ISM Dispatch 4: BOA's Chief Economist Mickey Levy's Forecast

During the morning keynote session at ISM on Tuesday, Bank of America's Mickey Levy gave what I'd describe as a balanced and realistic look at the current economic situation in the US -- and what we can expect to experience throughout the rest of this year. The title of his presentation, "Emerging from Deep Recession; Early Signs of Stabilization," suggests a rather optimistic tone given the general pessimism of the moment, although once he got into the presentation, Levy was much more of a pragmatist, expressing skepticism and concern at the governments response to the situation. He began by discussing the current and recent bleak situation: businesses are cutting production, employment and investment (and prices are dropping). The global recession is undercutting US exports as well (I'd also argue that a stronger dollar is hurting US exports, too, but Levy did not get into this).

Looking forward, Levy sees economic growth returning (i.e, Real GDP, in economist speak) in the second half of 2009. But things could get worse both before and after they get better (at least initially). The GDP gap, as measured in the shortfall of real activity relative to potential activity) now exceeds 6% and unemployment could rise to 9.5% (or possibly more) from the current 8.5% level. And longer term, the potential of the economy could also be "constrained by the surge in government debt and related policies". But in the meantime, what will it take to achieve a healthy expansion (and what will these policies mean for procurement and operations organizations)?

First, we must "unclog" monetary policy transmission channels. Translation: banks need to start loaning again to businesses and support consumer spending by becoming less stingy with credit cards, auto-loans, non-conforming bank loans, etc. Second, we must stabilize the banking sector, by moving towards stability in housing and home prices (the uncertainty of the fall -- and how far housing prices will dip -- is currently increasing uncertainty by making it difficult to value assets). Last, to emerge from recession into a sustainable recovery, we must boost international demand and help restore order to banking and finance in the UK and Europe.

Achieving these three goals is easier said than done, despite some early positive trends when it comes to the stabilization of housing prices and consumer spending. In Levy's view, business will continue to proceed cautiously this year and investment spending will continue to decline through 2009. Eventually, falling prices will spur demand, hopefully along with the aggressive fiscal stimulus, something Levy is not so excited about. He believes that the long-term implications of what the government is doing could lead to significant inflation, not to mention the impact of mortgaging the country's future on future tax increases to fund the current deficit spending.

Levy cut to the chase (something hard for economists) when it came to his view on the Obama plan. It is, in his words, "costly and poorly designed, but could help support demand." The plan banks on "huge deficit spending financed by Fed monetization to stimulate demand, poorly structured tax reductions, too little infrastructure spending, and generally wasteful, low return spending." In fact, according to Levy's analysis, "only $1 in $6" of the stimulus plan actually goes to true stimulus -- infrastructure. And the tax reduction components are only targeted "tax credits and exemptions" rather than rate reductions. The net result of these activities is "unprecedented peace-time federal deficit-spending and debt buildup."

How would Levy grade the plan? In his view, "If you submitted this package to Larry Summer's undergraduate class at Harvard, you would have gotten a gentlemen's B" at best. One of his major concerns are the longer-term implications of the spending and plan that will force bond yields to rise (driving inflation). Levy puts it best when he notes "Fiscal policy makers in Washington have lost any sense of fiscal responsibility -- [they might be] well intentioned but are not responding in the most economically rationale way." Translation: the current inputs/stimulus are setting us up for a dangerous set of outputs.

In summary, Levy expects to see a slight rebound in 2009Q2, but the rebound will be "slow or bumpy" reflecting many of the obstacles discussed above. One of the challenging ironies of returning to growth he noted was that traditionally, household spending leads economies out of recession, but this time around, households are finding themselves focusing on lower debt and increasing savings vs. taking advantage of lower prices. Longer-term, Levy is concerned that the "unprecedented surge in government debt and misallocations of national resources will constrain productivity gains" not to mention the debilitating economic impact that he expects from an unnecessary "onslaught of government regulation."

What are my key takeaways from a procurement perspective from Dr. Levy's comments? I'd suggest first and foremost that procurement organizations should double-down on their efforts to partner with suppliers to avert the risk of supply chain breakdowns and failures as a result of a prolonged dip and bumpy recovery. Rather than just focus on achieving purchase cost savings from taking advantage of a current favorable climate for sourcing, companies should devote as many resources as possible to supplier development and management (along with enabling technology to enable such efforts to scale). Second, companies should plan for significant commodity price inflation in 2010-2011 (both oil/energy and raw materials) not just as a result of a slight rebound, but because of the continuous running of the printing presses in Washington at the moment.

The last piece of advice I have is the critical importance of managing supplier, supply markets and related intelligence inside companies. The nearly unprecedented slowdown that happened in the past few quarters and the commodity markets rollercoaster portend an environment of extreme volatility. Those who have their finger on the pulse of their operations, their suppliers and the underlying cost elements driving total supply chain costs will be in the best position to take advantage of market opportunities throughout the rebound -- while lowering costs and downside risks in the interim.

Jason Busch

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