Noël Perry | TRANSPORT FUTURES
I RECENTLY ORDERED a new set of golf clubs and, in the process, learned several important things about supply chains and the risks within the current economy. Lesson one was about supply chain failures. Such things occasionally happen in normal times: We have to wait several days for a back-ordered part, or the TV we want is out of stock at all of the local electronics outlets. Random variations in demand will challenge any supply chain.
What’s important about today’s environment is that such failures have become commonplace. I have been worried about that risk several times over the past 20 years as we have had four periods (2004, 2014, 2018, 2020-2021) when truckload capacity utilization has headed toward 100%. That 100% mark is the line when supply chain failures commonly begin to occur. My experience with the golf clubs suggests that the current capacity crisis meets that threshold.
In the current markets, we have a combination of supply and demand problems that lead to failures. The restrictions on service demand mean that the excess savings accumulating in consumers’ bank accounts are pumping demand for products, just like my nifty new golf clubs. At the same time, the various lockdowns have put unprecedented pressure on supply chain capacity, already tight from decades of persistent cost-cutting. We learned that surge capacity is a concept limited to out-of-print business texts. So, the high-end Asian manufacturers of the sophisticated castings and graphite parts that form a 2021 golf club are working through long backlogs—if they can get the supplies and labor they need. Once completed, the shafts and heads may sit in a port for weeks waiting for container ship capacity. Even when the container finally gets unloaded in Long Beach, who knows how long it will take to find the drayage? Finally, what about those Help Wanted signs we see everywhere these days. Are those signs also in front of the golf club assemblers?
THE APOLOGISTS FOR INFLATION, INCLUDING THE PEOPLE AT THE FEDERAL RESERVE, TELL US THE 5.39% IS A TEMPORARY EFFECT: LOTS OF TEMPORARY SUPPLY CHAIN PROBLEMS, LOTS OF TEMPORARY PENT-UP DEMAND.
You know the answer. Last time I ordered clubs, I got them within two weeks. This year maybe within three months. Is that a supply chain failure? You will still buy the clubs, won’t you? Sure, I like the brand, and I have good clubs to use in the interim. But what is the conversation like at the commercial offices of Titleist, the brand I am buying? The salespeople have got to be worried about the purchasing behavior for expensive clubs that take three months to arrive. With every golf magazine advertising eight of 10 fancy club brands, how many people who have looked at Titleist are buying from Ping, or Callaway, or Srixon, of simply putting off that new, impulse purchase? That is supply chain failure—loss of sale!
Here’s lesson two, the scary one. Who cares if I play with my old clubs for three months more? In contrast, people should care about extra money chasing after limited supplies of goods. My wife and I haven’t traveled in two years. We haven’t been to a concert or Broadway show in two years. We have extra money for discretionary spending, hence my expensive golf clubs. But the supply of those clubs is limited. Titleist knows it. This set of clubs is almost twice as expensive as the last I bought from them. Sure, the technology is a little bit more sophisticated—is it twice as hard to produce? No way. I have experienced golf club inflation: higher prices for the same items. You know, I am glad I plunked the money down now. How much more will Titleist be charging next year? That’s “expectations.” Keep that in mind as I finish this piece.
This story is really about the entire economy, not just this silly game I play once a week. With extra money and a high savings rate chasing a limited set of goods—kept limited by supply chain failures—cartels like OPEC, the shipping alliances, and conservative management teams are more interested in today’s margins than growth. Each day in the business press I see another article about price increases in various sectors: used cars, food at the market and restaurants, gasoline prices at the pump, natural gas, and extra charges at the doctor to name a few.
The result is inflation across the entire economy, 5.39% in May for the U.S. The apologists for inflation, including the people at the Federal Reserve, tell us the 5.39% is a temporary effect: lots of temporary supply chain problems, lots of temporary pent-up demand. Some of that is certainly true. However, it is also true that the U.S. has a permanent and worsening labor shortage. Moreover, consumers are far from running down all that money saved since the lockdowns hit. Running the $2.6 trillion remaining will take years, putting pressure on pricing for the entire time. Here’s the point: inflation starts with some kind of stimulus. We had that in 2021. We will continue to have stimulus as long as housing prices keep going up, as long as the oil producers succeed in managing their volumes, and as long as the consumers run down that money burning holes in their pockets.
I emphasize those stimuli because of that word I mentioned above: expectations. Whatever your accounting view of inflation (there are many), the value of money, an abstract representation of the value of goods or services, is only as much as consumers think it is. Historically people have little trust in the value of Argentina’s currency; it inflates. They have good trust in the dollar’s value; it does not inflate, at least not usually. However, if expectations change, as they did in the 1970s, then the dollar inflates, whatever the politicians and bureaucrats in Washington say.
We face this risk right now. The average consumer doesn’t see temporary inflation. He or she just sees pricing going up. That consumer has no idea about changes in money supply, about government stimuli or anything the Federal Reserve does. He or she just sees pricing going up—or not. In July of 2021, that consumer sees pricing going up and is probably complaining about it routinely. That is how expectations for inflation start. Should those expectations be reinforced over the next six months or so, this “temporary” inflation would look more like a trend, a trend that could get worse, just like it did 45 years ago.
OK Noël, we’ll adjust cost of living increases and all that. That might work were it not for two things. First, adjusting transport prices is no easy task. The price increases lag cost increases, management misinterprets price increases as competitive gains, there are significant transaction costs from changing prices. Those are the specific trucking problems.
The second matter of adjustment is much bigger. It turns out that the U.S. economy and federal government financing is dependent on low interest rates. Washington borrows money at 2% or less. Interest charges make up about 10% of the federal budget, depending on one’s accounting. But when inflation goes up, you have to adjust interest rates up along with inflation. If you are my age, you may remember 16% mortgage rates in 1981. It follows that the U.S. Treasury will have to increase its bond returns upwards. With a 5% inflation rate, that would mean something north of 6%. Now the Federal budget would be paying 20% or 30% of its revenue for interest, not including paying for the trillions in additional debt going on the books the last two years. In the meantime, we hope the Federal Reserve would have the courage of Paul Volker and would be raising its interest rates dramatically to kill this round of inflation. I say “we hope” they will have that courage. Their recent behavior is tied instead to stimulating growth, just what an inflating economy does not need. Such counterproductive behavior is how modest expectations for inflation lead to major expectations for inflation, and the 14.8% inflation Paul Volker fought, or worse.
Now you know why I advise all managers in today’s supply chain world to focus their attention on the business pages and the subject of inflation. It is the prime threat to our current prosperity. When Volker did his triage, the economy suffered its worst year since the Depression (exceed only by 2008-2009 since). Unfortunately, Volker was facing a problem with far less difficulty than we face today. The Congress was functional. The President was more concerned with inflation than growth. The federal deficit in 1980 was about 2% of GDP. It is 15% now. That means Volker’s policies, which knocked inflation down to 3% in two years, will probably be much less effective today, even assuming the Fed has his courage.
What does this mean in practice? Over the next five years, what has been irrelevant, inflation, will most likely become a manageable nuisance. Growth will slow. You will have to relearn all those hard lessons about inflationary pricing. In the background will be that much bigger risk—those expectations becoming a trend, an accelerating trend. What would happen then would be the stuff of history books, something like the 2008-2009 Great Recession or, I think, worse. What to do?
The advice seems ludicrously simple. The history books tell us that companies that emphasize value, that understand and adapt to their environment, find a way to manage through crises. They come out the other side battered but stronger. I emphasize this because current management behavior is more about classic contemporary business-school finance thinking than a fundamental long-term focus on value. Just as this risk may change long-held ideas about inflation and governmental policy, it will force the same change in many current business practices. The COVID-19 experience has already taught us that the 2020s have started with a burst of uncertainty. Stay tuned for more!
Noël Perry is Principal with Transport Futures, located in Lebanon, PA. He can be reached at [email protected].
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