Weak dollar weighs heavily
Macroeconomics 29.11.2004
For countries outside of the USA, the steep drop of the dollar is changing the business environment dramatically.
The concerns that we have had for a long time and have repeated many times are now, unfortunately, turning into reality. Despite all of the US president’s statements the financial world considers the Bush administration as a danger to the US deficit and is consequently discounting the value of the US currency. Since this is no problem to neither the ordinary American, nor their main consumer product
supplier China, not many in their world are worried about the situation.
However, despite all the claims –from various ‘European’ experts as well as Americans – that the weak USD is not a severe threat to the EU economies and even lower values can be overcome, the ordinary business world knows better. Only global enterprises which operate and manufacture in all currency regions have a natural protection against currency movements. Local industries – and this applies on the whole to the leather world – have only limited potential to protect themselves.
speculation is leaning towards almost completely against the USD and there is indeed very little argument to be found for the currency. There is - at least in the short term - a high risk of a further and steep fall. However, no one should underestimate the substantial risk for the global economy if the USD crashes – and the threat is high. The financial markets are finally considering the option that the world – in particular Asia - could get tired of financing the American deficits. So, rumours are spreading about even national banks considering relocating their currency reserves from the USD to the euro.
Whilst the Americans are not bothered about the value of their currency at the moment, eventually they will have to worry about who is going to lend them money. A normal investor could lose interest in investing into something that has now been losing value for a long time and has no bright future either. So, the US could end up in the same position as in the 70s following the first oil crisis, in that they may need to raise interest rates massively to attract enough money into their economy. This would mean global inflation and an abrupt end to the boom in US consumer spending, the real estate market and an end to the export dreams of the countries thriving on the US consumer market. Others would call this scenario a global economical crisis.
The bigwigs in politics and finance know this and so they are fighting hard to calm the world and to generate enough global growth outside the USA to reduce the world’s dependency on it and to give the US time to recover without too much harm to the global economy.
With unrest in the Middle East and the poor outlook for the EU-economy, almost all of the challenges to replace the American locomotive lie in Asia.
We repeat our concerns about the outlook for the global economy and if the leather business is still a leading indicator then the last months are clearly sign of gloomy prospects for 2005.
There has been very little general news of any real interest from the financial markets. The stock market rally ran out of steam, consumer confidence in the USA fell and the outlook for the euro region is looking more negative according to the latest studies. only However, there is still a spark of optimism in Asia and the east where the emerging markets continue to see any progress with their growth.
Market intelligence
Well, the leather pipeline has not produced any exiting news either – at least as far as business and activity is concerned.
The market trend continued to be soft, in Europe more so than in other places in the world, due to the sharp decline of the US dollar weighing on prices.However, raw material prices did not collapse and despite a lot of isolated problems in the trade, sales have by no means come to a standstill.
As we mentioned in our last report, we think that the global pipeline of leather production is divided into different positive and negative segments at the moment. On the negative side we have to accept that the furniture leather trade has been and still is facing tremendous problems. Increased production, in particular in China, has not been covered by the equivalent decline in Europe or other regions of the world such as South America. The excess of capacity, the poor state of the consumer markets and the continuous reduction of prices have driven leather into a situation where many people say it has almost becomeobsolete as a product.
This has been the subject of many editions of the market intelligence already, but it seems that we are now finally seeing what we have expected all along. In many discount shops around the globe you can now buy leather sofas (or what people consider to be a leathersofa) at prices which are below the fabric equivalent. In many cases the prices for leather are similar to the artificial products, if one wants to avoid the term ‘plastic’.
Since leather is not, as such, a product that is needed in furniture making – just as it is not needed for garments, in that it has always needed some kind of an image to be the preferred choice of the consumer - the medium low end of the market completely be destroyed. Mass producers in South America and Asia that are supported by the big retailer discounters have absolutely no affinity to the product as such, and have just looked for cost advantages and production volumes. Consequently, leather furniture in many cases has been counted out of the market.
So we have entered into a spiral of low price and low image. This combination and the excess capacity has not only completely destroyed price levels, but has also led to the budgets and the market forecasts many had made with their new factories, not being fulfilled.
So we might have seen one of the worst third and fourth quarters of furniture leather production and prices for quite some time. It is too early to decide how much damage has been done and how long it will take for business and prices to recover. Many will pretend that the problem is only related to the poor global economy, but we are of a different opinion.
Apart from the general problems in the furniture leather sector there are also some isolated difficulties in automotive leather production. Apart from rising competition and massive price pressure, there are some individual markets that are simply not performing as they were expected to. The news that the rising star of Chinese automotive production is reducing its workforce, has hit many in the trade. There are a lot of rumours of contracts being cancelled and credit extensions.In view of the size of the company this is bound to have quite a remarkable influence on the market. Even more so when due to the difficulties in the upholstery leather sector, the market is not able to absorb the extra quantities which were planned specifically for the automotive sector. This situation seems to be a direct result of the tremendous slowdown in car sales in China. Volkswagen, in particular, has cut production and also seems to have been affected by strike action for some weeks.
Over the past week we have spoken to some of our sources in China to get a better understanding of the situation in the furniture leather industry in the country. The information we received states clearly that the problems are not affecting the industry as a whole across the country. As we have mentioned before, tanneries without a marketing strategy, a quality reputation and that are geared towards the export market are facing the greatest difficulties, which are a lack of sales and increasing financial problems.
However, despite all of the gloomy reports there is some good news coming from companies that concentrated on quality leathers, did not not over-expand capacity and have strong relationships with their customers. The tanneries are very busy, enjoying good contract prices and making the of the general fall in the price of raw material . So, to sum it up, there is nothing really outstanding about China’s situation as it is similar to everywhere else in the world.
Leather production in Europe from a seasonal perspective is going somewhat better. While furniture leather production is battling the same problems as stated above, it seems that the shoe and vegetable leather tanning sectors are doing much better. Many of our sources reported that their premium customers are in full production, confirm good order books into 2005 and even the battered markets like Spain and Italy have confirmed that the production is at acceptable levels.The main area of interest at the moment is not only for better quality leather, but also for lightweight economical hides and skins which are being used in fashion trends for the next summer.
A strong trend at the moment is for everything that is natural - which translates as vegetable products. In a way this is misguiding the consumer, but if it is supporting sales and prices at least it is for the good.
Although those in general business activity in Europe are faring a lot better, a lot of tanneries are suffering from the fall in the US dollar. Many tried to defend their positions by shifting their purchases from the eurozone to the US dollar region and some European suppliers have rarely been asked to offer in US dollars. The substitution of raw materials is most definitely limited, at least when it comes to high quality products. The main problem we see is that higher volume production in Europe is going to disappear due to price and production costs. In the present currency climate, volume production of leather in European terms cannot be justified. We are nearing a situation similar to that in in the mid-nineties, when the dollar was at similarly low levels and various tanning production facilities had to close down. Today the situation is even more problematic, because there are alternative production facilities in Asia, South America and India.
So it is more and more evident, that the pressure on European tanners is going to mount if the US dollar is not re-evaluated and we would not be surprised to see more production facilities closing down in 2005.
The split market seemed to settle down a bit. Fewer offers in Europe, in particular, are lifting some of the pressure from the market. However, we don't see this as a chance for a turnaround as yet. Leather fashion in general is not favouring splits in volume and consequently we have no reason to believe that over the next months the demand for split will increase substantially. So this market will be much more supply driven.
Lambs and sheepskins reported some better news. Many suppliers confirmed that there is a lot of interest in lower priced skins. Large sheepskins and shorn lambs have produced a lot of enquiries in the past weeks and although sellers cannot be happy with the prices obtained, at least some movement of product has been seen. Interestingly the demand was not just coming from garment manufacturers - skins today are also considered more by ladies’ shoe manufacturers. For next summer’s fashion hairsheepskins are being considered as a possible alternative to calf and kips. The classical garment business, in particular double face, is still suffering from the problems with the Russian market. As the season is already over, it is hard to believe that there will be still any recovery. However, with the decline of prices which we have seen in Europe in particular, we do have a fair chance of some good quality lambs finding a home in the next nappa season for the next summer. We will definitely know more about this in January 2005.
What can we expect from the rest of the year? Despite all of the negative reports - including our own - we tend to believe that the worst could be behind us. Not that we actually think that things are going to turn to the better by the end of the year; nor that we do not think that there are no more obstacles to face, but it seems that most of the readjustment in the leather pipeline has been done. Raw material prices could be in their final round of readjustment to reflect market realities. In Europe the increased seasonal kill will now start to dwindle and after a period of low production due to the season, business interest as well as production should increase from February 2005 onwards. Since the pipeline tends to always have the stop-and-go syndrome and we have definitely been in the stop period for quite some time, inventories in tanning and manufacturing should be on the low side. As a consequence, they need to be replenished and after the raw material suppliers have cleared their warehouses and gained more confidence, a better market should come as no surprise. Before this happens though, we believe we still have some bumpy roads to travel in the coming weeks, but again it might not be a bad idea to consider this option a little and anticipate the situation. Let's just hope that the concerns the we aired in the macroeconomics section will not hit us early and hard.
