Credit is the oil of the economic engine, and credit ultimately is a creation of confidence writes management guru Ram Charan in his recent book, Leadership in the Era of Economic Uncertainty (MacGraw Hill, 2009). Until all players are confident about the intentions and strengths of the others, there can only be stagnation.
Charans advice to CEOs and business leaders, in this environment, is to conserve cash. Your focus must shift from the income statement to the balance sheet, he says. Protecting cash flow is the most important challenge almost all companies face today whether they realise it or not.
Clearly, the importance of cash flow and credit availability cannot be overemphasised. In the unending cycle of inputs and outputs, driven by profit motive, credit plays the godboth for the producer and the consumer. But peer inside this god and you will say, well, the devil is in the detail. Here are some figures to help you gauge the monstrosity of the credit problem.
For some years, credit growth has been surpassing the growth of economic activity. In 1980, for example, debt levels for US banks were running at 21 per cent of gross domestic product (GDP). By 2007, the figure had grown to 116 per cent of GDP.
Isnt this jump monstrous? If you thought so, what would you call this one? For the US to create its first trillion dollars took its entire history of two hundred years. To create the next trillion took the last 6 months. We are creating a trillion dollars every 6 minutes!
What kind of growth is this? Does it have any relation to the reality on earth? No wonder then that now even ordinary readers are ranting against the global monetary system. Banks and Central Banks create money out of thin air, complaints a reader in a blog. When you get a loan they give you money by a tract of a pen, just like printing new notes. This is just not fair even if the government makes it legal. Moreover, it creates profound imbalances into (sic!) the economy, by permitting people that did not produce anything before to buy goods and service. Invest without produce and save. Investments without real savings… The very basic economic law is that you produce then you save and then you consume. The way around is physically impossible. You cannot consume what you have not produced.
Repeat of past mistakes
And whats been the government response to the credit crisis the world over? Cut interest rates, print money, slash taxes, get credit flowing. This might work in the short term but this is not a long term response: a recipe for a W-shaped cycle of bust and boom.
Sign up for Computerworld eNewsletters.