LIQUIDITY ANALYSIS. "WIKINOMICS" & THE CREDIT DEMAND CONUNDRUM (*)
. "Q&A with the CEO of Lego", Monocle

The key "mystery" of the current global economic expansion is, without a doubt, the low level of long-term interest rates. A year ago, the governor of the Bank of England, Mervyn King, addressed the issue in a speech at a dinner for Kent Business Contacts. Among the causes of low interest rates, King singled out the tepid pace of credit demand: "... business investment in the developed economies has been weak in recent years for reasons we do not fully understand".

For reasons we do not fully understand? How interesting! A couple of years ago, an article by economist-investor Thomas Nugent caught my attention, because it provided a clue to this phenomenon. This is the key quote:

What is interesting is that, with a booming economy, business-loan demand is falling, not rising. This is not your father’s traditional economic expansion. Productivity is mitigating the need for bank borrowing. To see this, think about the notion of infinite operating leverage whereby business technology is, in effect, “taking over.” Higher sales-GDP from applications can be considered “pure productivity” that doesn’t tax resources or drive up prices.

If Apple Computer sells more songs over the Internet, people are simply downloading more songs at a buck a song. This transaction has neither fixed nor variable expenses and therefore adds to GDP as pure productivity gains. This type of activity increases GDP without price pressure. It’s pure productivity, and it brings into question the entire rationale for expectations that the Fed will be raising interest rates just because GDP is growing (at least until more evidence accumulates of potential labor-market tightness).

This is much more realistic than it sounds. In fact, it may be the only way to explain the simultaneous drop in credit demand and in credit spreads that took place between 2002 and 2006. The issue came back to my mind as I listened to a Q&A session by journalist Tyler Brûlé with Jørgen Vig Knudstorp, CEO of Danish firm Lego. (Brûlé's new journalistic venture is called Monocle). Knudstorp, describing the amazing turn-around in the fortunes of the company, says:

We completely changed the way we run the business. We really involve users to an extreme degree ... They even decide their own products ... We are not involved in the design process ... We have become more virtual ... We have open-sourced the company and it does not take a lot of investment to generate a lot of cash.

In other words: by "open-sourcing" the company, Lego needs to invest considerably less. This is innovation at its best, and it goes a long way in explaining the weakness in business-loan demand. Wikinomics, anyone?

(*) De nuestro Global Liquidity Blog.