What Would a Federal Debt Default Mean to Manufacturers?

July 19, 2011
Default could sabotage manufacturing's tenuous recovery -- depending on how long it lasts.

As lawmakers in Washington scramble to avoid a debt default, manufacturers are left wondering, "What does this mean to me?"

If the federal government defaulted on its debt, would it indeed be the "major crisis" that Federal Reserve Board Chairman Ben Bernanke described earlier this month, or would it be similar to Y2K -- much ado about nothing?

Mark Walker believes it depends on how long a default would last.

"If it's a couple of days that's one thing," says Walker, who is partner in charge of the manufacturing and distribution niche for the Dallas/Fort Worth-based CPA firm Weaver LLP. "But if it gets into weeks or longer, then that's another problem."

An extended debt default, Walker asserts, not only might sabotage the manufacturing sector's recovery but also could propel the U.S. economy right back into a recession, as it would breed uncertainty "that the economy isn't on as sure footing as we hoped it would be going forward."

"Uncertainty always breeds contraction within the general economy, and so certainly the manufacturing sector wouldn't be excluded from that," Walker says.

At the very least, says IBISWorld energy analyst Justin Molavi, "manufacturers would face a difficult situation."

"For one, if the U.S. defaults, interest rates would rise, which means many manufacturers would have to pay more for the equipment that they are leasing and for future financing activities," Molavi says in an e-mail.

U.S. manufacturers also would find themselves in an even deeper hole as they try to compete with low-cost countries, "and many companies would move operations abroad to avoid interest-rate rises and possibly to explore stronger market segments," Molavi adds.

Recession Redux?

Bernanke has said that the "shockwaves" from a U.S. debt default would be felt "through the entire global financial system."

On July 13, the Fed chief told lawmakers on Capitol Hill that failure to reach a deal by the Aug. 2 deadline could "throw the financial system into enormous disarray and have major impacts on the global economy" if Washington halts debt payments.

For U.S. manufacturing, Walker says a reprise of 2008-2009, "when everything just dried up," is certainly possible.

That brings up painful memories.

"I mean literally [manufacturing] just kind of fell of a cliff, which was an interesting phenomenon that I hadn't really seen before and to that severity," Walker recalls. "You saw manufacturing just really rein in and you saw inventories drop throughout the supply chain. If we had a default, that would be one of those worst-case scenarios."

Silver Lining?

When it comes to speculating about the possible ramifications of a default, Walker is wary of making gross generalizations about the entire manufacturing sector.

He believes some sectors -- such as energy -- actually could benefit. In the event of a debt default, the value of the dollar likely would take a hit, and oil prices could rise.

"The energy sector would probably say, 'Thank you very much' and keep on going," Walker says.

IBISWorld's Molavi agrees that the possibility of higher oil prices "is generally good for the industry worldwide," but U.S. consumer demand likely would shift toward alternative fuels.

"With a slow-growing economy and a shift toward products that are more fuel-efficient, U.S. demand for gasoline will continue its downward trend," Molavi says.

Molavi adds that a sharp increase in interest rates "would surely eat into" oil companies' profit margins, but the large integrated oil firms, buttressed by healthy reserves of cash, likely could weather the storm.

It's hard to say how manufacturers in other sectors -- such as automotive -- would fare, however.

At the very least, a debt default probably would send the stock market into a tailspin.

"I mean, that certainly is what happened in 2008 and 2009," Walker says.

Then again, when it comes to correlating a manufacturer's stock price with the "underlying strength of the balance sheet," the market tends to be "totally irrational."

"So I wouldn't make a correlation that the balance sheets of the companies themselves were in danger, but typically you'd see the stock market take a hit" when an economic or financial meltdown occurs, he says. "And everybody takes a hit when that happens."

The Timing Could be Worse

Some analysts and observers have said the timing of the debt crisis -- as U.S. industry struggles to get a foothold on recovery -- couldn't be worse.

Walker, however, argues that the timing could've been worse.

"If it happened a year and a half ago when we were already down, then it probably might be worse timing than now because then it might have tossed a lot of companies just completely over the edge," he says.

Looking at the crisis in a positive light, Walker asserts that the timing could be a blessing in disguise.

If politicians come up with "a workable plan that addresses the spending and the ongoing raising of the debt ceiling, you could see that that would be an actual positive" that might be a catalyst for an even stronger economic recovery.

Given the sharp ideological divide between Democrats and Republicans, however, that's a colossal "if."

"When it comes to Washington," Walker says, "all bets are off as to how thing are going to work out between the two political parties."

What would a debt default mean to your business? Let us know by answering this week's poll question.

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