Herman Kahn

Interesting times we live in, when most of the world’s business media has a front-page tab on their Web sites that says something like “Euro Crisis – Live – Follow Here” as if there was a hostage drama or bank heist on the go.

Perhaps it is a bank heist of sorts, in the frantic run up this week and next to the Brussels summit in on 8-9 December, where the 27 Eurozone leaders are expected to make some binding, if not bold, decisions.

There has been short-term market relief following the US and China’s undertakings to make dollars more easily available into the European banking system. But everyone knows that liquidity, while a problem in itself, is a symptom of the larger problem of sovereign debt. And sovereign debt is only a problem when lenders don’t see future growth such that loan capital looks safe at less than, say, 7%.

In the world of foresight we talk about the need to “think the unthinkable,” a phrase coined about Herman Kahn in the 1960s when he was making scenarios about the road to US-Soviet thermonuclear war. So I was curious to see this exact phrase pop up in various media analyses where implications of Euro-demise, such as redenomination risk, cross-border contract liability, and so on are getting a thinking through, at least in the media, for example here in the WSJ.

Adaptive Measures

This is scenario planning “lite”: thinking down the path to, and implications of, a plausible operating environment — even if it is highly unlikely — and determining best responses, necessary hedges, and other adaptive measures. (Non-lite would be to do the background work, not just the journalistic summary.)

As the unthinkable forces itself to be thought, even the Corporate Executive Board was motivated to put the injunction to their executive partners as follows: ”As the threat of a potential euro zone breakup looms, we strongly advise companies to enhance their scenario planning disciplines. Leading companies in our network begin by documenting project assumptions and building scenarios off of those variables to test profitability under a range of outcomes before committing capital.”

But to this they add the intelligent real-world rider, often missed by scenario-ists: ”Don’t make the mistake of assuming that entire projects, P&L’s, or budgets need to be reconfigured under volatile outcomes. Instead, build your contingency plans around critical, controllable line items.”

The World Bank on May 18 released a report “Multipolarity: The New Global Economy” with outlook for the geo-financial system to 2025.

“Multipolarity” catches the World Bank up with what has been clear for a long time: an actually, genuinely different global economic order is unfolding as growth moves to emerging economies, with countries such as China, India, South Korea, Russia, and Brazil accounting for the majority of economic growth in the next decade and beyond. And, on the back of this, the dollar will lose its pre-eminence as global reserve currency.

The report is nevertheless important at a meta-level. When the World Bank puts out a perspective, that means the perspective becomes more-or-less institutionalized wisdom. Global financial revolution, effectively, is no longer a theory out there. It is the “official future,” and financial and political institutions are more likely to act in line with it. Therein a reinforcing feedback loop.

Renminbi

A couple of things stand out. Report author Mansoor Dailami says the euro and renminbi will establish themselves on an equal footing to the dollar. This seems plausible, but one is left wondering – given the pace of innovation in finance, and in computing, and in communications and networking, and the 14 years to 2025 – will we still be looking at a system where national or regional currencies are  “dominant?” Could the world financial system not evolve differently, for example away from a global reserve requirement altogether, or towards more multi-currency baskets? (The report does entertain the adoption of the IMF’s Special Drawing Rights system.)

The foresight principle: In looking at the future it’s tempting to see new agents dominating current structures, but often the structures themselves change.

The other point that pops out is an expectation that cross-border M&A deals originating in emerging markets will be an increasing feature of the new corporate landscape.

This is as solid a prediction as one will find. But it surely will not be one way. While cash-flush emerging-market companies will look to diversify into European and American companies, or take them over entirely – particularly ones that have Asian brand recognition and prestige (remember the Japanese corporate shopping trips of 1980s) – developed-world companies will be returning the favor, buying their way into emerging market companies to get a piece of their growth.

And we’re not talking passive investment here. The action will be immersive developed-meets-emerging market M&A (and surely also corporate raiding, hostile takeovers, etc.)

M&A is “speed” for corporate leaders. A big high, often followed by acrash. But if history is any guide, the lure of buying someone else’s growth, not to mention instantly enhancing a company’s industry size-power footprint, is more intoxicating than the sirens of Odysseus, so one can confidently predict it going forward.

Which is to say the spreadsheet-anticipated wins in economies of scale, scope, market synergies, or vertical integration of M&A will be up against the problems of marrying company cultures, systems, products, brand values and business models — a vexing problem that routinely defeats even the best business leaders.

But add to this, here, very significant cross-cultural management and staff issues, problems of distance, and regulatory systems that are often purposed to different ends, and you have a leadership challenge indeed for firms that venture down this path. But venture they must, because companies in low-growth markets can only buy back their shares for so long (aka “we’ve got no ideas about what to do with investor money, so we’re giving it back to you”) — witness GE’s $12bn share buy-back announcement this week.

Predictions of the dollar’s demise are as old as the greenback itself of course, but over recent weeks the specter of the dollar heading way way below its trading range — a dollar crunch — has entered the zone of the credible, or, in scenario terms, the ‘cone of plausible uncertainty.’ That means decision-makers with lots at stake are taking it seriously.

Like the British pound, the dollar has been under a cloud due to perceptions of economic fallout from the credit crunch and global recession, but particular questions about the US currency have recently surfaced, driven by reports [Robert Fisk's 'The Demise of the Dollar' story in The Independent (Oct 6)]  that “Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council” (Saudi Arabia, Abu Dhabi, Kuwait and Qatar).

The subtext is far from merely financial. Practically, it would mean that on any day, the real cost of oil to US consumers and businesses would go up or down depending on the strength of the currency. This is something America is not used to. But, more deeeply, dropping dollar-denomination of oil is a direct shot across the bows of Washington’s say over oil affairs, and the hegemony of the dollar as the dominant global reserve currency.

De-dollarizing oil would not in itself push the US currency below its 25-year range. But it is portentous of the clear trend to a genuinely multi-power world, for better or worse, in which the dollar will get no favors. That will push the dollar down, at least while the news and fallout make their way through the financial and real economic systems.

Rumors of de-dollarization have been hotly denied, as further reported here, but as the Independent points out, denials are to be expected, and are always issued in these situations. They mean nothing. Even cub reporters know that.

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Scenario thinking

What’s particularly interesting to me is that a ‘scenario’ of dollar demise has become not only plausible in the mainstream view of the future, but scenario thinking is being used as a way to consider the nature of this outcome, and how best to respond without predicting the outcome either way. As recently as directly pre-credit crunch, the media question would have been: ‘what is the best prediction for the dollar (or the housing market, or credit default swaps?) and that, rather then scoping out the implications of the lesser-likelihood, would have dominated the discussion.

So, what struck me forcefully in the Business Week video interview above, where BW Chief Economist Mike Mandel interviews the news magazine’s Economics Editor Peter Coy (see Coy’s underlying story here), is how the less-likely, non-predicted, but very significant outcome is actively addressed:

Says Coy: “It’s so hard to know what the dollar is going to do. We don’t argue that we know… what we do is we say, ‘it could happen’ and let’s take that possibility seriously, in the same way we should have taken the possibility of falling housing prices seriously…”

This is not formal scenario-building of course. But it is, fundamentally an adoption of the framework, saying in the classic ‘scenarios’ way: “we can’t predict if it will happen or it won’t, but if it does it will have significant impact. So let’s just ask: ‘what if ‘ it does and explore the outcomes and our responses. What will the word look like? What would be the implications, the knock-ons and spinoffs? If it comes to pass, what would be wish we had done today?”

Perhaps failing to predict the credit crunch has dented predictors’ halos enough to cause a mini-zeitgeist-shift towards the only real way to cope with important uncertainty: exploring all outcomes that pass the plausibility and significance test, whether or not we actually believe they will happen.