Dennis C. Butler, President
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
Centre Street Cambridge Corporation
Post Office Box 390085
Cambridge, Massachusetts 02139
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© Copyright 2014 Dennis C. Butler, All Rights Reserved
Revised: October 8, 2014 TAF
© Copyright 2014 Dennis C. Butler, All Rights Reserved