Recovering from (our) Recession

… Not for the squeamish or faint of heart.

A few days ago, I attended the Keizai Society’s panel presentation “Recovering from Recession“. The panelists did an excellent job in interpreting the current economic data and both the short and long term issues. In addition, they cited lessons learned from Japan’s Lost Decade and how it applies to our current situation. The good news is we did learn a lot from their Lost Decade and other recessions; the bad news is that things are going to look gloomy for some time!

Dr. Daniel Okimoto, a Stanford University professor, who is Director Emeritus, Shorenstein Asia-Pacific Research Center (APARC) started the evening. Even though many of the issues he raised were not “new-news”, Dr. Okimoto did an excellent job of putting them in perspective to describe the current situation.

Here are highlights of his presentation followed by some of my own analysis:

• Outlook is gloomy – but tending to improve.” He sees a “fragile recovery with major uncertainties in the international economic system” with “persistent structural problems” that are “very worrisome”.
• Typical recession recovery patterns are not V-shaped – they are jagged saw tooth patterns. These recoveries take place over five to seven years. If these past patterns hold true, the bad news is we have only gone through less than two years if the recession ended in June 2009.
• The really bad news for the economy is the structural “deleveraging” underway. Corporations and households are paying back loans while banks are foreclosing on bad loans. This results in lack of investment and spending which does not create demand to drive the economy. The only remaining place demand can come from is government spending which is problematic.
  
  Consider: the US deficit is around 10% of our Gross Domestic Product (GDP). Cumulatively our debt is 85% of our GDP. Meanwhile, Japan’s deficit is around 8.6% of GDP and their debt is 188% of GDP. 60% of Japan’s tax revenues (40% of national budget) is used in repayment and debt servicing of loans even with much of this being low interest (~0.3%) government bonds. Neither nation can afford additional borrowing. Both need to scale back significantly on deficits therefore neither government can significantly drive demand in their economy. In the short term, these items combine to provide a fragile outlook: high probability for double dip inflation along with unemployment staying near 10% in the US.

Long term structural problems that concerned Dr. Okimoto were:

• We have shifted economic risk from the private sector to countries / governments (i.e. Sovereign Risk). And there is concern that several nations may default on their loans.
• Even though there has been regulatory bank reform in the US, the “Shadow Banks” – i.e. the investment banks, money market mutual funds, and securities dealers play an increasing role in the economy as an intermediary between banks and customers. These Shadow Banks don’t have government insurance (like FDIC) but may require government bailouts since these are institutions are too interconnected and may be “too big to fail”.
• Imbalance in trade. It is a “Faustian Bargain”: China exports inexpensive goods to the US while growing their economy and jobs. The US receives low cost goods and services in exchange. And then China purchases US sovereign debt. China went from $300 B of foreign reserves in 1999 to over $2.4 T in one decade: levels historically never before seen.
  
  In 2008, 36% of China’s economy serviced domestic demand (i.e. 64% of their economic output was exported) while 71% of the US economy was domestic demand. Japan is better with 56% domestic demand. The US clearly needs to increase domestic “savings” by cutting imports and increasing exports.
• Crisis of capital democracy: when growth rates are not robust the worst features of capitalism surface. These can be seen in the toxicity of the US political “partisan cold war”, placing individual interests over public welfare.
• Increasing income & wealth gap. In 2009, nearly 15% of the US population was in poverty. In Japan nearly 17% were in poverty. In addition to unemployment, this creates concerns about social stability.

Dr. Okimoto closed with “What is more worrisome – the global economy working its way back from the 2008 implosion or is it the politics (mismatched short term and long term needs along with institutional needs)?”

I am concerned that this realistic scenario of depressed consumer and commercial spending along with an unlikely rise in government spending during a prolonged recovery poses significant challenges to the semiconductors, military / aerospace, and consumer electronics industries. These are all industries that have seen high growth curves and rapid declines forming repeated boom-bust cycles. Due to the severity of this recession, the recovery is likely to be longer than past recoveries. Therefore strategic planning is essential.

Key items that management should consider are:

• Measured growth – Ensure sufficient capacity to capture reasonable levels of the upside of the saw tooth but not too much due to the danger of periodic down swings. Don’t be fooled by the short term burst of pent up demand and do not plan on sustained growth.
• Product development – Consider investing wisely in your product portfolio in addition to (or in place of) paying down portions of corporate debt (deleveraging). Having the best products and solutions not to mention “hot items” (the iPhone is an example) will give you an edge to outperform the market. And beware, delaying product development until the end of the recovery may permanently disrupt your product pipeline or put your company at a significant competitive disadvantage.
• Continuous improvements – Improvements to operations (such as lean manufacturing) – and product development aren’t one time fixes. The value is in consistent and continuous application of the improvement methodologies. Companies will need quicker responses, faster time to market, and lower costs to be successful.

In addition to planning for the economic landscape, companies need to pay attention to the changing political landscape. When the US government and the public gets serious about the balance of trade, companies that have proactively balanced their manufacturing portfolio to increase domestic manufacturing will be ahead. This is not a question of if, but when, since it is clear the current situation cannot continue indefinitely. Recent hopeful signs for US manufacturing include GLOBALFOUNDRIES opening a new semiconductor fabrication facility (“FAB 8”) in Saratoga County, New York and Samsung moving FLASH NAND memory production to Austin, Texas.

These are critical topics that require detailed corporate planning – not just reactive short term actions.