WHEN 90% IS NOT GOOD ENOUGH
May 10, 2020 § Leave a comment
Usually 90% is a pretty good target. High schoolers in the top 10% get automatic admission to the University of Texas. Maybe not in engineering, but you get in. 80% right answers for 25 questions will get you a driver’s license. But when it comes to the post Covid 19 economy, 90% will not cut it, according to a story in a recent issue of the Economist. Much of the argument goes that an average of 90% means high nineties is some areas and much lower in others. In China, the manufacturing sector and export shipping are dramatically up, but consumer spending is still down, way down.
This observation reminds us that the US has increasingly become a consumer-based economy, with manufacturing going abroad, notably to China. The exception is the manufacture of petrochemicals. More on that later. The inference, therefore, is that a post Covid 19 recovery will lag in consumer goods being purchased. In large part this will be because of uncertainty regarding the disease and its likelihood of either lingering or reappearing. Job losses and savings being ravaged are not conducive to a climate for discretionary spending. When Germany allowed reopening of smaller retail stores, shoppers simply did not turn up. The same happened in China. Nieman Marcus declared bankruptcy, indicating that even the well heeled are likely to be cautious. Business models premised on continuous growth (think Uber), with investment in market share increases trumping earnings retention, are seriously damaged now and the model may be in question. Risk and uncertainty are recipes for less investing. At the very least, discount rates go up with risk, making the returns less attractive. The current rally in the stock market may prove to not have legs.
Innovation and creativity have been the hallmarks of economic growth in the last two decades. The list of the most valuable companies in terms of capitalization is informative: Amazon, Google, Apple, and Microsoft. All arrived there through some combination of innovation in technology and business models. Creative thought is difficult during the pervasive anxiety during a pandemic. Video conferencing is a poor substitute for personal interaction, not the least for the cross fertilization of ideas that occurs by chance in casual white board sessions and the like. Zoom meetings are now purpose driven and prone to distractions. Innovations that do see the light of day will find financing harder to obtain, except in narrow areas that are responsive either to the disease or to the restrictions brought on by the disease. The pipeline could endure a dry spell.
The US does have one thing going for it which could offset cheap labor abroad, which, in any case, has become less cheap over time. That is low cost energy. Natural gas prices are lower than in the cheap labor countries. Until this Covid 19 inspired downturn, US gas prices were less than 25% of those in India or China. They are artificially low in those countries now because liquefied natural gas (LNG) prices are pegged to the price of oil, which has plummeted. In fact, US export of LNG must be in trouble because the producer delivered cost will be over USD 5, whereas landed prices in Asia are under USD 3. But, when some semblance of normalcy returns, US natural gas prices will remain under USD 3 and Asian prices will drift back up to high single and low double digits. The certainty of low prices is why the US is a worthy target for manufacturing investment.
For goods where energy is a major component of cost, this is an area where manufacturing can return. For goods where natural gas is also a raw material it already has, in the last decade of the low gas price trend. The US also has the lowest cost ethane, a raw material for many plastics. This means that select sectors of manufacturing could return and should be given incentives to do so.
This pandemic has exposed ugliness in the more affluent societies. Americans earning less than USD 20,000 per year are twice as likely to have lost their jobs as those earning over USD 80,000. Mortality is greater in the minorities. The government is expected to do more. There is squabbling regarding federal action versus that in each state. States not being allowed to run at a deficit, federal bailout appears the only option, one which is resisted by elements of Congress. It is possible, perhaps likely, that the economic upheaval wrought by this pandemic will call for radical changes. What these are, and whether the changes are a net benefit for the future, will be determined by leadership and luck. This extraordinary period occurring during a presidential election year is unfortunate timing. The bipartisan response to the emergency sought recently by President George W Bush may be extremely difficult to come by.
We got lucky that the economy was robust at the time the pandemic hit. It allows for a quicker recovery. However, a 90% recovery will be uneven across sectors and is likely to lead to a world that is recognizably different. The term “new normal” has been thrown about. Regrettably, the emphasis will be on the “new”, and the habits formed during extended lock downs may be enduring. The last few percent always take longer, in innovative projects and cell phone battery charging.