It’s hard to see the supply chain crisis getting meaningfully better any time soon. Covid is not as under control as the authorities have convinced themselves. China is in the midst of an energy crisis that isn’t going to resolve soon, and that’s leading to factory shutdowns and new supply shortages. The latest word from the tech sector is that the chip crisis will extend into 2022. Oh, but magnesium is about to become scarce, which will very rapidly put a dent into car production.
We’ve taken to reading the Substack Doomberg, styled “Chicken Little got a Bloomberg terminal, and the sky has been falling ever since.” He’s amusing and looking for fundamental developments that haven’t been sufficiently well noticed or interpreted. Doomberg ranks #8 on Substack among financial sites, so it’s not shabby. Even though we don’t necessarily agree with what he says, his information nuggets are good.
A recent piece was useful for a different reason, in that it contends the supply chain mess is going to be so severe and protracted that it will force a great uncoupling. From his post Opposite George:
So, here’s our best guess at what is going to transpire after the coming dark storm clouds finish drenching us with their rain of doom:
- The breaking of the European energy markets is just a symptom of a greater disease. It reflects the demise of the just-in-time logistics philosophy at the heart of modern capitalism.
- Companies can no longer delegate their survival to the tight performance of their supplier base in the name of efficiency. This works until it dramatically and disasterously doesn’t.
- There will be a massive build out of raw material and work-in-progress inventory, which will likely further exacerbate ongoing inflationary pressures in the near term.
- There will be a staggering wave of onshoring. Businesses simply can’t rely on unreliable ports, a shortage of longshoremen and truck drivers, or a backup in rail car availability. So, they won’t.
If we’re right, the scale of the upcoming wave of onshoring will likely surpass the flight from the cities we observed after Covid, at least as measured by economic impact.
I don’t mean to sound dismissive, but well off people decamping to the exurbs or another state requires enough cash and a good enough credit rating to make a down payment, plus movers, and a little more cash to buy new curtains and odds and ends like lights and end tables. This was a wave of single transactions all heading in pretty much the same general direction.
By contrast, it has taken 40 years to create tightly coupled supply chains that include substantial foreign sourcing, both of raw materials, intermediate product, and often a great deal of sub-assembly.
It doesn’t do any good to get more raw materials or inventory, even if you had someplace to put them, if you don’t also have the equipment and direct labor and systems (mechanical and IT) and skilled supervisors and plant managers to keep everything moving and prevent equipment and safety disasters. How long would it take to design and build a new factory, or an expansion of an existing factory? You have to get approvals, contract to have the structure built, buy equipment and have it delivered (oh, again probably from overseas, putting you back in the crosshairs of the ports/shipping mess), hire and train workers, shake down the operation…even assuming you could find seasoned operations managers who were good enough to manage a startup (way harder than overseeing an established operation).
For instance, at Deere, management is merely attempting to fill in for union workers. They’ve already had one accident and they are now clamping down on reports of other safety incidents. Startups or major expansions are at least an order of magnitude more difficult to execute.
Let’s look at other practical issues. Will we have rare earths mining in the US any time soon? We let China have that not because rare earths are actually all that scarce, but mining and processing are really nasty. But there is also specialist know-how, and we’ve ceded that too. Think the US will have enough fabs any time soon to meaningfully reduce our dependence on China, Taiwan, and South Korea?
How about more mundane products, like textiles? The US ceded that a long time ago (US spinning mills were on their death bed in the 1980s). Europe has largely given up on fabric manufacture for clothing, even on the high end (my former tailor is in despair that he is limited to supply from Asia, and the fabrics are inferior to what he was able to get from France and Italy, although even that have been getting thinner, for want of a longer-form, more technical discussion, for some time too). And what about the cutters (who are high skilled)? Who exactly will sew?
And what about pharmaceuticals? We already get nearly all our Vitamin C from China, both as a medication/dietary supplement and a preservative. On the order of 80% of our drugs come from China, not just active materials but the entire compound. India provides much of the rest. Pray tell how do we repatriate that in any reasonable time frame?
But let’s get back to the biggest reason there is no way, no how we will see a massive wave of onshoring, no matter how bad supply chain breakdowns get: management incentives and financialization.
Look at some of the steps I set forth above. Even if a very brave company got religion and decided to embark on that path, what would it entail? Massive up front expenses, not all of which could be capitalized. That means trashed earnings until the new reshored company is humming, which is years down the road. And would retained earnings be enough to pay for all the investment? If not, that means borrowing or issuing stock. Gee, do you think investors would be keen about that?
On top of that, the current leadership would almost certainly be unable to execute a change program of this scale. Think they are prepared to sign job death warrants?
More generally, giving up on supply chain dependence is a huge negative for executive and manager pay. In many if not most cases, its real purpose was to transfer income from lower level workers to the executive and mid manager ranks by reducing hourly-type labor content and increasing risk. Both the (often illusory when properly risk adjusted) savings and the increased enterprise complexity justified higher pay.
And it is not as if one can expect political support for this type of shift. Moving production on shore will increase costs, if nothing else the need to recoup the considerable business restructuring and investment costs. Making voters pay more for stuff, or worse, asking them to sacrifice for any reason other than war, is not a popular proposition.
ECONNED provided the obligatory discussion of what might happen after that financial system near death event. The book set forth four scenarios. I regarded the last one, paradigm breakdown, as the most likely, and the response to a continued supply chain is likely to be the same. From ECONNED:
Paradigm breakdown, meaning key elements of the current system are no longer viable, but that is a possibility that no one is prepared to face, since the old system seemed to work well for a protracted period.Thus the authorities reflexively put duct tape on the machinery rather than hazard a teardown….
Let’s use a different metaphor to illustrate the problem. Say a biotech firm creates a wonder crop, the most amazing creation in the history of agriculture. It yields far more calories per acre than anything else, is nutritionally extremely complete, and can be planted and harvested with far less machinery and equipment than any other plant. It is tasty and can be prepared in a wide variety of ways. It is sweet too, so it can be used in place of sugar and high fructose corn syrup at lower cost. We’ll call this XCrop.
XCrop is added as a new element in the food pyramid and endorsed by nutritionists and public health officials all over the globe. It turns out that XCrop also is an aphrodisiac and a stimulant (hmm, wonder how they engineered that in) and between enhanced libido and more abundant food supplies, the world population rises at a faster rate.
Sales of XCrop boom, displacing traditional agriculture. A large amount of farmland is turned over from growing other types of produce to XCrop. XCrop is so efficient that agricultural land is taken out of production and turned to other uses, such as housing, malls, and parks. While some old-fashioned farms still exist, they are on a much smaller scale and a lot of the providers of equipment to traditional farms have gone out of business.
Twenty years into the widespread use of XCrop, doctors discover that diabetes and some peculiar new hormonal ailments are growing at an explosive rate. It turns out they are highly correlated with the level of XCrop consumption in an individual’s diet. Long-term consumption of high levels of XCrop interferes with the pituitary gland, which controls almost all the other endocrine glands in the body and the pancreas.
The public faces a health crisis and no way back. It would be very difficult and costly to put the repurposed farmland back into production. Some of the types of equipment needed for old-fashioned farming are no longer made. And with the population so much larger than before, you’d need even more farmland than before. The world population has become dependent on the calories produced by XCrop, so going off it quickly means starvation for some. But staying on it is toxic too. And expecting users simply to restrain themselves will likely prove difficult.
Mind you, that does not mean there won’t be some increase in domestic content. It may not be enough to impact any macro measurements, but plenty of citizens are becoming more survivalist in orientation, looking to produce more of their energy and food and building up more emergency stores, as in carrying more inventory on a household level.
Another way the US can see more de facto onshoring is by purely domestic players stepping into production and service gaps created by supply chain interruption opening up opportunities for them to take ground. But again, it’s hard to see how significant this will become on a US economy basis.
The one thing that could make Doomberg right is war with China. And that’s not implausible given the bizarre US love of eyepoking, particularly over issues that China regards as non-negotiable, number one being the status of Taiwan.
What ended the last great period of globalization was the Great War, which also created huge financial stresses due to the inability to ship gold to settle balance of payment differences. But let’s worry about that some other day.