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The Other Credit Crunch
Much has been made of the apparent lack of demand for credit as well as apparent supply (especially well-collateralized and credit-worthy credit) during a period when the banks have been mouth-to-a-fire-hose gorged on money. Small businesses, as UBS notes, have been at the center of this debate - as the engine of the economy, politicians have been vociferous in the face of banks ignoring their suggestions to lend. This initial credit crunch, however, has led to a structural change among small businesses which may have a much larger slowing-impact on OECD growth than is currently understood. Small businesses horded cash and reduced their reliance on bank loans after the crisis as the fear of the credit crunch remains front-and-center (and therefore crushed a key transmission mechanism of monetary policy). This drop in demand is driven by the hidden credit crunch - a structural shift to more just-in-time inventory management regime. This in turn reduces the inventory:sales ratio (which is exactly what we have seen in an unusual divergence from large business and appearing like a structural decline). The worrying aspect of this, and indeed the other credit crunch is that the inventory management regime-change among small businesses exaggerate anaemic growth since restocking has traditionally helped to drive economic growth above trend in a recovery phase. As UBS' Paul Donovan concludes, "the traditional concept of inventory restocking may be a great deal more lacklustre in the current environment."
UBS: The inventory revolution
The focus of politicians and markets in the last few years has been directed towards the pattern of the credit crunch through bank lending. Banks have been urged to lend more (indeed, ordered to lend more in some cases). In particular, there has been a concern about the credit offered to small business.
There is evidence that some of the pressure on banks may be misdirected, and that the economic problem has been a potent but hidden credit crunch rather than the more visible availability of bank credit. The hidden credit crunch has in turn led to a structural shift in small businesses inventory management.
The hidden credit crunch
Small businesses do not rely on bank credit as much as is thought. The popular perception is that bank lending dominates small business credit — and for investment in equipment and machinery there is certainly some validity to that assumption (although loans from family also play a role). However, the most important form of credit by volume is the credit that helps to fund working capital — intercompany credit. This is mainly the credit that arises from the invoicing process; companies do not have to pay for their goods immediately, but (for a certain value of goods at least) have time in which to settle the account with their supplier.
With the onset of the financial credit crunch in 2008, large and small companies looked to maximise the liquidity that they had. The increase in cash on balance sheet in the corporate sector overall has been remarkable. ... Other OECD economies also saw corporate cash levels increasing.
This increase in cash at least partially reflects a decline in the availability of credit in various forms, including intercompany credit. The increase in cash balances also reflects the successful reduction in the volume of credit offered by non financial businesses — less credit offered to clients means more cash on the balance sheet, at least near term...
The inventory reaction
Confronted by reduced intercompany credit, the evidence is that small businesses changed their inventory management techniques, in a way that had not been tried before — at least, not for this size of business. Small businesses moved to just in time inventory management.
This first chart shows the reaction. The US NFIB survey includes a variable for small businesses' desire to increase inventory. Meanwhile the US ISM survey includes coverage of whether surveyed companies (generally larger companies) believe their customers (including smaller companies) need to increase inventory holdings. For most of history these two lines are relatively closely correlated, as one would expect. Large companies predict their customers' need to restock, and small companies agree that they do need to restock. But the onset of the financial crisis and an inter company credit crunch changes this pattern.
From 2009 onwards large businesses repeatedly report that their customers need to increase their inventory levels. Small businesses, meanwhile, report that their inventory levels are too high and that they have no plans to increase inventory. This divergence is extremely unusual, and seemingly reflects large businesses judging their customers' inventories by the standards of the past, without accounting for a shift in behaviour which large business itself has brought about. After all, why would a small company hold 45 days inventory if only offered 30 days intercompany credit from its suppliers with which to fund that inventory position?
...
What is different about this credit crisis is the fact that small businesses not only have the motive to pursue just in time inventory management, they also have the ability to manage inventory in a just in time fashion. Software, technology and on line ordering has advanced to a stage where essentially any business can pursue a just in time inventory management process. The infrastructure was simply not available in the past, even as recently as the 2001 economic downturn.
If small businesses are more likely to be efficient in their management of inventory, then inventory:sales ratios should undergo a structural decline. That, indeed, seems to be what has happened.
Inventory:sales ratios have reached record lows in the retail sector. With small businesses accounting for the majority of inventory holdings (circa 70% in most advanced economies), this improved efficiency in inventory management suggests that the traditional concept of inventory restocking may be a great deal more lacklustre in the current environment. Inventory restocking has traditionally helped to drive economic growth above trend in the recovery phase — and so the inventory revolution may help to explain the somewhat anaemic nature of the economic recovery to date in the OECD economies.
Source: UBS
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AAPL is now definitely in the "sell into strength" category.
CAT is down again for the day on the back of the earlier rosy ISM data.
QE3 was discussed at a major brokerage meeting in DC last week. It was suggested, it was "coming for sure". More hopium.
But China's new wealthier than ever before i-Plantation owners are shopping for Rolls Royce, Bentley and Aston Martin.
All is well when what was formerly known as a communist nation turns out to be the biggest baddest slave trader and slave employer that ever ruled mankind. Forget Egypt, forget Greece and Rome. Forget Spain, Portugal, France and Britain. Forget the US. All that is history and small potatoes compared to what China has accomplished.
China is taking the cake when it comes to slave labor. They don't bring in slaves from other cultures. No, that would potentially backfire. They just enslave their own people with help from the Triads which are China's modern day slave traders.
Unless we can bring back slave trade and slave labor, the US will have to suffer. I really don't see any other possibilities. We need a two tier system or maybe a cast system? The Indians have figured that out and seem to thrive. So, welcome to the Twilight Zone folks.
There is a limit to how low inventory can go so eventually we will get to the point where production equals sales even if we never get a restocking bounce.
The reduction of trade credit has helped neutralize monetary policy - that may be a reason to pump up fiscal policy.
Inventories can go to zero actually.
Orders can be directly wired to the suppliers who use Dhl to ship within 24h to the customer.
We already do this for about 30% of our product range.
The important thing is that you need local producers and no chinese 6 month import suppliers.
Our german brands are good at it and I guess that's the reason why they can compete so good against china.
Doing it this way raises net margins with 6%!
Next step is production on demand. 14 day preorder.
Wait... 1st World people still make... things?
*head asplodes*
Small businesses are hoarding cash and stretching their employees super thin too. I say DONT WORK FOR ANYBODY!!! START YOUR OWN CASH BUSINESS!!
http://silvervigilante.com
Just in time inventory works grand ...until it doesn't.
All it takes is for one key component or one key supplier to go tits up, then you are in trouble, particularly if you run a small business with limited buying power in the marketplace.
Also, depending on the industry, just in time inventory may not be cost effective due to price inflation over time and increasing transportation costs.
Just in time inventory works grand ...until it doesn't.
Exactly, and us Americans are gonna find that out when the union thugs in the transportation industry go on strike when the shit hits the fan. I'm gonna love seeing the riots at the grocery stores which typically have less than a weeks worth of stuff on hand. Makes me feel smug about my year plus supply of "necessities", including food.
And those of you who believe the unions won't strike and hold their fellow Americans hostage are fucking naive dreamers. So don't be knockin on my door looking for a handout.
I have so many comments on this subject that I don't know where to begin so I will start with a couple of key concepts. First, bank lending facilities have changed significantly over the past four years in relation to how they advance/lend against inventory. Advance rates against inventory continue to decrease or are curtailed with formula changes so if the bank lowers the lending capacity with inventory, it is natural inventory levels would fall (as inventory is a big consumer of cash on the balance sheet and is also subject to significant risks with obsolesence). Second, banks are much more inclined to lend against trade receivables than inventory. Trade receivables are much easier to track down and collect (if a company fails) than inventory (which can walk out the door or become worthless when a business fails). Third, if your creditors are reducing payment terms, a business is forced to turn inventory over quicker (or keep lower levels of inventory on hand). So as your suppliers look to improve cash balances by keeping their receivables lower and turning quicker, businesses are forced to turn over inventory purchsed from the supplier quicker (leading to lower inventory levels). I could go on and on but its hard to believe that UBS or for that matter, Wall Street or Washington is just figuring this key concept out (as it only took them roughly 3 years).
That is, sources of capital (which in this case is credit) have become so restrictive for small businesses that they are being forced to become increasingly creative to generate internal cash flow to support business operations. Personal funds are stretched/exhausted (e.g., no home equity left, investments have been hammered, family, friends, and close business associates no longer have large amounts of liquity to offer, etc., etc., etc.), banks with rather lend to a perceived risk free environment (e.g., UST's and only the strongest companies which don't really need credit) with most lending criteria now nationalized/governed by Washington (through the SBA program and as dictated by the regulators), and key suppliers/creditors have tightened up to improve their internal cash position. These have all squeezed small businesses that now must look to the secondary lending markets or worse yet, Pirate Funds (this is a more appropriate term than rape and pillage as once you see the pricing from these funds, you'll understand the reference) to support operations.
For some unknown reason, both the Fed and Washington assumed that by simply providing excess capital to the market, that it would find its way to Main Street and support growth. Just the opposite has happened as this capital is now "trapped" in the largest financial and non financial blue chip companies that are hording this valuable resource (as noted in previous articles posted by ZH). So before anyone jumps on the bank wagon that small businesses are building cash because they want to, think again as they are building cash because they have to. Not a bad strategy but also supports the notion that any growth the government is hoping for from small businesses by investing in new equipment, inventory, employees, etc. is going to be very slow indeed as the capital these businesses need has never been so time consuming, expensive, management intensive, etc. to secure.
As I side note (which is something I don't like to do and ZH advices against), I have written three books on this topic which are specifically focused on small businesses and the importance of managing financial resources. When topics like this are posted it really gets my blood boiling as I'm sure I'm preaching to the choir (of small business owners) about how frustrating it has been to really get Wall Street and Washington to understand the challenges they face every day. Maybe they are so clueless they'll never understand the flow of capital to small businesses or maybe their entire plan is to restrict the flow to provide even more competitive advantages for thier biggest donors (e.g., Apple now sits on over $100 billion of cash which it uses as a competitive weapon). But one thing is certainly clear is that none of the fools in Washington or Wall Street have any real understanding of this issue (but why would they as everyone in Washington has been bought while everyone on Wall Street can only how to invest "other peoples money").
I agree with a lot of your perspectives and would note that in the middle market I see many companies hoarding cash, banks putting more restrictions on receivables and large customers pressing much smaller suppliers for ridiculous credit terms. For all that the public sector has supposedly increased cash through leverage, the private sector is hoarding cash because the credit environment is so uncertain/unavailable to them.
Absolutely goddam right!
I'm a lawyer in one of the only expanding areas (criminal defence and civil rights) in business for myself for 13 yrs and in the black but can't get my own f'ing bank to give me enough credit to hire an associate. WFT!!?
Double post.
Be aware that a PRODUCER cannot work with a just in time inventory, otherwise the costs will SOAR in a big way.
Or he will fire people and cut his costs, which is what's happening worldwide.
The DISTRIBUTOR, on the other side, can do it with less efforts, but in doing so he will put in serious difficulities the producer.
Rinse & Repeat