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Who's Going to Pay for This?

Who's Going to Pay for This?

The sudden resort to bankruptcy protection by two leading metalcasting companies is no indictment of their managers. But, it is a startling indication of how difficult it is now to maintain a successful organization in a market defined by demand and shaped by regulation — but distorted by external factors that sever any sensible relation between those two forces.

Citation Corp. and Intermet Corp. now will be reorganized, and it's apparently a final recourse for both companies. In recent years other metalcasters have arrived in bankruptcy court, but given the scope of manufacturers' rawmaterials costs and the availability of bankruptcy law it's possible these two will not be the last to seek protection. What drove these decisions was the instability of the steel scrap market. Intermet first warned of its problems in a September earnings forecast. It cited the rise of steel scrap from roughly $160/ton at the start of 2003, to roughly $210/ton at the end of last year, to approximately $395/ton at the end of August. Citation president and CEO Ed Buker explained his firm was met with steel scrap prices up to $420/ton.

Steel scrap is an essential raw material. And, it's a commodity, so manufacturers know they must manage the risk in order to maintain their organizations effectively.

Fortunately, steel scrap responds well to market forces, because the supply is fed by old capital goods and construction materials that are being replaced with new steel products.

The problem now is that the scrap market is not following any typical pattern. Demand is being driven by buyers overseas, principally in China, where there is no domestic scrap market of any scale. Steel is heading there to feed demand, but it's not returning as "new scrap."

Domestic manufacturers have been facing this problem for months. Some steelmakers have attached surcharges to finished products, but that solution won't last and it's not feasible for every manufacturer.

Earlier this year an array of manufacturers formed the Emergency Steel Scrap Coalition to argue for federal action. Their primary aim was to put a limit on scrap exports, which is a questionable tactic both legally and strategically.

Such solutions are remedial, at best, and steel scrap is only one commodity market that's being distorted by Chinese demand: in oil, natural gas, and all sorts of ores, the pattern is the same.

What looks like a commodity problem actually is a monetary problem. China continues to peg its currency value to the U.S. dollar, meaning Chinese consumers can acquire whatever raw materials they need without any fear of serious inflation. They are serving domestic demand, but they're "exporting" a critical part of the cost of doing business.

Left largely unexamined is what safeguards Chinese authorities have to contain the damage of the inevitable slow-down in their economy.

So what's to be done? The Bush Administration rejected within hours a September petition by manufacturing interests for a Section 301 investigation. The goal of that petition was to force the currency problem into the realm of federal trade law. The rejection has not ended the quest for some federal action, but it should be plain to all that if China will not normalize its currency for its own good, U.S. trade laws are unlikely to get the job done.

And so, another set of laws is called into use. The standard criticism of the corporate bankruptcy routine is that it challenges our sense of fairness. When all is settled, someone — suppliers, contractors, employees, communities — is left poorer than they had reason or right to expect to be. Citation and Intermet chose a reasonable solution to their problem, and the companies will recover. But, their creditors may well wonder where the money went.

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