Recession, Commodities and the Automakers

In a major recession, production slows. That means that factories are making fewer cars, fewer computers, fewer factory machines, and fewer of just about everything else as well. With less production, the need for raw materials drops as well. This is the reason why we see things like falling oil prices, falling steel prices, and so on. Unfortunately, this means a second wave of recessionary pressures as the producers of those raw materials feel the pinch and begin scaling back their operations to keep pace with the shrinking demand.

This week we see several visible examples. The first is U.S. Steel (NYSE: X), which announced on Wednesday that it plans to close three US plants and send as many as 3500 workers to the unemployment lines. The Pittsburgh Business Times reports that the factories to be shut down are Keetac in Keewatin, Minn., Great Lakes Works near Detroit, and Granite City Works near St. Louis. These shut downs are billed as temporary and the workers are being laid off, but may return to work if demand picks up and the factories are restarted. There is, however, no current schedule for when that may happen. An outside observer would bet that these shut downs would last for at least all of 2009, but that will depend greatly on the changing economic conditions going forward.

The second indication of the raw materials slump is from the copper mining industry. Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) after already suspending its share buyback plan, has decided to cut output and eliminate its $2/ year dividend. Of course this news did not help the share price which fell sharply on Wednesday morning after the news. The falling prices of copper and molybdenum mean that Freeport cannot afford to continue working some of its higher cost mining operations and still turn a profit. Consequently these operations will be shuttered until metals prices revive. With far flung operations all around the world, Freeport did not indicate in its press release how many jobs would be cut, or where they would be lost. Freeport also mentioned that they are reducing their purchasing as well in an effort to cut costs. The slowdown keeps rolling along like so many dominos stacked in a line.

Imagine now that one or more of the big three automakers were to declare bankruptcy and start closing all or most of its factories. The demand for steel and metals would drop even further, hurting not just the employees of the car factories, but even more employees of companies like U.S. Steel. In the case of the car companies, the trickle down effect is quite large since Detroit buys all kinds of materials and parts from hundreds if not thousands of US and global suppliers. Every one of those suppliers would feel the blow like a debilitating body punch, knocking the wind out of their operations. The cascading effect of factory closings and laid off workers would be immense and would continue to feed the recession both at home and abroad.

As Americans, we should care about what happens abroad, because America, though we are a net importer, does still export a substantial amount of goods and services. Many American companies also have foreign operations whose profit is funneled right back into the United States. Without these export markets to buy American goods, the American economy takes another crippling shot.

Right now, the economy needs all the help it can get. That means preserving jobs through the next year so that more people are still out there buying goods. One way to preserve a million or more jobs that might otherwise be in jeopardy is to help the automakers through this rough patch. Certainly some of their troubles are their own fault and are the result of poor business planning, but at this point that's not as important as keeping Americans working. Let's give them the Federal loans for which they are begging, this time, but only because we can't afford another million or more workers thrown out the door of closing factories right now. Let's include with those loans equity positions for the government so the taxpayer eventually gets their money back -hopefully, with a profit, and let's include some real accountability and control over how the loans are used. We don't want to be in the bail out game at all, but the economy is in crisis. During a crisis, it is necessary to take unpalatable steps to get through to the other side. In a healthy economy, we could tell the automakers that they made their own mess and it is up to them to fix it or declare bankruptcy, but we don't have a healthy economy, and as a country we can't take the additional hit right now.

Comments

[who:]

Too true! Major company like the autos would be a disaster similar to letting AIG or C go under. Also, I don't think it will cost US taxpayers $150 billion to help the 3 autos, plus more direct assistance to man on street will be felt via employment.

Money to the financial companies has not a positive impact on the main economy. Similarly, rates cuts are being felt instead credit has been tighten up.

2008 Dec 04 11:02 AM

[Pipo:]

In a very good video interview the CEO of Freeport McMoran (FCX), explains the situation commodity profducers are in.

ceotalk.blogspot.com/2...

2008 Dec 04 02:30 PM