Tough Road Ahead for Europe's Auto Industry ... Europe as a Whole is an Economic Basket Case ... Let's Learn From Its Example

OVERVIEW

The European economy is in recession. And it's going to get a lot worse before it gets better, whenever that may be. Its welfare entitlements government knows best way of governing has run out of gas. Permanently.

Let's look first at debt to GDP. If a country's deficits in a year exceed its growth in GDP, its economic situation is deteriorating. That's simple math. If I owe $100 and earn $100, but spend $105 the next year, I have a deficit of $5 unless my earnings increase by a similar or greater amount.

Europe continues to spend as if its earnings (GDP) are growing, but its earnings are in fact decreasing. It's in a state of quasi permanent recession. And its creditors have run out of patience. The credit spigot is being turned off.

When the latest recession hit, governments as usual kicked in with spending programs to offset the effects of the recession. {That's Keynesianism at work, and we've long employed this play-money-get-out-of-jail-free card approach, too.} The problem is that Keynesianism doesn't work when the situation is structural rather than temporary.

And the negative effects of Europe's welfare state on its competitiveness and finances had been accumulating for a long time when the latest recession hit. Since shortly after the close of World War II, as a matter of fact.

As a result, Europe's financial problems today aren't temporary and Keynesianism won't work. Most European countries are in a long term mess of epic proportions (especially in southern Europe with France included therein). There is no magic bullet, Keynesian or otherwise. Lots of long term pain lies ahead.

To summarize the European situation, most of its companies are globally UNCOMPETITIVE when it comes to selling goods and services. Instead of addressing those very real competitiveness issues, however, those countries increase borrowing and government spending. Time is running short, and its financial problems can no longer be ignored. Its creditors have "had enough."

AUTOS

So let's look again at the auto industry and use Europe as a cautionary example for us right here in the good old U.S.A. The lessons of Europe are staring us right in the face. Government isn't the answer. Neither is redistribution. The answer lies within us as We the People.

We've written several times using the global auto industry as an example of what happens when excess capacity is put in place during an easy credit, debt induced demand bubble situation.

Of course, once the excess capacity has been built, it can't be "unbuilt." Unlike people, factories can't be laid off when demand weakens.

Thus, building expensive factories to accommodate temporary and artificially created demand during the bubble days of easy credit later results in havoc for the industry, its participants and its workers, too. Throw in the global nature of all these interconnected resources, and it presents a troubling picture which will take many years to rightsize. Painful years, too.

Ford Plans Deep Cuts in Europe reveals the European auto industry's rightsizing story which is just getting started:

"Ford Motor Co. outlined a broad plan to stem its operating losses in Europe by closing three auto-assembly and parts factories, trimming 13% of its workforce and 18% of its new-car production capacity in the region.

The restructuring aims to return Ford's money-losing European operations to profitability by mid-decade amid a sharp decline in new-car sales across Europe that is not expected to be reversed soon. . . .

The workforce reductions include 5,700 hourly and salaried workers at . . .  three plants and another 500 salaried employees across Europe. . . .

The auto maker has projected a loss of $1.5 billion in Europe this year and a similar loss in 2013. . . .

Ford's plans are the most drastic by European auto makers as they cope with the industry's chronic overcapacity, made worse by a slump in car sales in the region to their lowest level since the early 1990s.

The European restructuring plan is an attempt to match its success in revamping its U.S. business in recent years. Under CEO Alan Mulally, Ford borrowed $23.5 billion to help speed a sweeping restructuring plan in the U.S. Ford cut 30% of its salaried workforce, reduced plant capacity by 25% and gained concessions from U.S. unions, including a lower wage rate for entry level workers.

"We are really trying to reflect reality of the slower growth in Western Europe," said Mr. Mulally. "The actions are absolutely appropriate for the current reality." . . .

Mr. Shanks (Ford's CFO) said the cost-cutting plan for Europe wasn't envisioned two years ago when the company was formulating its mid-decade plan. "This particular restructuring plan wasn't something we had in mind because we didn't think the external environment was something that we would be facing. That hasn't only changed the current reality that we are living in today, but had a major impact on that."

Ford said it expected European vehicle sales to be about 14 million in 2012 and 2013 before rising to around 15 million by 2015. At that modest level—several million below where Europe stood five years ago—Ford expects to be profitable. Ford also said the company's European losses in 2013 will be about $1.5 billion, similar to this year, mostly as a result of restructuring costs. . . .

General Motors is expected to announce next week more details about the restructuring of its unprofitable Opel unit. Vice Chairman Stephen Girsky is attempting to fashion together a plan that would include trimming management and hourly workers along with reaching a definitive plan to close the aging Bochum, Germany, plant. The plant employs about 3,100 workers and no new vehicles have been slated for production after the Zafira minivan concludes in 2016. Closing the plant could save GM as much as $2 billion. Opel is also expected to expand a buyout program across its three remaining plants to help with its downsizing efforts."

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But what about the European auto companies themselves? What excess capacity problems do they have?

Well, they very well may have even bigger problems than the European operations of Ford and GM.

Daimler Warns as Europe Car Makers Cut Back says this:

"A profit warning from luxury auto maker Daimler AG signaled the European auto industry's financial pain is deepening even as auto makers on Wednesday took a series of long-awaited measures to excise more costs and remove production capacity. . . . It also said it assumes 2013 financial targets "will not be met." . . . amid a "significant worsening of the market environment in major markets in recent months," it was forced to lower its forecast for the entire group, it said....

Daimler's new-car registrations in Europe fell 6.9% in September according to ACEA, the European automobile manufacturers' association, and it is also struggling in China, where snags in its sales organization have pushed it below Audi and BMW in sales growth this year. Daimler has said growing competition in China's crowded luxury car market also is hurting prices. . . .

PSA Peugeot Citroën SA, the European car maker in deepest trouble, separately announced a government bailout of its auto financing arm and said it would share the cost of making four new vehicles with General Motors  struggling Adam Opel unit as part of a wide-ranging cost-sharing pact with the U.S. auto maker. . . . Peugeot has previously said it would close a car plant in Aulnay, outside of Paris, in 2014.

Volkswagen AG provided a contrast with its struggling rivals, reporting a third-quarter profit of €11.29 billion on rising vehicle sales and revenues, a reflection of the German auto maker's global reach and broad vehicle portfolio. But Europe's biggest auto maker by sales warned that the outlook for the industry is deteriorating. . . .

Apart from a Saab Autos factory in Sweden, a GM plant in Antwerp, Belgium, and a Fiat plant in Italy, little capacity has closed in Europe since the 2008 financial crisis, unlike the U.S."

Summing Up

EUROPE

Europe's automobile manufacturing overcapacity will negatively impact the global auto industry's unused capacity as well.

After the horse has left the barn, of course, the lesson to be learned is simple. 

Don't build excess industry capacity to support an artificially created demand. Especially when this temporary demand is attributable to a debt induced consumer demand bubble.

Of course, that's easy to see now that the 'temporary excess demand' horse has made its proverbial barn exiting maneuver.

But now that the horse is out in the open and easily seen, swift remedial action must be taken. And that's the Europeans' problem. Taking swift action to address big problems isn't a characteristic of the European social-democratic welfare state.

THE U.S.

But what about the U.S.? We have lots of debt. Do we have temporary or permanent excess installed capacity?

The answer to that question, of course, depends on whether our current state of weakened demand proves to be long lasting or temporary. Right now it looks like it could be long lasting due to government policies which don't favor private sector growth. Of course, that could change, and let's all hope that it does.

Because if growth stays weak and debt goes higher as the economy remains stalled, we'll have lots of permanent overcapacity to go along with the excessive and growing nation's debt levels. And that would take us down the exact same path as Europe is traveling.

In the U.S., we would then find ourselves severely overcapacitized in the restaurant, retail and hotel industries, as examples, and we would also have more than enough buildings, both commercial and residential, as well.

Accordingly, it would take many years for the markets to clear. By then we'd be an economic basket case, to say the least.

So here's the deal.

Unless we start now in common sense fashion and stress private sector growth initiatives, including energy independence (instead of government redistribution and entitlement spending programs), our U.S. economy will remain weak for at least several more years. We'll become another Europe.

All we need to do is admit as a society that choosing government redistribution and entitlement programs as the path to prosperity is a losing proposition. Look at Europe.

This acknowledgement that the private sector and not the public sector is the answer to our economic woes will quickly result in more people working and producing competitive goods and services for both the domestic and world markets. And that will create the good jobs and resulting tax revenues to support the government programs we have in place and decide to keep.

Simply put, this public to private sector shift in emphasis is essential for us to eliminate the current economically debilitating double whammy of (1) overcapacity and (2) weak demand.

Time alone won't solve our U.S. problem of overcapacity, and trying to "help" with more government spending programs will only make it worse.

At least that's my view.

Thanks. Bob.