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Thursday, February 26, 2015

tis the season -- or this year, not -- but keep it out of our data

As yet more snow falls, we're reminded ... that it's the start of spring? While this year is colder than any I remember, though not so bad in terms of total snow, it does raise the question of how to interpret economic data. Of course housing starts are down, but they're always down this time of year. Some prices are up and others down, again as in the past. Since it was the most recently updated series -- the new data were released at 8:30 am this morning -- I use the Consumer Price Index as an example.

The graph on the left is of the raw CPI "headline" series, unadjusted for seasonality. As you can see there are regular spikes, up and down, in the data. If you look at the unadjusted series, you'll find that there is a downward spike every November, and an upward spike that includes March. (Click to open it in the FRED database, if you hover your cursor over the graph you'll see the date and value for each point.) If we're the Federal Reserve, trying to gauge what is happening to inflation, we thus know the March number will give a number that is too high, the November one too low. Now we can look at changes from the year before, but that is less than perfect because random factors -- unseasonal weather, Easter falling in March rather than April -- might make price changes in one month higher or lower than normal. We could do a regression to get a monthly adjustment factor, but that implicitly assumes a constant pattern across a span of a dozen or more years.

Work by economists in statistical agencies around the world points to using deviations from a rolling average as superior to a regression. (In fact the methodology was initially implemented in Canada, not in the US.) Formally this is an ARIMA correction [AutoRegressive Integrated Moving Average], which in the software iteration currently used across the government allows correcting for anticipated idiosyncratic factors such as alternate dates for major holidays, e.g., a New Years that falls in the middle of a week or an Easter that falls in April and so shifts the timing of the Spring Break found in many school schedules.

The result is a seasonally adjusted series; I have that for the CPI just below the unadjusted one. It's not a totally smooth series, because the underlying data aren't smooth, but the upward spike in March is muted or absent, and the downward November spike vanishes. The real test comes from looking backward: the consensus of the users of the data is that the correction is pretty good, and that large deviations are generally a function of one-time events that all know will affect the data, but for which there's no historical precedent to make a correction. (An example is the impact of this winter's series of blizzards in the Northeast or the Federal shutdown of a few years ago on employment data – we know there will be one, but it's hard to know the magnitude.)

Now seasonal corrections are not for everyone. If you're trying to do a short-term budget, you want to know the actual price change this year, not whether it is higher or lower than in recent months or relative to a "normal" year. For most purposes, however, we do want seasonal corrections.

For more detail see the relevant BLS page.

Thursday, February 12, 2015

Promises versus Deliverables: Jeb Bush and 4% Growth

Jeb Bush has set the presidential race pace with a promise of 4% growth. Other contenders, Democratic and Republic, will make similar promises, or perhaps already have – I've not looked. My intent here is to examine the issue, not the man.

In the medium and long run growth rates are about the supply side. Now in the short run demand factors matter, and since we're still in recovery from our Great Recession, we can hopefully have a few years of above-normal growth. My own estimation, taking into account the retirement of the baby boomers, is that we're about 7 million jobs short of where we need to be. Of course the next Administration won't take office until early 2017, and realistically their policies won't kick in until 2018. We're adding jobs at a 2 million per year pace. So if we keep that up, by then we'll be pretty close to normal. Looking at the supply side is thus sensible.

4.0% growth isn't going to happen

So what are long-term growth prospects? Basic (macro)economics is that over the long haul growth is a weighted average the growth of inputs – here I look at capital and labor – and total factor productivity, the growth of the economy over and above that due to more inputs. Work in this tradition goes back to a 1957 paper by the Nobel laureate Robert Solow; we thus have nearly 60 years of work, and a sense that the approach is pretty robust way to organize our thinking. So what we need to do is gauge the range of these three factors.

Let me begin with labor force growth. My own estimate, based on Census projections of the population by age and the propensity of people of different ages to work, is that by 2018 the underlying trend will be on the order of 0.4%. Now the baby boomers are working longer than their predecessors, so this may prove a tad low, but it is the right order of magnitude. For example, if we look at past employment growth, we see that it has gradually fallen over the past 75 years, averaging over each decade. While the rate as of January 2015 was 2.0%, that reflects the recovery from the deep trough of 2009 and is not sustainable. In fact, the (geometric) average of employment growth since 2000 is 0.5%. So I'll use that as my base case.

Next is the growth of productive resources, factories and housing and cars and shopping malls. At present investment is far below normal, particularly for structures and residential, and for investment by the government (down in all subcategories, from roads to office equipment). So we could see an uptick. Looking at the pre-Great Recession average, we might see 2.2% growth in business and residential investment, and 2.5% if we add in consumer durables such as automobiles. On the other hand, with population growth down and the average age rising, we may well see all forms of construction remain at lower levels. I'll use the higher numbers here.

Finally, there's productivity. The trend over the past roughly 30 years is 1.1% growth (or more precisely 1983-2011), with a lot of volatility. Will it come in higher? I see no reason to think that will happen. Yes, we are seeing lots of innovation. No, it is not boosting growth. Biotechnology has been advancing for 10,000 years, since the early domestication of wheat, sheep and cattle. To pick one modern crop, selective breeding at the International Rice Research Institute in Los Baños, Philippines led to high-yielding varieties in the 1960s. Modern genetic engineering is a continuation of this trend, and the productivity gains from the standpoint of the overall economy of future innovation will be modest. Likewise adding to longevity will do little in the short run to boost output, as reversing the trend toward retirement will require decades. IT is leading to an array of gadgets, but "robots" have been central to our factories for the past 2 decades, and while my first computer could not always keep up with my typing speed, in my own work I've seen diminished returns to improvements in hardware, software and improved data resources. As emphasized by Robert Gordon, there are many reasons to think that productivity gains will not pick up. Even if they do, that's also a long-run process, as workplaces gradually reorganize to incorporate new tools. In sum, we won't see a surge during 2018-2021; a 1.0% rate is all we'll get.

...and there's not much a future president can do about it

Let's put it together: 1.0% productivity, 0.5% employment growth, 2.5% capital growth. Discount the latter (as per economic theory) for diminishing returns (which matches their share in output) by (respectively) 0.6 and 0.4. That gives us 1.0 + 0.3 + 1.0 or 2.3% growth.

Guess what? Growth of 2.3% happens to be what we've averaged since the 2009 trough of our Great Recession. It's also consistent with interest rates, as the gap in yields between 3- and 5-year bonds implies 1-year interest rates of 2.2% in 2019 and 2.6% in 2021. (Look for a pending post.)

So 4.0% growth isn't going to happen, and there's not much a future president can do about it.

Let me put in a plug for my home institution, Washington and Lee University. For over a century our students have held a Mock Convention to nominate the presidential candidate of the party out of power. In due course, as the primaries unfold, I will urge our economics majors to analyze the economic proposals of the candidates. I'll add my own analysis here from time to time. So watch for updates.

Tuesday, February 10, 2015

Reflections on NADA Week 2015, San Francisco

Ruggles based on a column in Wards
minor additions by Smitka

There was a lot going on in San Francisco in January. The week began with the American Financial Services Association (AFSA) conference. Following that, J. D. Power and Automotive News held conferences on the same day, while at the same time, NADA workshops were in session. There was simply no way to take it all in so I’ll only comment on the high points of sessions I attended.

AFSA:

Notably absent from the AFSA conference was the Consumer Financial Protection Bureau. I got the impression they weren’t invited and wouldn’t have come anyway. Last year, CFPB’s Patrice Ficklin addressed a packed room. Since last year’s event, AFSA commissioned a scholarly study, conducted by the highly regarded Charles River Associates, that isn’t kind to CFPB’s suspect methodology called Bayesian Improved Surname Geocoding (BISG) which CFPB uses to “prove” unintentional “disparate impact” discrimination. One gets the impression that zealots at CFPB see discrimination behind every tree and will stop at nothing to “prove” it. According to the Charles River study as summed up in an AFSA bulletin, “BISG estimates race and ethnicity based on an applicant’s name and census data. AFSA’s study calculated BISG probabilities against a test population of mortgage data, where race and ethnicity are known. Among the findings:

• When the proxy uses an 80% probability that a person belongs to an African American group, the proxy correctly identified their race less than 25% of the time.

• Applying BISG on a continuous method overestimates the disparities and the amount of alleged harm and provides no ability to identify which contracts are associated with the allegedly harmed consumers.”

To say that race and ethnicity is “known” in the case of mortgage data is a HUGE stretch as mortgage applicants are asked to “self describe” their race and ethnicity without any objective standard. For example, if a person is ¼ Native American, ¼ Asian, and ½ African American, what objectively is their race? People have a variety of motivations for how they will answer such a question. And with no objective standard, the margin of error is impossible to calculate.

Yet, no lender will stand and fight CFPB in court. CFPB knows they have an immense intimidation element working in their favor, and they leverage it at every turn.

Having said this, CFPB has done a lot of good in some areas. But attempting to prove discrimination where there is none is likely to cause a huge backlash that could overwhelm any good they might do.

MTV:

A highpoint at the NADA conference was a press conference presented by MTV. The attraction for me was that they stated up front that their research debunks the conventional wisdom regarding Millennials, who we are told are taking over the world. There is good reason to be suspect of research undertaken and then repackaged by people who know nothing about auto retail. We know that there are a LOT of Millennials out there. We know they will grow up and as they do, they will become more like the generations who came before them. And their children will complain about how stodgy they are.

One of the excellent points the MTV study makes is that there is a good reason Millennials tend to get their drivers license later than earlier generations. It has more to do with more restrictions imposed these days than in days past, not that Millennials have little interest in vehicles and are reluctant to drive. The study also showed that Millennials with both a drivers license and a vehicle drive a lot, in fact more than previous generations Baby Boomers and Gen Xers. So they'll need to replace their cars more often than other generations, good news for us in the business.

There are many who think Millennials are brats. The MTV study supported this, pointing out that this generation received a trophy for just showing up. “They want what they want when they want it,” said Berj Kazanjian, the Senior Vice President for Ad Sales Research for MTV. He said the study revealed a level of idealism on the part of Millennials. “They want things to be fair. They don’t want anyone to pay more or less for the same product.” I sat there thinking that this wasn’t sounding much different than what my own parents, who were raised during the Great Depression, sounded off about Boomers. Don’t idealism and being young go hand-in-hand?

The Q&A lasted long after the presentation officially ended and eventually turned into a spirited discussion. I mentioned my own “surveys” when I asked roomfuls of Millennials if they think 10% is a fair dealer gross profit on a new car. The consensus answer is that 10% is “fair.” This coincides closely with TrueCar’s survey which shows consumers think 8% is fair. But when I ask the same room if a $3000 profit is “fair,” the tone of the room changes instantly and I hear comments about car dealers being cheats and liars. The MTV presenters thanked us for “keeping them honest.” While I think their research shows interesting results I do think they need to enlist the input of someone who understands automotive retail to frame questions in a way relevant to the industry, and thus translate what customers mean in our context as opposed to the words they utter as general principles.

At least it seems that MTV isn’t interested in selling their advice to dealers on a consulting basis like many who conduct self serving research. They just want to sell some advertising. They may not feel it's worth their trouble to restructure their survey on our behalf, but we benefit from their not trying to spin the data to drum up our business.

Oil Economics:

It is always interesting to hear economists provide their SAAR predictions for the coming year. There was a lot of talk about oil economics and how the current low price of fuel at the pump will impact the mix of vehicles sold. It seems apparent that small vehicles will need to be heavily incentivized to keep the assembly lines running and to minimize CAFE fines. This will reduce residual values on those vehicles. There were some estimates on how long the moderate fuel prices will last, up to 24 months. As someone who was raised in the oil patch to an oil company family I have watched OPEC curtail its own production to maintain price equilibrium. In fact, they produce about the same amount of oil today as they did 40 years ago when the population of the earth was half what it is today and consumption much less than today. This is despite the fact that OPEC had 5 members then, and 12 today. However, OPEC has on occasion allowed the global market price of oil drop to drive out high cost competitors. They are the low cost producer and Saudi Arabia is sitting on around $700 billion in dollar reserves. I recall distinctly the oil glut of the mid 1980s. The economies in oil patch states took major hits. There were huge numbers laid off from various oil companies during that era. Just last week Schlumberger announced a layoff of 9000 workers.

It is hardly a surprise when a cartel acts like a cartel. Frackers, sand and shale producers, ethanol producers, EV car manufacturers, battery makers, etc. will take a hit. With the world market price of oil below the cost of production where would Keystone get the traffic it needs to pay its debt service?

The issue in the U.S. has NEVER been our dependence on foreign oil. The issue is our dependence on the global market price of oil as controlled, or at least heavily influenced, by OPEC. Does anyone think an American oil company would sell its oil to American consumers for less than the global market price? In fact we know the answer, because when we tried price caps in the 1970s, the response of the industry was to leave oil in the ground.

Oil is a fungible commodity. It makes little difference from a price standpoint if the fuel we put in our cars came from a foreign country. Yes, it is always nice to keep money at home, and with all things being equal, the transportation advantages means a lot of domestic oil stays home. But that doesn’t have a major bearing on the price.

Saudi Arabia finds itself in an interesting position. The Sunni Saudis aren’t fond of their Shiite Iranian OPEC partners. Through their policies they cooperate – though that is likely not their primary motive – with the U.S. Government in its sanctions against Iran for its nuclear program as well as its financial support of terrorist groups in the region. Their policies likewise support the Administration in its desire to curtail the oil revenue of ISIS. Their policies, intentionally or otherwise, reinforce our sanctions on Russia over its Ukrainian incursion. The low price of oil doesn’t help Venezuela either, something that might please the Administration. Low fuel prices will give the U.S. economy a real shot in the arm and it could carry through the next election cycle. The EU may avoid another recession, which also helps the U.S. At the same time, the Saudis are accomplishing what they wanted to accomplish all along, which is to force high cost producers to fall by the wayside. As production wanes, the global market price will rise on its own. It will take time for it to come back online. During previous periods of “glut, many ethanol plants went bankrupt. It may well happen again.

The Administration will have to bite its tongue as their alternative fuel initiatives will become less interesting. There will be less conservation. CAFE might have to be revisited. There are rumors of EV inventory piling up. Of course we find an emphasis on fuel efficiency in the policies of Europe, Japan and China. That leaves pressure on American producers, from Toyota to GM, to engineer and make fuel efficient, and hence often small, cars and light trucks. They would really like to add US volume to spread their cost base. So there are lots of tensions building.

My best guess is we will see moderate oil prices for 24 months or longer barring anything unforeseen.

The Current State of Leasing and Residual Based Financing

Ruggles, February 2015

According to the most recent Manheim Market Report, “Lease originations exceeded 3.5 million for the first time since 1999. It will take only a slight increase in 2015 to push new leases above the all-time high reached in 1999.” This is largely the result of Auto OEMs attempting to counteract the negative impact of long term financing, which is also reaching new highs. Both initiatives are efforts by the OEMs to maintain volume and production in the face of rising MSRPs and transaction prices. Increasing finance terms take consumers out of the market for extended periods of time and dramatically decreases the chance the consumer will return to the same dealer and/or manufacturer for their next vehicle.

The new vehicle market is increasingly skewed to high income households. This increases the importance of the late model pre-owned vehicle market. The pre-owned market is currently running at a 42 million unit rate. Compared to selling rates from the depths of the Great Recession, new vehicle volume is up by 42%. Preowned selling rates only dropped by around 20% at the height of the Recession, showing considerably less volatility than the new vehicle market. Despite dramatic volatility in certain segments caused by sudden spikes in fuel prices, the absolute change in residual values over the last 19 years is 3.5% as measured by the Manheim Index. That fuel price volatility has proven to be temporary as consumers adjust to higher fuel prices in a few months. According to Tom Webb, Manheim’s Chief Economist, the change residual values in the last three years has only been 2%. That’s stability.

Is there any real danger in the recent dramatic lease percentages? Most experts agree there is absolutely no danger and considerable upside. There is still considerable pent up demand in both the new and pre-owned markets. Less affluent households, and those consumers who are interested in the greatest value, gravitate to the pre-owned side as evidenced by the explosion in Certified Pre-Owned numbers, which set new records every month. Increased new vehicle short term leasing and/or residual based financing is required to provide the inventory to fuel these increases.

There are many who regard pre-owned vehicle leasing, especially in the CPO area, as the greatest untapped area of opportunity in the auto retail business. There are some who claim the residual based payments on pre-owned aren’t enough less than subventions on new vehicles to justify a consumer to go with the pre-owned. A careful study of this theory shows that is the exception, not the rule. There are many credit unions and other lenders around the country offering residual based programs that dramatically reduces the monthly payment while still shortening the term. The truth is, dealers who are not offering their customers such a program probably aren’t aware of their existence or are held hostage by their own pay plans, which incentive F&I departments to continue to extend term while adding in rate participation. This is short term thinking at its worst. Dealers need to wake up and recognize that this short term “gain” carries with it long term penalties. Scot Hall, Executive Vice President of Swapalease.com, a leading auto lease facilitator is a big proponent of leasing/residual based financing on pre-owned. He says, “Those cars are generally going to be serviced to a high degree and reconditioned to a high degree, so setting up, say, a short three-year lease on those — or maybe even a two-year lease on some of those cars — I don’t think there would be a lot of risk, if it’s done correctly. I think it would benefit the consumer, and especially as more and more leases are coming back off the new end, this would be another avenue to help dealers and manufacturers move those off-lease vehicles from a remarketing perspective.”

For credit unions and other lenders offering a pre-owned residual based program, their yield is considerably higher due to the higher daily balances. This is particularly important in today’s margin compressed environment. Further, there is really no competition allowing for somewhat higher interest rates to be charged while still maintaining the short term low payment objective. They get their borrower back more often while both dealer and lender achieve the objective of retaining the consumer and doing business with them more often.

So what is the future of auto retail? Longer terms with lower volume or shorter terms, higher sales, more pedigreed pre-owned inventory for dealers, more customer loyalty, and ultimately higher profits? After all, it is more expensive to find a new customer than to retain the ones you already have.

Saturday, January 17, 2015

US Inflation

Here are 4 graphs that give an overview of inflation from the perspective of both producers and consumers. Data are percent change from the same month of the previous year.

On the left is the overall movement, on the right data that excludes food and energy. In other words, if we ignore the recent drop in commodity prices, which is a one-time event rather than a trend, what does inflation look like? (Click on the graphs to enlarge them.)

PPI: All Commodities
PPI less food & energy
null
CPI All Items
CPI less food & energy

So as we start the New Year, the news is of an economy where growth is not accelerating and where labor markets have slack, such that between them "push" (labor costs, the biggest cost component for the economy as a whole) and "pull" (weak demand) are not leading to price increases. Indeed for the past half year inflation has trended down, and is well below the Fed's target of 2% [their preferred metric is PCE inflation, I won't detail how that differs here, except to add that the picture it gives is nearly identical, except that the level is lower, 1.4% instead of 1.6%.]

Since I'm teaching our senior "capstone" course this term under the theme of "modern macroeconomics" I'll periodically publish data on this site, roughly once a week. So this is but the first installment of many. One theme for the course is the size of "the" fiscal multiplier (in quotes because policy in a deep recession might reasonably be expected to have a different impract from that in normal times). What impact doees fiscal policy have in different classes of macro models (old-school structural vs new-school DSGE)? How can economists measure it empirically, given the general lack of unanticipated [as opposed to built-in] variation in policy? Of course I'll also try to familiarize students (and blog readers) with the current US policy stance. Is now the time to be trimming monetary stimulus? to be cutting back on public works? For the latter, doesn't the US have an aging highway system and network of bridges that are showing their age? If so, isn't the time to address that when there's no cost pressure and when borrowing costs are cheap? But for the data side, at a minimum we'll delve into employment, the term structure of interest rates and other metrics besides fiscal ones.

Now to my annual "Faculty Activity Report," not that I'll get a wage bump out of it, other than the one W&L provides to offset inflation. Er, hopefully it's the "core" rate sans food & energy that they use....but I shouldn't complain. While it's not much, next door at VMI [Virginia Military Institute] the faculty get nothing.

Saturday, January 3, 2015

Japanese Suppliers: May the New Year be Happier!

originally posted at The Truth About Cars, Jan 2, 2015

Go HERE for an index of my posts there

車輸送カルテル罰金、日本郵船71億円で合意

OK, you probably can’t decipher that. The news – this headline from Yomiuri – is the latest in the supplier antitrust cases that ring the world, from Japan and Korea through the US to Germany. Even China has gotten into the act, slapping fines on firms that charge “excessive” prices for OEM aftermarket parts, though that is a reflection of price discrimination (selling for what the market will bear) rather than collusion.

Fines to date now total $2.5 billion. Even in the auto industry, that’s serious money. Whether we see private antitrust suits (which in the US carry treble damages) is unclear. Will Toyota be willing to go after its suppliers, without whom it cannot produce cars? Will it tighten its purchasing operations, where likely the “ordinary” parts central to collusion have younger, less experienced purchasers?

Now at one time, 50 years ago, kickbacks were not unusual in the US industry, but the one account of the internals of the cartels – a Nov 16th scoop by Hans Greimel of Automotive News in Tokyo – carried no suggestions of suppliers getting buyers to turn a blind eye. Instead, it’s the intrigue of classic cartels in the US, meetings in obscure locations, rules for who is to bid in what manner to make their behavior less obvious to purchasers.

The excuse suppliers give is that they’re in a low-margin business. OK, but why should we care? Car companies need to pay enough that suppliers hang around for another model, but they’re in a low margin business, too — we customers have a plethora of mid-sized cars and small CUVs to choose among, and despite all the attention TTAC readers pay to hot vehicles, in the end price does matter. Furthermore, all of us who are in one way or another in the car business (and surely no one reading this blog does without, and without owners there is no car business) – anyway, all of us want the industry to focus on their core business, not on gaming the system. We don’t want management resting on its laurels, especially when they’ve won their prize by cheating.

Anyway, I’ve done my judge’s reports for my portion of the site visits for this year’s round of 35 PACE Award finalists. There are many suppliers out there that by the 5% of sales metric are high-tech firms; it would be bad for the industry if Japanese suppliers aren’t among them. However, the gut feeling I get from the last few year’s of closed-door, non-disclosure presentations by PACE finalists is that Japanese suppliers aren’t in the game the way they used to be. I don’t see the innovative firms I visit benchmarking themselves against Japanese suppliers, while I see bigger and bigger sales shares for these US- and Europe-headquartered firms coming from Japanese nameplates. [For a story that reflects this, see a Dec 9th article by Hans Greimel on Toyota’s revamping of R&D among its closely-held suppliers.]

Demographics are at play – Japan's population is both aging and falling. While proportionally more Japanese graduate from college than ever before, 40-plus years of very low fertility means their absolute numbers are down; the number of Japanese who turned 20 in 2014 is half that of 1969 – so that (mortality aside) the number of 55-year-olds, at the experienced end of their engineering careers, is twice that of those potentially taking up the profession. With the number studying abroad in sharp decline, those graduates are even less likely to have experience living in English-speaking countries than in the past. The pool of potential engineers is smaller, and with a small number of exceptions these firms have only Japanese-speaking engineers in their home office. The flip side is that the US looks increasingly good as an engineering location, with more suppliers and car company engineering centers in a day’s drive from metro Detroit than ever before. In contrast, operations are scattered in Europe and China.

So while the news focuses on Takata and whether they will see a big drop in business over the next few vehicle development cycles, we really ought to look as well at the list of firms in the various cartels. Won’t their customers opt when they can for other suppliers? – most of the members of the busted cartels are Japanese companies. Yes, the yen is weak, creating a “buy Japan” incentive. However, no car company wants the risk of long logistics lines; JIT (just-in-time) manufacturing is the industry norm. There’s no guarantee, either, that the yen will stay at ¥120/US$, down from ¥100 in June and ¥80 2 years ago. So this is one more strike against the Japanese industry (in the sense of “Made in Japan”) and against the Japanese supplier industry (since they are more domestic than their US and European rivals).

I wish them a Happy New Year – 謹賀新年. At least for Japanese suppliers, 2014 wasn’t a very good one. I’m afraid, though, 2015 won’t be any better.

Oh, and that headline: ¥7.1 billion in fines on [the shipping company] NYK Line in a car transport cartel…

Mike Smitka

Monday, December 22, 2014

Oil Economics and the Auto Industry

by Ruggles - from my Auto Finance News column

Drill Baby Drill has finally worked, but only because OPEC cooperated, at least temporarily. Until just recently, increased U.S. production hasn’t resulted in low fuel prices at the pump. There is no good reason for global oil market prices to have stayed so high for so long in the face of dramatically increased U.S. production UNLESS OPEC had curtailed its own production to provide price/supply equilibrium. That has been their modus operandi for decades. OPEC started off with 5 members and now has 12, yet they don’t produce any more oil now than they did in 1973. In that period of time, global population has doubled and oil consumption has almost tripled. It’s not because OPEC couldn’t or can’t produce more. They operate like a cartel, because they are.

The recent decision to continue production at current levels prompted a steep drop off in oil prices, fuel prices at the pump have taken a dive to the delight of consumers, EVs and hybrid sales have slowed dramatically, and the alternative fuels and high cost oil producers are shaking in their boots. So are some bankers. One imagines the lenders for Trans Canada being relieved they aren’t going to have to extend credit to build Keystone, thanks to the measure being blocked in the U.S. Senate. After all, how would the debt for the pipeline be serviced if there is no traffic on the pipeline due to a lack of financial viability of Canadian oil sand and shale production in a relatively low global market price environment?

So how will the recent OPEC decision to continue production at current levels impact the auto industry. It is clear that with cheap fuel at the pump, the sales of small fuel efficient vehicles will have to be steeply incentivize or many auto OEMs will be paying HUGE CAFÉ fines. That won’t help residual values on the pre-owned versions as Rene Abdallah, Vice President of RVI Group, has been saying for a few years. RVI Group is the leading insurer of automotive residual values in the United States.

Fortunately for lenders and captives engaged in leasing, there aren’t too many smaller vehicles in lease service. On the other hand, sales of “heavies” will boom providing temporarily strong residuals, short term auto industry profits, and setting us up for the next spike in fuel prices…... you know, the type of spike that kills residual values of “heavies,” stops sales of new “heavies, and triggers recessions.

Who knows how long our economy will enjoy these fuel prices? What else could happen? The low fuel prices will help keep a lid on inflation, even though auto fuel isn’t technically a part of the Consumer Price Index. Will the Fed take advantage and raise interest rates, feeling there is less risk in doing so? This is a mixed bag and it is hard to know which element will carry the most weight. A rise in mortgage loan interest rates and auto loans would most certainly result in some consequences. Will those consequences be enough to slow the economic growth spurred on by lower fuel costs, or will the momentum created by the low fuel prices overwhelm the other issues? Who knows? That’s for the economists to calculate through their mathematical models.

The Obama Administration and the “Green Movement” are disappointed that interest and investment in alternative energy and sales of fuel efficient vehicles will wane. On the other hand, the Administration can’t help but be pleased that the sanctions on Russia over their incursion into Ukraine carry extra weight now. There is also rampant speculation that Iran and Venezuela aren’t pleased with this decision crammed down their throats by U.S. ally Saudi Arabia. The House of Saud, Sunni Muslim Arabs that they are, aren’t particularly pleased to see any extra petro dollars go to Shiite Muslim Persians to develop nuclear weapons and spread terrorism through Hezbollah and other terrorist groups, around the Middle East. Many think the Saudis took advantage of the situation to do what they wanted to do along, which is to manipulate the global market price of oil to a level to force many competitors out of business so they can raise the price with impunity down the road. After all, they’re in it for the long term dollars, not the volume. Iran and Venezuela are thinking short term. They can’t sell any more oil under the OPEC pact, but they receive substantially fewer dollars. Who do the Saudi’s see as competitors? Answer: Oil sand and shale producers, frackers, alternative fuels producers, and the EV industry. There are rumors of over 3K unsold Tesla Model S cars parked in some secret location. Sales of PRIUS and other hybrids and EVs have stalled.

For a while U.S. consumers will be thrilled. The moderate oil prices may help the world’s largest economy, the EU, avoid a second recession, which is also good for the U.S. But there is another shoe to drop. We just don’t know when. We should enjoy it while we can.

Thursday, December 18, 2014

Takata and The Quality Dilemma

revised version posted by Smitka at The Truth About Cars

The Takata airbag inflator problems illustrate a fine dilemma: quality standards across the auto industry are good, those for safety-critical devices very good. The result is that only things that occur very rarely get through the production process, and many of those either cause no problem or don't get reported. That makes confirming that there is in fact a pattern challenging, and figuring out the root cause (or causes) extraordinarily so. The number of known deaths (the media suggests 5) is a very small fraction of the number of lives saved by Takata airbags. So the other dilemma is that the fundamental robustness of the manufacturing process means the benefits of a recall are also very low, and the quality of work in your local dealer's repair bay is not equal to that in an airbag plant or vehicle final assembly plant. The cure can be worse than the disease.

Anyway, I spent a day this week with an airbag manufacturer, listening to engineering presentations on a new airbag design from the supplier's senior engineers, with a senior car company airbag engineer also in attendance. I won't name the companies, and what I write is based on information that should be available from public sources. (I spot-checked a couple of the points.)

1. First, globally there are tens of millions of Takata airbags on the road. I've not been able to find a number, but I would guess that over roughly 1 million such vehicles have been involved in a collision that led to an airbag deployment. Of those, to date there are 5 known fatalities and several more injuries. Actual problems are exceedingly rare.

2. The cause is as of yet unknown, as there are multiple failure modes. Which one(s) are leading to the observed problems? Small numbers mean (i) this analysis is intrinsically very challenging. It is complicated by (ii) the evidence going up in smoke when an airbag inflator explodes and (iii) other evidence going up in smoke because documents in Japan were sent to the incinerator. The concentration of incidents in very high humidity locales suggests deterioration of the ammonium nitrate "propellant" due to hydration, wich could cause the sheets of material to turn into clumps (sheets go "whoosh," clumps go "boom"). However there are several incidents in areas not known for high humidity. So there could be two different problems, or one systematic problem and the random one-in-a-million manufacturing defect, or all random problems some of which just happened to be clustered geographically. So last week automakers who use Takata airbags got together to decide how to jointly collect and analyze disparate data in the hopes that the combined data would allow meaningful analysis. This was a meeting cleared by the Dept of Justice as not violating antitrust because it was limited to engineers discussing a narrow set of issues. Almost every car company uses Takata for at least a few airbag applications, so it was basically a meeting of the global customer-side engineering community.

3a. If the actual problem is not systematic, then a recall may do nothing at all except cost lots of money, because the same one-in-a-million bad inflator ratio won't change. If anything, a rush to increase production will make monitoring production process compliance more challenging and could lead to a higher number of (idiosyncratic) random defective airbag inflators in cars.

3b. Again, other manufacturers cannot substitute their inflators for a Takata inflator -- they would have to design a product that matched the gas generation profile needed to match the Takata airbag, verify their method of manufacturing produced parts that actually worked to design, test prototypes with the Takata airbag to make sure there was no unforseen interaction (vent angles or orientation slightly different, lots of subtle interactions). Then they would have to set up a production facility, run off a lot of parts coming through the actual production process on the machines and tooling and inspection processes that would be used (rather than the prototype build process), and have these tested and retested. This is necessary because the bag portion is very, very specific (the exact grade of material and how it is folded are all very carefully specified, tested and then monitored during production for exact replication). It would be very hard to do this in under 6 months, and production does not ramp up from nil to full overnight. It would be impossible to do this in 6 months across all of Takata's airbag-inflator-vehicle combinations, because each would need to be tested separately. Engineers can work 16 hour days for a while, but not for month after month. There isn't excess engineering and testing capacity just waiting for a recall to come along, and car companies want their engineers to continue working on new vehicles, they don't want to stop everything under development to re-engineer an old (perhaps decade-old) product.

If you need to find a needle in a haystack, maybe it's not worth finding the needle.

4. Nevertheless, of the inflator manufacturers, as far as I can tell Takata is the only one whose inflator operations did not start out as a division or factory of a rocket engine or explosives company. Instead Takata was a cut-and-sew operation that had expertise in fabrics that then added in-house pyrotechnic capabilities. That adds to the suspicion of a systematic albeit very rare propellant problem, but again, the number of incidents remains very small and there is essentially no ability to cull the necessary information from incident reports or (when they were kept) piles of shrapnel.

5. For reference, manufacturers of inflators include Autoliv (the other really big player), TRW, Key Safety Systems, Daicel and (making only inflators) ARC.

6. Finally, I want to reiterate that the numbers indicate you are much safer in a car with a potentially defective Takata airbag than a car without any airbag. The Takata airbag defect matters only in a frontal collision. Even if the inflator did spin off shrapnel, which is (order of magnitude) perhaps a 10 in a million chance, the chance you will be seriously hurt is lower. If you don't have an airbag, you'll be using your head -- to slow down the rest of your body. That story never has a good ending, and can readily have a fatal one, the latter at a rate much higher than 10 in a million.

mike smitka, from Toronto

Wednesday, November 19, 2014

Friday, November 14, 2014

Waiting for the stars to align: Japan's Consumption Tax increase

Japan, as does much of the world, has long-run fiscal challenges. Its population aged faster than anticipated. No mechanism was put in place to automatically adjust pension and healthcare revenues.Note 1 In addition, the slowdown of economic growth and the late 1980s bubble and its collapse both meant that revenues plummeted, leaving the economy with a one-time buildup of debt as the aging process commenced. The result was a large initial buildup of debt, and an inexorable subsequent rise.

...right now the stars are aligned around the consumption tax...

Addressing the issue required however the proper alignment of stars. First, the political system had to be configured so as to allow decisionmaking. A long era of prime minister of the season meant that doing much of anything has been a challenge. Then there's the economic system: even deficit scaremongers recognize that raising taxes in a recession is a bad idea.Note 2 So Japan also needed to have the economic stars align. For the initial decade or so, the aftereffect of their bubble muted discussion of tax hikes. External shocks – the Asian financial crisis in 1997, worries about spillover from the end of the US dot.com bubble, then 9/11 and 3/11 [the Tohoku megaquake], and more recently the sharp recession touched off by what is known in Japan as the "Lehman Shock" provided excuses to postpone, from the perspective of politicians if not economists.

Then came Abe. He is only the second prime minister in many, many years to not face a constant risk of losing his majority support in the Diet; the political stars aligned. Likewise the economy has been recovering bit by bit from the Lehman Shock and 3/11. While the reality may be something less, weak labor markets that kept youth from launching careers, headlines trumpted the rise of GDP and diminishing deflation. The denoument was that on April 1, 2014 Japan increased the consumption tax (消費税) – its national sales tax – from 5% to 8%. That had a predictable negative impact on growth, and so it remains an open question which way Abe and his cabinet will lean for authorizing the next increase in the consumption tax, a 2 percentage point bump scheduled for October 2015. The legislation is in place, but there is still an opt out.

One metric is inflation. Unfortunately a disadvantage of a large bump – in this case 3 percentage points – is that while it will produce a correspondingly large jump in the price level, the base effect will wear off if the underlying wage and other cost dynamics (and firm pricing power) remain unchanged. So we are now at the point where inflation is trending down. The depreciation of the yen helped hide that, particularly as higher import prices have been sufficient to offset lower global energy prices. But that effect too will wear off. Global headwinds now threaten; China, not the US, is Japan's largest trading partner. (Japan's exports to China of computer chips and the like are incorporated into iPhones and similar goods that are promptly re-exported to the US and ... whoops ... Europe. No out there!) So my sense is that if the economic stars are aligned, that is temporary.

All this begs one question on the nature of the tax increase: why large jumps? Instead of raising taxes by 3 percentage points in one fell swoop, why not raise rates by 0.75 percentage points every 6 months over two years? or (given the 10% end point) raise rates in increments of 0.5 percentage points every 6 months for 5 years?

That would have multiple advantages:

  1. Incremental bumps would lessen the surge of big-ticket purchases just before the rate increase went into effect, and the subsequent negative rebound. Such volatility serves no good macroeconomic purpose.
  2. Maxi bumps make sales data hard to interpret for the private sector – how much of the March 2014 sales surge was because the economy was doing well and how much was due to consumers pulling purchases forward? Such uncertainty serves no good business purpose.
  3. Volatility makes macro data hard to interpret for us economists. Yes, readers are shedding crocodile tears in sympathy, but some economists do have politician's ears (such as Koichi Hamada, a friend of Abe and former University of Tokyo and Yale professor whom I've known for 30 years). If such economists are honest – Hamada is not a mere political hack – then they are surely tempering their advice.
  4. Frequent mini bumps would add to inflation for some time to come. Surely that would be better if the goal of policymakers is to shift expectations away from deflation.
  5. Mini bumps ought to be more robust politically. You can with good reason argue that, in the midst of a slowing global economy, now is not the time to bump the consumption tax to 10%. It would be harder to argue that going from 8.5% to 9.0% should be postponed.
  6. Mini bumps ought to be easier to extend. From a fiscal perspective, even at 10% Japan's deficit will remain large, and at 10% the consumption tax is much lower than in many OECD countries. So why stop at 10%? That's surely much easier to sell if it's a continuation of mini bumps rather than a maxi jump.

Tightening loopholes through strict implementation of a national tax ID system may be the most desirable step. Right now though the stars are aligned around the consumption tax.

 
  1. Money is fungible and there is no particular economic reason to run retirement programs on a stand-alone budgetary basis. Having separate retirement and healthcare accounts and taxes to match is however to my knowledge universal.
  2. Cutting retirement benefits would have the same net budget impact and the same short-term contractionary impact as a tax increase, though with 25+% of the population already benefitting from Japan's programs, that's politically infeasible. It's also morally objectionable, as the twenty-five-percenters paid taxes during their working lives and so fulfilled their end the social contract. Extending the retirement age is a compromise: those near retirement may be treated unfairly, paying in more and taking out less than they anticipated, but at least the ex post adjustment is muted.

Thursday, October 23, 2014

Michigan's Anti-Tesla Ban: Bloomberg is Off Base

Bloomberg has an op-ed "Detroit Fights Innovation -- Again" which in fact is not about the Detroit Three of GM, Ford and Fiat Chrysler [the merger was consummated on Oct 12th] or even manufacturers, but about Michigan and (indirectly) automotive dealers. It makes the very tenuous claim that state policy that blocks Tesla from running company stores (in contravention to existing state law) is tacit protectionism that represents a step backward. Indeed, the article implies that the restriction is ultimately aimed at preventing a Chinese invasion. In fact the policy is misguided because history shows that there's no need to fear factory stores, at least as long as they're not set up by a car company so as to undermine their own existing dealers.

First, there's the red herring: China. The editors – there's no by-line, though David Shipley is listed at the bottom – ignore that GM and VW are the biggest players in China, and that purely domestic firms are in a tailspin (Warren Buffett has thrown away a pile of money on BYD [比亚迪汽车]). Two firms less successful in China, Honda and Volvo, are however already exporting. The camel's nose is well inside the tent: all of China's major players are multinationals who already have dealerships spread across all 50 states. And protecting the Detroit Three? Don't they editors realize they have but 46% of the US market?

Second, multiple automotive firms in multiple countries across multiple decades have tried and failed with factory stores. If you read carefully, you'll even find Tesla talking about defects with their distribution model. A modern dealership is comprised of six interlinked businesses: new vehicle sales, used vehicle sales, used car wholesaling (trade-ins), finance & insurance [including warranties], repair services, and parts sales, both retail and wholesale. (Some add a seventh to the mix, body shops, which in practice are a very different business from service & repairs.) So a manager must handle trade-ins, push used car sales and otherwise place a priority on things other than selling new cars in order to make a profit. On top of that, dealers are in a constant battle over what sort of physical "store" is needed, how much and what kind of advertising is necessary, and many other decisions important from a financial or strategic perspective. All this requires an ability to say "no" to the factory. No company has ever granted the manager of a factory store that level of discretion.Note

More important for potential new entrants, independent dealers provide billions in financing to a car company, because they hold inventory, not the OEM. The real estate is theirs as well. Any potential new entrant that needs a large distribution footprint -- that is, any company outside of the supercar niche -- can't afford to ignore that. If Elon Musk wasn't so good at bilkingmilking investors, he would need that money, too.

So the Bloomberg editors are accurate that Michigan -- which is far from being in the vanguard on this issue -- should not concern itself with Tesla's retail strategy. They are however accurate for the wrong reasons: factory stores have been a bloodbath for all who have tried, and will remain so. Indeed, they're critical to a car company's financial viability. Contrary to the editorial, it's not incumbent car companies that should be concerned, or existing dealers. It's Tesla shareholders and bondholders who should worry.


Note: The factory rep who has actually sold a car to a real customer is the rarest of creatures. To my knowledge there are none with the experience of running an independent dealership. Then there are incentives: a factory rep works for a salary, and their career depends on saying yes to their boss. They are not offered compensation commensurate with what the principal of a (successful) independent dealership can earn. So both corporate incentives and practical knowledge stand in the way.

Tuesday, October 7, 2014

Espresso and Pizza

photos fixed Jan 3, 2015

The base post lies at Espresso and Pizza on October 7, 2014 on The Truth About Cars.
I don’t normally post about vehicles themselves, but I am endlessly fascinated by the industry, and constantly surprised to learn of new niches. On the finance side, I’m amazed at the variety of vendors that show up at conferences such as those sponsored by Auto Finance News. One of these years I’ll make it to SEMA (the Speciality Equipment Market Association), which by reputation has both the credible and the incredible. But back to my topic: once in a while I do find products – or rather niches, I’m not a “car guy” – that intrigue.
I have fond memories of the local Good Humor trucks, which once made the rounds of Detroit. Then there was the lunch truck at the Chrysler Mack Stamping plant, where I worked some decades ago. Perhaps they’re still in business, but of late I see few such. Yes, the funnel cake van is a fixture at community festivals here in rural Virginia, and at least one of the local BBQs sell their pulled pork from a truck. The vendors of sausages and gyros unload everything from a trailer to set up under a tent, while the Ruritans sell hot dogs and burgers from a modified trailer. Other than the huge step vans on Constitution Avenue in DC, today I seldom see truck-based vendors, and the ones I do see are very utilitarian in their setup.
In Japan the historic model is the pushcart vendor (yatai 屋台). Going back to the 1800s, the Tokyo (Edo-mae) variety of sushi started out that way, a snack food sold on the streets, low not high cuisine. Into the 1970s (but now largely vanished) you could find yatai in the evening outside train stations, selling noodles or yaki-imo (sweet potatoes kept in hot gravel) or tako-yaki (octopus “donut holes”). It was in Tokyo that the phrase “chestnuts roasting on an open fire” first took on meaning for me, because that was another staple of street food. Such are not unknown in the US; you still find pushcarts in Central Park and elsewhere in New York [by which I of course mean Manhattan]. When I worked on Wall Street (well, actually Pine Street) I was fond of hot pretzels. But in Japan the modern version of the pushcart vendor is likewise relegated to the grounds of the local shrine during community festivals (matsuri).
Then I spent a year in suburban Japan. There you encounter a modern version of the yatai of old, imaginative and entrepreneurial. These are (often) young couples in “kei” trucks (mini minivans) fitted out to be one or another sort of mobile restaurant. You encounter them in suburban parks and other places families frequent, or in urban plazas. [In most of Japan parking along the street is not an option. In the areas I frequented the police made no exception in the late evening, when streets were only occupied by the occasional taxi and by drunk sarariman tipsying towards their train home.]
Here and below are photos by Smitka
Entrepreneurial, imaginative. First, the imaginative. To be practical, imagination must be constrained, not given free rein. Keeping things small(er) is one such constraint, pushing creativity in much of the world in directions irrelevant to the US environment. In Japan you find many adaptations to narrow streets and small lots. There are the local restaurant delivery services. At one time that would have been a Chinese restaurant or sushi shop, but tastes have changed and now that niche is dominated by contemporary sorts of foods. In the US delivery is done by employees in their own car. Not so in Japan – it’s by company scooter. In Chiba (a city of 900,000 just east of Tokyo) that might be the local Pizza Hut franchise. [I was never tempted to sample their fare...] Similarly, the backhoe that as I write is digging a trench to improve my driveway’s drainage is small, but it’s a monster compared to the construction equipment at sites in urban Japan.


So I should not have been surprised at vendors in their “kei” minivans, laid out to take advantage of every cubic centimeter. I unfortunately don’t have a photo of my favorite, a “kei” that a couple fitted with a wood-burning oven appropriate for two small pizzas. Not a viable business? Actually, it was about right – they didn’t have much workspace to toss the dough and lay on the toppings, and with the very thin crust they used – something I’ve seen in Milan and Tokyo but not the US – a “pie” didn’t take long to bake. The wait wasn’t bad. Theirs was a one-off, a personal project, but it looked something like this:
My most recent encounter was with a mobile coffee shop. I had a chance to chat with the owner/barrista in between customers. He had designed the layout himself, and helped do the fitting. Water, propane for heat, a grinder, an espresso machine, a sink, a fridge … the whole works, and he roasted his own beans [his logo proclaims that: 自家焙煎]. He wasn’t however in the suburbs but instead near Tokyo Station, taking advantage of real estate laws that set fairly restrictive floor-area ratios forcing newer office buildings to include an off-street plaza. He had a rotating schedule of such locations where he’d negotiated access (presumably for a fee). While he had an awning and some seating, most of his business was take-out. That sultry summer day he was busy enough, though he’s inclined to take the day off in truly inclement weather. Here is the van, with the “master” at work. (Click to enlarge!)
Home Roasted Beans Master at Work Service Counter
In my experience restauranteurs are quite finicky about their setup. This entrepreneur may have been willing and able to take a hand in finishing off his creation (see his 大月珈琲店 Facebook page for photos). However, welding and fitting are not part of the typical Japanese skill set, where “do-it-yourself” does not include even the most basic of household repairs. So with a little bit of digging I found several companies that specialize in such, including ZECC, Maku, Aian Cook ["Iron Cook"], and (winner of the best name) Mobil Cafe Mom’s: Production of Customized Car. The used car page on GooNet lists 104 “mobile retail” vehicles for sale, with prices from around $12,500 for a used truck to $25,000 for a brand new one, albeit none of these have appliances. An example from carsensor.net lists one with already equipped with sinks, plumbing and exhaust fan at $17,000. Yahoo Auctions Japan likewise lists numerous vehicles, so it appears to be an active segment. (I didn’t check Rakuten; in Japan eBay botched its initial entry and is not a player.)
Now I’m sure there are similar specialized firms in the US, and maybe on the West Coast mobile vending remains a lively business model. Yes, there are unusual promotional vehicles, such as the Oscar Mayer Wienermobile – there’s one on permanent display at the Henry Ford Museum in Dearborn. But I’ve not seen such whimsical “mobile kitchens” outside of Japan.
Links to (Japanese) pages with photographs:
  1. Pizza Boccheno
  2. ZECC, which specializes in making “mobile retail” vehicles. Lots of photos.
  3. Pizza Ci Vediamo [note the Coleman brand tent!]
[Note: max "kei" dimensions are 3.4m x 1.48m x 2.0m with an engine of 360 cc - a Smart is too wide and has too big an engine.]

Saturday, October 4, 2014

Labor Market Update: little bad news, but no acceleration

I post below a series of graphs on the US labor market updated through September 2014. As I read it, the latest CES (Current Employment Survey) and CPS (Current Population Survey) releases from the Bureau of Labor Statistics show more of the same – job growth a bit above population growth, little bad news, but no hint of an acceleration in the economy that might soak up what I estimate to be a 7.6 million shortfall in total employment, and 8.7 million gap if we subtract the rise in those working involuntary short hours. All this is calculated correcting for demographic effects including baby boomer retirement. As the graphs indicate, there's been no drop in participation by older Americans; the brunt of our recession was born by prime-age workers and especially new school leavers.

Warren Buffet's Berkshire Hathaway buys auto retailer VT Inc.

From Slate Magazine: "Warren Buffett's Latest Deal Has Officially Made Car Dealerships Cool"

I don't think so. I have a LOT more to write on this as someone who has spent a career life in the retail auto business AND worked in the van Tuyl organization. This time, Warren might have bit off more than he can chew

This is a REALLY BIG DEAL!!!!

Ford Poised to Realize an Upturn in Margins?

http://seekingalpha.com/article/2538735-is-ford-on-the-cusp-of-an-upturn-in-margins?app=1&uprof=53

A good piece from Seeking Alpha on Ford, instructive in the importance of margins, or as we call it in the retail auto business, "Gross Profit," what consumers hate to pay. "Success for any company begins with gross margins as this tells you how much it costs a company to make whatever it's selling. This is a pure look into a business' ability to show pricing power with its suppliers and demand from its customers."