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Logistics Management (LM) Group News Editor Jeff Berman recently caught up with Paul Bingham, Supply Chain Transportation Economics Consulting, for S&P Global Market Intelligence, to discuss various supply chain- and logistics-related topics. Among the topics covered were: the impact of inflation on infrastructure projects, a potential recession, and the impact of tariffs on operations. Their conversation follows below.
LM: How do you view the impact of inflation, in terms of what it means for funding related to the Infrastructure Investment & Jobs Act (IIJA)?
Paul Bingham: A bill that big and long lasting does not have a fast fiscal stimulus impact on the economy, and also, very importantly, does not result in very quick improvements of additions to the transportation system. Years ago, we had the so called “shovel ready” projects. Those are few and far between except for where states were already including planning based on other funding sources to be going forward with rehab maintenance and repair expansion projects that were already in the works. Having said that, every state is required to and has a long-range transportation plan, and the Federal Highway Administration forces them to produce an update every few years. And in that update states are required to have a prioritized project list with some funding against it. There is also a component of that statewide long-range transportation plan, which is a state freight plan, which is even more detailed, with each of those having a forward-looking set of identified projects included in it, with some engineering cost estimates of what those were at the time they were prepared…against budgets that probably, in many cases, did not do much allowance for inflation.
For the last decade, there has not been a whole lot of inflation. So, the cost engineer estimates were within a couple percentage points, even if they ended up being two or three years old in general. I am making big generalizations here.
Right now, we are in a radically different world where we have Produce Price Index inflation running at almost double-digits and consumer price inflation of upper single digits at best, so it is a very different world from a cost planning perspective where suddenly those budgets that were there and also for the prioritization of projects, maybe the rank ordering is similar, in terms of what projects should be done next. But how far a given dollar is going to go, or a billion dollars, is clearly something that calls for a reassessment.
LM: How would that type of reassessment work?
Bingham: If you just go to the states and say “ok, we have this current backlog of $2.3 billion worth of projects in our plan,” you know they better go back and say “well, you know, it is not $2.3 billion anymore, because those cost estimates are now all obsolete. If states actually put that out to bid, all the bids are going to exceed that so their budgets are going to be blown in the sense of scaling the work and counting on a certain number of projects getting developed for a given amount of money. You know those estimates are basically wrong, and nobody currently has that in the long-range transportation plan because none of them [plans] had the level of inflation that we are faced with now. And there is no way their contractor set is going to run at a loss when they have to pay more for labor and more for fuel and everything else they are buying. It is actually impossible for the contractor community to do that and, importantly, I would add, that even before this inflation issue came into play, there was already an independent inflationary impact on trying to put so much infrastructure through the system.
LM: Why is that the case?
Bingham: Because you were already in a situation where Congress was saying “OK, we are going to accelerate the use of the current federal contracting capacity through the state DOTs and even in some cases county governments and so forth.
Where the construction industry, the independent planning industry, you know they only have so much capacity…there are only so many bridges they can build at the same time. There was already going to be an inflationary factor, just from the fact that you were going to be trying to collectively push the construction industry, the engineering design planning industry, all of them, to use more resources than they had readily available
LM: What would the effect of that be?
Bingham: It was going to run you up the cost curve through the lower hanging fruit to the ones that were more expensive to acquire i.e., basically having to bid some of that capacity away from private sector use and applications, which is the classic crowding out problem in the economy. The Fed does something and does it big; it is inevitable that is not in a vacuum that happens in the context of private sector activity so that would even have an impact of tending to raise inflationary costs for similar construction in the private sector. It is not only that you raised the costs for that particular piece of highway but also the private sector terminal developer who is trying to build a parking lot around freight facilities is going to have to pay more for construction. That gets built across the economy then in terms of what do you collectively get for it. If you get three-to-five years out, what are we actually adding in terms of physical system capacity expansion and improvement?
I would argue you have the double whammy of the size of that infrastructure bill affecting the markets fundamentally and then overlaying it with 40-year high inflation. It is going to eat up even more of those budgets. We can anticipate probably less than what Congress was even led to believe it would get for the level of money, in terms of what was going to get spent on the infrastructure that was tied to transportation and freight. And that is another important sub-note that in the IIJA there is a lot of infrastructure funding that is not going towards serving freight transportation directly. It is great that there is an improvement in broadband telecommunications in rural areas and that will indirectly benefit freight transportation and logistics supply chains to some degree but not as much as if more of it had been put into building out the freight system. The perspective is there was a monumental achievement and a bipartisan agreement to have this bill happen but we need to be careful in our expectations around what we are really going to net from it, in terms of the improvements for the supply chain nationally and also regarding what’s happened in the economy—inherently what was the result of lumping together a bill like this all at once rather than, say, over 20 years, having done it more evenly. This is what the politicians could not figure out how to do and then of course you pay for that as a taxpayer, in terms of trying to push it all through in a compressed amount of time.
LM: This is like kicking the can down the road, in that it can only be done so many times, right?
Bingham: But when you do kick the can down the road, you are going to be paying a higher price for having done that, and the maintenance you deferred becomes only more expensive to do later when you did not do it earlier.
It is clearly so optimal from a federal infrastructure spending perspective if the taxpayers are trying to get the most bang for the buck on this infrastructure spending, Congress should have figured out how to do this more evenly over time and not lumping it in all together at once in a few years.
LM: With GDP down the last two quarters, is the economy in a recession?
Bingham: Our company is still not labeling this or even forecasting a U.S. recession in 2022 or 2023. I would say we are near it or on the cusp of it. We have said that the risk of a recession is now between 40%-to-50%. But we are still saying—based on the fundamentals (low unemployment, solid retail sales, rates, final sales numbers), there are many signals saying a soft landing may just be possible. The Federal Reserve might pull it off. Because you have households that still have substantial wealth, despite the correction in the equity markets, and despite some softening in housing. Households have still paid down debt going back through the pandemic, and they still have borrowing capacity on their revolving credit that is below the level they were at in 2019. There is still capacity for spending that exists that was not there in some previous recessions. And we still have labor markets that are tight, in terms of wage appreciation. Unemployment is still low, partly because of workers being choosy and picky about what jobs they have taken. We are not in a situation where the workforce is saying ‘gee, I cannot get a job,’ or “I am worried about losing my job tomorrow’ so I am going to stop spending. Even though there is this enormous discontinuity between consumer spending and consumer spending behavior. We have seen these incredibly low scores on consumer sentiment…but at the same time if you look at what the households are actually doing, they have not pulled back on the spending yet. We are not seeing it reflected in the actual buying behavior through the latest data. And we don’t see it in freight, in data related to for-hire carriers. They are not in a freight recession in terms of their earnings and loads, as per DAT data. We don’t see it in terms of the trade backlogs. There is some softening in trade but bringing down Transpacific container rates from historic highs and bringing them down as far as they have come down already, they still remain well above where they were in 2019.
We may be headed towards a recession but we are not there yet. Based on the data released so far, we are not at/to the point to say yes, we are already in and we are forecasting a recession. Now, our macroeconomists have said there are elements of the economy that are clearly slowing down and we are calling it a growth recession, where are not going to achieve potential GDP growth this year because there is sectoral weakness, where some sectors are clearly already in a downturn. We can see that. It has already started in housing and anticipate it is going to spread because of the Fed Reserve monetary policy purposely trying to slow some of that economic activity. But that is different than getting to the end of 2022 and saying that was a recessionary year. The risks are on the downside…. another covid wave or further disruptions we could not have anticipated and other enormous downsize risks that could tip us into recession. From all the data we have right now, we are not at the point to say, yes, we are in a recession.
There is going to be a lot of debate about that because there are other economists that are saying this is a recession and are anticipating revisions to the numbers and are being skeptical to some of the consumer behaviors sustainability and some of the impacts to some of the other policy changes, even perhaps some assumptions about government spending at a fed and state level. Some of the trade situation…as some other nations start to raise their interest rates and central bank policy, there are a lot of risk factors that could easily pull us into recession but we are not there yet.
LM: Shifting gears to trade. Are tariffs a tax on business?
Bingham: Shippers, businesses and economists view it as a self-imposed tax on your country when you impose tariffs.
The Trump argument that “the foreign companies will pay” really depends. There are some market conditions, where essentially you can push back over the borders with very elastic demand, conditions in certain markets and certain supply markets where that can happen. But I think most economists in their academic research have been able to quantify and say, well, the majority is the reality of the tariffs, at least this set and others, traditionally, are paid for by the businesses and consumers in the country, which applies to tariffs and, in fact, it gets treated in the literature as a tax. It is called a tariff but in reality, you are taxing imports
LM: How do you view the trade deficit as it relates to export activity?
Bingham: That is part of the GDP story, it is not unrelated. If you look at Q1, one of the big reasons we went negative is the trade gap increased and GDP is net exports. So, if you export less and import more, it goes right through to GDP for that quarter. So, this trade deficit is not this abstract concept that just economists happen to monitor, it is part of GDP.
LM: What about the impact of inventories on GDP, as it relates to high inventory costs? It seems like there is a really delicate balance in terms of between having the inventory you need to have and in wanting the inventory you need to have and planning for it. And now in the second half of 2022 there are a lot of questions, especially as it relates to basic consumer demand.
Bingham: Substantial amounts of capital investment go into those big picture decisions. For a Walmart or Target to say do we risk stockouts again like we suffered through the pandemic earlier or do we try to capture that revenue for our shareholders by having the goods for sale when the customers want/[need] it and not losing those customers to our competitors. Because when retailers don’t have the product, you know they just hate it. It is horrible but at the same time…you get to where you are right now, which is OK. They overshot on some categories, where their models on demand at the SKU level are off…and now they have way too much patio furniture, to the point where they realize they are not going to sell these goods at their current prices out of inventory timely. That leads to the need to discount and they go to their shareholders and tell them they are going to do that. It is such a big problem….and you have seen a cascading. It started with Target and then Best Buy and other retailers are admitting they got it wrong in terms of timing and amount and as inflation bites more on consumers where some of that consumer spending holding up is not consistent across SKU categories obviously as they spend more on food and more on energy. They are going to spend less on patio furniture or dishwashers.
LM: Wouldn't that really apply to all different types of durables?
Bingham: Absolutely. In the first quarter, our macroeconomists were forecasting, in value terms, a decline in consumer durable expenditures for the year 2022. They said there were enough factors in terms of this shift toward services and towards food and energy, which were already increasing in price in the first quarter. That was going to hit consumer durables most dramatically, because that is where people can defer their expenditures…and if they just bought new exercise equipment or home appliances last year that they were likely to buy less of those products this year anyway. There was already some of that advanced pull-ahead spending in the pandemic of some of that household furnishings and sports equipment and other things where, you know, if you bought them one year you were unlikely to replace them the next year
LM: So, is it fair to say that in 2020 and 2021, those were good times for them?
Bingham: Absolutely, there were record sales for things like Pelotons selling at a record price and then it crashes as everyone that bought one got one. For certain people that were able to defer prices that situation could work out for them. And that is going to help the inflation story and ultimately it helps the supply chain story.
LM: In what ways?
Bingham: If you stop some of that ordering and inventory build, it will allow some of these retailers to reduce the cubic space they need for reducing inventory…and it will get accelerated by the increase in their capital costs because what is also pushing them to do this is the inventory carrying costs creeping up. As interest rates go up, holding on to that inventory means you are going to start to pay more for your cost of capital. That is squeezing you even more to say ‘wait a second we need to recalculate this here.’ Holding on to this is not paying off when our cost of carrying costs have increased. That works broadly across the economy. Businesses have different costs of capital but all of them are going to fit well, with very few exceptions of going against the market on average companies’ carrying costs are going up with their costs of capital.
Give retailers credit. They took some risks and are focused on trying to reduce the risk of stockouts, and feed the pipeline and get the supply chain primed to get inventory into the stores despite all the headwinds on supply chain performance i.e., delivery times taking twice as long from your suppliers and things like that. And inventory carrying costs will subsequently increase as a result. That helped push some of the inflation and is part of the inflation story, partially but not all of it. And that gets resolved in reverse and some of those inventories get drawn down and that drawdown actually helps pull up and support GDP because if you pull out some of that inventory build demand on the import volume and you soften that import activity and have the net exports not fall in parallel then there is some possibility to make some gains on the net export side of GDP independent of the rest of the domestic economy.
LM: Could that could be viewed as a good thing for improved port throughput and to alleviate the ongoing high levels of port congestion?
Bingham: Absolutely, if you can move it even towards balance and reduce it even a little bit between the empties and the loaded containers on the imports and the exports that itself would help.
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Thu, June 30, 2022 – 2:00 pm EDT
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