Welcome to the world of assets


Posted on March 24, 2022 6:23 PM by

Erik Kravets








(Article originally published in the January/February 2022 edition.)




Asset prices are on the rise, signaling a new wave of inflation.


Federal Reserve Chairman Jerome Powell and his counterparts, such as European Central Bank board member Fabio Panetta, have described inflation as “transitional” time and time again, but that worn-out term is starting to sound almost as out of place as “fifteen days to slow the spread”. .”


Maybe inflation is here to stay? Nobody believes that prices will return to where they were in 2020. That would require deflation, where the cost of goods and services tends to fall, not rise.


In this scenario, consumers delay their purchases and save money because everything they plan to buy will end up being cheaper. This puts pressure on companies facing revenue cuts, forcing them to cut bottom line costs to stay afloat. This means negotiating lower prices with their suppliers, which perpetuates the same problem downstream. Or, much more likely, companies cut costs by laying off workers and closing sites.


Friendly Reminder: The goal is to have stable prices and Goldilocks. This has traditionally been understood as a price increase of 2% or less in any given year. The US 10-year inflation average for the years 2011-2020 was 1.75%; for the euro area, 1.28%. In other words, in Europe and America, central banks have done a decent job.


We’re all used to the idea that, year on year, prices may go up a bit, but there won’t be any sudden or surprising moves.


Tipping point?


At least until now. Year-on-year inflation for 2021 hit 5% in the EU and 7% in the US, well above anything anyone considers acceptable. Quarter after quarter, the two economies have accumulated figures not seen since the 1980s. Is this still “transitional”?


The rumor in the street is even more serious. Some older cars sell for more than they cost when new. And dealers are selling new stock as soon as it arrives, perhaps because the manufacturer’s suggested retail price for a new car is cheaper than buying a used car. Martin Weiss of Deutsche Automobil Treuhand (DAT) remarked: “Price increases are often 5-15%. In some cases, they can be significantly higher. It’s crazy what we see. »


And that’s another side of inflation: if prices don’t rise fast enough to keep in line with the market, the result is a shortage. People snap up assets because they immediately feel their value. This strains the supply chain, which struggles to restock new product because the cost of production has, in the meantime, exceeded the revenue generated at the final point of sale.


When this self-reinforcing price spiral becomes powerful enough, it forces companies to raise prices faster and faster – quarterly or monthly, rather than once a year.


Inflationary spiral


Take Hyundai Heavy Industries (HHI), South Korea’s largest shipyard, where newbuild prices are up 12% year-over-year. HHI was paying more for steel sheets to fill its existing orders, so it incurred a loss. Sheet steel accounts for 90% of the material used in the manufacture of a typical commercial vessel.


HHI’s situation – its product prices are up but its bottom line is underwater – is what triggers the inflationary spiral. Shipbuilding contracts are normally divided into four parts with specific triggers: a down payment due on signing, a second installment due when the first steel plate is cut, a third installment due when the keel is laid, and the remains due at launch. All of these payments add up to a single total price for the new build, which is generally not variable.


This model operates in a low inflation environment with stable costs. An owner could calculate a price, obtain financing and then, ideally, depreciate the vessel via a long-term charter party after paying the shipyard. To avoid the situation in which HHI currently finds itself, in which it absorbs the shock of rising steel prices, it will have to contractually offload these price issues onto the owner.


Two options are available to you. First, the price of new construction does not need to be quantified in advance; on the contrary, it can evolve according to the market and the owner will not know what his ship will cost until after its final launch. Typically, this construction is accomplished by building price adjustment clauses into the shipbuilding contract requiring the owner to cover more expensive materials or even higher labor costs and new taxes and fees. .


Second, cost-plus contracts may become fashionable, which require the owner to reimburse the shipyard for all shipbuilding costs and guarantee a fixed, pre-determined profit margin for the yard.


These two contractual mechanisms protect against inflation but complicate the buyer’s life. Particularly tricky is the fact that the shipowner will only be able to offer a charter party rate after the launch of the new construction since any risk in the commitments made to the shipyard will, in turn, have to be passed on to the charterer. . Thus, the shipper will necessarily pass on this risk to the freight side, i.e. to the shippers, who, in a spiral, will demand more money from the consignees. This is what is meant by “perpetuating the same problem downstream”.


While the global backlog for new builds was at a 31-year low in January 2021, that has since completely reversed. Peter Sand, BIMCO’s chief shipping analyst, summed up the situation by saying: “In 2021, the order book was only 2.5 million TEUs. Since then, a record 3.3 million TEUs have been ordered.


A Lloyd’s List byline recently warned: “New on-order capability risks flooding the market when it arrives in 2023.” From zero to hero, shipbuilders look back on what has been called a “year spectacular”. It’s just a shame that inflation took advantage of it.


So why not just buy an older ship and avoid all that hassle and uncertainty? Well, in April 2021, Clarksons reported that its Pre-Owned Index was up 33% year-over-year, with the global total value of the global merchant shipping fleet exceeding $1 trillion. This 33% increase is even higher than the 12% premium you would pay as an HHI customer, so maybe the wait for court is worth it.


This is starting to sound very familiar to you – like choosing between a new or used car, perhaps? The fact that over time these problems are identified industry by industry is a bad sign. Because the reality is that they are shared, that they affect all sectors and that they are becoming secularized.


Flashing red


In terms of the global economy, virtually all of the status lights on the control panel are flashing red. The IMF reported in late 2021 that the response to COVID-19 in 2020 was the “largest increase” in public debt in 40 years, reaching just under $250 trillion globally. And that’s not taking into account 2021, a year when spending was even higher.


At the same time, global revenues are down for the second consecutive year. Whether you are rich or poor, your situation today is worse than two years ago – again. The biggest declines have perversely affected the poorest quintile of earners with a 6.7% drop in 2021. And military tensions, like those between Russia and Ukraine, are rocking energy markets.


Other problems, like port congestion and freight chaos, are no better than they were last year, although time has passed and solutions have been tried. In fact, while last year’s focus was on offshore shipping, truckers and railroads are now also at risk.


For two years now, the word “transitional” has been used to describe all sorts of problems – lockdowns, shutdowns and quarantines, shortages, shipping delays, inflation, runaway spending. Anything “transient” is relatively easy to rationalize. But when it becomes clear that a situation is not “transitional” but rather a reflection of a new status quo, a new normal, it can trigger a shift in mindset and perspective that can often lead to a different behavior.


How should we act in a world that sets the barrel of high inflation and tax hikes in order to both dilute the value of debt and help service it? In the face of price uncertainty, where money spent now is worth more than money spent later, and where assets retain value rather than depreciate? Shortages that are compounded by the fact that shortages are almost inevitable, so shoppers will walk away with whatever is available for sale – and it will cost more tomorrow, anyway?


When incomes drop every year while one band-aid after another fails to fix the fundamental problem, which is that the tricky Humpty Dumpty of the just-in-time economy is broken and there is no no decent replacement yet, will we just have to make it work with the chunks?


measuring stick


A feedback loop occurs when part of a system’s output is used as input for the future behavior of that system. The global response to COVID-19 has become a latticework of externalities that now govern our daily decisions.


The way out will be hard, but it will probably lie first in the price of a container from Shanghai to Rotterdam. All upstream and downstream risks and all costs – for vessel, bunkers, labor – will be taken into account. Unlike governments and central banks, this container will tell us the unvarnished truth.


This is going to be an expensive container. And this will only be the first of a long series.



The views expressed here are those of the author and not necessarily those of The Maritime Executive.



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