Two phenomena that we have not seen in a long time have recently appeared. Whether they are short-term events or long-term realities is provoking debate. I am speaking of the distinct but related issues of inflation and shortages of, it seems, nearly everything.
Inflation was a major factor in the U.S. economy throughout the 1970s. The term “stagflation” was coined during that time (just in time for the 1980 presidential campaign that resulted in Ronald Reagan’s landslide victory over President Jimmy Carter). Since then, inflation has been a topic of minor interest—until this year. With the apparent demise of the COVID-19 pandemic, and government efforts to return to vigorous economic growth, inflation has now appeared. While the Biden administration, for good political reasons, has sought to minimize the problem, the most recent inflation report last month revealed that most of the economy experienced significant inflation in April. Consumer prices rose a seasonally adjusted 0.8 percent in one month and the annual rate of inflation was 4.2 percent, the highest rate since 2008, the year of the financial crisis. Industrial goods including steel and aluminum, food and services (bought an airline ticket lately?) all contributed to the increases.
The second issue, shortages, no doubt contributed to the inflation increase. Optimists note that shortages are generally temporary until supply and demand are in balance. Imbalances can result in price volatility due to changes in supply chain management, popularly known as “just in time.”
Ever since the 1970s, the industrial world has been fascinated by “just in time” inventory management. Most readers know what that means: manufacturers and retailers reduce inventory costs by ordering parts, raw materials or goods for sale in quantities and on-time schedules that reduce holding times for components and raw materials to a minimum. Everyone up and down the supply chain needs less warehouse space and minimizes the time between paying for goods they needed and receiving payment from their customers, saving on the cost of borrowing. All these are good things.
This system was developed principally by manufacturers in Japan (most notably Toyota) in the aftermath of World War II and inspired by W. Edwards Deming. By the 1970s, the successes of this system, which had many elements in addition to just-in-time inventory, was winning converts outside Japan. By the 2000s, companies in many industries were operating based on “just in time.”
The pandemic wrought havoc on the assumptions underlying the prevailing wisdom. In the first few months, businesses shut down, sharply reducing new purchasing. That lasted three or four months. By the end of last summer, some businesses reopened (travel, leisure and restaurants excepted), but in the fall and winter surges in COVID cases and deaths caused another slowdown. By January 2021, vaccinations began in earnest and recovery in some sectors accelerated. Then the shortages started showing up. Semiconductors, essential to auto production, were not being produced in sufficient quantities to support production. Lead times for other parts lengthened also. Solvent for automotive paint, for example, is a byproduct of petroleum refining. When the pandemic hit air travel, refinery production slowed; naphthas that are used in making paints slowed as well.
Steel and aluminum prices took off last year and, despite expectations, the cosmic prices have stayed high. Other markets around the world are seeing higher prices and reduced deliveries, but the U.S. remains at the top of the charts in terms of prices.
Naturally, these industries that are linked to one another recovered at different rates. Housing prices have surged, fed in part by lumber shortages; lumber prices have tripled in the past year. We are still feeling that shortage in reduced housing starts. Add to that the cyberattacks on the Colonial Pipeline (gasoline shortages) and the recent attack on a major meat producer. And don’t forget the Ever Given, stuck in the Suez Canal in April, that made headlines. All these supply disruptions keep markets (and all of us) on edge.
These short-term issues raise questions about the future of just-in-time inventory management, and they should. Companies will need to reevaluate their reliance on global supply chains. In the main, I think those supply chains will continue to be vitally important. But demand for some goods and services will not come back to pre-pandemic levels for a long while, perhaps never. For example, the volume of commuters every day is not likely to return to pre-pandemic levels in the foreseeable future, affecting public transportation in cities and wear and tear on roads.
In industry, speculation is already beginning about changes that may come to supply chains. Because manufacturing technology is extremely complex and the various parts of the supply chain are interdependent, it is not clear how specific companies or industries will react to the post-pandemic reality. But clearly, companies will strive to reduce the risks that shortages in key parts will shut down assembly lines.
Most experts seem to believe that the lean inventory strategies will not disappear, but that there may be more flexibility in inventory management. The return of huge warehouses stockpiling six months or one year of needed inventory is not likely because the costs are simply too great to justify the expense. But warehousing could see a comeback.
One interesting area of discussion is the possibility that procurement of raw materials and components for businesses will be localized. A supplier down the road a few miles seems more desirable than one 10,000 miles away.
While that may happen to some extent, there are two forces at work to make that possibility somewhat remote: (1) the continued cost-efficiency of overseas sources compared to U.S. sources; and (2) the globalization of each company’s customer base. To service growing overseas demand, pressure will build on companies to locate manufacturing closer to customers overseas as well as in this country. Growth in Africa and Asia will likely expand more than in the Americas.
In addition, import supply chains have a dramatic advantage in transportation costs. The Jones Act and other regulatory requirements in the U.S. make domestic transport much more expensive than international transport, giving foreign sources of supply a distinct advantage for overseas suppliers.
In some industries like steel and aluminum production, shortages of domestic products continue to be a major problem. Prices are going up in other global markets too, but not as fast as in the U.S. If buyers see that high prices might be here to stay, they could begin to make longer-term decisions about where to locate production (if corporate taxes increase in the U.S., this could accelerate that decision-making). Because the U.S. is an island of high prices compared to other global markets in steel and aluminum, this trend could affect U.S. consumption of both commodities.
Pressure is building on the Biden administration to relax Section 232 and Safeguard restrictions. Sustained high prices in the U.S. disadvantaging steel and aluminum buyers will increase that pressure, as will pressure from U.S. exporting industries laboring under retaliatory tariffs imposed by the European Union and the UK, among others.
“Normal” is still a long way off.
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