What the Heck is Going On Over There?

My prime business associate in Malaysia recently asked me the pertinent business questions to which everyone in the world wants to know the answers: What the Heck is Going On Over There?

Here's what I told him:

Hello Chew,

The questions you ask about the US economy are difficult to answer clearly. The missing buyer demand is not returning quickly, so business cannot grow until the demand increases.

The companies that make consumable products, or that make the goods that carry and package the consumable products, have been liquidating their raw stock inventory for many months whenever any buyer appears. The liquidated raw inventories are not being replaced with new raw inventory, so the demand for industrial goods has been missing also.

This cycle of liquidation is nearly ended, as manufacturers' inventories are very low now, and any new demand cannot be met from inventory - but will require new investment.

Will substantial new demand reappear? This is the major question of 2009 and 2010.

There are two types of US demand - private consumers, and government ("public") demand. Examples of public demand are military orders (guns), public works orders (highways), and public construction orders (courthouse buildings). Private consumer demand covers every conceivable product used by people, and is potentially much larger than government demand. Statistically, consumer demand makes up about 70% of US economic activity.

Government demand would seem to be more secure and predictable, but in fact is the opposite. Regardless of published intent to spend, government contracting is slow, and often payments for goods and services is even slower. Even now, last year's highly publicized government emergency economic support for "shovel-ready" contracts are mostly still tangled up in government bureaucracy.

Consumer demand is different, and better. We have a well-founded belief that the US consumers have lots of pent-up demand, because we see the singular success of the new US government program for trading old cars for new ones with a sizeable government rebate (the program called "cash for clunkers" - funny name, eh?). For the first time since the recession began, the US government has put significant sums of money directly available to consumer buyers - and the consumers have spent the money immediately. The car industry is suddenly very busy, and very happy.

In contrast, the US government program for putting monies into banks to give them lendable funds has been almost totally unsuccessful, because the banks are simply keeping the money in the vaults, and not lending it to the consumers who will buy the goods that run the factories, truckers, packagers, and retailers. One could argue that the banks are the wrong parties to recapitalize the economy because the banks are now overly risk-averse, when the economy needs some element of risk-taking to return to overall health.

So, the current state of the US economy seems to be
- slowing or stopped inventory liquidation
- cautious but still interested consumers
- widespread pent-up demand by consumers
- lack of urgency to buy (prices aren't going up, and might still go down)
- lack of confidence by buyers to make large financial commitments
- unwillingness of the prime sources of consumer liquidity, the banks, to participate in recovery

The return of consumer demand will be influenced heavily by the length of time that goes by while no new economic shocks hit the fragile consumer. Barring any such new economic shocks, we think consumers will come out of their bunkers with purses and wallets open within a matter of three-six months.

When the consumers return, they will discover an inventory outage, with resulting longer wait times than expected. This outage won't last long, as the capacity to fill the inventory pipeline is waiting in the wings to swing into action. One interesting side effect is likely to be the resurgence of domestic US production, rather than overseas production, due to the need for very fast turnaround of orders.

The requirement for producers and their suppliers, then, is to hang on for another six months while demand builds. The requirements for economic facilitators, like banks and government entities, is to keep a steady hand on the wheel - no changing the rules in the middle of the game - in order to inspire a growing confidence in all parties.

The bottom line is that the future must be a foreseeable future, and not simply a throw of the dice. We're getting there, slowly. This is what the stock market tells us by bouncing nicely from the lows of this year to today's much improved values.

Regards/Jim