More on supply shock

Re the post below, Alex sez:

This domino effect idea is kind of hard for me to buy. It reminds me of the Y2K bug or something.

Basically, the disaster rests on the idea that if a bunch of consumers (car manufacturers) of some product (car parts) cease to exist, then the manufacturers of those products (car part manufacturers, natch) go out of business.

Uh, what? I thought that when demand goes down, even drastically, supply goes down to match, not to 0. Sure, they'll have a hard time for a while. But to me, the natural thing to happen would be the following: all suffer for a little while, until one fails, then another, then another. As these part manufacturers fail, business gets better and better for the rest, until we reach equilibrium, and the supply meets the demand. It's not like they'll all fail exactly simultaneously.

Why would this not happen? Admittedly, this is still very bad.

Apparently, it's a bit more complicated than that. I've found a better explanation of the supply shock phenomenon here--definitely worth a read.

The problem isn't so much that globally people won't be able to manufacture cars--it's that nobody will be able to manufacture cars in America for the next year or so. And this will cause all car manufacturers in America to shutter their plants--even the ones who were performing well, like Toyota, Honda, etc. Moreover, the problem is greatly exacerbated by the fact that we are in the midst of a once-in-a-century credit crisis: normally when companies encounter short term revenue shortfalls they simply borrow money to cover operating costs, but these days they can't get a loan, and so a short term revenue shortfall can spell doom for a company. Given a long enough horizon things will even out again, but most of the car manufacturing will have moved overseas by then.

In the end, the potential number of jobs lost is staggering: it could be as much as 200,000 just from the car companies alone, plus like 600,000 more from all the companies that support them. To put that in perspective: suppose that tomorrow, Adobe, Google, and Oracle all went out of business. Imagine how that would affect the economy of the Bay Area, and even California as a whole. You know how many people those three companies employ? About 90,000. So if all this really happens, it's going to be, like, Armageddon in the Rust Belt. And when you think about all that economic devastation, and the timing of it--coming as it does in the midst of a credit crisis and on the brink of recession, if not depression--a $20b loan seems like a small price to pay to keep the auto companies alive until things get stable again.

Supply shock

A must-read article in the NYT--one of the few I've read that actually do a good job explaining a concept from economics. Apparently, one of the main risks of GM and Chrysler failing is that it will effectively destroy the entire car manufacturing industry in the United States, including companies like Toyota and Honda, which have factories in the South. The reason is because GM and Chrysler generate a lot of the revenue for parts suppliers--the companies that make axels and sparkplugs and such--and, do to the credit crisis, these parts suppliers can't borrow money to stay in business. But if they go out of business, then all the other car companies--Ford, Toyota, Honda, etc.--will suddenly not be able to buy parts, causing their assembly lines to stop:

As a result, the hypotheticals about the domino effect of the companies’ troubles through the vast network of auto supplier firms — which employ more than twice as many workers as the carmakers — are becoming real.General Motors and Chrysler, for example, owe their suppliers a total of roughly $10 billion for parts that have been delivered. G.M. has held off paying them for weeks, and Chrysler is paying in small increments. But the cash shortages at G.M. and Chrysler are getting more severe, according to their top executives and other officials.

...

Many of their suppliers are teetering on the verge of bankruptcy themselves, and do not have the luxury of extending credit much longer.

“I don’t think that suppliers will be able to get through the month without continued payments on their receivables,” said Neil De Koker, chief executive of the Original Equipment Suppliers Association in Troy, Mich., a trade group.

When suppliers big and small start failing, the flow of parts to every automaker in the country will be disrupted because as suppliers typically sell their products to both American and foreign brands with plants in the United States.

“There’s no question it will hit Toyota, Honda and Nissan too,” said John Casesa, principal in the auto consulting firm Casesa Shapiro Group.

“Many of the small suppliers will simply liquidate because they don’t have the resources to go reorganize in Chapter 11 bankruptcy,” Mr. Casesa said. “They’ll just go away.”

It is the dire scene laid out at the first set of Congressional hearings on an auto bailout in mid-November by Ford’s chief executive, Alan R. Mulally.

“Should one of our domestic competitors declare bankruptcy, the effect on Ford’s production operations would be felt within days, if not hours,” Mr. Mulally said.

...

In years past, suppliers have often been able to assist a troubled automaker by extending payment periods to get through tough times.

But by Mr. De Koker’s estimation, hundreds of suppliers no longer have that flexibility. They cannot borrow money in a frozen credit market, and they cannot buy raw materials without first being paid for parts they already shipped.

The Big Three, along with their foreign competitors, are what most people think make up the entire auto industry. But the car manufacturers are just the top of the pyramid.

While G.M., Ford and Chrysler employ 239,000 people in the United States, the country’s 3,000 or so auto suppliers have more than 600,000 workers.

If the bailout effort fails, and GM and Chrysler go under, can't the government work out some kind of plan to extend credit to the parts suppliers, so that they can keep feeding parts to the surviving car manufacturers in the US? At least that way GM and Chrysler wouldn't take everyone down with them...

PS: Here's a quote that doesn't bode well for the Mixed Metaphor Index:

“It’s like the dog chasing the tail,” said Tom Mullen....

“Everyone is stretched like a bungee cord,” he said. “We are waiting to hit the bottom of the river and waiting to be slingshot back up, hopefully."

I count four, with some pretty serious incoherence. What kind of a river slingshots you up when you get to the bottom of it?! First we're a dog, then we're sinking in rivers...there's even a bungee cord thrown in for good measure. Insanity.