Since this series is primarily concerned with the question “What is money?” it’s necessary that we at least have a general historical perspective of humanity’s relationship with money. What money have we used in the past, and how has it changed as humanity came into contact with successively superior forms of money?

We weren’t always using rands and dollars. Money, just like technology, language and life itself, evolves. In fact, the most recent form of money, fiat, will only be 50 years old in 2021. More on this topic in a moment.

The traits of sound money 

Examples of primitive forms of money are numerous: shells, salt, glass beads, cattle, rare stones etc. These early forms of money were by no means perfect and lacked several of the characteristics of sound money as outlined below:

The hardness of money is its resistance to unpredictable supply increases and debasements of value. Fungibility requires that units are interchangeable and indistinguishable from one another. Portability is the ease with which monetary units can be transported and transmitted across distances. Durability entails the resistance of monetary units to rot, corrosion or deterioration of value. Divisibility is the ease at which monetary units can be subdivided or grouped. Security is the resistance to counterfeiting or forgery.

Of the traits listed above, hardness is the most essential. Historically, only truly scarce and hard-to-acquire items could function as a reliable form of money – scarcity was the critical element. This scarcity could be unlocked by expending tremendous amounts of human time and energy. In other words, it was a challenging process to come into the possession of this scarce item. The harder it is to create this money by expending time and energy, the harder the actual money is. That is why humanity eventually settled globally on gold as the superior form of money: it had an annual inflation rate that was closest to zero and satisfied the majority of the critical traits of money. Eventually, even silver was demonetised in most parts of the world as the supply could more easily be inflated by expending more energy. With gold, this was the hardest to do.

Money hacking and the birth of inflation

Terrible human tragedies have occurred in the past where different groups of people came into contact with others using relatively “softer” forms of money. Inevitably, one group’s money could easily be “hacked” by the technologically superior group.

For example, when Portuguese and other European traders came into contact with West Africans exchanging tiny glass beads on the Gold Coast, known as aggry beads, they realised that the West African people had no interest in their foreign money. The Portuguese, however, had access to Venetian glass-making technology which was lightyears ahead of the West Africans at the time. These traders went back to Europe, accumulated many cheap glass beads, and flooded the Gold Coast’s “scarce” money with cheap money. The aggry bead had been hacked. The Portuguese proceeded to trade everything of actual value – food, clothing, cattle, land and so on – for worthless glass beads. It was time and value theft on a monumental scale. The scarcity of West African money was corrupted, and a world of value was confiscated.

There are various other examples of this type of “money hack” occurring throughout history. Another interesting example of this happened on the island of Yap in Micronesia, where the Yapese’s precious Rai Stones could be quickly and cheaply created by an Irish-American captain and his crew who got shipwrecked on the shores of Yap.

–  Rai Stones on the Island of Yap

Today, this same surreptitious form of theft is happening on a global scale that dwarfs these historical scenarios. The mechanism that makes this possible is commonly referred to as inflation, whereby more money is created and injected into the economy, supposedly to stimulate spending and economic growth.

Inflation is taxation without representation – everyone who holds cash pays this tax – but since it’s not a direct payment, nobody notices or realises that their hard-earned value is slowly melting away. Historically, the rate of devaluation has been too gradual for us to feel the diminishing value and purchasing power of our money (much like the proverbial frogs in boiling water). Still, there is reason to believe that this is about to become increasingly evident in the years to come.

What happened in 1971?

The reason that we’ve been able to uninhibitedly create money out of nothing for the past 50 years (as of 2021) is because of the following oft-forgotten moment in history:

In 1971, President Richard Nixon effectively abandoned the global gold standard. You can find the whole speech online, but here’s the crucial snippet for context:

“In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nation’s currency is based on the strength of that nation’s economy — and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators. I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.”

– President Richard Nixon’s address to the nation, 15 August 1971.

Notice that word “temporarily”? Well, as it turned out, it was permanently. Thanks to the Bretton Woods Agreement, which was introduced after World War II, the dollar was backed by gold, and all other currencies were pegged to the dollar. Since Nixon suspended the convertibility of the dollar to gold, the tie to gold for the whole world was effectively broken. And so we entered into the age of fiat currency – the softest money we’ve ever had, controlled by governments and central banks (and by extension the wills and whims of those at the helm of these institutions).

Humanity’s money has changed and morphed throughout history based on relative scarcity and the technological capabilities of the time. Since our tie to gold was broken in 1971, money is no longer scarce. It is being created with no particular expenditure of time or energy at the discretion of global governments and central banks. It’s all heading in one direction, sharing the inevitable fate of all fiat currencies throughout history: hyperinflation and ultimately, worthlessness.

This form of money has profound implications on the state of society itself: rampant consumerism and short term preferences are a natural result of a form of money that incentivises immediate gratification (i.e. our collective time preference as society becomes higher and higher – we increasingly tend to neglect the longer-term consequences of our decisions in favour of the short-term).

Where do we go from here?

The global fiat monetary experiment celebrates its 50th birthday in August 2021. Perhaps we should rather consider it the 50th anniversary of the gold standard being hacked. This seems more apt (and less celebratory).

Here is the main problem with having a select group of people able to control something as powerful as money itself: the temptation to breach the trust of the masses and abuse this power for personal gain is too great to resist. As the old adage goes: “Power tends to corrupt and absolute power corrupts absolutely”.

In the next instalment of The Melting Ice Cube Series, we take a closer look at inflation from a numerical perspective and how seemingly small figures, compounded over time, melt the ice cube at an ever-increasing rate.

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Two young fish are swimming along when they happen to meet an older fish swimming the other way, who nods at them and says “Morning, boys. How’s the water?” The two young fish swim on for a bit, and then eventually one of them looks over at the other and says, “What on earth is water?”

The moral of the story is that we do not always understand the fundamental nature of things that surround us every day. Just as the younger fish did not have any concept of water, many people today do not fully appreciate the nature of that thing that is so ubiquitous to us humans – money.

Here, at the dawn of a new decade, humankind faces a predicament when it comes to money:cash, the simplest form of money, is losing value faster than ever before. This will affect businesses and individuals alike, especially if we are unaware of the fact that it is happening.This series of blog posts attempts to uncover the ways in which businesses can mitigate the effects of the rapidly declining purchasing power of cash.

Cash: a melting ice cube

Money is a technology. It has evolved over millennia to facilitate exchanges of value between people, and to store that value over long periods of time to be used as and when the holder of that money sees fit. We’ve seen various iterations and manifestations of money over the years: shells, precious stones, glass beads, gold, and, most recently, government-issued “fiat” currency.

Fiat currency is not backed by a physical commodity but relies on a shared faith in the power it holds. Being disconnected from a commodity means that the purchasing power of fiat currency can vary. Inflation results in the purchasing power of fiat currency dropping, and this means that you get less bang for your buck.

Many people are surprised when they learn that the world’s currencies are no longer backed by gold reserves. This is why, since the outbreak of Covid-19, central banks the world over have been able to stimulate the economy by creating new cash and injecting it into the economy. The Federal Reserve in the United States has created around $9 trillion since March 2020. To give you an appreciation for the scale of that injection, approximately 20% of all dollars that have ever existed were created last year.

This is shocking, and it has a direct impact on every person and business holding cash. This is because the purchasing power of cash, in real terms, is being diminished at an alarming rate. Cash has steadily lost purchasing power to inflation over the last 50 years, and the rate of loss is now increasing more and more rapidly. Michael Saylor, founder and CEO of MicroStrategy, has dubbed this a “melting ice cube”.

The decline in purchasing power of the US dollar between 1913 and 2019.

Creating a buffer

If your business holds significant amounts of cash on its balance sheet, you may need to consider creating a buffer against incoming inflation to prevent erosion of the value that your business has already created.Monetary inflation and “quantitative easing” by central banks is a surreptitious force which steals time and value from businesses and citizens alike by inflating away the purchasing power of the cash that they hold. This may have sounded like a conspiracy theory ten years ago, but now it is becoming a fact that most economists and “finance people” agree on.

The question arises of what to do about this precarious situation. Clearly, we must take some form of defensive action against the approaching inflationary storm. Ignoring these economic realities in the hope that it sorts itself out is not a proactive strategy. In fact, it is no strategy at all. First, we must be aware of the underlying problem. Then we must formulate a solution.

A business needs cash on hand to move quickly, and to be flexible and responsive on short notice to changes in the external environment. The cash a business holds on its balance sheet is like an internally generated insurance policy to deal with unforeseen circumstances in the short term.

Varying degrees of accessibility

Now, this “insurance policy” need not be held 100% in the form of cash in the bank. It can be broken up into tranches of various degrees of liquidity and accessibility, depending on the needs of the business.

For example, if a business holds three months’ worth of operational expense cover in cash, it can be held in different forms, ranging in short-term accessibility. The table below shows an example of this type of diversification.

An example of the forms in which a business can keep cash, ranging from most accessible (top) to least accessible (bottom).

The example above is by no means prescriptive. Each business should consider its own position and requirements, and develop a strategy accordingly.

The concept behind this table is that each block represents a percentage of the total cash held by the business, starting at the top. A bucket of water makes a useful analogy – we scoop from the top first, not from the bottom. The top of the table is the most immediately accessible, the middle slightly less so (perhaps the money market account has a 32-day notice period in order to yield a higher return), and the bottom is the least accessible, and also the least likely to be required in the short term, if ever.

The chances are lower that a business would need to dip into the darker shades, and so that cash can be converted into a form that will produce a strongerhedge against inflation since the likelihood of having to draw on it is much lower over the long term.

The opportunity cost of holding the entire operational expense cover in cash, however, is very high. The lower levels of the reserve might never be touched, but it is still prudent to hold this internal buffer within the business. The form in which it is held is important, and each alternative will come with its own set of pros and cons. These need to be considered in detail by the business before making an allocation to a specific inflation hedge.

More to come

The Melting Ice Cube Series will attempt to explore the intricacies of the phenomenon of the loss of purchasing power of fiat currency during the first quarter of 2021, at a time when awareness of these larger global economic forces is more essential than ever before.

We hope that you will join us on this inquiry over the next few months. The greater macroeconomic realities with which we are faced at the present time affect us all – both personally and on a business level. In order to navigate this potentially turbulent and volatile time, we must keep an open mind and be willing to learn and explore avenues which, up until now, were considered non-essential “nice-to-haves”. Very soon, they will be critical.

As we look ahead at the year and decade which lies before us, we may be filled with uncertainty, worry and even fear – but there is always hope. Arming ourselves with knowledge and education will be our best chance of collectively navigating ourselves towards greener pastures and a brighter future.

Let’s make the journey together.

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Key Performance Indicators do just what they say on the box; they indicate how well your business is performing in key areas. If we liken a business to a vehicle, KPIs are the dashboard. They can answer questions such as: How fast are we going? How much fuel is in the tank? Should we change gears?

Just as you would check your car’s dashboard while you drive, so you should also keep an eye on your KPIs as a business.

“Key Performance Indicators indicate how well your business is performing in key areas.” 

Although KPIs are not compulsory, they should be included in a management report pack where they can be regularly viewed and, where necessary, investigated.

Designing your KPIs

When designing a set of KPIs for your business, you should ask the question: “What information do we need to make decisions based on the core operations of the business?”

This enquiry should be your point of departure and the KPIs will naturally emerge from the answers to this question. Answering this question will also help you to crystallise a deep yet simple understanding of the nature of the business.

Less is more

There is always the temptation to overcomplicate the KPI creation process. This often leads to a myriad of vague KPIs across the board, most of which will be of little use in making mission-critical decisions. Moreover, a weak set of KPIs will inevitably dilute crucial insights. We should guard against this over-the-top approach. KPIs are, after all,  key  performance indicators.

To return to the vehicle analogy, the dashboard shows you only the most important readings for your car. A cluttered dashboard is distracting and essentially useless because the crucial indicator should be evident at a glance. The same applies to KPIs for your business.

In order to whittle down the various indicators, we need to align our priorities and focus on the few measures that are truly indicative of the performance of the business. The idea is to be able to answer this question at all times: “Are we winning or are we losing?”.

“We need to align our priorities and focus on the few measures that are truly indicative of the performance of the business.”

Keeping score

Behavioural psychologists have proven that people play a game very differently when scores are being kept. In this sense, KPIs can be used as the scoreboard within an organisations’ incentive structure to motivate the team to play harder and assume more ownership of their deliverables and responsibilities. Everybody wins, and when they know they are winning, that is good for the whole business.

“KPIs can be used as the scoreboard within an organisations’ incentive structure to motivate the team.”

When designed correctly, these incentive structures can lead to positive feedback loops within the organisation. This has the potential to unleash greater human ingenuity, which is arguably one of the most valuable commodities in any organisation.

Lead, don’t lag

In their book   The Four Disciplines of Execution  Sean Covey and his team make a distinction of particular relevance to KPIs: the idea of lead and lag measures.

Lag measures  are reported after the fact. They typically shed light on what has already happened. Little attention is paid to the causal factors of this historical data. By contrast,  lead measures  are predictive and future-orientated. So while lag indicators look backwards, through the rear-view mirror, lead indicators look forward to the road ahead. In essence, lead measures are proactive, taking initiative for the future journey.

“Lag measures are reported after the fact; lead measures are predictive and future-orientated.”

Let’s use the vehicle analogy as an example. Our lag measure is revealed when we do a roadworthy test. Let’s say the car failed the roadworthy because the tyres are slick and one brake light is broken. The lead measures in this example are regular service check-ups on the car, to ensure that broken lights get fixed and tyres are in good order. When we concentrate on lead measures (regular car services), we can be more confident about the lag measure of “roadworthiness”, and that our vehicle will pass the test.

To put it simply, attaining lead measure targets invariably leads to the attainment of lag measures. This is far better than looking at a lag measure of, for example, revenue growth at the end of each month, and hoping that it will look better next month. Instead, we should be focused on lead measures, for example, reducing machine downtime through routine preventative maintenance. We predominantly want to make use of lead measures because this puts us in control.

Qualitative and quantitative indicators

Not all KPIs need to be finance-orientated. In fact, it’s a good idea to have a blend of both quantitative (hard numbers) and qualitative (softer and more subjective, but still measurable) indicators.

Quantitative indicators  will zoom in on things like revenue growth, machine downtime and physical output.  Qualitative indicators  bring awareness to the more subjective and ethereal dimensions of the business. This includes customer and employee satisfaction and motivation levels, the success of training programs and awareness campaigns, as well as other elements which are harder to quantify in absolute terms. Although they are slightly more difficult to measure, however, we should not neglect them.

“Quantitative indicators focus on things like revenue growth and physical output, while qualitative indicators bring awareness to things like customer and employee satisfaction and motivation levels.”

There are significant lead measures to be uncovered on the qualitative side of the KPI dashboard. Take the time to figure out how best to collect the data to gain these insights. As an example, Creative CFO uses OfficeVibe to gauge the morale of its team anonymously. It is a great way to keep tabs on the more subjective side of running a business, which can be just as illuminating as the hard data.

Final thoughts

When identifying a business’ KPIs, what are the key takeaways?

  1. Keep it simple. When designing your KPIs, distil them down as much as possible to gain only the most essential and illuminating insights.
  2. Are we winning or losing? Ask this question of every KPI.
  3. Lead, don’t lag. Concentrate on being proactive and focus on lead measures that will invariably help you achieve your lag measure targets.
  4. Blend qualitative and quantitative indicators. Don’t focus exclusively on hard statistics, but look at the affective aspects of your business performance too.

Ultimately, every set of KPIs will be as unique as the business that designs them. They should be tailored to reflect the key drivers of value, as well as the best way to interpret these. The process of building out a business’ KPI dashboard should take time and careful reflection, which can be seen as an exercise in setting priorities.

Business owners have often been impressed by the clarity and decision-making capabilities that emerge from this exercise. Moreover, the exercise empowers business owners to initiate effective action to take their organisation from strength to strength.

No matter the size of your organisation, there will be those few key indicators of unparalleled importance. Identify them, track them, refine them, and let them lead your decisions.

If you require some assistance in this process, please reach out to us. We would be happy to cast a KP-eye over things.

Happy reflecting!

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