Recession rebound

Recession rebound Sourcing shifts will rebalance, grow world trade, economist says.

By Eric Kulisch

      There are increasing signs that the U.S. economy and ocean container trade are turning around, but the transition from recession to recovery will have its ups and downs, according to Walter Kemmsies, chief economist for Moffat & Nichol, a Long Beach, Calif.-based marine infrastructure engineering firm.
      Although freight transportation is expected to grow slowly in coming years, the long-term outlook for the global economy and trade remains strong because the economic collapse had more to do with problems in the financial and housing markets than manufacturing and consumer goods, he said. Contrary to many prognosticators, Kemmsies is upbeat that demographic changes, outsourcing and containerization will continue to spur robust trade.
      And, he predicted, one of the key drivers for future U.S. growth and narrowing the trade deficit will be exports of agricultural goods and other commodities.
      'People have a negative outlook on container volumes because the U.S. economy is going to grow slowly. But trade has grown a lot faster than gross domestic product. So trying to make the case that growth is going to be slow because the economy is slow is a dangerous assumption to make,' he told American Shipper following a Sept. 22 presentation at the Council of Supply Chain Management Professionals' annual conference in Chicago.
      The U.S. recession appears to have ended in June, Kemmsies said, although the National Bureau of Economic Research won't make an official determination for a while.
      New unemployment claims peaked in March and growth in continuing claims has slowed, an indication that people are beginning to find jobs again as the federal government's stimulus spending begins to kick in. The Labor Department reported Oct. 2 that the unemployment rate in September rose to    9.8 percent from 9.7 percent in August, but economists typically view employment as lagging GDP growth. Kemmsies said he doesn't expect the number of people hired to exceed the number of people losing jobs until at least May. Many industries, such as housing and the financial sector, have been restructured and won't return to their pre-recession levels any time soon, if ever, he added.
      Kemmsies, who helps clients evaluate the market for transportation infrastructure mergers, acquisitions and distressed asset sales, predicted the U.S. economy would grow 5.5 percent in the fourth quarter. The rate, he cautioned, is not as rosy as it sounds because the increase is based on a very low floor of economic activity, most starkly manifested by a 28 percent decline in new car sales through August versus the same eight-month period in 2008.
      His outlook coincides with that of The Conference Board, whose August forecast of short-term economic activity increased for the fifth consecutive month, and Federal Reserve Chairman Ben Bernanke, who stated in late September that the recession was probably over. U.S. GDP shrank 0.7 percent in the second quarter, according to the latest government figures, compared to a 6.4 percent decline in the first quarter.
      The health of U.S. trading partners, other than the United Kingdom, has also substantially improved because they were less involved in mortgage-related investments. Germany, Japan, Canada and France went from negative growth in the first quarter to small positive growth in the second quarter, while China's growth bottomed out around 6 percent during the January-to-March period and then improved to 8 percent. Mexico also slowed its decline in productivity during the second quarter.
      The Asia Development Bank on Sept. 22 reported too that Asian economies are much stronger than at the beginning of the year. It forecast China's annual growth to be 8.2 percent this year, up 1.2 points from its previous report in March, and 8.9 percent in 2010. India is expected to grow 6 percent instead of 5 percent, and Asian developing countries will grow 3.9 percent instead of 3.4 percent this year, according to its revised forecast. Regional growth in 2010 was also upgraded to 6.4 percent from 6 percent.

'Trying to make the case that growth is going to be slow because the economy is slow is a dangerous assumption to make.' Walter Kemmsies chief economist, Moffat & Nichol

      Container volumes at major U.S. ports, Kemmsies pointed out, have also increased 51 percent from February to August. Although 2009 container volumes are down 20 percent per month on a year-to-year basis, such comparisons are meaningless during a recession, the Moffatt & Nichol economist said. The important fact is that volumes are recovering from the first quarter of this year.
      Similar positive signs are found in other freight sectors. The American Trucking Associations also reported seasonally adjusted increases in truck tonnage for July and August. The August reading was the best since February. On an annualized basis, however, tonnage was down 7.5 percent from August 2008, which was the best year-over-year showing since November 2008.
      Kemmsies predicted U.S. exports would reach 2008 levels next year and continue to rise after that. Overseas sales of goods and services grew 12 percent last year, with most of the increase coming before the financial crisis on Wall Street in September, according to government figures. Kemmsies said imports are not expected to reach their 2007-2008 highs until 2012.
      'I won't believe we've truly recovered until I see someone like Macy's have higher sales growth than Wal-Mart as people shift upmarket again,' he said.

How We Got in This Mess. Although the current financial crisis had its roots in the banking and housing industries, trade played an indirect role precipitating events, Kemmsies told several hundred logistics professionals gathered in Chicago.
      That's because China used the vast sums of money earned from selling goods to U.S. consumers, and driven by a lot of outsourcing, to buy huge amounts of U.S. treasury bonds instead of its own currency, which would have raised the value of the yuan and made Chinese goods less competitive in America. The huge demand for treasuries drove down bond yields to the 3 percent and 4 percent range instead of around 6 percent, forcing pension funds and insurance companies to search for ways to make a higher rate of return on their investments.
      They leaped at the opportunity to buy mortgage bonds developed by creative Wall Street financiers, who packaged pools of mortgages in securities and in an attempt to spread the risk of mortgage defaults. The resulting deluge of capital in the financial markets drove down long-term interest rates, which helped spur demand for houses and in turn rapidly pushed up housing prices. Banks, now relieved of their mortgage liabilities by having sold the loans to the securities market, rushed to make more and more home loans, often with little regard for the creditworthiness of borrowers.
      China didn't technically manipulate its currency to maintain low exchange rates, but achieved the same effect by not repatriating most of its export revenues. The low exchange rate serves as a further incentive for U.S companies to relocate production to China.
      The Asian nation also used its export revenues to buy huge amounts of oil, copper, steel and other commodities it needed to run its factories and build cities for workers close to manufacturing centers. The demand for resources also led to a run up in commodity prices.
      Meanwhile, Wall Street firms believed that the United States would continue outsourcing and Americans would use ever-expanding equity in their homes to finance purchases of other goods. The idea worked well until the Federal Reserve increased interest rates and left them at a high level longer than normal out of concern for inflation, without realizing the housing sector was going into decline, Kemmsies said. As variable rate loans kicked up, the default rate skyrocketed out of control.
      Any sustained recovery in the global economy depends on the U.S. consumer, whose spending constitutes 70 percent of the U.S. economy, Kemmsies said.
      'If the American consumer doesn't join the party there isn't going to be a party,' he said.
      But fears in many quarters that consumers are going to save instead of spend their money are overstated, he said. As the U.S. population ages, spending on services will increase faster than spending on goods because older people have already purchased most of their household needs. Any change in savings is likely to come from baby boomers that postpone retirement and build up reserves to cover health care costs. And those savings are likely to be directed at services, not manufactured goods. Consumer spending is down primarily because younger people are the ones out of work or who don't have the personal equity to obtain bank loans during the tighter credit environment that now exists. As the economy stabilizes and younger people are rehired, consumer spending will gradually recover, Kemmsies said.
      A major bump in the road to recovery could come in 2011, when the Fed will have to start pulling excess liquidity out of the system by raising interest rates. The danger, Kemmsies said, is that if the central bank raises rates too much it could trigger another recession. A slow response could tip the country into a heavy bout of inflation. He expressed confidence that the Fed had learned its lessons from the recent cycle and will be able to thread the needle by raising rates a modest amount, which would slow GDP without stalling the economy. At that point the country would also need a second stimulus bill, he recommended.
      'I'm not worried about the next six quarters. I'm worried about 2011,' he said.
Trade is King. The shocks to the global economic system in 2008 did not derail the long-term trends driving growth in international trade, Kemmsies said, dismissing arguments that the 'new normal' means perpetually slower growth rates than earlier this decade.
      Trade has grown twice as fast as global GDP, with trade in manufactured goods 68 times greater than in 1950. It has been facilitated by containerization, the Internet, and expansion of free trade agreements ' all of which lower the cost of trade ' and magnified by population changes.
      Kemmsies predicted the volume of products shipped by containers will continue to grow, as will free trade agreements and technology adoption by international businesses. The number of container terminals around the world, he pointed out, has grown from 75 in 1970 to 570 in 2008.
      About half of all U.S. imports are containerized today, up from 40 percent four or five years ago. Containers, which allow for the more efficient movement of goods by sea and thereby long-distance sourcing, are also used to transport about 30 percent of U.S. exports, including to a greater extent agricultural products to better maintain quality. The substitution of containers for bulk shipments is highlighted by a Finnish company, Langh Ship Cargo Solutions, which recently announced the development of specialty containers for transporting steel coils and long steel products. Using containers allows customers to ship smaller quantities of steel with more desirable delivery frequency.
      Kemmsies estimates that 80 percent of the world's mid-to-large-sized companies still do not use enterprise resource planning systems to manage their manufacturing and distribution operations on a global scale, and adoption of such technology in the coming years will further facilitate trade.
      He said his biggest fear is financial sector protectionism as countries that bailed out banks try to restrict investments to domestic industries instead of allowing banks supported by taxpayer money to invest where the returns are highest. Attaching strings to foreign investments 'would be a disaster,' he said, because the financial sector led the way for globalization.
      Anticipate protectionist rhetoric or measures if President Obama's popularity declines further as he tries to regain popular opinion for health care and other pet policies, Kemmsies said.
      The changing U.S. demography also dictates that America will be even more reliant on foreign producers of goods than in the past, Kemmsies said. U.S. population growth is projected to slow from greater than 1 percent to about 0.65 percent. By 2020, more than 30 percent of the U.S. population will be above 55 and by 2030 a third of the population will be in that age bracket. That means that the United States will have to utilize young labor in other countries to produce things at a reasonable cost and develop an immigration policy that can help blunt the labor shortage, he elaborated in an interview after the conference.
      'If we didn't outsource we'd have a crisis on our hands' because of potential inflation and diminished output, he said. He disagreed with experts who say that U.S. companies have outsourced all the production lines they can shift overseas, noting that the auto and housing-related sectors have lagged in this area.
      U.S. paper imports, for example, are growing even as consumption of paper products has fallen for more than 10 years because paper manufacturers have disinvested from domestic manufacturing. Some production for goods that require frequent design changes or have obsolescence may return to Mexico and other places closer to shore, but China will remain the main place for achieving economies of scale, he said. Factories returning to the United States will be the exception, rather than the rule, even with the threat of higher transport costs, he added.
      In the past year, for example, Hanesbrands has consolidated most of its U.S. and Central American undergarment production and moved it to Asia.
      The Obama administration's push to make smaller cars, Kemmsies said, will accelerate the move of production overseas because small cars require cheap labor to support their small profit margins, he said. The environmental policy direction undercuts Obama's effort to prop up the domestic auto industry and save U.S. manufacturing jobs.
      The United States has lost about 5.5 million manufacturing jobs during the past 10 years. Kemmsies projected that it will lose another 3 million to 6 million manufacturing jobs by the end of the next decade.
      His analysis, which is in line with that of the International Monetary Fund and World Bank, shows future productivity in the emerging markets of Asia and South America is expected to grow faster than in North America and Europe because the former regions have faster growing populations and output per person, as well as younger populations earning lower wages. As more products of higher value are outsourced, wages for products that require skilled labor should rise.
      The same trends also create an incentive for manufacturers of low-budget items such as diapers and kitchenware to relocate plants in developing countries so they can sell competitively priced products to the local market. It doesn't make sense, Kemmsies said, for a company to make products with high-wage labor in North America and Europe and incur shipping costs to sell them to people who make less than $3 per hour.
      'Globalization is not about cost minimization, but about profit maximization,' he said.
      The outsourcing pattern could be broken at some point, however, because China's population is forecast by the United Nations to start decreasing in 2032 due to its one-child policy, he warned.

Commodities Correction. Kemmsies was even more bullish about growth prospects for shipping bulk commodities, saying the gap between manufactured goods and other products must narrow.
      Historically, raw materials were sent from underdeveloped countries to the developed world to make finished goods. As China, India and other countries stepped up manufacturing capabilities, they also required more steel, copper, oil and other raw materials to build and power their factories. The commodity trade slowed over time as they used their own resources to support their export industries.
      Increasingly, developing countries cannot economically meet their own resource demands and are purchasing raw materials from lower cost sources. As extraction costs increase for producing high-grade or hard-to-reach coal, minerals and oil, developing countries are turning to developed countries for some of their commodity needs. That's because countries like the United States use a lot of machinery instead of labor for mining and oil drilling. As production costs start to equalize and commodity prices rise, more mines and oil fields can be profitable and go into production.
      Trade in bulk commodities will probably grow faster than container trade in the near future, Kemmsies predicted.
      The trend towards raw materials with a high-capital, rather than labor, content carries with it the answer to the U.S. trade deficit, the former JP Morgan and UBS analyst said.
      'You can't expect China to keep buying Treasury notes. At some point we have to sell something tangible' to pay for manufactured goods, he told American Shipper. 'That's why I think agricultural exports from the United States are going to take off.'
      The U.S. agriculture advantage is based on plentiful water resources, capital intensive farming and genetically modified food techniques, he said. U.S. farmers can generate economies of scale through the use of equipment, fertilizer and seed compared to other countries where small farms are prevalent and arable land is scarce. As the leader in genetically modified foods, the United States already has the regulatory regime in place necessary to protect the environment from cross-pollination and can get to market faster than other countries seeking to enter the field.
      Testifying to the new trend is the June decision by the Port of Longview, Wash., to grant a long-term concession for the development of the first export grain terminal built in the United States in more than 20 years. Under the agreement, EGT Development LLC, a partnership between Bunge North America, ITOCHU and STX Pan Ocean, will invest more than $200 million in the facility to serve the growing Asia market, with the port contributing $6 million to build the dock.
      Bunge is a large wholesaler of raw and processed food and feed ingredients. ITOCHU is the second-largest marketer of grain and food products in Japan, and STX is a major shipper of agricultural products.
      At full operation, the terminal will be capable of handling 8 million metric tons per year of grain, oilseed and protein meals, according to Bunge. It features a rail loop track unloading system capable of holding four 110-car unit trains at any given time. In addition to handling shuttle trains, it will be able to unload barges from the Columbia River.
      Other U.S. commodities, Kemmsies added, are similarly positioned for export growth.
      'This is where we start paying our bill for cheap imports,' he said at CSCMP.
      As per capita incomes rise in developing economies and they invest in transportation infrastructure, they will import more goods and global trade will come into greater equilibrium, he forecast.

U.S. Port Sector. The macro global economic changes are being exacerbated by demographic changes within the United States that are impacting the structure of the domestic maritime industry. People are migrating to the Southeast and Southwest ' where the weather is nicer and the cost of living cheaper ' and to the coasts. Ports, therefore, are going to serve larger local economies and have to prepare for higher non-discretionary volumes. Retailers and manufacturers in recent years have set up more distribution centers in those regions and scheduled more ocean shipments through Gulf and East coasts ports to be closer to their customer base. Ocean carriers are offering more all-water services that bypass the West Coast, and the expansion of the Panama Canal has spurred plans for port, rail and highway investment in preparation for more cargo flows.
      Competition between ports for market share and investment has intensified as a result. Kemmsies and other industry professionals say ports need to take advantage of the lull in cargo volumes to start planning for future trade increases because of the long lead time required to obtain environmental permits and government funding. Doing preliminary work now will allow ports to adjust to market conditions as needed. But Kemmsies cautioned that investments should be targeted to prevent the creation of too much capacity.
      Building new capacity before there is sufficient demand is a recipe for financial loss, as the technology bust at the turn of the century demonstrated. Internet retailing is now a common practice, but at the time people lacked sufficient access to the Internet or were not comfortable with online shopping. Many of those who invested prematurely went out of business, Kemmsies said.
      'If too many terminals come on line at the same time before demand is there, we'll have structural excess capacity,' he said. The federal and state governments should help guide where investments make the most sense, he added.
      The United States neglect of infrastructure investment in recent decades has left the country with aging, poorly maintained roads, bridges, locks, sewer systems, pipelines, electric grids and other facilities that cannot reliably move goods and people, or deliver services. All levels of government are experiencing massive budget shortfalls as a result of the recession and are deferring maintenance and expansion at even greater levels.
      Kemmsies said public-private partnerships can help provide necessary financing and improve operations in many cases.
      Government entities, including port authorities, are best suited to take the risk and manage the uncertainty of the permitting process and building public support for projects, Kemmsies said. Once a project is ready, a private investor should be brought in to assume the construction risk and then operate the facility. A private operator can operate more efficiently and use tolls or other payment schemes to make a return on its investment.
      By selling the up-front rights to existing facilities, such as a highway, the government can monetize its value and take the revenues to start other greenfield projects, Kemmsies and other privatization advocates say.
      But Kemmsies drew a distinction between congestion and capacity, saying there are many process and technological improvements that can be made within the transportation system to address congestion, and thereby increase throughput without laying down more concrete and asphalt.
      Kemmsies generally supported the federal stimulus program, saying it was a necessary evil to prevent a 1930s-style depression. He lamented the fact that government didn't spend as much on infrastructure as initial hype suggested it would. Companies are more willing to invest in new facilities and products if they know the infrastructure is in place to help them efficiently move their goods.
      'If you really want to help this economy out you put money in things that will increase productivity,' he said.
      In the meantime, terminal operators, railroads, trucking companies and other transportation providers who took on too much debt in an undisciplined grab to expand their capacity are focusing on 'sweating their assets' ' working them harder to maximize revenue ' Kemmsies said. They are cutting costs and getting rid of equipment and real estate that doesn't immediately benefit the bottom line.
      Nonetheless, companies should still consider making intelligent investments in automation, such as radio frequency identification or container-handling machinery, that can make their remaining assets operate more efficiently and improve customer service and safety, he said. Automation also addresses challenges associated with environmental sustainability and land availability because terminal operators can raise capacity by densifying operations instead of expanding acreage.
      But Kemmsies cautioned terminal operators to target efficiency improvements where they can do the most good, noting that more lifts per hour or gate moves may not be worth increasing if other parts of the supply chain create bottlenecks that cancel out those speed gains. Solving those impediments will enable shippers to reduce inventory levels and financing costs.
      A good way forward for marine terminals and ocean carriers is to tap into shippers' sophisticated logistics and trade management systems to identify, and concentrate on giving priority moves to goods with a short-shelf life or high financing costs, he suggested.