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The most valuable of all capitals is that invested in human beings.
- Alfred Marshall
Economics is the study of how society manages its scarce resources
- Gary Becker
The fate of any business is intrinsically related to how it responds to the demands and pressures of internal and external forces. Internal constraints encompass various factors, including but not limited to people, culture, strategies, execution, sales, and the ability to maintain a healthy list of returning customers. Among the most crucial external forces impacting a business' fate are macroeconomic trends, which determine the contexts in which a business is born, nurtured, and thrives. Ignoring macroeconomic trends or forces while making critical business decisions invites careless risks and increases the probability of business failure.
So, what is macroeconomics? What are the minimum trends that you, as a business leader, should pay attention to in order to increase the probability of success for your enterprise? As a refresher and for level setting, a simple definition of the economy is that it is a study of ways to make decisions that find proper balances between unlimited wants or needs and limited resources (i.e., goods, money, time, etc.). Macroeconomics is a branch of the economy that studies how the aggregate of economies works. It concerns the big picture of the entire economy.
In antiquity, the people of ancient Egypt (also known as Kemit) observed the cyclicality of nature across many disciplines. Macroeconomics is one such discipline that is inherently cyclical. For instance, there are periods of peace and prosperity contrasted with periods of war, depression, or even revolutions in economically weak countries. These periods are respectively referred to as booms and busts. Every country experiences these cycles driven primarily to two few factors; first monetary policy which includes interest rate and money supply managements, and second, fiscal policy that includes taxation and spending. These policies are correlated to countries’ management of debts and credits.
Given the interdependent nature of the world economy in the 21st century, as a business leader, these cycles, and the policies that regulate them, affect you directly.
Needless to say, your understanding and careful study of these cycles, especially when they transition from one phase to another, could tremendously increase your probability of success.
What exactly is credit, and what is debt? Hedge Fund investor Ray Dalio provides an elegant definition in his book “Principles for Dealing with a Changing World Order – Why Nations Succeed and Fail” and his free e-book on Economic Principle: “Credit is the giving of buying power. This buying power is granted in exchange for a promise to pay it back, which is the debt.” All serious economists would tell you that taking on debts is not the issue. Real problems arise when meaningful assets are not produced with the credits, and the failure to repay interest-sensitive debts in a timely manner. This is what creates problems in the economies of most countries. If the country you operate in is experiencing these problems, your business will be affected.
There are numerous ways for economic policymakers to address debt issues for a relatively stable economy. However, four solutions are most common: (1) austerity measures, which involve reducing spending by cutting social programs; (2) debt restructuring (or worse, defaults), which resemble a form of bankruptcy; (3) quantitative easing (QE), which essentially means that the central bank “prints money” or “creates money” out of thin air (not backed by gold) and injects it into the economy; and (4) the transfer of money, which involves redistributing money from the rich to the poor or vice versa. Each of these solutions has economic impacts for targeted objectives. For example, QE stimulates growth but is inflationary, while austerity measures and also debt restructuring/defaults reduce debts but are deflationary.
Business leaders need to get a good grasp of macroeconomic terms such as Gross Domestic Product (GDP), inflation, growth rates, and ratios such as GDP per capita and debt-to-income.
GDP is an economic term denoting the annual or quarterly monetary value of all final goods and services produced within a country. It holds significance because it serves as a key indicator of a country’s economic size and health. It sheds light on the economic output alongside consumption and government spending during a specific period. A higher GDP reflects a healthier economy. Economists utilize various GDP-related ratios to gauge a country’s economic well-being. Among these, GDP per capita (GDP divided by the total population) measures the standard of living in a country, while the GDP growth rate signifies the percentage change in GDP from one period to another, indicating economic expansion or contraction.
Interest rate represents the cost of borrowing money, expressed as a percentage of the principal amount borrowed. Short-term interest rates are primarily determined by central banks. In the USA, the Federal Reserve Bank (the Fed) establishes a “target interest rate,” also known as the “fed funds rate,” which serves as a benchmark for financial institutions like commercial banks to borrow money among themselves. Commercial banks then set long-term interest rates, impacting anyone who borrows money for various investments.
Depending on the central bank's objectives, such as combating inflation, deflation, achieving full employment, or fostering economic growth, the target interest rate significantly influences the entire economy. Therefore, it is a critical indicator that business leaders must pay close attention to.
Business leaders don’t need to be economists. However, they need to study and understand key economic terms, cycles and trends to get a better grip of external factors that affect their businesses. This important exercise would help entrepreneurs reduce risks of business failures and improve their success rate.
Until we meet again, keep paying attention to macroeconomic, the primal driver of capitalism.
Fal Diabaté
Managing Partner, Barra Advisory Group