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Wednesday 27 May 2015

Logisticians must reassess Asian supply chain threats

Global logisticians now have two reasons to dust down their contingency plans to cope with heightened supply chain risks in the Far East -- financial and now political. As mentioned in my last blog: "Heightened global supply chain risks herald gathering storms?" the Chartered Institute of Purchasing and Supply's latest quarterly risk index shows that the risk of disruption to corporate supply chains is running at an almost record high, and in particular highlights China's slowdown and its manufacturing sectors at serious risk of defaulting on state-backed loans. So much for the financial risks but now comes the political, which if realized will have far greater adverse, global economic consequences.

The problem is the potential flashpoint over China's development of artificial islands in the South China Sea, around the largely uninhabited Paracel and Spratly islands, a region potentially rich in oil and gas but contested by geographically much closer countries like Vietnam, the Philippines and Malaysia. China says its right to the area goes back centuries to when the Paracels and Spratly island chains were regarded as integral parts of the Chinese nation, and in 1947 it issued a map detailing its claims. Vietnam says it has actually ruled over both the Paracels and the Spratlys since the 17th century and has the documents to prove it. The other major claimant is the Philippines, which invokes its geographical proximity to the Spratlys as the main basis of its claim for part of the islands' grouping.

China's fatuous claim lacks merit and is akin to Britain, say, reclaiming the Hawaiian Islands, previously called the Sandwich Islands after the Earl of Sandwich and whose flag today contains a Union Jack. Geographical proximity must surely be a more valid claim, which does not favour China.

The fear is that, natural resources apart, China's moves are politically motivated, and America's President Barack Obama said that his county is concerned that China is "flexing its muscles and power" to dominate smaller countries in the region. According to American estimates, China has expanded the artificial islands in the Spratly chain to 2,000 acres, up from only 500 last year. It has already built an airstrip capable of taking jet fighters. If China' activity continues apace it would give them defacto control of the maritime territory they claim, said Admiral Samuel Locklear, head of the US Pacific Command, speaking to the US Senate. That means China could base warships and 'planes on the islands, and install long range detection radars, potentially giving them the ability to enforce an air defence identification zone.

China has embarked on a substantial modernization of its maritime and paramilitary forces, as well as naval capabilities to enforce its sovereignty and jurisdiction claims, if necessary. At the same time it is developing capabilities that could put US forces in the region at risk in a conflict. The flip side of this development is a significant rearmament programme by China's smaller neighbours who feel threatened by China's posturings. They are prioritizing their spending on their navies amid the rising tensions in the South China Sea, with annual defence spending in South East Asia projected to reach $52 billion by 2020, up from the expected $42 billion this year, and submarines will feature prominently in that.

Peter Dutton, professor of Strategic Studies and Director of the China Maritime Studies Institute at the American Naval War College, said: "Tensions in the South China Sea pose an economic security risk to the entire globe." He went on the say that: "If a flare up were to arise between China and one of its smaller neighbours those global trade routes could be affected, hurting the world economy." It is not difficult to see why. Each year an estimated $5.3 trillion of trade passes through the South China Sea, with US trade accounting for $1.2 trillion of the total. In 2013 the US exported $79 billion of goods to countries around the South China Sea and imported $127 billion from that region. Should a crisis occur the diversion of cargo ships to other routes would harm regional economies as a result of increased insurance rates and longer transits. Even if shipping companies still attempted to pass through the area during a conflict, whether to access resources there or to cut transit times, "the insurance costs would be prohibitive," said Peter Dutton.

There are some who feel that the trade routes and the concern over freedom of navigation will never become a point of contention in the region because, as the argument goes, everyone needs the shipping lanes to function, most of all China. But if recent history is any guide politicians pay scant regard to economics.

Sensible global logisticians, therefore, should reassess their vulnerability to any disruption to trade passing through the South China Sea, especially if they are reliant on JIT deliveries of component supplies that are only sourced from that region, and so avoid a repeat of the upheaval caused by the Japanese tsunami of 2011, which cost global corporations around the world billions of dollars.
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Saturday 16 May 2015

Heightened global supply chain risks herald gathering storms?

In the logistics firmament it is often said that demand for forklifts is an accurate bellwether for any economy, in that it is usually the first into a recession and the last out but that observation tends to apply to individual economies. For a global take on economic prospects perhaps the best bellwether is shipping, particularly the dry bulk vessels, and the bells from that quarter are not ringing joyously.

As if to highlight the gathering storm, the Chartered Institute of Purchasing and Supply's latest quarterly risk index, backdated to 1995, shows that the risk of disruption to corporate supply chains is running at an almost record high, helped by a drop in commodity prices and a slowdown in China. Admittedly, the risk rise is not universal. In North America and western Europe the supply chain risk fell last year but that does not mean these areas will escape unscathed if current trends in global commodity trade and deflation persist much longer.

What we are seeing in the global supply chain is essentially a financial risk that began with the global financial crisis in 2008. In the Far East, particularly China, the manufacturing sectors are at serious risks of defaulting on state-backed loans, while in South America collapses in soya bean, copper and oil prices are affecting much of that Continent. In Australia the collapse in mineral prices, particularly iron-ore and coal, have left the country with the highest unemployment for 13 years, with apparently worse to come as investment continues to fall. In Japan, once the world's second largest economy, manufacturers are reluctant to spend on machinery upgrades, where the average age of their facilities and equipment is now 15 years, the highest in 30 years, and the antithesis for any efforts to boost economic recovery. Japan's lost decades of stagnation and deflation have prompted companies to restrain investment and now those same fears over deflation threaten the rest of the global economy.

Nowhere, perhaps, is the problem most acute and obvious than in shipping, and by extension the banking industry, which by some estimates has about half a trillion dollars worth of outstanding loans to shipping companies, much of which is at significant risk of default. The current market state for shipping commodities across the world's oceans is dire, which even an expected record of over 100 ship scrappings this year will not improve. Daily earnings for the industry will still tumble, though it must be said that prediction is not the shipping industry's forte. As recently as February this year it forecast that shipping rates would jump but now forecasts are turning bearish as China's imports of coal plunge and its iron-ore imports expand at its lowest pace on record. As the world's second largest economy, China will expand the least in a generation this year, according to estimates compiled by Bloomberg. Despite an expected demolition of 6% of Cape-size vessels, earnings per vessel will still slump about 20% this year, based on a survey of 10 shipping analysts. Freight rates have been pushed to historic lows, thanks to a perfect storm of collapsing commodity shipments, particularly in coal and iron-ore, combining with a market glutted  with vessels ordered as long as a decade ago. Ships competing for spot cargoes today are earning about $4,200 a day this year so far, the worst start since 2000. Cape-size average earnings are now expected to drop to $11,000 a day this year, having been predicted only in February this year to rise to $18,750 a day.

China is the world's top iron-ore and coal consumer, importing almost 60% of the world's sea-borne iron-ore and about a quarter of the global coal shipments. It is worrying, therefore, when China's Iron and Steel Association sees overcapacity for sea-borne iron persisting until at least 2019, as the world's largest suppliers expand production even more. The risk to coal shipments, however, has more permanent forces at work --- pollution. China's biggest coal company, China Shenhua Energy Co, which supplies about 16% of the country's coal, cut its sales 10% last year and forecasts another 10% cut this year. This reflects China's attempts to reduce its energy intensity in coal dependence so as to cut pollution, understandable in a country where air pollution from all sources kills an estimated 1.2 million a year. Part of China's strategy is to develop alternative sources of electricity generation, such as hydro, wind, nuclear, gas, and solar PV. Cuts to China's demand for fossil fuels are so great that its imports will be heavily affected. The sea-borne market in coal cannot expect any comfort elsewhere from fast-developing countries. India's Energy Minister has made it clear that India's thermal coal imports could potentially go to zero within two to three years.

China's imports of copper in February 2015 tumbled the most in four years, while oil and iron-ore imports slowed to the weakest rate in 3 months. China is now already building the world's largest renewable energy system, for which it deserves a bow, and which in 2013 stood at just over one trillion kw/hrs, almost as much as the combined electricity generated by France and Germany. All this bodes ill for the shipping industry and shipyards, where orders for new ships have plunged to about 400,000 dwt a month for this year, according to Clarkson, the world's biggest ship broker, the smallest since the early 1990s, and about 98% below the peak commissioning rate set in 2007, when 23 million dwt were ordered in a single month.

Now is not a good time to be in shipping, without a long purse, and never, perhaps, have global logisticians faced such uncertain times. Let us hope that uncertain times do not mean living through "interesting times" as the old Chinese curse goes.  
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Saturday 9 May 2015

Will the Tories save Britain's economy?

Unsurprising to this writer, the Tory party won an overall majority in the British general election but was its greatest recruiting sergeant, a recovering economy, worthy of its achievements and if not what now needs to be done? In response to the first part, the answer looks negative. It's true that the previous coalition Government presided over a fall in unemployment to 5.6%, among the lowest in Europe, and that economic growth last year was impressive for a mature, developed economy but that is only a small part of the picture, outweighed, it seems, by the dark side of the economy.

Britain has two persistent economic problems: falling, inflation-adjusted pay and poor productivity. On the former, inflation-adjusted pay is down by about one tenth since the start of the financial crisis in 2007, a fall not exceeded since the 1920s. This means that by early 2014 the nation's buying power was still almost 6% below its pre-recession 2007 peak, and it will not recover quickly anytime soon, according to research by the independent National Institute Economic Review. This publication predicted that the drop in inflation-adjusted wages is so steep that "it will not be until early 2020 that this previous peak is regained."

The picture for poor productivity looks even direr. After Gross Domestic Product (GDP) fell sharply in 2008-09 there was a brief rebound in 2010-11 but its growth rate since has scarcely budged above zero. According to the Bank of England, output per hour of work has not been so sluggish since Queen Victoria's time, excluding two exceptional times in the immediate aftermath of two world wars.

The weak productivity growth, said the BoE's governor, Mark Carney, is not the result of a lazy workforce, bu rather that companies have not been buying new machines and software workers to raise their performance. While there may be an element of stricter bank loan conditions and uncertainty over the economic prospects holding back such necessary investment, it seems companies have found it cheaper and easier to add people rather than buy equipment, said Carney, (and easier to release people --Ed). This parlous problem is reflected in Japan today, where the average age of the country's machinery is the highest in years because manufacturers are reluctant to spend on upgrades. At an average age of 15 years for facilities and equipment, it is the highest in 30 years. This means that Japanese companies, like Britain's, could fall behind their foreign rivals. Behind Japan's dangerous strategy of using near clapped out, low productivity machines was the country's lost decades of stagnation and deflation, which prompted companies to restrain investment. Just such a scenario could now face Britain if prompt action is not taken.

It is to be hoped that any pre-election nerves that may have held back British investment will now be dispelled, especially now that horse trading between the two former coalition partners, so emasculating for firm policies desperately needed in the country's best interests, is over. But it will need much more than a more conducive political climate.

Just as businesses have their qualms over making new investments so, too, do individuals take a more frugal view of their spending habits when the devil drives, a point that might also crimp business investment. The current labour market does not instill much confidence in that regard. Job creation, for example, between 2008 and 2014 has been dominated by rising self employment and part-time work, with the latter now accounting for 27% of the total workforce, the highest since records began and which includes many professions. The Trades Union Congress (TUC) claims that the number of part-time workers who say they want to work full-time is still almost double the number before the recession at 1.3 million and that at the moment the economy is still not creating enough full-time employee jobs to meet demand. Zero hours contracts, while suiting some, also create uncertainty over employees' future spending plans.

To avoid a long, Japanese-style situation, the British Government must take firm action over the economy, education and its social programme, all of which impact each other. Job vacancies in skilled areas run into hundreds of thousands and they do so because many school leavers' literacy and numeracy levels are lamentable. UK school leavers are among the least literate and numerate in the developed world, with 80% of 16-24 year-olds' standards no better than primary school leavers' achievements. It is the most damning indictment of British school education, admittedly influenced by social problems like single-parent families. This brings us to how social problems impact education and the economy. The Government's spending on social benefits by far and away absorbs the lion's share of total Government spending and so it is here where the scalpel must be wielded more but with expert precision. If taxpayers' largess is showered on single parent families, for example, in a way that encourages more, then not only does that increase the likelihood of children achieving poor academic standards it also diminishes the potential pool of apprentices so desperately needed in certain manufacturing industries.

The UK Government could cut billions of pounds from its budgets, with the savings partly going into measures to boost economic productivity as well as paying down its high debt. Much of industry encouragement should focus on manufacturing, particularly the export market because here the country's disturbing, chronic and worsening balance of payments crisis is a serious threat. This problem has been ignored for far too long and time is running out on both the balance of payments and poor productivity.
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