Impact of the US Debt Downgrade on Supply Chains

Yesterday evening, the S&P credit rating agency downgraded U.S. sovereign debt from AAA to AA+ with a negative outlook. As noted by my good friend Jason Schenker, an economic forecaster, “the US Downgrade should not be a surprise…..the re-pricing of U.S. and other sovereign debt is far from over.”

What does this mean? Before you panic, consider a few other key points associated with this event.

– The S&P is simply reporting what many of us have known for a long time: The current spending is out of control, and the people in Washington have no idea what they are doing. Second, the problem is likely to become even more pronounced, as the dollars flowing don’t seem to have any tangible quantitative basis or performance goals any longer. As noted earlier this morning by a Treasury representative who confirmed that initially an error was made in the S&P calculation of debt: “A judgment flawed by a $2 trillion error speaks for itself.”

– In 1945, foreigners owned just 1% of U.S. Treasurys; today they own a record high 46%, according to research done by Bank of America Merrill Lynch. What this means is that the US Treasury is still viewed as the safest bet out there. Where else will the money run? Europe? They are in their own mess, and are reeling from the debt with little hope of coming out anytime soon. China? Who is going to invest in a country where there is one government party that can change the rules at any time? Russia? Brazil? The level of corruption and lack of transparency in financial transactions makes these economies highly risky and highly suspect. In the short term, the US is still the safest place to put your money.

– The impact is largely psychological, and has been already priced into the market based on the fall last week. As the WSJ noted this morning, “Because S&P left the U.S. short-term credit rating unchanged, the downgrade is unlikely to have a big impact on money market funds that own U.S. Treasury bill.” However, there may be some impact on interest rates which is good for those companies that already have a lot of cash, putting them at an advantage in many markets.

– This is the “new normal”. Get used to it. The WSJ notes that “Lessons from other countries, such as Canada and Australia, suggest it can take years for a country to win back its AAA rating.” Again, good sense dictates that the US has a long, long hard road ahead to be able to get back into the good graces of Wall Street and other global investors, who can’t be fooled by political rhetoric. You make your numbers, or else.

In terms of supply chains, the short-term impact could be challenges availability of capital, short-term commercial paper, higher costs of capital, and other components that could impact supplier’s financial health. Strategies for dealing with these challenges were documented in a paper I wrote in 2008, when the first economic crisis occurred.

Some of the recommendations that emerged from the executives we spoke with suggested that this is an opportune time to review and re-build category plans, and to double check the status of suppliers. The use of cash management incentives, financial appraisals, and more focused supply market intelligence was emphasized in terms of actions. Individuals also mentioned that they are bringing in their accounts payable teams, in order to be more active in evaluating supplier scorecards, and plan for contingencies around high risk suppliers.

In the same light as retention, companies recognize the need to continue forward with much needed capital investments that are planned or underway. This is good news for the underlying economy, as these investments will continue to support sectors that are in communication, commercial construction, pipeline, communication, and other much needed capital infrastructure work. Capital investment is clearly stable in technology, aerospace, telecommunications, and especially in oil and gas. In the latter category, an oil and gas executive noted that in the current environment, the ability to further build relationships with capex suppliers should be further strengthened, and the size of the supply base may be optimized in this light. This may be an opportunity to build increased customer of choice relational capital, as suppliers will clearly value customers who provide them with more work in a difficult economic environment. In this respect, supply chain management should be prepared to act proactively to build contractual relationships, or even risk having their best, most financially secure suppliers, leave them and focus their business on more attractive customers. There was clearly an emphasis on the part of many managers we spoke with to confront the issues, sustain activity, coach associates, manage and award contracts to the best, most financially stable suppliers. This may involve a deep re-categorization of market sectors, and a true evaluation of what suppliers are best positioned to weather the storm.

In any case, hang on….it’s going to be a crazy ride!