Saturday, January 15, 2011

The US Car Industry

The Economist often focuses on the US car market and industry. In recent times, they heavily bagged the US government bailouts of GM and Chrysler and then reluctantly admitted that they may have been wrong and the bailouts effective. In their latest report on the US market they note the recovery of the US industry and the re-entry of Volkswagen into the US market with the production of a new saloon, "which is to be built in a new factory in Tennessee".

They also note that the upheavel of 2008 allowed some considerable changes to the heavily unionised part fo US production (GM, Ford, Chrysler) to put it on a more even playing field with the foreign owned sector of US production.

The 2008 crash allowed Detroit to push through changes that had long been blocked by unions and timid management. Capacity was cut drastically: Ford alone closed 17 factories and reduced employee numbers by over 40%. GM ditched brands such as Hummer and Saturn to focus on Chevrolet, Buick and Cadillac, while Ford got rid of all brands except Ford and Lincoln. Health care for company pensioners, long a millstone, was transferred to union-run trusts. New workers can now be hired at lower rates than those ramped up by the United Auto Workers during the boom years. Alan Mulally, Ford’s chief executive, reckons his company can compete on price with factories opened in weakly unionised southern states by Japanese, South Korean and German carmakers. Ford may have made as much as $10 billion in profit last year.
The Big Three have changed, but their home market has changed even more. GM may still be the market leader; Ford’s trusty F-150 pickup is still the bestselling vehicle. But Detroit no longer dominates its backyard. For the Big Three now read the Magnificent Seven. Toyota, Honda and Nissan have been joined by Hyundai and its sister brand Kia in a fragmented market where seven manufacturers each have more than 5% of the market (see chart). And an eighth is trying to join the club.
The graphic below on US car sales shows that GM and Ford still lead, closely followed by Toyota, Honda, Chrysler and Nissan. The Koreans are making headway while Volkswagen and other European carmakers all see the US market as important but only make up at most 13 per cent.

One can only wonder what this left graphic will look like in 2020, with the entry of the Chinese into the market. The Chinese need to avoid the mistakes of Hyundai when it entered Western markets with low quality cars tarring later high quality models with the same brush. Despite doing well in all categories of service and quality for many years many people still see Hyundai as a 'cheap' model car. My mechanic told me when I was buying a new car "buy anything except a Korean car, they are hopeless". But according to quality surveys this doesn't seem to be the case.
After sales quality matters a lot with Toyota taking a big hit in recent years with several recalls battering its quality image.
It seems likely that the Chinese will dominate the lower cost segment of the market in coming years. Whether they will then easily be able to move up the quality ladder in subsequent years is more difficult to foretell. It is clear that Chinese authorities want to develop a strong car industry through acquisition of foreign companies, joint venture and increasingly local brands.
Getting cheap, efficient and long-running electric cars to market will also be a major battleground over the next 20 years and will probably be essential in the Chinese and Indian markets (as well as elsewhere in crowded developing countries.
Another problem as noted in another article in the Economist is over production:
The American rescues averted catastrophe, but they—along with continued European subsidies—have exacerbated the overcapacity that has dogged the sector for years. The car industry can produce 94m cars a year, against global demand of 64m. Unless that changes, it will never return to health.

Tuesday, January 4, 2011

Predictions of Doom 2

Nearly all posts about the potential for doom in the Australian economy revolve around housing, either directly or indirectly. The best writers on potential housing trauma are Leith van Onselen who writes a brilliant blog backed by reasoned argument and a myriad of data (some of which I had referred to in my book so I know it's right!!). Other excellent doomsters are David Llewellyn-Smith and Delusional Economics. All believe that Australian house prices are over-valued and that household debt is a real problem for Australia. If you are inclined towards bearish sentiments about housing then these writers will seriously make you worry. While the housing market is obviously very important I want to focus on some bigger picture variables that will undoubtedly affect not just the housing market but the wider Australian economy.

Now the point is no one really knows what will happen to the Australian economy this year but we do know what factors will matter. Former RBA governor Ian Macfarlane once argued that if you only had one variable to understand the Australian economy then the variable you would choose would be the international economy. But the problem with this simplistic (but reasonably accurate) scenario is that the variable itself has changed. In other words the international economy as a variable affecting Australia has changed. The part of the international economy that matters most for Australia is now China and Asian generally. It would have seemed absurd 10 years ago to have a US economy in severe crisis and the Australian economy to be experiencing a boom, but the Chinese economy has changed the global economy enormously.

But as I've written continually the real question for Australia is how the sub-variable China is affected by the wider variable of the international economy, which is still dominated by the Western economies, despite the rise of the developing world over the last 20 years or so. Can China continue to grow in 2011 if the US and Europe remain affected by financial woes and hamstrung by low growth. This is the so-called de-coupling debate.

I've written previously about decoupling. Indeed I wrote in January last year that:
2010 will provide some further evidence for the long-running debate over decoupling. The financial crisis bolstered the anti-decoupling case as world financial markets were universally shaken by events in the United States. Since this time, however, the decouplers' argument has looked more sound as some began to talk of a North Atlantic financial crisis rather than a GFC. Certainly, Asia did well in 2009 compared to what many thought lay ahead at the end of 2008. Govt stimulus in China has helped enormously, but even in China this can't go on forever.

No doubt we shall get further evidence about whether China and the rest of Asia is ultimately as export dependent as economists like Stephen Roach contend and whether the issue of final Western demand really does continue to matter.  
Well it looks like the 2010 evidence is that decoupling had some legs over the course of last year, but at the risk of taking liberties on extensions (and to mix the metaphor) I think that the jury is still out. 2011 will provide further evidence because recent US tax cuts notwithstanding, the impact of fiscal stimuli throughout the world will be further unwound and the need to pay off debts will continue. Debt really is the thing to watch in 2010, not just public debt as the media wants to focus on, but household debt as well, not to mention the seemingly forgotten problem of foreign debt.

As David Barbosa writes in the NYT (via Michael Pettis):
For nearly two years, China’s turbocharged economy has raced ahead with the aid of a huge government stimulus program and aggressive lending by state-run banks. But a growing number of economists now worry that China — the world’s fastest growing economy and a pillar of strength during the global financial crisis — could be stalled next year by soaring inflation, mounting government debt and asset bubbles.
Now this is a common theme of China bears but Pettis is even more bearish:
I have almost no doubt that during 2011 all the growth expectations are going to be revised sharply downward. By the end of next year, I suspect that the consensus will be that for the rest of the decade we should expect growth rates in the 6-7% range for China.
Do I believe these lower numbers? Not really. About a year and a half ago I wrote in a Financial Times article that, assuming consumption growth could be maintained at 8-9% a year, Chinese GDP growth would average 5-7% annually over the rest of the decade.
My prediction caused a lot of strong disagreement and accusations of being overly pessimistic, but the truth is I think I was being optimistic. If GDP growth slows so substantially, it seems to me that consumption growth of 8-9% will be very hard to maintain, so I would argue that we should be prepared for even lower average growth numbers, perhaps in the 3-5% range. But I do think the consensus next year will migrate down to the 6-7% range, even though next year’s growth should remain high – probably in the 9% range.
Barbosa argues that Chinese problems will have significant ramifications for the rest of the world economy (a reversal of the traditional Western-led 'coupling' or 'globalisation' argument).
A sharp slowdown in China, which is growing at an annual rate of about 10 percent, would be a serious blow to the global economy since China’s voracious demand for natural resources is helping to prop up growth in Asia and South America, even as the United States and the European Union struggle.
And because China is a major holder of United States Treasury debt and a major destination for American investment in recent years, any slowdown would also hurt American companies.
Pettis does not agree with Barbosa that a slowdown in China will be bad for the world or for the US:
I am not sure why Chinese holdings of USG bonds suggest that a Chinese slowdown will hurt US companies, but I have already explained why I do not think a sharp slowdown in Chinese growth is necessarily bad for the world. It will be very bad for commodity exporters – or at least non-food commodity exporters, since I think the demand for food from China will continue strong – but the overall effect on the rest of the world depends on the evolution of China’s trade balance. A contraction in the surplus creates net demand for the world, and so might even be marginally positive.
This marginally positive outcome won’t be evenly distributed, of course. Non-food commodity exporters will be badly hurt, while commodity importers and manufacturers will benefit.
I don’t even think such a rapid slowdown in Chinese growth will be bad for China. Again it depends on how it takes place. If there is a serious attempt at rebalancing the economy by raising wages, interest rates and the currency, China can manage a much slower GDP growth rate while still maintaining a fairly high growth rate in household income and consumption. I discussed this in more detail in an entry last month.
Non-food commodity exporters obviously means Australia (although we do export food as well).

Pettis then provides some notes on what is worth watching in 2011. Wisely he does not call them predictions.
First, although I do not believe inflation [in China] is going to be as big a problem as many think (I believe the Chinese financial system has a built-in inflation-stabilization mechanism – see my November 18 entry), if I am wrong and inflation continues to rise, this will create a real problem for monetary policy.
Second, debt levels are worryingly high and are starting to act as a serious constraint on the rebalancing process. My friend Victor Shih at Northwestern University has done great work in trying to figure out the government balance sheet, and he worries, correctly, in my opinion, that it is becoming increasingly difficult for the PBoC to raise interest rates without creating a great deal of financial distress in government-related entities. Even the PBoC balance sheet is a real problem. How can they raise RMB interest rates without running a huge negative carry?
Third, the trade constraints are going to get worse, not better. Ashoka Mody and Franziska Ohnsorge have a very interesting piece on Vox that suggests that we shouldn’t count too heavily on consumption growth in the developed world to boost global demand. That means we are going to spend the next few years fighting over anemic demand growth, and we will be apportioning that demand via trade disputes.
Fourth, although GDP growth rates next year will be very high to see off the current leadership, I am pretty sure that by the end of the year there will be much more concern about the rebalancing process and what that will mean for growth rates. In order to get those high growth rates, I don’t think we need to take the 2011 lending quota too seriously. Whatever it is, it will be breached.
Another China-focused economist is Andy Xie who argues:
By the middle of 2011, most analysts may declare that the world has finally put the financial crisis behind.
The reality is quite different. The global economy is kept afloat by massive monetary and fiscal stimulus around the world. The main problem in the global economy – high costs and declining competitiveness in the developed world, and inflation plus asset bubbles in the developing world continue unabated. Either inflation in the developing world or unsustainable sovereign debt in the developed world will spark the next crisis.
The most likely candidates to trigger the next global crisis are the U.S.'s sovereign debt or China's inflation. When one goes down first, the other can prolong its economic cycle. China may have won the last race. To win the next one, China must tackle its inflation problem, which is ultimately a political and structural issue, in 2011. If China does, the U.S. will again be the cause for the next global crisis. China will suffer from declining exports but benefit from lower oil prices.
On the other hand, if China has a hard landing, the U.S.'s trade deficit can drop dramatically, maybe by 50 percent, due to lower import prices. It would boost the dollar's value and bring down the U.S.'s treasury yield. The U.S. can have lower financing costs and lower expenditures. The combination allows the U.S. to enjoy a period of good growth.
One could describe the global economy as a race between the U.S. and China, to see who goes down first.
This coming year is China's opportunity.
The best way for China to deal with inflation, according to Xie, is to address its property bubble.
China's inflation problem stems from the country's rapid monetary growth in the past decade. That is due to the need to finance a vast property sector, which is, in turn, to generate fiscal revenues for local governments to finance their vast expenditure programs. Unless something is done to limit local government expenditure, China's inflation problem is likely to get out of control.
The government now recognizes inflation as the country's main challenge. It has raised interest rates once, deposit reserve ratios several times, and announced its intention to introduce price controls. The barrage of unconventional measures is due to the belief that China's economy is different from others and the conventional measure of raising interest rates may not be effective or necessary. The reluctance to change the price of money and the willingness to change the price of goods and services has not worked well so far.
The ineffectiveness of the recent measures casts doubts on the government's sincerity in fighting inflation. The constant and marginal policy announcements could be interpreted that the inflation fighting is now largely a propaganda job. Such perceptions could spark popular panic, which would cause the household sector to hoard goods like rice and cooking oil. When the masses flee from holding money, a full blown crisis will unfold.
So at the beginning of 2011, we are in a similar position to the start of 2010. Debates about China will produce much heat in Australia, the real question is whether they'll produce any light. For what it's worth I think that economic liberal commentators have too much faith in the Chinese Communist leadership to manage the Chinese economy without booms and busts. While China will probably continue to grow rapidly over the medium term, the belief that it can continue to grow uninterrupted by poor policy decisions and the reality of economic cycles is pure fantasy.

I also have no doubt that by this time next year we'll have a clearer position on the debates about globalisation and decoupling and about the ability of Australia to profit from a long-term mining boom.