Monday, October 02, 2006

The great container smuggle

Ralph Schwan sees patterns the rest of us miss looking at the same thing. Think China's commercial success is due to low labor costs? Ralph looks at China's export scheme and discerns a banking op of no mean magnitude. The clues lay stacked behind your local Wal-Mart.

The following piece arrived in my email box just this morning. It's unedited, pure Ralph Schwan. It may explain, for the first time, how China became the world's manufacturer of choice. ~ FTS


There's a lot of talk about what enabled China to become the industrial supplier to the world. Low labor costs are first on that list - but any third world nation will have low labor costs. The thing that really enabled China to fit into that slot was something we miss. It was the really low costs of shipping goods from there to here and Europe. Shipping costs have always been the natural barrier to "world" trade. Were it otherwise, Henry Ford I would have said, "I need to build a plant in Argentina, India or China." George Westinghouse would have said the same. They'd have just shopped the world for the cheapest labor. All cars, motors and TVs would have always been built somewhere else.

Obviously, the shipping costs obviated such a thought from minds back then.

What changed? Really, what has changed since the 1970s?

Best I can tell it's the use of shipping containers, those big steel boxes that'll ride on a boat, a train car or a truck trailer. That's how everything sold at Wal-Mart gets here from China.

It costs about $2000 to ship one from Shanghai to the west coast, Oakland or Seattle. I figure that it costs another $1000, minimum to get it from there to, say Kansas, by train and then truck.

Here's what inspired my thinking about those containers. I was talking to a guy who imports after-market auto parts for pick-up trucks, lots of fancy wheels and other gizmos. They all come from China. He told me that his shipper was having troubles making timely deliveries because their storage yard was packed with the containers. According to him, for every three that come here, only one ever carries anything away. So the shipping yard is packed and stacked full of "empties."

There are only a half dozen shipping companies in the world that own all of these containers. I was stunned to discover that there are 18 million of these boxes! There's enough cubic feet in 18 million 8 by 8 by 20 foot boxes that if one laid the whole human population end to end, then stacked them, we'd all fit! Yup, all 6.5 billion of us! If you lined the containers up, end to end, they'd circle the earth 2.7 times. Packed into one spot, corner to corner, side-by-side, they'd make a square with sides of 10 miles.

If a lot of the containers end up in a storage yard, never being recycled back to China for a new load, it's pretty logical that they'd need that many. But . . .

I build stuff for a living. Most of it's made of steel. I took a look at that big steel box and realized I'd want five figures to build one. In big time production mode, that would drop to $7500. There's that much welding involved. The steel costs alone, FOB a rolling mill in China, are over $2000. Even if I had laborers at 20 cents an hour and a factory 20 miles from the rolling mill, the overhead costs of the shop, 20 mile cartage, electricity, machine tool wear, welding rods, wastage on the steel plate, etc. would force me to a price of $6000. The box weighs 2.5 tons. $6000 ain't a bad number, given what's involved in building one. If I wanted to buy one for storage at my shop and got told, "It'll cost you $6000," I wouldn't even blink at the price.

Tumble the numbers with me. At $6000 each, three cost $18,000. The shipper made 3 x $2000, $6000, to send them to the US, full of Chinese made goods. Only one goes back for re-use. He's instantly down by $12,000, the logical result of a trade imbalance - and that doesn't even account for the fuel costs by the ship to get them here. Nobody is going to ship the empty containers by truck or rail back to a port. That would cost $1000, each. So, the shipper really ought to include the additional costs of $12,000, distributed into every three shipments. Instead of it costing $2000 to get a container full of goods from Shanghai to Seattle, it ought to cost $6000. $2000 + (1/3 x $12,000) = $6000. But even at that number he's just giving the container away at what it cost him - a very bad business practice - so the number has to be greater than $6000.

But if it cost +$6000 to ship it from China, then the Chinese labor discount vanishes from the goods in the box. The product would be the same price, or less (!) if manufactured here!

In trying to figure this out I came on an article,

http://www.spiegel.de/international/spiegel/0,1518,386799,00.html

It says that the cost of the container in China is $2500. That's nuts. The raw steel, alone, is $2000, probably more like $2300 counting a 15% wastage in cutting it to the sizes needed.

If it sells for that price in China, and I've no reason to doubt that it does, then it's a deal, more like a steal. It could only sell that cheap if the government was subsidizing it to the tune of $3500. The manufacturing company makes the necessary $6000, but more than half comes from the government. That's the sole way the shipping company could be paying only $2500.

Now comes a nifty little Ponzi scheme. The shipper goes to a bank, a big international bank. He seeks a loan. The collateral is the shipping containers. He spent $7500 for three of them. But the fair market value is at least $18,000 (what they'd cost if built anywhere). He borrows $17,000. He buys six new containers for $15,000 and pockets $2000. But the fair market value of the new six is $36,000. He borrows another $34,000, using those six as collateral. With that $34,000, he buys 12 more containers and pockets $4000. I could keep doing the iterations, but you can see the game. It's a doubling up with each pass, with a cash profit of about 15% put into the shipping company each time. To keep it simple I started it at low figures. It's probably running at around 1,000,000 containers a year - given that 18 million of them have been built in only 30 years.

The shipping companies can offer very low rates from Shanghai to Seattle - all they want to do is break even, if that. They have a market incentive for that. They do NOT make money on the shipping. They make money by buying containers for shipping! They have to keep the shipping costs very low, as that's what's driving the whole "globalization" concept. If shipping costs were anywhere near their historical norms, then the low labor rates in China would be offset by the shipping costs, and importation would also go back to historical norms. We'd build far more stuff locally! Then the shipper would make very little money - as ocean shipping would drop substantially. But far worse from the shipper's perspective - he'd not need any more new containers. The scheme collapses.

Does the scenario make sense to you? NAFTA and GATT were what enabled it on a "legal" basis. But in a free market, shipping costs should be a significant aspect of a wholesale purchase decision. They always have been. The only way we'd buy stuff from China would be if the costs of getting it from there to here fell way below all historical precedents. And they have.

Shipping via the containers did cut those costs, as it eliminated the old "stevedore" system, which was slow and labor intensive (at both ends). But the container system has a failing. Oh, it's a grand system where countries are trading back and forth at near even rates. But when those rates go into imbalance the containers will stack up in the importing countries, never getting back to the exporting one.

And those containers are pricey by design. They have to be built of steel in order to be stacked atop each other. They're designed to carry almost 50,000 pounds of goods. The box on the bottom has to carry the weight of all the boxes on top of it when they're stacked. So, they're built to the hilt, with reinforcement welded to the corners to carry the load. They ought to last for 100 years, with a new coat of paint every decade or so.

If they recycled in a nearly balanced-trade world, then the acquisition costs would be a triviality over that century. They'd probably make 600 trips, six a year. The $6000 cost would get amortized by the 600 trips, to $10 a trip, easily covered in the costs of shipping. But they're a terrible concept in a world where manufactured goods flow only one direction.

They end up 1000 or 2000 miles away from a port, having been carried inland by trains and trucks. It would cost $1000 to transport them back to port, empty. Those costs aren't built into the shipping price, as again, it would begin to make more sense to build stuff at home. So, the result is that the containers stack up far from a port.

That should cause the shipping costs to rise very rapidly, as the shippers would have expensive assets sitting in storage yards, earning them NOTHING. They'd also have to acquire additional containers, while knowing that two out of three were going to end up also sitting in storage, 2000 miles from a port and 10,000 miles from the factory in China!

So, they had to come up with a Ponzi scheme where the cost of a container didn't matter, or more properly, did matter but in a positive, rather than negative, manner. The bankers don't mind. The shipping companies are paying interest on the principal they've borrowed. Like any Ponzi game, someday it'll crash. The bankers don't mind that either. Then they'll loan money to move manufacturing back here, and charge interest again! It got China industrialized, so companies in China will now borrow from them, too. Oh, and it really masked inflation by getting cheap goods delivered to consumers in America and Europe. So, the banks probably made far, far more that way than what they'll lose when the shippers finally are forced to default on the "container loans." Plus, I'd bet that the shippers don't default, but get a government to bail them out! That's the plan, I'd think.

The assumed subsidy paid by the Chinese government is a triviality in the matter. It probably amounts to $60 Billion, but it's spread out over several decades. It was a ultra-low cost way to get industry booming there! It's insidiously clever when you think about it. If they'd have subsidized industry directly, they'd have had to spend 10,000 times that. If they'd have directly subsidized shipping, the whole world would have screamed "foul!" But they subsidized just a couple of factories that were popping out shipping containers. Then they got some bankers in bed with them, and the world never even realized what's up. They just set up a rather nifty Ponzi scheme that would drive shipping costs way, way below what they'd be in a "free market" - and the world beat a path to China's door!

Yes, the world had to abandon tariffs in order to mask what was going on. But that was really more of a smoke screen than we realize. It got us blaming our governments and "low third world labor rates." We become stuck at that level, never going beyond it, to look at how it can cost so little to ship the stuff made in China all over the world. At first glance, we attribute that low cost to the shipping containers - since they eliminated the old stevedore system. But we never think about how expensive those containers are or how they'd have to be constantly recycled in order to justify that cost. If they don't recycle, then the shipping costs would need to rise greatly in order to cover the expense of getting them back to the producing country or building new ones to replace those lost offshore.

It's really something we don't think about. If I hadn't bumped into a guy who was complaining about shipping delays, I'd have never considered it. Yet, when he told me that only one in three get shipped back, I was a bit surprised that it was that high. Grain doesn't ship in them, so what were we sending back? All I could figure was that the one in three went back carrying scrap metals or used machine tools from a closed factory here, heading for a new factory there. Even then, It took me a week of pondering it from every angle, trying to figure out how the shippers can stay profitable with that much in asset value sitting useless in storage yards. If 2/3rds of the UPS or FedEx truck trailers were just sitting, unused, in storage yards, then they'd be selling them at huge discounts, raising their delivery rates substantially, or verging on bankruptcy - probably all of that!

The only way to explain how that many of the shipping containers can be sitting here is if there's something running outside of an ordinary market situation. This little Ponzi game is my best guess at explaining it. I can't prove it directly. But I'm absolutely certain that $2500 cost for a shipping container can't possibly be right. It's worth lots more than that. It might be what it costs the shipper, but somebody is paying the manufacturer in addition to that. Of that I'm sure.

I'm also sure that if I could buy something worth $6000 to build, for only $2500, I'd do it. If I couldn't really sell it back into the market, but somebody would loan me $5500 against it at 5% interest, I'd jump at that. And then I'd buy two more and double the gain, ad infinitum - well not to infinity. It obviously couldn't go that far. But I'd do it until the bottom fell out! I'd have those collateralized assets stacked up anywhere I could find room, doing nothing. If I could leave them sitting in somebody else's yard, at their expense, all the better. When the bottom did fall out, I'd just tell the lender, "You can have 'em. I have no use for them." If somebody was dumb enough to loan me that against an asset, an essentially illiquid asset, then how could I refuse the offer?

Bottom line: I'd be enticed into doing the same thing that I see others doing. So, I'm not really accusing - just explaining. The good news is that the bottom will drop out, probably pretty soon. You see, if I stacked them into an equilateral pyramid, with a base of mile, the 18 million containers would stand a half mile tall. They're built for stacking, but not that high! The bottom will fail; it has to.