Have We Reached the Top?
From the manufacturing trenches today, it might be easy to sit back and ignore a number of potentially impactful forces massing on the economic horizon. After all, many manufacturers—from the smallest machine shops to the biggest multinationals―have realized solid growth these past few years. In fact, despite the rise in manufactured export products from Asia to North America, many local and regional domestic manufacturers have managed to thrive. But we’re concerned about how long this period of growth and economic tranquility will last.
In reading the economic tea-leaves, it’s not difficult to see why. Much of the growth in North America in the past five years has been fueled by cheap, readily available credit―both on the consumer and business-to-business fronts. Many households have tapped into the rising equity of their home prices to fund purchases, and at the same time, many businesses have been able to access growth capital through banks willing to fund nearly any reasonable investment. But might a new credit crunch impede this cycle?
Consider how according to Jay Bryson, Global Economist for Wachovia, that “there is a significant risk that credit availability could become seriously impaired.” Bryson explained in an article on the newswire that in a “genuine credit crunch lenders broadly curtail credit—including [credit] for well-qualified borrowers”. Even low interest rates won’t help the situation in this regard because “the supply of credit wouldn’t match the level of demand.” And this would impact both businesses and consumers―whose access to capital and subsequent spending is the life blood of our economy.
Many bankers who we have spoken to recently are worried about the availability of credit. In the consumer markets, the meltdown in the $2.5 trillion sub-prime mortgage market―which has already resulted in the bankruptcy filings of 11 mortgage companies and catastrophic losses al a handful of big name hedge funds―is causing lenders to scrutinize new applications from even highly qualified borrowers in new ways. And even U.S. Federal Reserve Board Chair Ben Bernanke is concerned as well, noting that “housing prices” will likely remain weak for a longer period of time and to also expect more foreclosures. In the business markets, many buyout firms are finding it hard to acquire companies―and have been at a disadvantage in bidding against industry-based acquirers―because their lenders are having a difficult time coming up with the billions in debt financing needed to complete transactions.
If a credit crunch were not enough to convince you of a risky fork coming up in the economic road, consider the specter of inflation. As we go to press, oil futures have soared past intraday all-time highs in the past weeks, as have commodity prices from corn to sugar, thanks in large part to the booming demand for ethanol. As oil prices rise, we’ll see a cascading impact across the economy thanks to rising logistics and transportation costs, not to mention an increase in raw materials costs for resins, plastics, foam and other commodity inputs that make up a substantial portion of what we buy.
But don’t just take economic forecasts at face value. Consider how Caterpillar, a company that we consider to be a leading economic indicator because their machinery is used to build roads, construct new homes, and mine for minerals and natural resources, recently missed its financial estimates. According to the Financial Tinies, “The unexpectedly weak performance of Caterpillar’s U.S. operations comes amid growing worries that the problems in the domestic housing market could spill over to the rest of the economy.” Caterpillar missed its numbers in part thanks to “problems in the diesel truck market and weakness in U.S. sales of heavy machinery.”
As we see things, it looks like we’ve reached the top. But whether the U.S. economy slows or actually dips into a full-blown recession in 2008 remains to be seen. Still, we’ve observed that smart manufacturers are beginning to use this time to examine their options, including how best to lower their fixed and variable cost structures in the event that things take a long-term turn for the worse.