Sunday, May 10, 2009

Green Shoots? Not So Quick, Because...

"Real Recovery Will Hinge on Capital Spending", according to James Cooper of Business Week.

"Companies are still chopping costs aggressively in an effort to limit the recession's hit to their profits, and there's no indication they are ready to put away their axes. Capital spending, a crucial part of the economy's growth engine, remains especially vulnerable.

"Falling outlays for everything from computers to forklifts to office space accounted for 4.7 percentage points of the 6.1% decline in first-quarter real gross domestic product. In fact, the 16.8% drop in capital spending since the third quarter of last year is the largest since the 1930s."

"The major weight on capital spending right now is the recession. Businesses don't make decisions to shell out money based on cautious optimism. They have to see actual improvement in demand and profits."

Right now, both demand and profits are not there to justify capital spending. What about external financing, such as bank loans? Not there, either. Borrowing cost remains high.

"In the credit markets, borrowing rates for any company less than investment grade are in double digits, and those for many higher-quality borrowers are still more than 8%. These rates remain extremely high in relation to both inflation and riskless Treasury notes.

"At banks, senior loan officers said they continued to tighten lending standards in April for all types of business loans, although the pace did slow compared with January. Their reasons: an unfavorable economic outlook, less tolerance for risk, and a worsening of problems in some key industries."

"Perhaps the biggest factor working against a capital spending recovery is that U.S. businesses have a growing glut of production capacity—they can go a long time before needing to expand. "

Conclusion: Until the excess capacity that had built up during the bubbly years of cheap credit gets purged from the system, the real recovery will not come.

The businesses are doing what needs to be done - cutting the excess and trying to reallocate the resource to where it's needed. The danger is cutting short this process by forcing the money be allocated to the sectors/companies that are trying to remove excess. All that will do will be to re-inflate a bubble yet again. With all the stimulus money and government-led projects, I'm afraid that's what is going to happen, whether we like it or not.


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