Extremes in construction’s PVF sub-sector
BY MORRIS R. BESCHLOSS
PVF and economic analyst
With President Barack Obama having been in office well into the first 100 days as this is written, I’m already confused as to where this newly minted administration is heading.
As the general economy continues to deleverage, with consumer demand deflating at a record pace, I have stepped up my pvf sector contacts to determine what cracks, if any, are forming in the façade of the prime sub-sector of the plumbing, heating, cooling, piping industry that is proudly keeping its head above water.
What I’m finding is the emergence of two extremes. Power is red hot, while commercial development has literally ground to a standstill.
Power generation construction and maintenance has reached levels never before experienced in that sector. Although industrial as well as residential demand for power availability has been impacted by the growing recessionary shrinkage, increasing lack of availability could create record blackouts and brownouts as the demand factor returns to normal levels in the next year.
The gap between potential supply and demand is almost certain to reach record levels before remedial action is able to close the gap of future productive capability versus the potential upshot in demand.
In the meantime, a major shutdown of drilling rigs in the Gulf of Mexico, oil sands conversion in Canada and the Bakken Belt development are in severe remission.
Although the breakeven point in oil production may be debatable, it is certainly well above the mid-40s level, where it seems stuck as the first quarter of 2009 winds down.
The Obama Administration seems so captivated by renewable energy, climate control, environmental extremism and tighter cafe standards that domestic drilling for offshore oil, shale conversion and natural gas exploration is all but forgotten. This sub sector of oil production, refining and transmission is in a virtual holding pattern.
Also in a state of suspended animation is the commercial sector of hotels, motels, high-rise apartment buildings, shopping malls and condominium construction. Since this important segment of the construction industry is dependent on developers who take out huge loans to make these developments happen, they’re caught in the credit squeeze of banks and other financial institutions who are calling such loans, even if the loan interest has been paid up to date. This is a problem of a moribund banking system, attempting to protect its balance sheets, choked with mortgage-backed securities and its derivatives.
This puts much of the pipe, valve, fitting sector’s rejuvenation on the back of “power.” It’s no exaggeration to exclaim “How goes the electric power industry this year, so goes the pipe valve fitting business.”
Also questionable is the continued dynamics of exports, of which two-thirds are industrial products. Although the slowdown in world trade undermining this huge $2-trillion sector (one-seventh of America’s total gross domestic product 2007) is inevitable, an even greater danger could be the resurgence of protectionism.
Will “Buy American” recreate visions of Smoot Hawley?
For the first time in decades, the patriotic slogan, “Buy American,” is cropping up in the prospective Super Stimulus Bill. The $75-billion committed to infrastructural projects carries with it the provision that would exclude foreign-made component materials or finished products in any project funded by the U.S. government. This dictum opens up the specter of Smoot Hawley by one side of the debate, and the reaction of “It’s about time” by those who have seen increasing manufacturing jobs fleeing American shores.
Free traders argue that lower-cost products that meet domestic quality standards should not be prohibited. This point of view prevailed during the Bush administration, which led to a major acceleration of imported producer and consumer goods by America’s business sector, as well as by individual consumers. On the other hand, it is being vehemently opposed by American-based manufacturers and labor unions, who see America’s industrial base frittering away.
Opponents of “Buy America” restrictions point to Smoot-Hawley legislation of the early 1930s, which ignited trade wars and accelerated the downward spiral of the Depression in its early years. It’s up to the American people and their representatives to make the final judgment as to which way to go.
Asia’s leading industrial powers headed for major economic contraction
China, Japan and South Korea, the three-pronged Southeast Asian growth triumvirate of the past 20 years, are headed for a major letdown.
The Japanese finance ministry is forecasting a 1.8% contraction for the year ending March 31 and a 2% downturn for the following fiscal year. The Bank of Japan doesn’t even begin to see a return to growth until well into 2010.
South Korea’s outlook is equally pessimistic. It has just experienced its first year-on-year quarterly growth decline since the Asian financial crisis of 1997 — 98. A gross domestic product decline of 3.4% in the fourth quarter followed an even more precipitous decline of 5.6% in the previous quarter. This is South Korea’s first half-year sequential decline since 2003. Exports from Asia’s fourth biggest economy slumped 11.9% in the final quarter, with semi-conductor shipments being the most hard-hit.
China remains solidly in the black but is facing a possible one-third downturn from its estimated 10% economic growth in all of 2008, which cooled off dramatically in the last quarter. China is desperately attempting to make up for its loss in exports by converting its hundreds of millions of agricultural tenants into more urbanized consumers. On the success of this metamorphosis may rest the Asian titan’s driving force behind a worldwide second half 2009 economic recovery.
U.S. leads world productivity
Despite a slowdown in world productivity in 2008, output per hour worked in the U.S. increased slightly, by 1.7%, up from 1.5% in 2007, according to the latest annual productivity report issued by The Conference Board, the global business membership and research organization. The most recent productivity advances have been realized, however, through rapid layoffs, suggesting that the productivity of remaining workers and firms is actually strengthening.
U.S. productivity growth is expected to slow to 0.5% in 2009 but may improve during the second half of the year. “This will provide an opportunity for improved competitiveness of U.S. firms when the recovery starts,” said Bart van Ark, vice president and chief economist of The Conference Board. The Conference Board quarterly gross domestic product forecast suggests that the U.S. may reach the trough of the recession by mid-2009. Innovation remains a crucial trigger for growth and recovery, the report noted. “But it requires continued investment in capital and labor — not just job cuts — which is a big challenge in the current economic climate,” van Ark added.
The Conference Board’s productivity report shows that world productivity growth slowed sharply in 2008 and is set to decelerate further this year as the global recession deepens. Global output per hour worked rose by 2.3% in 2008, down from 3.7% in 2007. It is expected to slow further to 1.8% in 2009 — the weakest productivity growth since 2001. This dramatic deterioration in the production efficiency of goods and services reduces the potential to raise wages, reduce prices and support an increase in living standards, the report warns.
Europe suffered a dramatic slowdown in productivity growth, with many European firms slow to reduce headcount in response to falling output. Productivity growth across the 27-member European Union fell from 1.3% in 2007 to just 0.2% in 2008 and is expected to come to a complete halt in 2009. The gloomy prediction comes a week before The Conference Board launches a new, monthly Euro Area Leading Economic Index, which will signal forthcoming peaks and troughs in the business cycle of the 16-nation bloc.
The effects of the deteriorating world economy on productivity across emerging economies differed widely, depending on each country’s exposure to international trade and global finance, dependence on natural resources and the fiscal resources at the government’s disposal. Brazil, for example, benefited from the commodity boom and improved export performance early in the year and saw productivity growth increase from 2.3% to 3.7%. In contrast, China’s productivity growth fell from 12.1% to 7.7% as a result of a drop in exports and investment.
Developing nations face cash scarcity
If the world is to have a chance to snap out of its recessionary lethargy this year, much of the push has to come from companies in the developing nations that have been the globe’s fastest-growing economies in the past decade.
The world’s financial investment centers have scrupulously avoided risk for the past year, choosing instead to seek the safe haven of U.S. Treasury debt. This has literally denuded the once well-heeled investor; who previously provided companies in developing nations with a backbone of investment capital needed for a comeback and growth.
J.P. Morgan Chase & Company estimates that such companies need to refinance more that $200 billion in external debt in 2009. The largest borrowing needs emanate from companies in financially embattled Russia, Turkey, Mexico, South Korea and the United Arab Emirates.
As the global credit crunch put a headlock on the world in general, the aforementioned countries have sunk to the bottom of the list of potential borrowers, with international capital sources closed to them. This means that these companies must turn to indigenous providers to meet their growing obligations. Barring that, they may try to renegotiate with their creditors, seek government’s aid or face default.
In its report, J.P. Morgan listed 17 companies in emerging markets that could go into default this year. Those at risk of technical default include Russian steel giant oao Severstal.
In a further sign of borrowers’ degenerating financial health, Fitch ratings downgraded the credit ratings of 88 emerging market companies in the fourth quarter of 2008; the most in at least seven years.
Morris R. Beschloss, a 53-year veteran of the pipe, valves and fittings industry, serves as pvf and economic analyst for The Wholesaler.