The ad displays numerous situations of individuals doing pretty common human activities (hiking outside, playing video games with friends, eating a gyro, etc.), but in each of these circumstances, individuals are checking their phones as messages sent from “Friend” are flooding in, offering playful and catchy replies to the verbal communication or outspoken events going on in their real lives. Well, “Friend” is not a human, but a small wearable A.I. necklace. The way that “Friend” can offer unsolicited banter and quick one-liners is through its small microphone that records live audio, analyzes what was said and by who, and then sends a text message reply to your phone. I suggest you watch the full advertisement as well, found here. 

Putting these unorthodox logistics aside (normalizing conversing aloud to a plastic rock and wearing something that is undeniably listening to your every second), my response was to try and understand the problem that this company is trying to solve. Based on their website and my initial intuition, I would imagine that Schiffmann would reply back to me with a single term: “loneliness.” And this is a serious problem today, especially in the US. As a country, about 60% of Americans classify as lonely. This was only exacerbated following the COVID-19 pandemic, as loneliness jumped 7% just between 2018 - 2020. We know that these feelings can also cause extensive health complications including increased risk of heart disease, stroke, and developing dementia. 

But interestingly, young adults are twice as likely to be lonely than seniors. Almost four out of every five (79%!) adults aged between 18 to 24 report feeling lonely, compared to 41% of seniors aged 66 and older. Furthermore, more than two in five adults (42%) aged 18 to 34 report “always” feeling “left out,” compared to just 16% of people aged 55 or older. This is unreal! Almost four in five young adults feel lonely in our country. So why is this? Well, it's too hard to pinpoint singular direct causes to explain this current situation, so I looked at historical data. 

Between the late 1970’s to the 2000’s, average loneliness rates for US high school students (typically 15-18 years of age) were actually decreasing steadily. However, we start to see some substantial increases between the timeframe of 2007 and 2012, which was the last year of data recorded in the survey. Another study shows similar results. Between 2000 and 2003, school loneliness was still decreasing. However, it continually spikes every ensuing reporting year, as seen in the figure below. 

Fig. 1. School Loneliness Means, Worldwide, by Sex.

Why has loneliness become so rampant? This cannot be attributed to a single cause, but the usual suspects of rising screen time, dopamine loss, and social media addiction are key players. Looking at the stretch between the mid 2000’s until now, a similar trend line appears: social media and screen time substantially increase. 

To an extent, we’re all aware of the increased trends of internet use over the following decades post-dotcom era. So what effects does this movement have today, especially on the adults of tomorrow? Well, 95% of US teens have access to a smartphone. That is not necessarily a bad thing, but what are they using it for and how often are they on it? 

Nearly half of all US citizens aged 13-18 admit to using the internet “almost constantly.”  A similar study found that 41% of these teens have a screen time of more than 8 hours a day. Additionally, average entertainment screen time among children has amassed to over 5 and half hours daily. The reason for these statistics? A growing dopamine culture fixated on social media dependence by scrolling apps like Tik Tok and Instagram. This trend is not going away. More than half of US teens now say it would be difficult for them to give up social media. 

Relying on technologies to avoid the social world and cope with social anxiety can heighten feelings of loneliness. Numerous studies have demonstrated this for years. In 2000, an experiment assessing just under 300 undergrad university students found that pathological internet use significantly increased their score on the Loneliness Scale, but nobody seemed to listen. Between 2000-2015, the number of teens who got together with their friends everyday dropped by more than 40%. So there is absolutely a relationship between screen time and loneliness. This is actually alarming. We’re a social species that craves connection. But online connectivity is clearly not working for everyone.

So now a tech startup is trying to solve loneliness by mass-producing a physical LLM that is going to constantly send the user quick texts. Thus forcing them to spend even more time interacting with their phones, which is one of the core drivers associated with loneliness. This almost qualifies for satire. Is our best solution for human loneliness really laying in a plastic necklace that floods my phone with dry, surface level reactions to my personal lived experiences? I personally don’t think so, but apparently others do. 

Let's look at the list of angels and VCs that invested in Friend. They include Perplexity CEO Aravind Srinivas, Z Fellows founder Cory Levy, Solana founders Anatoly Yakovenko and Raj Gokal, Caffeinated Capital's Raymond Tonsing, and Google senior product manager Logan Kilpatrick. Well this makes some sense, but maybe in a cynical way. Each of these media and tech moguls has either directly contributed to the rise of screen time or at least benefited from it, right? So the same people that aim to make money on this “wearable loneliness solution” are also the ones that in one way or another exacerbated this problem in the first place? 

The great Sun Tzu quotes “Victory comes from finding opportunities in problems”, but why is the solution arising from the same industry that intensified the problem? We are trying to create human-type artificial acquaintances to solve loneliness, when really the answer is just organic human connectivity amongst ourselves. We’ve known this for centuries, but the thing that Silicon Valley realized is that they can’t generate an ARR business model on creating real human connection. Instead, they have tried to sell technology like Friend’s as the novel panacea.

As a 24-year old urban single who works as a co-founder for an environmental startup, I am probably their exact target customer! Yet the concept of Friend’s product seems ridiculous to me. Sure, there are wild-eyed startups that come and go, promising grand ideas trying to forever change the world, but this is not the only company trying to mass produce your A.I. best friend. Just check out Replika or Rabbit R1 for a few more examples. 

I believe social media algorithms and addictive scrolling culture have captured our vulnerability and dependance by tapping into our evolved primal instincts. Our access to social media is the easiest it has ever been in history, yet our connectivity needs are not being fulfilled. I am worried that this model of monetizing humanity’s necessity for some sort of human connection is now being pursued to create other types of products and services that cater to the rest of our assured instinctual needs, things we can’t feel fulfilled without.

Out of the basic human instincts of connectivity, creativity, reflection, activity, sexuality and hunger (factors that helped our societies prosper during our history’s ups and downs), an argument can be made that modern tech startups are trying to sell products that either streamline an instinctual need or use it to further market other products. Is that really progressing the species? It’s easier to formulate solutions first when you initially form the problem. 

Time will tell if Friend really takes off. Who knows? Maybe I’ll rock a Friend in the next decade, but after doing the research, I’ve donned a tinfoil hat. Creating a scalable business model that seeks to profit by replacing the human connection that would truly meet our needs seems, well, non-human to me. It's not hard to think that social media has now poisoned the majority of us to believe we require some witness in our lives. This belief is fueled by the constant desire to glorify ourselves to our friends, family, and acquaintances. We’re also now comfortable with that witness being run on Python, and that's a whole other issue in and of itself. It’s as if we’ve traded genuine human connection for a digital viewer, and we’ve become strangely content if not more comfortable with it than actual humans. I just hope that next time I’m in a socially awkward position with another human, I can make a joke of it with my interlocutor, instead of resorting to checking my phone. And who knows, that situation may be the beginning of a long-term friendship. 

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Today’s global citizens face unparalleled challenges that are complex, global in nature, and deeply in need of solutions produced from interdisciplinary collaboration. Heightening concerns about global warming, growing calls for social justice and public policy reform, and the strain of our global population size on increasingly finite resource pools characterize the challenges – and opportunities – that face businesses today. Because corporations as a whole are by far the largest global economic power when compared to the total revenue of all governments and all NGOs, businesses have a disproportionate ability to address these problems (World Economic Forum, 2016).

Following the creation of the United Nations’ Sustainable Development Goals (SDGs) in 2015, the world has witnessed the emergence of movements that call for businesses to take a more active role in shaping social, environmental, and economic outcomes. For too long, proponents of these various movements say, businesses have not been held accountable for the externalities they create and the power they hold in not only minimizing their own negative impacts, but their power to solve problems that NGOs and governments have struggled to adequately address. Up until the beginning of this modern paradigm shift, companies have been widely accepted to only be accountable to shareholders, and their sole imperative was to create value in the form of profits for their shareholders. Today, social movements, such as the B Corp Movement and the Human Rights Movement, are arising that challenge this norm. The backbone of such movements is the idea that companies should create value not only for their shareholders, but for a broader spectrum of parties affected by companies called stakeholders. In this context, the term “stakeholder” refers to any party affected by the company in question, including but not limited to suppliers, customers, employees, the environment, communities, society, and shareholders.

This paper will focus on one of the aforementioned movements – the B Corp Movement – that was created specifically to bring about stakeholder capitalism. The beginning of the B Corp Movement began on July 5th, 2006 with the formation of the non-profit, B Lab, which is responsible for the administration of the B Corp Certification, a certification designed to verify that a company truly creates value for all stakeholders and lives up to its stated mission and values. Companies seeking B Corp Certification must complete the B Impact Assessment (referred to throughout this paper as the assessment), a tool designed to assess the impact of a company holistically based on five categories: Governance, Workers, Environment, Customers, and Community. Companies pursuing B Corp Certification must achieve a score of 80 points or higher on the assessment to obtain certification, with the maximum points obtainable in the assessment being 200. In addition to reaching the 80 point threshold on the assessment, certifying companies must also become a Benefit Corporation. Benefit Corporation legislation brought forth by B Lab created a legal framework (in the states and countries that have approved this legislation) that enables mission-driven companies to remain mission-driven through changes in leadership and ownership, as well as capital raises, by incorporating values and mission into the companies’ foundational governing documents as well as including legal language that protects companies in the event that they should take an action that prioritizes the needs of other stakeholders above those of shareholders (Rawhouser, 2015). In order to remain certified, B Corps are also required to pay an annual fee to B Lab based on sales, publicly publish annual impact reports, and recertify every three years.

As will be discussed later in this paper, certifying as a B Corp poses a number of direct benefits to companies including distinguishment from businesses employing ‘greenwashing’ practices, the solidification of mission and values in the company, and heightened attractiveness to customers and employees, among many others. As many companies came to recognize these benefits, by 2014 the number of Certified B Corps surpassed 1,000 (Gehman, 2017). Today, there are over 6,500 B Corps across more than 70 countries and 150 industries (B Lab, 2023). In fact, as can be seen in Figure 1.1, the B Corp Movement is growing at a pace resembling that of an exponential curve.

Figure 1.1: Count of Certified B Corporations Worldwide, 2007-2016 (Cao, 2017)

As a passionate social entrepreneur, I have a vested interest in the growth of social innovation ecosystems, with the B Corp Certification being a key component of the advancement of stakeholder value creation. During my time as a Peer Mentor at the University of New Hampshire’s B Impact Clinic, a student-run group in which students serve as consultants with the primary duty of helping client companies gain points on the B Impact Assessment, I became invested in understanding what factors contribute to, or inhibit, the growth of the B Corp Movement, a movement I had personally witnessed have a profoundly positive impact on many organizations and their stakeholders. This paper was written to assess which factors drive the growth of the B Corp Movement – defined as the emergence of Certified B Corps and the ecosystem that supports it – and which factors suppress the movement from growing further. Research on this topic may be of use to B Lab in that it will identify areas in which to continue fostering growth and improvement areas that could enhance the adoption of the B Corp Certification. The contents of this paper also serve to contribute to the greater body of research by adding to the relatively small collection of research that exists on B Corps and the B Corp Movement, as well as by providing insights into the broader trend of the increasing prevalence of social enterprises and the unique resources, such as the B Corp Certification, that have facilitated the strengthening of this trend. More broadly, this research is of interest to the entire ecosystem invested in stakeholder capitalism: the idea that our capitalist systems should consciously incentivize companies to provide value to all stakeholders.

WHY CERTIFY?

In order to best understand how the B Corp Movement has grown over time, and to establish a baseline knowledge of the movement, this paper will begin with an exploration of what benefits companies are pursuing when they seek certification. On B Lab’s website, the intended benefits are identified as demonstrating high social and environmental performance, making a legal commitment for accountability to all stakeholders (through incorporation as a Benefit Corp, a required part of the certification process), and exhibiting transparency by displaying performance on the B Impact Assessment on the B Lab website and the certified company’s website (B Lab, 2023). B Lab further elaborates on numerous benefits that B Corp Certified companies experience in the B Corp Handbook; among the benefits stated include lower churn and cost of acquisition as well as higher retention rates for employees and customers, attraction of value-aligned investors and suppliers, and increased competitiveness of job applications which leads to improved quality of accepted candidates (Honeyman, 2019).

One benefit of B Corp Certification frequently highlighted in the literature is the avoidance of ‘mission drift,’ defined as the failure to holistically honor two or more conflicting missions, such as the mission to maximize profits and a socially or environmentally centered mission (Park, 2018; Moroz, 2021). The certification process accomplishes this result by requiring incorporation as a Benefit Corp or, in the case of LLC’s and other non-corporate for-profits, institutionalization of similar ‘mission lock’ clauses into the company’s governing documents. This change solidifies a company’s mission statement and commitment to all stakeholders into the certified company’s fundamental governance structure, in effect forcing the company to reconcile and actively manage any discrepancies between its mission to create profits and its more altruistic mission(s) to benefit its non-shareholder stakeholders. In addition, the B Corp Certification process itself requires that companies institutionalize positive practices, such as the measurement of social and environmental impact or regular performance reviews with employees, that may have previously been unspoken norms. By solidifying these policies and procedures, certified companies are far more likely to retain such practices that value all stakeholders through events such as changes in ownership, macroeconomic downturns, and changes to the leadership team (Park, 2018). With improved odds of retaining positive practices, Park suggests that B Corps are enabled to make long-term commitments to social and economic good that are perceived as exceptionally credible (2018).

Non-certified and B Corp Certified companies alike use the assessment to benchmark social and environmental performance, and to expand policies and procedures as the organizations’ maturities evolve. Despite the evolution of Environmental, Social, Governance (ESG) and other methods of measuring social/environmental performance, there are few comprehensive resources for companies to measure qualitative aspects of these performance areas and benchmark continual improvement over time (Grimes, 2018). This is especially the case for small to medium enterprises (SMEs), which may struggle to quantify the impact of their practices for lack of financial means to acquire the appropriate measurement tools. In contrast with purely quantitatively driven approaches to measuring social/environmental impact, such as ESG, the assessment assigns a quantitative value to qualitative factors. For example, a company seeking certification may obtain points on the assessment for having certain policies or procedures present in their employee handbook, whereas such qualitative factors are unlikely to be accounted for when using a purely quantitatively driven method of performance measurement. Due in part to these advantages of use, since the assessment was launched in 2007, over 60,000 businesses have registered to use the assessment (Muiru, 2019).

Based on the literature, becoming certified as a B Corp poses a number of reputational benefits. One of the baseline benefits of the certification is the role it plays in distinguishing certified companies’ impacts from greenwashing, the practice of a company marketing itself as ‘green’ and ‘good’ when in reality, the magnitude of the company’s impact is far less than its stated positive impact (Cao, 2017). By certifying as a B Corp, businesses are vetted by B Lab and evaluated using rigorous sustainability standards. Consumers who see the B Corp label on products can thus be assured that the company they are purchasing from is not only appearing sustainable, but also operating in a sustainable manner. Kim suggests that the current business environment is, “in the midst of a ‘greenwash’ revolution” and that the B Corp Certification “helps consumers sort through the marketing hype to find businesses and products that are truly socially and environmentally responsible (2017).” Kim further concludes that a key driver of the B Corp Movement’s growth is the recognition of the PR benefits to appearing sustainable and the increasing efforts of for-profit companies to be perceived as “green and good (2017).”

Evidence suggests that the B Corp Certification might offer businesses more than simply the reassurance of their stakeholders that they are not greenwashing. The certification may also serve as a differentiator for businesses that achieve it, particularly in industries where competitors have well-defined CSR and sustainability practices. In fact, Kim identified a correlation between the prevalence of CSR in an industry and the emergence of new B Corps in the industry (2017). SMEs, in particular, often struggle to differentiate themselves against larger incumbent competitors with well-known and well-established sustainability programs. The B Corp Certification offers SMEs an advantage in that they can use the certification as proof of their embodiment of environmental and social responsibility, a stamp of approval that their larger counterparts experience greater difficulty in obtaining (Park, 2018). By providing this proof, social enterprises can build trust with stakeholders. Trust built on the basis of strong social and environmental responsibility may have financial benefits too; research by Woulfe and Sifre found that almost 70% of millennials would pay more for products sold by socially and environmentally responsible brands (2015). Park suggests that achievement of the B Corp Certification is not only valuable for companies selling to end-consumers; the certification can also attract B2B customers because “entrepreneurs like to work with like-minded clients who share the same values (2018).”

The B Corp Certification can help certifying companies define their individual identities. Grimes finds that the greater the extent that entrepreneurs “perceive ESG-related values as central and distinctive to their identities,” the greater the desirability of related certifications becomes to these entrepreneurs, because such certifications validate the entrepreneur’s alignment with those values (2018). Grimes maintains that while both the legitimacy deficit explanation (certifying as proof of not greenwashing) of why companies pursue certification and the identity-work perspective are generally plausible, the identity-work perspective is more feasible given that if companies primarily sought B Corp Certification to overcome legitimacy deficiencies, they would be expected to pursue certifications that are widely adopted and under-scrutinized in that there are few penalties associated with inauthentic certification (2018). While the B Corp Certification is growing in adoption and awareness of the certification is increasing, it is by no means common in today’s business environment. Grimes’ argument posits that in addition, if companies adopt sustainability certifications primarily as promotional tools, they are frequently subject to “increased scrutiny and skepticism (2018).”

According to some academic research, as a result of their adoption of sustainable practices, B Corps can experience greater long-term profitability and higher valuation premiums compared to competitors. Gazzola found that companies identified as sustainable when compared to competitors in the industry saw less volatility in their stock prices, as well as finding a statistically significant correlation between net income and point values in the environment, customers, and workers sections of the assessment (2019). Gazzola attributed the correlation between the above sections of the assessment and net income to the intangible benefits obtained by adopting the stakeholder-based practices necessary to become B Corp Certified, such as ease of attracting high-quality human capital and strong customer retention rates (2019). Chen found that from 2007 to 2011 (the length of the study), B Corps financially outperformed their public company industry competitors, both large and small (2014). Chen did, however, find no correlation between B Corps’ revenue generation and productivity and their score on the assessment, except for the year 2011, which was the final year of the study (2014). Ultimately demonstrating the link between sustainable practices and long-term valuation appreciation, a team of Harvard researchers completed a detailed quantitative analysis that showed that by investing a dollar on a highly sustainable company in 1993, a portfolio of about $23 is reached after a decade, as opposed to a portfolio of $15 when selecting comparable low-sustainability companies (Eccles, 2014). One meta-study found that “the relationship between socially responsible business practices and financial performance was positive in 27% of the 167 studies examined, not statistically significant in 58% of the studies, and negative in just 2% of the studies (Sneirson, 2009).” Many proponents of stakeholder capitalism argue that not only are sustainable practices beneficial to the environment and other stakeholders, but also to shareholders holding investments with long time horizons. As will be discussed later, short-termism can be a significant headwind to the adoption of the B Corp Certification and practices associated with stakeholder capitalism, due to the main financial benefits of sustainable practices being realized in the long-term.

According to Grimes, all certifications face a chicken and egg dilemma (2018). For companies to seek a given certification, the certification must be perceived as valuable. However, the ultimate goal of certifications is to become adopted, and as more companies adopt a given certification, they dilute the certification’s perceived value. Due to this dilemma, early-stage certifications frequently struggle to grow in prevalence. Grimes further posits that, “while traditional and widely accepted certifications are adopted due to a need for conformity and legitimacy, early-stage certifications are adopted due to a need for authenticity (2018).” Since the B Corp Certification is a rapidly evolving, relatively unestablished early-stage certification, these suggestions support the theory that companies adopt the B Corp Certification not to overcome a legitimacy deficit but to affirm socially and environmentally aligned identities. However, if the aforementioned pattern follows, as the B Corp Certification continues to grow in prevalence, an increasing number of businesses will seek the certification as a means of conformity with social and environmental performance expectations rather than as a form of differentiation.

INDIVIDUAL AND ORGANIZATIONAL CONSIDERATIONS

After discussing the advantages and disadvantages the B Corp Certification offers to businesses that achieve it, it would follow that the way the decision is made to certify, or decertify, at the individual and organizational levels should be analyzed. An overarching theme across the literature is that the decision to certify or decertify is predominantly top-down leadership-driven (Martin, 2020; Rawhouser, 2015). One of the most common scenarios in which a business pursues B Corp Certification is the case in which the entrepreneur wants to leave an imprint on the organization they founded and becomes attracted to the B Corp Certification and incorporation as a Benefit Corp for their potential to institutionalize and therefore immortalize the founding principles, mission, and values (Rawhouser, 2015). As a required component of obtaining the B Corp Certification, companies must also become a Benefit Corp or (incorporate comparable clauses that protect stakeholder value creation, in cases where incorporation as a Benefit Corp is not possible), which not only solidifies a company’s mission in its governing documents, but also theoretically protects management from discourse in the event that enforcement of the company’s stated mission conflicts with shareholder value maximization. Not only does this help the founder(s) of a business retain control during their tenure, but it also ensures that important aspects of their vision for their company will continue to be implemented beyond their tenure.

B Corp Certification has been disproportionately adopted by women-owned businesses, with one study finding that women-owned businesses are 3.65 times more likely to become B Corp Certified than otherwise identical non-women owned industry counterparts (Grimes, 2018). The study found that women-owned businesses were especially likely to obtain B Corp Certification when they fell within region-industry contexts where sustainability norms are weaker, mimetic pressure to become a B Corp is lower, and women-owned businesses are less prevalent (Grimes, 2018). In fact, Grimes found that for all businesses, propensity to become B Corp Certified was higher in contexts where sustainability norms are weak (2018). In support of this conclusion, Kim’s research found that extreme profit-maximizing business conduct in an industry, such as mass layoffs or hostile takeovers, is predictive of B Corp emergence in that industry (2017). These findings may support the identity-work theory of why businesses pursue certification, given that propensity for women-owned businesses to obtain certification is higher in contexts where many of the defining features of these social ventures, such as an emphasis on sustainability, would be considered abnormal, or rare. In these contexts, B Corp Certification serves as a differentiator, rather than as a means of conformity to pre-existing norms within the companies’ regions or industries. However, some researchers believe women social entrepreneurs may pursue certification to overcome discriminatory legitimacy discounts associated with negative gender stereotypes, patriarchy, and institutionalized gender segregation (Thébaud, 2015; Zhao and Wry, 2016). Further examining the impact of stereotypes on the decision of women-owned businesses to pursue B Corp Certification, many studies have identified widely held stereotypes that women more strongly adopt and embody sustainability and ESG-related values, making it unlikely that women-owned businesses would pursue B Corp Certification to overcome a legitimacy deficit with respect to embodiment of sustainability (Baltes, 2010; Hyde, 2021; Koenig, 2014). Grimes’ findings concluded that women entrepreneurs have been crucial early adopters of the B Corp Certification, and that their adoption and championing of the certification has helped build up the significant legitimacy that the certification holds today (2018).

Many socially responsible companies ingrained in the Business and Human Rights (BHR) Movement disapprove of the B Corp Certification because it is possible for companies operating without proper human rights due diligence or violating human rights to become B Corp Certified. While the assessment encourages the use of social impact assessments as a method of assessing impact on communities, the BHR Movement vehemently argues that human rights impact assessments (HRIAs) should be employed within the assessment as HRIAs adhere to the entire scope of international human rights law (Bauer, 2015). The main differences between HRIAs and social impact assessments are that HRIAs are framed by the International Bill of Rights while social impact assessments are not, and that HRIAs consider how an organization could possibly interact with each and every right identified by the United Nations as a Basic Human Right while social impact assessments focus more narrowly on an organization’s direct impacts to individuals or communities (Bauer, 2015). The broad scope and international legal compliancy of HRIAs makes them a generally more comprehensive choice with respect to human rights due diligence. The assessment does include a disclosure questionnaire and many of the questions within this questionnaire are closely related to BHR content, and although the disclosure questionnaire is unweighted in terms of the point value answers add or detract from a company’s score on the assessment, companies can be disqualified from B Corp Certification based on their answers to disclosure questions. However, BHR advocates argue that the disclosure questionnaire’s focus on company procedures, rather than actual impact, allows businesses to be assessed based on stated processes when their impact on human rights may still be severely negative (Bauer, 2015). The structure of the assessment being incapable of assessing and verifying true impact on human rights as well as being nonconforming to international human rights laws gives rise to objections to the B Corp Certification from the BHR community.

Figure 1.2: US-based B Corp Decertification Rates Between 2007 to 2020 (Martin, 2020)

The average attrition rate for the B Corp Certification since its inception is approximately 33% to 34%, according to multiple academic studies (Cao, 2017; Martin, 2020). As can be seen on Figure 1.2, the attrition rate has been drastically declining since 2012, with academically published records of the number of decertifying organizations being nonexistent after the 2018. Martin found the certification’s attrition rate to be higher in small businesses, with SMEs particularly citing difficulty in extracting tangible extrinsic benefits from certification and a lack of support from B Lab and the greater B Corp ecosystem (2020). For example, B Corp Certified law firms frequently complained about B Corps expecting free legal services from them, while some companies stated that they had become disillusioned by how “detached and bureaucratic” B Lab had become in its administration and leadership of the B Corp community (Martin, 2020). Other firms were less focused on the extrinsic benefits of the certification, stating that they decertified because they believed that their missions could be achieved without being affiliated with B Lab (Cao, 2017). Some companies stated that they decertified due to the recertification process, which is required every three years, being “highly cumbersome, complicated, and time consuming (Martin, 2020).” Many companies believed the certification process was too easy, witnessing companies they believed did not have a true commitment to stakeholder value creation obtaining certification; others believed that the certification process was far too difficult and expensive to justify the benefits, which are hard to quantify (Martin, 2020). These conflicting accounts display the aforementioned dilemma early-stage certifications face in that they must attempt to build legitimacy for the certification by growing adoption, but also must retain the prestige of the certification by making it difficult to obtain and being selective in awarding certification. As shown in the results of Cao and Martin’s studies, this dynamic in early-stage certifications has led to some dissatisfaction with the B Corp Certification on both ends of the perceived difficulty spectrum, though the decertification rate is notably decreasing year-over-year, which may reflect the maturing of the certification. The vast variety and contradictory nature of decertifying companies’ complaints suggests that many decertifications may be due in part to inaccurate expectations company leadership may have had about the B Corp Certification’s benefits, and furthermore, B Lab’s mismanagement of said expectations.

Lack of succession planning or loss of a “certification champion,” whether through M&A of the certified company, changes in management, or changes in shareholders, were cited as among the most common causes of decertification across the academic literature examining B Corp decertifications (Cao, 2017; Martin, 2020). While the new controlling or operating parties in each case illustrated a situationally unique motive for decertification, a common motivation was renewed commitment to maximizing shareholder value and a preoccupation with short-term financial results – an operational philosophy that several academics have argued leads companies to under-invest in long-term growth and sustainability (Farley, 2013; Lazonick, 2009; Pearlstein, 2014; Stout, 2018). In fact, McKinsey found that 55% of CFOs said they would forgo a positive investment if it meant marginally missing quarterly earnings targets (2013). Given the established link between corporate sustainability and long-term profitability, but not necessarily short-term profitability, a strong focus on short-term profits could easily prevent management teams from recognizing the value in adopting socially and environmentally responsible practices and by extension, prevent management from pursuing certifications, such as the B Corp Certification, that requires such practices to be instituted. As will be discussed later, economic incentive structures in today’s markets – particularly the public markets – encourage such mindsets centralizing around short-term profitability, further constraining the B Corp Movement’s growth. Despite the prevalence of these short-term focused strategies and their demonstrated ability to shift organizations away from sustainable practices and B Corp Certification, Martin’s study generally attributed decertification not to abandonment of company missions, but to a diminishment in perceived value of the B Corp Certification, except in cases of M&A (2020).

CHALLENGES AND OPPORTUNITIES FOR SOCIAL VENTURE STARTUPS

As the B Corp Certification was designed to lend legitimacy to true social ventures, it would follow that factors governing the emergence of new social ventures would be of importance when holistically analyzing the growth of the B Corp Movement. When considering social venture startups as a crucial component of the certification’s demand-side growth, a number of challenges and opportunities specific to social venture startups become relevant to the growth of the B Corp Movement as a whole. As the B Corp Certification stands today, because the assessment focuses on processes and procedures, with some of the highest point value policies being quite expensive to institute (such as exceptional healthcare benefits), businesses must achieve a significant degree of organizational maturity to reasonably expect to cross the 80 point threshold to become B Corp Certified. This poses a barrier to entry for new ventures pursuing immediate certification. The annual dues associated with B Corp Certification, as illustrated in Figure 1.3, can also pose a financial barrier to entry for new ventures, which have unreliable or nonexistent cash flows. In an attempt to keep early-stage startups engaged with the movement, B Lab created the Pending B Corps Program, which helps startups gain a head start on the full B Corp Certification process and signal to their stakeholders that they are value-aligned with and are actively pursuing the certification (B Lab, 2023). Becoming a Pending B Corp is a temporary status that expires after a predetermined period of time set by B Lab, incentivizing startups to eventually go through the more rigorous B Corp Certification process. To become a Pending B Corp, startups must complete the legal requirements associated with B Corp Certification (becoming a Benefit Corp or non-corporate equivalent), submit a prospective assessment that will not go through the verification process as a traditional B Corp Certification submission would, and pay a small one-time fee determined by the startup’s local B Lab organization (B Lab, 2023).

Figure 1.3: B Lab Fee Schedule (B Lab, 2023)

In addition to the barriers startups face in obtaining certification, the unique challenges new social ventures face in growing to the point where certification is a feasible possibility affect the growth of the B Corp Movement as a whole. Thompson found that social ventures tend to struggle to find early-stage funding from angel investors and venture capitalists, even in geographic regions and industries that traditionally have a strong venture capital industry (2018). B Lab states in the B Corp Handbook that B Corps and Benefit Corporations do not struggle more than traditional ventures in raising investment capital, even citing an example in which Danone, a publicly traded Certified B Corp, was able to negotiate a lower cost of capital from several major banks due to its achieving the B Corp Certification (Honeyman, 2019). This does not directly contradict Thompson’s findings, as Thompson found that achieving B Corp Certification increased the odds of obtaining startup funding from impact investors – investors focused on investing in social ventures that garner profits while also making a positive social or environmental impact (2018). However, prospective B Corp startups and B Corp Certified companies alike would fall under the category of social ventures, and as such, should experience similar challenges and opportunities when seeking financing, regardless of what those challenges and opportunities may be. Despite B Lab stating that B Corps and Benefit Corps do not experience challenges in raising capital, this is a challenge consistently cited by social entrepreneurs in Thompson’s study (2018). Some social entrepreneurs in the study believed their struggles in maintaining investor interest were derived from the lack of famous or extraordinary social venture liquidity events that could reference to generate interest in social ventures more broadly (Thompson, 2018).

However, one of the most consistent inhibitors of investor interest cited by social entrepreneurs was the inability of investors to distinguish between social ventures and nonprofits, with many investors becoming disillusioned with social ventures due to their dual pursuit of both impact and profits (Thompson, 2018). Often, social entrepreneurs will heavily emphasize the impact potential of their venture, giving off the impression that (whether true or not) the entrepreneur will prioritize their mission for impact over their mission for profits, therefore degrading the perceived upside potential of the investment opportunity and investors’ trust that the entrepreneur has the investors’ best interests in mind. By contributing to the formation of a new organizational category and identity, the B Corp Certification and the Pending B Corp designation for startups specifically, combats this issue by making it easier for investors and other stakeholders to understand what the company inherently is and does the same way they understand a nonprofit or a corporation (Grimes, 2018).

Legal structures (such as the Benefit Corporation structure) that are tailored to the needs of social ventures, as well as specialized legal help for establishing and maintaining these corporate structures, were also found to be key growth drivers for social ventures, as not only do these structures protect management from shareholder primacy and immortalize the company mission through capital raises and changes of ownership, but they also lend legitimacy to the social enterprises’ fusion of impact and profitability under one organizational structure (Thompson, 2018). A study by Rawhouser explored factors that make a state or country more or less likely to adopt Benefit Corporation legislation, with the study finding the adoption of Benefit Corporation legislation positively correlated with tax attractiveness, green economic activity, Democratic party control, and greater levels of legislative activity and activism in the state or country (2015). The study also found that greater levels of nonprofit activity in a state or country was negatively correlated with adoption of Benefit Corporation legislation, with Rawhouser attributing this to notable resistance of nonprofits to the existence of Benefit Corps (2015). Surveyed nonprofit managers stated that the emergence of Benefit Corps may threaten the nonprofit category, citing that it is difficult for a nonprofit to transition to a for-profit entity and that with nonprofit organizations being heavily dependent on donor dollars, they fear that prospective donors would prefer to invest in Benefit Corps that are designed to make a positive impact while also yielding a return on investment for donors (Rawhouser, 2015).

Other identified drivers of growth in the number of social ventures are infrastructural in nature, such as the existence and prevalence of impact angel groups, social venture accelerators, and social venture entrepreneurship competitions in developing social innovation ecosystems (Thompson, 2018). Education on impact investing was another key growth driver of social innovation ecosystems, as with more education on impact investing comes a greater availability of investment capital seeking to be allocated to social ventures (Thompson, 2018). The expanding saturation of ESG assets and methodologies is having a profound impact on awareness and industry knowledge of impact investing. In recognition of the importance of impact investing to the B Corp Movement, B Lab created the Global Impact Investing Rating System (GIIRS) which uses assessment results from portfolio companies to measure the impact of an impact investment portfolio (B Lab, 2023). According to Muiru, GIIRS “makes it easier for impact investors to measure impact, and thus encourages entry into this investment category, improving access to capital for B Corps and finally, encouraging B Corp Certification as a result (2019). There are over 100 GIIRS-rated impact investment funds managing upwards of $1.5 billion in assets under management, with each of these funds being likely to prefer B Corps to non-B Corps, further encouraging certification (Grimes, 2018; Muiru, 2019).

Based on the academic literature, bottom-up approaches to building social venture ecosystems are generally more successful at producing ecosystems that scale than top-down attempts to replicate existing examples such as Silicon Valley, because formation of entrepreneurial ecosystems is primarily driven by social interactions between individuals, and because with a bottom-up approach, the ecosystem has the appropriate infrastructure for its stage of development (Dorado, 2005; Furnari, 2014; Thompson, 2018). In early-stage social venture ecosystems specifically, Thompson cited “new terminology, the use of social media to attract like-minded individuals, the creation of dedicated physical [work]space, the development of new legal forms of organization and legal practices, and the establishment of new resource pools and methods for funding social impact businesses” as key developments that supported the growth of social innovation ecosystems (2018). B Lab appears to have employed a bottom-up approach in facilitating the growth of the B Corp ecosystem by creating the B Hive, a network designed to connect social entrepreneurs, who often go on to partner, patronize each other’s businesses, serve as mentors to one another, among many other ways entrepreneurs collaborate (B Lab, 2023). Not only does the B Hive serve to improve B Corps’ sustainability practices by providing opportunities for B Corps to collaborate towards common outcomes, with social interaction opportunities being a key driver of the creation and growth of social venture ecosystems, but it also aligns with the bottom-up ecosystem growth approach as the B Hive provides an environment for partnerships to organically form without investing in expensive infrastructure that may be premature for the size and complexity of the community.

CHALLENGES OF CERTIFYING PUBLIC & MULTINATIONAL CORPORATIONS

Publicly traded multinational corporations have the unique ability to move markets and make strides to change the culture of the overarching business environment using their large budgets, extensive workforces, and wide exposure to audiences across the globe. However, these entities face perhaps more challenges than any other for-profit organizations in obtaining the B Corp Certification, due to characteristics inherent to the certification and the global financial markets, as well as the cultural expectations of managers to maximize profits. If large publicly traded companies face incredible difficulty in adopting the B Corp Certification, this is a significant constraint on the scalability of the movement, as these organizations hold far more power than small to medium sized businesses (or even large private companies) in making the infrastructural and systemic changes necessary to realize the ultimate vision of a sustainable and equitable future that B Lab is trying to accomplish.

Among the most significant challenges to public multinationals pertains to the assessment being far better suited for SMEs than for larger companies that may have slow and bureaucratic approaches to embracing the drastic changes necessary to become B Corps. The larger an organization is, the more heavily ingrained its procedures, processes, culture, and practices are, further compounding this challenge. The assessment has an inherently complex approach to encouraging sustainable and equitable practices across all facets of a business, but public multinationals also have inherent complexities that make navigating the assessment even more demanding than it is for SMEs, such as their multiple subsidiaries, highly sophisticated corporate structures, diverse product lines and customer segments, and exposure to various regions across the globe with varying laws and cultural norms (Stubbs, 2017). Furthermore, public multinationals’ tendency to have diverse product lines that span industries make them more vulnerable to disqualification from eligibility for B Corp Certification, as organizations of this size are disqualified for having greater than 1% revenue exposure to any of the following industries without a formal commitment to exit those industries: tobacco, firearms, weapons or munitions, coal, pornography, and casinos (B Lab, 2023). Additionally, as the vast majority of publicly traded multinationals are C Corps, the B Impact Assessment would require conversion to a Benefit Corporation, which is extremely complicated for sizable organizations with complex legal structures (B Lab, 2023). While there have been a few companies that were structured as Benefit Corporations prior to their Initial Public Offering (IPO), as of 2020, the feat of becoming a Benefit Corp while already publicly traded has never been accomplished (Martin, 2020). Additionally, there is significant pushback from supporters of the B Corp Movement on involving public and multinational corporations, as many of these supporters feel as though large corporations inherently cannot achieve the social and environmental performance standards that traditional B Corps can, and that by extension, bringing these corporations on board would dilute the movement (Marquis, 2020).

B Lab has established two “large enterprises pathways,” which are intended for eligible private or publicly traded companies with $100 million to $999 million in annual revenue, and with 10 or more subsidiaries operating in multiple countries, as well as companies with over $1 billion in annual revenue, which have to abide by additional criteria (B Lab, 2023). The first large enterprise pathway involves certifying the parent company as a B Corp. In this pathway, the parent company may certify by fulfilling the performance and legal requirements for over 95% of operations, while maintaining full transparency (B Lab, 2023). This approach requires less visibility and participation from subsidiaries but is considerably more resource-intensive and involves more upfront costs than the second large enterprise pathway (B Lab, 2023). The second large enterprise pathway involves each subsidiary independently meeting the B Corp Certification requirements. This approach is less resource-intensive for the parent company, garners a more organic process of building buy-in and momentum, and makes meeting the legal requirements an easier feat for the subsidiaries (B Lab, 2023). However, depending on the organization, this method can be more expensive over time and may not be possible for businesses with more centralized corporate structures (B Lab, 2023). Companies with over $5 billion in annual revenue must choose from one of the two large enterprise pathways, but these organizations must also participate in B Lab’s B Movement Builders program (B Lab, 2023). The B Movement Builders program was created in recognition of large multinational corporations’ ability to move markets and alter the overarching culture of the business environment. The program is designed to help participating companies “make credible commitments, identify opportunities for scalable collaboration, and work internally to affect impactful transformation that accelerates a global systems change of business and culture (B Lab, 2023).” B Lab has also created a multi-stakeholder advisory board, called the Multinationals and Public Markets Advisory Council (MPMAC), to solicit feedback and recommendations to B Lab on how to best enable large multinational and public companies to participate in the B Corp Movement (KKS Advisors, 2017). In recognition of the importance of impact investing to the growth of public and multinational B Corps, through MPMAC, B Lab is engaging with large institutional investors such as BlackRock, CalPERS, and Morgan Stanley, to collaborate on expanding industry knowledge on impact investing and on the implications of the Benefit Corp structure and the B Corp Certification (KKS Advisors, 2017).

A key challenge that plagues publicly traded companies seeking B Corp Certification is the public markets’ inherent focus on maximizing short-term profitability and shareholder returns. This imperative directly conflicts with the long-term stakeholder value creation strategy promoted by the B Corp Certification which, as discussed earlier in the paper, the academic literature generally agrees maximizes shareholder returns and profitability in the long-term. The public markets’ focus on short-term profitability has been reinforced by a longstanding cultural norm in the broad business environment that is predicated on the misconception that maximizing shareholder value is legally required of businesses, as well as short-term oriented economic incentives. Despite the overwhelming body of research demonstrating that shareholder value maximization is not legally required of businesses, this assumption has been baked into expectations for corporate managers and the incentives that influence their decisions (Park, 2018; Sneirson, 2009). For example, if corporate managers are successful in significantly increasing their firm’s stock price and therefore shareholder wealth, they are more likely to keep their jobs, get raises and promotions, and reap more informal rewards such as recognition in the workplace and the feeling of a job well-done (Sneirson, 2009). To align employees’ economic incentives with those of shareholders, firms often offer stocks and stock options as part of compensation packages. With these economic incentives aligned, the public markets directly encourage corporate fiduciaries to maximize company share price and therefore, their own compensations (Sneirson, 2009). With such powerful expectations, further reinforced by economic incentives, executives believe shareholder value maximization is a core purpose of their jobs. In conjunction with the financial markets, most for-profit companies measure financial performance on a quarterly basis, meaning that employees’ ability to operate the organization is based on how the business performs in the short-term. The measurement of performance in the short-term therefore leads to decisions being made based on their short-term results, thus solidifying the organization’s focus of short-term shareholder value maximization (Marginson, 2009). By granting points on the assessment for measuring customer satisfaction, employee satisfaction, product quality and other measures of corporate success, the B Corp Certification aligns with the prominent suggestion within academia to address the issue of short-termism: institute measurement of non-financial measures that better reflect long-term performance (Lambert, 1998; Sliwka, 2007).

The issuance of dividends is another incentive that has traditionally aligned investors with long-term value creation. Without dividends, the only way to make returns on stocks are to rely on capital gains, which tend to be much more volatile and event-driven than dividends. The more investors that buy and sell stocks in the short-term, the more volatile stock prices become, further incentivizing short-term investing strategies that exploit volatility. This relationship has been well-documented in multiple studies that conclude that companies that do not offer dividends have significantly more volatile share prices than those that do offer dividends (Baskin, 1989; Johnson, 2009). As can be seen on Figure 1.4, less companies are offering dividends today than ever before. Konieczka’s sample of over 2,000 companies with market capitalizations above $100 million and net profits above $10 million traded on the AMEX, NASDAQ, and NYSE stock exchanges saw 98% of companies offering dividends in 1983 and only 55% offering dividends in 2011 (2014). This underpins an increasingly volatile market environment, making conditions ideal for short-term trading and therefore suppressing the likelihood that public companies will be valued based on long-term stakeholder value creation. The predominance of economic incentives focusing public companies on short-term profitability is a significant headwind for the B Corp Movement, as these companies have the most power to make the systemic and cultural changes necessary to accelerate the movement but are the least incentivized to make such changes.

Figure 1.4: Percentage of Companies Paying Dividends Over Time (Konieczka, 2014)

Companies that have IPOed with only B Corp status and not incorporation as a Benefit Corp have experienced significant attacks, such as hostile takeovers, on their social and environmental practices, with these attacks driven primarily by short-termism in the public markets (Park, 2018). Social ventures have proven more resilient towards these risks than companies that do not have social and environmental performance built into their core business models, as it is difficult to separate these core competencies from, for example, a clean energy company, than it is to separate them from a more traditional company that donates money to charity (KKS Advisors, 2017). It is notable that despite posing higher barriers to entry to becoming a Certified B Corp, B Lab's recent decision to require Certified B Corps to register as Benefit Corporations is likely to facilitate greater protection for public companies seeking to maintain their social and environmental practices and values, and may thus spur greater adoption and greater success rates of B Corp Certification among public companies (KKS Advisors, 2017).

QUALITATIVE INTERVIEW METHOD

As a core component of this paper’s research into the growth drivers and inhibitors of the B Corp Movement, we conducted interviews with five founders, CEOs, and executives at companies that are actively pursuing B Corp Certification as well as another five such professionals from companies that have already become Certified B Corps. Within the sampled company, obtaining a suitable diversity of company size, industry, and length of certification status was prioritized. While this diversity was largely successfully executed upon, the sample does have some limitations. The sample did not include representatives from any publicly traded companies due to confidentiality and materiality issues arising from there being only approximately 30 publicly traded Certified B Corps (B Lab, 2023). However, representatives from the privately held companies interviewed were asked to provide their perspectives on how they believe becoming a publicly traded company might affect their ability to be achieve or maintain B Corp Certification and their ability to effectively further their missions. Another limitation of this sample is that due to immense difficulty locating and obtaining responses from executives representative of companies that chose to decertify after previously achieving B Corp Certification, these companies were not represented in the sample of interviewees.

These in-depth interviews were approximately 30 minutes long, with the questions designed to address common themes that arose in the literature review such as identity theory, the importance of social venture ecosystems, and the advantages and disadvantages of becoming certified. During these interviews, participants were asked open-ended questions about their reasons for joining the B Corp Movement, the role that B Lab plays in accelerating the movement, how the certification process could be improved, the reactions of their investors to their pursuit of B Corp Certification, their perspectives on the mission lock (Benefit Incorporation or other legal equivalent) requirement, and how the certification has affected their views on the company’s overall identity (the qualitative interview guide can be found in Appendix A). After the interviews were completed, records of interviewee responses were analyzed for common themes to develop insights into the broader sentiment surrounding the B Corp Certification and many of the aforementioned factors related to the growth of the B Corp Movement.

QUALITATIVE INTERVIEW FINDINGS

Across the literature, avoiding mission drift by becoming a Benefit Corp (or other legal equivalent) and by institutionalizing sustainable and socially responsible business practices was generally identified as a key motivator for adoption of the B Corp Certification (Farly, 2013; Lazonick, 2009; Martin, 2020; Pearlstein, 2014; Rawhouser, 2015; Stout, 2018). When executive respondents were asked about the main reasons for their pursuit of certification and about how they required the requirement to become a Benefit Corp (or other legal equivalent) to become a Certified B Corp, the vast majority of respondents cited the fear of a change of control in their companies being a catalyst for mission drift as being one of their top three motivators for pursuing B Corp Certification. Despite much of the literature suggesting that the mission lock requirement was a significant barrier for companies pursuing certification, only one respondent cited the mission lock as a challenging aspect of the certification process, with all other respondents solely expressing appreciation for the mission lock requirement as a method of securing the long-term survivability of their companies’ missions. Many of these respondents also indicated that the mission lock requirement was not a difficult hurdle in the certification process, as a result of their company’s stakeholders and internal cultures already being value-aligned with such a change.

When executives were asked if becoming publicly traded would affect their companies’ abilities to execute on their missions and values, as well as to retain B Corp Certification, almost all respondents specifically cited a desire not to IPO their companies to avoid what one interviewee described as “aggressive profit-seeking behavior” present in the public markets. This sentiment was even shared across executives representative of companies in such financial standing necessary to properly execute an IPO. This near unanimity in reaction to the idea of becoming publicly traded suggests that not only are there few publicly traded B Corps because of the difficulties that existing publicly traded corporations have in achieving certification, but also because organizations that naturally align with the B Corp Certification consciously avoid the IPO process due to the notoriety of the public markets for focusing on short-term profitability over sustainable and socially responsible business practices. These responses are illustrative of a clear aversion to mission drift, as well as conscious decisions made by interviewed executives to avoid mission drift, thus tangentially supporting the conclusion made by the literature that avoiding mission drift is a key motivator for adopting the B Corp Certification.

Many executives expressed a value of long-term profitability – in large part catalyzed by sustainable and socially responsible business practices – over short-term profitability, demonstrating awareness of the correlation between long-term profitability and factors that serve as key performance indicators in both the B Corp Certification and ESG frameworks, a relationship that is widely accepted across academia and more granularly, across the literature pertaining to Certified B Corps. However, not a single respondent cited the pursuit of greater long-term profitability as a reason for pursuing certification. Some respondents did, however, acknowledge that this was a benefit their companies realized as they navigated the certification process and subsequently became B Corp Certified. These findings suggest that while pursuit of greater long-term profitability may not be a driver for initial adoption of the B Corp Certification, it may be a driver for continued engagement with the certification through recertification and conscious efforts to improve scores on the B Impact Assessment.

Regardless of industry, company size, certification status, or length of certification, three overarching themes emerged as the most consistent reasons why executives chose for their companies to pursue B Corp Certification: using the B Impact Assessment to benchmark impact and as a roadmapping tool, distinguishment from greenwashing, and differentiation in the marketplace. Pertaining to the former, all of the executives from companies not yet certified indicated using the B Impact Assessment as a growth roadmapping tool for improving their businesses’ social and environmental impact across each of their key stakeholder groups. One executive from this subset even indicated that while their company does not anticipate becoming B Corp Certified in the near-term, they use the B Impact Assessment extensively as a tool for improving impact across their operations. With the B Impact Assessment being a free to use, easily accessible online tool, it is possible that the assessment is used by many to gain an initial understanding of the B Corp Movement and to gain immediate value from the certification process, which may often assist companies in deciding whether the B Corp Certification is the right choice for their company. In this sense, the user experience while navigating the B Impact Assessment may be a critical determinant of whether a B Impact Assessment user decides to progress further in the certification process.

In support of the conclusions made by the literature and furthermore, support of the original intent of the B Corp Certification, almost all of the interviewed executives indicated that a core reason for their pursuit of certification was to distinguish themselves from other greenwashing companies in their respective industries and to differentiate themselves in the marketplace. These motivators are closely related in that within many industries, distinguishment from greenwashing companies is a demonstrable differentiation in the marketplace, where it is often difficult to prove the legitimacy of claims made about social and environmental impact. A key example in the literature that illustrates this interconnectedness found that for all businesses, propensity to become B Corp Certified was higher in contexts where sustainability norms are weak (Grimes, 2018). Many executives cited both distinguishment from greenwashing companies and the value-alignment of the certification with their company’s mission as reasons for pursuing the certification, suggesting that these two motivators are not mutually exclusive, as was suggested by Grimes (2018). However, Grimes’ conclusion that the decision to pursue B Corp Certification is predominantly top-down leadership-driven was validated by the qualitative interviews, as all interviewees framed the decision to pursue certification as an idea sourced from top leadership, with the decision also made by top leadership – often with buy-in from other stakeholder groups such as employees and customers (2018).

When asked directly, no currently certified companies cited reasons that they believed would be likely to compel them to decertify. One interviewee stated: “the [B Impact] Assessment was quite unwieldy in the beginning but has gotten better and better each year.” This sentiment being consistent across all of the interviewees that had recertified at least once, and the lack of consideration paid towards decertifying by executives of B Corp Certified companies supports the conclusion made by the literature that the certification’s attrition rate has rapidly declined over time and further suggests that this decline in attrition may be due to improved user experience while navigating the certification (Cao, 2017; Martin, 2020). Beyond the general improvement of the B Impact Assessment, another explanation for this trend is the emergence of B Corp consulting as a rapidly growing industry. Of the Certified B Corps represented in the sample, all had received paid or unpaid B Corp consulting help for their original certification or one of their recertification efforts. As a catalyst for growth in the B Corp consulting industry, there now exist about one dozen B Impact Clinic programs, in which university students are given an experiential learning classroom experience where they consult with businesses seeking B Corp Certification. This free service for businesses not only drives adoption of the B Corp Certification by lowering barriers to entry with respect to the time, effort, and money required to successfully certify, but every year they also teach hundreds of university students the skills necessary to become a practicing B Corp consultant, further developing the workforce that could improve the certification experience for businesses as well as expediting the speed at which businesses can complete and submit the B Impact Assessment.

When inquiring into the role that executives believed B Lab plays in facilitating the B Corp Movement, all the interviewees who had not yet become certified were largely unaware of the role that B Lab played in the process, beyond creating and updating the B Impact Assessment. In contrast, all of the executives representing currently certified companies were aware of B Lab’s role in community-building, with many interviewees within this group sharing that a key reason for their adoption of the certification was the existence of the B Hive network, and the more informal networking opportunities for aspiring and current B Corps, which all connect the B Corp community together. Furthermore, the majority of these executives indicated that they had learned about the certification and gained interest in it first by becoming involved in the B Corp community. This supports Thompson’s findings that bottom-up, high-touch, networking-driven approaches to developing social venture ecosystems are generally more successful at reaching scale than approaches in which significant infrastructure is created prior to community engagement (2018). Validating the findings in Martin’s research, the majority of aspiring B Corp executives who were interviewed indicated that their main pain points with the certification process were the lack of support from B Lab and the greater B Corp ecosystem in completing and submitting the B Impact Assessment as well as the significant delay between submission of the assessment and notification of certification, which currently ranges from six to nine months (2020). Both of these prevalent pain points illustrate B Lab’s under-resourced status as a constraint to the growth of the B Corp Movement, and further demonstrate the importance of B Impact Clinics and B Corp consultants in relieving stress placed on B Lab by the rapidly increasing demand for the certification.

There were several noteworthy outliers across interviewee commentary on B Lab’s role in accelerating the B Corp Movement. Two executives from currently certified companies mentioned another company in their community that had decertified due to how time-consuming and expensive the recertification would have been for the company, supporting Martin’s findings that the recertification process was a key reason for attrition due to its being “highly cumbersome, complicated, and time consuming” (2020). However, one interviewee from a long-time Certified B Corp that is notably at a significantly more mature stage in the company’s growth than the decertified company mentioned earlier was, stated: “we love the recertification process, because it forces us to keep improving,” suggesting that Martin’s conclusion may be more applicable to SMEs who may not have the same organizational bandwidth to allocate to recertification, than to larger corporations (2020). Two executives of currently certified companies cited fear that an upcoming update to the B Corp Certification – which will be made in an effort to standardize the process of becoming a B Corp – would make the certification process far too easy, leading to dilution of the value of the certification both in overcoming legitimacy deficits and in serving as a differentiator for companies that achieve certification. Another executive of a currently certified company stated that rising anti-ESG sentiment may soon spread to the B Corp Movement as well, which would subsequently negatively affect the movement’s ability to maintain support from both sides of the political spectrum. This executive emphasized: “unless B Lab adjusts their language to be clear that profitability is an important consideration [in the assessment], they will not have a movement that everyone can identify with.”

Several executives from current and aspiring B Corps identified a major inhibitor in the movement being the lack of value-aligned, patient capital that is both tailored to the specific needs of social ventures and favors social ventures over traditional, shareholder primacy-driven ventures. Many of these interviewees expressed beliefs that the current venture capital model of funding companies only promotes ventures that have the potential to be billion-dollar companies and only promotes founders that are willing to exit their company, by selling it or by executing an IPO, in order to deliver returns to their investors. Many interviewees also expressed beliefs that most venture capitalists and angel investors do not have a clear understanding on what social ventures and B Corps are, and do not prioritize companies that operate on with a stakeholder-focused philosophy as opposed to a shareholder primacy philosophy. These responses validate findings by Thompson, who found that social ventures tend to struggle to find early-stage funding from angel investors and venture capitalists, even in geographic regions and industries that traditionally have a strong venture capital industry (2018). The comments made by the aforementioned executives also reflect Thompson’s findings that drivers for the growth in number of social ventures are infrastructural in nature, such as the existence and prevalence of impact angel groups and venture capitalists, social venture accelerators, and social venture entrepreneurship competitions (2018). Notably, the consistent response from these executives contradicts claims made in the B Corp Handbook that B Corps and Benefit Corps do not struggle more than traditional ventures in raising investment capital (Honeyman, 2019). However, all interviewees across this study stated either that their existing investors were either indifferent to their certification status or actively supportive of it, further validating Thompson’s conclusion that B Corp Certification aids companies in raising money from existing impact investors (2018). Overall, the feedback received on investor viewpoints with regard to the certification highlights two key inhibitors to the movement: little availability of impact capital and a scarcity of education on social ventures and B Corps across the general investor population. Thompson’s research identifies the latter as being a significant root cause of the former (2018). One interviewed executive of a Certified B Corp stated that the B Corp Certification “needs to get even more recognition across the business community but especially across everyday consumers, and [the B Corp Certification should] become comparable to ‘1% For The Planet,’” further elaborating that, “this will make the certification an even more powerful differentiator and stakeholder engagement tool for those who obtain it.” This insight would support the conclusion made by Grimes, who suggested that the B Corp Certification could present an opportunity for investors, in particular, to understand what a B Corp (and a social venture) is the same way they understand nonprofits and corporations (2018).

CONCLUSION

The B Corp Movement presents a promising opportunity to solve key problems in the social venture ecosystem, including the legitimacy deficit associated with claims made concerning social and environmental impact, the lack of a qualitative method for incorporating social and environmental performance improvements into businesses’ growth roadmaps, and the lack of awareness of the role social ventures play in society. Although the B Corp Movement is not yet widely recognized by the general consumer, the B Corp Certification has seen rapid adoption from the business community. The qualitative interviews and literature review revealed a number of potential avenues for accelerating the B Corp Movement and breaking bottlenecks that may inhibit the movement’s growth. These include education of investors on impact investing and the B Corp Certification, increased infrastructure available to social ventures and B Corps, the expansion of B Corp consultancies and B Impact Clinic programs, and the advent of new patient and value-aligned investment capital deployment structures that better support B Corps in scaling their impact and scaling their businesses. Systemic changes to economic incentive structures in the public markets that encourage long-term investing and stakeholder-focused business practices, such as those proposed by the Long Term Stock Exchange, may also serve as an accelerant to the B Corp Movement by allowing publicly traded companies to more readily participate in creating the sustainable and equitable impact that characterizes the movement. In order to educate the general consumer about the meaning of the certification, a handful have companies have championed the certification in marketing efforts; if this tactic were to grow in use over time, this would be likely to significantly elevate the awareness of the B Corp Certification and its meaning. Through further investigation into the growth drivers and inhibitors of the B Corp Movement, the emergence of true stakeholder capitalism may come to fruition more efficiently and holistically.

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APPENDIX

APPENDIX A: Qualitative Interview Guide

Current B Corp Founders/CEOs

o How did the requirement to become Benefit Incorporated (or other legal equivalent) influence your decision to certify?

o What would you say are your top 3 reasons for joining the B Corp Movement, and now that you're involved, how have those motivators changed? (follow up question: what are the tangible ways that being a B Corp creates tangible value for your company?)

o What role do you believe B Lab plays in accelerating the movement?

• How well do you believe B Lab plays this role and why?

o If you could change something about the certification, what would it be and why?

o Are there reasons that you may choose not to recertify? (can follow up asking if the annual fees paid to B Lab affect your decision to recertify?)

o What do your investors, if any, think of your B Corp Certification status?

o Do you feel that IPOing and becoming a publicly traded company would jeopardize your B Corp Certification or your company's ability to pursue its mission? Why or why not?

o How has obtaining B Corp Certification changed or not changed how you view the company's fundamental identity?

Founders/CEOs Attempting to Certify

o How did the requirement to become Benefit Incorporated (or other legal equivalent) influence your decision to attempt to certify?

o What would you say are your top 3 reasons for wanting to become a B Corp?

o What role do you believe B Lab plays in accelerating the movement?

• How well do you believe B Lab plays this role and why?

o If you could change something about the certification, what would it be and why?

o What do you think threatens your chances of getting certified the most?

o What do your investors, if any, think of your attempt to become a B Corp?

Introduction

Silicon Valley Bank (SVB) was a unique institution in the values it strove for and the customers it served, which separated its identity from other, larger banks that exist throughout the world. Established in 1983, the company developed for about 40 years before its demise. It was able to IPO in 1988 and expanded across the globe into areas such as Israel, the U.K., China, Canada, Germany, and Denmark. The bank was built to help advance innovation throughout economies. Their website pushes this message frequently with slogans such as “the financial partner of the innovation economy” and “advancing innovation for a better world” (Silicon Valley Bank, n.d.). This meant that SVB catered to a smaller and more niche clientele, mainly consisting of venture capital firms, startups, and wealthy individuals. While one can argue that it was essential that SVB existed for these clients as it provided a banker for this ecosystem, it also left the company exposed to the ebbs and flows of the startup and venture capital world. More so, without proper risk management, potential downturns or stress would expose the bank to failure as risks materialized. As discussed below, the fall of SVB revealed systematic risks that all banks face; however, the individual characteristics of the company’s clients, assets, and liabilities caused the second-largest bank failure since the fall of Washington Mutual Bank in 2008, as shown in Figure 1. To dig into this, several areas will be examined, such as the regulatory environment, the effects of COVID-19, accounting designations, the macroeconomic landscape, inadequate risk management, a concentrated funding base, weakening profitability, and government intervention.

Importance of Regulation on SVB’s Frame

The regulatory stature in the background of SVB’s failure serves as an excellent explanation of why the company could operate the way that it did. The most crucial regulation for the bank came in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) installed during the financial crisis in 2008 via the Obama administration. This law was a flight toward regulation in the wake of fear and banking contagion spreading throughout the economy at the time. Dodd-Frank heavily regulated the financial industry and prevented it from making riskier investments that could expose its capital to more significant losses in the future. While covering the bill would take up too much space and time, it is summarized quite nicely by Niall Ferguson in his book The Ascent of Money as he writes:

Dodd-Frank was a near perfect example of excessive complexity in regulation. The Act required that regulators create 243 rules, conduct 67 studies and issue 22 periodic reports. It eliminated one regulator and created two new ones. By 2014, according to one estimate, the total number of new restrictions associated with Dodd-Frank (27,669) exceeded the restrictions generated by all the other legislation passed under the Obama administration. (Ferguson, 2008)

Some would argue that it was because of increased regulation like the Dodd-Frank Act that banks became less competitive as an investment causing their growth and innovation to slow. This is suggested by comparing the financial sector to the overall market since 2008 in percentage appreciation terms, as shown in Figure 2. However, this is a discussion for another time.

The importance of the Dodd-Frank Act concerning SVB comes with a rule implemented upon the Act’s inception. Specifically, it required banks with more than $50 billion in assets to take annual stress tests given by the Federal Reserve. These tests would examine a bank’s balance sheet and ability to stay liquid or solvent in the event of an economic contraction of varying levels. The Act also created the Financial Stability Oversight Council (FSOC) and the Consumer Financial Protection Bureau (CFPB), which oversaw the supervision of the Act. While SVB would have been subject to these tests in 2008, the bank never had to conduct them due to legislation changes in 2018 under the Trump administration. The Reduced Regulatory Burdens for All but the Largest Bank Holding Companies Act eliminated the need “for bank holding companies with less than $250 billion in assets to comply with most aspects of the ‘enhanced prudential standards,’ including resolution planning, stress testing, and single-counterparty credit limits” (The Harvard Law School Forum on Corporate Governance, 2018). If one examines the size of SVB’s assets before failure, curious enough, it was right under the threshold at $212 billion. In effect, legislation changes in 2018 removed the need for SVB to conduct stress tests as extensive as the larger banks in the U.S. are required to do, along with having more relaxed supervisory on the health of its balance sheet. This regulatory frame allowed SVB to take on more hidden, individual risks that supervisors missed before its downfall. As discussed in the next section, these risks were only enhanced as COVID-19 stimulus introduced trillions of dollars of liquidity into the system.

The Effects of COVID-19

Around $5 trillion was given to different sectors of the economy over COVID-19 times; such areas included households, restaurants, airlines, hospitals, local governments, and other institutions. More importantly for the topic of SVB was that businesses received $1.7 trillion, and “more than nine million small businesses – generally those with 500 employees or fewer – collected loans through the Paycheck Protection Program (PPP)” (Parlapiano et al., 2022). Needless to say, a ton of money flooded the system, with many businesses and individuals flush with cash. More so, front and long-end rates were dropped from lowering the federal funds rate and quantitative easing. This allowed for cheap money, which boosted the stock market, and even more so boosted the size and quantity of equity offerings that SVB’s clients could complete. Due to this, one can see a massive increase in the bank’s deposits post-pandemic as most of these startups needed to place their newly acquired dry powder somewhere. To increase this funding, SVB sometimes required startups to hold most of their cash with the bank for it to conduct business with them. For example, “CNBC has reviewed six agreements that companies signed with SVB regarding financing or credit solutions. All required the companies to open or maintain bank accounts with SVB and use the firm for all or most of their banking services” (Goswami, 2023). In simple terms, to gain a loan from SVB, a company would need to hold their cash there as well, most likely forcing an even greater amount of deposits to flow into the bank, as shown in Figure 3.

As these deposits came into SVB, the bank realized that the opportunity to loan was diminishing compared to the vast amount of funding it received. More so, because the bank operated in such a niche sector, its knowledge of whom to loan to was more concentrated, further narrowing the options. For instance, when looking at SVB’s loan book, one can see just how focused it was on the technology and venture capital sectors, as shown in Figure 4.

Rather than push to invest in startups or firms they felt would not give the desired return, SVB decided to park the funds from depositors in ultra-safe assets. However, while one may think there should be no issue with doing so, it comes down to the specific characteristics of the assets they invested in and the macro environment that affected them, which will be discussed in the following sections.

The Importance of Accounting

SVB’s strategy of piling funds into safe assets such as Treasuries or Agency asset-backed securities (ABS) was common for banks following the 2008 financial crisis. Due to increased regulation, as discussed earlier, banks must also hold a certain amount of high-quality liquid assets (HQLA) on their balance sheet. The number of HQLAs banks buy is dictated by their Liquidity Coverage Ratio (LCR), which has to maintain a level above 100%. The LCR measures whether the bank can meet stressed outflows of deposits for 30 days or more. Calculating the LCR is simply the stock of HQLA the bank holds divided by the net cash outflow over 30 days, equaling greater than 100% . Of course, Treasuries and Agency ABS meet the criteria for HQLA due to the high liquidity and low credit risk associated with these securities (both are usually rated AA to AAA). However, even though the perceived risk of these securities is low, the way that SVB handled investing in them exposes idiosyncratic risks the institution took.

SVB’s latest 10-K shows that by the end of 2022, the bank had a massive bond portfolio valued at nearly $120 billion. One can see this increase in Figure 3 as securities increased along with deposits. Comparing these bonds against all the bank’s assets, it was a staggering 57% compared to an industry average of 24%, as shown in Figure 5. This had several implications for the bank’s profitability as these long-term fixed assets decreased in value as interest rates rose, as discussed in a later section. While other banks may hold fixed securities, they will also have a more considerable amount of loans that usually have a floating rate which will adjust to a rising rate environment, keeping profitability stable.

It is crucial to break down this bond portfolio to understand it better. Accounting is prominent in how this portfolio is laid out on the company’s financial statements. There are two distinct categories that the securities purchased can be placed into. The first is Available for Sale (AFS), meaning the company purchased these investments to sell them later in the future. The accounting treatment of AFS securities considers the fair market value as time goes on and will record unrealized gains or losses that will affect the company’s asset and equity values depending on the change. The second is Held to Maturity (HTM), meaning the company purchased these securities to hold them until maturity. The accounting treatment of HTM securities differs from AFS in that the investments' fair market value is not considered when showing the value of assets and equity as time progresses. Instead, the HTM category is kept at book value with no fluctuations taken into account, with a separate category describing any unrealized gain or losses that investors can view. However, these unrealized changes are nonimportant due to the nature of HTM, as the securities already have a set amount of return and value that will be realized once they expire. With these two distinctions, SVB could separate its bond portfolio into each category and disguise any changes under the larger HTM section. Investors never seemed to pay attention to this accounting manipulation until the macro landscape changed.

Yield Up, Price Down

A macroeconomic issue that usually occurs with hot economies began to rear its head again when deposits were flowing into SVB. Inflation grew massively as the U.S. economy, pumped by COVID-19 stimulus, began to overconsume, creating supply and demand imbalances throughout several sectors. The effect was the Federal Reserve’s choice to take decisive action to control skyrocketing price rises by lifting its benchmark rate by 500 basis points (as of the end of March 2023) and conducting the offloading of its balance sheet through quantitative easing. The effect was a rise in yields across the curve that has not been seen in the past decade, as shown in Figure 6.

On the asset side, this is when the trouble began for SVB. Thinking about how bond math works, one knows that as rates rise, the pre-existing bonds on the market have their price drop due to better-yielding options becoming available. This is precisely what happened to SVB’s extensive portfolio of AFS and HTM securities, as they were bought when yields were still low. Looking at the AFS side first, one can see that it was a much smaller portion of the overall portfolio sitting at a book value of around $28 billion of the $120 billion. Most of the securities were comprised of Treasuries ($17 billion), with Agency MBS making up the second largest allocation ($7.7 billion). One can also see a relatively sizeable unrealized loss of around $2.5 billion, driven by these securities having both lower yields than the present market offered and having longer maturities in the range of one to five years for the Treasury allocation and over ten years for the MBS allocation. With greater maturity comes more duration, which measures how sensitive a debt security’s price will be to changes in interest rates. The larger duration meant more significant losses on these investments as rates rose. Figures 7 and 8 illustrate the size of the AFS side, the unrealized losses, and the duration it was exposed to.

While a review of the AFS side’s size, duration, and considerable unrealized loss was startling, a glimpse of the larger HTM side is what eventually caused panic. SVB had around $91 billion of the $120 billion portfolio dedicated to the HTM allocation, with a shocking amount of $57 billion in Agency MBS. Worse, most of these MBS had a maturity of over ten years, meaning the duration was substantial, driving the disturbing $15 billion unrealized loss. Figures 9 and 10 display the HTM size, unrealized losses, and maturities.

It is essential to compare the HTM losses to the bank’s capital, which was around $16 billion, as shown in Figure 11.

The unrealized losses on the HTM side accounted for 93% of SVB’s capital, which would have been destroyed at any time if the portfolio were to be liquidated in the event of stress. Such a high exposure to losses made SVB stand out as other banks had not committed such a massive portion of their assets to securities. This becomes apparent when one compares the percent of assets in securities, as discussed before, with the unrealized losses as a percentage of capital, as shown in Figure 12.

While SVB is an outlier in how it invested its deposits in longer-duration securities, it exposed a systematic risk that all banks experience as rates rise, which is a decrease in the worth of the ultra-safe assets they hold. For instance, Figure 13 shows the fall in value across the financial sector of institutions with AFS securities. This makes sense, as banks are required to hold these assets to comply with regulations. However, banks also manage risk using financial derivatives such as interest rate swaps to hedge against interest rate exposure. Most banks with large AFS bond portfolios take part in these swaps as an insurance policy; however, when one looks at SVB, it seems they sold off their insurance right before trouble began, which begs the question: why?

Inadequate Risk Management

Interest rate swaps effectively transfer unpreferred types of payments for a preferred type via a switch. For instance, there is a fixed-floating swap that allows the party receiving fixed payments from their investment (think of a traditional bond) to transfer that cash flow to another party that, in return, will pay floating from an asset they hold (think of a Treasury Inflation-Protected Bond (TIP)). There is also floating-fixed, which is just the opposite of the example given above, and floating-floating, where two floating rates are exchanged. The point is that banks like SVB can use these instruments to hedge against changes in interest rates by engaging in a fixed-floating agreement so that as rates rise, they receive a floating rate that adjusts along with them. For HTM securities, the importance of these hedges is diminished since HTM assets are planned to be held until the securities expire. More so, these swaps are also marked at fair value, meaning their volatility with changes in the market will affect the P&L of banks, which is unfavored by most institutions and viewed as not worth the insurance on the HTM side. However, most banks with extensive AFS bond portfolios will engage in these swaps, or instead; they will hold very short-maturity securities such as three-month Treasury bills that have minimal duration. The Financial Times (FT) explains this relationship between the value of swaps and rates concerning the two accounting categories very well:

So if rates rise then a bank makes money on the hedge (receiving a higher floating rate than what it pays in fixed), but the bonds stay at par (if kept in the HTM account). If rates fall then they lose money on the hedge (receiving a lower floating rate than what it pays in fixed), but it can shift bonds from HTM to AFS and sell them at a higher price. That means it basically becomes a directional bet on interest rates that flows straight into the income statement, something most banks abhor. (Wigglesworth, 2023)

While SVB’s duration management was sorely lacking, the bank did seem aware of this issue as they had hedges on their books in early 2021. More so, the bank felt the impending rise of rates the Fed was signaling due to increasing inflation. The CEO, Daniel Beck, addressed that by saying:

…We’re certainly positioning at this point for the potential for higher rates. So in the quarter, we put on close to $10 billion worth of swaps on that available-for-sale portfolio. And we’re going to continue to do more to protect against that, to mitigate the impact of potential further rate movement. (Wigglesworth, 2023)

The company’s financial statements accurately reflect Beck’s promise at the time. However, if one fast-forwards a year, all these swaps seem to have just vanished. By the end of 2022, only $550 million of swaps were left, meaning the rest had been sold, as shown in Figure 14.

Why did SVB take off their insurance? Especially if, at the beginning of 2021, it felt rates would rise. Well, it turns out that as time progressed, rates did rise and began to affect SVB’s clientele of tech startups and VC funds as cheap money no longer existed. The slowdown of the fast-moving startup world was apparent as investors moved away from high cash flow promising growth opportunities to more stable value plays. A great example of this change is shown in Figure 15, showing the number of equity offerings substantially slowing as the Fed signaled and then raised rates throughout 2021 and 2022.

To SVB, this meant fewer deals were available for their clients, and less funding in deposits would flow through the doors. In turn, profitability most likely started to weaken as tech startups needed more of their deposits back (discussed in a later section), there were fewer loans to give out to attractive opportunities, and their bond portfolio was yielding less than the market was giving. These factors resulted in a move to sell their interest rate swaps, leaving SVB open to massive interest rate risk. At the beginning of 2022, SVB started to unwind the derivatives first by selling “$5 billion of AFS hedges to book a $204 million gain, and in the second quarter it dumped another $6 billion of hedges to lock in a $313 million gain” (Wigglesworth, 2023). If one thinks about it, the gains make sense because as rates rise, these hedges become more valuable, meaning they can be sold at a greater price than purchased. However, the point of these hedges was never for speculation but for insurance. SVB seemed to lose sight of that fact in the attempt to sell their protection for a small boost in their profitability to cushion the pain from the macro environment. In simpler terms, the bank sold its protection for a small gain in exchange for exposing itself to the probability of significant losses that materialized. Management suggested that these sales were part of a transition to focusing on “downrate sensitivity” (Wigglesworth, 2023). The company was essentially attempting to call the peak in interest rates while cushioning its profitability. Curiously, management was sort of right in that rates on the long-end 10-year Treasury peaked at around 4.25% in October of 2022. However, this did not prevent the rise in unrealized losses nor the equity investors or depositors from noticing. Once they did, the lack of insurance was not there to protect the bank from the spark that caused the institution's failure.

A Concentrated, Shrinking Funding Base

The heavily concentrated depositors that made up the liability side of SVB’s balance sheet felt the effects of the changing macro environment the most. As rates rose, money became more expensive, causing deals to slow and startups to burn through cash quicker. This caused a need for their deposits which the bank had to hand over. Another critical point is that most of SVB’s depositors were businesses instead of consumers. This matters because as rates rise, companies are more willing to move their deposits to a higher yielding option, such as a money market mutual fund, instead of a bank that is holding deposit rates low to keep net interest margins (NIM) level (NIM is just a bank’s returns from its assets minus what it pays its depositors or to its debt holders). With rising rates, SVB’s NIM was shrinking as its cost to keep depositors increased. For instance, “in the fourth quarter of 2021, its cost of deposits rose 2.33 percent, from 0.14 percent in the final quarter of 2021. That’s bad but not lethal: the company’s interest-bearing assets yielded 3.36 percent in the fourth quarter, up from 1.99 percent, rendering a tightening (shrinking profitability) but still positive spread” (Armstrong, 2023). These combined factors made deposits slip; by the end of 2022, they decreased by $16.1 billion. However, this fall was not the most dangerous thing about SVB’s funding base. If one looked at the percentage of uninsured deposits, it could be seen that almost 88% were above the $250,000 protection the Federal Deposit Insurance Corporation (FDIC) promises to back up if a bank fails. This is extremely important as it incentivized a large portion of SVB’s funding base to flee if any trouble was suspected, as businesses knew they most likely would not get their money back if the bank fell. The breakdown of these deposits is shown in Figure 16.

Lighting the Tinder Box

As 2023 emerged, the bank most likely realized that deposit bleeding might continue and that profitability could suffer further. To remedy this, SVB attempted to switch some of its longer-duration assets in the bond portfolio with shorter-duration, higher-yielding investments. The decision to do so resulted in almost all of the AFS securities being sold to the larger investment bank, Goldman Sachs. Due to the sale, SVB was forced to record a $1.8 billion loss, and to patch that hole in its capital; it decided to work with Goldman Sachs to raise new equity in the amount of $2.25 billion. The choice by the bank to rearrange its portfolio sparked major concern from depositors and investors, who decided to take a closer look at the company’s financials. Once it was discovered that SVB had unrealized losses on its HTM securities of almost all of the company’s equity, panic ensued, and the dominoes began to fall. SVB rushed to meet withdrawals from depositors as equity investors sold stock as fast as possible. The bank encountered several obstacles while trying to stop the bleeding. The equity offering run by Goldman Sachs fell through as investors realized a run on the bank was materializing. Some may also argue that the equity offering would never have worked due to the lack of confidence behind Goldman Sachs, which never actually underwrote the deal. On the depositor side, SVB quickly found itself running out of cash and realized it would have to either sell its HTM assets or use them as collateral to acquire funding from lenders of last resort. The latter option was much preferred; however, as Wall Street Journal (WSJ) points out that on Thursday, March 9^th, the day the bank was experiencing its highest withdrawals and was attempting to borrow the cash, it ran out of time as the computers that process the transactions at the Fed close at 4:00 p.m. PT and do not open until the next day. The WSJ writes, “The Fed needed a test trade to be run before the actual transfer could occur. That took time and the Fed didn’t extend its own daily deadline of 4:00 p.m. PT for collateral transfers to help SVB. Time ran out on the bankers and SVB couldn’t get the money that day” (Miao et al., 2023). As a result, the bank could not acquire enough funding to stop the run and, on that Thursday, suffered deposit outflows of $42 billion, as shown in Figure 17.

The following day, Friday, March 10^th, it was announced:

Silicon Valley Bank, Santa Clara, California, was closed today by the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver … All insured depositors will have full access to their insured deposits no later than Money morning, March 13, 2023. The FDIC will pay uninsured depositors an advance dividend within the next week. Uninsured depositors will receive a receivership certificate for the remaining amount of their uninsured funds. (Scaggs, 2023b)

Government Intervention

The decision by the FDIC to take SVB into receivership and insure both insured and uninsured depositors effectively ended the bank’s 40-year history. The government’s choice to save SVB has been met with several viewpoints as discussions about moral hazard and too interconnected to fail clash. On the one hand, moral hazard has its place in this discussion as the poor choices by the management of SVB, which resulted in its failure, were quickly remedied by government intervention. However, it is vital to remember that in the event of bankruptcy, which the company entered on March 17^th (a little over a week after the initial crisis), equity investors usually get next to nothing while management is fired, and creditors obtain anything left from the sale of assets. More so, management is usually given a certain amount of company shares as a part of their compensation package, meaning they suffer heavily when the business they run goes under. In effect, management is punished by the loss of their jobs, equity, and credibility, while investors lose capital due to poor due diligence. On the other side, the government’s backing of depositors of both insured and uninsured nature adheres to the argument that SVB was too interconnected with the venture capital community to fail. A stronger argument for this would center around the psychology between humans and banking, where confidence is key. If the government had just let SVB fall, panic might have spread further and wider than the initial fear the bank’s failure caused. The backing by the government ensured that other liquid and solvent banks with proper risk management were not punished with unnecessary bank runs. That being said, the result of SVB’s failure has already dealt confidence damage that cannot be undone. It will most likely result in the increased cost of funding for banks as jittery depositors move their funds to either super large banks deemed too big to fail or to money market accounts yielding close to five percent (as of March 2023). Due to this, banks will most likely see a shrinking of NIM as profitability is squeezed from both the liability and asset side via tightening lending standards to keep a more significant amount of capital in case of deposit outflows. The result could trickle throughout the U.S. economy as lending slows, causing businesses and consumers to borrow less as it becomes more expensive. However, only time will tell if these issues materialize.

Conclusion

The fall of Silicon Valley Bank exposed systematic interest rate risk that all banks experience in a rising rate environment. As mentioned, most of these banks work to protect against these risks via shorter maturity assets or interest rate swaps. SVB did not. Through several individual choices made by the bank’s management, it exposed itself to unnecessary danger in exchange for short-term profitability that eventually resulted in its downfall. As a result, the FDIC took SVB into receivership before ultimately selling the company’s assets to First Citizens Bank. The story of SVB’s failure is one of the ever-growing importance of risk management within a financial institution. More so, SVB’s case emphasizes the importance of seeing beyond short-term profits to consider long-term threats that can destroy over 40 years of development.

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Note from Author

Hi everyone, I apologize for the length; there are multiple narratives that weave together with this story and I felt it was important to include them all. As always, I hope you enjoyed reading as I enjoyed writing! If you want to learn more, I have included both an annotated bibliography and works cited below that displays the sources used for this piece.

Annotated Bibliography

Armstrong, R. (2023, March 10). SVB is not a canary in the banking coal mine. Financial Times. https://www.ft.com/content/7cf4eb45-78b7-4e6e-b134-1f0b082ba203

Robert Armstrong runs Unhedged, offered by the Financial Times. He writes market commentary with his co-author, Ethan Wu, almost every day. When Silicon Valley Bank failed, Armstrong and Wu wrote several pieces detailing different aspects of the bank's failure. This article is an excellent example as Armstrong makes several points about the individual risks and characteristics that made SVB's failure self-induced and not a signal for banks everywhere being in danger of suddenly failing.

Dodd-Frank Act. (2018, August 21). History.com. https://www.history.com/topics/21st-century/dodd-frank-act

The Dodd-Frank Act was instituted in 2010 by the Obama administration. It was created to enforce heavier regulations and supervision on banks with assets over $50 billion. This held until 2018 when the Trump administration changed the law to allow banks with assets under $250 billion to have less scrutinizing enforcement compared to their larger colleagues. This article by History.com lays out the details behind the original Dodd-Frank Act.

FDIC | Failed Bank List. (n.d.). https://www.fdic.gov/resources/resolutions/bank-failures/failed-bank-list/

The Federal Deposit Insurance Corporation (FDIC) frequently releases U.S. bank data. In this example, the FDIC shows the number of failed banks with their size in both assets and deposits. One can examine that Silicon Valley Bank is second to the top of the list as Washington Mutual Bank, which failed in the 2008 financial crisis, was the largest bank to go under in U.S. history.

Ferguson, N. (2008). The Ascent of Money: A Financial History of the World: 10th Anniversary Edition. Penguin.

Niall Ferguson's The Ascent of Money is a detailed book describing the history behind the creation of money and its ability to improve economies throughout the globe. Ferguson instructs readers in the creation of debt, equity, insurance, housing, and other critical financial topics that exist in the world today. Ferguson also gives an account of the 2008 financial crisis, which occurred while writing the book, with a brief mention of the Dodd-Frank Act, which was seen as a rush to regulation by lawmakers after the spread of banking contagion.

Levine, M. (2023, March 22). Silicon Valley Bank Ran Out of Money. Bloomberg.com. https://www.bloomberg.com/opinion/articles/2023-03-22/silicon-valley-bank-ran-out-of-money#xj4y7vzkg

Matt Levine writes for Bloomberg Opinion and focuses on several topics within the finance world. His past experiences include being an editor of Dealbreaker, an investment banker at Goldman Sachs, and a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen, and Kratz. Levine is a highly talented and knowledgeable writer that followed the failure of Silicon Valley Bank as it occurred. He brought several fine points to the table, including the highlighting that SVB ran out of money due to the computer that processes transactions through the Federal Reserve closing at 4:00 pm PT, which was first revealed by the Wall Street Journal (article quoted within the paper).

Parlapiano, A., Solomon, D. B., Ngo, M., & Cowley, S. (2022, March 12). Where $5 Trillion in Pandemic Stimulus Money Went. The New York Times. https://www.nytimes.com/interactive/2022/03/11/us/how-covid-stimulus-money-was-spent.html

This New York Times article lays out the total amount of Covid stimulus the government provided in stunning detail. It breaks down where these funds went, such as households and businesses. The effects of this stimulus were apparent for Silicon Valley Bank as the cheap money that flowed throughout the economy gave markets a boost resulting in more equity deals being completed. In turn, SVB's clients of startups had more cash which they parked within the bank.

Peccatiello, A. (2023a, March 12). Banking Crisis? By Alfonso Peccatiello (Alf). https://themacrocompass.substack.com/p/banking-crisis

Alfonso Peccatiello writes a personal substack commentary named The Macro Compass, where he addresses macro events occurring throughout the world and the best way he feels to trade them. Peccatiello has managed money and has significant experience addressing macroeconomic changes and how they affect markets. This article discusses the failure of Silicon Valley Bank and some of the individual risks the bank took that ultimately led to its demise.

Scaggs, A. (2023a, March 9). Silicon Valley Tank(s). Financial Times. https://www.ft.com/content/c94279a4-4ec2-4a0c-86fb-be8375e12ef2

Alexandra Scaggs writes for the Financial Times and provided several excellent articles about the failure of Silicon Valley Bank as it occurred. This article discusses the fall in SVB's stock price as panic ensued before the bank's demise. Another report by Scaggs quoted within the paper discusses SVB being taken into receivership by the FDIC, which occurred on March 10th, a day after this article was written.

The Harvard Law School Forum on Corporate Governance. (2018, June 13). Rolling Back the Dodd-Frank Reforms. https://corpgov.law.harvard.edu/2018/06/13/rolling-back-the-dodd-frank-reforms/

This article by Harvard Law described the legislation change to the Dodd-Frank Act that occurred in 2018 under the Trump administration. The easing of the Act created an environment where smaller banks of assets under $250 billion, such as Silicon Valley Bank, could operate with less regulation and supervision. More specifically, the stress tests and balance sheet risk-taking restrictions were more relaxed than larger banks within the United States.

Wigglesworth, R. (2023, March 17). How crazy was Silicon Valley Bank’s zero-hedge strategy? Financial Times. https://www.ft.com/content/f9a3adce-1559-4f66-b172-cd45a9fa09d6

Robin Wigglesworth, via the Financial Times, writes this excellent article detailing in easy-to-understand how the elimination of hedging occurred within Silicon Valley Bank. Wigglesworth breaks down the relationship between interest rate swaps, accounting measures, and interest rates changing in the macroenvironment. He also displays the elimination of these swaps via SVB's 10-K. More so, he describes how combined with no hedging, SVB's liability side was highly concentrated and interconnected, eventually leading to quicker panic when the trouble started.

Works Cited

Armstrong, R. (2023, March 10). SVB is not a canary in the banking coal mine. Financial Times. https://www.ft.com/content/7cf4eb45-78b7-4e6e-b134-1f0b082ba203

Bloomberg L.P. (n.d.). Bloomberg [Dataset]. https://www.bloomberg.com/professional/solution/bloomberg-terminal/

Ferguson, N. (2008). The Ascent of Money: A Financial History of the World: 10th Anniversary Edition. Penguin.

Goswami, R. (2023, March 13). Silicon Valley Bank signed exclusive banking deals with some clients, leaving them unable to diversify. CNBC. https://www.cnbc.com/2023/03/12/silicon-valley-bank-signed-exclusive-banking-deals-with-some-clients.html

Miao, H., Zuckerman, G., & Eisen, B. (2023, March 22). How the Last-Ditch Effort to Save Silicon Valley Bank Failed. WSJ. https://www.wsj.com/articles/how-the-last-ditch-effort-to-save-silicon-valley-bank-failed-89619cb2

Parlapiano, A., Solomon, D. B., Ngo, M., & Cowley, S. (2022, March 12). Where $5 Trillion in Pandemic Stimulus Money Went. The New York Times. https://www.nytimes.com/interactive/2022/03/11/us/how-covid-stimulus-money-was-spent.html

Peccatiello, A. (2023a, March 12). Banking Crisis? By Alfonso Peccatiello (Alf). https://themacrocompass.substack.com/p/banking-crisis

Peccatiello, A. (2023b, March 14). Contagion Risks. By Alfonso Peccatiello (Alf). https://themacrocompass.substack.com/p/contagion-risks

Rosenthal, J., Simon, P., & Milonopoulos, G. (2023, March 10). U.S. Banks: SVB Situation More “SV” Than “B.” CreditSights.

Santilli, P., & Benedict, J. (2023, March 12). Silicon Valley Bank’s Meltdown Visualized. WSJ. https://wsj.com/articles/silicon-valley-banks-meltdown-visualized-3da2263b?mod=saved_content

Scaggs, A. (2023b, March 10). SVB: RIP. Financial Times. https://www.ft.com/content/cea7e32a-5ea3-4a6f-ab6d-1360a9de9557

Silicon Valley Bank. (n.d.). Silicon Valley Bank. https://www.svb.com/newsroom/facts-at-a-glance

SVB Financial Group - Financials - SEC Filings. (n.d.). https://ir.svb.com/financials/sec-filings/default.aspx

The Harvard Law School Forum on Corporate Governance. (2018, June 13). Rolling Back the Dodd-Frank Reforms. https://corpgov.law.harvard.edu/2018/06/13/rolling-back-the-dodd-frank-reforms/

Wigglesworth, R. (2023, March 17). How crazy was Silicon Valley Bank’s zero-hedge strategy? Financial Times. https://www.ft.com/content/f9a3adce-1559-4f66-b172-cd45a9fa09d6

Personally, this is one of the last authentic speeches delivered by a US president warning of greater spheres of influence internally within the US.

A vital element in keeping the peace is our military establishment. Our arms must be might, ready for instant action, so that no potential aggressor may be tempted to risk his own destruction. . . . American makers of plowshares could, with time and as required, make swords as well. But now we can no longer risk emergency improvisation of national defense; we have been compelled to create a permanent armaments industry of vast proportions. . . . This conjunction of an immense military establishment and a large arms industry is new in the American experience. . . .Yet we must not fail to comprehend its grave implications. . . . In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.

And this is essentially how the world has operated since the 1960’s till 2020: multiple industries lobbying and vying for power to influence consumers, with the US government acting as their personal legislative arm. In doing so, our leaders (I’m referring to those in developed nations) have stolen what is not rightfully theirs to lift themselves and these industries to unnatural heights. Through monetary and fiscal policies that have propelled growth and productivity to present levels, they have not only stolen wealth and prosperity from our children and our children’s children, but they have also created a political dynamic that has grown weary of the Constitution and its attendant political norms.

So how did we get here?

In a ‘reasonable’ world, (assuming a closed-economy) you would expect a group’s GDP to increase in line with the wealth of its people.

As a people, you can’t be a lot richer than your economy grows without stealing that wealth from someone else.

How’d we steal?

We did this by ‘stealing’ wealth both externally through trade in favor of the developed nation, and internally from future people in our own country through artificially low interest rates, monetized debt-driven stimulus, and an increasingly levered financial system supporting investments into industries that don’t necessarily drive productivity. And while the US has been doing this for some time now, I wanted to focus on the accelerating separation between net worth and GDP that has been occurring since 2008.

In 2008 the world faced its largest financial crisis since the great depression leading to the introduction of quantitative easing (QE) to provide liquidity for banks in a time of crisis. While the introduction of QE was justified, for me the real issue that stemmed from this was that QE never really stopped, and just like a drug you begin building a tolerance and asking for more.

We continuously transform emergency government intervention policy into permanent government policy. 

1. Interest Rates

2. Balance Sheet Control

3. Central Bank Communication aka Faith

These are the three main ‘tools’ which the US central bank has been using to play its game since 2008. The third being perhaps the most underrated tool and least mentioned because of its simplicity. The reason we still trudge along as resemblance of a society, Faith, which the central bank has provided exactly just that with its verbal promises in press releases and meetings, always giving the public the benefit of time ahead of its decision to maintain its “extraordinary accommodation” far into the future.

So we went along for another decade with the three ‘tools’.

Then came COVID-19.

Then came low interest rates.

Then came more QE.

Then came stimulus checks and PPP loans.

Now, we are looking at the widest ever gap between individual wealth and GDP.

Even with all the news of recession and inflation, is that it is no longer possible to inflate wealth without sparking inflation in the real economy.

So the lines must converge, and if they do, it would be a wealth destruction bigger than 2008. I hate saying this, but I believe the alternative is worse. The politicians that run our government recognize this problem, but the result of parties’ inability to cooperate towards common ideals is the continuation of public policy that patches cracks rather than fixing the material, such as the latest student loan forgiveness package that seeks to relieve college graduates from debt, but does so by handing out money rather than addressing the systemic drivers of increasing tuition costs to students. As I mentioned earlier, it is difficult to put the genie back in the bottle. Once new measures are taken for emergency purposes, in the hopes of gaining political favor, the government is then able to leverage these measures for non-emergencies when they do not restore economies to equilibrium, but instead exacerbate long-term drivers of poor economic health. The long-term implications of these short-sighted choices do not prevent the politicians that made these choices from being re-elected, so the dynamic is unlikely to change.

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“I said that we needed to shift the focus to improving the quality and returns of economic growth, to promoting sustained and healthy economic development, and to pursuing genuine, rather than inflated, GDP growth and achieving high-quality, efficient, and sustainable development”- Xi Jinping, President of the People’s Republic of China.

While China has excelled over the past decades, many economists are now predicting that several headwinds will affect the country’s overall growth rate. The most prominent indicator is a large amount of debt invested in non-productive assets like infrastructure and real estate. This article aims to explore the reasons behind China’s explosion in growth, how it has been pushed to a level that is difficult to maintain, and how the country needs to transition and deleverage to produce real growth.

Building the Rocket

Before the late 1970s, China was worn down from several conflicts, such as the second Sino-Japanese war and its civil war. More so, the nature of Mao Zedong’s leadership required most enterprises to be nationalized. While this provided stable pay and suitable living conditions, it offered little incentive for workers to innovate and grow the economy. Additionally, China was isolated before the 1970s, allowing for a minuscule amount of knowledge, technology, or investment from the outside world. Due to these reasons, the country was considered very poor during the time (Figure 1).

Figure 1: China’s Historical GDP Per Capita

The spark for change came when Mao Zedong passed in 1976, and two years later, Deng Xiaoping won leadership. He immediately recognized the need for reform and installed several open-door policies to achieve a socialist market economy. Michael Pettis, a finance professor at the Guanghua school of management at Peking University specializing in Chinese financial markets, summarizes the strategy quite well. He states that the act of enforcing liberalizing reforms allowed for the creation of social capital. It is important to spend some time on this term. The World Bank defines social capital as:

“Social capital refers to the institutions, relationships, and norms that shape the quality and quantity of a society's social interactions. Increasing evidence shows that social cohesion is critical for societies to prosper economically and for development to be sustainable. Social capital is not just the sum of the institutions which underpin a society – it is the glue that holds them together”.

Pettis explains the term in a broader sense; for instance, he discusses the model of social capital and how it states there is an appropriate level of capital stock (investments) per worker that is contingent upon the worker and businesses’ ability to absorb the additional capital stock. While this is slightly confusing, it is simplified to say that an economy’s framework must encourage the ability for it to absorb more productive investments. The higher social capital is, the more prosperous a country can become from natural growth. Ultimately, it comes down to having the right institutions and leaders to implement this structure. Pettis explains that the framework of social capital should accomplish three things:

1. Create incentives and rewards for innovation that is defendable through legal action.

2. Encourage the creation of business ventures and phase out older, less efficient operations.

3. Maximize participation in the economy by the whole population while minimizing variability in that participation.

Looking at this list, one can derive that the first two imperatives enforce the third. Suppose this framework of social capital is accomplished. In that case, there is an incentive to innovate and be competitive, which leads to new business ventures, and therefore, a higher participation rate in the economy. To Pettis, social capital is not just the social norms but the entire legal, institutional, and economic system along with the relationship between them that allows the economy to absorb more capital investments and drive productivity growth.

Returning to the topic of China, it can be argued that Deng’s reforms in 1978 built the social capital needed to help the country advance. They relieved the constraints and opened the door for China to improve its trade and learn from the outside world. The country boosted productivity by incentivizing the creation of businesses, which created abundant wealth for the population. For instance, during this time, citizens could produce and sell products by themselves without state-controlled interference. However, it wasn’t long before this growth began to push on the walls of what the economy was capable of.

China quickly realized the lack of capital investment disallowed physical capital to catch up with the already established social capital (as discussed earlier). To increase its infrastructure and capacity to grow, Deng instituted what many believe to be an economic development model that was founded by an economist named Alexander Gerschenkron. The Gerschenkron model was developed to describe the growth seen in Europe throughout the 1930s and in the Soviet Union post the second world war. It discusses how countries poised to grow through industrialization start as relatively backward and in need of investment. The backwardness of the economy refers to lacking the necessary resources to develop and industrialize. These items can consist of: insufficient capital, labor, technology, and political stability for the country to organize and expand. One of the essential items on the list for China was the need for physical capital. While investments to develop these assets can be obtained from multiple sources, for instance, foreign investors, the Gerschenkron model recognized that that path was risky and left the country vulnerable to large capital outflows and economic changes in the investor’s homeland. The safer route, which the government of China proceeded with, is to raise savings rates for corporations and elite individuals who would then invest in the economy. More specifically, the government realized that household income growth led to higher consumption and lower savings rates, diminishing domestic investment. By constraining household income, consumption fell, and savings rose. The government then saw that the private sector was skeptical about investing in the needed productive ventures as the country was still relatively undeveloped and risky to fund. In turn, central authorities allocated savings by identifying productive investments and projects, which was relatively easy due to the considerable lack of physical, advantageous assets. This led to the household and corporations’ savings rates to increase during the early 1990s and 2000s, which they then used to invest and grow, as shown in Figure 2.

Figure 2: China’s National Savings Rate (as a Percent of GDP)

While instituting the Gerschenkron model helped China achieve physical capital equivalent to their social capital, there is still an essential part of the growth story that needs to be addressed: demographics.

Adding Fuel

China’s people play a crucial role in its ability to grow. As mentioned at the beginning of the article, before the 1970s, China had several conflicts that hurt its population base. In 1949 Mao Zedong encouraged the citizens to reproduce to restore manpower. This sparked a baby boom where the population grew massively. It became so large that the government began to stress over the number of children and if the people would be able to care for them. A mismatch developed where the number of children added to the growing population; however, they were not working or producing anything, only consuming and draining the country, which put the food supply at risk. For instance, from 1959 to 1961, the Great Chinese Famine killed an estimated 15 to 30 million people, leading to the government’s action to curb population growth. Central authorities began to push for fewer births which worked as the population slowed from 1970 to 1976. However, it leveled off with no movements until the government instituted the famous one-child policy in 1979, which limited couples’ ability to reproduce more than once. Figure 3 displays the effect the policies had on China’s birth rate.

Figure 3: China’s Birth Rate

While slowing the birth rate will most likely hurt China’s growth in the future (discussed later), the fact of the matter was that the population had still grown to be massive. More so, it was full of youth that would age into the working population precisely when Deng took over, instituted reforms, and adopted the Gerschenkron model to grow social and physical capital (as discussed earlier). This led to a perfect storm where China’s working population grew in line with positive structural changes. Figures 4 and 5 display its peak throughout the 1990s and 2000s.

Figure 4: China’s Population by Age Group

Figure 5: China’s Working Population

Take Off!

The combination of reforms, central authorities investing in productive assets, and the labor force coming to age set off an explosion of economic growth within China. The country accelerated its prosperity through the model of transferring savings to investments. It should be noted that the distribution of this newfound wealth was skewed toward the rich and businesses due to the model’s structure of constraining household income growth for workers. However, income grew at such a rate that all Chinese citizens benefited from the expansion, as shown in Figure 6.

Figure 6: China’s Gross National Income

One of the most important events during China’s ascension was its admission into the World Trade Organization (WTO) in 2001. Central authorities saw the trade group as an opportunity to continue to drive change within the country. To meet WTO requirements, further reforms took place that improved both legislative and regulatory requirements. More so, China refined its laws surrounding copyrights, patents, and trademarks while overhauling national economic institutions. Many of the reforms lead back to Pettis’s social capital discussion and how the creation of these organizations allowed for further incentivization of innovation and investment.

WTO also allowed China to join an organization built to provide more structure and regulations in the global trade industry. That, combined with the advancement of transport logistics, communications technology, and the emergence of global value chains, allowed for an environment where China’s export business would thrive. By 2010 China was already the world leader in exports surpassing the U.S. and Germany, as shown in Figure 7.

Figure 7: Share of Global Exports

China continued to grow from 2000 to 2010, pushed by its structural and genuine growth factors. However, as China’s physical capital converged with its ability to absorb it (social capital), the room and opportunity for real wealth and productive investments peaked, which left the country to turn to more cyclical solutions to keep growth rising.

Going Too Far

By 2010, signs of China’s demographics were already showing signs of stagnating. For instance, if one glances at Figure 5 again, it can be seen that the working population peaks at around 70 percent and then begins to fall rapidly. It displayed a significant signal that the fuel that pushed the machine started running out. More so, in comparing China’s population by age to other countries like the Euro Area and the U.S., it can be seen that China is forecasted to be at a considerable disadvantage regarding demographics and the working population. This is most likely due to the implementation of the one-child policy. Please compare Figure 4 with Figures 8 and 9 to see the analysis.

Figure 8: Euro Area’s Population by Age Group:

Figure 9: U.S. Population by Age Group:

While Europe is expected to have a working population that slowly decreases over the next 80 years, the rate at which it is declining is nowhere near as steep as in China. On the other hand, the U.S. is scheduled to steadily increase its working population over time, leaving China the worst out of the group.

China’s productivity was stagnating as well. Figure 10 displays China’s total factor productivity, a measure of an economy's changes over time regarding inputs such as capital and labor. While the country had a massive spike between 2003 and 2011 (over 22 percent), one can observe it slowing as 2010 passed.

Figure 10: China’s Total Factor Productivity

With demographics and productivity leveling, China realized it had to act to keep the growth train running. To do so, a massive amount of cyclical credit expansion was used over the last decade. Figure 11 compares China’s non-financial sector debt as a percent of GDP to the U.S. and Europe. It took China only ten years to lever the economy, whereas Europe and the U.S. took about 30 to 40 years to accomplish the same expansion.

Figure 11: Non-Financial Sector Debt as a Percent of GDP

It should be noted that debt is not necessarily bad as long as it contributes to productive investments that will create real growth higher than the cost. It can be thought of like this: the effective use of debt is an increase in the economy’s debt-servicing capacity (GDP can be used as a proxy) that is larger than the increase in the debt servicing costs. This was the situation within China till the mid-2000s. However, even though real investments began to dry up, China’s central authorities kept using their ability to create and direct credit to whichever area of their choosing through what is called: credit window guidance. This allows a central bank to impose a bank credit growth quota for commercial banks. That forced debt creation to flow into corporates and households (Figure 12) that levered up during the credit expansion and ultimately contributed to investing in non-productive assets that gave the illusion of natural growth. To return the use of debt, in this situation, it should be thought of like this: non-productive assets increase the economy’s debt servicing capacity (still using GDP as a proxy); however, it is now smaller than the increase in the debt servicing costs as these investments turn out to be worth less than initially thought.

Figure 12: China’s Debt Split by Sector (as a Percent of GDP)

Most of the non-productive investments were focused on areas such as real estate and infrastructure. The piling on of credit led to high investment rates and asset price bubbles within these sectors. For instance, in 2018, real estate investment reached eight percent of China’s GDP, as shown in Figure 13.

Figure 13: China’s Real Estate Investment (In USD and as a Percent of GDP)

Popularity in real estate has also boosted the construction industry, which benefited from the increase in building; by 2016, real estate and construction combined for around 29% of China’s GDP. This growth quickly attracted the financial sector as bank lending is the primary source of real estate funding; by the fourth quarter of 2018, real estate loans accounted for about 28% of all outstanding loans and 40% of the new loans being issued. All this funding caused the real estate market to appreciate immensely and attracted higher valuations due to initial capital gains and extrapolations that the asset prices could only go up. The housing market quickly became a way to invest money with the expectation of ample returns - so much so that housing accounts for 78 percent of all assets in China (including stocks, bonds, etc.) compared to 35 percent in the U.S (Figure 14). These investments have caused Chinese households to lever up quickly (Figure 15).

Figure 14: Different Asset Class Valuations in 2017

Figure 15: Household Leverage Ratio by Country

The high leverage in housing and corporations, along with unprecedented asset price appreciation in real estate (and other sectors), has put China at risk and makes for what many economists call an unsustainable growth model. China's central authorities have recognized the threats of high leverage and have vowed to reform and crack down on the reliance on debt for growth. For instance, regulators implemented what became known as “the three red lines” for property developers. These consist of stringent limits on a company’s debt-to-asset, debt-to-equity, and cash-to-short-term debt ratios. These red lines have already affected the real estate market and large developer companies like Evergrande by making it harder for them to access credit, forcing them to pay down debt, liquidate assets, and, in some cases, default.

Returning Safely to Earth

While China has stated its attempts to reverse its course from using the pro-cyclical, debt-heavy model for growth, it still has a lot of change to implement. Pettis argues that growth can only be achieved through investment, consumption, or trade surplus. He breaks each of these options down with different paths China can take (more on that here). To simplify, China has already invested heavily in its economy, and it is what is causing most of the issues. If it were to attempt to reallocate funds into more productive investments, say in the technology sector, it might find that area of the economy unable to accommodate the large inflows. For instance, China currently invests 40 to 45 percent of GDP annually, with around 60 percent split evenly between infrastructure and real estate investment. On the other hand, the technology sector only makes up 10 percent of GDP, making it very difficult to absorb the transfer. More so, there is already plenty of capital chasing high-flying technology ventures, and inflow may cause another bubble and result in more non-productive investments.

As for China’s trade surplus, it is already at around four to five percent and makes up nearly one percent of the rest of the world. For it to increase further seems unlikely for a country of its size as the world most likely could not support the demand needed to sustain this path. That leaves consumption as the only option, which may be the right one when only looking at the numbers. For instance, China’s household consumption only makes up about 38 percent of GDP and is historically low compared to other countries, as shown in Figure 16.

Figure 16: China’s Household Income (as a Percent of GDP)

The reason household consumption is so low is due to household income being strangled from the current model of high savings being invested by elites and corporations. If China reallocates and increases income, the economy could switch its development model from investment-driven to being powered by domestic consumption. However, for this to happen, households must achieve a higher income by keeping more of what they produce. This means a higher share of GDP will have to be allocated away from either business or the government. As companies in China obtain roughly the same percentage of GDP as other countries and would be less willing to transfer it to households, it will most likely have to come from local governments.

The challenge is getting local governments to step away from the high savings and investment model and transition to giving more to households to increase demand. This issue will likely be heavily debated between the central authorities and the local governments in the coming years. For instance, in 2007, then-Premier Wen Jiabao stated that rebalancing domestic demand toward consumption was a top priority for China’s economy. If one glances back at Figure 16, it can be seen that it has been a challenging goal.

The overall issue again comes back to Pettis’s discussion of social capital. China’s current model is built around institutions, laws, and regulations that enforce and benefit governments, corporations, and elites who adhere to high savings and investments. New social capital must be implemented for China to switch to another model based on demand driven by consumption. This is where the issue begins to raise its head. First, it is incredibly difficult to create new social capital and institutions that support a new structure. Second, the groups profiting from the current model have amassed a large amount of political power, which means they may look to block change as the cost of adjusting will most likely fall on them. While the demand-driven path makes sense in numbers, the political consequences could make it challenging to execute.

If China cannot replace these non-productive investments and the artificial growth they create, it is most likely that a contraction will be seen. There are usually two ways that this event can happen. One is a significant drawdown, such as the U.S. in the early 1930s, which is harmful in the short-term but tends to be more beneficial for the economy in the long-term (permitting political or social conflicts does not make things worse) as debts are restructured, and reform is forced into place. Another option is smaller drawdowns that result in stagnant, low growth rates, such as Japan after the 1990s. Pettis argues that if the country cannot pivot, the most likely occurrence would be similar to Japan with a period of ten to 20 years of low growth. This is due to China’s financial system being largely closed off with the ability of financial authorities to control and restructure systemic liabilities before a significant drawdown can occur.

Perhaps the more optimistic and important thing to note is that China’s central authorities, especially the President, Xi Jinping, have recognized the need for change. In a recent speech on understanding China’s new development stage, linked here, he states:

“I noted that our economy was now in a slowing growth phase, a painful structural adjustment phase, and a phase of absorbing the adverse effects of previous stimulus policies. I emphasized that, at the same time, the world economy was also in a period of profound adjustment, which made for an extremely complex economic development environment. This required us to gain a proper understanding of the characteristics of the current stage of Chinese economic development and to undertake practical reforms and adjustments”.

It is a positive signal that Xi Jinping realized that economic growth could not be sustained at current levels nor via current methods. Even though growth will most likely come down from past highs, it can still be achieved through a different driver, such as demand instead of supply. It is also vital to recognize that the President does not face a political cycle making it a more streamlined process for him to implement painful but necessary reforms. However, the political situation will make it difficult and perhaps too constraining for China’s central authorities to implement change, forcing a vicious, self-reinforcing cycle of slow growth. It will most likely depend on Xi Jinping’s ability to implement structural reforms in a timely manner to avoid debts surging to unmanageable levels.

Conclusion

While China’s immense growth seen throughout the past few decades is certainly impressive, there is no denying that the country has developed some structural and cyclical headwinds. To create and sustain real growth in the long-term, China’s central authorities, especially the country’s President, have recognized the situation and are working to implement change. However, it will still be challenging due to the political and structural issues of implementing reform.

Note from Author:

Hi everyone, I apologize for the article’s length; there is just a lot to unpack regarding China’s economy. As always, I hope you enjoyed reading as I enjoyed writing! If you want to learn more, there is an excellent interview with Michael Pettis (whom I mention several times throughout the article), where he speaks on many of the things I discuss. I have included it here:

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Pricing Warrants

Warrant strike prices can be priced in three ways:

• Using the valuation at a recent equity round: In this case, if Company XYZ just raised a Series A round at a $100 million valuation, the strike price of the warrants would be $100 million divided by the number of shares outstanding. This is how the vast majority of warrant strike prices are determined

• Agree to a negotiated value: If there was not a recent equity round, the lender and company may agree to a negotiated strike price

• Using a discount to a future raise: The least common method of pricing warrants is to price at a discount to a future raise. In this case, if Company XYZ knows they will be raising a Series A in eight months, but are closing their venture debt deal this week, the two parties might agreee to have the strike price 10% below the equity value of the upcoming Series A round. If the Company XYZ’s Series A valuation is $100 million, the valuation associated with the warrant’s strike price calculation becomes $90 million

Advantages for Lenders

• Warrants make an excellent complement to venture debt investors’ double-digit interest rates by providing lenders the opportunity to participate in the company’s growth in equity value and high potential upside

• Warrants also help venture debt investors mitigate the heightened risk of startup failure by allowing the equity upside from incredibly successful portfolio companies to compensate for the losses from the 70% - 80% of startups that fail

• Unlike the principal loan amount, warrants present no upfront costs to lenders as payment only occurs once the lender decides to exercise the warrants

• Warrant strike prices are usually priced at the value of company equity at the time of issuance, giving lenders a significant discount on future equity should a portfolio company have significantly grown in value

Advantages for Companies

• Since the lender is required to pay for the shares if they decide to exercise the warrants, the warrants create a source of future cash flow for the company

• Accepting warrants is an excellent incentive to entice venture debt investors to invest in the company, especially when considering that most lenders choose not to exercise their warrants unless the company is being liquidated, or sometimes in cases where the expiry date is approaching and the company growing rapidly

• Warrants typically lead to only 1% - 2% dilution when exercised, which is far less dilution than founders would incur if taking on traditional venture capital financing

Disadvantages for Lenders

• Warrants have a finite life; they can only be exercised on or before the expiry date

• Warrant holders receive no control rights that shareholders traditionally have and warrant holders, by definition, are ineligible for dividend payments

Disadvantages for Companies

• When exercised, warrants do result in mild dilution. Though the dilution is relatively insignificant, many founders rely heavily on venture debt to retain full ownership of their companies, and in these cases warrants can defeat the purpose of seeking venture debt

• If the equity value is higher than the strike price at the time the warrants are exercised, this results in that portion of shares being purchased at a discount

Like all securities, warrants have the potential to shift economic incentives once issued, so careful consideration should always be taken from both parties before approving a deal.

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S2F models are the ideal way to predict the price of any commodity asset or precious metal, as they perfectly reflect a supply and demand intersection. S2F calculates the price of an asset by dividing the total supply by the annual increase in supply, or flow. Despite S2F models theoretically accurately reflecting movements in supply (scarcity) over time and scarcity’s impact on the price of an asset, S2F models are rarely used by investors outside of the crypto sector. While a great tool in a perfectly predictable world, it is impossible to accurately calculate a result using such a model. Take gold for example - no one can know how much gold is mined each day, and no one knows how much sits in vaults around the world. Any estimation would be a wild guess, making the S2F model great in theory, but impractical in real life… unless applied to Bitcoin. Bitcoin was the first asset with a capped supply, and the ability to see the exact flow of supply, all viewable on the blockchain. For the first time, the S2F model had the perfect asset to track.

S2F predicts the price of Bitcoin on any given date by dividing the total supply of Bitcoin, divided by its annual flow. The total supply of Bitcoin was 21 million, though it is estimated that around 2 million of these coins have been lost over the last decade, bringing this number to around 19 million. Annual flow is the number of Bitcoin mined in the year. This can be calculated by multiplying the block reward (6.25 BTC) by the number of blocks mined in a day, multiplied by 365. For more information on how mining works, see a previous article here. The supply divided by annual flow should show the price of Bitcoin, according to the S2F model.

Bitcoin enthusiasts rallied around this model, especially after proving accurate up until the 2021 bull market. The S2F model served as a note of certainty for investors in such a volatile asset – a graph that had been true so far, suggesting that it would probably continue to be true in the future. Unfortunately, that trend has ended. Today, the Bitcoin S2F model suggests that the price of Bitcoin should be about $100,000, and yet the price sits just above $20,000. What happened to the S2F model, and does it still have merit as a price prediction tool in the future?

As with most other growth asset classes, Bitcoin has been dropping over the past few months as a result of the dreary economic conditions rolling in. Bitcoin itself has been hit with wave after wave of problems. From poor government policy written by politicians with no understanding of Bitcoin, to interest rate hikes, and billions of dollars of liquidations, the Bitcoin market has dropped to its 2017 highs, something that has never happened before in the Bitcoin market. The question must be asked, what is the driving force behind the price of Bitcoin? The S2F model says that scarcity should be the largest driving force behind price, and yet economic outlook has overshadowed this fact to decrease the price of Bitcoin well below its fair value. The Bitcoin S2F model has proven inaccurate, not because of its failure as a model, but because of investors’ failure to understand the asset. Treated as a speculative tech stock by wall street, as a pyramid scheme by politicians, and as a get rich quick grab by day traders, Bitcoin is facing a reputation crisis. One might think that an asset such as Bitcoin that is immune to inflation and to poor economic policy by central banks should be the safe haven asset of every investor in the world during these economic times, but the truth is that most Bitcoin investors know little about the underlying technology that makes Bitcoin an attractive investment. As a result, Bitcoin is often treated, even by many sophisticated investors, more so as a speculative, volatile asset that can result in short-term profits, rather than a long-term hold that grants unique benefits to asset holders. The failure of the S2F model serves not as a sign of Bitcoin’s imminent failure, but as a sign that Bitcoin is being looked at wrong by investors and could recover in the coming months. While the worry and fear that came from the recent price drop can cloud the judgment of investors, the S2F price deviation highlights that Bitcoin is an incredibly oversold asset. Confident investors can buy Bitcoin without a worry, knowing the value of the scarce asset they own, while the rest of the world scrambles to make sense of the economy around them. Do not let those clouded by fear change your perception on the value on Bitcoin. If you owned 1 Bitcoin at $60,000, you owned 1/21 millionth of the only true scarce asset on Earth. If you own 1 Bitcoin at $20,000, you still own 1/21 millionth of the only true scare asset on Earth. Pay no mind to the noise, and continue to hold with confidence.

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Investors may get back less than invested. Investments or strategies mentioned on this website may not be suitable for you. This material does not take into account your particular investment objectives, financial situation or needs and is not intended as a financial recommendation.

The US Central Bank conducted the biggest interest raise since 1994 last week, which has undoubtedly spooked investors as evidenced by the headlines running with this narrative.

But rightfully so; paying more than $5 a gallon for gas may have been the norm in California for some time, but even in places with less aggressive oil regulation we have seen the average gas price rise like a rollercoaster with no dip. Inflation is being felt everywhere.

All this is happening as the Central Bank’s credibility teeters, with public trust actually having been at peril for sometime (53% of Americans say they don't trust the central bank, and this was in 2021).

This is not a playbook for what central banks should do next, but more so an exploration of what demographics show us regarding the transfer of wealth, which has not been looking so good recently.

Even with the market sell-off in recent weeks, wealth is abundant, but what happens to wealth over time?

The Population Boom

After the end of two world wars we were treated to a sizeable increase in population growth from the generation we have dubbed the Baby Boomers.

As this generation nears retirement, its important to understand the implications this brings forward.

Prior to the Baby Boomer generation, the population slope had never experienced quite the upheaval it has now seen for the last 70 or so years. You would think that being born into a cohort with more people would lead to more competition for jobs, housing, social programs, spots in good schools, and on a macro level, more competition for things as basic as natural resources. So how did this generation of people from the largest population explosion ever, end up in aggregate, very wealthy?

Interestingly enough, David Willets wrote the book “The Pinch: How the Baby Boomers Took Their Children's Future - And Why They Should Give It Back”. In his book, David alludes to the idea that in a democratic system being part of a larger cohort is actually  preferable because it gives that group more voting power on generational issues and more sway in marketplaces. When the Baby Boomers were young, they voted for policies that benefited them, such as low cost or free higher education, family support systems, and strong social welfare. When the Baby Boomers got to the peaks of their careers, their voting patterns changed again.

Just take a look at the divide between the age of voters in the UK in the last decade alone.

This leads us to where we are today, with a projected $70 trillion in assets expected to be handed down over the next two decades.

The Transfer

Properly addressing and managing the transfer of a generation’s wealth could be the  make or break for an economy. If it is not handled correctly, we could genuinely see assets and businesses go without the stewardship they relied on with their previous owners. Regardless, all of this money changing hands is bound to give a boost to the wallets of a younger generation which has famously been saddled with economic headwinds like student loan debts, stagnant wages, and turbulent job markets.

You might be forgiven for thinking “this is great, it is going to finally give my generation the healthy financial boost they need to unsaddle themselves from debt, or  even just become bigger spenders/investors.” While there are definitely going to be some good things that come from this transfer, it may not be all good news.

Starting with savings, the graph below shows the U.S. Personal Savings rate since the index began. Other than a couple of spikes in December of 1992 and December of 2012, we have not seen this metric rise above 10%: an ode to spending pressures and good marketing that capitalism has produced. Of course you are probably thinking: “What about 2020?” Well, we all know it shot up due to unique market conditions rather than long-term, sustained macro trends. If I had to guess, the pre-existing downward trend only continues into the future.

To add insult to injury, smaller inheritances are more likely to be squandered.

Obviously it is easier to spend less money than it is to spend up more money, but it more has to do with where this money goes.

If I received an inheritance of $50,000, it wouldn’t mean I could quit my job, or even purchase a home with straight cash at this point… (I say this from the perspective of someone living in the US).

Of course, $50,000 would be a fat deposit for a house pretty much anywhere in the world, but it would still be up to the recipient of the inheritance to qualify for financing for the remainder of the purchase price.

An asset-based inheritance may give someone an injection of cash, but it doesn’t increase their incomes or polish up their credit score, so more often than one would think, it is difficult to deploy this capital effectively.

Also, despite the GameStop and r/investing craze from the pandemic, only 58% of Americans have funds invested in the stock market (89% with a household income greater than $100,000). Additionally, only 35% said in 2019, that they had anything invested outside 401(k)s. Another important point to note is that while the median inheritance size is $69,000 dollars, the average inheritance size is over $700,000.

What this means is that a large majority of this wealth transfer is coming from, and going to wealthy households. A lot of this wealth is tied up in small businesses and respective owners/trustee recipients.

How many examples are there of businesses out there that have been successfully run by a CEO after they were promoted into that role from their previous position as son of the CEO?

Of course, successful handovers do happen but reputations exist for a reason.

A US Census Bureau study found that 66% of family businesses do not survive the transition from the first generation to the second, of those that do survive, only 50% then make it on to the third generation. But like I said earlier, the real bulk of inheritance that will likely be of global impact rests in the form of trusts and the dubbed ‘trust-fund babies’ receiving the above-average inheritances.

Most developed nations in the world today have some form of estate tax that is levied on the passing down of assets. This includes the US, where there is a federal tax of 40% charged for estates over 11 million dollars in value. Of course, given this high value, the charges don’t apply to 99.9% of inheritances but for those that it does apply for, those charges are pretty steep. So, naturally when Uncle Sam comes knocking at the door looking for his ‘fair’ share of the estate, the great American has improvised and developed a whole industry around this to shield themselves, where firms like insurance companies will offer life insurance policies to cover the estate tax burden.

Beyond this, it must be recognized that the actual valuations given to family companies can be pretty fluid and more often than not these institutions are valued lower than they probably should be for reporting purposes.

Even more to the point, an 11 million dollar family business would likely have some kind of succession plan in place with pre-existing employees in executive positions. The argument for an estate tax is that while it might cause some turbulence in large institutions during a transition phase, that can be planned for, even if it means taking on a loan, selling some shares in the business, or sitting down with an estate lawyer and jumping through some loopholes.

This tax provides strong revenue from people that can afford to take the loss while also reducing the tax burden on smaller businesses or regular folks that might only get few thousand dollars in their trust fund. So, it will continue coming down to the government primarily to redistribute this wealth over the next two decades. The bigger question is where? Student Loan Forgiveness? Public Infrastructure? The Agriculture Industry?

If anything is to be taken away, it’s the fact that around the globe, wealth will be transferred abundantly over these next decades, and it will be messy, sketchy, ugly, and all of the above. But what will the government do? More importantly what will we do? Are we to make policy decisions that favor us in the moment or will we think longer-term?

"Planning for the future without a sense of history is like planting cut flowers." -Daniel J. Boorstin

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“Millions of people will die because these ports are blocked”- David Beasley, Head of UN World Food Program.

While Russia’s invasion of Ukraine has brought the energy market to the forefront, it has also extrapolated other issues. A significant topic not getting as much media attention is the jeopardization of food security within both emerging and developed markets. Due to the war stress-testing several inputs that go into feeding the population, the world could be pushed into a global food crisis. This article will discuss the war's effects along with some suggested short and long-term solutions to today’s growing food insecurity.

Major Producers At War

Food security has always been an issue, even before the war in Ukraine. Problems such as growing demand, combined supply chain disruptions, currency devaluations, climate change impacts, and a rise in fragility and conflict affect farmers’ abilities to yield crops and feed countries worldwide. Unfortunately, the war has plunged the issue into the deep end by sparking several more disruptions. A considerable number of commodities that go into feeding the world are now being jeopardized as both Russia and Ukraine are major exporters of agricultural products, including wheat, barley, corn, rapeseed, and sunflower oil. Figure 1 shows the major wheat exporters, with Russia and Ukraine being number one and five, respectively.

Figure 1: World’s Largest Wheat Exporters

Together, Russia and Ukraine produce 30 percent of the world’s wheat exports and 60 percent of its sunflower oil. More so, at least 26 countries rely on Russia and/or Ukraine for more than half of their grains. Due to the war, Ukraine’s farmers cannot tend the fields and yield crops. The UN Food and Agriculture Organization (FAO) has estimated that the war will leave 20 to 30 percent of Ukraine’s farmland unplanted or unharvested for the 2022 season. There is also the issue of already harvested and stored grain sitting in ports blocked by the Russian Navy. Figure 2 displays a map of Russian forces within Ukraine controlling any travel out of the Sea of Azov and the Black Sea. As a result, Ukrainian grain exports have been halted.

Figure 2: Map of Russian Forces Within Ukraine

Export Bans Multiply the Pressure

While Ukraine cannot get its exports out to the world, Russia is still free to supply the necessary inputs to produce crops. However, due to the war, Russia has decided to use food as a quiet weapon by banning exports of wheat, meslin, rye, barley, and maize to the countries within the Eurasian Economic Union (EAEU), except Belarus. Russia did not stop with grain products as they swiftly moved to halt exports of fertilizer that countries import to grow their crops. China performed a similar ban on fertilizer exports last summer due to rising global and domestic prices. To control and ensure the fertilizer industry within China would remain stable, the National Development and Reform Commission (NDRC) ordered major fertilizer companies to stop exporting. The desired effect was achieved as the price of fertilizer within the country began to fall; however, the global price was pushed farther up as the supply from China dwindled, as shown in Figure 3.

Figure 3: China’s Ban on Fertilizer Exports

With Russia and China banning fertilizer exports, prices have only risen. With fertilizer becoming more expensive, the effect does not bode well for countries that rely on importing to grow crops. For instance, Brazil, the world's largest fertilizer importer, is already having trouble getting enough nutrients for its produce. Moreover, the South American nation leads in global exports of soybeans, coffee, and sugar, which could be reduced in availability due to the higher prices. Examples of decreasing harvests are already being seen in France, where the agriculture ministry has announced it will cut corn plantings by six percent due to expensive fertilizers. As shown in Figure 4, France plans to sow the smallest land area in the last four years.

Figure 4: France Corn Plantings Shrink

With growing prices and export bans by major agricultural producers, other nations are beginning to fear they will not have enough supply to feed their domestic population. As a result, counterproductive protectionist measures have started to develop in countries banning food commodity exports. By the end of March, 53 new food trade interventions were imposed. Out of the 53, 31 were restrictive to exports, and nine involved curbs on wheat exports. Figure 5 shows the progression of restrictive and liberalizing exports/imports from when COVID-19 began. The pace at which restrictive export curbs are rising reiterates the protectionist culture countries are adapting.

Figure 5: Restrictive Food Export Curbs Rising

More specific examples are shown in Figure 6, a summarized list of countries that banned food exports in the months following the beginning of the war. It is derived from the International Food Policy Research Institute. The complete list that includes other countries that have banned other items such as beef, butter, fruits, and vegetables can be found here. As governments continue to ban crucial exports, the global food supply shrinks, putting tremendous upward pressure on the price of food and food inputs, as discussed in the next section.

Figure 6: Countries with Food Export Bans

The Price of a Meal is Increasing

As the war rages on and countries worry about feeding their domestic population, the global food market continues to be stressed. The war has had a significant effect on the prices of agricultural commodities. For instance, in examining wheat, the price rise is nothing short of astounding and is amplified by the export bans, as seen in Figure 7.

Figure 7: Wheat Prices Rise Substantially

While wheat is a crucial input that goes into feeding the world, it is not the only one. In order to look at rising food prices from a 10,000-foot perspective, one can examine the FAO’s food price index. The index comprises an average of five commodity groups: meat, dairy, cereals, vegetable oils, and sugar. Figure 8 shows the index’s historical price along with the cereal and oil groups. To clarify, the cereal index comprises an average of groups of wheat, maize, barley, sorghum, and rice price indices. The oil index contains an average of ten different oil price indices. Meat, dairy, and sugar are similar in the fact that they are well diversified and show a fair overview of their commodity markets. For the complete description of each index, visit here.

Figure 8: Historical Price of Food Index

All three indices have increased substantially since the start of the war. The most recent report released at the beginning of June indicated that the food price index decreased slightly but is still severely elevated from a year-over-year perspective. This is most likely due to the rising prices in the cereal index, which is led by the surge in wheat, which has increased for the fourth consecutive month. Fertilizer followed the same pattern, rising nearly 20 percent from January to March.

The rate at which the price of food and food inputs are rising is affecting the world in both emerging and developed countries. The effects are felt more in countries with low to middle-income levels. As a typical, low-income family spends two-thirds of its income on food, it is becoming increasingly more difficult for them to afford to eat. The World Bank estimates that ten million people are thrown into extreme poverty for each one percentage point increase in food prices. If food prices stay elevated for the rest of the year, global poverty could go up by more than 100 million.

Emerging-market governments are feeling pressure from rising food prices. Food insecurity has morphed into a source of social unrest. There have already been protests in Sri Lanka, Tunisia, and Peru as governments cannot subsidize enough to keep up with rising energy and food costs. Developed markets are feeling the effects as well. Nearly ten million Britons cut down on food consumption or missed meals in April, and France plans to issue food vouchers to the poorest households. Figure 9 displays a world map with countries that are low, medium, or highly dependent on importing food to feed their domestic population. These countries will continue to feel the effects of the shrinking global food supply and rising prices. The following sections will discuss short and long-term solutions.

Figure 9: Countries’ Net Food Imports as a Percentage of Domestic Food Supply

Short-Term Solutions

Several entities have stepped up to try and relieve growing food insecurity. The World Bank stated that it is launching a financial package to provide support. It will give financial aid to countries, including Ukraine, that are hosting refugees, and developing economies suffering collateral economic shocks. It will begin with $50 billion in the current quarter (quarter one of 2022) and will reach about $170 billion in the 15 months following (in June 2023). The World Bank also stated that for price pressures to dissipate, both developed and emerging markets must reduce their export and import restrictions, which are artificially creating price hikes. The World Bank plans to encourage food production, enable market access and private sector investment, and protect the most vulnerable populations through well-targeted and cost-effective cash transfers. The bank also plans to mobilize two programs. The first is the Global Agriculture and Food Security Program (GAFSP), which G20 set up in response to the 2008 food crisis. The second is a multi-donor trust fund called Food Systems 2030, which can help countries strengthen their food systems to meet short and long-term goals.

Other governments have stepped up to provide funding and expertise in the fight. The U.S. Treasury met in April with multilateral institutions to discuss how to tackle food insecurity. The U.S. then decided to allocate funding to a new global food emergency package, bringing the total amount of assistance given for the issue to nearly $2.6 billion since February. More so, the U.S. plans to relieve the global fertilizer shortage with a $500 million program via the U.S. Department of Agriculture. Looking at other organizations, the Asian Development Bank stated that it, along with the FAO and World Food Program (WFP), will support efforts to feed Afghanistan and Sri Lanka. The African Development Bank will use $1.5 billion to help supply fertilizer and seed to 20 million African farmers.

In terms of the war, an estimated 20 million tons of agricultural products are stuck inside Ukraine. Before the war, the country could export grain and oilseed via ship at a rate of up to six million tons per month. However, about 80 percent of the world’s merchant ships are now stuck in Ukrainian ports, while the other ten percent have been attacked or hit by Russian assaults. More so, Russia now has four submarines in the Black Sea guarding any attempt to export any grain out. The EU is setting up a plan for Ukraine to export the commodities via rail. The union feels they can transport the 20 million tons over the next three months. However, there are severe bottlenecks at the borders as neighbors use different rail gauges. More so, if trucks were to be used, they could be hampered by drivers, fuel, and customs officials. Overall, the plan to exit by land will be much slower and could be dragged down by several bottlenecks.

Long-Term Solutions

Perhaps the shortest long-term solution would be for the ports within Ukraine, for instance, the port of Odesa, to be opened back up, which would immediately alleviate some of the price pressure in the global market. However, with Russia using food as a weapon, this seems unlikely until the war ends. With no knowledge of when this will happen or the outcome, it may be fair to say that it could be some time before Ukraine and Russia return to exporting food. Suppose the ports were to open without the war ending. In that case, it may take some extreme increases in food insecurity that would ultimately force Russia’s hand to make a peace agreement to let the ports operate without any interference from the surrounding battle.

The war will eventually end (hopefully), but the world will still be left with growing food insecurity and will need solutions to tackle it. Most long-term solutions focus on reducing food waste, attacking climate change, and improving infrastructure programs and trade policies. While food insecurity poses a threat, every issue is an opportunity, and this is no different. New ideas must be invented to create a more efficient system for feeding the world. However, funding, whether it is from private ventures, NGOs, or government entities, will be required to fulfill these solutions. The world must recognize that these innovations are needed and continue showing support for them.

Conclusion

Russia’s invasion of Ukraine has pushed fears surrounding the ability of the global population to be fed. The ability to find efficient and timely solutions to growing food insecurity has never been more relevant than now. Governments and organizations must continue to search for the best possible ways to relieve the rising prices and shrinking supply. In the meantime, it is best to hope that the ports within Ukraine can open or that the war ends soon.

I hope you enjoyed reading as I enjoyed writing! If you want to learn more, the Financial Times has a great podcast: The Rachman Review, which recently had an episode discussing the crisis. I have included it here:

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Maybe you’re sick of hearing about voter fraud on the news. Every four years, half of the country is outraged that their favorite politician lost. Four years later, those accused of committing voter fraud in the last election are the ones accusing the other party. Back and forth, we play a ridiculous blame game amongst our nation, never reaching any conclusions or creating sound voting practices to avoid future fraudulent votes. Blockchain technology holds a potential solution for voter fraud that could rework our election day logistics to create a more secure, accessible, and transparent voting system.

Why do voter fraud allegations occur? What do these instances have in common? It is often said that votes have been cast by people unable to vote, be it noncitizens, dead people, or fake individuals that had an identity fabricated to gain an extra say in the choice of candidate. Additional measures to prevent this possibility, like voter ID laws, are often controversial due to their potential for Jim Crow type abuse. Claims of fraud are often non-substantiated, with only a handful of actual voter fraud allegations leading to arrest, but mistrust of America’s elections is nonetheless exacerbated. Whether or not there are large scale operations fabricating votes and swaying elections, it seems prudent and necessary to restore faith in our elections to create a more unified nation.

An technologically enabled election process would be more secure than the one used today. It is difficult to think of a single company that still relies on pencil and paper to do business, but government always lags behind innovation. A ballot, once filled in by the voter at a voting booth, runs through a machine that logs its information, and the ballot is stored in a box for potential recounting. In 2016, there were 230 million ballots cast. Surely, there exists potential for extra slips of paper to go missing or added to a box by a political agent. Mail-in ballots pass through the postal service, reaching the hands of dozens of workers on its path to be counted. Blockchain could provide maximum security and integrity of each vote cast, removing any shred of possible ballot tampering. A user who casts a vote through a blockchain voting system can be sure that their vote will not be changed and will not be touched or tampered by any individual.

Imagine a system where every US citizen eligible to vote is given an NFT worth “1 X year election vote.” A voter could transfer said NFT to whichever politician they want to see elected. Come election night, the person with the highest count wins. These NFTs, minted by the US government, are impossible to replicate or tamper with. Any question on voter eligibility would be auditable, with a record kept on the blockchain of each citizen given an NFT visible to the public. This system could easily protect the privacy of any voter, by not publicly recording who they voted for, but rather whether an individual was given the opportunity to vote. Thousands of ballot counters would no longer be staying up through the night to tally votes, and recounts would be unnecessary. A perfectly auditable and public system that still maintains the privacy of a voter can be accomplished through blockchain voting.

This improved election process would also be more accessible than the one used today. Every year, Americans take the day off work, close their local town halls or schools, and stand in line to enter the voting booth. An incredibly inefficient process such as this could be improved through blockchain. Much like shopping, work, and even doctor appointments can be done at home, so could voting. Any voter could cast their “NFT ballot” from home. Arguably, this might increase voter participation, as it lowers the effort needed to cast a ballot, a win for a democratic republic like the United States that seeks to hear the voices of as many citizens as possible. Those citizens that do not have access to electronic devices at home can simply log in on a publicly available computer, such as those available at libraries.

How might this impact international election sentiment? While any democratic nation should adopt a blockchain voting system to once and for all solve the issue of voter fraud, what about nations that actively suppress their citizens’ votes? North Koreans must love the Kim family; Kim Jung Un received 100% of the votes cast in the latest election. Right? Blockchain serves primarily as transparency in whichever setting it is used. In non-transparent elections, how might blockchain serve a role? While no tyrannical dictator will ever allow for a true, auditable election, adoption of these measures abroad could serve to pressure those leaders. Any step taken by the free world towards freedom and democracy comes at the expense of tyrannical leaders working to suppress their people. Not only would blockchain technology work to make our own elections more efficient, more secure, and more trustworthy, but would serve as a groundbreaking step in the fight for freedom and democracy worldwide.

How do we move towards a safer, more secure, and more accessible voting system? There are still several hurdles to cross before these measures can be adopted worldwide. In 2018, West Virginia piloted a mobile voting application called Voatz, with the goal of increasing voting accessibility. One major problem with Voatz was the issue of identity verification. Doesn’t that bring us right back to the voter ID debate? Creating a program that can verify the identity of hundreds of millions of Americans, accounting for document typos, name changes, address changes, death certificates, etc. is a daunting task. Many of the same issues that create the possibility for voter fraud today might still arise with these scenarios, and more. Denial of Service attacks also pose a threat to a digital voting system. Whichever blockchain is chosen to host a nation’s elections will be fronted with unimaginable traffic all at once. A blockchain that can handle this kind of traffic would be expensive and difficult to make and maintain. If the voting software crashed on election day, then what? Even if it could be done, a foreign attacker could create millions of server requests on the UI side of the program, to crash any NFT wallet provider that would hold the NFT votes. What happens if your vote is inaccessible on election day? These problems, and many more that might arise are enormous hurdles for any blockchain election advocate to overcome. With innovation comes hardship. Nonetheless, the potential for a blockchain voting system is an interesting topic in the digital world and could serve to prevent voter fraud across the globe in the future.

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The two: 1) Britain’s Classical Economics and the evolution into 2) Keynesian Economics

Yet, we are rarely exposed to other systems of thought.

It is ironic that in the ‘Land of the Free, Home of the Brave’ we are not taught more ideas on how free-market economics and its branches of thought can operate. After all, is economics not a social science? Is it not a collection of production and consumption processes all culminating in an attempt to solve the central economic problem of how we utilize finite goods with an infinite appetite for consumption?

This is the foundation of economics: every study, paper, theory, economic policy, or experiment is ultimately an attempt to find a solution to a problem, that by its very nature, has no single best solution.

So let this be a call to continue diversifying thought and open up exposure to other ideas on how to approach this central allocation problem that unifies all economic theories.

Now, the first thing to know about all of these schools of thought is that they all agree with one another on most issues. For example, the concept of opportunity costs: the forgone benefits that would have been derived from an option not chosen. But economists can differ on the concept of taxation of businesses and how to approach taxation. Going back to the idea of economics as a social science, there is a certain element of philosophy and morality that influences every economic decision, no matter how much economists attempt to wash it away with mathematics.

To make matters even tougher, the only real way to apply a new theory come is to study the results, which means phasing out current policy and bringing in a proposed untested new policy. This is difficult to implement because the stakes are so high; should a policy shift go unexpectedly wrong, it would have an impact on thousands if not millions of lives.

Furthermore, I have a gut feeling that most economists deep down have questioned the very models they use today for their forecasting ability (ahem, U.S. Federal Reserve). So I do believe there are plenty of economists that agree with some of the principles of one school of thought and then disagree wildly on some other areas. This is actually a good thing.

To make sense of things I want to look at the two school’s of thought I presented at the start, and a third one: 3) Austrian Economics.

1) Britain’s Classical Economics

This is the big boy, the elephant in the room that will probably never go away, and it shouldn’t. For all the flaws that Adam Smith brought forward with his monumental book, “The Wealth of Nations," released in 1776, his adamant support for further Division of Labor among manufacturing lines, compounded by Immanuel Kant’s own book, “The Groundwork and Metaphysics of Morals,” in 1785 have since led us to realize advancements in productivity that for some seemed unfathomable. Kant stated:

“All crafts, trades and arts have profited from the division of labour; for when each worker sticks to one particular kind of work that needs to be handled differently from all the others, he can do it better and more easily than when one person does everything. Where work is not thus differentiated and divided, where everyone is a jack-of-all-trades, the crafts remain at an utterly primitive level.”

As suggestions of how to build a better world, these were the prescriptions of these early economists when economists weren’t even a thing.

Markets should be free because the more that people are allowed to trade freely with one another, the more they can specialize and count on others to specialize to deliver all of the goods that they need.

Nations have also done the same thing; they stopped trying to hoard gold as would be suggested by mercantilist philosophies and instead realized who does what well. Once this is known, trade amongst other nations increased wealth and allowed countries too, to specialize.

Government intervention in free markets should be limited exclusively to making sure that contracts are upheld and fraud is not allowed to take place. This gave us an economic incentive to have a government and create laws and next thing you know, you have a society that through classical economics, is assumed that everybody buying, selling, and working is perfectly rational and will always make the most logical decision possible to forward their own selfish interests.

More or less, classical economics argues that we can all work together to make the world a better place by being selfish. It certainly helped accelerate us into this high-tech world.

2) Keynesian Economics

Prior to Mark Zuckerberg making a dating app on a college campus, and before the forewarnings of Nero and the Matrix, came along John Maynard Keynes. He would advocate for stronger government intervention through further regulation of central banks. So putting Bretton Woods aside, what did Keynes bring forward?

If a regular person has heard of any economists, it would be Keynes. He is touted as the most influential economist of the 20th century and he defined the way that almost all governments around the world manage their economic affairs as the rollout of new technologies bolstered by global wars changed the economic landscape.

Factories, markets, advanced financial systems, consumer debt, and public corporations were all commonplace during Keynes’ time, and the ebbs and flows of national prosperity were no longer determined by the harvest but rather by the business cycle. Around this time, economies started experiencing ups and downs that could not be explained exclusively by outside forces, but rather by the sentiment of the people within the nation. Since consumers were the center of modern economies, their changing preferences, expectations, and feelings of optimism, fear, or doubt impacted the economy. This led to the widely-accepted realization of business cycles and boy did Keynes have a solution for us.

The solution was to try and smooth out this business cycle by artificially influencing the spending of consumers. And who better to do this than our own governments? Nations would do this through fiscal policy, which called for taxing people more and spending less government money during economic booms, and then taxing less and spending more during an economic downturn. It would also be influenced by monetary policy set by a nation’s central bank, which really is just a doorway for political and financial entities to comingle, kind of like Paul and Nancy Pelosi.

As it sounds, Keynesian Economics advocated for more intervention from regulators of power, which is why I have a deep suspicion Austrian Economics was never to really take off across these major groups of power.

3) Austrian Economics

The Austrian school hated the idea of Keynesian Economics because it was tampering with the free market, which would limit efficiency and cause a whole host of other, unintended problems.

It was dubbed Austrian Economics because of its birthplace in Vienna (although founded by a Polish man).

The Austrian school shares a lot of similarities with classical economics and most of the economists that have now gone on to define this field didn’t even know that they were creating an academic discipline of economics, in the same way that Adam Smith didn’t know he was creating economics as we know it. What this school of thought did was refocus the power and interests on the consumer, the individual.

With this, these scholars started adding in more allowances for how individuals acted, and specifically how they valued things. Carl Menger was the father of the Austrian School of Economics and is credited with contributing to the theory of Marginal Utility alongside his student Friedrich von Vieser. The theory of marginal utility was an extremely important contribution to economics as a whole. It argued that goods provide a utility, but their utility is decreased for every extra unit of that good there is.

This ran contrary to the classical school of economics which simply advocated for making as much stuff as possible and then letting the free market decide what went where. Now again this might sounds obvious to us now, but you have to remember some important things.

This was the first inkling of economic theory adapting to a world of genuine sustained growth. Before the 1800’s, the idea that anybody could have too much of something was pretty bizarre, but with factories all across Europe working day and night to produce all manner of everything, the decisions everybody were making were starting to shift from, “can I afford this?” to “would I rather have this or that?” This deeper understanding in a world that was becoming more and more plentiful eventually culminated in the Subjective Theory of Value.

This theory argues that an item is not worth the sum of the materials and labor that go into making it, but rather it is worth a function of how important it is. For example, this would explain why diamonds are worth more than water if the latter is needed to survive and the former is not.

However today, Austrian economics is today seen by most conventional economists as a very fringe ideology for its reliance on conjecture rather than rigorous mathematics and statistics.

This makes a lot of their theories non-falsifiable, which in plain English means they are impossible to prove wrong, which sounds great, but in reality it just means that because there are no rigorous models drawn or prescriptions set, it’s very hard to contradict the theories. And like I said earlier, economics is not usually the place you want to ‘test’ your ideas out, given the risks of a major economic collapse.

My point is there is no ‘right’ framework for an economy to operate in; it will always be messy somehow and maybe that is the beauty of it all along. But that also does not mean that we try to fix a problem with solutions that continue to put Blu Tack on the cracks of the Hoover dam. We need greater diversity of thought and to solve 21st century problems, we require 21st century solutions.

So, maybe we all just need to stop and look around.

“Life moves pretty fast. If you don't stop and look around once in a while, you could miss it.” - Ferris Bueller

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If you have checked your day trading account, retirement account, or listened to the news, you may have noticed that the stock market has hit a bit of a rough patch in the past month and 2022 as a whole. Earlier last week, the S&P 500 was down 20% from its highs set in December, placing it in bear market territory (Figure 1).

Figure 1: S&P Drawdowns Since 1900

The main perpetrator of this sell-off has been the lofty valuation multiples (P/E, EV/EBITDA, etc.) that equities received after two years of stimulus. In the low interest rate environment that took place in reaction to the pandemic, risk asset values soared. Investors were “pushed” into riskier assets, such as high beta stocks, to get higher returns than near-zero yielding safe government bonds. This pushed multiples higher. However, as interest rates have rapidly risen in 2022, these valuations have come back down to Earth (Figure 2).

Figure 2: S&P 500 Price to Earnings and the U.S. 10 Year

This type of multiple compression was seen at a more drastic scale for tech stocks during the popping of the Dotcom Bubble (Figure 3). Like the Dotcom Bubble, we see multiples compress before earnings fall. With markets being forward-looking entities, are growth stock multiples fully priced to reflect a decrease in earnings, or will there be further pain as earnings decrease? If they aren’t fully priced in, how will the markets react when earnings actually get bad like those seen during previous recessions?

Figure 3: U.S. Tech Stocks’ Price and Earnings Now Compared to Dotcom Bubble

Despite the drastic compression in multiples seen in the past couple of weeks, there may still be some room on the downside. During the hangover of the Dotcom Bubble, the P/E for S&P companies fell to ~-7x below the historic 5-year moving average (Figure 4). While the S&P 500 is already -2x below its 5-year moving average, there may still be room for further compression. It is unlikely to see compression to the same degree as the Dotcom Bubble, but still enough for the S&P 500 to further decline on a multiple basis.

Figure 4: S&P 500 P/E Minus 5-Year Moving Average

The other main driver that determines the S&P’s value is earnings. Earnings are still expected to increase by around 10% next year because of this lagged effect of interest rates (Figure 5). However, margins have started to show signs of compressing due to higher inflation and exceptionally high readings of the PPI as companies’ input costs rise faster than the price of the goods they sell. Even though companies may be beating earnings estimates, margins become more critical in inflationary environments.

Figure 5: Earnings Set to Increase as Margins Get Squeezed

Retail sales can be seen as an example of inflation’s effect on earnings (Figure 6). On paper, what is reported in earnings filings, retail sales have increased heavily in 2022. However, using 2019 price levels, real retail sales appeared to have peaked in the first half of 2021.

Figure 6: Inflation-Adjusted Retail Sales

These inflationary pressures have started to eat into traditional retailers like Walmart (Figure 7). Consumer staple (CS) stocks, including Walmart, are thought to be safe places to hide out during equity sell-offs. Before May, CS stocks were able to fend off the sell-off that plagued the rest of the S&P 500. However, several value retailers like Walmart and Target reported disappointing Q1 earnings, citing inflation driven by higher transportation costs from fuel and employment costs (CNBC).

Figure 7: Walmart Getting Beaten By Inflation

Overall, this has been the worst return of the S&P 500 during an earnings season by a wide margin in the past decade (Figure 8). While there have been many other macro factors at play, saying it is occurring amid a -20% S&P drawdown, this is a sign of investors starting to price in worsening future earnings likely due to rising recession risks.

Figure 8: Average Weekly S&P 500 Return In Earnings Seasons

Growth stocks have been one of the worst areas hit by this equity sell-off. The last time growth stocks were this overvalued compared to value stocks was during the Dotcom Bubble. The growth to value ratio has significantly decreased from its peak but still has a way to return to the historical mean.

Figure 9: Growth to Value Stock Ratio

This overvaluation of growth stocks compared to value stocks was a symptom of a low interest rate environment. This relationship between the growth to value stock rotation and interest rates can also be seen through the high to low beta (essentially the same thing as growth stocks, which have a higher beta due to their increased risk) and the 2-year change in the 10 year advanced by 18 months (Figure 10). The effects of interest rates historically appear to be strong on the high to low beta ratio. The rapid increase in the 10 year in 2022 shows that high beta stocks are in for a rough couple of months.

Figure 10: High vs. Low Beta Stocks with the 2-Year Change in the 10 Year Advanced by 18 Months

Speculation levels in the options market have also settled. Put option open interest, which is used to hedge falling security prices, has outpaced call option open interest, which pays off when a security’s value rises above the strike price. Many day-traders used call options as a speculative tool in the past two years to leverage their positions. However, the wind has sharply shifted as investors use more put options to hedge against falling equity values.

Figure 11: Put to Call Option Ratio Means Portfolios are Bracing for Choppy Waters

Finally, this was stolen from another substack; even though the carnage in the equity market has been brutal there is still room to fall. Looking at equity risk premium, which is calculated by subtracting real yields from equity earning yields, equities still haven’t reached the historically cheap level (Figure 12). With the Fed put a non-existent option for the equity market, the idea that the Fed will step in to save markets as they have in the past two decades seems to be far-fetched in an inflationary environment. The Fed is focused on controlling inflation, especially being able to produce results before the midterm elections in November.

Figure 12: Equity Risk Premium is Saying Equities Still Have Room to Fall

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Stable coins maintain their pegged value through algorithmic issuance of tokens. While the tokens trade based on traditional market supply and demand, the issuing body (Tether, Circle, Luna) adds or removes tokens to stabilize the price. When the crypto market has a red day, investors flock to stable coins to avoid further losses, waiting to jump back into their original investments once they have bottomed out. On these red days, demand for stable coins is hot, and the price might increase by a small amount. The issuing body would then issue additional tokens to stabilize the price.

Stable coins are not always pegged at $1. Several projects seek to back their tokens with decentralized blockchain assets, most commonly Bitcoin or Ether. On-chain collateral for their currency removes any speculation or doubt that the issuing body has full backing for their currency. This is important for investors, as falsified collateral reports have been published in the past. Tether, issuer of UST, the largest stable coin to date, was fined $41 million by the CFTC after it was discovered that they only had enough collateral to back their tokens about 25% of the time. On-chain collateral would be visible and transparent to any investor.

Terra was one of the first issuers to back their stable coin, UST, with on-chain digital assets, using their token Luna. It is important to note that Terra also had several billion dollars in Bitcoin collateral on the side. Their stable coin UST was pegged at $1, but in periods of demand for stable coins, the price might rise to $1.01. At this point, investors in Luna can convert their Luna for UST. This increases the supply of UST, which will help bring down the market price back to $1. The investor can then sell the UST at $1.01, making 1% on the transaction. The brilliance of the TerraUST/Luna conversion is that investors are incentivized with an arbitrage opportunity to regulate and maintain the stable coin’s price. In the Terra ecosystem, no issuing body increases or decreases the supply of UST; rather the market does so itself. Investors trust that this self-correcting cycle will hold up their stable coin.

On May 10th, the price of UST fell from $1 to $0.62, a shock to the cryptocurrency community. In the following days, it fell further to less than a cent. For the last six months, crypto lending platform Anchor offered a 20% yield to investors who bought UST and lent it on the Anchor protocol. This move was meant to be a marketing campaign by Terra, hoping to draw in new customers. Such a high return led to countless investors flocking to UST, hoping to be rewarded with such a high yield. This opened the door for a dramatic attack, being likened to George Soros’ attack on the Bank of England.

Terra held several billion dollars worth of Bitcoin in collateral for its UST stable coin. An attacker borrowed $3 billion in Bitcoin and bought about $1 billion in UST. The attacker then started selling the UST very quickly, destabilizing UST and dropping it below the $1 peg. Terra sold more and more Bitcoin as the price of UST dropped, hoping to restabilize the price. However, this caused the Bitcoin market to tank as well, with so many coins entering the market. The attacker then bought back their Bitcoin, essentially “short selling” Bitcoin for a huge profit. As a result of the attacker dumping $1 billion in UST on the open market, other market participants lost faith in the stable coin and their promised 20% yield, causing a massive bank-run on UST, with almost all holders attempting to sell. As a result, the attacking party made off with a huge gain on their short sale of Bitcoin. UST and Luna are now worth practically nothing, as investors lost faith in the tokens.

While on-chain collateral for stable coins was a widely anticipated development for the crypto community, the Terra attack shows two important lessons for investors. First, the attacker relied on the widespread panic and subsequent bank run on UST once its price was low enough that investors lost faith. Stable coins with larger market caps, and therefore larger liquidity pools, are harder to manipulate. While no stable coin issuer can simply increase their market cap at will, investors and issuers alike should see the benefits of more established projects, understanding that smaller cap projects are riskier investments, as they are prone to similar attacks. Second, the irresponsibility of Do Kwan, founder of Terra, is greatly responsible for the bank run that occurred on his token. Kwan, an energetic and eccentric entrepreneur, is also a shady businessman, who began his career with an algorithmic stable coin project named Basis Cash in 2020, which also failed to maintain its $1 peg. Kwan’s 20% yield Anchor marketing campaign was unsustainable from the start and was designed to be a Ponzi scheme. Kwan paid investors their 20% yield with money from new investors, taking advantage of investors for his own company’s gain. The unrealistic expectations of investors led to their exaggerated fear when the coin dropped, causing the bank run and crash of UST. Investors need to be wary of unrealistic returns and conduct research on the individuals they are trusting with their money.

Want to hear more from us? Be sure to subscribe to Venture Time to see weekly posts on subjects ranging from investing and entrepreneurship to macroeconomics and cryptocurrency.

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What do you know about our company/organization?

This question is not about your company knowledge, it’s about your investment in the opportunity you’re seeking. It’s not uncommon for people run a quick google search to brush up on a few facts to bring into the interview. However, to set yourself apart you need to familiarize yourself with 1) the leadership, 2) the product, and 3) the mission to fully understand the company/organization you are looking to be a part of. To put it simply, this prompt is assessing how much you care. Ensure you align what you’ve learned with your goals and principles. If you find issues with the company that compromise your values or that indicate poor leadership, then maybe it’s not the place for you. Preparing for this question in advance will not only show you care, but also help you to avoid job dissatisfaction down the road.

What are your strengths?

This question requires a balance of confidence and humbleness to avoid coming across as arrogant. You need to believe in your abilities to fill the role you’re applying for, but not so much that you prove yourself incapable of learning from others. Unlike weaknesses, most people won’t take your word for self-proclaimed strengths. Structure your answer with either 1) a strength applicable to the job, 2) a strength you’ve applied in a previous experience, or 3) a personality-related strength. A strength applicable to the job provides the potential to fill hiring gaps, while a previously applied strength allows you to reference other people who gave you related positive feedback. Finally, personality traits such as the ability to persevere or adapt are a perfect opportunity to pull from your personal “story” and times where you’ve experienced personal growth. This type of well-rounded answer will back-up your answer, prove you’ll be valuable in the role, and demonstrate humble, personal reflection.

Tell me about yourself

This is an opportunity to present your own personal pitch and an answer you should practice and commit to memory. This prompt may appear easy at first, but it’s important to have reasoning behind your response and avoid listing off the details already on your resume. It’s a perfect mix of who you are and why you’re valuable to the role you’re applying to. First, think about something you do that promotes an active and healthy lifestyle and make sure you give a reason why you do it. Next, mention volunteer work/instances of giving back and what it’s taught you. You should show that you do more than just work and that what you do is important to who you are. This demonstrates initiative. Finally, mention industry applicable experience, how it has added to your skillset, and why you found value in the work. It’s imperative that every answer has a reason to be there and there’s a “because.” This structure will allow you to efficiently convey personal and professional aspects about yourself as well as your involvement with your community. The number one thing to remember is presenting what you do as valuable with concrete, confident answers.

What’s your biggest weakness?

This is one of the most uncomfortable questions to be asked during an interview. Instinct may tell you to deny all weaknesses because it’s easy to assume that the interviewer is trying to find something that may disqualify you from the job. However, this question can be one of your greatest strengths if you give a well-structured answer. The interviewer isn’t evaluating your self-proclaimed weakness as much as they are focusing on how you answer the question. People who are unable to see their own flaws are often difficult to train and work with. It’s not about the weakness, it’s about demonstrating self-awareness and an ability to act upon improvement areas. Avoid stating that you don’t have any faults or taking too long to think about your answer. It gives the impression you’ve never self-evaluated your weak points before. A weakness that you are actively improving is something to be admired because it demonstrates self-awareness, reflection, and discipline. There are three types of weaknesses you can have in an interview 1) a weakness you are correcting, 2) a weakness that doesn’t interfere with the job, and 3) a weakness with a lighthearted response. You should always begin with a weakness you are correcting and continue with the list if multiple answers are requested. It’s important to think about the who, what, where, when, and why of a specific scenario and avoid general answers. This opens up the opportunity for you to reflect on what you’ve learned and the actions being taken to improve. The next two types of weaknesses will ensure that any further examples won’t detract from the impact of your first response.

Tell me about a time when you’ve took on a leadership role

The number one thing to focus on is how you have resolved conflict. Leaders have a difficult job, because they are responsible for their team’s success and culture. This is a great opportunity to highlight your abilities in a hostile or stressful situation. Focus on 1) how you’ll address those involved and 2) what actions you’ll take if you don’t have the answer. Think of a conflict in the past that you’ve resolved and highlight the skills you exhibited to find a solution. Admitting that sometimes you don’t have the answer can show that you’re not afraid of asking for help. When speaking about your leadership, be sure to highlight the accomplishments of the team as a whole over personal accomplishments. It is easy to think that in an interview the goal is to assign as much credit to yourself as possible, but the best leaders are true team players that recognize the role that the team as a whole played in the orchestration of positive outcomes. By highlighting the team’s accomplishments, and even personal accomplishments for other team members that you helped facilitate, you appear to be a stronger leader than if you only highlighted your own personal accomplishments. If you’ve never held a leadership role, think of a time where you’ve solved a problem that had a positive impact on a larger group of people, or how you’ll build upon your experience as a team member to be a good leader.

So, you didn’t get the job…

No matter how prepared you are, sometimes things just don’t work out. Your attitude after the interview is what determines your success in the next one. The best thing to do is to kindly thank your interviewers and ask them for feedback. Most people don’t take an interview “class” and those who are best are the ones who have had the most practice (this is often those who have been rejected multiple times). Practice makes perfect and understanding where you could improve is key to opening up even better opportunities in the future.

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This is the idea that inspired the creation of geothermal energy infrastructure, which harnesses heat energy emanating from inside the Earth. Geothermal technologies, while under-resourced today, have the potential to solve climate change and hold significant advantages over current non-renewable and renewable energy technologies. The remainder of this article explains how geothermal technologies work, the different applications of these technologies, why it could be one of the best sources of clean energy, and how likely it is to be adopted by existing players in the energy industry.

Geothermal Technologies Explained

Geothermal technology harnesses thermal energy from beneath the Earth’s crust. Traditional geothermal energy is obtained by siphoning heat from nearby volcanoes or areas where geothermal resources are close to the surface (such as California), but these techniques are limited in their applicability, as there are many areas of the world where these conditions do not exist. However, many innovative alternatives to traditional geothermal technologies have been developed that make it possible to obtain geothermal energy from almost anywhere in the world.

One such alternative is called EGS, or engineered geothermal systems. In an EGS, several wells are drilled. Then, the rock at the bottom of each well is fractured, creating a reservoir. A fluid is then sent down, percolating through the cracks. The fluid comes up a well on the other end of the reservoir and is extremely hot, making it useful for heating buildings directly or going through a turbine to produce electricity. A simple example is shown in Figure 1, as detailed in Jamie Beard’s excellent TED Talk on this subject.

Another alternative to traditional geothermal technologies is closed-loop systems. Closed-loop systems are similar to EGS in that they involve drilling multiple wells and creating an underground reservoir. However, instead of using fracking to create a reservoir, the reservoir is entirely drilled. EGS typically uses water as a medium to propogate thermal energy, but closed-loop system designs enable the use of optimized working fluids that heat up faster than water and at lower temperatures. One of the most effective of these working fluids uses carbon dioxide, and not only is the use of these fluids less water intensive, but it also reduces climate change. Examples of closed-loop systems can be seen in Figures 2 and 3.

Some geothermal companies have even developed hybrid systems that benefit from the increased surface area and heat from the fracking used by EGS as well as the use of optimized working fluids and low drilling costs associated with closed-loop systems.

Why Geothermal Technologies Could Play a Pivotal Role in Solving Climate Change

Geothermal technologies are rapidly evolving, and due to the recent development of EGS and closed-loop systems, these technologies are becoming implementable across the globe. Not only is geothermal energy 100% renewable, but the processes used to obtain it produces minimal greenhouse gases. More importantly, geothermal technologies can be implemented using much of the same infrastructure currently used to drill for oil.

Currently, most applications of geothermal technology are limited by their geographic closeness to a volcano. This is because volcanoes are among the only accessible locations on the Earth’s crust where the conditions necessary to harness geothermal energy exist: hot rocks, pore spaces in the rocks, and water filling those pore spaces. Luckily, the oil and gas industry has developed innovative technologies that solve this problem, such as drill bits that can steer towards areas under the Earth’s surface that possess the aforementioned conditions and fracking technology that creates new pore spaces underground. While these technologies were originally created to access oil stores, they can easily be adapted to create or tap into areas where geothermal energy can be siphoned.

Many avid environmentalists suggest that geothermal may be the key to making the oil industry sustainable, because pre-existing oil drilling infrastructure can be adapted to obtain geothermal energy relatively easily. But what about the jobs lost due to this transition? Well, the transition towards geothermal would actually result in the creation of an estimated 3-4 times more jobs than other renewables. Part of the reasoning behind this statistic is that because geothermal technology requires much of the same infrastructure and expertise as the oil and gas industry, few if any workers in the oil and gas industry would experience structural unemployment due to a transition to geothermal energy. As Jamie Beard put it, “we don’t have to retrain geophysicists to install solar panels; we can let geophysicists do what geophysicists do best, but for geothermal instead of hydrocarbons.” Hypothetically, geothermal should stand as a politically non-polarizing solution that addresses climate change but also keeps the oil industry alive and oil workers employed.

But how does this flavor of geothermal compare with other renewable energy sources? Estimates rank geothermal as one of the least expensive sources of energy, being as much as 80% less expensive than oil and gas at scale. Additionally, unlike many solar and electric technologies that rely on rare earth minerals to remain functional, geothermal technologies are not dependent on limited, nonrenewable resources. Geothermal technologies can also harness energy regardless of weather conditions, contrary to wind or solar technologies. As such, when applied to energy grids, geothermal systems do not require methods of energy storage, mitigating the intermittency problems associated with wind and solar. As is shown by the Global Energy Network Institute in Figure 5, these attributes make geothermal a significantly more reliable energy source than other renewables.

Geothermal systems are shown to be highly energy efficient, using 25% - 50% less energy than alternatives to power systems used for harnessing energy. Geothermal systems also have a long lifespan, with pipes lasting between 25 and 50 years and pumps lasting for at least 20 years.

Disadvantages to Geothermal Technologies

Despite having a plethora of advantages over current energy technologies, geothermal is by no means perfect. Below are the main disadvantages to geothermal technologies:

• Geothermal power plants emit 97% less acid rain-causing compounds and about 99% less carbon dioxide than fossil fuel counterparts of the same size, but nonetheless, they do emit relatively small amounts of greenhouse gases in the form of hydrogen sulfide, carbon dioxide, methane, and ammonia.

• The fracking procedures used in EGS use a high amount of drinkable water, and may result in other environmental externalities. All non-traditional geothermal procedures also have the potential to contaminate groundwater.

• Specific locations can cool down over time, making it impossible to harvest more geothermal energy in the future. The only way to get around this problem in the long-term is by sourcing geothermal energy directly from magma, and the technology for this is still in the very early stages of development.

• Much like oil drilling, geothermal drilling can increase the frequency and intensity of earthquakes in certain areas. For example, Europe and South Korea have both experienced man-made earthquakes due to geothermal projects. While the increase in seismicity is almost always not enough to be felt by humans, the potential for man-made earthquakes still exists. Luckily, the oil and gas industry has developed advanced technologies to monitor seismicity to best prevent these kinds of earthquakes from occurring.

• Most of the ideal land in the US that could be used to harness geothermal energy is on federal land, and it is far harder to develop a geothermal project on federal land than an oil project. This is because geothermal projects are subject to the National Environmental Policy Act (NEPA) and without a categorical exclusion like oil and gas development has, it is nearly impossible to gain approval for the development of a geothermal project on federal land. Since geothermal energy does not have a lobby to convince the US government to change this policy, most geothermal projects have to be on state or private land for the time being.

• Currently, the most significant limitation of geothermal technologies is the need for a geographic closeness to thin crust areas or volcanoes. Unfortunately, technologies such as EGS and closed-loop systems have not yet reached scale and are primarily being developed by startups.

How Likely are Oil and Gas Companies to Embrace Geothermal?

According to Jamie Beard, “most oil and gas companies have geothermal teams and corporate leaders,” but how likely is it that oil companies will fully embrace this promising technology? Just last September, 12 of the world’s largest oil and gas companies pledged to become net zero, but without a specific timeframe. Despite the synergies between some renewables, such as geothermal, and oil companies’ stated emissions goals, the industry has not put its money where its mouth is. In 2020, the entire oil and gas industry invested $12.7 billion into clean energy solutions, a disappointing 0.2% of the industry’s $4.68 trillion in revenue. In 2021, about $100 million in investments went to geothermal startups specifically, with many of these dollars coming from oil and gas companies. Oil and gas companies tend not to show interest in a technology unless it shows considerable scalability, so these relatively low investment amounts may reflect that oil companies are primarily investing in geothermal startups to see what happens while leaving the door open to acquire first-movers who prove a concept scalable and profitable.

No matter how small these amounts might sound compared to the scope of the climate crisis, Jamie Beard estimates that only half a billion dollars worth of field deployments would be enough to garner a scalable geothermal concept. While oil and gas companies championing geothermal technologies would obviously accelerate the evolution and adoption of the technology beyond belief, the geothermal revolution appears to be marching on without this tailwind. For example, a geothermal startup called Sage Geosystems has begun retrofitting abandoned oil wells to siphon geothermal energy in Texas. There are currently over 29 million “orphan wells” across the globe, all of which having the potential to contaminate land, water, and air, while harming ecosystems, wildlife, livestock, and humans. Orphan wells also emit about 2.5 million tons of methane per year, the climate damage equivalent of three weeks of global oil consumption. While these abandoned wells may be perceived as useless by oil companies once oil dries up, they are free infrastructure for innovative geothermal startups like Sage.

Sage Geosystems happens to be primarily comprised of oil and gas veterans who used their knowledge of conventional oil industry technologies to make clean energy through geothermal applications. It is not unusual to find oil and gas veterans applying their pre-existing relationships and technical expertise to the geothermal startup space. Hopefully, these entrepreneurs will successfully leverage their connections to the oil and gas industry in order to form partnerships that will lead to wider adoption of geothermal technologies.

As oil companies start to feel the shrinking pain associated with being outcompeted by renewables, they will eventually be forced to adopt sustainable technologies in order to maintain their scale. Geothermal technologies offer oil and gas companies the once-in-a-lifetime opportunity to maintain their scale, provide lower energy prices to customers, maintain their workforce, and actually reach their net zero emissions goals. It is uncertain whether these corporate giants will recognize the potential of geothermal technologies before it is too late to preserve their size. More importantly, if oil companies can successfully adopt and scale these technologies, they could transition from being the cause of climate change to the solution. The oil industry’s redemption arc can be imagined, but will it be realized? Only time will tell.

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Roughly 13,000 years ago during the Pleistocene ice age, humans were able to traverse across the Bering Sea from Asia into North America. Today, we are beginning to see another opportunity forming near the Arctic, this time due to the melting of the polar ice caps.

The image above shows the declining size of the ice caps, and while this will have negative consequences to coastal cities, ecosystems, and humans, it also opens the door for new traveling routes across the Arctic ocean. This article focuses on what nations are planning to do in the region and particularly focuses on Russia’s objectives.

“Increased ice melt in the Arctic will open up shorter transit routes to Asia, provide easier access to proven substantial reserves of unexploited natural resources, and see a continued increase in tourism and visitor numbers. While offering economic benefits to the region, there will be a greater risk of accidents and environmental disasters such as oil spills, which will require close cooperation with all Arctic states and Arctic communities to ensure safety at sea.” - The UK’s Defence Contribution in the High North

As much as we would all love to see the ice caps preserved, governments have been prepping and bolstering their capabilities for greater travel and movement across the region for some time now, as can be seen in the infographic below.

Why? Well, like the quote from earlier said, there are “proven substantial reserves of unexploited natural resources,” and a lot more resources than most would think.

The United States Geological Survey (USGS) released the very first assessment of Arctic oil and gas resources in 2008, revealing that the Arctic holds 13% of the world’s undiscovered oil reserves and 30% of the world’s undiscovered natural gas reserves, of which Russia holds more than half. While many argue that Russia cannot keep up with the financial costs of war in Ukraine, it is no secret that Putin views the Arctic as a pile of untapped cash. Commodity prices are high and the Arctic represents a vast treasure trove of commodities.

Another point mentioned was the “shorter transit routes to Asia.”

Typically, shipping to Japan from Rotterdam would use the Suez Canal and take about 30 days, whereas a route from New York would use the Panama Canal and take about 25 days. But if the Europe-Asia trip used the Northern Sea Route along the northern coast of Russia, the trip would last 18 days and the distance would shrink from around 11,500 nautical miles to 6,900 nautical miles. For the U.S.-Asia trip through the Northwest Passage, it would take 21 days, rather than 25.

Controlling these routes brings significant advantages to countries and corporations looking for a competitive edge.

Going back to Russia, we saw the build-up of Russian troops around the Ukraine-Russia border as early as March and April of 2021, almost an entire year prior to the actual invasion.

We see a similar scenario unfolding in front of our very own eyes in Finland as it considers NATO membership, begins lessening its energy reliance off of Russia, and ultimately signal its decision to side with the ‘Western’ members of the Arctic Council.

With Russian troops gathering around the borders of Finland, we see people in Finland moving farming equipment near the Russian border and banning all Russian overland freight transport with trucks carrying Russian license plates.

We see Prince Haakon of Norway visiting Kirkenes, the town that borders Russia, trying to calm relations between the two sides while the Norwegian authorities quietly arrest Russian spies within Norway.

At this year’s Arctic Council meetings in March, all member nations (everyone but Russia) boycotted the meetings in response to the Russian invasion. In response, Russia's ambassador-at-large to the Arctic Council unconvincingly stated that “Russia firmly believes that there is no potential for conflict in the Arctic.”

In stark contrast, Klaus Dodds, a geopolitician at Britain's Royal Holloway University who studies Arctic relations, stated that “the Arctic is facing its biggest crisis in 35 years,” while Russia prepares for its final year (2023) holding chairmanship of the Arctic Council.

As can be seen, the Arctic is getting very noisy. It could be that Russia’s strategy all along has been to use Ukraine as a distraction and to create a situation that effectively prohibits the U.S. and NATO from responding to Russia’s land grabs and military build-ups in the North. The focus on Ukraine and the fear of a direct confrontation allows Russia to take many steps in other locations without any response.

Welcome to a divided world…

"A house divided against itself cannot stand" - Abraham Lincoln

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She writes, “it's also hard not to think of Bitcoin as a big old truck belching out fumes as it's overtaken by faster, more environmentally friendly models. Cryptocurrency exchanges are bursting at the seams with Bitcoin alternatives. Many newer cryptocurrencies use more ecofriendly mining models, which environmentally conscious investors might want to check out.”

Newbury, along with hundreds of other outspoken environmentalists including Elon Musk and Elizabeth Warren, are fearful that Bitcoin adoption could lead to more drastic climate change. The notion that the Bitcoin network, which is the most secure computer network created in the history of the world, is of lesser value than some other coin being shilled on Coinbase is absurd, and completely ignores the inherit value of a secure, decentralized, and private form of money. Nevertheless, energy usage and emissions in Bitcoin are the hot topics in the Bitcoin environmental debate. While it is paramount to be aware of the possible effects of new industries and technologies on the climate, these arguments against Bitcoin are misguided and misleading.

Bitcoin miners secure the network by validating transactions and are rewarded with Bitcoin in return. The financial incentive for miners is to pay as little money as possible to be rewarded with the greatest amount of Bitcoin.

CEO of Foundry, Mike Colyer, said “The Bitcoin network is ruthless in its drive for the lowest cost. Miners around the world are looking for stranded power that is renewable. That will always be your lowest cost. Net-net this will be a big win for Bitcoin’s carbon footprint.”

The concern that most anti-Bitcoiners have on energy consumption is that the Bitcoin network is far too carbon-intensive due how much electricity the network uses. However, very few Bitcoin miners are using energy from nonrenewable sources. In fact, it is estimated that about half of US Bitcoin miners use renewable energy to power their machines. The simple fact is renewable energy is more affordable than nonrenewable for these miners. The exodus of miners from China to Iceland, Canada, and the United States allowed for greater use of geothermal, wind, and nuclear-powered Bitcoin mining operations.

As Colyer stated, it is in the miner’s best interest to use renewable energy. Plans to mine Bitcoin with geothermal energy from untapped volcanos have been proposed in El Salvador and the pacific island, Tonga, the former being a country with Bitcoin as a legal tender, and the latter planning on doing so soon. Tonga is a small nation that has 21 active volcanos. Each volcano can produce 95,000 megawatts of energy at any time. With only 120,000 people living in Tonga, 40,000 megawatts would be enough to power their entire national grid. Lord Fusitu’a, a former member of Tongan parliament, stated that the excess energy would be used to mine Bitcoin. Each volcano could generate $2,000 in Bitcoin per day, all mined from free geothermal energy that was otherwise going untapped. Tonga is by no means a rich nation, so transforming their only natural resource of geothermal energy into income for its people, while also securing the Bitcoin network, shows the incredible opportunity that Bitcoin extends to underdeveloped nations without draining the energy grid. Critics argue that Bitcoin uses too much energy, but they overlook the clear benefit that Bitcoin and Bitcoin mining has. Never was there a method to convert excess energy into money until now. While there are miners that use nonrenewable energy, there is a tremendous incentive for Bitcoin miners to use otherwise wasted geothermal energy, and the mining industry will most likely proceed down this route in the coming years.

With Bitcoin mining quickly moving green using free geothermal energy, another concern with Bitcoin is the large amount of energy that securing the network draws. Estimates rate Bitcoin’s energy usage at less than 1% of the worlds energy usage. While this is a large number, it is misguiding when thrown around as an argument against Bitcoin’s utility. No, 1% of the world’s energy is not an efficient use when dedicated to a worthless internet coin, but Bitcoin is so much more than that. The less than 1% of the world’s energy that Bitcoin takes reflects the most efficient use of energy in the world. Instead of being turned away from Bitcoin for this statistic, you should instead be amazed at what Bitcoin could do for only a small share of the world’s energy consumption.

Think about this:

Bitcoin adoption would remove the need for banks. Banks have hundreds of offices and buildings around the world, and thousands of commuters who drive to and from work each day. The banking industry consumes roughly 260 terawatt hours per year, more than twice the energy that Bitcoin consumes.

Bitcoin adoption would also remove the need for mints, treasuries, and other government organizations that create and store physical money. These buildings draw significant energy, have a massive carbon footprint, and similarly require thousands of commuters to drive to and from work in their gas-powered cars, and use their computers that draw energy. Bitcoin adoption would provide banks and freedom of money to billions of people across the globe, protecting them from government corruption, theft, and irresponsible monetary policy. This humanitarian cause alone is worthy of substantial resources put behind it.

The bottom line is this:

Every industry in the world uses some of our energy resources on Earth. As citizens of the world, we should be focused not on squashing innovation because it has costs, but on finding the most efficient uses of our limited resources. Bitcoin is the most efficient use of energy ever created and has a built-in financial incentive to use renewable and untapped clean energy sources. While Bitcoin comes with a cost of energy consumption, it is irresponsible to write it off for this reason, as this standard would similarly write off many other important technologies being used in the world today.

Want to hear more from us? Be sure to subscribe to Venture Time to see weekly posts on subjects ranging from investing and entrepreneurship to macroeconomics and cryptocurrency.

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― Japanese Proverb

Those who follow the market have probably heard about the drastic devaluation of the Japanese Yen (JPY) in the past month (Figure 1). For those who don’t follow the foreign exchange market a rising USD/JPY is a weakening yen as it takes more yen to match the value of $1 USD. Since COVID, there have been multiple significant headlines regarding large devaluations of nations’ currencies from the Turkish Lira, Russian Ruble, and the Sri Lankan Rupee more recently. Currency devaluation is not a rare phenomenon within emerging market countries like the ones previously mentioned, but what’s different about the yen is its historical reputation as a safe haven asset. For those who don’t know, safe-haven assets have stable demand, liquid markets, strong relevance within the market, and will retain value in times of market turbulence. These can range from metals such as gold, U.S. Treasuries, and currencies like the Swiss Franc (CHF), Japanese Yen, and the U.S. Dollar (USD).

Figure 1: USD/JPY Sell-Off

In the past year or so, the dollar has been on a tear. Despite 40-year high inflation in the U.S., the dollar has been sustained by three main macro drivers. First is the safe haven aspect previously mentioned, as rising geopolitical risk and market uncertainty cause investors to seek quality assets, and what’s a better store of value than cold hard cash (well, all commodities and any asset that hasn’t lost 8.5% of their value in the past year). The second is the globalized nature of inflation. It stems from inefficacies within the global supply chain to meet strong demand from wealthy consuming countries and has since spilled over into most countries. Yes, the 8.5% CPI YoY headline is bad, but it’s not an isolated incident. Think about it in the old analogy of getting chased by a bear, or in this case inflation. You, the U.S., don’t need to outrun the bear to survive. All you need to do is to outrun your friend next to you, other countries. The final and most important driver is what the Fed has been doing to combat inflation, raising interest rates (Figure 2).

Figure 2: Rising Yields Are Driving The Dollar

Given that currencies are evaluated on a relative basis, usually to the dollar, this has caused devaluations of many currencies unless you are a commodity exporter, which Japan is not. What sets the yen apart from other currencies is not only the drastic nature of the sell-off for such a safe currency. It is a symptom of a disease that has been plaguing the Japanese economy for the past two decades: Japanification.

Brief History Lesson

I won’t dive too deep into the idea of Japanification, but to understand why the yen is depreciating, one has to understand the unique state of the Japanese economy. In the 1980’s, Japan became a manufacturing and exporting juggernaut as the world moved towards globalization. At the same time, the U.S. was coming off the gold standard, letting the dollar float. The dollar soon became the preferred payment method for oil exporters, ushering us into the petrodollar stage. High demand and floating nature gave the dollar, and therefore the American consumer, significant purchasing power, letting them buy higher volumes of goods for cheaper from countries with weaker currencies like, you guessed it, Japan. This sparked a wave of Japanese imports, the effects of which can still be seen today, as Toyota was the top-selling car manufacturer in the U.S. in 2021.

Figure 3: Effect Of American Purchasing Power On Japanese Stocks

As the dollar appreciated, U.S. exporters struggled to find demand for their products. To bolster U.S. exports, the U.S. agreed with other major countries at the Plaza Accord to devalue the U.S. Dollar (Figure 3). This did not go over well for Japanese exporters as they found a drastic decrease in their primary customer’s purchasing power. At the same time, Japanese equities and real estate markets that were heavily overvalued were about to burst. Long story short, Japan faced a severe economic slowdown just as its population growth leveled off (Figure 4).

Figure 4: Japan YoY Population Growth

This lack of population growth caused the median age of Japan to rise. In 2022 the median age in Japan is 47.3 years compared to the global median of 30.9 years. This population aging has had a deflationary effect on the economy since. According to a Bank For International Settlements study, adults between 30 and 60 tend to have a deflationary impact. They produce more than they consume, given that they are deeper into the workforce than a recent college grad who just took out massive student loans. This age range is more focused on saving than borrowing, which means they benefit more from deflation increasing their savings rather than inflation reducing their debt. This is bad for a central bank trying to jump-start a struggling economy as expansionary monetary policy and modern economies depend on credit to succeed. It just so happens that Japan’s median age of 47.3 years sits at the trough of this relationship, shown in Figure 5.

Figure 5: How Does Age Affect Inflation?

How To Unsuccessfully Deal With Deflation

This has left the Bank of Japan (BOJ) in a tricky spot as they have had to find new monetary policy methods or aggressively push old ones to force Japan out of its deflationary spiral. Do you think the size of the Fed’s balance sheet is bad after over a decade of quantitative easing? The BOJ was one of the earliest adopters of QE and holds a similar-sized balance sheet to the Fed, but when adjusted for the size of the two economies, the BOJ’s QE vastly outpaces the Fed’s (Figure 6).

Figure 6: BOJ Was Printing Bank Reserves Before It Was Cool

The extreme dovish attitude of the BOJ is the not-so-secret answer to the problem of a devaluing yen. While everyone is rushing to hike rates to combat inflation, the BOJ maintains its dovishness. This is because Japan is still a percent below the BOJ’s inflation target of 2%. While everyone is worrying about inflation increasing, the BOJ sees signs of inflation moving to its long-term target (Figure 7).

Figure 7: Japan Headline CPI YoY%

This push to 2% has made the BOJ maintain expansionary monetary policy measures. The most important right now is the idea of yield curve control (YCC) (Figure 8). YCC is the idea for a central bank to set a longer-dated interest rate and then buy or sell bonds to get to the target rate. This is different from the Fed’s QE as the market prices in rates that are based on the set amount of bonds being bought by the Fed (among other things). Here, the BOJ buys and sells bonds (Japanese Government Bonds “JGBs”) based on what the market is setting as the equilibrium interest rate to meet their target of 0.25% on the 10-year JGB.

Figure 8: Japan Yield Curve V.S. U.S. Yield Curve

The YCC policy has led to a vast yield difference between Japan and other developed nations like the U.S., and this difference in interest rates is the primary reason why the yen has been selling off (Figure 9). Despite the yen’s rapid devaluation, the BOJ continues to buy bonds to suppress yields.

Figure 9: The U.S. Is Leaving Japan In The Dust When It Comes To Hiking Rates

Implications Of A Weak Yen

At this point, you might be thinking, “wait, isn’t a weak yen what drove Japan’s expansion in the ’80s?” You wouldn’t be wrong. Typically, a weakening yen has resulted in a strengthening Japanese economy or at least an appreciation in Japanese equities. However, in recent months this relationship has harshly diverged (Figure 10)

Figure 10: Yen And Nikkei Separate

Yes, Japan is the 4th largest exporter and is a net exporter, but it is important to look at the goods they are importing and exporting. As a manufacturing country, Japan typically exports electronics, cars, and refined commodities. More important, are Japan’s imports. Japan happens to be the 5th largest importer of crude oil and imports many raw commodities, which they then turn into finished goods. Now, a weakening yen may be increasing demand for exporters within the country, but the rapid rise in oil prices and other raw material inputs have outpaced the price of the finished goods (Figure 11). A weakening yen also means it’s now more expensive for Japan to purchase inputs, causing margins to get crushed. To summarize, the price of goods Japan is importing is rising faster than the price of goods that Japan exports.

Figure 11: Weak Yen And High Commodity Prices Are Dangerous For Japan

Margin pressures can be directly seen when comparing Japan’s CPI and PPI. Margins for Japanese companies are getting squeezed to the lowest levels since the early 1980’s as producers fail to raise prices to keep up with higher input costs (Figure 12).

Figure 12: Japanese Margins Are Shrinking

The question then becomes, will the BOJ step in to save the yen by opening the yield curve flood gates and letting interest rates float? The answer is probably no. Looking at Figure 13, historically, when the BOJ intervenes in the currency yen, volatility tends to be much higher at a mean of 20.7% but was only 9.6% a week ago.

Figure 13: When Does The BOJ Step In?

This is a lose-lose situation for Japan as if they let the yen further depreciate, margins for Japanese companies will contract further and the buying power of the Japanese citizen will rapidly decrease, spelling economic doom. However, if they let yields rise, they abandon their 2% inflation target, and go back to deflation, reducing the incentives to borrow that fuel economic growth.

Why Should You Care?

So why should you care what the central bank of a country thousands of miles away does with its monetary policy? It just so happens that Japan is the second-largest holder of U.S. debt right after the Fed (Figure 14).

Figure 14: Who Owns U.S. Debt?

After the BOJ’s extreme expansionary monetary policy, interest rates in Japan were left near zero or negative. Japanese investors and institutions had to turn to the U.S. for positive yields on safe government bonds, which led to Japan being the primary foreign holder of U.S. debt and has continued to increase their holdings (Figure 15).

Figure 15: Amount Of U.S. Debt Owned By Major Foreign Holders In The Past Two Decades

So what happens if the BOJ chooses to save its currency by letting the rate rise? Well, then yields in Japan will have positive returns again. All those Japanese holders of U.S. debt seeking positive yields overseas could start to pull back their foreign investments and place them in domestic securities. This spells trouble for the U.S. Treasury market, with run-off beginning in the coming months. There is a potential that the two largest buyers of Treasuries, the Fed and Japan, will be exiting (by exiting I really mean fewer inflows from Japan, not a complete exit) the market at the same time. If these two exit, or reduce their buying simultaneously, then a massive void will form in the Treasury market. If no one steps up to fill the void, demand won’t match supply, causing interest rates to move higher.

Conclusion

On the surface, the yen’s devaluation appears to be attributed to the strength of the dollar. However, like an iceberg, below water level is a complex system with potential global repercussions. The yen crashing is a symptom of a more significant systematic problem Japan has been facing for the past four decades. It has left the BOJ with a difficult dilemma to save the yen, with the BOJ having options either resulting in deflation or the yen crashing, drastically increasing import costs and reducing profitability. Both of these situations have the potential to spell doom for the Japanese economy, resulting in a “pick your poison” type situation for the BOJ.

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Know Your Story

It’s daunting to prepare for the countless combinations and variations of questions that could be asked during an interview. Instead of having answers prepared for specific questions, it’s important to know your story. What does this mean? It means understanding who you are, how you got here, and where you’re going. For any job or competitive opportunity, there will always be a “perfect” candidate on paper with the inherent indicators of success to include a degree, credentials, and job-specific experience. The “perfect” candidate could be describing you and it doesn’t necessarily mean that you’ll succeed above others with lesser qualifications. A resume depicts what you’ve done, but the interview is an opportunity to reflect on how what you’ve done has shaped who you are.

What to Do When You Have Little Prior Experience

At the start of everyone’s professional career their resume is inevitably lacking relevant experience. This is especially common among college students looking to join organizations with competitive membership on campus or major-related internships. This is a perfect opportunity to make your story valuable. The first step is to identify the values and lessons you took away from significant life events, experiences, and challenges that you’ve encountered. Here are some basic examples:

• Leadership

• Adaptability

• Desire to learn

• Team building

• Dependability

• Positivity

It’s easy to reference relevant work experience and accomplishments. Knowing your story and effectively using it to back up your values is what fosters authenticity.

For example, let’s say you want to highlight your leadership skills in an upcoming interview. If you’ve led a team, then take it a step further and discuss 1) Your personal confidence before taking on the new responsibility, 2) The difficulties you faced along the way, 3) How you overcame the obstacles and 4) How it made you better. By presenting your answer in this format, you’ve not only answered the question and referenced relevant leadership, but also took control of your interview by sharing your story. There’s a difference between the experience itself and the process you endured within it. This not only makes you a leader, but also a person who has displayed grit, operated under stress, and rose to the challenge to lead a successful team.

Now, what if you’ve never been a formal leader in a professional environment? Once again, take control of your interview and don’t discredit your authentic experience. How have you succeeded as a member of a team? What have you learned from your superiors that you hope to implement or not make a part of your leadership style? You may not have taken on a leadership role yet, but your perspective as a team member can make you successful in a new and different position. Understanding your story and extracting your core values from authentic experiences is key when your “paper” credentials may not suffice.

Weakness is a Strength

The dreaded question, “what’s your greatest weakness?” almost seems wrong to ask in a setting where your goal is to showcase your abilities. Instantly, the interview takes a negative turn when you begin to depict weak points. In the same way, an investor may ask an entrepreneur to reveal a fault in the product he/she is pitching for an investment. Many people are hesitant to answer this question because they see weakness as vulnerability. Don’t be like those people; change your perspective and take control of your interview.

Turn a negative question into a positive answer; you should be most excited to answer this question because it’s an opportunity to demonstrate a growth mindset. If an entrepreneur claimed to have no flaws in his/her product, most investors would be skeptical. The ability to identify faults is proof that the entrepreneur has a methodical and solid business plan. Everyone has weaknesses. The ability to identify deficiencies within yourself is the only way to be better and it proves that you are self-aware enough to do it. Now, here’s how to do it:

1. Self-reflect on instances where you’ve failed or when you didn’t get the outcome you wanted. Then, take responsibility for your deficiencies and be receptive to external feedback.

2. Change your mindset. A growth mindset is engrained in the belief that our capabilities are not predetermined and can be improved over time.

3. Be accountable for your internal dialogue. Your mind is powerful and negative thoughts lead to negative outcomes.

4. Your goal should be to turn the weakness into a newly equipped strength. Actively work towards this goal each day by implementing small, manageable, and measurable changes.

Now, how does this four-step process come into play when an interviewer asks you to self-proclaim a weakness? Let’s say you are terrible at giving presentations in front of large groups of people and this is part of the necessary skillset to be successful in your sought-after role.

1. Self-reflect: Identify times where you displayed weakness while speaking in front of others. Were you prepared or could you have practiced more? How did you react when you began to fail?

2. Change your mindset: Believe that you are great at public speaking. You pinpoint shortcomings that resulted in the failed presentation like limiting your everyday opportunities to speak in front of others and relying heavily on filler words that caused you to lose your train of thought and panic. You are a capable speaker and have pinpointed two areas that need improvement to allow you to realize your full potential. This is a growth mindset.

3. Be accountable: Find a way to convince yourself that the weakness is an opportunity. If you are a great writer and find difficulty voicing your knowledge, then focus on what you’re good at. Think of public speaking as another way to share the words you put on paper.

4. Your goal: Work towards making your weakness a strength by starting small. Challenge yourself to speak up in class and voice opinions in front of other people. Start explaining the concepts you write about verbally to build confidence in your knowledge and avoid panic during formal situations. Make the goal measurable by deciding to ask one question per class per day.

When asked about your greatest weakness, be prepared. It’s an opportunity to share your process for self-improvement. Explaining the process is far more effective than offering an example of a self-proclaimed strength. In any job, there will be times where you are challenged. By responding with resilience, you prove your ability to overcome unforeseen obstacles and master new skills demanded along the way.

A Two-Way Street

In this article, we’ve discussed the importance of “your story” and how authenticity is key to making your experience relevant and finding opportunity in your weaknesses. This is the foundation to not only being a top applicant, but also ensuring that acquiring the new position will equally serve you. If you’re compromising yourself to fill a role, then consider seeking alternative opportunities. A job interview tends to be perceived as one sided but remember that your employer needs you just as much as you need them. One way to be proactive about evaluating whether a position will return value is to ask the interviewer questions when given the chance. The winning interview mindset provides the necessary foundation to answer the variety of questions that could be asked and gives you the ability to assess whether an opportunity is valuable to you.

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As a private company, there is one catch to ESOPs: employees cannot make money on their stock if the company never has a liquidity event (i.e. a merger, acquisition, or IPO). Without the possibility of a liquidity event, the incentive structure suddenly breaks down and company founders are giving up equity in their company without a subsequent return on investment through increased productivity and initiative. This problem arises quite frequently in small businesses and other companies where the founders want to retain full control over the company through the long-term. Fortunately, there are other methods of tying employee compensation to company growth that do not involve exchanging equity, and profit-sharing is one such method that many companies use.

Types of Profit-Sharing

Generally, there are two types of profit-sharing plans, with the first being comprised of bonuses given over certain time intervals (usually annually) and the second being a type of employee retirement plan.

Employee Retirement Profit-Sharing Plan

The employee retirement profit-sharing method, also known as a deferred profit-sharing plan (DPSP), can be set up through your company’s bank. The plan involves deciding upon a percentage of net income amount to contribute to your employees’ accounts, but the company has the option not to contribute if, for example, it is unprofitable that year. How that percentage is determined is discussed below, but for DPSPs, as of 2022 the contribution limit may not exceed the lesser of 100% of an employee’s compensation or $61,000 ($67,500 including catch-up contributions). Additionally, the amount of an employee’s salary that can be considered for a profit-sharing plan is limited to $305,000.

Bonus-Based Profit-Sharing Plan

By distributing profits as bonuses, companies set aside a certain portion of profits according to a formula and designate whether the percentage of profits is before-tax or after-tax. These bonuses are usually distributed on an annual basis, but some firms distribute on a quarterly or monthly basis. More frequent payouts have the advantage of increasing employee identification with organizational goals and reinforcing employee involvement, but the disadvantage of being unpredictable in volatile product and market cycles.

How Profits are Allocated

As the name would suggest, profit-sharing is almost always calculated as a percentage of net income. Some firms use revenue as the determinant instead, but this is quite rare because promising a percentage of revenue does not require that the business is already profitable to distribute this additional compensation whereas using net income as the determinant makes profitability a prerequisite. Some companies take this a step further by requiring that a minimum profit threshold has been reached and then distributing the gains above this threshold once it has been exceeded.

The question then arises: how do you decide who gets what percentage of profits? There are two common ways of approaching this aspect of the profit-sharing plan. The first method involves establishing ‘tranches,’ which are generally defined by employees’ levels in the organization. For example, perhaps partners split 30% of shared profits, senior managers split 40%, and so on. The second and most common is called the comp-to-comp method. In the comp-to-comp method, an employer calculates the sum of all its employees’ compensation, subsequently dividing each employees’ salary by that total. This percentage, for each employee, is then multiplied by the amount of total profits being shared.

Example:

Company XYZ has two employees, with employee A earning $80,000 per year and employee B earning $100,000 per year. The company shares 10% of annual profits with employees and has earned $100,000 of net income in the fiscal year. Each employees’ annual bonus is calculated as follows:

Employee A = ($100,000 * 0.10) * ($80,000 / $180,000) = $4,444.44

Employee B = ($100,000 * 0.10) * ($100,000 / $180,000) = $5,555.56

Why not have each employee take the same percentage?

Often, companies that entitle every employee to the same percentage of the profit-sharing pool find that this structure incentivizes freeloading in which less productive workers reap the benefits of the business growth produced by more productive workers. This can create a sense of unfairness and demotivation among the company’s most productive employees, stifling growth in the long-term. For this reason, a proxy for employee contribution to the business’s growth such as level in the organization or salary, is almost always used to determine each employee’s payout.

Best Practices

Fortunately, profit-sharing can be structured to include practices common in ESOPs that avoid over-rewarding employees who leave the company after only a year or two. Profit-sharing plans can ‘vest’ over time by starting an employee out at a lower percentage of the total profit pool, with that percentage increasing each year up to a predetermined cap. Companies can also incorporate ‘cliffs’ into their profit-sharing plans by establishing the policy that employees are not entitled to profit-sharing payouts until they have worked for the company for a certain period of time. These ‘cliffs’ can be prorated, meaning that employees who work for the firm longer than the predetermined period of time receive rewards for that period after it is exceeded.

To best implement a profit-sharing plan, it is crucial to speak to a legal or HR professional to understand the rules involved with doing so, such as the requirement not to discriminate in favor of highly compensated employees. Additionally, profit-sharing plans should be continually updated and revised periodically to adapt to changing employee expectations, new market conditions, and evolving strengths and weaknesses of the business.

Pros and Cons of Profit-Sharing

Pros:

• Motivates employees beyond their salary amounts without giving up equity in the company

• Easily integratable with other employee incentives (for example, the retirement option can be enacted concurrently with other retirement options such as 401K)

• Provides an opportunity to train employees on financial measures and operational behaviors and strategies that affect those measures

• Compensation is given from profits, so there is low financial risk to the company

• Enhances productivity, loyalty, initiative, and creativity in employees

• Provides employees with improved financial prospects, especially in companies where a liquidity event is unlikely

Cons:

• Can be demotivating if the company is unprofitable

• Profit can be too broad an objective to focus employees on specific behaviors that lead to organizational success

• If employees focus solely on maximizing profit, they may suffer from short-termism and make decisions that undermine the long-term health of the company. Profit is not the only financial or non-financial measure that can be determinant of a business’s success so it is paramount that all employees consider multiple KPIs and stakeholders when making business decisions

• Reduces disposable income that could be reinvested into the business

For small businesses and other companies in which management is not aiming for a liquidity event, profit-sharing is a viable alternative to employee stock option plans and other equity-based compensation models. By correctly administering profit-sharing plans, companies can motivate employees to go the extra mile while also improving their financial outcomes.

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