The Leather Pipeline 

For those who only have to report on the events but are not directly affected by them, it has been a marvellous two weeks. For those who are in any way involved in the global economy, the last two weeks have probably been a nightmare.

The fundamental notion that politicians act in the interests, and for the benefit, of their constituents and their people was certainly open to question. The economic and political interdependencies are simply too complex to be dealt with solely by threats and gambles, and this is perhaps especially true when trying to push through certain convictions. Anyone who needs confirmation of this has probably been well catered for in the last two weeks.

The threats of tariffs on imports into the US became reality. There were questions over how the tariff rates were calculated and how small islands with no exports to the US could even make it onto the list. It did not seem particularly well thought through, but that does not alter the facts.

Perhaps someone then pointed out to the US president that these tariffs will not be borne in the first phase by those he wants to hit, but by the companies in the US that import the goods and may even need them urgently. Even if the president thinks that perhaps factories in the US will eventually produce many products again, he needs to be reminded that this could still take a while.

With such a dependence on imports and such a large share of global consumption, sudden tariff shocks for US consumers and for the domestic economy are not a particularly brilliant idea. The consequences, which were intended to threaten exporting countries and make them compliant, will only take effect in the second stage. Whatever you think of it, one thing is for sure: it will initially cause a great deal of damage. The effect this is having on consumers in the US could be seen last Friday in a new consumer confidence survey, which fell to its lowest level since 1952. Here too, for an economy that is almost three-quarters based on consumption, it is not a particularly good idea to point out that medicine always tastes bitter before it helps.

Obviously, this conviction did prevail in the government in Washington DC and with the president, because presumably someone was able to explain to him that many US companies would first have to pay tariffs if they wanted to maintain their products, some of which they urgently need to keep their production going. Whether this would have been financially feasible for many companies was perhaps not even tested.

In this light, the postponement of tariffs for 90 days for almost all countries except China looks somewhat different. It may be that it is being sold to the public as an ingenious strategic move to negotiate deals, but the truth is that the 90 days are needed first of all to get the goods that are already at the border or en route into the country with minimum tariffs. At the same time, of course, there is the hope of reaching new trade agreements within the three months. It only took another two days for smartphones, computers and other electronic parts and devices to fall under new conditions and lower tariffs. Golf balls are likely to follow soon and, if we are lucky, golf bags and shoes too.

However, someone will perhaps be able to explain to us at some point what was expected from not only excluding China, of all countries, from the 90-day decision, and even increasing tariffs again for this most important trading partner. If you look at the amount of consumer goods and goods as a whole that come to the US from China, it may be politically explainable, but it is probably not very clever economically.

Obviously, the president’s advisors did not get through to him so that it could be explained to him that this form of negotiating with the Chinese is not particularly promising. The main problem now will be to find a way out of the deadlock without losing face on either side.

In the international financial markets, the waves were certainly high and the stock markets tumbled and rose on a daily basis, depending on the news. By the end of the period, however, there was a growing conviction that little good could be derived from the disputes for the global economy as a whole. The globalised economy with its division of labour, which has brought so much prosperity in recent decades, is now under serious threat. Focusing the debate on China now is of little use, as the US government obviously completely overlooks the extent and intensity of the dependencies that have developed in recent decades. One can certainly understand some of the arguments put forward by the US government and there is certainly a need for discussion. President Donald Trump may well find it inconvenient that he has to negotiate with many people and possibly for a long time, but that is the way things have become on this earth. It is a multidimensional problem and if you just look at the global supply chains in the leather industry, you can see this very clearly.

With the big announcements on Liberation Day, April 2, almost all countries were initially shocked. For anyone who had anything to do with raw materials, leather or leather products, it was clear that these tariffs would not be sustainable in any way. At first, of course, everyone saw the rates as an insurmountable barrier to the US markets. Very quickly, however, it became clear that this would first of all, and with the immediate effect, burden importing companies in the US. Nobody was in any way prepared for this and even as Mr Trump was celebrating on stage, the financial markets and members of the leather industry, including meat companies, began to calculate the consequences.

Baseline tariffs of 10% were already a factual reality and difficult enough for many products. However, these are still figures that can be negotiated somewhere between exporters and importers. However, tariffs of almost 50% for imports from Vietnam, of over 100% for China and, for many other countries, of the order of 20%-40%, are neither sustainable nor can they be ‘digested’ by the parties involved in the short term.

At the same time, of course, US exporters of raw materials and, in this case, suppliers of cattle hides, realised that it would be extremely difficult for them, initially indirectly, but then also very directly after the rapid reaction of the Chinese government with counter-tariffs. The more the situation between China and the US escalated in the form of increased tariffs, the quicker it became clear that with reciprocal tariffs of over 100%, business would come to a complete standstill in both directions. And so, it did.

Much more problematic, however, is how to deal with the goods already in transit. There will very quickly be large quantities of goods in the ports of both countries that can hardly be moved with the current customs rates. The easiest option may be for US beef companies to give Chinese customers a corresponding price discount to compensate for the customs duties incurred. For many others, including importers of finished goods in the US, it is difficult to imagine how these pitfalls can be avoided.

The more time passes, the more thought is given to how current supply chain models can continue. Around 30% of US cattle hides regularly find their way to China on a weekly basis. It is by far the largest sales market for US cattle hides and if you look at individual categories, the percentages for cow hides, for example, is many times higher. All this at a time when the supply of cattle hides clearly exceeds demand anyway.

If you look at the tariffs and the current price levels at the same time, factoring the duties into the price of many hides means that the costs for collection, processing and transport are unlikely to be covered. In principle, this would mean that a sale to China would be more like a disposal with additional costs. The normal economic reaction is then to check what other alternatives and markets are available for the product and whether these could possibly offer a better result. In those other markets, and these are the majority of countries, where there are no counter-veiling tariffs on US hides at the moment, this will presumably exert considerable price pressure on the hides, at least in markets where other raw materials can be replaced with US hides.

Of course, this is only part of the problem. It is not just a question of where the rawhide should and can go, but also of quickly finding new locations for leather and finished leather product manufacturing, again taking into account possible final customs duties and costs. Individual alternatives may be found quickly for many things, as capacities are globally not fully utilised, but this is unlikely to be possible quickly for entire supply chains.

For the time being, the focus will probably be on by-passing third countries to get raw and wet blue hides to China. However, this will not help with tariffs that are then levied on finished goods coming back into the US. Under the given circumstances, the only option is to relocate production in its entirety away from China, at least for the products that are then to find their way back to the US.

The bilateral relationship between China and the US is therefore the strongest influencing factor on the leather value chain at the moment. If significant proportions of the production capacity and the sales market suddenly disappear at the same time, the difficulties this will cause for the remaining markets are self-evident. If a one-to-one replacement were possible under otherwise identical market conditions, then other countries might even be happy. However, this is not the case, as previously explained.

The fear now is not so much that leather, for example, might no longer be produced, but rather that the products already in the pipeline might have to find other markets. In the meantime, Europe is already discussing the possibility of the markets being flooded with consumer goods from China in the short term, which would of course put pressure on prices at the same time. What may please consumers on the one hand will be a major problem for the already hard-hit European industry on the other.

The situation also poses a major problem for China. The Chinese economy is already suffering and this would of course be massively accelerated if Chinese manufacturers were to seek a replacement for the lack of sales in the US in their domestic markets. This would also put massive pressure on prices and significantly increase the problems in China in terms of large capacity and a weakening of consumption.

In addition to all the clear problems in the economy as a whole, it should not be overlooked that the entire geopolitical situation, including tariffs, also has a considerable psychological impact. Leather remains an ‘optional’ material and is not a basic material anymore. With only a few exceptions, this means that leathergoods may suffer disproportionately in times of weaker consumer sentiment. Let us not forget that we already had great difficulties with leather sales before all these new problems and have been looking for ways out for years. The hope remains that in uncertain times, ‘value for money’ will count more again when you finally reach the consumer and get the message to the recipient. 

The market for splits will certainly be an interesting topic in the near future. If leather production in China declines sharply now, there will certainly be a shortage of splits and split products. One of the key questions is whether this could be compensated for by imports of finished products. In addition, a further fall in the price of hides would of course open up more and more options for the direct production of collagen and gelatine. If, for the leather industry itself, there is also less material available in China, it would be in direct proportion to the possible decline in demand for leather owing to shrinking exports. In any case, the same imbalances that we see in the general leather market are also building up in this sector. 

The market for sheepskins has not yet reacted to the new situation. However, the importance of this sector is not the same as that of cattle hides. Of course, China is home to important processors of sheepskins, but they do not only produce in China and do not play such a significant role in the overall market.

Making forecasts for the near future is probably not very reliable at the moment. It is hard to imagine that the rifts between China and the US can be mended quickly with the current leaders on either side. Even a correction to the tariffs and individual agreements would not make the general mistrust disappear. Added to this is the major concern on both sides of the dispute for not losing face. An almost impossible task, given how far things have already progressed.

Nevertheless, there is no doubt that the next few weeks will decide which direction goods and production will take, and what the reaction of consumers to the erratic financial markets and the general uncertainty will be. In the US, it is now necessary to analyse exactly which goods can be produced on home soil in the future, how consumers will behave and how quickly prices in the country are likely to rise. Otherwise, as always, the world does not stand still, more changes will come and, somehow, things will continue.

Share this story: