Dear readers,
As you know, the Silicon Valley Bank bankruptcy last Friday has triggered tension in the financial system, bringing back memories of the worst moments of the 2008 financial crisis.
Analysis of its bankruptcy tells us that the bank's problem was its exposure to bonds acquired in previous years, with a lower interest rate because interest rates were lower then. As interest rates rise, new bonds issued have higher yields and old ones are less attractive and lose value. By increasing the differential between the new and old bonds, the problem is accentuated and the losses generate tension, depositors withdraw their funds from the bank and bankruptcy arrives.
This description, being true, is incomplete and could lead us to think that the problem is localized when in fact it is systemic.
The financial system is not a static entity that acquires assets and holds them until maturity, like a calm pool of dammed water. On the contrary, it is a continuous flow like a torrent, which is continuously capturing and allocating capital and liquidity.
The speed with which capital flows is the interest rate, when the interest rate is low or negative, capital flows very quickly, but when the interest rate is high the torrent dries up.
From this perspective, the solution should be easy, if central banks reduce the interest rates the problem would be solved. Unfortunately the reality is more complex.
The interest rate is the price of capital, and as Adam Smith taught us, prices are constructed by the intersection of the supply and demand curves. If, as John Forbes Nash demonstrated, the supply and demand curves are also affected by the different bargaining power of economic agents influencing the price determination.
Thus, when the capital in circulation is abundant, its price falls, and when it is scarce, its price rises, and there is nothing that can prevent it. Economic agents, including Central Banks, can delay or speed up the process but not prevent it.
And the effects of capital scarcity are serious because Capital is the most important resource of our social-economic system, this is why it is called capitalism.
Curiously, despite the fact that the word capitalism haunts us all day, it would be difficult for all of us to define capital (I kindly suggest that you try to do it). For the moment we will approach the concept of capital remembering that it is generated with economic growth and is consumed with risky assets (mainly debt).
Economic growth presents a causal relationship with the availability of energy. The improvement in living conditions that the industrial revolution has brought comes from the greater availability of energy in the history of mankind. To give us an idea, in a first world developed country, energy consumption per inhabitant provides work equivalent to that produced by 100 human slaves in Ancient Rome. No Roman Patrician had so many slaves.
This huge availability of energy has represented the greatest economic growth, capital generation and improvement of living conditions in the history of mankind.
In the 1970s, with the first Oil Crisis, the growth in energy availability slowed, the Oil market became cartelized (OPEC), and economic growth slowed, and with it the generation of capital. The capital scarcity brought the increase in interest rates during Paul Volcker's term as Secretary of the Treasury. Inflation is not the problem, it is just the symptom, like temperature in an infection.
Access to the sources of economic growth can be obtained by paying in cash or with debt, and as the sources of growth were drying up, the system began to push them with debt. From this point of view, debt is the current consumption of future growth (capital consumption)
We have reached the moment in which the scarcity of energy resources (Peak Oil) is weakening growth and the generation of capital. But at the same time, the system supports the largest debt in history by overconsuming capital.
If capital is consumed by excess debt and is not regenerated at the same rate because growth is weak, capital becomes scarce. And don't forget that capital is the most important resource of the social-economic system in which we live.
We can look for somebody to blame but we will not solve the problem. Solving the problem means focusing on optimizing that critical resource that has become scarce. In other words, from now on, the highest priority of the economic system will be Capital Optimization.
The Second Law of Thermodynamics teaches us that to optimize a resource in a system it is necessary to reduce its entropy and that entropy is reduced with information.
And information theory teaches us that the exchange of information requires a common language between sender and receiver.
The highest level of information exchange to reduce entropy is process integration, when the sender and receiver collaborate on the process and share the information needed to plan and execute it efficiently.
SAP has been since its foundation the leader in process integration. First integrating the processes of the departments of a company, then the information of the companies within a group and finally integrating processes between groups of companies until reaching 70% of the World’s GDP.
Financial services have remained isolated from this integration process, very few banks have transformed their processes to SAP and none have integrated their processes with those of their clients.
Optimizing Capital requires integrating the business processes of the real economy with the processes of the Financial System, and if 70% of the real economy is in SAP, the integration of the real economy with the financial economy must be done with SAP Banking.
Our team has dedicated the last 14 years to this objective, until developing the Technology that integrates the business processes of the real economy (Sales, Production, Purchasing, etc.) managed on SAP Systems of Chemical, Pharmaceutical, Telco companies, etc. (70% of World GDP) in terms of generation and consumption of Capital and Liquidity.
With this information and supported by SAP Banking technology, the system proposes financial instruments that cover the capital and liquidity deficits of some agents with the capital and liquidity surpluses of others, adjusting the spread and optimizing the consumption of capital of the participants in the integrated collaboration environment.
We are working on presenting our system to the market and looking for business partners and investors.
If you are interested, do not hesitate to contact me at ferran.frances@capitency.com
I look forward to reading your comments.
Kindest Regards,
Ferran Frances.
www.capitency.com
Join the SAP Banking Group at: https://www.linkedin.com/groups/92860
Visit my SAP Banking Blog at: http://sapbank.blogspot.com/
Let's connect on Twitter: @FerranFrancesGi
