Compound errors

Compound errors
Walter Kemmsies
Moffatt & Nichol

Difficult environment, slowing growth mask a very positive thing ' the economy is increasingly growing on its own.

      Many sectors of the economy, not just the freight movement industry, have been unprepared to handle the economic recovery, and capacity issues are likely to persist due to the uncertain economic outlook and unstable financial markets.
      Part of the problem is the unusual financial sector-driven nature of the recession, which caught most policymakers, decision-makers and forecasters off guard. However, there were other contributing factors such as the liabilities some industry segments incurred, such as ocean carriers placing orders for larger vessels. Other companies required dramatic capacity reductions to staunch large operating losses.
      Severe financial problems usually require drastic changes that carry the risk of overreaction. Even as the economy and financial sector continue to recover, slowly or quickly, capacity issues are likely to persist across a wide range of industries.
      In the 50 years since 1960 there have been eight recessions. Only two of these recessions were caused by a negative shock to the supply of resources that impact the ability to produce any good or service:
      ' The first occurred in 1973-1974 when the Arab Oil Embargo resulted in severe oil shortages in North America and Europe. Energy is an essential input into the production of all goods and services.
      ' The 2007-2009 recession can also be thought of as a supply-side recession in that credit, like energy, is required by all forms of economic activity.
      The reason it was so difficult to predict the financial sector-driven recession is the banking system is not very transparent. Consumer and mortgage debt had grown at a high rate for a very long time. It was clear a debt problem was developing. However, it also was not clear when a crisis would occur and how policymakers would react.
      It can be argued policymakers waited too long. Nonetheless, when they finally recognized the nature and severity of the problem, the policy prescription to address it was well known and executed accordingly. Whether the recovery policies could have been better designed and/or executed is tangential to the topic at hand.
      It is possible some people were excessively negative on the economic outlook because they hoped the developed nations' governments would not intervene and let events run their natural course. However, that was politically unviable.
      The bottom line is policymakers took action and succeeded in bringing about a recovery. This did not come for free. It's reasonable to expect growth in the near to medium term to be below the long-term trend rate, as the economy recovers and governments get their finances in order. How much lower and for how long depends on policymakers' actions.
      The credit crunch impacted everyone who owed money. In 2007 mortgage loan default rates began rising and eventually reached the highest recorded rates in at least the last few decades. Bank failures began to rise. As the credit crunch began to unfold in 2008 many companies drew down lines of credit and deposited those funds in their checking accounts to ensure they met short-term payment obligations. Companies and municipal debt issuers needing to refinance experienced great difficulty doing so.
      The freight movement sector was not exempt. Well-run carriers had significantly increased their liabilities, mostly in orders for large and expensive equipment.
      Enterprises, private or public, that had worked hard to avoid insolvency were unsurprisingly more concerned with cutting costs than with future expansion. As the recession lengthened to become the longest and deepest since the Great Depression, the focus had to remain on cutting costs. The relative minority of companies flush with cash took advantage of opportunities presented by others' predicaments but were nonetheless still cautious.
      As the economy and trade began recovering in 2009, companies were generally unprepared, since they were still focused on cost-cutting and financial issues. In the second quarter of 2010, most industrial companies reported better than expected profits and raised 2010 growth forecasts.
      However, large manufacturers could be held back by difficulties securing critical components from supply chains weakened by the downturn. Some suppliers to large industrials are finding it hard to rapidly increase production capacity and report financing remains expensive and difficult to access.
      U.S. and European manufacturing supply chains are showing signs of straining to cope with demand. The Financial Times reported a survey by MFG.com, an online marketplace for manufacturers, found 51 percent of big U.S. manufacturers reported 'significant supply chain disruptions' in the second quarter. And 42 percent of small and mid-sized suppliers said they had received queries or work from larger companies in need of urgent assistance because of supply chain problems.
      Generally speaking, the economic outlook is good. The slowdown in economic growth is to some extent attributable to the decline in the fiscal stimulus, which has left expansion increasingly dependent on consumer spending growth.
      Consumer spending is growing slowly because the recovery in employment has been slow. Companies have posted more job openings than layoffs, however the offered salaries are low enough that many may feel they are better off staying on unemployment benefits until better opportunities come about.
      Supply chain constraints that are slowing the economic recovery are likely to continue for some time. As the financial sector recovers and the bottlenecks become more critical it is likely that growth will increase again. The timing of all that may be uncertain, but it will be well-received news because it will show that the recovery has become self-sustaining.      
      Walter Kemmsies is chief economist of Moffatt & Nichol, a marine infrastructure engineering firm. He can be reached at (212) 768-7454 or e-mail, wkemmsies@moffattnichol.com.