See
also:
General Index
of all guest columns written by Dennis C. Butler,
CFA
For years, companies that are
directly or indirectly involved in the building and maintenance of the
nation's transportation infrastructure have complained about the federal
government's failure to consistently appropriate sufficient funding for such
purposes (by way of full disclosure, we have interests in companies that
fall into this category). The so-called "highway bill," which supports much
of the roadwork done throughout the country, is frequently delayed and
under-resourced. Should the reader be tempted to write this off as whining
by contractors accustomed to feeding at the public trough, we would offer up
as a reminder the fact that providing appropriate road networks, bridges,
and related structures is one of the fundamental duties of government, as
pointed out by none other than the great economist Adam Smith. It is also
important at this time to consider the impact that the country's failure to
keep its highways in good condition is having on the economy and, in all
likelihood, employment.
Modern industrial
methods, not to mention the country's international competitiveness, require
good transportation. For decades, businesses have worked to reduce their
manufacturing and operating costs through the adoption of new materials,
processes, and technology, including transportation improvements. Canals and
railroads played a huge role in the development of business in the
nineteenth century, as did automotive technology in the twentieth. Taking
advantage of an efficient transportation infrastructure built up over many
decades, in more recent times companies have employed something called "just
in time" ("JIT"¯) inventory management
techniques: instead of holding large stockpiles of raw materials, parts or
retail goods, suppliers are called on to deliver their products as needed in
the manufacturing or selling process. Since inventory represents a
significant investment for many businesses, considerable savings are
possible when it can be reduced to an as-needed purchase. Computing power
and modern communications technology make JIT possible, and the system
functions almost automatically. Transportation is essential to JIT, as
trucks must get goods to the factory or store when needed.
As made clear in a recent
Reuters report, transport has now
become the weak link in the JIT chain. Because some roadways are "too
potholed and congested" for JIT purposes, companies including Whirlpool,
Caterpillar and other household names are forced keep truckloads of
inventory parked in lots near congested areas, and lease space in "just in
case" warehouses. Measures such as these in the aggregate cost billions of
dollars. It has been estimated that the annual cost of traffic congestion
alone comes to $27 billion for driver time and excessive fuel consumption.
The additional trucking hardware and extra business inventory needed to make
this jerry-rigged system work are also burdensome. An improving economy will
only exacerbate the problems.
Good government would normally address
infrastructure issues as a matter of course, but that presupposes political
will, something in short supply in the U.S. Gasoline taxes fund road
repairs, but as the tax rate has not changed for 20 years the annual $40
billion they generate has not increased, even as costs have risen. Improving
the highway system would require about $170 billion annually, so achieving
the goal of having good roads and structurally sound bridges will in all
likelihood remain a fantasy for some time to come. Nevertheless, the costs
must and will be assumed somehow, including a weakened U.S. competitive
stance in international trade. Ultimately U.S. consumers will bear the brunt
through higher prices for most of the goods they need. Unfortunately, their
higher spending probably will not go to filling potholes or preventing
bridges from collapsing.
Bumpy roads have not stopped the transportation sector of our economy from
doing well. U.S. automakers are producing at the highest rates since 2002,
and the selling rate for new cars may approach the 16.1 million annual
figure for 2007. Railroads have also been doing well, hauling car parts as
well as the cars themselves, the energy products needed to fuel them, and a
multitude of other industrial and consumer goods. Some railroad stock issues
have reached new highs. These and other economic data, such as the highest
new home sales in six years, all indicate an improving U.S. economy.
The improving economic outlook may already be
reflected in the prices of U.S. stocks. Although market averages such as the
Dow Jones and S&P 500 have been hitting new highs regularly this year, the
march higher has been irregular. A decline in market "breadth"¯ (a comparison
of the number of stocks with rising versus those with falling prices)
indicates that not all stocks are showing a similar magnitude of gains;
indeed, many have fallen in price even as the averages move higher. Smaller
company shares have been notably weak.
The bond market
— in our view, the locus of some of
the greatest speculative behavior in the current period — ¯experienced an
interesting event at quarter's end. A well-known bond trader unexpectedly
left his firm to join a competitor, leaving behind a fund approaching $300
billion in size. Besides setting tongues a-wagging, the move resulted in
price declines of 0.3% to 0.4% among securities in which the trader held
large positions. Some nervous market participants rushed to sell, fearing
that increased client churn would force liquidations and depress prices. Not
surprisingly, the biggest impact was seen among securities that have limited
"liquidity,"¯ meaning they are difficult to buy or sell in significant
quantities without moving the price to an undesirable degree. Since the
financial crisis, liquidity has been of increasing concern as banks have
reduced their inventories of bonds, leaving the market to big asset
management firms
(one reason why some believe the largest fund mangers should be included
among systemically important financial institutions). One suspects that the
minor price changes caused by one speculator's career move would pale in
comparison to what could happen in a real market dislocation.
"We did what we did, we didn't do what we
didn't do, and the result was what happened."
When Paul Volcker made the above remark, he was
referring to his tenure as Chairman of the U.S. Federal Reserve three
decades ago. But the sentiment he expressed has broad application in
business, investing, and, indeed, in life. We can never truly know if our
actions will produce the desired outcomes, or what unintended consequences
may result. All of us must make judgments based on our knowledge and
experience, assessing whether the probability of success outweighs that of
failure. In the midst of an emergency, especially, we make choices, hope for
the best, deal with the outcome, and, in the case of public officials, cope
with the inevitable condemnation from armchair critics.
As with the Fed of the late 1970s and early 1980s,
central bank officials in Fall 2008 had to make decisions in the face of
great uncertainty. The situation was far more dire than the inflationary
environment Volcker dealt with in his day. The nation was facing a severe
economic dislocation as its financial system careened toward collapse.
Debates about what to do reflected the ideological divide among
policy-makers. Some argued that the crisis should be permitted to run its
course, allowing the system to purge its "imbalances." Much the same would
be heard in Europe a few years later when some advocated allowing Greece to
collapse economically because a contraction of severe enough magnitude would
eliminate that country's too-high wage rates and force fiscal rectitude on
its politicians. U.S. "imbalances"¯ included too much debt and exorbitant
home prices. What's wrong with putting pressure on real estate prices that
had risen at unprecedented rates, and reigning in a housing finance system
that had become too "creative,"¯ promoting home ownership for many people who
could not afford it?
The problem with the laissez-faire approach is that
it entails costs that may not be worth the strains it imposes on the body
politic. From the perils of streets full of angry protestors it is a
relatively easy transition to extreme political movements, as we have seen
in some European countries. Given the severity of the situation, there was
also the potential cost of massive unemployment, lost potential output, and
a generation of citizens potentially unable to find jobs in which they could
learn their way to solid careers.
Fortunately, the alternative course
"active measures
to fight a looming economic depression" was chosen. Despite the uncertainty
surrounding the untested and bold policies adopted during and after 2008,
the probability that doing nothing would turn into disaster was quite high:
the experience of the Great Depression, when disenchantment threatened the
foundations of U.S. capitalism, remains a powerful model for what can happen
in financial crises. In a system characterized now, as it was in the 1920s,
by increasing inequality, the consequences could have been even greater in a
more interconnected world.
The measures adopted since 2008 have engendered
strong criticism from some quarters. In our view these critics are enjoying
the luxury of experiencing the result of what happened, while never knowing
the outcome of doing what we didn't do.
_____________
Dennis C. Butler, CFA, is president of Centre Street Cambridge Corporation, investment counsel. He has been a practitioner in the investment field for over 27 years and has been published in Barron's. He holds an MBA from Wharton and a BA in History from Brown University. His quarterly newsletter can be found at
www.businessforum.com/cscc.html.
"Current low valuations reward the long-term view", an article by Dennis Butler, appears in the May 7, 2009 issue of the
Financial Times (page 28). "Intelligent Individual Investor", an article by Dennis Butler, appears in the December 2, 2008 issue of
NYSSA News, a magazine published by the New Yorks Society of Security Analsysts, Inc. "Benjamin Graham in Perspective", an article by Dennis Butler, appears in the Summer 2006 issue of
Financial History, a magazine published by the Museum of American Finance in New York City. To correspond with him directly and /or to obtain a reprint of his featured articles, "Gold Coffin?" in Barron's (March 23, 1998, Volume LXXVIII, No. 12, page 62) or
"What Speculation?" in Barron's (September 15, 1997, Volume LXXVII, No. 37, page 58), he may be contacted at:
Dennis C. Butler
President
Centre Street Cambridge Corporation
Post Office Box 390085
Cambridge, Massachusetts 02139
Telephone: 617.441.9695
Email: cscc@comcast.net
URL: http://www.businessforum.com/cscc.html
Your comments and suggestions for these pages are most welcomed!
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