Capital competition
Infrastructure must vie for shrinking capital pie.
Walter Kemmsies
Moffatt & Nichol
Beyond the current difficulties in obtaining credit due to the dysfunctional banking system in many major economies, an even more intense competition for capital is shaping up that will negatively impact transportation.
In many parts of the world, the United States in particular, there is substantial need for infrastructure investment, not only for necessary maintenance and repair, but also because of the change in the world's economic structure. Much of the needed investment is being delayed because credit markets, bank loans and bonds, are still recovering from real estate bubbles that occurred, and in some cases are still occurring, around the world.
It is important to begin making investment plans and secure credit now for two reasons:
' As the economy recovers, labor and raw materials costs are likely to increase, which will raise the cost of construction.
' At the same time other segments of the economy will also begin to invest, which means competition for capital will remain intense even after credit markets become functional again.
Capital Supply Issues. Similar to the 1973-1974 oil shock, the world economy is struggling with another supply shock, this time caused by a lack of credit as opposed to an oil embargo. The difference is that an oil supply shock can be reversed a lot faster than a credit supply shock.
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Central banks bought a lot of low-credit-quality securities and loans from banks in order to prevent them from becoming insolvent. That is not enough to make banks start lending again. The poor state of the economy means loan default rates remain close to historically high levels. Borrowing money in the bond market is difficult as well because bond investors are also concerned about defaults and prefer instead to buy U.S. Treasury securities, even though the yields on them are near historical lows. Investors are primarily concerned with preserving capital at this point. This is also evident in the equity markets where the flow of new initial public offerings of shares remains well below historical averages.
Governments of the world's major economies resorted to deficit spending in order to stop the gap between production and consumption from widening. Stimulus included extended unemployment insurance benefits, lower tax rates, rebate programs such as 'cash for clunkers' and spending on infrastructure in the form of TIGER grants for 'shovel ready' programs. Large amounts of government bonds have been issued, which would have crowded the private sector out of the capital markets were it not for its reticence about investing during the recent downturn.
It is unlikely that the major industrialized economies will recover fast enough for the deficits to decline quickly. This means sovereign governments will likely continue to issue bonds and crowd out private sector investment, including semi-public-sector institutions such as port authorities.
As the world economy recovers the demand for capital is likely to grow faster than the supply of capital, which means interest rates will increase. If the central banks monetize the debt, meaning they buy government bonds, then we could end up with too much money chasing too few goods and inflation could rise, which would also push interest rates upward.
In short, as the economy recovers the rationing of capital will not improve. Right now interest rates are low because central banks have made a great effort to achieve that, but it is difficult to obtain financial capital. As the economy improves, demand for capital will grow quickly and interest rates will rise in order to put it to its highest and best use.
Capital Demand Drivers. The poor state of almost all types of U.S. infrastructure is getting more attention in the media. Eric Kulisch covered this in the April issue (see 'Infrastructure in a political divide,' at www.AmericanShipper.com/links), as did the History Channel in a program called The Crumbling of America.
The American Society of Civil Engineers has tracked this for a long time in the form of a report card, where different types of infrastructure are graded on a scale where A is the highest and F is failing. For 2009 the ASCE gave U.S. infrastructure an overall grade of D and estimated it would take $2.2 trillion to bring it back to a state of good repair. That is about 17 percent of U.S. gross domestic product.
Underlying ASCE's poor grade is a large amount of infrastructure operating beyond its design life. The American Association of State Highway and Transportation Officials estimated in 2008 that it would cost $140 billion just to bring U.S. highway bridges back to a state of good repair.
These figures don't include the upgrades to congested highway corridors. Neither do these figures include upgrades to U.S. infrastructure to support its efforts to increase exports.
In addition to maintenance, repair and improvement, there are other critical U.S. infrastructure investments to be made. For example, electricity grids (on which the country is critically dependent) also require upgrading, water systems in many locations are not in compliance with the 1965 Clean Water Act, and prison space and hospital beds are in short supply.
None of the estimates above include needed investment to accommodate future growth by the private or public sectors. America's population is growing and migrating. Congestion in some corridors is likely to be persistent and may require frequent upgrading of road, rail, sea and air transportation facilities, as well as energy, water and government operated infrastructure such as schools and prisons. Developing economies also have great need for infrastructure investment and may compete for capital by offering investors a better risk-return profile than investments in the United States.
Forewarned is Forearmed. Obtaining permits and rights to expand or build new infrastructure is a lengthy process. Delaying the decision and permit process today could prove very costly down the road. The time to prepare for the intense competition for capital is now.
Walter Kemmsies is chief economist of Moffatt & Nichol, a marine infrastructure engineering firm. He can be reached at (212) 768-7454 or e-mail, [email protected].