The Cutting Edge — October 2003

Business Briefing

By Art Raymond, A.G. Raymond & Co., Inc. (araymond@raymondnet.com)

We’ve all heard Benjamin Disraeli’s quotation. “There are three kinds of lies: lies, damned lies, and statistics.” That renowned British prime minister had it right. Statistics can lie and, more importantly, can mislead those seeking an informed opinion. Reliance on a few statistics rather than the whole story can spin a mistake into a myth.

Today’s economic news abounds with such ill-founded beliefs…

Myth No. 1 – Raising the value of the Chinese currency will fix the U.S. economy.
By now everyone knows that the Chinese yuan, also known as the renminbi, is pegged to the U.S. dollar. With that situation the relative value of the two currencies does not change in spite of trade or capital flows between the countries.

Pundits, politicians, and businessmen impacted by the tidal wave of Chinese imports are now calling for the yuan to float or at least be repegged at a lower rate per dollar. The National Association of Manufacturers has concluded that Chinese goods are 40% cheaper than if costed with a properly valued yuan. The result, so they say, has been a significant loss of jobs particularly in manufacturing.

NAM’s claim must be taken with a grain of salt. No one can accurately compute what the correct yuan/dollar exchange rate should be. That determination is best left to the foreign exchange market. Nor can anyone say without doubt the direction a floating yuan might take. Remember, in an open market, it’s the flow of capital around the world that causes currencies to move up or down. China allows capital into the country but prohibits money to leave. If cash were allowed to flow freely, the yuan might actually fall.

China channels its import profits and direct investment by foreigners into mismanaged state-owned banks. Plus its stock and bond markets are dysfunctional. The results are poor returns for its local investors. Household savings in China are equal to about 100% of GDP. Given the chance to move their money to other countries where investment returns are healthier, Chinese may choose to sell yuan and buy U.S. dollars or euros. The market will, as appropriate, set the value of the yuan. In this case the appropriate rate might be more yuan per dollar. Few have considered that possibility.

While China’s bilateral trade surplus with the U.S. is huge ($100 billion in 2002), its balance with the rest of the world is now in deficit ($75 billion in 2002) for the first time in eight years. China is the biggest importer of South Korean and Taiwanese products. If Hong Kong is counted as part of China (and it is), the combination will soon be the largest export customer for Japan, Singapore, Malaysia, and the Philippines.

Also we must remember that China’s foreign exchange reserves total about $356 billion, much of it in U.S. treasury debt. If the yuan rises against the dollar, the value to the Chinese of these dollar-denominated assets declines. U.S. debt securities then must be priced higher to attract buyers. To do so means higher interest rates. That scenario usually presages a slower economy, not a desired result. A yuan revaluation causing the wholesale dumping of U.S. debt by China could unhinge the world financial system and risk a deep recession.

Beyond helping to keep U.S. interest rates low, China can rightfully remind us of other benefits from U.S.-Chinese trade. For many products they are the world’s most efficient workshop turning out tons of inexpensive goods for the U.S. consumer. Many of these items can no longer be manufactured in the U.S. And, most importantly, China is and will be a significant customer for U.S. goods and services as the living standards of their people rise.

Don’t forget that other Asian countries also account for a significant part of America’s trade deficit. Like the yuan, the Malaysian ringgit is pegged to the dollar. The Hong Kong dollar is tied to the greenback through the actions of a currency board. Officially other Asian currencies float, but central banks have been intervening on a large scale to hold their currencies down as the U.S. dollar has fallen. For competitive reasons no one wants their currencies to rise vis-à-vis the yuan. And these countries hold large amounts of U.S. treasury debt too.

Myth No. 2 - Manufacturing is disappearing in the U.S.
In spite of reports to the contrary, manufacturing is alive and well in the U.S. As a share of our economy, real goods production was 39% of GDP in 2002. Compare that to a high of 35.5% in the 40’s, 34.9% in the 50’s, and 33.6% in the 60’s.

Manufacturing over the past ten years, in fact, has been growing. From 1992 through 2000 U.S. manufacturing grew by 5.3% annually. In 2001 production declined by 4.1% but bounced back by 6.1% in the first three quarters of 2002.

Yes, the number of true manufacturing jobs has declined (see myth no. 3 below). Our producers are making more with less. Do we really want to make less with more? Isn’t higher productivity one of the selling points of your woodworking machines and tools?

The current story resembles the decline in agricultural employment in the last century when millions left the farm for the factory. These workers were productively absorbed by our economy, and that transition resulted in a higher standard of living for everyone.

Myth No. 3 – This economic recovery is jobless.
The TV talking heads are bombarding us with reports of jobless economic growth. Do those reports make sense? Could the economy really be growing without adding jobs?

Seems there are two sources of employment data. One is the Establishment Survey in which the U.S. Labor Department (DOL) asks businesses how many employees they have. The other is the DOL’s Household Survey that asks people if they have a job. For a variety of reasons these surveys yield different results especially when the economy is in transition.

For the twelve months ending in August, the Establishment Survey showed a loss of 463,000 jobs. The Household Survey indicated the creation of 313,000 new jobs. The job loss blamed on President Bush also improves from 2.7 million in the Establishment Survey to only 220,000 in the Household Survey. Using the latter numbers just might change your opinion of our economy.

The Real Issue
What we need is leadership and diplomacy, not the whining and posturing of those in power here and around the world. China must make domestic market reforms, fix their banking system, and understand their new place in the world order. The U.S. must focus on lowering its current account deficit, now running between 5 and 6% of GDP. The answer is not as simple as raising the value of another country’s currency. Economic solutions rarely are.

By tilting at the foreign exchange windmill, we expend energy better used to help our own economy. To create an environment attractive to the high tech manufacturing needed to replace old, smoke stack businesses, our leaders must develop policies that help both industry and our workers. Industry can benefit from incentives to investment. The misplaced steel tariff that has actually cost jobs must be repealed. Displaced workers must be retrained and supported during that training.

We must remember that world trade is not a zero-sum game. China and the U.S. are the growth engines of the world economy. The challenge is not to put either country’s workers out of jobs but rather to employ the labor pool of both countries to best use.

Bottom Line: There are no silver bullets for the world’s economic woes and imbalances. But blaming our problems on others sounds like the defense attorney who attributes his adult client’s guilt to some childhood incident. Let’s put the electioneering and flag waving behind us, take responsibility for our own failures, and get to work building a better world for everyone’s benefit.

Sector Situation Report

Latest news from the wood products industry by sector…

Office Furniture – BIFMA reported that July shipments increased 1% vs. a decline of 16% in the same month last year. This performance is the first positive shipment comparison in 30 months. Adding to that positive note, orders improved by 2% vs. July 2002, only the second positive comparison in 30 months. Industry shipments are down 7% YTD; orders, down 5%.

• Steelcase posted a 7.2% revenue decline in their 2Q2004 but a small operating profit. Gross margin increased to 28.6%. On the bright side the company sees a slight improvement in orders in the 3Q.
• Meanwhile Herman Miller saw sales decline 6.5% in its 1Q2004 but managed to squeeze out a small profit.

Kitchen Cabinets – Cabinet sales rose 12.5% in August vs. the same month in 2002 according to the KCMA’s Trend of Business Survey. For the first eight months of 2003 cabinet sales were up 10.5%.

• American Woodmark, the second largest U.S. cabinetmaker, reported sales growth of 12.7% for their 1Q2004, but gross margin fell to 21.8% from 26%. Management blamed the shortfall on the introduction of a lower-priced product line. Operating margin also suffered, falling to 8.1% from 11.1%.
• Masco, the largest U.S. cabinetmaker, reported better performance in their cabinet divisions during their 2Q2004. Sales increased nearly 9% to $743 million with operating margin rising to 15.2% from 14.7% in the same quarter last year.

Home Furniture – The American Furniture Manufacturers Committee for Legal Trade has grown to 31 members in support of their anti-dumping petition against Chinese wood bedroom producers.
Meanwhile Chinese manufacturers have retained Washington, DC, legal counsel to challenge the dumping allegations.

In the real furniture world, retailers indicated encouraging Labor Day sales. However analysts are unable to determine if an upward trend in furniture sales is developing. Retailer Pier 1 Imports reported 2Q2004 sales up 4%. Havertys noted that its August sales were up 10.7% on increasing store activity.

At the producer level…

• Furniture Brands International management has trimmed its 3Q guidance on sales and earnings, its fourth such reduction in FY2003. Also retailer Havertys is ending a strategic alliance with FBI. The 1997 agreement allocated half of the retailer’s floor space to FBI products. Havertys is continuing the development of their own branded products, mostly sourced from offshore manufacturers.
• La-Z-Boy, America’s second largest furniture producer, reported a 9.2% decline in 1Q2004 sales to $451 million. Operating margin fell to 2.5% as a number of plants ran at less than full schedules to avoid inventory building. The wood furniture segment saw operating margins at (4.5%) due to costs associated with plant closures. Management noted sluggish retail activity through the summer months and are predicting their 2Q sales to also be down in the mid single-digit range.
• Ethan Allen reported FY2003 sales of $907 million, up 1.7% over the prior year. Management is forecasting a stronger first half of their FY2004.
• Chromcraft Revington reported a 19.2% decrease in 2Q2004 sales and a 26.7% decline in net profits. Management attributed this weakness to increased foreign competition and a tough economy.
• Bassett Furniture announced that 3Q2003 sales fell by 5% due to falling sales to JCPenney, who is now sourcing furniture direct from offshore producers. Net income for the quarter was only $1.6 million on sales of $74.4 million. Wood furniture sales decreased by 10%. The Bassett Furniture Direct retail store program continues to grow with 96 stores now in operation.
• RTA producer, Bush Industries, announced a 10.3% sales decline to $70.8 million for its 2Q2004. First half sales were $145.7 million, down nearly 13%. The rollout of a commercial office furniture line plus additional placements in Top 100 home furnishings retailers is expected to result in a stronger second half.
• Another RTA producer, O’Sullivan, also announced a decline in business with its 4Q2003 sales of $51.6 million, down 33.1% from the prior year. Full year 2003 sales were $289.2 million, down 17.2%. Sales decreased in all distribution channels. Operating income for the year was 9.1% of sales vs. 11.4% in FY2002.

Wood Flooring – August shipments of strip flooring declined 4% over the same month in 2002. For the first eight months of 2003, shipments were down 1% over last year. In spite of strong new housing and remodeling numbers for the first half of 2003, flooring looks set to fall well below last year’s 10% growth.

For the last Business Briefing article, click here.