Too much efficiency amounts to fragility

Wednesday, 6 July 2022 — Albert Park

[6 min read]

Dear Reader,

In his last edition of The Daily Reckoning Australia, Jim Rickards explained the first E that has unintended consequences for supply chains — efficiency.

Today, Jim explains the hidden costs behind measures to improve efficiency.

Cost reductions might not be as simple as they seem — and they might impact your investments…

Read on below to find out more.

Regards,

Callum Newman,
Editor, The Daily Reckoning Australia

Dear Reader,

In my previous edition of The Daily Reckoning Australia, I listed a variety of techniques to optimise efficiency.

These concepts all involve planning the supply chain itself, sourcing inputs and raw materials, making the product in the most efficient manner possible, delivering finished products with optimised transportation lanes, allowing for the return of defective products or the disposal of any waste, and enabling people with the right skills to carry out these tasks.

Looking over these techniques and tools, one is not surprised to learn that there are hundreds more supply chain management techniques. Without getting into details, some of these other techniques include master scheduling, inventory planning, total quality management, continuous improvement, warehouse management, material requirement planning, cross-docking, vendor-managed inventory, and many more.

All of these supply chain management models have one goal in common: to reduce costs. For example, cross-docking is a method invented by Walmart where goods arrive at a distribution centre and are moved immediately from an arriving vehicle to another vehicle that’s headed to a particular store. The goods never enter the warehouse and are never included in distribution centre inventory.

It's as if the goods were shipped directly from the cargo ports to the individual stores; the distribution centre is just a place to change trucks, not a place to stack inventory. This process saves time and money and lowers costs to the consumer. It’s one of many ways that Walmart keeps its promise of ‘Everyday Low Price’.

And these supply chain tools have been greatly enhanced by computers, algorithms, and artificial intelligence. A company receiving inputs from 10 countries through four US ports, distributed to 10 warehouses using seven major trucking companies has 2,800 possible transportation lanes.

Computers can be used to optimise these lanes in ways that reduce the actual routes to perhaps the 40 that make the most sense in terms of time and money. The manufacturer will select from among these 40 options while using the computer to update the optimisation software with new inputs and continually searching for the best routes.

The downside of cost reductions

Why does cost reduction weaken supply chains and lead to breakdowns? The answer is that cost reductions have hidden costs.

When you increase the length of a supply chain to reach lower labour costs in Asia, you also increase the number of things that can go wrong along the way. When you reduce your trucking providers to the two offering the lowest rates, you increase your vulnerability if one of those two suffers a stroke or is disrupted by a natural disaster. If you route all of your inbound cargo to the Port of Los Angeles (instead of Houston, New York, or Tacoma) in order to be close to your distribution centre, what happens when the Port of Los Angeles becomes a global bottleneck — which it has?

Put differently, the hidden cost of efficiency is vulnerability. It might be more costly in the short run to use multiple ports of entry, multiple trucking companies, and widely separated distribution centres. But those redundancies can produce great savings in terms of keeping manufacturing processes running and avoiding lost sales if one of those ports, truckers, or distribution centres is disrupted by pandemics, weather, natural disasters, or power outages.

The best way to think of how the added costs of redundancy can produce savings is to think of it as insurance. When you buy insurance, you hope that you will never need it. When you pay your insurance premium, you consider it money well spent, even though it has no immediate return. When you have an insurance claim, you receive great value. The insurance can save you from financial ruin, even though the premium is a short-run cost. Redundancy or resilience built into supply chains can save your business from ruin.

All the best,

Jim Rickards,
Strategist, The Daily Reckoning Australia

This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.

Dear Reader,

Today is a holiday in the US. Americans celebrate what they used to be. And pretend they still are.

But back then, the government was microscopic. No Department of Energy. No Environmental Protection Agency. No troops all over the world. No foreign wars. No unpayable debt, unresponsive bureaucracy, or unworkable plans. Washington, DC, was still farmland.

With the important exception of the slaves, Americans were free to pursue happiness in their own way. And if they didn’t get a hold of it, it was their own damned fault. There were no ‘Independence’ cards. No unemployment benefits. No ‘disability’ or gimmie-stimmy cheques. The government did not aim to save people…nor save the planet. It neither led nor prodded; it was too feeble to do much of either.

Today, it’s a different story. Whether it is the inflation rate…poverty…the business cycle…racism…diversity…drugs…crop yields…working conditions…medical care…airline safety…the governments of foreign nations, the borders between them and who can trade with whom — the feds are on the case. With so much time and money devoted to stamping it out, it is amazing that there is any evil left in the US at all.

Total control

But now we focus on what must be the feds’ boldest — and potentially, most disastrous — program. Forget invading Russia! Forget the Cultural Revolution! They’re aiming higher than ever — trying to control the world’s weather. We’re just wondering how it will turn out.

The feds want to wean the world off fossil fuel. This, they say, will reduce carbon emissions and keep temperatures from rising. We offer no opinion as to whether this is true or not. Nobody really knows; it’s never been done before. We only note that reversing the Industrial Revolution is not risk-free. And if the program succeeds, it will be one for the record books, a remarkable exception to the general rule: the more ambitious the government program, the greater the calamity that follows.

Will it turn out like the First World War…the war that was supposed to make the world ‘safe for democracy’ and ended up killing 20 million people? Instead of promoting democracies, it led to a Bolshevik revolution in Russia and a fascist crackpot in Berlin.

Or maybe the fight against higher temperatures will go like the fight against alcohol after the First World War. There were a lot of very good reasons for wanting to ban booze. But prohibition turned drinkers into criminals…gave a big boost to the mob…and may have actually increased consumption of alcohol!

Or maybe we’re looking at something more like China’s Great Leap Forward. That program was supposed to increase food production (by planting seeds closer together)…and bring China into the modern age (with backyard steel furnaces).

Result: 50 million people starved to death.

Unexamined consequences

So, let’s look at what an energy cut-off, in a poor country, looks like. VICE reports:

‘Jason Anthony has been in a two-kilometer [sic] fuel queue for two days now. In the capital city of Colombo, in the crisis-hit South Asian nation of Sri Lanka, the 35-year-old sleeps in his tuktuk when he’s exhausted, or sits on the pavement with other drivers who have been there for several days too.

‘When the fuel station closes for the day, he walks several kilometers [sic] back home, only to return the next day to queue up. He showed VICE World News his makeshift home by the road over a video call.

‘“I was forced to quit my job as a tourist guide in February when things got bad here and tourists stopped coming. I had to become a tuktuk driver,” Anthony said. “Now, the fuel is so scarce that I’ve not worked in the last month. I can barely make ends meet at home but I’m forced to spend my days at fuel stations.”

‘Last week, newly-appointed Sri Lankan Prime Minister Ranil Wickremesinghe admitted at a parliament meeting that the country’s economy has hit rock bottom.

‘“We are now facing a far more serious situation beyond mere shortages of fuel, gas, electricity and food,” he said. “Our economy has completely collapsed.”’

‘Demonstrations have continued over the past month’, adds The Guardian, ‘as the country faces its worst economic crisis in 70 years with food, fuel, and medicine in short supply…’

Meanwhile, Argentina — always ahead of the curve — is suffering from rolling blackouts and fuel shortages, too. When we left in May, gas stations were running out of gas. Lines were forming. Rationing was proposed.

The country has substantial reserves of oil. But the gaucho feds rigged the price of gasoline (keeping it low) to appease the voters. And with an inflation rate of 50%, even the state-owned oil companies can’t raise the capital needed to drill for oil and refine it into gasoline.

Almost worthless

The story is much the same in Venezuela, which has the largest oil reserves in the world. For years, the country kept the price of gasoline below the cost of making it. And it paid oil workers in currency that was almost worthless. The employees got even. Parts disappeared. Tools disappeared. Trucks disappeared. Then, the employees disappeared…and finally, the gasoline itself disappeared.

Even natural gas — for cooking dinner — disappeared, which was not such a problem, because there wasn’t anything left to cook anyway.

None of these countries were always in such desperate straits. How did they get that way? Government policies — regulations, restrictions, corruption, incompetence, a big idea, a few bad decisions — and a little bad luck.

Could that happen in the ‘Western’ world…to modern, fully developed countries? Imagine Sri Lanka’s problems…or Venezuela’s problems…

…imagine a Great Leap Forward to a Post-Fossil Fuel World projected onto the US, France, Britain, and Germany.

What could go wrong? The same thing that went wrong in Sri Lanka, Argentina, and Venezuela? We don’t know. But we’re going to find out.

Regards,

Bill Bonner,
For The Daily Reckoning Australia