Choppy Waters Ahead for Railroads

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There’s a story of events that I largely subscribe to.? It goes like this.? Near the end of World War 2, the US and its allies got together at Breton Woods and decided to make the US Dollar the world’s reserve currency.? The US would print dollars that would facilitate global transactions and provide global shipping security through the strength of its navy.? This security and financial commitment would allow Europe to rebuild and enjoy greater access to foreign markets while the US would have greater control of global politics.

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With protection on the seas and a universal currency, global trade flourished.? Sure, there were bumps along the way like Vietnam and the Iranian revolution, but by the time the Soviet Union collapsed in 1991, the world was already entering a golden age of rising GDP, reduction in poverty, etc.

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China’s rise was meteoric as it became the factory to the world.? When I was in engineering school in the 2000’s, we all thought we would end up working in China one day and had lectures and class options to help prepare us for what seemed like a likely future.

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Companies also became bigger.? Big Tech gobbles up startups, sometimes simply for the talent (“acquihire”).? Fewer companies IPO, PE funds have become enormous, and even in rail the Class 1’s have consolidated to a market equilibrium.? This M&A activity, along with increased scale provide by the Internet and backed by free market access, have allowed corporations to become enormous.? In 2000, Microsoft had the largest market cap at $606 billion.? Today, it would only be #8 on the list with 5 companies surpassing $1 trillion in market cap.

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Yet beneath that shiny exterior, the rot had already set in.? Cheap labor provided by East Asian countries quickly replaced American labor.? Outsourcing became the new strategy and US firms were well rewarded with lower costs, higher earnings, and rising stock prices.? We could all buy cheaper goods, especially through new services like Amazon, but wages became stagnant.? All those outsourced jobs resulted in shuttered factories and reduced domestic investment.? Wall Street was booming while Main Street was boarding up windows.?

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Having the world’s reserve currency comes with some nice benefits, most notably seen after Russia invaded Ukraine and the US simply cut Russia out of the global financial markets.? That’s some serious political power to wield.? But it comes at a cost.

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In order to ship dollars out to the rest of the world, the US has to run a large deficit.? The US Treasury sells government bonds to foreign markets and in turn, prints dollars to fulfill those obligations.? These dollars provide the necessary market liquidity to facilitate transactions, but it does mean that the US national debt will be large.

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The strength of the US dollar is also an important consideration.? As the world’s reserve currency, dollars are in demand so their price/value must increase.? This in turn drives down the value of other currencies, like the Yuan, Yen, Euro, etc.

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A strong dollar has other implications, both positive and negative.? US consumers purchase imported goods with dollars because those dollars are in high demand.? Those cheap imports far exceed the number of exports from the United States, because a stronger US dollar makes it more difficult for US producers to sell US-originated goods into foreign markets.? This is why the US has a large trade deficit, meaning imports exceed exports.? US consumers benefit, but US producers (along with their workers) struggle.? This is one reason why the US has transitioned from a manufacturing-based economy filled with engineers and welders to a services-based economy made up of programmers and accountants.

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(Highly recommend reading anything by Michael Pettis on this subject).

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The outcome of this trade policy is a hollowed out middle class with stagnant wages and reduced purchasing power.? Coupled with a largely absent FTC/DOJ to limit market dominance of a few firms, the last several decades have been a boon to corporations.?

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The chart below is just one example of the impact these policies have had on the American worker.

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The Times They are a Changin’

All of this leads me to conclude a few things.? First, labor is back, baby.? Union membership has decreased considerably since the 1970’s/1980’s.? Having worked with a union at ADM, I heard all the stories about how guys would lock their boss in his office, smack him on the head with their channel locks, all sorts of crazy stuff you wouldn’t see happening today.? The rail unions were able to get their contract pushed all the way to the final boss of Congress before being defeated.? The UAW were able to get considerable concessions out of Detroit.? Labor is having its best time in decades.

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Second, industrial policy is in vogue again.? I’d have to do some more reading to really plant the flag, but it seems like there has never been a heavier handed government in industrial policy – Republican or Democrat – since the 1930’s.? The infrastructure bill, subsidies for chip manufacturers, big tariffs beginning with President Trump, the government seems to be doing more to put its hand on the scale of markets than it has in quite some time.

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Finally, corporations are on notice.? Lina Khan at the FTC, for better or worse, has put a moratorium on any significant M&A activity.? I mentioned previously how at least part of the Republicans in Congress really did not appreciate having to go on the record with a vote against labor to avert a railway strike in 2022.? And the Republican party, the traditional home of the business community, now no longer seems quite as welcoming.?

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The fact that populists like Donald Trump and Bernie Sanders rose to prominence during the 2016 election seems like less of a mystery and more of an expectation.? Hindsight’s 20/20, but given the situation, is it any wonder populism took off??

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In the wake of President Trump’s nomination as the GOP candidate in 2016, the GOP was clearly broken.? The traditional coalition of fiscal and social conservatives, national security hawks, and the business community had splintered.? President Trump’s first term generally delivered wins of the last of those constituents including the “Trump Tax Cuts” in 2017 that dramatically reduced the corporate tax rate and deregulation.?

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However, President Trump’s embrace of the American working class, with the surprising appearance of Sean O’Brien, the president of the Teamsters Union, speaking at the Republican National Convention, is a strong departure from Republican Orthodoxy.? Hearing Mitt Romney speak at the RNC in 2012 as he accepted the Presidential nomination for the party is a huge difference compared to today’s GOP.?

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Now that Donald Trump has named Ohio Senator JD Vance as his vice-presidential nominee, that populist-first, America-first approach is now cemented into the next generation.? Vance, someone who has come out in strong support of FTC chair Lina Kahn’s reign of terror for Wall Street and skepticism of right-to-work laws is a huge slap in the face to the business community.?

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What the Next 4 Years Could Look Like

With the addition of Vance to the Trump ticket, we now have some idea as to what the outcome of the election could look like, sort of.? Since the dueling Presidents debate a few weeks back, the Democrats have been all over the place.? So far President Biden has resisted calls from party leaders for him to step down, but I wouldn’t be surprised if he does eventually.

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The most likely outcome by far would be for Vice President Kamala Harris to take up the banner and become the Democratic Party’s nominee for president.? If President Biden doesn’t step down and is able to win a 2nd term, his age and health would likely see VP Harris take over as President at some point in his 2nd term anyways.

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Pinning Harris down on policy, at least in terms of industrial policy and what her administration’s view of the rail industry would be, is difficult simply because she hasn’t demonstrated or talked substantively about anything rail related up to this point.? However, if we take the safe bet and say that she’ll follow a traditional Democratic platform of being pro-labor, pro-environment, and pro-transit, we can probably expect something like a repeat Biden term minus the massive infrastructure bill.

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What impact has the Biden administration had on the rail industry in the past four years?? Here are some notable items:

• FRA mandates two-man crews
• CPKC merger approved
• More active STB including hearings on poor rail service
• Reciprocal switching implemented
• Massive funding for and expansion of Amtrak and passenger rail
• SAFE Trains Act eliminating CRRC’s presence in the car builder market

It’s been a bit of a mixed bag.? Remove the CPKC merger and you could say the Class 1’s in particular have not had a great time.? In a 2nd Biden/Harris administration, you could see some ?advancement or implementation of the CARB rule from California in some form or fashion by the EPA nationally.

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What would a Tump/Vance administration look like?? Here are some guesses:

Rail Safety regulation – This one seems like a done deal.? When your VP’s only major legislative effort was a rail safety bill that was never passed AND you invite the mayor of East Palestine to the RNC it becomes very easy to contrast yourself with the previous guy by delivering something that could be seen as a pretty populist piece of legislation.?

If President Trump decides to make this any kind of priority, you would think the Republicans in Congress would get in line without too much fuss.? As I’ve written about previously, it might have been better for the AAR to take the deal on the table rather than kicking it down the road.

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Class 1 friendlier STB, maybe – This one is hard to gauge, but if a Republican administration appoints more Republicans to the board, the safe bet would be that rulings would generally favor the business community.? That was the old GOP.? Under the new GOP, maybe a more populist-leaning appointee gets put on the STB who’s less likely to side with large monopolies.

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Protectionist trade practices – Trump has said that he’ll increase tariffs on Chinese imports to 60% if he were to win reelection.? While that may seem great for protecting American businesses, tariffs rarely work.? Studies of the Trump tariffs that were previously enacted shown that the only thing that really changed was price inflation and more votes for Trump in certain rural geographies.

However, Oren Cass makes a reasonable point that protectionist policy, such as what Reagan did with Japanese automakers in the 1980’s, can result in increased manufacturing investment in the US.? I think it’s possible you could craft some smart policies in that same vein, but I don’t think Trump is necessarily interested in that.? I think he sees tariffs as a political weapon when negotiating with foreign leaders.? This may depend a lot on who he would staff his administration with.

One additional result from a 2nd Trump term could be a run on the bank, so to speak, by producers for durable goods.? As Jason Miller, a supply chain professor at Michigan State University rightly pointed out, the expectation of increased tariffs could see businesses import a lot of products before those new tariffs are put into effect.? A demand spike of that magnitude could send the North American rail network into a tailspin, depending on your belief in its current state of resiliency.

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Get your Popcorn Ready

Whatever happens with the outcome of this election, it looks like it’s going to be a mixed bag for the rail industry and Class 1s in particular.? A Democratic administration could largely be negative for Class 1’s, but maybe less so for the rest of the industry while a Republican administration could also be negative for the Class 1’s, offset by any further deregulation or tax cuts.? A huge, unseasonal demand spike driven by the tariffs could send service down the tubes for another year as well.

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I always knew the run-in to the election was going to be an absolute circus.? That’s kind of baked into the cake with President Trump.? Unfortunately, we’ve still got plenty of time for more craziness, especially if President Biden does decide to step aside.? Get your popcorn ready.

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