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Q&A: Top Economist On Pandemic Pain, Lasting Fallout

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Q&A: Top Economist On Pandemic Pain, Lasting Fallout

The coronavirus is severely disrupting container shipping and global supply chains in 2020, but that's just the beginning. The pandemic is laying the foundation for permanent changes to the business of international trade.

For insights on the possible timing of a U.S. recovery and the signals to watch for, as well as the long-term consequences to global supply chains, FreightWaves interviewed economist Paul Bingham, director of transportation consulting at IHS Markit Ltd. (NYSE: INFO). The following is an edited version of that conversation:

Canceled sailings

FreightWaves: Before we talk about the long-term consequences, let's look at the next few months. There was a jump in volumes into California in April that was the catch-up from the earlier China shutdown, and now we've entered the period when a large number of blanked (canceled) sailings are slashing U.S. import capacity. How do you see this playing out through the rest of 2020?

Bingham: "What we just saw was the tail end of the story from February [the Hubei province shutdown] playing out as Chinese factories came back online and orders that had been sitting there for weeks were finally filled. That was a supply story. Now we're into a demand story with the mass cancellations of orders from North America and Europe. This is not going to be a few weeks — this is going to be sustained."

Terminals are worried about incoming boxes piling up, because the businesses that ordered the cargo may be closed or may no longer have the demand or may not have the ability to pick that cargo up.

"It's going to be a real problem. Those containers will keep racking up [storage] fees. At a certain point a business owner may think, ‘We can't sell it, the fees have run up, we'll just abandon it.' If the cargo is owned by, for example, a restaurant chain that goes bankrupt, [terminal charges] get thrown in with the claims against that particular business and the cargo may be auctioned off. All of this clogs up the system at the terminals."

Timing the recovery

Some states are starting to reopen their economies but I don't see how this bounces back anytime soon, given all the debt and unemployment, which will curtail the urge to consume almost anything but necessities.

"That behavioral lag is what's going to take time. Our macroeconomists are looking at consumer-expenditure behavior coming out of recessions when you have high unemployment and high debt. We have forecasts with varying timing for the [outbreak] peak and none of them are calling for a recovery before 2021. So, the liner companies are going to have trouble right through peak season. It's not like pent-up demand is going to suddenly spike.

"The brick-and-mortar ‘retail apocalypse' that was already playing out will accelerate. More malls will close, we'll never go back to the level of in-store sales we had before, and e-commerce is never going back to where it was in January. Its market share gain from this will be permanent.

"When the economic recovery does happen, it's going to be incremental. Certain goods will come back more quickly than others, more out of necessity than out of behavioral taste. Some sectors and some countries will take years to recover.

"There may also be a whole generation of consumers who have been chastised and will say to themselves, ‘I'm never going to get caught like that again.' It's just like the people who went through the Great Depression — how your grandparents always talk about what they learned. Years from now, you could have people saying, ‘I learned back in 2020 that I'm never going to do that again,' whatever that may be [excessive debt, excessive spending on non-essential goods, etc.]."

How can we see the signs of a recovery in the ocean-carrier data? For example, we're currently seeing around 20-30% of U.S. trans-Pacific container-ship arrivals from Asia being canceled. Do we know things have turned the corner when we see that drop to 10-15%?

"That would be a good signal. I'd also watch utilization [the percentage of container slots on vessels that are filled]. If the carriers start attracting more cargoes and the utilization starts to creep up, that's a sign of recovery. But in either case, you've got to see the signals sustained over a period of some time, not just a few weeks."

Ship layups

Another timing factor involves the carriers. When they axe services, they lay up vessels, and with their chartered-in fleet, they let expiring charter contracts roll off. We're already seeing this in smaller markets like the Caribbean, where the charter durations are short so the charter roll-offs are more immediately apparent.

"Right, the carriers are not just blanking two or four weeks of sailings. It's much worse than that, so you're going to see what we saw in 2009: A lot of vessels are going to be at anchor in places like Singapore. What's different now versus 2009 is that back then they could put a skeleton crew on a laid-up ship and when the service restarted you could say, ‘Swap back the [operating] crew.' But today, [with coronavirus travel restrictions seriously impeding crew movements] that's no longer trivial to do. I don't know how that will affect layup plans.

"With ship charters, the whole reason carriers deliberately have a portfolio-management strategy [fleets partially owned, partially chartered] is that you don't want to get stuck with a 100% owned fleet at a time like this. You're paying a premium to charter some of your tonnage so you can put it off-hire when demand drops. There's no question the carriers are going to do that. They will tell the vessel owners, ‘OK, it's yours. We don't want it anymore.'"

Rates and bankruptcy risk

The carriers have been able to keep container freight rates fairly steady by cutting capacity. If they can't continue to do so, there's the risk of a major bankruptcy. Do you think they can hold firm on rates and if not, what are the repercussions for U.S. cargo shippers from a carrier failure?

"Again, it's important to watch slot utilization. The carriers are trying to calibrate their slots in a way to hold up rates. They've done OK so far, but I wouldn't be buying freight futures assuming I could make a lot of money in June. I don't think this is sustainable.

"I don't know which company it would be, but I do think there's a chance of a carrier failure. In the Great Recession [2009], there would have been multiple bankruptcies if there hadn't been sovereign intervention, and this will be a deeper and sharper global recession than that one was. If this [carrier failure] happens, it will be worse than what we saw with Hanjin [a South Korean carrier that went bankrupt in 2016-17]. There would be stranded cargoes, problems at the terminals, a huge mess if the carrier is involved in an alliance — you'd get an enormous disruption."

Threat to globalization

Let's move on to longer-term changes as a result of the coronavirus crisis. What about globalization? Do you think this event will persuade countries to deglobalize — to onshore — or will it ultimately make global supply chains more diversified?

"The answer is not onshoring. You hear a lot about onshoring, that we're too dependent on the world and we should make everything here in the U.S. If you believe that, go talk to the chicken processors and ask how well that's working out. We don't import poultry. We do it all here and now we've got these massive poultry plants going down because of COVID-19. The simplistic answer of ‘if only we made it in the U.S., we'd be perfectly safe' is ridiculous.

"The answer is diversification, and this has already been going on for a while. For years, companies have been saying, ‘We can't have this single source of supply in China. How do we better manage our total supply chain? We can't have our whole supply chain shut down if there is one outage.' So, there will still be factories in China supplying things to the U.S., it's just that they won't be the only factories in the world providing that supply."

Repricing of risk

Another long-term issue involves contracts. The lack of foresight to consider the possibility of a pandemic was a failure of imagination, but that's not going to be the case going forward. The question of ‘who pays for what?' will have to be litigated for current contracts, but all new contracts will take the pandemic risk factor into account and specifically assign that risk. The higher the risk, the higher the risk premium and the more a party will need to be compensated to take on that risk. This will have massive implications for how all transactions will be negotiated going forward. How do you see it changing the business of global trade?

"There are two parts to that. The first part is the refinement of the legal practice around issues like force majeure and the language of contracts and who's the responsible party under what terms. There will be a refinement of the risk assessment.

"The second part is the pricing element. I agree with economists who say that what is happening now is proof that we have been underpricing certain risk. We've done a bad job of modeling that [pandemic] risk. If regular insurance markets had worked better and we had been appropriately acknowledging how risky this was all along, governments would not have to be stepping in to the degree that they are.

"Now that we know, the world is going to have to price this risk better going forward. This will clearly raise overhead and operating costs for businesses that were not paying enough in the past. They will be paying for it going forward, which is appropriate, because they should have been paying for it all along."

But if global trade is acknowledged to be riskier because of the pandemic threat, and insurance costs, equity returns and interest rates must be higher to compensate for higher risk, how are the consumers of goods going to pay a higher price to cover that if we're in a deflationary environment due to the economic damage the outbreak has caused?

"Even if you're in a deflationary environment, you have to incur this extra cost factor in the factors of production, so it would moderate the amount of deflation. Your cost of insurance will be going up even if everything else is going down. And if you raise the price, all else being equal, ceteris paribus, you'd consume less unless you have completely inelastic demand."

That assumes, though, that the consumer pays the cost of the higher risk. In ocean container shipping, the consumer often doesn't pay the carriers eat the added cost because several of the carriers have implicit or explicit government support.

"Right, if sovereign governments choose to subsidize the liner market, as they typically have, including by stepping in and saving carriers during big recessions, you would continue to see what would be considered ‘dumping' from a trade-law perspective. What you're dumping is container services. Prices can be offered on a sustained basis below what would be acceptable in a purely competitive market because you don't have a purely competitive market."

In closing, would you agree that the COVID-19 pandemic will permanently change the global supply-chain landscape, and if so, how?

"Absolutely. It will be significantly different. We've accelerated the factors of change that were already underway [such as supply-chain diversification and the move toward e-commerce]. There will also be changes in demand and supply and shifts in geographies, and as all of that changes, it will change the derived demand for transportation and the net that's left in any trade lane for carriers. And on top of that, we've added this sudden recognition of the risk premium — which we should have been paying for all along." Click for more FreightWaves/American Shipper articles by Greg Miller  

 

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