Are the Fears Inflated?

You’ve probably seen the headlines about some economists becoming increasingly concerned about inflation. So, should we be concerned?  (Note: please keep reading. This is not one of those in-depth analysis involving T-bills and yield-curves, but more of a big picture, horse-sense type of view.)

Definitions

The most basic definition of inflation is: Too many dollars chasing too few goods.

A more precise definition from Investopedia:

“Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.” 

Some inflation can be good

Complicating Factors

Inflation is inherently challenging, because it means your money is worth less, because it can buy less goods or services. However, economists generally believe that a low, and steady, inflation rate of around 2% is good because it signifies a growing, healthy economy. Inflation, under control, does help to balance out imbalances in basic supply and prices.

We have not had to deal with high inflation for a long time. The last time inflation was above 5% was in 1990. The last time inflation was above 10% was 1980. The Clinton administration achieved strong economic growth, with low inflation, by significantly increasing imported low-priced goods from China. Economists labeled this strategy as “importing deflation”. This strategy worked so well it has been advanced by every administration since then, except for one.  But that’s a political discussion, and I’m not swimming in that pool.

The other factor limiting inflation has been technology, especially the tremendous efficiency benefits provided by the Internet. Technology and the efficiency it provides, lowers just about every type of cost, thus reducing inflation.

Current Situation

But let’s get back to this “Too many dollars chasing too few goods” thing. Why are economists concerned?

Too Many Dollars?

The government flooded the economy with cash in 2020 with the stimulus deals. This helped many people in financial distress, but many people received checks they didn’t need.  Consumers spent this windfall or saved the money for future purchases. And now, there is even more stimulus money on the way. From my point of view, there are too many dollars currently in circulation. This by itself might not be a problem, but...

Too Few Goods?

Ever since the economic restart, some goods were in short supply. The list included both consumer goods and industrial goods in an extensive range of industries. For example, there was a severe shortage of hotel towels in October, and some of those are produced in Pakistan. And now, there are reports of cat food shortages in some areas of the country.

While many of the shortages have been alleviated, some have intensified. We see the headlines for computer chips and steel, but we know in the commercial equipment industry that these products and a host of others are in short supply. The supply chain is in a mess. I’m guessing manufacturing material, and component shortages are in the worst shape since WWII.

So, we can’t make enough products to satisfy demand. Combine this with consumer products sitting on ships for days waiting to dock and then being delayed a few weeks due to port congestion, and you end up with too few goods. The inventory numbers confirm this.

What? – Me worry?

Federal Reserve Chairman Jerome Powell has finally admitted that he expects some inflationary pressure as the economy reopens but expects it to be temporary. Previously, he said he is not concerned because inflation doesn’t “change on a dime” and that a return to standard 2% inflation rates is not a danger. He also thinks the FED will be able to control the inflation once it starts.

In effect, he is saying they will be able to control the boulder once it begins to roll downhill.

What happens, however, if that boulder rolls right over the FED and anything else you put in its way. It’s like the old Chaka Chan and Rufus song: “Once you get started, oh it’s hard to stop”. Inflation isn’t something you want to see gaining speed quickly. 

Big Difference of Opinion

There are those economists sounding the alarm based on the factors previously cited and the movement in the 10-year treasury yield curves. But Chairman Powell and other economists in the Biden administration say “Move along, nothing to see here”. Of course, they can’t both be right. So, hope for the best, but be prepared for the worst.

This post originally appeared in the FTR blog. For more information on FTR, the leader in commercial freight analysis and forecasting: FTRintel.com 

 

If You Start Me Up - Restarting the Industrial Economy

 When the economy was in lockdown there was a strenuous debate on what would happen when the lockdown ended. One argument was the economy would stay in recession for months before gradually recovering. This view supported the case of preserving the lockdown since there was little benefit to opening back up. “You can’t just turn the economy back on like a light switch”, they claimed. The opposite view claimed that when the economy reopened, there would be a “V” shaped rebound, with the economy taking off like a rocket. This argument supported opening the economy up fully and immediately, despite the health risks.

As it turned out both sides were wrong, or at least only partially correct. After the fifty governors started reopening their state’s economies to one degree or another, economic activity jumped, but it wasn’t a capital “V” recovery. It was more like a lower case “v” recovery. This is because manufacturing has been lagging compared to the robust comeback in the consumer goods sector. When that proverbial light switch was turned on, the demand side of the consumer economy snapped right back, except for those contact-service industries. Demand also jumped on the industrial side but it is hard to gauge due to the

If you start it up!

supply factors discussed later.

Consumers who were able to maintain their income, spent heavily on goods and non-contact services. In many cases, they had even more disposable income due to government stimulus checks. It was relatively easy to restart the export goods pipeline, so easy the ports have been backed up for weeks as containers arrived.

Manufacturing Lags

It is much more difficult to jump start the industrial side of the economy. Factories were shut down for weeks. Some of these factories had never been idled except for a few days at the end of the year for holidays. There are startup and maintenance issues with some types of equipment. Workers need to be recalled, and material and parts inventories need to be replenished.

In addition, there were significant health factors involved in restarting the factories. Social distancing, disinfecting, contact tracing and quarantines all impacted productivity. Some workers declined returning to factory jobs due to personal or family health concerns. While many employees switched to working at home, this is not an option for production workers. There is also a major issue with government stimulus and extended state unemployment benefits providing a disincentive for reentering the workforce. In some states, the hourly unemployment benefit is close to or greater than the average factory wage. This is causing a severe worker shortage in certain industries.

There are also problems acquiring imported parts. Mexico remained on lockdown weeks after the U.S. restarted. Overseas producers rebooted more quickly, however; the U.S. ports were flooded with containers of restocking consumer goods. This is causing gridlock and delaying the delivery of key industrial components to manufactures for weeks.

All these problems resulted in a dysfunctional supply chain. There are steel, aluminum and wood shortages, among others. Even computer chips for autos and trucks are scarce. There are component shortages in many industries which are slowing production and raising prices. My sources tell me that the problems are intensifying in February, with no relief in sight. One manufacturing expert says “So the supply chain has basically dissolved.” It’s difficult to determine what the true demand is coming out of the lockdowns, but it is readily apparent that we have a supply chain quagmire, the likes of which this country has not experienced since WWII.

A Wide Gap Between Consumer Demand and Industrial Supply

The great disparity between the rebound in consumer market versus industrial is illustrated by comparing orders for van trailers, those hauling consumer goods, and those for flatbed trailers, used for transporting industrial goods. For the 2020 September-December time period, van orders were up an astounding 160% over the same period last year. Flatbed trailers were up only 31% (still respectable).

The good news is that flatbed orders have shown a noticeable improvement starting in November and are accelerating in 2021. The ISM PMI for manufacturing remains at high levels indicating that demand is strong for manufactured goods and is growing. Now supply just needs to catch up.

The Future for The Industrial Sector Looks Bright

The supply chain clog will be cleared at some point due to the laws of economics and the profit incentives of free markets. It could take an extended time since conditions are still worsening. The vaccine should lower infection rates and allow many people to return to the workforce, including factory jobs. Also, as state unemployment benefits run out, the job numbers could spike. This should drive down unemployment, and with the reopening of the travel and hospitality sectors, give a welcome boost to GDP.

This post originally appeared in the FTR blog. For more information on FTR, the leader in commercial freight analysis and forecasting: FTRintel.com

 

In 2020, 20K May Be The Key Number For Class 8 Trucks

The current state of the Class 8 truck market has fleets carefully evaluating their truck needs for the next few months and placing orders for delivery within that timeframe. OEMs can easily schedule production to deliver on time and suppliers are having few problems keeping pace.  The Class 8 market is currently operating as a normal industry, with demand and supply in close balance.

However, this situation is also highly abnormal, since Class 8 trucks are one of the most cyclical industries in the entire economy. When the freight market is growing, fleets must forecast how many trucks they will need in the future, sometimes as far as a year ahead, and order accordingly. When the freight market is receding, fleets must decide how many older units they can afford to replace, based on declining revenues, and reduce orders accordingly.

There have been a few years where production has been near replacement demand levels, estimated at around 240,000 units. Weak GDP and freight growth are typical during those years.  But there is still some cycling, as shipments start below replacement demand levels at the beginning of the year and then rise above them at the end. So the market still cycles, and doesn’t remain right at replacement levels for very long. Also, orders in these years tend to follow traditional trends as well, higher in Q4 and lower in Q3.

How We Got Here

Class 8 orders set a record at an astounding 497,000 units in 2018.  Freight growth surged in 2017 and kept on going in 2018. Fleets did not expect the jump in business and there was a shortage in trucking capacity. The ELD mandate reduced overall productivity, exacerbating an already bad situation.  Rates spiked as service levels tanked. Carriers desperately needed more trucks, but OEMs and suppliers ran out of manufacturing capacity, intensifying the shortages. As freight continued to grow, the big fleets began ordering for 2019 deliveries in the summer of 2018. Just under 53,000 orders were placed in July 2018, traditionally the weakest month of the year. This was followed by a record 53,300 orders placed in August. 

OEMs were able to find enough workers to ramp up build rates and suppliers resolved most of their issues, leading to production of over 340,000 trucks in 2019, a record for a year not impacted by an emissions mandate pre-buy.

Orders slowed significantly in 2019 because most of the orders for delivery in that year were placed between July and December (estimated at 225,000).  Orders in January – September 2019 averaged a paltry 13,300 units a month; volumes more likely seen during a recession even though economic growth continued. But you can’t evaluate 2019 orders without taking the record set in 2018 into account. You need to look at 2018-2019 together. Orders averaged 28,000 units a month over the two-year period. For 24 months orders were 40% over replacement demand level (20,000 units a month), fueling two terrific production years for Class 8 trucks. Freight growth stalled in 2019, but production remained robust for much longer than expected because total hauling capacity just caught up with freight volume.

The Great Reset Is Here

Fleets traditionally begin ordering for the following year in October. Under normal conditions, orders in the fourth quarter are the highest quarter by far. Large fleets evaluate their equipment needs for the following year in the summer and send their quantities and specifications out to the OEMs for pricing. They then place their requirement orders in Q4, often issuing orders out in a 12-month window. Medium-sized and smaller fleets often order in quantities based on what the big fleets do.

However, conditions this year are much different. The big fleets are determining what older trucks they are going to replace in Q1 and just placing orders for those. The rest of the market is following their lead and placing smaller orders for shorter delivery times. Q4 monthly orders were 22,000, 17,600, and 20,000, for an average of just under 20,000, which is equal to replacement demand. As mentioned before, this is consistent with many other industries in a low-growth environment, but what has caused this abrupt change in typical ordering patterns for Class 8 trucks?

Caution Reigns Supreme

This is not a poor business environment. Freight levels are high after a couple of years of vibrant growth. Rates took a hit from the high prices in 2018 but have started to recover some. There is plenty of freight to haul, so well-managed fleets will be profitable, as poor-manage fleets go bankrupt due to the slowing of freight growth. The economy keeps growing and a recession is unlikely in 2020. However, it is a highly uncertain environment, with much downside risk.

The key risk factors are:

-         The economy has slowed from its strong performance over the last couple of years. FTR forecasts GDP growth at 1.7% for 2020, down from 2.3% in 2019.

-         The industrial sector of the economy is weak. The ISM manufacturing index is at 46.8%, indicating manufacturing is contracting. The index is at its lowest level in ten years.

-         Class 8 truck loadings are expected to be basically flat in 2020, at a 0.9% growth rate.

-         There are continuing tariffs and trade wars. Yes, it does look like some conflicts are calming down, but one tweet can change everything in a moment.

-         Business investment in most sectors of the economy has pulled back due to this same uncertain environment.

-         There is a caustic political environment and there is an impeachment trial.

20K in 2020?

Under this highly uncertain environment, there is no speculative ordering of Class 8 trucks. This is like a mountain climber on shaky terrain. One careful step at a time. Orders are for only what is needed – out for one quarter at a time.

Usually, when the market hits equilibrium, where supply and demand are balanced, it doesn’t remain there for long, because demand is almost always cycling up or down. But this time is different. Uncertainty may even increase before it decreases because the upcoming election could be between candidates with starkly different business and economic philosophies. Throw in the possible conflict with Iran and the ledge gets even shakier.

Flat freight growth means fleets do not need to expand. A growing economy and high freight volumes enables them to replace old units with minimal risk. So, we are left with only replacement demand, estimated to be around 20,000 units a month. 

Therefore, the Class 8 market is in a holding pattern. Orders and build rates may stay locked in this range for a while. That means ironically, we are stuck in the 20,000-truck a month range in the year 2020. It could be the most stable Class 8 year ever.

The 2019 Class 8 Truck Market Was A Thriller

You could make a movie out of the dramatic Class 8 market in 2019. But it would be a terrible movie. And a movie we have watched before.

It Was the Best of Times

The movie begins with great joy in the industry. The freight surge in 2018

creates unprecedented demand for trucks (not counting the emissions pre-buy of 2006). OEMs are cranking out trucks as fast as possible. Suppliers are keeping up after disruptions in 2018. Dealers are finally getting stocks, and they are flying out the door. Fleets are putting the trucks into service, and profits rise. Factory workers, truck drivers, investors, and every industry stakeholder are happy, happy, happy.

But Then Things Change

By the end of the year, freight growth stalls. Fleets have enough trucks to handle the available freight. Production at the OEMs slows. There are layoffs at both the OEMs and suppliers. Trucker wages, especially owner-operators, fall. The weaker performing fleets go bankrupt. Fleets pull back on orders for next year due to the high degree of economic, trade, and political uncertainty. The industry people are all sad, and nervous about the future as the movie comes to a close at the end of December.

And We’ve Seen This Movie Before

The Class 8 truck market is one of the most cyclical industries in the entire economy. And while this downturn is similar to previous ones, it does have some unique features. The 2019 FTR forecast was for a robust first half of the year, a stepdown in Q3, and a further erosion in Q4.

The build in the first half of 2019 was even higher than our lofty numbers. I realized at the FTR June forecast meeting in mid-May, that something was amiss. We had the market softening in Q3, but there were no signs that production was slowing down much at all, a short six weeks prior to July. And Q3 did ease, a mere 3%, but at almost 93,000 units, it is still one of the top quarters in history.

But the inklings about a Q4 drop started in July. Fleet confidence started to fade as freight growth slowed. Spot rates dipped, as well as profits. OEM backlogs were plummeting due to lower orders and elevated cancellations, as fleets pulled orders out that they had placed many months ago. Supply of trucks was finally catching up with demand, which always happens, but this time it was more sudden. There was talk that OEMs were considering drastic Q4 cuts, even as Q3 production remained robust. I wondered aloud during an August meeting, “What are the OEMs going to do? Build like crazy for nine months and then just shut the whole thing down?” It sounded crazy when I said it, but it doesn’t sound crazy right now.

The Roller Coaster Was Wild This Time

We’ve experienced wild demand swings in the industry before, but nothing like this time. For example, in the last 12 months (December 2018 – November 2019) Class 8 orders have equaled 180,400. In the previous 12- month period (December 2017 – November 2018) orders were 513,500. And of course, the economic shock, the extreme outside factor, the black swan which cause this precipitous crater was, was, …. Oh yeah, there wasn’t one. This is just the cyclical nature of the Class 8 market.

Production is expected to drop around 30% from Q3 to Q4. Once again, the big economic hit is …… none. Although there are enough economic and environmental pressures present to increase uncertainty entering 2020:

-         GDP growth falling to 0.9% in Q1.

-         Freight growth of only around 0.5% for most of 2020

-         Manufacturing growth in decline for four straight months, probably headed for a “manufacturing recession” (six months or more under 50 ISM), similar to 2015-16.

-         Uncertainty due to trade wars, tariffs, etc.

-         Political turmoil in the news daily.

-         The upcoming 2020 election which will slow business investment as the day approaches. The expected contrast in business philosophy between the candidates will amplify this effect.

Recession Talk?

Several months ago, there were many economists raising the possibility of a recession in 2020. There wasn’t much support for these forecasts and that talk died down quickly, with the general consensus being no recession is imminent.

However, I think there is a better recession argument to be made now based on the factors listed above. Also, the Class 8 market is a leading indicator, and the order numbers for October and November do signal possible trouble. I don’t think a recession is coming in 2020, but the conditions are similar to 2016 when economic growth nearly stalled out. It would not take much of a bigger dip or an outside force to push the economy under water for a short period.

Based on October and November orders, it appears Q1 production will start off weak. If manufacturing begins to recover in February, it will stabilize the Class 8 market and orders will improve. Hopefully, the 2020 version of the movie is not a horror film.

What is the Trade War’s Impact on U.S Manufacturing?

(This post appeared on my work blog in early October. Just a few days later there was progress on the trade talks. Conclusion? Both Trump and the Chinese read my blog!)

I regret to inform you that we are involved in a trade war. I regret it, because months ago I told my colleagues to calm down, proclaiming there would be no trade war. I believed that both China and the U.S. realized that a trade war would be too damaging to both countries and, therefore, they would strike some sort of deal. I even replaced the term “trade war” with “trade conflict” in our company reports, when the countries were just in the threatening stages. I don’t even like the term. It’s not like it’s a real war, but that’s the term we use. So, I admit it: I was wrong, so wrong.

What impact is this “war” having? When it began, the media went into panic mode, warning that the economy would be severely affected, with some even predicting a repeat of the Great Recession. That hasn’t happened yet because most journalists do not understand economics. Economics is basically the study of how people react to changes in order to maximize their benefit. Most dire predictions about the economy assume that people, and companies, will not change their behavior due to the tariffs. And this is absolutely false. People and companies adapt and make choices based on the new supply and prices of goods. Therefore, it is almost impossible to predict the impact of the tariffs as they are happening.

The business response to tariffs can be complicated. Take the real case of a component supplier to the commercial vehicle industry facing a 25% tariff on goods produced at their China factory. If you assume all costs get passed on, the product cost rises by 25%. They raise their price by 25%, which means truck and trailer OEM’s raise their prices to the dealers, who raise their price to the fleets, who charge more in freight rates, which results in higher prices to consumers.

However, this supplier, in this case, shifted its production to Vietnam, resulting in just a 15% increase in costs. But the changes didn’t stop there. Aftermarket customers balked at buying products from the new Vietnamese factory until the quality could be proven, leading the company to increase production at its U.S. factory. The supplier was also limited in how much it could raise prices due to market competition. So, the company is making less profit on roughly the same amount of sales, and there is minimal impact on down the supply chain. While less profit is not good, it is not catastrophic to the economy.

Also, I recently read an article about the effects of the tariffs on a company that produces a consumable sporting goods product in China. The company had achieved a dominant market share by utilizing cheap Chinese labor to slash costs. It could then price its product under the competition, and yet still achieve a higher margin. Now, due to the tariffs, its cost is more than the competition, and it can’t raise prices due to the competitive nature of the market. The company officer was whining excessively about how the tariffs were eating into his profits. Pardon me, but it was your decision to produce in China, which provided enormous profits and allowed you to crush the competition. And now you are complaining that your profits are no longer enormous. I just can’t feel any pity here. But this company is absorbing all the impacts of the tariffs, and I am not paying a penny more for this item at the store.

But the tariffs are having an impact. The farmers and other “targeted” industries are obviously suffering. It should be noted that these sectors are hurting as a result of Chinese actions. Instead of negotiating a deal, the Chinese choose retaliatory, targeted tariffs. However, I am not going to debate the merits or hazards of this trade war here. But how are the tariffs impacting the economy?

Two areas where the tariffs are causing problems are construction and manufacturing. Total Construction Spending was up just 0.1% in August, and June’s and July’s tepid numbers were revised downward. Year-to-date spending is down 2.3% versus the same period in 2018. How do tariffs impact construction spending? The tariffs increase economic uncertainty, and this decreases business investment. Business investment is an important element to overall economic growth, and obviously essential to the construction market.

Manufacturing is also displaying weaker numbers. The ISM (Purchasing Managers) Index for manufacturing was 47.8 in September, the lowest value since 2009. It has been below 50 (indicating manufacturing activity is contracting) for two months in a row. However, the index had been declining before the heavy tariffs kicked in, so what is the impact of the tariffs alone?

Let’s compare the last time the ISM index cycled down in August 2015, with this cycle in which began in August 18 (see graph). The ISM in this cycle was stronger until we hit May 2019. And in August the downward slope of the line increased. Therefore, a rough estimate of the impact of the tariffs on manufacturing is the yellow area on the graph. It indicates the tariffs began having a noticeable effect in May and it intensified in August.

The economic data from China is even more dire, with a report indicating China’s economy is growing at its slowest pace in 27 years. I may have been wrong about if a trade war would start, but I was correct about the impact to both countries.

Therefore, this conflict needs to end soon. The uncertainty is beginning to choke the economy, which would still be doing surprisingly well without this anchor. We may be on our way to a manufacturing recession (in my book, it takes six months at an ISM of 50 or below, and we are currently at two). If China’s GDP can recover, it helps the world economy, which leads to more U.S. exports.

There is still a lot of money sitting on the sidelines, waiting out the war. As soon as economic peace is established, this cash will come pouring back into the economy, providing a temporary boost. Which is exactly what we need right now.

It’s Time for an Economic Celebration!

The U.S. economy is setting a record this month for achieving the longest period of growth in its history. The economy has been growing for 121 months, breaking the previous streak from the 1990s. This doesn’t surprise me. Everything about this recovery has been unusual, so the fact that it is unusually long is par for the course.

However, the reason this recovery has run so long is because the hole we had to climb out of was so deep. It’s called the Great Recession, as opposed to the recession of 2008-2009, for a reason.

-         It lasted 19 months

-         It’s regarded by some as the second worst downturn of all time

-         The unemployment rate reached 10%

-         Real GDP fell 4.3%

-         There was a global financial crisis

In trucking, it took over 10 years for freight volumes to reach their pre-recession levels. For commercial vehicles, the drop in Class 8 truck production from peak month to trough was 80% and 81% for trailers. Our industry is one of the most cyclical in the entire economy and suffered greatly from the downturn.

Some analysts are downplaying the length of the recovery because of the weakness of the growth rate over time. The average annual GDP growth rate during this expansion is a paltry 2.3%, which puts it dead last on the list of economic expansions since 2019 (the next lowest is 2.7%, in the 1990s).  I believe the substandard performance is mostly the result of the severity of the crash.

Imagine a cyclist is zooming down the road, hits a bump and crashes her bike.  As a result, she sprains her knee. How long before she is biking again? After some rest and pain medication, she is back riding at half-speed in a few weeks. In a couple months, she is back at full speed, as if nothing ever happened. (Sounds like the 2001 recession).

But then another cyclist is gliding through traffic and gets hits by a huge SUV. He ends up in intensive care with serious injuries, including several broken bones. His recovery is excruciating slow, with minor incremental progress. He moves out of intensive care to the hospital and eventually back home. The bones heal and physical therapy begins. Maybe he gets back on the bike in a year, struggling to pedal slowly. Because he is a dedicated cyclist, he eventually makes it back to full speed, but it takes years.

Those pessimistic analysts forget just how devastating the Great Recession was. If you were one of the 10% unemployed, searching for work in one of the worst job markets ever, you don’t forget.

From the optimists, there is much political debate about who gets credit for the record recovery. In my view, the Obama administration did a great job climbing out of the economic pit. It got everything stabilized and held tight reins on the economy, so it would not fall back into the hole. However, at some point you could stop climbing and start running. Unfortunately, it’s difficult to transition from climbing to running. It takes different skills and policies, and they remained stuck in one gear.

The Trump administration comes in and can clearly see we should now be running and not climbing any more. They put some track shoes on the economy, gave it a push, and shazam! So, the Obama Administration primed the pump for several years, and the Trump people pumped away. See there is enough credit to go around. Can’t we all get along?

Dark Clouds? 

Nothing lasts forever, not even the longest economic recovery in history. The last two recessions occurred as a result of shocks, bubble bursts if you will, in dot-com and housing. There are no bubbles visible now, but you never really see the SUV coming at you until it’s too late, right? 

Yes, there are plenty of dark clouds headed our way. The economy is slowing after hitting a peak. GDP is expected to dip to around 1.5% in Q2. Will it continue to descend, or will it stabilize? It would help immensely if trade deals with China, Mexico, and Canada get finalized soon. This would provide a momentary boost to the economy, enough push that I don’t anticipate any serious economic problems until late in 2020.

Party Time!

I don’t expect economists to celebrate this milestone, because economists

don’t celebrate much at all. But for the rest of us, let’s party! We had to go through the misery of the Great Recession, we deserve to celebrate this 10-year anniversary (plus a month) of its passing. Raise your glass! Shoot off some fireworks! Here’s to 121 months of economic growth!

This post first appeared on the FTR website with minor changes here..  FTR is the leader in analyzing and forecasting the commercial transportation industry.  For more information on FTR reports and services, please click here.)

We’re Addicted To Cheap Chinese Goods

In the early 90’s, the Clinton administration provided trade benefits to China. There was strong criticism against these moves based on China’s human rights violations. However, President Clinton argued that expanding trade would lead to better relations with the Chinese and eventually better conditions for the Chinese people.

As trade with China increased, the Clinton economic team realized something significant; they could achieve economic growth without increased inflation. Usually, economic growth spurs inflation, which the Fed tries to control with higher interest rates. This can eventually lead to recession.

However, in the Clinton 90’s, the economy grew without a recession because we were able to “import deflation” from China. The toaster that priced at $10 (made in Missouri) could now be purchased for $8 (made in China). Add up the savings from a variety of everyday purchases and you are stretching the family budget. Multiply the savings over millions of families, and poof! – much of the inflation in the economy disappears.

Yes, the toaster jobs also began to disappear in Missouri, but the dot-com boom was just heating up, so high-tech jobs were growing. This began the transition of the U.S. from a low-tech workforce to a new, high-tech workforce, a problem we still struggle with today.

You may consider “grow the economy and import deflation” a short-term strategy with long-term difficulties. However, in U.S. political cycles, you leave after eight years. So, whatever consequences are created become someone else’s problem.

The convenient time for this policy to be evaluated, controlled, modified, etc., would have been at the beginning of the Bush II administration. But, the dot-com bubble burst in 2000. Whoops! – there went many of those dot-com jobs, and a recession began in March 2001, followed closely by the events of September 11. Taking any action at that time which disrupted the economy or increased inflation (if you stopped importing deflation, for example) could have proved disastrous. So, the Chinese policy continued.

In 2000, Congress did pass legislation promoting more Chinese trade and, in

2001, China was admitted to the WTO (World Trade Organization). The hope was that this would lead to China buying more U.S. goods, thus reducing the now-ballooning trade deficit. But this move only accelerated the import of Chinese goods. The Economic Policy Institute estimates that 3.4 million U.S. jobs have been lost since the WTO action. We may have imported deflation, but we also exported production jobs. Somewhere along the line, that Missouri toaster factory was toast.

The Chinese imports increased through the aughts (00s). Economists were confused about how the economy could be doing well with U.S. employment growth so tepid, but it looks like the trade policy is partially to blame. With manufacturing declining and the dot-com sector slow to recover, there were few places to invest capital, so everyone poured massive amounts of money into the housing market.

After the housing bust and Great Recession, the new Obama administration could also not risk disrupting Chinese trade. The economic recovery was very fragile for a few years and never great during the entire eight years. So, the Chinese goods kept flowing.  The Chinese were fortunate that economic and world calamities prevented U.S. trade policies from being critically reviewed, which enabled the cheap Chinese goods to keep flowing to U.S. consumers for over 20 years.

The Trump administration reviewed the numbers and wondered how we ever got into this precarious position. Today, we find ourselves in a trade war, which involves much more discussion about intellectual property and opening Chinese markets to U.S. goods than about slowing the flow of products into the U.S.  Why? We might as well face it – we’re addicted to cheap Chinese goods. Yes, we love those low prices at Walmart and online too! We have been buying the stuff for 25 years and we are hooked. This is surely the “new normal”.

You might have thought the renewed interest in Chinese trade would have revived the debate about human rights abuses. How about those advocates protesting exploitation of Asian workers? What about the argument that buying Chinese goods enriches a communist regime that may do us harm in the future? Nope, nope, nope. Crickets! Why? We are addicted to Chinese goods like a junkie on crack.

And the addicts are agitated because their “fix” might increase in price 10% due to the tariffs -- a 25% increase would be horrible! Of course, the simple calculations for the tariff’s impact on prices are always overstated due to the law of supply and demand and the fact that consumers will seek substitute goods.

In this highly politicized culture, the Chinese tariffs will either destroy our economy or have very minimal impact, depending on your attitude towards Trump. Of course, the truth is somewhere in between. However, the tariffs and trade negotiations have greatly increased business uncertainty, which is always detrimental to the economy. Therefore, it is beneficial to the U.S., China and, yes, the cheap-Chinese-goods addicts for this trade deal to be signed as soon as possible.

This post first appeared on the FTR website.  FTR is the leader in analyzing and forecasting the commercial transportation industry.  For more information on FTR reports and services, please click here