Strategy Driver for Global and International Business - Economics (Debt)

by John F. Williams

Editor’s Note-

This is the first installment of a five -part series on global corporate leadership . This article focuses on Economics/Debt.

1. Economics (Debt)
2. Environmental Factors
3. Political Factors
4. Technology
5. Social Factors

The series taken as a whole should help you define the answers for your company to these nine questions:

1. Who are the customers of the future?
2. How will my company distribute its product or service in the future?
3. Who will be my competitors in 10 years? 25 years?
4. What will the source of my company’s competitive advantage be in the future?
5. What skills or capabilities will make my company unique?
6. What role will strategic alliances/ mergers/acquisitions play in its strategy?
7. How will my firm alter the nature of competition in its industry?
8. How will my organization redefine the boundaries between industries?
9. What can my company do to create a new industry?

The Opportunity

The impact of personal, corporate (private sector) and government (public sector) debt on global corporations can be deadly to the corporation under specific circumstances. This impact is sometimes too subtle to be noticed at first glance. The debt structure of a foreign country or state must be researched in depth before planning strategic initiatives that require investing in that country or state. What makes this interesting is the inter-relationship between personal, corporate, and government debt; and the obligatory interaction of politics. Debt at all three levels must be assessed as input to strategic planning for investment in a foreign country.

The Solution

Historically, economies are cyclical. The frequency of the cycle is not always predictable, nor is the range always known, but they have been shown to operate in cycles. Thus, if an economy is operating in the positive portion of the cycle, it will tend toward the negative at some future point. The length of time in each portion of the cycle tends to change, given the propensity of governments to intervene for their own reasons. When public debt is high, government is sometimes tempted to print money and ignore inflation. This causes an erosion of the real value of the excessive public debt.
Because of the tendency for economies to operate in cycles, debt levels must be assessed as much as possible on each level. In a strong economy, high levels of debt may not cause an economic downturn. In the event of a downturn, however, high levels of debt will at least amplify the situation that could cause the downturn to deepen into a severe recession.

As we know, when inflation is low, interest rates are typically low, encouraging more extensive borrowing even though real interest rates are no lower. Thus firms and individuals think they can safely afford to borrow a much larger multiple of their income. Although borrowers have historically enjoyed inflation, this is a double-edged sword. This same low inflation that encourages borrowing also makes excessive debt more dangerous, because unlike in a high inflation economy, borrowers can no longer rely on inflation to erode their real debt burden if they need or decide to liquidate. The path of debt therefore is unsustainable. It is likely to make any economic “landing” hard rather than soft.

Conclusion

Debt is not necessarily a bad thing. Long-term economic growth can be increased if savings are channeled into productive investments rather than sitting idle. However, if a sudden surge in debt is seen, some very deleterious side effects can result; specifically, higher interest rates, falling asset prices, and economic slowdown. Asset prices fall because debts can only be serviced from cash, and assets can only be converted to cash if they are sold. If many debtors are required to sell assets at the same time, asset prices will fall.

Corporations (and individuals) must, therefore, assess the foreign country or state debt burden at the private, corporate and government levels before investing in a foreign country. They must also assess whether the debt is increasing or decreasing and if possible, the reasons. This information needs to be input into their strategic plans. Failure to do so could result in a very expensive venture that borders on failure, or at least provides no or little return on investment.