July 3, 2022

Support Notes

Admit it. The current recovery that expert, establishment economists have been forecasting has few clothes. Consensus economic forecasts quoted by the media have been consistently and significantly wrong to the optimistic side for the last 2 years, why should we expect their 2.5 to 3.5% growth forecasts for the next 5 quarters to be accurate?

While the experts were missing the recession of 2001 completely, they also under-reported the following major economic anomalies:

1. The US stock markets have lost roughly half of their value, $7.5 trillion, since March 2000 and the trend is still negative after a record 31 months. Add in the parallel losses on all other, global exchanges and the paper asset deflation is huge. In spite of the "things are in good shape" cheerleading from Wall Street analysts and government administrations, could we be in a "secular bear market" like the one from '66 to '82 when stocks declined 12% over 17 years in constant dollars?
2. The total interest-bearing debt in the US for consumers, corporations and governments has grown past $32 trillion, or almost 3 times the underlying economy. Although interest rates have been dropping the past few years, the debt at all levels - consumer, corporation and government- has been growing even faster than the underlying economy. Ditto for the rest of the world, especially third world countries. Credit market defaults and risk premiums are now rising which suggests credit crunches ahead. Credit crunches cause fire-sale deflation at the margin. Could this hit all asset classes backed by debt eventually? Won't paying down the debt-tower, at the very least, hamper future growth? 2
3. During all past recessions consumers have stopped spending and started saving which helps to reduce imports. For the first time ever, debt-fueled consumer spending increased during our corporate capital expenditure downturn. By buying houses and cars, the US consumers have pulled the US and the rest of the G7 countries temporarily out of recession starting in Q4 '01. Our balance of trade deficit has exploded, however, and now the dollar's value is starting to erode because of too much dollar supply and not enough demand.3
4. For the first time since 1915, when the Fed started being an active business cycle player, the stock markets have not revived 6 months before a "recovery" like the one started in Q4 '01. In spite of big interest rate reductions, double digit money growth and timely government tax cuts (for political reasons, not economic, but who's quibbling), both the economy and the markets have responded poorly. Why? What are the markets whispering (maybe shouting) to us?
5. The current "productivity capacity gap" for the US economy is assuring higher unemployment rates ahead. US productivity has been improving 2.5% per year and the labor force is growing 1% for a total productive capacity rate increase of 3.5%. The economy's growth for the last 7 quarters has averaged about 2% and now is in a stall. Notice what has happened over the past 2 years: first, over-time wages disappeared for the average American worker. More recently, August payroll cut announcements, along with five weeks of unemployment claims over 400,000 (through 9-22-02), are suggesting another round of layoffs from corporate America. Even the ever optimistic, average economist is forecasting a rise to 6.3% unemployment by Q1 '03. Where will the demand stimulation come from to get the entire planet growing at 3.5% or better for a few quarters to create some over-time, new jobs and new corporate investment? 4
6. Where has been the discussion about how to unwind the inter-related bubbles for the: money supply, stock market, phony corporate profit reporting, appreciation of the US dollar, all debt bubbles and excess global production capacity investment. They all inflated together in a reinforcing spiral since '94; shouldn't they now all rewind in a negative spiral? 5

Let's face it! We haven't had a post-bubble economy like this in the US since '29. Because economists and central banks worldwide have been using models developed since WW2 that have been tuned to control price inflation since 1980; they are still trying to take each new data point and fit it into the consumer-led business cycles that we have had since WW2. Quoted economists also happen to work for entities that want consumers and voters to think everything is all right and roaring back as usual so they will keep buying stocks, cars, houses and vote for the incumbent in November. The media wants to report good views, because it gets better ratings and if business does pick up so will their low levels of add revenues. Who wants to get stoned for being the bearer of tough news?

Considering the elephantine anomalies above, maybe it's time to consider the growing minority view that we are currently in the third year of perhaps a six-year, Japan-lite process of having to work off the excesses caused by all of the inter-related bubbles which have fueled each other since '94. 6


When the Federal Reserve interest rate hikes and the stratospheric stock values finally did in the 18-year-old bull market, huge interest rate deductions temporarily salvaged half the stock market bubble and further inflated most debt bubbles. The inter-related mortgage debt explosion, housing valuation bubbles and auto sales bubbles have all seen notably, huge growth in the past 12 - 20 months.

The debt-fueled, consumer spending spree for homes and autos hasn't been enough. Total US corporate profits, sales demand and investment prospects haven't improved enough. CEO surveys confirm that capital expenditure increases are not in the budgets for the foreseeable future. Now both the housing bubble and consumer confidence trend lines are decelerating rapidly. 7

If consumers don't get scared by - declining stock markets, rising unemployment, wage freezes, and accumulating "for sale" signs in the neighborhood - and start saving out of their paychecks, the old fashion way, then the lenders will stop the borrow-and-spend game. Sub-prime lenders and Fannie Mae are looking at rising rates for: delinquent mortgage payments, home foreclosures and insurance rates for laying off the risk for their asset-backed securities they sell to investment funds. Lending requirements are starting to tighten, interest rates for the least creditworthy will start to rise and loans will be foreclosed causing credit crunches and slower economic growth. 8. No matter what scenario you pick, there will still be record levels of debt to be serviced as an overhang to a not growing fast enough global economy which will cause both good and bad deflation of all asset categories. 9


First, we will have to be our own horse-sensical, foreword-looking economists. If we are heading into a synchronized, global downturn starring asset-deflation that will eventually cut across all classes of assets including your own inventory, shouldn't we consider some of the following always smart measures.

Pay down debt. In inflationary times, like the '70's, borrowers of fixed interest debt prospered at the lenders' expense. In deflationary times, borrowers can get killed even at low interest rates. If a distributor, for example, is currently borrowing at 4% to finance inventory that is deflating at 2% per year and the company has no profits from which to deduct the interest, the after tax cost to net worth is significant. Debt levels, moreover, could still be rising to finance interest costs, operating losses and more empty volume that requires more assets. The hits could get worse if US interest rates have to go up to slow a sinking dollar and sell more government bonds to finance expanding government deficits; or, if, good deflation is supplemented by fire-sale, bad deflation, because credit crunches are forcing competitors to dump product on the way to bankruptcy.

Reducing debt is, however, easier said than done. Most WDs should know how to:

1. Identify and deal with big-volume, high trade credit customers for which margins are thin, profits are really non-existent and the customers themselves are bankruptcy candidates in a prolonged post bubble economy. There are lots direct-ship, brokerage customers, for example, in the printing paper and home building materials channels. When analyzing such customers, keep saying "volume is vanity, profit is sanity" to get over sales-volume, ego needs. Don't rent out your balance sheet to unprofitable, risky customers.
2. Buy some commodity inventory in smaller quantities, when possible, to increase turns and fill-rates more than the gross margin drops from paying a higher price. Take advantage of the real reason that (master) wholesalers exist and manufacturers that want to buy market share with better turn-earn economic offerings. This frees up cash, improves asset productivity, gives customers better fill rates. For this measure, keep saying "buy the lowest total procurement cost at a higher price."
3. Identify the bottom 50% of all stocked items that are 1% of the sales and perhaps 10%+ of inventory and deal with them on a profit-losing, but cash-flow positive way. Apply losses to tax-loss carry-backs to get even more cash into the business. This is type of housekeeping should have been done both preventatively and remedially on an annual basis, but small cash-trap investments have been accumulating at most distribution centers for years. If this is a big opportunity, it should be done with your banker's complete understanding and blessing; otherwise, they might get anxious about reported losses for tax purposes even though cash and debt-service capability is rising.

Most WDs might not know the following more dramatically successful ways to reduce debt while boosting profitability, productivity and morale.

1. Downsize and upgrade the customer portfolio based on estimated and even forecasted profit contributions. Most WD's are unknowingly spending about 50% of their operational activity and costs on serving sales volume that actually generate net losses. If a typical WD would just rank its customers by estimated profit before interest and taxes and use the report to implement about 7 different profit improvement plays, both profits and personnel productivity would explode while inventory and receivables needs would shrink. 10
2. Help all employees be part of the solutions for - productivity, profitability and balance sheet liquidity improvement - instead of part of the deadweight problem. It starts with their education about the ABC's of corporate finance and how they can be responsible for getting much better total pay and job satisfaction faster. Although it sounds like a huge undertaking, there is an affordable solution (in a box!) that will deliver immediate positive cash-flow and morale-upgrade benefits. 11 Going to a "high commitment culture" will also play well in contrast to the average worker's impression of the big, corrupt capitalists in the news. There still can be integrity, control and pride within small business America jobs.
3. Reduce distribution capacity and competitive intensity on a local market basis. Here's a lesson from the past. In 1984, the Houston market was in the first half of about a 6-year, oil-bust depression. During the late '70's a number of distribution chains in a particular industry had opened up enough new locations in Houston to more than double the number of competitive players. One local CEO competitor, at my suggestion, sent letters to fellow CEO's who owned Houston locations stating that because there was too much capacity he was either a seller to or buyer of anyone else who saw the same long-term, big glut, no demand problem. Most of the other CEO's contacted the client, win-win rationalization deals resulted and losses were minimized.
4. Sell over-appreciated commercial property. In some markets, commercial property has also become an inflated asset bubble. In Boston, a sharp real estate operator has just put 50+ properties on the market with an asking price of about $650 Million. Perhaps they have noticed two key trends. A) Commercial vacancy rates in the Boston area have risen from 8% to 25% in just the past 12 months. And, B) lots of investors' money has flowed out of index and money market funds into real estate investment trusts (REITs) for their high yields. Why not sell high to funds that are required to invest new proceeds into real estate. Individual investors are always the last buyers of whatever is hot right at the top!

Had enough advice for one reading? This article and its support notes do offer a lot of food for thought with some revolutionary conclusions, but the record, economic dislocations that are all around us demand major rethinking of our unspoken assumptions and actions. Plenty of companies have already made one or two rounds of typical financial cuts with the expectation that things would pick up again like they always have, at least since WW2. Well they haven't yet and they may not for some time. If it looks like business conditions are going to be underwater for longer than we can hold our normal financial breath, shouldn't we be looking into more radical solutions like growing gills or signing up all of the employees to be part of customer profitability centric solutions.