Boeing’s Shutdown Not as Scary as It May Appear
The drop in the price of Boeing stock by 24% since the beginning of March has served as a big drag on the Dow. Now it singlehandedly may be putting down GDP by 0.5% more.
Manufacturing data has been sluggish for quite a while, which in itself has spurred concerns about a potential recession. As the thinking goes, when production output slows, people get laid off, and this reduces spending. Less spending reduces the money supply, especially when we borrow less, and the money supply basically equals the amount of money loaned out, not how much people make.
Money that is earned and spent doesn’t increase money supply, because it just involves people passing money from one to another. People give money to your employer, they pass it on to you in wages, and you pass it back to companies when you spend it. When we spend less or earn less, this does reduce the money supply because it takes it out of the system, but we tend to overestimate this impact as it can be offset by borrowing only a tenth of this amount lost.
When we borrow to buy something though, this is where we get new money supply, because the loan creates new money. This is different from your employer giving your money, because banks don’t just hold a pile of cash in their vaults which they hand over, they instead put money in their vaults and leverage it, where banks can lend out 10 times this vault money, their reserves.
This is actually the part of the economy that we want to focus on, more so than numbers like how much money was earned by companies and later passed on to employers to spend. GDP isn’t the be all end all of economic growth, even though it does matter, and while the expansion of credit will eventually find its way into GDP, borrowing levels are the lifeblood of a modern economy, and we therefore don’t want to get too alarmed when we see how Boeing’s shutdown is expected to affect the economy.
GDP is more of an indirect measurement of economic growth, even though we may think of the total manufacturing output as the economy itself. There’s much more to economies than this and this isn’t even the most important thing, and it’s actually the borrowing by companies that they use to expand that has the biggest effect from the supply side.
Lost wages from a shutdown remove a certain amount of money out of the economy, on a dollar for dollar basis, but borrowing multiplies money by 10 times, so it’s the amount of borrowing and how this debt gets paid back that packs the bigger punch.
If the reduction in production is more across the board rather than just being a one-off situation like with Boeing, we may want to worry about a half a point reduction, which the Boeing shutdown is expected to cause if it lasts for a whole quarter, because this is more likely to indicate a trend. When a company shuts down the production of one of their aircraft for a while and the reason isn’t reduced demand but instead result from a temporary situation arising from regulatory issues, this is nowhere near as big of a deal as it would normally be.
GDP growth these days has been floating around 2% this year, and both the financial markets and the Federal Reserve have been quite happy with that. There have been plenty of people worrying about this going too low, but this has been quite stable and has been helped along with 3 recent rate cuts by the Fed, who have more of these treats in their sack to give out if needed.
As testimony to the importance of the borrowing part, the Fed sees production decline, meaning GDP growth, and they step in and make it cheaper for everyone to borrow. We borrow more as a result, this increases money supply, and not only stimulates demand, it does so with the multiplier effect, making these moves quite powerful indeed. This fixes the problem pretty quickly unless we are in a real economic mire, where this will still work but may need more time to play out.
We Can Simply Create Enough Money to Offset the Economic Losses of Boeing
Our economy is therefore managed by a single control, the lever that ramps up or turns down the amount of borrowing in an economy. The Fed ramps up the economy two ways, by lowering the rate that they charge to lend to banks, and by borrowing more themselves and buying treasuries. When they want to slow down the economy, they do the opposite, by charging more to lend and by selling treasuries and essentially paying back money that they borrowed to buy them.
Money is created by lending and destroyed by paying back borrowed money, and therefore we need to keep up the amount of credit in circulation and carefully manage this to manage the economy. When production declines like we have seen with Boeing, we just get the system to borrow an amount that offsets this loss and we’ve addressed it, which can happen both organically and through monetary stimulus.
A lot of people will be temporarily put out of work by Boeing’s halting production of the 737 MAX, but this can be made up for by just seeing us to borrow more overall to offset this loss. It really is that simple. Companies borrow more, they expand more, they produce more, and production eventually picks up. The numbers here may appear large but this is not something that cannot be easily dealt with, and this is not where the 0.5% reduction in GDP comes from, as the loss of production itself is what causes this.
Organic growth in itself and the expansion of the money supply that this has produced on its own has gone a long way to offset the impact of all these recent additional tariffs, and in case that this needed a little help, we’ve had the Fed push their magic lever forward three times to make sure that we don’t lose any real altitude, which will also serve to offset the Boeing problem as well, in addition to anything else of the modest variety that ails us, and it’s all modest right now, this side of the 2020 election anyway.
We do need enough demand in place to make this work, but lowering rates exposes latent demand, which is subject to the influence of price with credit just as everything else is. You reduce the cost of borrowing, we borrow more, we spend more, and we produce more to satisfy this greater demand.
Boeing continued to contribute well to GDP even just building and parking these planes, which they have been doing lately, because GDP measures production only, and this instance is an excellent example of this effect. Not building them for now takes this production off the grid and this is where the effect on GDP comes from.
The shutdown isn’t expected to happen until January, and is expected to last a full quarter, and the expectation is that between the impact of the shutdown itself and the accompanying reduction in production from Boeing’s suppliers, we’ll lose half a point off of 2020 Q1 GDP.
As alarming as this may appear to be, this is nothing like a drop in GDP from the economy itself contracting, and is not something that investors should concern themselves about too much, unless they of course own Boeing stock, which is where the sparks are originating from and will be mostly confined to.
It’s obviously better for the economy if they continued to just build them and park them in their lots, waiting for the day that they can start filling orders again, but this really doesn’t have that big of an impact on the economy either. While this big of a drop in GDP, essentially reducing its growth level by a pretty massive 25% all by itself, should normally startle the Fed and have them sliding down poles like fireman do, they will realize that this fire isn’t all that big and likely won’t take any action at all, and none will really be needed either.
It has been estimated that this affair with the 737 MAX has already resulted in a 0.2% loss in GDP thus far, where if not for this incident we’d be that much higher. Once again though, this is not an organic issue and is more like the contraction of production that the strike at GM caused. After the strike ended, we saw this temporary effect on GDP and on the labor market go away, and the same thing will happen with Boeing’s slowdown, provided that they actually do resume production that is.
GDP numbers are important as a forecasting tool, and where the numbers are at any given point in time only are useful in looking to predict trends, and we’re focused on more than just the next quarter with this. We use these numbers to figure out what we’ll need to do in order to keep them in line with our future needs, where if they are expected to be too low down the road, we’ll jump in ahead of that to better shape these future numbers to our liking.
Boeing’s Problems Should Resolve Themselves in Good Time
Once things are up and running, which may not happen as fast as Boeing likes but will happen, their production will ramp up again and this will all be made right, at least if demand for the aircraft is maintained. This is a separate worry though but as time goes on, and people get more comfortable with flying in these improved versions which have corrected the original safety concerns, the impact of all this may end up being pretty minimal, and Boeing may take its rightful place again among the other industry leaders.
Our GDP forecasts need to account for the temporary nature of all this, where we need to discount this temporary effect. Moreover, building surplus planes right now, beyond the surplus that has already been built, is not something that has that much of a material effect on the economy at all, even while it is going on.
This can still serve to scare some people though, and when we get the Q1 GDP numbers next April, we need to account for these temporary effects and basically just ignore them, although this is bound to cause some false fears and may inspire some sort of negative reaction in the stock market in particular.
The economy itself, the part that matters, still looks good regardless, and the recent rate cuts will increase borrowing enough to handle both this and the effects of the trade war. The Fed will not cut rates to address a temporary situation like this anyway, because that in itself will need to be corrected later with a corresponding rate hike, and that’s not a stable way to manage things, They also aren’t prone to jumping to conclusions like the stock market famously is, over-reacting to things and then settling in to a more deliberated view once the fear gets filtered out.
Investors in Boeing stock haven’t had much to celebrate as it bounces around its current zone, but it is still actually up year-to-date, unlike a lot of stocks under pressure. Boeing is still producing some nice trades though and while its volatility requires that we trade it carefully, there is some real money that can be made from it under the right guidance.
We have seen a lower high from the previous move though, so we need to be aware that this may happen again, especially with the expectations of this shutdown looming. Real money is being made on this from both the long and short side though, and another 10% gain like we saw from late October to late November may be in the cards again if we are patient and enter when it does show us it is ready for another move to the upside, although we may need to settle for less again this time, with another Fibonacci-like retracement.
From an investor’s perspective, the idea is that we have likely oversold this stock longer-term, as we almost always do in these cases, where the actual problems do not run so deep and are of a much shorter time frame than investors look at. It’s hard to imagine the 737 MAX fiasco making Boeing worth 25% less long-term, and this does tell us that we have overdone things now, but this is by no means unusual with stock valuations.
In a few years, and investors invest for even longer than just a few years typically, this will all be just a memory, and the stock will remember why it has gained over 75,000% over the past 45 years, by being such a big fish in a big pond.
The 737 MAX was a huge blunder by Boeing, but once the initial shock hit the stock over the first two months, it really hasn’t come down much from there even given that it is on the bottom of the range that it has traded in since. We’ve been in a sideways move ever since, a holding pattern that sharp traders have been milking while sharp investors wait for it to start flying again like usual.
This story has been for the most part already told and we’re just waiting for them to clean the debris from the tarmac and get this plane back in the air again. We want to make sure that we step around the debris that is left and not trip over it, or especially not let our concerns about it become overblown where we see it puffed up in quarterly GDP growth numbers and start to think that the sky itself is falling, even a little bit.
The economy itself continues to hum along quite well and any real effect upon our economy from this will both be minor and easily managed. As big as Boeing is, the U.S. economy dwarfs it of course, and if it is the U.S. economy that we’re concerned about, we have to look at all the aircraft in the air, not just one, and the skies look plenty friendly regardless right now.
Editor, MarketReview.com
Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.
Contact Robert: robert@marketreview.com
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