Prices Still Too High

Global Glut Bringing Asian Chaos to Stable Economies

Publisher's note -- This article appeared recently in the Los Angeles Times. We expect you to find some insights and also some junk.

by Evelyn Iritani

There was a time when low interest rates and a housing boom would have translated into higher prices and a cause for celebration at Sierra Pacific Industries, the Redding, Calif., wood products giant.
     But instead of popping corks, Sierra Pacific and other U.S. wood products firms are shutting down production lines, trimming jobs and bracing for a further drop in prices that have already plummeted as much as 40% in the last 18 months.
     The reason: Too many countries are producing too many things made of wood.
     For the first time, these companies are facing stiff competition in their own backyard--not just from Canada but from Chile, New Zealand, Austria and Finland. Those same countries are also edging out U.S. firms in Asian markets, where the strong dollar has become a penalty.
     "Losing markets in Asia wasn't nearly as bad as having that [foreign] product coming here," said Stan Blaine, marketing coordinator for the Sacramento-based Wood Molding and Millwork Producers Assn. "Only a certain number of our members were shipping to Japan. But when the foreign product came here, it affected a lot more people."
     The wood products business is symptomatic of a global glut of apparently unprecedented scope--of everything from wood frame windows to automobiles, apples, semiconductors, oil, steel and more.
     In a phenomenon that is both a cause and an effect of the Asia crisis, the world is awash in unneeded stuff.
     This is where today's economic flat tire meets the road--where the chaos of financial markets translates into tangible woes in the "real" economies at home and overseas, closing factories, throwing workers on the street and putting companies out of business. It is a big reason why, even after financial markets stabilize, today's global economic crisis will linger for years.

     Falling Prices Erode Value of Assets
     And it is at the core of deflation, an economic condition so unfamiliar to today's Americans that it needs explaining: It's when prices go down, not up.
     Sounds good, but if deflation cuts too deeply into the revenues of manufacturers, farmers and governments, it leads to production cutbacks, bankruptcies and rising unemployment. Falling prices erode the value of the assets of banks, which prompts them to cut back on lending. Nervous consumers start expecting prices to drop even further and put off spending.
     It was largely to prevent the nation from falling into that downward spiral, one which has dogged Japan for years, that the U.S. Federal Reserve has slashed interest rates twice in recent weeks. The idea is to encourage spending and borrowing by making it cheaper.
     "When you have a deflationary background, it's tough to get the economy moving no matter how low the interest rates are, because the public loses confidence and everybody keeps saving," said Jim Glassman, a senior U.S. economist at Chase Securities in New York.
     Deflation can be destabilizing in other ways. Already, low oil prices are threatening the political stability of key oil-producing countries in the Middle East, Latin America, Eastern Europe and Asia. They fueled the recent economic collapse in Russia.
     Deflation "is making the world a bit more unsafe," said Roger Diwan, director of global oil markets for the Washington-based Petroleum Finance Co. Ltd.
     The trigger was last year's abrupt collapse of Asia's fast-growing markets and the spread of fiscal instability to Russia and Latin America. Those events have thrust more than one-quarter of the world into recession and destroyed markets for thousands of products.
     But today's all-encompassing glut has deeper roots.
     It can be traced to the collapse of communism and the opening of Russia, China and India to the world economy; the dramatic and often unjustified expansion of manufacturing capacity fueled by "hot" capital seeking high paybacks, particularly in Asia; the success of trade liberalization efforts, such as the World Trade Organization; and the creation of a technological, financial and transportation infrastructure that dramatically accelerates the movement of products and capital across national boundaries.
     In simple terms, there is too much of nearly everything chasing too few buyers. Capital is not all that's moving across borders with lightning speed; so are goods--cars, apples, toys--by the shiploads.
     Auto manufacturers are saddled with enough factories to produce 70 million vehicles a year, at least 20 million more than the world can consume. In Southeast Asia alone, auto sales are expected to fall from 1.3 million last year to 450,000 in 1998.
     Oil stockpiles are 550 million barrels larger than in 1996, pushing prices down from about $18 per barrel at the beginning of 1997 to as low as $12 per barrel this year. In 2000, steel producers will have the capacity to produce more than 800 million metric tons, at least 200 million tons more than is likely to be needed.

     Less Buying Power Depresses Prices
     Every time another country slides into recession, the contraction in the buying power of its people sends prices down further; competition becomes more cutthroat as manufacturers look for ways to ensure they will be the last survivor.
     In the auto industry, for example, several South Korean auto makers are in bankruptcy, and there are rumors that other small Asian competitors may follow.
     The good news is that auto prices are dropping in the United States to a level not seen since the 1980s. Ford Motor Co. trimmed an average of 0.3%, or $61, on its 1999 models debuting this month, the company's first overall price decrease in more than three decades.
     But the flip side of declining prices is stepped-up competition, consolidation and, eventually, lost jobs.
     "There is nothing we can look at historically in the past that was a model for what's happening today," said David Cole, director of the University of Michigan's Office of the Study of Automotive Transportation. "With globalization, this stuff is happening very quickly. It's very brutal, very tough. It's not a business for the weak and faint of heart."
     In a textbook boom and bust, a drop in prices would weed out some of the less efficient producers. Eventually, market forces would restore the balance between supply and demand, and prices would start to recover.
     But the textbook has not yet been written for these times.
     Financial markets have replaced traditional supply-side pressures as the driver of economic ebbs and flows, according to Barry Bosworth, an economist at the Washington-based Brookings Institution.
     Easy access to capital during boom times encouraged risky investments and the creation of unnecessary factories across Asia and elsewhere in the 1980s and early 1990s. When markets started collapsing in Asia last summer, investors just as quickly reversed the flow of capital out of these countries.
     And globalization has made it all but impossible to limit the effects of overcapacity to one country or even one region.
     "One person's financial crisis becomes another person's financial crisis, and through that you introduce a business cycle globally," Bosworth said. "The transmission isn't through demand and supply but financial markets."

     Dramatic Effect on Supply Is Possible
     As more countries enter the marketplace, it becomes difficult to predict prices or production, since the actions of individual governments or large companies can dramatically affect the supply of goods entering the market.
     When U.S. producers dominated the wood business in this country, for example, it was much easier to figure out whether competitors would respond to a slump in demand by cutting prices, shifting product type or developing new markets.
     It's another thing to guess how competitors in Finland or Chile will respond, since they are ruled by a dramatically different universe of laws and market factors, such as credit availability and production constraints.
     "It's very difficult to judge the disciplining pressure that world trade places on national economies," explained Marcus Noland, a senior fellow at the Washington-based Institute for International Economics. "The logs don't have to leave Norway. If everyone knows they're sitting there, they can affect prices here in the U.S."
     The massive transfer of technology over the last decade also has increased the likelihood that a manufacturer in Chile or China can produce goods that can compete in the more quality-conscious Japanese, U.S. and European markets.
     Faced with the gloomy prospect of a world drowning in goods, everyone hopes that the other guy will blink first, since those who blink--by closing factories--suffer the most.
     And today, Asia's debt-laden manufacturers are the most reluctant to slash production because they desperately need to boost exports to make up for lost domestic sales.
     "The reality is that [relying on exports] is inherently high-risk, and what you're seeing in Asia is a lot of countries on the losing side of gambles," said Greg Mastel, vice president of the Washington-based Economic Strategy Institute. "What if the downside of that lesson is not learned?"
     This is particularly worrisome in industries in which global overcapacity has already taken a heavy toll, such as semiconductors and steel.
     The U.S. Department of Commerce recently determined that Russia was selling steel plate in the U.S. at more than 50%, or $100 per ton, below the cost of production.
     "We do have to be vigilant about not becoming a dumping ground," said David Aaron, Commerce undersecretary for international trade.
     But combating the flood of imports with dumping cases has its own perils at a perilous time for the world economy.
     If the U.S. appears to be retreating from its commitment to open borders, it runs the danger of triggering retaliation, recalling the trade wars that preceded the Great Depression. That danger is particularly keen in countries such as Malaysia, Hong Kong and China, where a free-market backlash is already starting to surface.
     "The U.S. trade deficit is a massive safety valve for the rest of the world," said Gordon Richards, chief economist for the National Assn. of Manufacturers in Washington.
     "When we run a trade deficit, we issue dollars to pay for those imports, and those dollars go abroad and have a stabilizing influence. The U.S. and Western Europe cannot be allowed to become islands of prosperity in a sea of recession."

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