Efficiency and Fragility

Efficiency and Fragility

What’s at the root of the supply chain breakdown? That’s a critical question, but the answer is almost irrelevant. The supply chain is a complex, dynamic system of immense scale. It’s of a complexity comparable to the climate, as a system. This means that exact cause and effect can’t be computed because the processing power needed exceeds the combined processing power of every computer in the world.

The core problem is that supply chain experts have spent the last 30 years making supply chains more efficient. Supply chains impose costs on business. Efficiency amounts to cutting costs. Cutting costs increases profits. The supply chain revolution since the early 1990s has been about cost reduction, which gets passed to consumers in the form of lower prices. That practically explains the entire phenomenon.

For decades, we’ve heard about trade deals such as the North American Free Trade Agreement (NAFTA) and China’s admission to the World Trade Organisation (WTO). Tariffs were cut on a bilateral basis even when multilateral agreements were not in play. Even larger trade deals have been implemented recently, including the Trans-Pacific Partnership (TPP). Historic predecessors included the European Free Trade Association (EFTA) and the European Union (EU).

All of this was done under the banner of ‘free trade’. That’s a high-minded purpose, but the not-so-hidden agenda was to expand supply chains without tariffs so that cheap labour could connect with rich consumers.

Paying the price for cheap goods

The supply chain revolution involved more than cheap labour (mostly in Asia). It also involved scarce commodities from Africa, high technology from Taiwan, financial capital from the US, and high value-added human capital from Europe, Canada, and the US, among other sources.

Supply chain managers and consultants became experts at optimising the links and cutting costs. A more distant source might be more efficient than a local source because of cheap labour. More expensive air transport might be more efficient than ships because the goods would spend less time in inventory.

Long-term purchase agreements might be more efficient than one-time purchases because of lower unit costs. Short-term purchase agreements might be more efficient because they allow for substitutions of certain components. There was no single right answer. There was only a relentless search for optimised (that is, cheaper) supply chains.

The touchstone of these efforts was the idea of just-in-time (JIT) inventory. If you’re installing seats on an automobile assembly line, it’s ideal if those seats to arrive at the plant the same morning as the installation. That minimises storage and inventory costs. The same is true for every part installed on the assembly line. The logistics behind this are daunting but can be managed with state-of-the-art software.

All these efforts are fine as far as they go. The costs savings are real. The supply chains are global. The capacity of this system to keep a lid on costs is demonstrable.

There’s only one problem. The system is extremely fragile. One missed delivery can result in an entire assembly line shutting down. One delayed vessel can result in empty shelves. One power outage can result in a transportation breakdown.

Who’s to blame? Everybody…

In a nutshell, that’s what’s happened to the global supply chain. There’s a lack of redundancy. The system isn’t robust to shocks. The shocks have occurred nevertheless (pandemics, trade wars, China-US decoupling, bank collateral shortages, and more), and the system has broken down.

The failures have cascaded. Delays in receiving commodity inputs in China have resulted in manufacturing delays for exports. Energy shortages in China have resulted in further disruption of steel production, mining, transportation, and other basic industries.

Port delays in Los Angeles have resulted in components and finished goods being delayed in the US. Semiconductor shortages have halted production of electronics, appliances, automobiles, and other consumer durables that rely on automated applications (the Internet of Things — IoT).

Everyone is blaming everyone else. Ships that can’t unload at ports blame the truckers who are supposed to remove the containers already ashore. Truckers blame state regulators that make them wait in line for days to pick up containers, only to tell them to come back tomorrow. Retailers blame distributors. Customers blame retailers. The problem is they’re all right.

The supply chain breakdown is not at one single bottleneck. It’s up and down the supply chain at all levels, from component suppliers to manufacturers to transportation providers to customers.

What is the Biden Administration doing about this?

They’re busy making things worse.

First, the Biden Administration ordered the Port of Los Angeles to stay open 24 hours a day and work three shifts in a row to ease the backlog. The problem is that working longer was never the problem. The port can’t unload the vessels because there’s no place to put anything. The piers and storage yards are full. Containers are stacked to the sky. Working longer hours does nothing when there’s no place to put the cargo.

The next Biden Administration move was even more misguided. They proposed a penalty on containers that remained on the docks for more than six days. But no one wants the containers moved faster than the shippers. It’s just a physical impossibility when they can’t get the trucks to the ports. The penalty doesn’t speed up the transportation process, but it increases the cost of goods, making inflation worse and could drive some retailers out of business. A real supply chain crisis with unavoidable delays and added penalty costs is a bad combination for the economy.

In my next edition, I’ll focus more on the science of risk at play behind the current supply chain collapse. Because by properly understanding what’s going on, we can think about solutions that might actually help…instead of hurt.

Regards,

Jim Rickards Signature

Jim Rickards,
Strategist, The Daily Reckoning Australia

This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.