Reindustrialization in USA - Euler Hermes

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Euler HermesEconomic Outlook n° 1187 | Special Report | The Reindustrialization of the United States• • •Which favorable market conditions support a full-fledged U.S. recovery?The favorable economic environment in the short-runfor private sector development is a product of distinctlyunfavorable conditions which actually started well beforethe Great Recession. Accommodating monetarypolicy, credit availability, lower cost of capital and the(timid) rebound in the housing market are some ofthe major positive contributors to this.In the late ‘90s and early 2000s, the Federal Reservekept monetary policy too loose for too long. When thehousing bubble burst in 2006, it destroyed billions ofdollars of wealth and wreaked havoc on the economy.As a result, the subprime mortgage crisis developedin 2007, impairing the financial markets. In 2008oil prices rose to a record high creating yet anotherhuge drag on the economy. As the financial crisisreached its height in the Fall of 2008, credit marketscame to a virtual standstill, paralyzing the economy.To counteract the chaos, the Federal Reserve droveshort-term interest rates virtually down to 0%, andthen injected $1.4 trillion of liquidity into the financialsystem, more than doubling its balance sheet in justa few weeks. Congress and the President passed the$700 billion Troubled Asset Relief Program (TARP) tokeep impaired banks functioning, and in early 2009,an $800 billion stimulus package was passed in anattempt to jump-start the economy. By this time theeconomy was losing over 700,000 jobs per month, thefastest rate in over 60 years (Figure 1). Although therecession technically ended in June of 2009, only abouthalf of the total jobs lost have been recovered, and GDPhas averaged a mere 2.2% annualized growth ratesince then, well below the long-term average of 3.3%..Yet this chaotic backdrop helped set the stage for aneconomic recovery, which although tepid, was idealfor a manufacturing rebound. The deep recessionhad caused manufacturers to cut employment to thebone, so after the recovery began they were able tooperate with minimal labor costs using highly productive,motivated workers. Unit labor costs plungedin the manufacturing industry, particularly in somesouthern states. At the same time that labor costs werefalling, so were the costs of capital. The Fed had drivenshort-term rates virtually to zero, which was an openinvitation for investment. Starting in the fourth quarterof 2009, the investment component of GDP set a blisteringpace over four quarters, growing at annualizedrates of 41%, 20%, 15% and 16% respectively - whilethe economy as a whole grew less than 3%. Creditconditions eased substantially and commercial andindustrial loans have grown more than 10% annuallysince the Fall of 2010 versus a long-term average of6% (Figure 2).In addition, high credit quality manufacturers are alsoable to tap the corporate bond market at historicallylow rates. The Fed’s QE programs further lowered thecost of capital by boosting stock prices. Energy costsfor manufacturers have also fallen, due in part to theemergence of very cheap shale gas. The housingmarket is now firming (Figure 3), setting the stagefor a rebound in manufacturers of home buildingmaterials and appliances.Approximately three quarters of U.S. manufacturing issold domestically, where conditions are very good, yetthe export markets are also in surprisingly good condition.Canada is the largest market for U.S. exports, consumingapproximately 19% of all U.S. exports. WhileCanadian GDP has experienced slow growth recentlyand is expected to grow only about 2% in 2013, theCanadian economy is in much better fiscal and monetarycondition than most industrialized nations, and1. Jobs Created and the Unemployment Rate2. Commercial and Industrial Loansquaterly annualized % change3. US Housing MarketFundamental Measures, Seasonally Adjusted Annualized Rates9005000600400Non farm payroll jobscreated (000’s) (left scale)1098508004800460020075044000870042004000-20076503800-400Unemploymentrate (right scale)66003600-6005503400-80055003200-10002002 2003 2004 2005 2006Source: Bureau of Labor Statistics2007200820092010201142012Source: Federal Reserve45020082009Permits (left scale)Starts(left scale)20102011Existing 1-FamilyHome sales ( right scale)Source: National Association of Realtors, Census300020128
Economic Outlook n° 1187 | Special Report | The Reindustrialization of the United StatesEuler Hermestherefore offers some stability to U.S. exports. Mexicois the next largest importer of U.S. goods, consumingabout 14% of all U.S. exports. Unlike much of the worldsince the recession ended in 2009 Mexico has enjoyedsteady and strong growth, with robust annual GDPgrowth of 4.6% versus a long-term average of 2.7%,clearly boding well for future U.S. exports. Centraland South America absorb 11% of U.S. exports, andprospects for continued strength in these emergingeconomies are good. China absorbs 7% of U.S. exports,and the long-term growth of the Chinese economy isexpected to remain very strong, despite a recent softpatch. Asia (ex-China and ex-Japan) consumes 13%of exports and like Latin America, growth in theseemerging economies is likely to be robust. Togetherthese major, strong markets buy 64% of U.S. exports.Europe is of course a weak spot and may be for sometime, but exports to the European Monetary Unioncomprise only 13% of total U.S. exports. Furthermore,the Fed’s quantitative easing policies have devaluedthe dollar, making export prices cheaper and boostingtheir competitiveness. Between the end of 2009 andAugust 2012, exports from the U.S. have risen 45%,a 15% annualized rate compared to the long-termaverage of 7.8%. ©Another positive sign for theindustrial fabric: insolvencieson the decreaseAs shown in Figures 4 and 5, business insolvencieshave overall been on a slightly downward trend overthe past decade. Insolvencies rose as the economydeteriorated through 2007, and increased furtherin 2008. Insolvencies often are a leading indicator,as they were when they fell sharply in 2009 as therecession came to an end. By that time, most of thevulnerable businesses had already failed, and thosethat survived had done so by:• reducing debt on their balance sheets,• becoming more risk-averse by not extending asmuch risky credit to other businesses, and• by reducing headcount.These factors allowed businesses to survive eventhough they put a weight on the economy which hasyet to be fully removed.4. Bankruptciesin millions300002500020000150001000050000198119831985198719891991Sources: Administrative Office of the U.S. Court, Euler Hermes1993199519971999200120032005Bankruptcies2007200920112013Looking at 2013, expectations are that the downwardtrend in insolvencies will continue. We expectthe decrease in insolvencies to be 10% in 2012 and6% in 2013. This will happen for two reasons: first,GDP growth in 2013 is forecast to be around 2%. Thisshould suffice to help decrease the number of insolvenciesin the economy. Secondly, businesses are stilloperating in the risk-averse manner which helpedthem survive the recession. They are carrying lowerdebt levels on their balance sheets, providing themmore of a cushion should there be another downturn.And they are still running in a very lean modeby keeping operational costs and payrolls as tight aspossible.5. Insolvencies to Decrease in the Manufacturing Sectorannual change, in %2.01.81.61.41.21.00.80.60.4Manufacturing tends to be more sensitive to thebusiness cycle as Figure 5 clearly shows, and as suchtends to be riskier as well. Manufacturing insolvenciesrose more sharply than the total economy in therecession and fell more sharply in the recovery, andwere higher than the total throughout virtually all ofthis time period. However, it is important to note thatafter the recent recession, manufacturing insolvenciesclosed the gap with the total economy becauseof the sector’s outperformance.0.20.02003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013Total Manufacturing ServicesSource: Euler HermesThe services sector is less sensitive to the businesscycle, as demonstrated by how much less insolvenciesfluctuated. Since it is less risky it also has an insolvencyrate lower than the total economy. ©9
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