What Suez’s ‘black swan’ means for inflation

Plus Intel’s gambit, WeWork’s blank check, F-35’s latest mess, and China-Iran pact

Welcome everybody to another edition of Contention! We’re back from our break, and ready with just about seven minutes of log-jammed dissident business news. This week we cover:

  1. What Suez’s ‘black swan’ means for inflation

  2. Intel plan reflects world chip conundrum

  3. Rapid Round: WeWork finally debuts, F-35 screws up again, China-Iran tie the knot

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What Suez’s ‘black swan’ means for inflation

Markets mostly advanced following another volatile trading week torn between optimism over a booming economic recovery and fears of rising inflation. The Dow was up 1.4%, the S&P 500 1.6%, and the Nasdaq declined 0.6%. 

The disconnects between key economic indicators, public statements from government officials, and the unexpected conundrum of a sideways ship in Egypt all point to deep confusion among those in charge of the global economy. 

The week’s best news: new jobless claims dipped below 700,000 layoffs for the first time since March 2020. At “only” 684,000, new claims finally came in under the pre-pandemic record, set in 1982. 

But “inflation” is usually a euphemism for rising wages, and improving employment conditions could mean good news for workers, bad news for corporate bottom lines. Federal Reserve Chairman Jerome Powell and U.S. Treasury Secretary Janet Yellen sought to tamp down these concerns over three days of congressional testimony. 

On Tuesday, Powell told the House Financial Services Committee that while improving conditions might mean some inflation, it would be “neither particularly large nor persistent.” He added on Wednesday at the Senate Banking Committee that with nine million jobs still lost since last year and a major dip in labor force participation, the job market has plenty of slack before bosses have to worry about raising wages -- and therefore costs -- to attract new talent.

But wages are not the only source of rising business costs, and new data reiterated ongoing supply chain price chaos upstream from the consumer market. Regional Federal Reserve bank data indicates historic production output, but also some of the slowest delivery times since the geopolitical upheaval of the 1970s. This means some of the highest producer prices in decades with the IHS Markit PMI printing the longest delivery delays since at least 2007, when the data series began. 

Enter the mess in the Suez Canal. On Tuesday, the Ever Given, a cargo ship longer than the Eiffel Tower, caught unexpected winds and ran aground, blocking the critical shortcut between the Red Sea and the Mediterranean. Roughly $10 billion in goods, or 12% of world commerce, passes through the canal daily, and hundreds of ships are now log-jammed behind the Ever Given.

The fiasco perfectly meets the definition of a black swan: a highly improbable, nearly impossible to predict event that appears out of nowhere to wreak havoc on complex human systems. A windy day has now caused a 20% surge in oil tanker freight rates in a matter of days. As the latest attempts to float the ship have failed, officials are preparing to try and unload the boat. But there are no structures in place built for such a task, and it raises the risk of the boat breaking apart, extending the blockage for weeks or months. 

Rerouting around the Cape of Good Hope -- the only alternative to the canal -- adds 6,000 miles to shipping voyages and hundreds of thousands of dollars in fuel costs alone. It also raises piracy risks, with additional cost implications. 

The hidden theme underlying all the data and weird news from the week: deglobalization. Long-term falling rates of profit forced a scramble for cost-cutting. Outsourcing input production to third parties allowed those producers to create economies of scale, cutting costs for all. Low wages in poor countries offset any increased logistical costs. 

This is how we’ve had at least a quarter century of deflationary trends, but the most important workforce in the system -- China -- has seen wages nearly double in a decade. This tide turning away from globalization has met with rapid pandemic-driven reallocation to create real chaos in supply chains. These chains are all interconnected, so this is just another way of saying the global system of production is experiencing permanent tectonic shifts. 

Businesses communicate with each other through prices, and big changes = uncertainty = price volatility and inflation. 

Hence the political priority for business’ most ardent allies: wage suppression. Inflation fears justify austerity, but if the Ever Given teaches us anything, it’s that every model is just one gust away from irrelevance. 

Intel plan reflects world chip conundrum

Intel, the world’s largest semiconductor designer and manufacturer, announced a major strategic shift last week, highlighted by a $20 billion investment in two new chip foundries in Arizona. The event served as a coming out party for new CEO Patrick Gelsinger, hired in February to turn around the legacy chip giant after years of slipping market share. 

The company’s challenges mirror those of the global economy, choking on the limitations of the world’s most critical industry. The hand gripping humanity’s throat: U.S. power. 

Gelsinger’s strategy dovetails with U.S. government efforts to re-shore critical supply chains, and will likely draw major government subsidies. He announced that the company would not only make most of its own designs, it would seek to provide chip foundry services to other designers. 

None of this, however, will relieve present semiconductor supply chain crises, as the strategy will take years to unfold.

Chip shortages have hit the auto industry especially hard, with analysts estimating that the sector could lose $61 billion in sales this year due to production slowdowns. Ford is only partially completing some of its trucks and SUVs, hoping for new chip deliveries to finish building them weeks later. Chinese EV manufacturer Nio shut down production for five days last week due to a lack of chip supplies. 

Increased costs and heightened inflation risks will likely follow. Other unexpected disruptions have only made things worse:

The pandemic exposed semiconductors as a chokepoint for all of global industry, and the industry’s complex processes dependent on bespoke facilities mean extremely high fixed costs and long runways to full output. Adding capacity is hard: supply problems could persist and become recurring. 

China -- the world’s largest semiconductor market -- would like to help fill this gap, and Chinese domestic investment in chipmaking increased by 407% in 2020 alone. But the country faces a second-order chokepoint: lack of critical chip-printing technology produced by only one company in the world, ASML. 

SMIC, China’s largest semiconductor company, earlier this month announced a one-year extension of a $1.2 billion bulk purchase agreement with ASML, but this only included older lithography tech. ASML is still waiting on a license from the Dutch government -- where the company is based -- to ship machinery necessary for the most advanced processes. 

This license is unlikely to come: both Republicans and “progressive Democrats” are pressing the Biden administration to put the muscle on technology exports to the People’s Republic, which would almost certainly block ASML’s sale. 

So then here’s the paradox: the pandemic exposed a profound lack of resiliency in global semiconductor infrastructure. The world’s two largest economies both want advanced domestic chip production, but the capital U.S. industry needs to re-shore comes from Chinese customers, and the technology China needs comes from U.S.-controlled businesses. 

Cooperation could ensure greater security for all, boost global fortunes, and advance human technological achievement, but this would undermine U.S. power. This then is the most critical chokepoint of all: every side of U.S. politics will sacrifice everything to secure continued American domination. 

Will they succeed in sacrificing the future for a decaying status quo, or will investment bypass them to shore up global economic resilience? How that question gets answered will define the years to come. 

Rapid Round

WeWork’s redemption song

Coworking real-estate company WeWork announced Friday that it is merging with BowX Acquisition, a special-purpose acquisition company (SPAC), in a deal that values the company at $9 billion. That is a steep fall from the $47 billion valuation the company achieved in January 2019 before a failed IPO.

WeWork’s IPO fell apart after lavish spending nearly bankrupted the company under the leadership of former CEO Adam Neumann -- a self-dealing former Israeli Navy officer with aspirations to live on Mars and become “president of the world.” SoftBank, WeWork’s largest investor, wrote down a $6.6 billion loss on the debacle. The red hot SPAC space has given the company a new lease on public listing life. 

Lockdowns beginning with the pandemic delivered another blow as remote workers stayed home, dropping members from 619,000 in 2019 to 476,000 in 2020. The pandemic might however be a silver lining for the company, with increased demand from employers looking to move away from less centralized office spaces.

Trillion dollar fighter jet shoots self

A U.S. Marine Corps F-35B fighter jet shot itself with its own gun earlier in March while flying over Arizona, according to a Pentagon Naval Safety Center report. The pilot was unharmed and landed the plane after a high-explosive round from its belly-mounted gun pod fired and then prematurely exploded. The cost to fix the plane: $2.5 million.

This mishap for the flawed fighter is the latest for what has become the most expensive weapons program in history, manufactured by military-industrial giant Lockheed Martin. The Marines’ version of the fighter costs $135.8 million apiece, but the total lifetime cost of the program for the U.S. military’s three branches could reach as high as $1.6 trillion, greater than China’s entire Belt and Road Initiative.

Despite repeated blunders like the self-shooting incident, the F-35 has been politically unkillable. Lockheed Martin boasts on its website that all but two states have F-35 parts manufactured in them. But that might be changing. The Pentagon has added the F-35 to a list of potential programs to review and possibly cut back. 

In March, House Armed Services Committee Chair Rep. Adam Smith (D-Wash.) said Congress should stop throwing money down the F-35 “rathole,” a few months after Trump’s last acting secretary of defense, Christopher Miller, called it a “piece of… I’m like, we have created a monster.”

China, Iran ink historic trade deal

On Saturday, China and Iran signed a major, 25-year trade pact that brings Tehran closer into the Belt and Road Initiative. There are few details of the specifics, but a draft proposal from summer 2020 detailed $400 billion in Chinese investment into Iranian healthcare, telecommunications, petroleum infrastructure, ports and railways in exchange for Iranian oil.

The deal has been in the works since 2016 but picked up after the U.S. exited the P5+1 nuclear deal and reimposed sanctions “intended to bring Iran’s oil exports to zero,” then U.S. Pres. Donald Trump said in 2019. This has since created economic hardship for Iran’s poor, halved the rial’s value and dramatically increased living costs. European companies worried about U.S. punishment pulled out of investment deals, forcing Iran to look east -- to China.

China’s recovery in factory activity and infrastructure building could provide a lifeline for Iranian oil exports. Chinese imports of Iranian oil rose to 856,000 barrels per day this month, the highest in two years. China’s total crude imports ranged around 11 million barrels per month in January and February, up 20% since December. 

The ramp up has historic significance: last week the U.S. Energy Information Administration confirmed that China surpassed the United States as the world’s largest oil refiner in 2020. 

Disclaimer

Our only investment advice: What the F-35 is doing…

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