Kuehl*: Small Factors Have
Big Impact on Economy

“When the winds of change blow hard enough, the most trivial things can turn into deadly projectiles.” That was the opening slide, and theme, of economist Chris Kuehl’s presentation to executives attending FMA’s Toll Processing Conference last month in Orlando, Fla.

Kuehl, managing director for Armada Corporate Intelligence, delivered a presentation on the state of economic affairs “beyond the dollar and price of oil,” highlighting the often-overlooked items that may loom large in the rapidly changing global economy.

To illustrate the strange new world we inhabit, Kuehl pointed to Iceland. The tiny island country in the North Atlantic has become the world’s leading smelter of aluminum.

“You have Iceland emerging as one of the great aluminum smelting countries in the world, despite the fact there is no aluminum in Iceland and there are no customers in Iceland. All of the ore is hauled in by ship, processed and then taken out of the country. The only reason it has become a center for smelting is because it sits on top of a volcano and energy is cheap, so they can afford to run a smelter when nobody else can. When you see Iceland becoming a leading producer of aluminum, you know the world is getting odd.”

Nowhere was oddness more on display than in the behavior of banks in the years leading up to the global credit crisis, one of a handful of financial issues that are keeping most people awake at night. “Banks lost their minds a few years ago, and we’re still paying for it,” Kuehl says. Their undisciplined behavior, however, was not entirely unexpected. Kuehl says the banking industry has historically engaged in wild swings in lending policy, from tight credit to open lending and back again.

The United States has already felt the first wave of foreclosures, though most were second homes and investment properties. The next interest rate reset, due at the end of this year, will hit closer to home—primary residences—which is why there is more urgent activity in Congress to provide assistance to vulnerable homeowners.

Once the crisis has passed and credit becomes more available, the market for new homes should revive, he says. “There are currently more families in rental units than is the norm. When you’re talking about the real estate market, that’s the trigger. A lot of people want to come back into the housing market.”

Another cause of sleeplessness, Kuehl says, is the weakened position of the U.S. dollar. While many economists decried the past strength of the dollar, the fact that it has lost so much of its value so quickly weighs heavily on America’s competitiveness.

The direction of interest rates is another concern, and the Fed’s decisions to lower them won’t provide the intended spark without international assistance. “We’ve reached the stage that if we don’t start getting help from other central banks, we’re not going to be able to accomplish what we’re trying to do.” The Euro bank, more concerned with inflation than growth at the moment, has been hesitant to lower rates.

Given the persistently high price of oil, Americans are not about to see relief at the gas pumps any time soon, either. Kuehl pointed to alkylate, an additive required in summer-blend gasolines now that the previous additive, MBNE, has been outlawed. Alkylate is a residue of oil refining, but is in seriously short supply. It is more than three times costlier than it was last summer. “Alkylate all by itself will increase the price of a gallon of gas by 50 to 60 cents,” he notes.

More trade disputes with China can also be expected over the course of 2008, particularly since this is an election year “and nothing gets votes faster than blaming China for everything,” Kuehl says.

Focus on China’s rapid growth and influence in the global economy ignores some fundamental problems the Chinese will face in the years ahead. Chief among them is food—or rather the lack of it.

“Two or three things are going to become real issues for China in the very near future. One of them is food. There is not enough food, and the distribution of those foods is breaking down. They’ve already had food riots. Nothing triggers political change in China more than food prices,” he says.

Additionally, the mid-winter snowstorm that cut power and snarled transportation, shuttering China’s aluminum and steelmaking capacity for a week, is illustrative of another Chinese weakness—infrastructure. “China has been accumulating these massive foreign reserves. Part of the way they accumulate it is by not spending it on themselves. That is going to change. They’re going to have to start pouring a lot of money into their own infrastructure development if they’re going to avert a crisis.”

China also suffers from a severe shortage of managers, Kuehl says. “There are not a lot of people in China who know how to manage large operations. It does not take very long interacting with the Chinese to know that some of the most basic aspects of management are going right over their heads, particularly things like making money.”

Though the food issue may be most acute in China, other countries face a similar crisis, Kuehl says. Rather than oil, it will be the price of food that will drive worldwide inflation.

The irony, he says, is that the agricultural machinery sector is booming. But much of that boom is being driven by alternative energy efforts. The conversion of agricultural products into energy rather than food, coupled with some drought conditions in 2007, will result in food prices that are 35 percent higher in the developing world. “We’re going to see much higher prices in almost every food category.”

For the manufacturing sector going forward, Kuehl says, the key is understanding the difference between jobs lost to overseas competition and those lost to progress. “It’s very evident we’ve lost jobs, but the majority of the reason is technology. We’ve got machines today that are much more sophisticated, much easier to use. They replace people and create a better product.”

On the labor side, the challenge is to convert employees for roles in a sophisticated, technologically adept workforce. “It’s going to be tricky to maintain the traditional ‘stand in one place and do the same thing all day’ job. It’s vulnerable to overseas competition and really vulnerable to machines.”

Finally, the biggest wildcard for the United States remains the upcoming election. Fortunately, there is some hope on that front, Kuehl believes. “If you have two candidates who inspire, everybody’s mood improves. Consumers begin to get confidence.”

*Chris Kuehl is managing director of Armada Corporate Intelligence, Lawrence, Kansas, and an economist for the Fabricators & Manufacturers Association. He spoke to the FMA’s Toll Processing Conference last month in Orlando.