Wednesday, December 17, 2008

Secular Decline

The semiconductor industry is about to report its first back to back years of declining sales based on projected sales for 2009.

Gartner Inc this morning reported that for the first time in the semiconductor industry's history, 2008 and 2009 will show back-to-back revenue declines.

The report follows on estimates from Gartner made late last week that 2008 would show a 4.4% decline in semiconductor revenue for sales of $261.9 billion. At the time Gartner said that "the worst was yet to come," but did not share projections for 2009.

Today Gartner said it expects semiconductor sales in Q4 to show a record quarter-on-quarter decline of 24.4%, surpassing the 20% decline record set in Q2 2001. With the declines continuing into next year, the market research company estimated 2009 will show a 16.3% decline from 2008 revenue, with semiconductor sales forecast to total $219.2 billion.
This points to the fact that although the semiconductor industry is very important to our prosperity it is no longer the driving engine of it. So far we have gone through four phases of applying microprocessors to our economy.

1. Industry - machine control
2. Office - computation and document production
3. Homes - entertainment and home offices
4. Communications - the internet, cell phones

There is a fifth phase coming. The application of microprocessors to vehicle power. The hybrid, plug in hybrid, and battery vehicles. Not only will it absorb a lot of semiconductors, it will also absorb a lot of power transistors. However, this market is not yet absorbing significant amounts of semiconductors.

What this points to is a secular decline. Easy profits from the application of microprocessors to the economy are no longer available. Productivity improvements in the range of 20% to 30% from a given project or general application are no longer possible. Another way of saying this is that the efficiency of capital is declining. This is one of the things that led to the housing bubble. Investment in real estate is the tail end of a secular advance.

Here is another way of looking at what is going on.
The share of employment in manufacturing as well as the relative price of manufactures has declined sharply over the postwar period, while the share of manufacturing output relative to GDP has remained roughly constant.
There is now no market segment that can absorb significant capital or labor at an above average rate of profit.

Here is a chart based on the Kondratieff Wave Theory of economic advance.

click on image for large view

If we look at the first wave starting around 1780 I think we can clarify a few things. At least in terms of that cycle. The first step in that wave happened a little earlier. It all started with the invention of the crucible steel process by Benjamin Huntsman in the 1740s. Before that steel was made by forging. You heated up the iron as hot as you could and then beat the impurities out of it. Black smithing it was called. And of course Smith was an honored name.

Huntsman settled near Sheffield, England for the coal (coke actually) that made his process possible. So the steel industry builds up as does the coal mining industry. As the mines go deeper into the ground the water that accumulated in them had to be pumped out and this required more and more labor as the shafts get deeper. Thomas Savery had invented the first crude steam engine for pumping water out of the mines around 1700. Thomas Newcomen improved on the Savery engine in 1712. The real kick came in 1769 with the invention of the Watt steam engine. The Watt engine was efficient enough to make it possible to mechanize a lot of tasks that had required hand or horse labor. Watt wanted to make the power of his engines understandable to the people of the time so he coined the term horsepower. Still in use today. Because of the way the term was developed there were a number of different definitions. All close to each other. I like the electrical horsepower myself which is 746 watts. And Watts? Named after the inventor of the Watt engine.

Oh. yeah. Where were we? Coal and the steam engine gave rise to all kinds of opportunities to increase the production of goods without having to keep a bunch of horses about. And horses have to eat whether they are producing or not. So these technological advances lead to increasing output. Increasing profits. And demand for more labor to install, maintain, and operate all this wonderful new stuff, not to mention invent more new stuff based on the change in economics made possible by the new inventions. A burst of capital is created which fuels the whole cycle. Then comes the bust. Because there are limits to what can be done with a new technology base, profits start to decline as more people get into the business of making stuff. Goods that were once scarce no longer command the scarcity premium they once did. The days of 20% and 30% profit are over and the general economy reverts to the more normal 3% to 5% profit range.

And these cycles get repeated. It appears we are at the end of one now. Fortunately for us - with so many people doing research - the cycles come closer and closer together. We no longer need to wait 40 years for the next big thing. So what is the next big thing on the horizon? I have no idea and neither does any one else. Because if we did we would not be in a secular decline. All I can say is: what ever it is it has already been invented and just awaits mass implementation. What you want to look for is an area of the economy where profits are rising despite the general downturn and which looks like it can absorb a lot of capital and labor.

Another way of looking at it is that our new President is screwed because unless he knows something we don't there is nothing he can do to get the next cycle moving. He is not profit minded nor does he get the need for fundamental research to serve as the foundation for the next advance. What he is in to is the redistribution of capital from the last advance. Which is basically a maintenance activity. Not very exciting. And in fact it delays the next advance by reducing the capital pools that will be required when we figure out where the money should go. Four years and out.

Cross Posted at Classical Values

1 comment:

Neil said...

"All I can say is: what ever it is it has already been invented and just awaits mass implementation."