Stephen Covey, in his acclaimed book, “The Seven Habits of Highly Effective People,” uses an interesting analogy to distinguish between management and leadership. Think of a team cutting its way through a jungle. The managers are the ones who make sure that the knives get sharpened, look after supplies to make sure the team has what it needs, etc. The leader is the one who climbs the tallest tree, surveys the entire situation, and yells, “Wrong jungle.” In the words of Peter Drucker, management is making sure things are done right, leadership is ensuring that the right things get done.

I am not aware of any mainstream senior US politicians crying “wrong jungle” when it comes to monetary and fiscal policy. In my opinion, they should be.

The politicians have taken the US to the edge of a fiscal cliff over prolongation of tax cuts that amount to less than $100 billion a year. We’ll shortly be coming up against another cliffhanger, in that the US government needs to approve an increase in the limit to the US national debt. The political dialogue and press coverages has focused on these issues. Yet these are “wrong jungles!”

The real issue is that the national debt in the US has risen by over $5 trillion over the past few years, and that US politicians have barely started discussing how the US debt spiral will be brought under control. The following charts provides a summary of the evolution of the US deficit and of US debt over the past few years:

U.S. federal debt held by the public as a percentage of GDP, from 1790 to 2012

Note that the dotted light blue line (“Alternative Fiscal Scenario”) between 2010-2030 reflects the Congressional Budget Office’s projections assuming that the status quo of fiscal irresponsibility continues. The dotted dark blue line (“Extended Baseline Scenario”) shows that growth in public debt can be stopped in its tracks, assuming the political will exists to make some tough decisions, for example the Bush tax cuts are stopped, Medicare reimbursement rates to doctors will go down, and that tax revenues will go up by 5 percent as a percentage of GDP.

The above chart does not even include:

(a) debt owed by foreign governments (another $4 trillion plus);
(b) debts and guarantees related to Fannie Mae and Freddie Mac, which the government argues are of a “temporary” nature;
(c) unfunded obligations (e.g. pension and social security).

Related to this issue: the US is beginning its next phase of Quantitative Easing, whereby it will inject $85 billion per month of stimulus into the US economy (about $1 trillion per year), financed by issuing US government bonds. Perhaps the biggest bubble on financial markets today lies with US Treasuries.

If the US does not curtail its deficit and rapid increase of debt, the following disaster scenario becomes virtually inevitable:

1. Financial markets lose confidence the US dollar and US Treasuries
2. The USD undergoes rapid devaluation against other major currencies (as occurred in 1984 and on other occasions).
3. Yields on US Treasuries could spike dramatically (double, triple, or even quadruple). .
4. The cost of borrowing for the US government increases dramatically. When the US government pays next to nothing (under 3 percent nominal interest rate) to service indebtedness, of course it is tempting to pile up debt. But should yields climb into double digits, it will become next to impossible for the US to work its way out of the debt spiral, much like the Greece one is in today, but with vastly larger effects on the world economy than Greece.

So when is this likely to happen? It is my own personal opinion that economics as a science has not yet reached the level of precision where it can forecast the timing of such a disaster scenario, present fiscal and monetary irresponsibility continuing, any more than geologists can forecast the timing of an earthquake on the San Andreas fault. But both geologists and economists know that the tectonic pressures are building, and it’s not a question of “whether,” only a question of “when.”

The US cannot afford to be in the “wrong jungle” indefinitely. Fortunately, the tectonic pressures only continue to build as deficits remain high. But it is entirely within the power of US policy makers to move us from the light blue dotted line to the dark blue dotted line. That will require leadership and courage.

Les Nemethy is CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on helping owners of mid-sized firms raise capital, find strategic or financial partners, arrange full or partial exits. He is the author of “Business Exit Planning," published by John Wiley & Sons, available on Amazon, and Uwolnij wartość swojej firmy published by Wolters Kluwer Polska. 

I have seen several situations where management was of the view that costs could not be cut without considerably affecting the revenues or profitability of a company, but a new management team or a consultant showed otherwise, or where economic duress forced management to rethink what was possible.

In today’s day and age, having a competitive cost structure can be vital to survival. Those competitors who have more efficient cost structures, quite simply, will have more resources to compete, and therefore will tend, over time, to gain market share. While it is usually possible for many businesses to achieve major economies of scale simply by growing volume, this article talks only about the case of reducing costs in the case of stable or even falling revenues, that is to say, in recessionary times.

Allow me to provide two examples, both prior clients of mine:

An automotive company: Prior to the Lehman crisis, the company in question had over €100 million revenues, but was barely breaking even. Waste was rampant; management was unaware. Staff were living the high life, driving fancy company cars, earning nice bonuses. They thought this was normal. In the year after Lehman, the company’s revenues dropped by over €30 million, and there were many millions of euros of losses. The company was in its death throes, with banks almost ready to pull the plug. A year later, thanks to a vigorous cost cutting program, the company was in the black again, despite a further €10 million decline in revenues.

A cement company: Corporate head office had performed international benchmarking, which showed that a local Central European subsidiary had a cost structure that was €5 million higher than its sister companies, given its level of revenues. Local management claimed that costs were as lean as they could be. “There is only skin on the bones, no fat,” claimed local management. When head office insisted, local management replied “it cannot be done.” At this point, headquarters hired my firm to “find” the missing €5 million, as headquarters said, “find fat, not muscle,” and help management implement the cost cuts. We did find and successfully cut €5 million, almost to the penny.

The two situations were different, in that the automotive company “got religion” thanks the owner/CEO waking up to the inefficiencies. In the second instance, the cut was imposed from outside the local management team. (Local management was lucky not to lose their jobs!)

Yet, there were a number of things that the two situations had in common. They went about the cost cutting process in a rational way:

1. First, look at your income statement. It requires the simple discipline of someone going through the expense structure of the firm, line item by line item, drilling into great detail as to what is truly essential or non-essential to the firm’s operations. Hundreds of items, from newspaper and magazine subscriptions to access to databases, may be reclassified as “options” or “luxuries,” rather than “necessities.” The cost/benefit of every single expenditure must be weighed extremely carefully. It is remarkable how few companies really drill down and look at expenditures at this level of detail on a regular basis. It is elementary, yet so often neglected.

2. Staffing needs to be looked at very carefully. Can several positions be combined into fewer positions? Can certain tasks be outsourced at lesser cost? The same attention given to expense items, as per the previous paragraph, needs to be paid on the organization chart. Sometimes one or more layers of management may be removed entirely; there are times when this even enhances management performance, putting senior management closer in touch with staff on the front line, and to customers.

3. Utilities are generally worth looking at closely. There is an entire industry of consultants that have sprung up, who will look – without charge – at your telecom costs, energy costs, etc., provided you share a percentage of savings with the consultant. The cost savings found by these consultants are often substantial. Some companies simply do not take the time to review and shop their contracts every time they come up for renewal. Telephony costs, for example, have been falling rapidly for over a decade. Management can take the time to learn how to perform much of these savings; even if they do not have the expertise and are not willing to learn it, it would still pay to use the cost consultants. In fairness, sometimes it takes some capital expenditure to reap the benefit of these savings, but not always, and where capital is required, the payback periods are often very rapid.

4. Productivity and efficiency. Whether your firm is a service company or a manufacturer, it is almost always possible to enhance productivity and efficiency. Once again, sometimes this requires an investment in technology or IT, many times not. It usually pays to use experts.

I hope this article has given you some inspiration to cut fat. If management thinks it can’t be done, they will ultimately be right. This will become a self-fulfilling prophecy: They will not succeed in cutting costs. A better paradigm is to believe that everything can always be done better, and at lesser cost. And it is better to cut costs of your own volition, before any external parties force discipline on you, and to not just do it once, but to keep reviewing costs periodically.

Les Nemethy is CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on helping owners of mid-sized firms raise capital, find strategic or financial partners, arrange full or partial exits. He is the author of “Business Exit Planning," published by John Wiley & Sons, available on Amazon, and Uwolnij wartość swojej firmy published by Wolters Kluwer Polska.

For anyone who has anything to do with business in Central Europe, it is important to know the risk associated with your country, and also where this fits in by comparison to other countries in the region. There are several reasons for this:

• Country risk underpins the risk associated with your company. The interest rate that your company pays for bank debt is at a premium to the interest payable on your country’s sovereign debt. If your country becomes riskier, it also means that it becomes more difficult and expensive for your company to borrow.

• Ultimately, how financial markets assess your country’s risk is a reflection of on your country’s fiscal management. It is particularly interesting to follow how your country is doing in relation to your neighbors, and to follow and understand the trends.

There are three ratings agencies which are considered the most important rating agencies in the world, whose job it is to assess sovereign (and corporate) debt: Fitch Ratings, Moody's and Standard & Poor's.

The following chart summarizes the current ratings of Central European countries:

As the above table shows, Austria is the best rated country in Central Europe. Without taking Greece into consideration, Hungary is the only major EU country that is not investment-grade among Central European countries. Turkey is in a very interesting situation. Fitch Ratings upgraded Turkish bonds from junk to the lowest investment grade (BBB-) as of November 5, 2012, thanks to Turkey’s stable economic growth and decline in current account deficit.

For most countries, obtaining an investment grade from two or more of the above ratings agencies is the crucial threshold for having easy access to global capital markets – many funds and other investors are precluded from investing otherwise.

Investment grade is a rating that indicates that country or corporate bonds have a relatively low risk of default, suitable for pension funds and other institutions. The lowest grades considered as investment grade are BBB-, Baa3, and BBB- for Fitch, Moody's, and S&P respectively. Credit ratings for bonds below these ratings are considered low credit quality, and are commonly referred to as “junk” bonds.

As the graph below shows, country risk impacts directly on borrowing rates:

The above chart shows that bond yields have been generally declining through Central Europe during the course of 2012. This is extremely positive, and bodes well for overall borrowing costs in the region. There is a high degree of onus on governments to manage fiscal and monetary policy and obtain confidence of rating agencies, as this may have a dramatic effect on government borrowing costs, and sustainability of deficits.

It also impacts directly on private borrowing: extensive government borrowing may squeeze capital availability to the private sector, and irresponsible economic management by government may also drive up borrowing costs for the private sector.

While many businessmen might prefer to ignore what government is doing, it is important for your business to understand and monitor sovereign risk.

Les Nemethy is CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on helping owners of mid-sized firms raise capital, find strategic or financial partners, arrange full or partial exits. He is the author of “Business Exit Planning,” published by John Wiley & Sons, available on Amazon, and “Ulwolnij wartość swojej firmy” published by Wolters Kluwer Polska.

 Mustafa Emin contributed to this column