing more difficult to be a politician in America nowadays.  (Smallest-violin-in-the-world-time.)  That’s because there is no longer any fat left to carve off and feed back to us in exchange for our vote.  This sociopolitical Ponzi Scheme is becoming starkly more apparent as our tide of wealth recedes – where there is less of our own treasure to take from, and promise back, to us.

There’s no more fat because, unlike before, budgets are actually going to have to become reconciled.  As our gross Federal debt has now topped $16 trillion – over that danger zone of greater than 100% of GDP.  And yet we still burn through over $1 trillion each year.  They let deficits run away because they are afraid for their own personal political careers, and as credit markets have given us a pass for now.  Which is hyperbolic foolishness – borderline treason, in my view.  (But let's just refer to it as gross negligence.)

When in 1933 FDR first rolled up his sleeves and got busy trying to right the effects of the Great Depression, he started with Federal debt to normal GDP (pre-collapse) at about 25%.  Budgets were about 3% of GDP.  The top marginal personal income tax rate was 25%; 1.5% for average incomes.

In other words, he had all the latitude in the world to harness the economic might of a young, industrializing and great economy, even despite its catastrophic collapse.  We don’t have that now.  We can’t spend our way out of this one.  There’s nothing left to spend.

I watch MSNBC plugs with Rachel Maddow, Ed Schultz or Chris Matthews for instance (no offense to them, they’re just reading the script handed to them for those bits, I hope) where they extol the virtue of Depression Era spending and public works as the way today.  It makes me chuckle (otherwise I’d be crying).

Spending on public works is not only the way.  It is necessary in a now clearly flagging infrastructure and faltering education system.  Public funding has incubated many of the most powerful private industries that helped make America, America.  I absolutely so agree with them.  But what I guess they don’t get is (and pardon the crude metaphor), parasites die to if they leech an unhealthy host to death.

The point is, increasing taxation on a healthily growing economy is all totally fine, if we can’t cut spending.  Tax rates are clearly much higher than when FDR started out in 1933.  And they can also clearly go higher.  But they would dangerously sap an already ailing economy, as spending cuts would – thus our rock and hard place.

Budgets are now 25% of GDP, not 3%.  Debt to GDP is now in the zone of when we were maxing out for World War II-time production.  We don’t have any more spending latitude so long as the economy is weak.

And not for nothing, when FDR was done, by say 1939 before the war started for us, tax rates were tripled to 79% for the highest incomes; 4% for average incomes.  Debt doubled to 50% of GDP.  The budget had tripled to 10% of GDP.  All that Keynesian effort… and unemployment was still 19%.  That’s certainly better than 1933’s 25%.  But we started in 1929 at 3% unemployment.  (For reference, I believe that “underemployment” was 28% by 1939, 38% in 1933 and 5% in 1929.)

The only obvious solution for right-sizing our debts and budgets, will have to come from all quarters – as the now two-year-long disregarded, bipartisan-composed Simpson Bowles Plan advocates.

Unfortunately for the politicians, the real work will have to involve doing things we don’t like.  Cutting popular plans we spend on.  Raising taxes (for all) to pay for what we can.  And politicians don’t like that pitch.  (Although personally, I think it’s coming right after this election, no matter who wins.  It’s either that or a credit/currency crisis in about two years.)   So they embrace the extreme.  They pander to their respective party’s fundamentalist core – blaming the other party for our nation’s woes and hoping that gets them re-elected.

In my view, the economy is weak and the necessary amount of jobs are absent, simply because the nation and world has lost confidence in the leadership of the greatest nation on Earth – the only one that has truly led the world in modern times - geopolitically and economically.  Now it can't even lead itself.  No wonder the world continues so adrift, four or five years now past the financial crisis.

The choice really is rather quite clear.  Our leaders must do the responsible thing – not the personally self-preserving thing like they continue to.  If our nation and the world see that, then we’re back in the game.  Like gangbusters.

Until then, we all just stand here, jaws agape, staring at our would-be elected officials blather on at us about how clear the choice is.

So yes, we do see how clear the choice is.  We only wish you did too.

Facebook Valuation Update - Still Expensive

I think Facebook shares (Nasdaq: FB) are properly valued at ~$12.50 per share. They IPOd in May at $38. They closed last night at $19.87. (Yes, that's how ridiculously overvalued the IPO was, as I wrote at that time.)

At last night's closing price, I believe Facebook shares trade at 7.0x consensus sell-side analyst estimated 2013 sales. For casual comparison, Apple shares (Nasdaq: AAPL) trade at 2.5x that.^*

I get that Facebook sales are estimated to grow ~25% over the next year; Apple ~21% (a company with sales 34-times greater, market cap 11-times larger than Facebook's; and with over three decades more than Facebook's three months of proven public company performance; and not controlled by insiders, like Facebook is).

In my view, at the end of the day, a public company's market multiple relies on its perceived future ability to generate cash for all shareholders. Period. It doesn't matter if they make iPhones, provide Internet-based social medium, or sell umbrellas.

How much cash do they have (net of debt) and generate now? How much do we expect that to grow (or not)? Everything else that we could talk about to characterize the business or its industry is effectively moot. That's because all that is ultimately boiled down and quantified in the answers to the above two questions.

Like I said, Apple sales are expected to grow ~21% in the next year; Facebook' at ~25% (if consensus sell-side analyst estimates are correct). If they continue to both grow at these rates over several years (which they won't, but let's just use it), Facebook will have turned $1 of cash into an amount ~1.25-times what Apple will have generated. Keeping it simple, it should not be unreasonable to expect Facebook to have a multiple not materially deviant from 1.25-times Apple's.

The price we pay to purchase shares of a publicly traded company is the perceived capitalized value of those future cash flows. With the Apple benchmark in mind, that is what ~$12.50 today is for Facebook to me.

But there is one more thing. Facebook is controlled. The insiders own most of the vote. In other words, it is barely a public company in actuality. Privately-held companies transact at multiples far lower than publicly-traded ones.^**

Publicly-traded companies that are effectively controlled by the insiders typically trade at discounts to valuations they should trade at, had they been fully democratically owned by all shareholders. In a controlled situation, public shareholders get nervous that the interests of all shareholders, and not just the insiders' interests, will be represented.

For Facebook, Our Dear Leader Zuckerberg presently controls 55.8% of the vote - all insiders 95.9% (per the offering documents). He has a majority vote (whether he stays on as CEO or not). Every other public Facebook shareholder, then, effectively has no voice on voting matters in most situations regarding the company.

Public share ownership is supposed to be about being a part owner in a company. If the public shareholders have no voice, then owning the shares is truly just like owning a commodity, and nothing about being a public partner. They can't - with full force - elect their representation; their board members. They can't fire the board members or CEO if their shares... oh, I don't know... get cut in half in three months' time, for example.

Only Our Dear Leader Zuckerberg can do that at Facebook. And everyone else has to just hope that his interests will always be aligned with ours. Because of that, $12.50 might still be overstating its value. But if it got near there, I'd start loading up on it. (Of course, if the world still has not ended for a second time, like everyone seems to be anticipating - precisely why it won't.)

At the end of the day, this is just my view. And there are many different views that make the market place, pushing these stocks all over. But I at least want to demonstrate that, despite Facebook's share price devastation, there is a decent argument for it to continue demonstrably lower. Happy Hunting.



* All multiples, unless otherwise expressed, refer to Total Enterprise Value ("TEV"), as a multiple of these measures. I calculate TEV as the equity market value, diluted and adjusted for in-the-money granted stock options assumed exercised, plus debt, less cash on the balance sheet.

** Primarily because publicly-traded shares open up a vast pool of investors not available to privately-held companies. And such public shares can thus be used as a far richer source of raising funds. It is far more lucrative to me, if I can sell the public a piece of my company at, say, 15 times earnings, versus bringing in a partner privately at maybe only one-quarter that. A new private partner pays the lower multiple because he does not have nearly as liquid an exit strategy for (or sale of) his investment. as he might if he owned a stake in a publicly-traded company. He also, by nature of being a private investor, owns a riskier company, as it has less options for accessing capital than a public one.

Facebook: The New High

At its height in 1999-2000, it had over 30 million subscribers – almost one-quarter of all Internet users in the US at the time – and was growing 25-30% annually.  By 2000, its nearly $7 billion in sales had been growing 35-50% annually in the culminating years.

At its peak market capitalization in 1999, it was worth $250 billion.  Time Warner liked it so much that, in 2000, they decided to merge with it.  At that peak, I get it was valued at 35x revenues, 138x EBITDA, 216x cash flow.*

I’m talking about one of the hottest items of the then-nascent Internet age in the late 1990s.  I’m talking about America Online.  For about $22 a month, you too could sign up to wait about 20 minutes (if you were lucky) for your dial-up modem to connect you to their online community.  It was an unstoppable business model.  Until everyone realized one day, you don’t need to pay anything for that (subscription fees were two-thirds of its revenue model then, the rest mostly ads) and it could be readily replicated away for free.

Fast forward to today…  As of year-end 2011, AOL is now down to 3.3 million subscribers (and only 36% of its revenues are now from subscription fees), out of the now 2.3 billion Internet users worldwide.  That’s down from 4 million in 2010, 5 million in 2009, 7 million in 2008… and oh yeah, the over 30 million in 2000.  With a current market cap 1/100^th that of its 1999 size (since spun off from Time Warner in 2009), it is now valued at 1x revenues, 6x EBITDA, 7x cash flow.

Today the latest hot thing is now Facebook.

It IPO’d at $38 per share last Thursday, with its first day’s public trading opening around $42, declining back to $38 by the close.  Facebook boasts over 900 million subscribers, growing ~25-30% annually (down from doubling three years ago).  It has now penetrated nearly 40% of the world’s 2.3 billion Internet users (they had only about 10% penetration just three years ago).  Its ~$4 billion in sales is growing around 45% annually (recently goosed by an uptick in advertising revenue).

At the $38 IPO price, its market capitalization is about $104 billion.  I get that to be a total enterprise value of 28x revenues, 45x cash EBITDA, 62x cash flow (all 2011).*

For perspective (albeit a bit off the top of my head) more “normal” looking valuations for “older-world” businesses range around ~1-2x revenues, ~6-9x EBITDA, ~10-15x cash flow.  But valuations price growth.  Those less-lofty, broader market multiples would typically be pricing ~4-8% growth.

So the big, fat stupid question is (always is), how high is too high?  The corollary, when are we in a bubble?  The only good answer is, until there are no more fools left willing to buy it there.  Every other “explanation” is just a bunch of people trying to make money selling books.

But to slap some numbers on it, Facebook subscribers are growing at 25-30% right now.  Worldwide Internet users are growing at 10-15%.  Facebook subscribers are 40% of all Internet users.  At these current growth rates, there will be more Facebook users than Internet users five years from now.  Which is impossible.  Even for Facebook.  (Sorry.)

The point is, Facebook subscriber growth has to start decelerating dramatically at this point.  It’s just simple math.  If we run subscriber growth out at a rate declining to about 15% by 2016 (still robust), by 2019 Facebook will have 3 billion users, or 58% of all Internet users.  Right now, Facebook makes $4.70 in revenue per subscriber (up from $2.16 in 2009).  If we hold that constant, then Facebook will be generating $14.5 billion in revenues in 2019.  That values Facebook at 7x 2019 revenues.  At that point it will be a more mature business, but still growing the top line in the mid-teens.

Apple is an iconic and transformative company.  It is a mature business, but has managed to reinvent itself and remain "cool" for a few decades now.  With the explosive success of iPhones and iPads, etc., Apple’s sales grew 66% in 2011.  52% in 2010.  Apple presently trades at 4x 2011 sales.

Again Facebook, with current growth of 25-50%, debuted at 28x 2011 sales.  According to the market then, Facebook is “just” seven times cooler than Apple.  If Facebook does everything perfectly for the next seven years, it will then be at a valuation “only” nearly double Apple’s current.  Beauty, of course, is in the eye of the beholder, but can we start to see that perhaps Facebook’s present valuation is maybe a little too beautiful?

And then to compare Facebook to America Online of 1999 is, of course, absurd.  AOL was a subscription fee-based model; Facebook is mostly an ad-based model.  They aren’t in any way alike.

Other than they are both Internet-based subscriber services.  That both came to be regarded societally as a ubiquitous online utility.  And they both offer their subscribers access to their “closed garden” online communities through chat and news.  And they both offer a secondary suite of products (Zynga’s games and apps for Facebook; Compuware for AOL).  And they are both the absolute craze of their respective times.  And they both boasted explosive growth in just several years’ time.  And they were both growing off a relatively new business model only a handful of years old.  And their shares both traded, thusly, at mind-bogglingly high market valuations. 

Aside from that, absolutely no similarity whatsoever.

I am of course being a bit facetious.  But only a bit.  28x sales is ridiculous.  It is.  It just is.  Turn off CNBC.  Pay attention.  There was a time, maybe five years ago, where 5x or 10x sales for fast-growing tech or Internet-based stocks was considered “nose-bleed”.

Now we’re chatting once more about 20-30x sales valuations.  The last time we got there… was the dot-com bubble of the late 1990s.  A bubble that peaked in mid-2000, with the tech-laden Nasdaq Composite Index’s peak.  From there the Nasdaq proceeded to crash ultimately almost 80% – a decline as severe as the 1929-33 stock market crash – and still is only half its peak after over a decade later.

The difference now, versus the late 1990s, is the bubbles only exist in a handful of hopefuls – the poster child right now being Facebook.  The overall market – unlike the late 1990s – is not expensive.  It has just clawed its way back to rather normal looking valuations that it had already achieved, pre-financial crisis by 2007.  To embellish, the S&P 500 Index P/E, in 2007 and now, is a very average looking 13-16x.  By 1999 that was over 30x – its highest ever.  In other words, the entire stock market of the late 1990s, unlike now, was expensive.  This is a possibly important caveat that may allow ridiculous individual overvaluations to persist longer than they otherwise should.

A valuation of 20-30x sales though, prices in everything good that could possibly ever happen to a company – whether it happens or not.  For Facebook, it means that mobile app users, growing at 50% annually (read: faster than overall Facebook user growth), won’t cannibalize ad revenue for it anymore, as Facebook admits it is a risk in their public filings.  (Ads can’t presently be shown on smart phone Facebook apps.  Thus that app use generates no income for Facebook.  Facebook does not control that.  Mobile users are more than half the size of total Facebook users.)

It also prices in no weariness; no boredom with the “new toy”.  No risk that the kids won’t think it cool one day anymore (ala MySpace).  No annoyance for the huge uptick in ad presence on your timeline.  On your banner.  On your photos.  On your news feed.  Its valuation relies weightily – if not solely at this juncture – on the fact that there is no other place for nearly one billion users to otherwise go.  For now.

After all, as subscriber growth now decelerates, increasing ad volume (and/or ad fees) must compensate.  This comes at the risk of annoying either subscribers, advertisers, or both.  And who knows if others will follow GM’s recent decision to leave advertising on Facebook because not enough people clicked on their ads.

But it is a risk.  And 20-30x sales valuations do not account for that risk.  Such a valuation also prices in the assumption of successfully breaking into brand new markets, like the Chinese for example.  Or Klingon or Vulcan or Romulan for that matter.

None of the aforementioned is impossible, or even improbable (well, maybe the interstellar bits).  But the world is a fragile place still in the wake of the financial crisis.  It is not a place where the benefit of the doubt is typically given to publicly traded companies.  20-30x sales gives all that and more to Mr. Zuckerberg and his management team.

They have done a spectacular job in the past several years fulfilling the American dream – running a small, upstart private company, with focus on finding new rounds of private capital investment to fund, while it grows an unprofitable model into a profitable one.  That’s what they have several years of proven experience in.

But they are a public company now.  As I write, they have exactly one business day’s experience in delivering, to the penny-plus-one, quarterly results to a herd of frenetic public investors.

20-30x sales places consummate confidence in them that they’ll continue to deliver for many, many more years to come, with never a misstep.  And that they’ll be naturals at their brand-new and yet to be proven fiduciary duties toward maximizing value for all public shareholders – irrespective of the fact that the insiders still hold 95.9% of the vote (Zuckerberg 55.8% himself).

But Facebook is different from most companies.  It is a revolutionary and transformative icon of society.  And to that, Facebook should command a higher than otherwise market valuation.

So was America Online, by 1999.  And it did as well.  Right up until it didn’t.

Like I said (even facetiously), Facebook is no America Online.  But at 28x sales, before jumping in, is it not prudent to give them, say three reported quarters, to show us they know how to behave like a public company?  Let the hype blow over?

Especially with Europe’s now two-year slow motion train wreck debt crisis, China’s real estate and banking sectors teetering, our own unresolved fiscal drama and while globally wallowing in a soft economic depressive state?

I think you know the answer.  Unfortunately though, even "smart" people can be trampled by the crowd.

* Total enterprise value (“TEV”), as a multiple of these measures.  TEV is the equity market value, diluted and adjusted for in-the-money granted stock options assumed exercised, plus debt, less cash on the balance sheet.  EBITDA is earnings before interest, tax, depreciation and amortization expenses.  Cash EBITDA is EBITDA, adding back non-cash stock compensation expense.  Cash flow is cash EBITDA, less capital expenditure.

The Bad Lesson

When Hadrian became Emperor in 117 AD, Rome had basically reached its greatest extent.  A little over 60 years later with the death of the last of the “Five Good Emperors”, Marcus Aurelius, things really started to fall apart.  Perhaps the first sign of trouble was what his son Commodus did, when he assumed full power in 180.  No, Mr. Scott, he didn’t make Russell Crowe’s [fictional] character become a gladiator.  He devalued Rome’s currency.

Although it wasn’t the first time it had happened (as Nero had done so first in 64), Commodus started off a series of significant devaluations that were repeated by him and subsequent Roman Emperors over the next four decades that led them into what is now known as the “Crisis of the Third Century”; a conflagration of economic and social calamity, civil war, invasion and plague.

That crisis may have dissipated by the mid-280s, but Rome never really fully recovered, spending the next couple hundred years being split apart, picked away from the fringes and ultimately just completely overrun by relentless Germanic invasions and sackings.

It was not that debasing their currency, the denarius, was so much the cause.  In my view, it was much more an effect, but an effect nonetheless that instigated subsequent other deleterious effects.  Rome had simply stopped expanding.  There was no more vast wealth to capture from rival lands to fund the ever increasing lifestyle that Romans had become accustomed to.  And their politicians had come to rely, in no small part, on a patronage system where interests were basically bought off for power, and vice versa.

It is a parallel for the US today.

I am not terribly concerned about invasion by hunnish Canadian tribes of the north massed on our borders (although simple migration into Gallia Belgica, Gaul and Hispania is how it started with the Goths for Western Rome).  Nor am I, of the drug cartel induced civil war in Mexico flowing over here (mostly because I don’t have to live anywhere near Arizona).  But nonetheless, probing powers do encircle our reaches today.

And I certainly can’t predict the next plague of scale.  But world population spent all recorded time up through the early 1800s trying to get to one billion.  And then in just ~200 years since, is suddenly seven billion – half of that expansion achieved in just the last 35 years.  So in my completely unqualified opinion, despite medical advancement, it seems we’re overdue since the Spanish Influenza of 1917-18, which killed ~3-6% of world population then and infected over one-quarter of it in just months.

Further, the US certainly doesn’t have a civil war in the 1861-65 context today.  But I can’t look at the current intransigence of the Republicans and Democrats and dismiss the notion that our nation is in some sense suffering the effects of a nation divided, perhaps like it hasn’t been since the notion that a house divided cannot stand was first proffered.

Nor can I pretend that the Federal Reserve, having now more than tripled the size of its balance sheet to $2.8 trillion in the last few years, will have no devaluing impact on our dollar ultimately.  Most of their activity now was so-called “quantitative easing”, which is not a sterile activity (meaning, it directly pumps inflationary dollars into the system).

And it’s not that we have stopped expanding the “reaches” of Emperii Americani, pardon my poor Latin.  But as the various quarters of the world expand around us at a good clip, it is as if we stagnate or contract on a comparative basis.  And this exacerbates our growing list of issues.  Our educational base is slipping away.  Our infrastructure is ailing.  We have real global competition for skilled labor, not just unskilled.  We hand out too much relative too what we can spare.  All of which existed before any financial crisis popped up, circa 2007+.  None of which are getting fixed by flooding the world with dollars, or running our debts toward the point of no return.

I must emphasize, all of these things are still treatable.  It’s not too late.  The only real issue – what is in the way of every solution presently – is that we lack the political will to demonstrate the leadership necessary to right our course.  So a simple (albeit a bit cliché) message to our elected representatives:  Lead, follow, or get out of the way.

Gone it seems are our “Good Emperors” – our Nerva, Trajan, Antoninus Pius, Marcus Aurelius.  What are left are the likes of Commodus, Septimus Severus, Caracalla, Elagabalus, Alexander Severus, and so on into oblivion.  But were the former truly “good”?  Or did they happen to simply preside over a Rome during part of its time of greatest expansion, whereas the latter hadn't?

And the world sees us at this pivotal point.  They look on with almost disbelief, just as the Chatti, Marcomanni, Frisii, Vandali, Huns, Sarmatians and Parthian did upon Rome.  In one sense unnerved.  In another relieved.

If our financial crisis, ensuing recession and political incompetence played out in a world that did not have even scarier things going on outside our borders, like it does at present, the dollar would likely have collapsed by now – and with it, our way of life.

But the dollar is still the world’s reserve currency, about 60% of the world’s allocated reserves, down from over 70% a decade ago – a decline very roughly equivalent to the decline in our share of world GDP in that time.  Hate it or love it, the dollar still represents the least risk, and is the most accessible and abundant store of wealth available to the world – a world that simply has nowhere else to go.  So for now, a loaf of bread or the New York City subway continues to cost ~$2, and not $20 or $200.

The only other potential competitive alternative to the dollar was the euro, which made it to ~27% of world reserves a few years ago.  But with the slow-motion dissolution of the Euro Zone now in play – or at least the perceived credible threat of such – that is no longer an issue.  Remember all those celebrities wanting to buy stuff in euro, on Fifth Avenue or Rodeo Drive?  You don’t hear much about that anymore, do you?

Then there's the Japanese yen, a currency issued by a nation ~200% of GDP in debt (effectively the most in the world), in a now two-decade deflationary depressive state and an aging, declining population.  Despite all the yen’s attention, as well as Japan’s economic prowess as we entered the 1990s, at the peak of their economic miracle over two decades ago, it was never more than ~8% of world reserves.  Now, ~3-4%.

Then there’s the Swiss franc.  The Alps, clandestine banking and their claim of geopolitical neutrality might somehow make you feel safer with their franc, but the simple truth is its economy is the size of Pennsylvania’s – less than 1% of world GDP.  It just is not nearly large enough to support a currency, should the entire world choose it to safely store wealth.  Duly note Switzerland’s decision late last year to flood the world with francs, to counteract its 50%+ appreciation v. the dollar through 2011 – nearly 80% appreciation from pre-financial crisis levels.

So for scale, that basically leaves the Chinese economy and their currency, the renmimbi.  But – and although we’re all guilty of it to some degree – they are a serial and gross manipulator of its value.  And I don’t think I’m ready to trust a state with my money that has little respect for real or intellectual property rights, let alone the basic human ones.  Nor do I feel comfortable with a nation whose appearance of stability is nothing more than a rather precariously balanced tug-of-war, literally between 700 million people on each side – especially this year as we approach its first unscripted transfer of power since the 1970s.

And gold?  There simply isn’t enough gold in the world, proven and probable, to support the level to which the world’s economies have inflated, or could continue to grow.  Which is why a last ditch reliance on it as a store of wealth sends its price ever higher.

So we are learning a bad lesson from the lack of a collapse in the dollar – that since there is no perceived acute pain, there must be no trauma.  Pain is good.  It reminds us we are still alive.  But our American pain is being deadened with the drugs of fiscal overspending and dollar fabrication.  We have been massively over-treating the symptom for the past few years now, masking its message that warns us of the actual injuries.

The dollar has not collapsed, not because we aren’t behaving badly (multiple negtion intended), but because everywhere else in the world that is denominated in some other currency – right or wrong – is perceived the worse evil for now.  And our interest rates remain low also as a result (abetted by the belief that we are in some form of depression, which we are).

Our central bank scrapes more and more silver out of our denarius each year, faster than ever over the past few years.  In a sense, our politicians’ deficits burn away almost one-tenth of our economy each year, purchasing their power.   Weak as they are, they will continue on in a fashion that, as far as they can see, risks seemingly nothing with each new day (read, election cycle), yet almost everything down the road.  Until when, what precious thing we once had – and still have – is lost.  When it is too late and perhaps gone forever.

The only thing any of us have any real control over in our lives.  The value of our full faith and credit… the value of our word.

Power to the People

According to Time Magazine, 2011 is the “Year of the Protester”.  We have the so-called “Arab Spring” effectively demonstrated in Tunisia, Egypt, Yemen, Libya and Syria.  We have Wall Street Occupiers everywhere from Lower Manhattan to UC Davis.  We have protesters in Greece, Spain and now Moscow.

The Arab Street is protesting repression by their dictatorships – ones that have been around for a while.  Ben Ali assumed power in Tunisia through a coup d’état in 1987.  Then-Vice President Mubarak became President of Egypt in 1981, after then-President Sadat was assassinated.  Saleh has been Yemen’s President since 1978.  Gaddafi ruled Libya since 1969 after a military coup.  Bashar al-Assad succeeded his father Hafez (both Ba'athists) to rule Syria in 2000, after his father had ruled for 29 years until his death.  Each ruled with an iron-fist for most of those years.

The so-called Wall Street Occupiers are protesting income and wealth inequality in the US – an inequality that is always present to some degree, and has been building now for decades.  European protests are a reaction to the measures their stressed governments have undertaken to reduce spending and get their budgets in order, going on now for over two years.  The recent protests near the Kremlin in Moscow are about alleged election-rigging – as if corruption in Russia just showed up last week.

So why now?  Any of these regional issues have basically been going on for some time.  But that’s just the “what” of it.  It is not really the “why”.  The particular “whats” might be disparate, but the “why” is shared.  The “why” is plain old economics.

Most people don’t get up every day trying to figure out what to get pissed off at and take to the streets about (or at least after some coffee).  They mostly just want to live their lives in as peaceful a manner as possible with the ones they love and care about.  Aside from a minute amount of agitators that live for this stuff, most people don’t publicly protest unless they're really upset, think it's their last option, and, that it might have an impact.  Having no job gives you a lot more free time to talk yourself into it.  Having no food gives you no choice.

Headline unemployment in the US has been over 8% for three years now; our duration of unemployment at an all-time high, double the worst previous post-World War II recessions and still rising.  As the world's greatest economic engine, our weakness touches every quarter of the Earth.  And so do our inflationary efforts to pull away from deflationary depression.

The Arab countries are the largest net importers of cereals in the world.  Food inflation there has been rising at ~5-25% annually in recent years.  With so many in that region living at subsistence level – where food consumption is 40-65% of their weekly budget – small increases in food prices basically have large consequences on millions there, not very different from the social effects of famine.  The Greeks have been grappling with significant cuts in their pensions and other social subsidies – a very large part of their incomes over there.  Russians are dealing with both a weak global economy and inflation as well for years.

And there is also the “how” of it.  It’s pretty simple – the Internet.  With more than 800 million users on Facebook, 300 million “tweets” per day, almost 700 million Skype users, 170 million blogs, a cell phone (most camera-enabled) for every 1.4 people on the planet out there…  Effectively, none of that existed just five years ago.  As a result, people today are more aware than ever about everything - and that includes that others too get occasionally upset with their plight.  This empowers and emboldens those like-minded.

Although it is finally starting to change, how much more different might China be today for example, had all that existed in 1989?  Having said that, it is shocking to me how precious few Chinese in their twenties understand Tiananmen Square to be nothing more than maybe a nice place in Beijing to eat during their lunch break, due to state-level information control.  (And also sad that most Americans in their twenties likely never heard of it either, as they have no excuse not to have.)

But as prolific as these protests seem to have become all of a sudden - except for maybe the Arab Spring - their near-term results will be ineffective, in my view.  To the extent I can understand them, the Wall Street Occupiers are directing their anger at the wrong places.  Greeks may have ousted their Prime Minister, but they will still have to take their medicine one way or another, and no matter who is in charge there.  A decade of popular support for Russia's strong man Putin serves his ego more than his power – so its withdrawal will do nothing more than perhaps make him grumpy (со всем должным уважением).

But here the protesters are.  And if it’s true that they will be inconsequential in effort, that merely dismisses the “what” of it.  It does not dismiss the “why”, and certainly not the “how”.  Either way, their presence should be taken as a message; a writing on the wall.

We conventionally consider the age of great monarchical empires to have fallen away in the early 20th Century – China’s in 1911, Russian Romanov in 1917, Austro-Hungarian Habsburg and German Prussian both in 1918 (Britain’s only exists today nominally).  They were dismantled through popular revolution.

In their place in Europe, rose socio-economic bodies that put the power in the hands of the people.  Radical political ideals competed for their hearts and minds.  Communists fought for the classless equality of the proletariat; Fascists for nationalist identity.  Both were radical, totalitarian-themed and hostile toward free thought, cultural diversity and form of expression - the sanctum of the individual.  And both have since failed as well.

What remains largely today are the empires of representative democracies.  I use the word “empire” very loosely, but because I believe despots can rule in a democracy as well, not just in monarchies or other totalitarian states.  They just take the form of party, rather than king or commissar.  And if those despots continue to care more for their own power than the will of the people, this latest form of rule will become challenged as well – harbingered by The Protesters against such regimes.

Our representative democracy here in the US will now come to face an existential question.  Can a representative democracy do the right thing when there are no longer any good options?  Can we make the tough choices necessary to sustain the prosperity of the people, when it might come at some cost to the prosperity of the individual?

Despite its obvious imperfections along the way regarding equality for race, creed or gender, it seems to have worked reasonably well on the way up.  When America has no foreign competition, because all those that would be, have literally been destroyed by fighting World War II on their own soil.  When the standard of living as a result increases by leaps and bounds, year after year.  When opportunity awaits the motivated, persistent, hard-working and talented who reach out for it.  When all of that creates so much wealth, our politicians can promise everything to everyone – purchasing our votes with our own wealth, and as if to suggest our successes actually had anything to do with them.

But what about when that upward arc begins to flatten out?  When we have real global competition for the first time?  When that bleeds away our standard of living into other quarters of the world, no matter who we vote for?  When there’s no more fat for politicians to carve off and sell back to us?  When we now must make adjustments, sometimes hard choices; real decisions?

Suddenly it’s not so fun anymore – not necessarily being the undisputed “number one”.  Suddenly it starts to feel and look a lot more like yet another aging empire.  That’s when people’s true character starts to come out.  When it comes down to survival, it’s suddenly every one for themselves once more; so characteristic of all heretofore societies in their last days that collapsed under their own weight.

And then the radical ideas don’t seem so radical anymore.  And then the people might actually be willing to deal with the devil that they don’t know.  And then revolution is in the air once more.  Dangerous words – the spark of so much war, so much blood, so much suffering in the past century.  So dangerous, because they speak of something so real and, from time to time, so present.

In a representative democracy, if the political leader is unwilling to give us the spinach we need instead of the ice cream we want if you will, it is because the electorate is unwilling to eat spinach – no different than a spoiled child.  After all, how can even the well-intentioned politician do good, if he can’t get reelected?  And what is to become of that representative democracy, when its governance must rely on the consent of the spoiled?

It prevails as every child, once spoiled, ultimately must – through discipline.  There simply is no other way.  Yes, we have become spoiled.  I can say it, because I’m not running for public office.  But whether I was or not, I would also remind us of the following…

We are a great society – I believe the greatest that can be found in the history books.  But we are at a crossroads.  If we want to continue to flourish with many more days to look forward to, it is up to us individually and collectively.  If we want serious politicians to make the serious decisions required for further prosperity, then we the people must get serious, be disciplined, grow up.

Because, right now, we don’t have any politicians acting serious – that’s for sure.  Even the ones that want to.  And that is nothing more than a reflection of those who would vote for them.  We are going to have to try something new now.  We the people are going to have to vote for the politicians that tell us what we don't want to hear.  They do exist.  They're just hiding right now, because they want to keep their jobs.

Being serious means we must ask for less right now.  Not because it is ignoble to strive for that great society on the hill, but because the latest generation has misspent our treasure, allegedly trying to get us there, and we have to be the responsible ones now and pay for their folly.  With taking less, we will also have to give more.  That is if we claim to care a lick about everything we have built, and the children who we would pass it on to.

We must remember to rely on ourselves, and ourselves alone, while at the same time be mindful to care for our sister and brother when they’re down.  The sanctity of the individual – of individual achievement, expression, success, dominion – must be preserved at all costs.  And part of preserving that means we must be charitable and remember to safeguard the individual sanctity of our neighbor.

Never have we been better situated to succeed in that endeavor.  Because we stand at a moment in history – as the richest and most powerful nation to have ever existed on Earth – where we can learn from the lessons of all others that have tried and failed.

The only thing left we need is a little resolve and discipline.  And the smallest reminder that this great nation was built by great people – was built by us – I believe is all it takes to evoke that which is already within us.

For if we don’t rise to the occasion, all we ever will have been in the annals of history, is someone else’s lesson of what not to do.

And that is what The Protesters are telling you.