Friday, July 17, 2009

The Trouble with excess capacity in the global economy........

Here is an excerpt from a Bloomberg article :

World Bank Sees Deflation Risk From Excess Capacity (Update2 ...

The World Bank Chief Economist makes a valid point.

""""""A failure to address excess capacity in the global economy may cause a “deflationary spiral” that would prolong the financial crisis and result in more company bailouts, World Bank Chief Economist Justin Lin said.

“Once excess capacity appears, the economy gets trapped in a vicious cycle,” he said during a lecture at South Africa’s University of Pretoria.

Investments made by companies between 2002 and 2007 have now turned into surplus capacity following the worst financial crisis since the Great Depression. If excess capacity isn’t eliminated, more jobs may be lost and corporate bankruptcies surge as spending and investments slide, compounding the crisis, Lin said.

Factories in the U.S. operated at 69.1 percent of capacity in March this year, the lowest since the figures were first collected in 1967, Lin said. In Germany, capacity utilization measured 72 percent, 65 percent in Japan and as low as 50 percent in some developing nations, he added. """""


Embattled industries include - The Airline Industry, the Automobile Industry, Computer Hardware Industry, Consumer durable goods and the Retail Industry.

The end consumer is cutting back on 'discretionary spending' and postponing purchases and looking to pay down debt. The consumer is also looking for bargains and is quite often spoilt for choice, before he eventually makes his purchase.

As a result, these industries are faced with slow sales and an inventory pile-up, and are being forced to lay off workers as they try to fix their bottomlines.

This is clearly a 'vicious cycle' that was supported by an era of 'easy money', that enabled weak and marginal firms to survive alongside efficient ones.

Unfortunately, I do not think that we will see any recovery until this excess capacity is 'flushed out' of the system. Many firms will have to shut down and we will definitely see more job losses.

Despite record debt levels, World Governments are instead bailing out and supporting failing and inefficient firms that took more risks than they could handle.
By restricting market forces, these bailouts will probably drag down the profitability of their efficient and profitable competitors.

Case in point : The Bailout of GM & Chrysler, could destroy the chances of Ford ever making it out of this crisis. (Yes I know Ford isn't profitable, but the GM Bailout is definitely hurting its chances)

This will result in the eventual recovery getting even more delayed.

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