Practical Chip Design

Warning to readers: if you aren't interested in listening to uninformed amateurs babbling about economics, you should skip this one.

It appears that we now see the outlines of how the economic crisis is going to hit the electronics industry, and even to some extent the chip design business. As we all pretty much knew, the collapse of the unregulated financial sector has caused a massive global reduction in paper wealth and a near-freezing of the credit markets in the real world. This in turn has made a few people—such as people just about to retire, or people caught in the middle of short-term credit transactions, who were in the wrong place at the wrong time—physically poorer, and almost everyone poorer on paper. To that extent, the real damage to the real economy was minimal.

But there were two collateral impacts, I think neither of which US Treasury Secretary Paulson estimated when he decided this would be a great time to force consolidation of the financial industry around his alma mater. The first was a very real impact on any organization that required short-term credit to operate. These victims include wholesalers or retailers with large, expensive inventories financed on credit—note the abandoned auto dealership down the street—and industrial companies that chose to run in a highly-leveraged mode, rolling over short-term notes instead of issuing bonds.

Unfortunately, there has been a tendency to prefer short-term instruments in order to finance operations. This rather perverse choice appears to be the result of Mr. Greenspan's decision to keep short-term Fed Funds rates much lower than long-term bond rates for a long period of time coming out of the dot-com bust. Seemed clever at the time. Fortunately, it appears from anecdotal evidence that many companies in the electronics industry, especially in Asia, went against this trend and are heavily cash-rich at the moment. So in that respect too the news is not bad for electronics.

But then there is the second collateral impact. Between the catastrophe in the financial shadow-world, the real drop people have seen in their borrowing power, and the unfortunate fact that rehashing the Great Depression makes a really great story on the evening news, we have succeeded in scaring the biological contents out of the average consumer, all over the world. This is now quantifiable as a sharp drop in consumer spending, beginning in September. This is real, and there is no choice but to respond to it.

Once again, there is good news for our industry. There is going to be a contraction in demand, unavoidably. It has already started. The good news is that a lot of people in our world saw that coming, and have already sharply reduced output. The result, according to a recent report, is that inventories in the electronics supply chain actually shrank a bit last quarter. That is outstanding, and could minimize the damage from shrinking end-user demand. Anecdotal evidence supports optimism. Capacity utilization at the big foundries is down, but not catastrophically down. Design starts appear to be staying nearly on trend-line. For now.

That leaves one big question: how long will the contraction in end-user demand last? On the positive side, it appears that central banks around the world have moved aggressively to stimulate their economies, and for the most part national governments are following a rational Keynesian policy of using stimulus and reduced taxation to move liquidity into the real economy. All of these measures should gradually reassure consumers, so that as they pay down their excessive unsecured debt and adjust to the hammering they have taken on the equity in their real property, they will head back to the store.

But then there is the bad news. In the US, the Federal Government is only one part of the picture. The US government has acted to stimulate the real economy. But most state and municipal governments present an entirely different picture. They, some operating under legal restrictions that require balanced budgets, and some living unaware of everything that has happened in economics since 1928, are taking exactly the worst approach: raising taxes and slashing spending in an attempt to recover their revenue shortfalls and investment losses.

If this is allowed to continue, the result for the US economy will be catastrophic. The systematic shift of spending responsibility from the Federal Government to the states, so carefully executed under the Reagan administration, has had at least one really perverse effect. While the US government can directly stimulate the financial community—where much of it goes into financing de-leveraging and consolidation, but that is another argument--much of the stimulus that impacts individuals and businesses has to come from states, counties, and cities. And that is just where it is drying up. The way the leverage is set, desperate state and local governments may be able to vacuum liquidity out of the real economy faster than the US government can inject it. That could prolong the drop in spending indefinitely.