Insight

By Dr Peter Standring, technical secretary, Industrial Metalforming Technologies (IMfT)

The definition of inflation is related to the context in which it is used. For a balloonist and a cosmologist, it implies an expansion of space. For someone in purchasing it indicates a rise in the price of goods and services. For governments, it means a reduction in the value of the currency and hence its purchasing power.

Whilst the economic aspects of inflation will predominate here, it is also possible that the context of the space itself may be considered important. This is because the opposite of inflating space with a medium is withdrawing it which in turn produces a vacuum. Remove a vacuum and the available space can be rapidly refilled by what is readily available and which flows most quickly and freely. This may not be what is wanted or required?

The third decade of this century has witnessed the first global pandemic in one hundred years and the first invasion of a European country in seventy five. For these reasons if for nothing more, since fasteners quite literally hold virtually all assembled manufactured goods together, inflationary pressures on fasteners caused by these events must be important and of concern. This article will seek to examine the: who, how, why, where and when impact that inflation may/will have on the global fastener industry.

The Who

Because of the Covid-19 pandemic, to make any sensible comparison with recent industrial data it is necessary to track back to 2018. In that year Global Industrial GDP was ~US$22 trillion of which construction dominated with ~47%, agriculture with ~15% and oil/gas, automotive and aerospace at ~10% each. In terms of steel use, construction totalled ~50%, Engineering products ~40%, transport ~5%, electrical goods ~3% and domestic ~2%.

With the exception of those engaged on military procurement, the successful involvement in trade requires risk free ventures. Risk is the ‘blue touch paper’ which once lit, can ignite the firework causing it to sail into the sky, or, if it fails to light, will result in unfulfilled expectation.

Table One provides an outline list of general issues that are basic to the requirement for unhindered trade. In normal times for these to run smoothly is always a ‘crossed finger time’ as demonstrated by the Evergreen’s – closure of the Suez Canal in March 2021. Add on the complexities of a pandemic, political sanctions, a war or two, and the speculation rapidly comes down to who owns the best crystal ball?

Table One: Conditions required for trade

The How

All children learn a hard lesson on inflation when the goods they saved their pocket money to buy suddenly become unaffordable due to scarcity and demand. The author vividly recalls leaving the UK one Friday in September 2000 to drive to Stuttgart. Having negotiated his way around numerous French road blockages due to agricultural worker’s protests, he was astonished to be told on arrival one day later that the UK had virtually run out of fuel for road vehicles. This was due to impromptu strikes outside its oil refineries and the resulting panic buying. Information exchange through 24/7 news outlets, which quite often appear to be making, rather than reporting the story, together with the reaction on social media, can very quickly lead to an avalanche of unexpected and often unwanted consequences.

Exactly the same situation exists within all modern supply chains. Data analysists monitor aspects of global trade to glean any information that might indicate a disturbance in the status quo.  Like the famous statement on Chaos Theory about the turbulence of a butterfly’s wing in one part of the world creating a hurricane in another; so a disturbance in obtaining the primary stock in a supply chain could and often does have devastating consequences further along.

Whilst the failure of an automotive supplier to meet the Just in Time (JIT) demands of the OEM’s assembly plant may result in a hefty fine for stopping the line, it is unlikely to influence the price of the vehicle. However, the increased costs due to the lack of silicon chips throughout the industrial sector will inevitably be passed on to the customer. Quite simply this is because all assembly plants are required to produce a specific output in order to be financially viable. Fall below a certain output number and they are unprofitable. However, if all competitors face the same problem, then the industry as a whole can increase their costs without prejudicing their individual status. The same is true for all basic commodity goods from foodstuff to electronics, paper to personal protective equipment (PPE).

Emerging from the recent pandemic, the companies which have survived are all desperately seeking to re-establish the financial basis on which they trade. When ‘cash becomes king’, how it is acquired tends to be of second order importance to having it. This fact has become crystal clear recently regarding the purchase of Russian energy products by countries seeking to oppose its Ukrainian activities.

So, costs which cannot be absorbed by increased in-house efficiencies must be passed on to the customer be they the supply chain partner or the end user. Hence, inflation.

The Why

According to current knowledge the greatest number of extinctions to life on earth (~95%) were caused ~250 million years ago by one hundred thousand years of massive volcanic activity and ~64 million years ago by the asteroid strike that wiped out the dinosaurs. The first was long term, the second, instantaneous.

Living in the Digital Age, it is highly likely (assuming we don’t destroy the planet) that this period will be considered as significant as any time in the geological past. In just half a human lifespan, digitisation has transformed virtually all work, education, health, communication, etc, reducing it to machine-based activities. Artificially intelligent (AI) software packages are in turn likely to become the ‘expert’ systems, which no human can hope to equal. Stock and currency markets, manufacturing design houses, transportation, energy utilisation, government taxation, weather forecasting all function by virtue of the digital systems that drive them. It is likely that AI systems, capable of providing an unbiased report on how any process could be made more efficient, would state: ‘Get rid of the humans, they simply clog up the system!’

In terms of fastener supply, this will naturally result from market demand. In a manufacturing Kanban system, nothing is triggered until a signal is sent from upstream that something is required. Then and only then, is an action to satisfy that demand initiated. Of course, for this to work, the whole manufacturing system must be under control and able to react.

In the global environment, demand can be cyclic due to seasonal changes; influenced by any number of causes of stability/instability; mactivated by reasons of urgency/constant flow; along with constraints imposed due to political factors. As in the case of an AI system learning to play chess, every new feature/move it engages with will require a variation on a theme in order to achieve a desired outcome.

At the present time, the demand for fasteners will be generated by those having the greatest need in construction and engineering as mentioned previously by steel consumption. This will be activated by the supply side business software and orders issued to fulfil the need. Where competition is fierce, it is likely that inflationary pressures will be resisted by those further up the supply chain leading to an inevitable cost crunching squeeze – of which more later.

The Where

As periods of massive inflation have demonstrated many times over, where it hits, it hits everyone. In the worst cases, devalued money requires wheelbarrows of the virtually worthless paper simply to purchase bread. Workers with hungry families require instant payment for their endeavour in order to purchase what their labour earns now because at the end of the day, they may no longer be able to afford it. Inflation feeds poverty which in turn suppresses purchasing power and the ability for many citizens to even buy what they require to live on. If a government has the collateral to borrow and fund huge national programmes of employment as the USA did in the 1930s and China has done in the last 30 years, then it can become the ‘blue touch paper’ which once lit, dazzles the world.

However, if the international financial lenders perceive a previously incurred debt mountain too large and precarious to climb, then countries seeking salvation in obtaining further loans have little hope of escaping the quicksand of inflation.

Of course, the flip side of what is in essence a currency devaluation, will mean that for those living outside the currency zone and who use a different (non-inflation infected currency), can benefit from purchasing low priced goods. Essentially, the workers operating in inflation struck countries provide the low labour cost cannon fodder for the country to perform on the international stage to provide, ‘lasting benefit for all!’

The consequence of this widely practised business approach to ‘acceptable’ slavery, (both seen between and within national boundaries) is to weaken/bankrupt long standing businesses within countries where the currency is not under threat. The laissez-faire, free market sympathies of Adam Smith, were formulated at a time when the global trading world was operated by individual government cartels locking others in or out of the patchwork quilt of their overseas activities. Since the 18^th Century, trade between so called equal partners has never been a successful idea. It led directly to the formation of the USA (the Boston Tea Party), the many straight line national boundaries which cover today’s map of the world and the ‘them and us’ situation found in supply chains.

The When

In the 1980s, China switched from operating a command economy to one based on capitalist principles. Its refusal to appreciate its currency coupled with its open arms approach to overseas buyers, made it the low-cost country of first trade interest. Almost everything that could be sold, was sold and populations around the globe were offered bargain base products at incredibly low prices. The outpouring of goods from China at, ‘The China Price’, refined the container ship revolution. This was accompanied by open invitations to any and all of the world’s leading manufacturing companies to set up business inside China on the most favourable of terms with access to the potentially largest and fastest growing market on earth. The proviso; often, joint venture involvement with a Chinese partner (which included the sharing of all training and supervisory roles) and, the demand that only the latest, state of the art equipment be brought into the country.

By 2001 when China was admitted to the World Trade Organisation, its role as ‘manufacturer to the world’ had been well established along with sufficient foreign currency to fund the next phase of China’s march toward economic dominance. What hadn’t and still hasn’t been settled, is how China’s huge State Owned Industries (SOIs) sector, can operate equitably within a free market, global environment.

Having woken up to how dependent the rest of the world has become on manufacturing in China, in particular to the significant reduction of its own lower and middle core network to support the bigger players, the former laisses-faire policies of the industrialised world are being rapidly reversed in an attempt to recapture what has been allowed to slip away. Global imports of Chinese fasteners tell their own story! All efforts to reverse this trend will be inflationary.

Where to from here?

Without being alarmist, it is easy to see the impact of the Covid-19 virus as a cause of multiple significant reactions. Imagine the monster from the Frankenstein story. It is made from various dead bodies and is often shown having a bolt through its neck, presumably to hold the head on? A switch is pulled, and an electrical charge surges through the body. The creature lives! Covid-19 could be equivalent to the charge that actuates the composite body gleaned from graveyards. This is not unlike the very different (political) ways individual communities have addressed the virus problem and are still trying to deal with it.

Subsequent lockdowns, supply chain problems, economic and industrial pressures together with one thousand and one additional issues have created many reasons why, in the Covid case, the human family have found it difficult to function as one. Throw into the mix, ‘irresponsible behaviour’, causing the displacement of millions of people who become, the ‘dispossessed’, etc, and ‘normal service’ is not likely to be resumed any time soon.

In the here and now, all manufacturers will face the on-going onslaught of severe inflationary pressures on their businesses. Those operating on loans from whatever source, will experience the ‘debt trap’ of payment upfront to be able to run their business and the downstream delay of payment from their customers. Those who can operate without requiring loans enjoy a small comfort zone dependent on the capital available.

A one billion US dollar vehicle assembly plant (not large) would be designed to have a throughput breakeven number of ~70% efficiency. Any number less than this would have a negative return on investment (ROI). Plant closure on ‘furlough schemes’, short time working etc, can be used to slow down the drain on expenditure.

The bigger the plant, the greater the losses incurred. Full production is required to trigger the supplies needed to keep running and operating effectively. Just in Time (JIT) systems means call-off numbers of supplies to match the demand. Introduce a shortage of computer chips and the global automotive industry catches a cold!

Basically, JIT means the automotive OEMs only pay for what they use – post very limited vehicle assembly. Delays cannot stop the line, so suppliers must produce and hold (as yet, unpaid for) stock.

A typical medium to large scale fastener manufacturer will need to order stock months before delivery. Smaller fastener producers will rely on the availability through stockholders. In this latter case, traceability of the stock may present problems. Whatever the situation, inflation will add a percentage increase in material cost of say ‘A’.

All manufacturers have similar direct costs involving: labour, tooling, energy, transport, etc, along with the indirect costs of premises, depreciation of equipment/facilities, etc. In a period of inflation all these factors will involve individual increases in cost, say ‘B’ x n (where n is the number of factors involved). Moreover, in almost all cases, the direct costs require upfront cash payment in order to produce the goods. Depending on their customer base, virtually all fastener manufacturers are paid for their products retrospectively – how retrospectively depends on their customer.

For one to one relationships (distributor/customer/OEM), the cash flow gap is written into the supply contract which the supplier enters into with open eyes. However, throw into the global pond, not one but two relatively minor asteroids (on the scale of things) and most well planned and smoothly executed plans are, in effect, scrambled. Again, for reasons of inflation, the purchaser of fasteners will also increase their costs/price by say, ‘C’. This means the inflationary increase will be the original price plus ‘A’ + ‘B’ x n, + ‘C’ (at the time of writing ~10% to 12% in each case). This does not include a desperate need of all concerned to try to restore the pre Covid-19 cash reserves. Given the limitations of most crystal balls, those companies operating on loans, will find it difficult to receive an open arms welcome from many funding bodies that they seek to obtain financial support from.

Companies that do not require loan support for their operations will look nervously to the horizon wondering what supply issues may be lurking out of view. In the other direction, they may consider just how well the customer and their customer base are tolerating these ‘once in a lifetime’ issues? The view from the middle is unlikely to stimulate any current desire to invest for future growth.

The apparent incompatibility between the demand for energy, fossil fuels and climate change, simply adds yet another massive global imponderable choice to the mix.

As illustrated in Table One, the current and immediately foreseeable conditions required for trade are not good. Currently, for individual manufacturers, ‘cash’ may well be king. However, all business, whether local or global, requires a stable environment within which it can operate. When an undefined war breaks out in Europe and talk of nuclear weapons being used is publicly discussed, as Shakespeare wrote in Hamlet: ‘Something is rotten in the state of Denmark’.