The State of Trade: The Year Ahead in Supply Chains - Forewarned is Forearmed

Phil Levy: Chains, Forewarned is Forearmed. We'll get to what we can, we got a lot to talk about today.

I am Phil Levy, I am Chief Economist at Flexport and I am very excited to be joined by our Founder and CEO Ryan Petersen. Ryan, welcome.

Ryan Petersen: Hello. Hey, nice to see everybody and thanks for thanks for joining us today. Thanks for hosting us Phil.

Phil Levy: It was great to have you and we've got a lot to talk about. It has been sort of a dramatic year in logistics and trade. So let's move forward and we'll give an idea to people of what we're going to talk about.

All right, so here's the plan for today, Ryan and I are going to take a look back at 2021. What the heck happened, then we're going to consider instead of giving you a clear crystal ball forecast of here's exactly what's going to happen in each of the next 12 months. We're going to sketch out three scenarios. Imaginatively put as steady as she goes, it can get worse, or it can get better.

We get a supply chain reprieve. But we'll try to think a bit about what are the indicators of each of those scenarios? How do we know if we're heading in that direction? And what would it mean for both the economy and for the logistic system?

And then we're going to conclude with a little discussion of, so with all of that what is the business supposed to do anyways?

All right. We were gonna start as we always start, which is we want to hear what's on your mind, and we are going to ask you, that as you look back at the year, which is not quite concluded, but it's getting there rapidly, welcome to December. You consider your own business in 2021, would you say that the year was really not bad or it was tough but manageable, or it's tough this would better end soon, or it's so bad I can't talk about it.

So let me and I'm gonna have to vote here. I'll reveal later though, I don't even see what you were saying. Alright.

Ryan Petersen: So we know your answer, you’ve been having fun analyzing that.

Phil Levy: We do enjoy knowing what's on your mind and where you're coming from with all of this. So give a little more time. Alright, so it looks like we've sort of excused the the extremes, and we've got a plurality coming in at tough but manageable, followed closely by tough this better end soon. Ryan, are you surprised? but I went with tough, but manageable. Ryan, do you want to confess?

Ryan Petersen: Well, I assume, Phil, that you're the one that said really not bad, because as an economist, you're just having a field day looking at all the chaos and analyzing, going crazy, that's my first assessment.

Phil Levy: My business. My business Flexport.

Ryan Petersen: Flexport isn't the, so bad I can't talk about it.

Phil Levy: So are you surprised? This is how people are seeing things?

Ryan Petersen: No, I mean that to see where everybody sits in the chain, you know, if you're an ocean carrier, you're doing pretty good. If you're some of the logistics providers, you may get some money if you're a customer, I think you're down towards the bottom here.

Phil Levy: Yeah. No, that's right. It's worth remembering how this has been sort of hitting different people in different ways. Alright, so let's get down to what we have see has happened over the last year, and I will sort of grab the microphone first and see if I can talk through some economics of what I see as having going on. How did we get to this point? What were the sort of key issues as we look back at 2021.

So, I would make the argument that a lot of what we've seen has been in the report, there's been a really unusual economic situation coming as the pandemic has started, and that has the upshot has been to preview what I'm gonna say, really heightened demand for consuming goods in a way that nobody really anticipated. So let me show a little bit of where I see that as coming from. All right, next slide, please.

US Gross Domestic Product

Let's do some graphs, let's get into some economics. Okay. So first, this is a picture of US GDP and I apologize to our fans around the world, we can talk, we want to know what's happened elsewhere, because a lot of this has been paralleled, but I'm going to focus on us statistics. And one of the things we see here, so here we are cruising along, this is quarterly data. The gray bar in the middle is our unusually short, unusually sharp recession, which is what you see is this fairly dramatic drop in GDP. But then you also see a pretty good recovery, you get that initial V shape, and then we kind of glide back on up and sometime around the second quarter of this year, we get to that US output is higher than it was before the shock. So there's this gradual recovery to where we were before the shock. All right, next slide, please.

US Merchandise Imports

If you look at what this is, same timeframe, but now we're looking at US imports and merchandise imports. So these are people moving goods, in some ways you see a similar shape is that sort of sharp dip right around the time of the recession, a little bit of a lag, this is monthly data. So it's gonna look like those are more joints and kinks.

But one of the things you see here, is, remember, in the last one it wasn't until spring of ‘21, that we recovered in terms of volumes, in terms of GDP. Here, we recover much much more quickly. This is by fall of 2020, we're actually getting back to the import volumes that the country was having immediately before the recession. And then it climbed up steadily from there. So we'll talk about, you know, a number of indicators in life. But this is right at the core of this, which is we started importing a lot of stuff, and it's not recovery, it got to be importing a lot more than we were doing before, if you look that you can see sort of where this was on the left, where we were in the year or more leading up to the pandemic. So things really went up. Alright, let's go on to the next one and see where this is all coming from.

US Personal Income

If you want to look at what people buy, a good starting point is how much money do they have in their pockets. That's usually a prerequisite to buying something is that you've got money on hand. And so this is tracking US personal income. And what we would normally expect to see is you hit a recession, again, you got those vertical gray bar, you hit a recession and people lose their jobs, they get shocks, various sorts, and income goes down. Would you want to focus on this graph, let's start with the top line, that top blue line, income doesn't go down, income kind of holds steady and then it goes up. And then it stays up. If you look all the way along, and this goes to the data that was just released last week, we never get back down to where we were in March of 2020. Income is elevated throughout. So that's one reason why whenever we sort of thought, Oh, no recession, batten down the hatches, you know, businesses are going to fail, things are gonna go under, income didn't go down.

Now we can ask, why didn't it come go down? Now we get to a couple of these lines underneath. The red line is government transfers to people. And if you look, all the kinks that you're seeing in that top blue line, match pretty well with the red line down below. That it's, you know that we had things like the CARES Act where the government is literally writing checks to people and putting stuff in. So that had an effect, it had its intended effect, it meant that people retained buying power. But they could still do all this stuff.

The last line, I want to point to one, here's the one right below, which is personal saving. What did people do with this money? Did they spend it all the moment it landed in their account? And the answer was no, they saved a fair bit of that. That's important as Ryan and I tried to figure out what comes next, because it says if people just spent everything, then the moment that the government transfers let up, you think ah buying power lets up. If they saved it, then that means they still have the capacity to keep doing stuff.

I also know there was a very interesting crossover in the number that was just released, where personal income stayed high, but this time and rather than being government transfers, you had seen a boom in compensation for jobs that was starting to sort of lift incomes the same way. So alright, so key story here, what are the reasons we've been having this sort of strong buying thing is that people's incomes have been maintained. Alright, next slide, please.

US Personal Consumption Expenditures

Alright, so here we get to the people have their money, they're buying stuff, what are they buying? So again, similar layout, the vertical gray bar helps you sort of peg this to the recession. And the thing you'll note here, what I like about this graph is this one says, what is really different about economic behavior under the pandemic? What is it where it looked one way beforehand and then it just looks really different after. And so, this is my favorite candidate graph for this.

Note, by the way, these are not levels, this is normalized. So that February of 2020 equals 100. So you can look and see how big the deviations are from February 2020. These categories are also I should note, in actuality, they're not equal. People spend way more on services than they do on goods. If you were going to assign weights this US economy is roughly just under 70% services in normal times, maybe 20% non durables and 10% durables.

But here, we've normalized them to make for easy comparison. And what you see is for this period leading up to the recession, it's boring, dull, nothing happens, people behave just the way they behave, nothing changes. Then, at the initial onset of the recession, you get a dip in all three categories, except for non durables, because everybody is going out and buying yeast and toilet paper, but so that that goes up a little bit, but everything else is going down. Got it, this is a recession, we understand, that's what happens, the buying goes down.

And if you just look at services, the services line is pretty much what you expect to have with the recession, there's a sharp initial drop, and then there's a gradual recovery. Note services still has not made its way back to where it was in February of 2020. So if you just look at that green line, that's what recession behavior and post recession behavior is supposed to look like.

Let's look at the other lines. The red line is particularly notable, this one is durables. And what happens is people all of a sudden decide, you know what, I'm shut up here at home, or this, I'm going to buy some stuff. And I'm gonna buy a lot of stuff. And if you look, that line climbs and climbs and climbs to the point where by this spring, you're getting somewhere like 35% above what you had in February 2020 levels.

So it's, you know, while it was there, overall, buying is fine. You saw the GDP number, the economy's doing fine. There's a heavy switch into I want to buy durables, and then you also see throughout this bet back off a little bit, but you see non durables also rising throughout. So this, to me, has been the big economic story of a switch towards people just buying a lot more goods and a lot fewer services. Alright, next slide, please.

Flexport’s Post-Covid Indicator

And that has posed the question, Okay, if that's the big story, how long does this last? When does this thing end? And, and I know that what you all are asking, can Flexport platform data tell us anything about this? So glad you asked. Actually, the answer is yes, it can. And here what we've done is taken essentially, that slide you saw before, where we had this sort of really elevated demand for goods and we scaled things a bit. So we combined durables and non durables, we scaled it so that zero was the flat part, pre pandemic. 100 was roughly the level you had during the summer of 2020, when things had already started getting elevated.

And then we asked, okay, how does it you know, if we sort of look at this, how is it or moved along and the green part here is data from the Bureau of Economic Analysis, showing how that number has moved? And it really matches what you saw before the sort of elevated demand for goods? And then how much, how is this going to proceed in the future? Well, for that, we did some analysis, using Flexport data, where it turns out that what people ship correlates with what people later consume.

And what we can say is, through the end of the year, we don't see this letting up that not only are we not returning to normal, where normal would be zero here. But we're not even getting back to where we were in the summer of 2020, which would be 100. That we're still elevated above that.

So this is something that we post regularly, you can look at flexport.com/research. It's among the indicators, we'll have another one for you in just a minute. But this is us trying to say, the driving force behind all this has been people really wanted goods and a lot more goods, and I'm going to let Ryan explain in a second what that means for the system and also whether he agrees with this analysis. But it's that demand for goods has put a lot of strain on things. All right, next slide, please.

The Ocean Timeliness Index (OTI)

Another Flexport indicator coming from Flexport data, and this is a brand new one that we've rolled out just for you as of this morning. This is trying to say what has happened in logistics and specifically, we're looking at the two major trade lanes and I'm gonna let Ryan talk through what those are. But basically, if you come to us and you say how long does it take to get something from start to pretty near finish? What has happened and you'll note that the time period on this is this thing stretches back into 2019. So if you look, you were initially looking in the 40 to 60 day range to move stuff along. Our latest numbers are on the order of I think 105 and 107. We have the release on our website. So Ryan, let me hand this over to you. First, if you see things the same way on the economics front, but also, what has this all meant for a logistic system?

Ryan Petersen: Yeah, just help folks with the acronyms. Who aren't freight forwarding industry insiders like me and Phil here. TPEB means Trans Pacific Eastbound, that's the green line, I think of that as Asia to the US. FEWB that's Far East Westbound, so call that Asia to Europe. Just to give you a picture of what you're looking at. And yeah, you definitely see that the congestion is real. I see a lot of media coverage about the high price and I think that's the thing that companies are most upset about, it hits the bottom line directly.

But timeliness is a key factor when you talk about all the stories you're seeing about store shelves and the reliability of the supply chain. If this stuff's taking a lot longer, it means lack of growth, you're losing, you're missing sales. But also there's a real financial cost of this that also goes unknown often goes unnoticed, where the cost of working capital, the cost of all that inventory sitting there, someone's got to finance it and slowing down your turns, it's making your business a lot less efficient, lowering your return on assets. And, and yeah, just creating real problems.

I think one of the big problems with shortages that I think worries me the most is, if a consumer goes to buy a product, and the company is sold out, that sends a signal to that company, hey, I better buy another product, I lost the sale, if I would have had it in stock, I could have made that sale, and they go place an order and replenish.

And if their competitor actually gets the order because the consumer couldn't buy it from you, buys it from your competitor, and they also go and replenish it. So one sale all of a sudden turns into two reorders, two replenishment orders. And I'm very worried of actually over production people buying too much inventory, and getting a sort of bullwhip effect that all of a sudden comes Q1 or come some point in the future kicking the can down the road, we end up with over ordering and too much inventory. And all of a sudden we have the opposite problem. That's my big fear from a lot of this is that you can get these unpredictable bullwhip effects in the supply chain.

Phil Levy: So as you look back at the year just passed, what are the salient things for you? I mean, we've sort of set the stage on, there's lots of demand. What a lot of people poke at is, Well, where was the problem? Was it in foreign factories? Was it the way you know, ports are operating? Was it the shipping lines? There's sometimes the mentality to this, which is, somebody forgot to flip a switch, we just have to find out who. When yours are very, you've been delving into each element of this? How do you answer that?

Ryan Petersen: Yeah, and I think human nature wants to find a scapegoat. We're like really eager to be, who's the villain so we can punish them for what has happened and I think there's something fundamental about us that we want to have an enemy. And I think you're looking at a complex adaptive system. The most complex system, which is the global economy, it's made up of lots of other complex systems and human beings and all of their emotions and psychology. And where nobody's in charge, and it's hard for information to flow freely through the system, you can have cascading effects of bottlenecks that show up in one place, show up a number of weeks or months later downstream, and cause other problems and trying to fix this thing actually created another problem somewhere else. You've seen that a lot with, for example, the Port of Long Beach right now, it's got a huge number of ships, some of the other ports don't. So it seems obvious that hey, why don't we route these container ships to Oakland? Well, we saw that earlier, they were doing a lot of that and creating bottlenecks at Oakland, it doesn't, you know, the problems just move around.

And these are human systems, and they're not used to the kinds of dynamic change that you've seen. And we saw that it was like a pretty boring line, it was goods and services didn't shift that much. And when they do shift dramatically, the graph that you didn't show was imports and exports where imports have surged while exports have gone down. And that's a really interesting trend as well, because in a time, that's much more steady state, remember that the journey of the container itself that physical, rectangular box is doing a loop, it needs to go back and pick up more goods.

In pre-pandemic, about 60% of the containers leaving the West Coast of the United States are empty. And when imports go up and exports go down, you've got to ship a lot more empties back. And no one needed to manage that in the old days, because hey, 40% of the exports are going back, it's kind of steady state, you don't need to track it that much like you're gonna ship 60%, you're gonna ship these empties.

All of a sudden, when exports go way down, there is a need for someone to flip the light switch and decide, hey, we're going to ship more empties back, we've got to just do this, even though no customer is contracting us, we're going to go ahead and ship them. And there were some, these are dynamic systems without a huge amount of you know, we want to believe there's this sort of AI managed system that's taking care of all of us, and we can just relax. But, humans got to make these decisions and move fast. And in a dynamic environment, not easy to do and really easy for us to criticize on the outside.

But you have to remember that, that initial, if you go back a couple of slides, that initial collapse in demand looked like bankruptcy, if you're sitting in an ocean carrier seat, and they had to idle capacity, they had to make some really dramatic decisions that all of a sudden got caught by surprise all of us, I can't find a single economist, I'm gonna criticize your profession, Phil, but I couldn't find a single economist who predicted most of this stuff, that goods would go up, it's not typically what happens in recession.

So we're, we're sort of in uncharted territory and one of the problems with data, broadly, is that it all comes from the same place, which is the past. And when the past suddenly looks dramatically different from the present and the future, it's really hard to make predictions off of that data. And, and so you know, the plight of, and there is not someone in charge, we can't point to one person whose job was to figure out how many containers to go back, it's a complex system. Even the companies themselves are like institutions made up of lots of human beings.

So reacting to this kind of dynamic change is not something that our current level of sophistication in the world's logistics infrastructure is just ready to handle, and it's a really interesting question for both policymakers and market actors is like, how do we make our organizations more resilient, more adaptive ability to see these changes in the economy and take appropriate action? I think the pandemic has exposed those flaws sort of across all of our institutions. Whether that's logistics, healthcare, lots of other areas where you're like, wow, we're kind of brittle, we're not really made to handle this level of adaptive change.

Phil Levy: So that's a very good point about how we're sort of constrained when you get this dramatic change, and we only have the past to rely on. And so what are the I very deliberately, when I sort of showed the consumption things you show the boring flat period that came first, yours are very well versed in what's happened with the shipping industry, people have started to focus many people now where they see this as you know, very high prices, extraordinary demand for containers, you know, why wouldn't you just have many more ships than you do? Can you give us a bit of a broader perspective, if we pull back not two years, but more like, you know, seven to 10 years? You know, what does the ocean shipping industry look like?

Ryan Petersen: Yeah, it's a really important thing for us to do, because businesses are pretty pissed off. Companies that are shipping stuff for paying a lot more for freight. And as you see from this ocean timely index that Phil's team has created, they're getting worse service, the transit times have deteriorated. So that's, you know, a recipe for an upset customer.

But if you go back in time, in 2016 the price of ocean freight, we had way too much excess capacity, way too much capacity for more ships. It seemed like all ocean carriers ran a similar playbook. My hypothesis is they all hired the same BCG and McKinsey consultants who told them the same thing is like, let's build the biggest ships in the world and that'll give you the lowest average cost. And you got these new mega ships that came online that ship 20,000, 22, 24,000 TEUs these monster ships.

And the economy didn't grow, following the global financial crisis, you didn't get this long run growth that we've had over the last 50 years of global trade started to slow down. And it wasn't there to match the new capacity that came online. And so these ocean carriers started to be really difficult businesses, they lost a lot of money for the last decade.

In particular, remember, and it's easy to forget, but in 2016 the price of ocean freight fell to all time historical lows, like all time since the dawn of mankind, it was never that cheap to ship something across the world as it was in 2016. Where the spot market over the last year approached $20,000 to ship a container from China to the US in 2016. You could do it for eight or 900 bucks.

And it's so we have such short memories, you know, like all these companies that are really pissed off and again, rightfully so, but quickly forget like, wow, you were really we were all doing pretty good when it was dirt cheap in 2016. And the prices were so low.

In fact, Hanjin is one of the largest ocean carriers in the world. A Korean champion failed, and they went bankrupt in 2016. And all the market chaos that fell out of that with people who had containers stuck on ships in a company that was in bankruptcy.

So these ocean carriers do not forget that they went through a really hard time, I presume there's some sort of psychological trauma that comes out of going through that stuff, and then when you realize that, at the start of this pandemic, these were precarious businesses that had lost a lot of money that had been in difficult places, some of them and taking bank loans from governments and like, they weren't really well, in a great place financially, that you're facing to the brink, you're looking at that and going, wow, you know, we're in a really difficult place.

And that context is really important for companies to remember, is like, it's an asset boom and bust cycle. It's a classic asset boom bust business, that is currently going through a boom, but it doesn't make it the sort of that's inevitable because these assets last for 25 or 30 years, a ship. And nobody can predict the price of freight in 25 years, you can't predict it next year. And so they're having to make these investment decisions over a long run historical basis, that there was no evidence to say that we needed more ships, until all of a sudden we needed more ships with this pandemic.

And right now, I'm told that a new build a new construction ship, if you happen to be lucky enough to have ordered that before all of this started, pays itself back in five months, at these current rates, where it used to be 25 years to get a return on the ship and a 25 year lifetime asset, it was not a great decision until recently.

Well market prices, there is a real function of pricing and market prices. We're lucky to live in a market based system and those high pieces of ocean freight are definitely sending a signal to folks, buy more ships, make more ships, build more infrastructure, build more capacity, because it's very profitable to do so.

And again, you end up in boom and that's the nature that's the origin of these boom and bust cycles is, you can predict sort of a few years from now we'll talk we'll be talking how people ordered too many ships and built too much capacity, and the price is so low, no one can make any money. And so, it's easy to say it's easy to allow your heart to fill with envy of how much money these companies are making easy to be upset. And again, rightfully so you're paying a lot more and not getting the same level of service that they used to get. But I'm not sure you want to sit in the shoes on the other side, over the long term of the cycle.

And because we're going to be talking for a few years about how these companies are under huge pressure and can't make any money again. So really dynamic industry and there's a reason that Wall Street loves technology companies is they don't have to go through that asset boom and bust cycle.

And if you look at the nature of these ocean carriers, they tend to be family businesses or state owned enterprises, because those are the types of institutions that can play the long game and ride out a 30 year boom and bust cycle and come out ahead. They have the longevity, they have the history where Wall Street Public Market company, there are a couple public companies, but they really have a hard time I think communicating to Wall Street who has such short expectations of quarterly earnings cycles. And these are much longer run cycles, and in many ways are better suited.

In fact, even if you look at the public companies, if you actually look at the makeup of their shareholder base, it's a small number of either families or governments that are owning the majority of those businesses, people who can ride out the cycle and play that game. It's easy to criticize, but I'm not convinced everybody wants to switch gears. You certainly didn't want to be in their shoes five years ago.

Phil Levy: Yeah. So, and let me sort of take from that, that is it's extraordinarily hard to predict the future users we do, we don't actually know what spot freight rates are going to be in a year, much less 25. But that is also critical because people have to make investment decisions, you're getting more capacity, and not just the carriers of course, but that's true for a lot of businesses that are deciding what they're going to sign on to with rates, what they're going to, how they're going to source, we're going to get to all of that, we're gonna do our best job of looking at the future.

Let's move on and we're gonna do another poll, we're going to ask what you're thinking about the future right now as you look towards the new year, that's rapidly approaching.

So, when it comes to moving goods, do you expect that 2022 will be, more of the same like 2021, even more difficult than 2021, better than 2021, or you tell me, which or just put all the burden on us. I think I'm going to have to choose that one. But the, but, alright, thank you for those who voted, nice quick response. Let me take a moment here. Alright, so it seems like we have a clear winner here which is, we expect the future to be just like the present.

Sometimes that works, so rather than responding to this poll, we're actually going to take each one of these scenarios and talk it through and see, what would that mean, how would that go. So we’re going to sort of cover all three. Yes, I think we have a clear winner with the more of the same.

Let's move on to our, let's move on and we're going to talk about each of these scenarios.

Scenario 1

So Ryan, their favorite thing was more of the same. I'm going to try and think about how would we have that from an economic scenario. What is, what would sort of provide the economic basis of this? I actually, it's not an easy task, there's a little bit of sort of threading the needle, I think you probably have to have demand come down a little bit, maybe the sort of pulling back from durables. This was what the Feds theory had been all along was it? This was sort of transitory because you know, hey, how many sofas and refrigerators are you going to buy? At some point you sort of exhaust that, in fact it might even dip a little, so it dips, but not too much. We're of course watching the new variant that's come out and the health situation has tended to drive a lot of this.

So, I think if you were trying to do a scenario where it kind of stays roughly the same, you'd be thinking about a challenging health situation, but not one that sort of brings a lot of additional stimulus, which would probably push you in another direction. So you're having sort of demand back off a little bit, but maybe not enough for ports to clear, and then I guess I would also toss in some of the interruptions, we haven't talked about interruptions yet, like you're an acknowledged author of books about the Suez Canal, it's a good book, but I recommend it to everyone. But can, from a logistics standpoint, can you tell the story that we really have a 2022 that looks a lot like 2021?

Ryan Petersen: Yeah, I mean, it feels like the default, we're almost in 2022, it'll be here in a month, there's definitely some reasons that there are some unknowns, unknowns always, there's some known unknowns that are coming out that make it hard to predict, so I put you in the, I put myself in the, you tell me scenario, I'm happily uncertain and don't know, and I think it's a comfortable way to live your life is to be ready for anything is where we all need to be at this stage.

But the, I'm not, you know we have, your post Covid indicator makes pretty clear demand's not gonna, it seems where it is right now, at least for the next 90 days or so as we predict ahead of the BEA’s analysis. The, I don't see a great, I don't see a lot of mechanisms for the supply side to resolve itself, some of the congestion, it's not like you're going to get new ships take a long time to build, new ports take even longer to build, some of the trucking we've had a long run challenge in truck driver shortages in the United States, and as much as we love to talk about self-driving trucks in Silicon Valley they're not here, they're not ready, you're not going to see that impact in the next, certainly not next year.

And, so driver shortages, you've got, shortages of almost every step of the chain that I don't see those resolving themselves, so like from my view the only real way that it does, that it improves as if demand comes back down to pre Covid levels, at least in the short term. Long term, yes there's some market pricing that's going to drive folks to buy more assets and that leads to that scenario that I'm also concerned about it, like we owe, we bought too many assets and all of a sudden the price collapses and we're back where we were in 2016, where no one can make any money and there's a whole different breed of chaos with bankruptcies and other problems.

But yeah, I think steady as she goes as a default scenario would be a pretty reasonable assumption. I'm not seeing a lot of things that show me it's going to get dramatically better.

Phil Levy: Do you think that we're in a sustainable state? One of the things that worries me and what I was trying to work towards what I'm saying with the economics of this was, even to maintain where we are, we kind of need a bit of pullback on demand. Because you've been focusing deep in things like, and maybe you want to say a word about this, how, you get to a point where there's just so many containers at a port that you can't even unload the empties and you kind of get to a log jam, which means that what might have been sustainable at the beginning of last year doesn't look sustainable or the beginning of this year, doesn't look sustainable now.

Ryan Petersen: Yeah.

Phil Levy: Do you think it's right that we actually just to make it viable to keep going that we need a bit of a pullback?

Ryan Petersen: Perhaps. It's one of the things that I'm most concerned about here is that, if you see a complex, in a complex system, if you have the same amount of input leading to a longer and longer output, a shorter, you know longer and longer delay in the output and that delay is increasing even as the input stays the same, it's a very worrisome sign. We see this in the technology systems that you build as if you have a system that's supposed to run a job and then the same amount of data is hitting that job but it's taking longer and longer to return the result, you likely have a negative feedback, a vicious feedback loop in the system that's causing things to get worse and worse and worse and impossibly in a compounding way that can lead to a collapse of that system and I'm referring, I'm not talking about collapse of global economy but a collapse of a technology system.

I think there's a really a good analogy there, potentially that we should be worried about, that's what got me really concerned because, although as you show imports are up quite a bit, over 2019 levels they're not actually up over the last six months, and yet we see that the delays keep getting longer. You saw that in your ocean timely index, it's getting longer and longer even though we're sort of at the high levels, in fact we're down a little bit from the peak of volumes and yet the delays keep getting longer, and that's a very worrisome sign.

In a flow, picture, you know there's two types of flow that we're more familiar with, would be one, would be just a flow of water and you can have what we call laminar flow or turbulent flow. Laminar is very smooth, all the molecules are moving in the same direction, they're not interacting with each other and the same number of molecules can move at a very fast speed in laminar flow, or you have turbulent flow where they're all interacting with each other and they can, the same number of molecules can go much slower, so there's two equilibrium states for that number of molecules to move down a river or move down, move, you know flowing out of a sink or wherever you may flow. Or similarly in traffic, like you, the same road 100 cars a minute might go streaming right through, or the hundred cars might go at five miles an hour in a traffic jam, and the same input could lead to very different outputs.

And the thing that's quite worrisome for me is that, if you're, though if those two analogies were to apply today, you may actually be in a case where the same amount of containers are just slow, they just have a new equilibrium straight which is much slower. And that would be really bad for everybody, I think bad for all the parties involved if ocean freight becomes less reliable, companies start saying, hey, I can't deal with my 70 day transit times, I'm going to move factories on shore, be a terrible way to resolve these problems for those of us in the logistics industry if it was, hey, we're just going to opt out and, either companies fail or manufacture in a different location and don't ship, I mean we should be happy that there's this boom, it should be leading to a golden age for all the companies is like, business is booming but very worrisome if in fact we reach a new equilibrium state which is much slower, and if it is the case it's probably because you have a positive feedback loop, which is a negative thing, it's a bad thing but a vicious cycle, where, for example, one way that we see this manifest itself is with the truck drivers, where a dreads driver, many of them are owner operators, so these truck drivers own their own truck and they get paid per load. Well if there's traffic jams there's delays, there's difficulty getting appointments and they're, they used to be able to do two loads a day, now they can only do one.

They're making half as much income, they opt out of the system, because maybe they get a job at FedEx, maybe they do over the road trucking something without the traffic jams that we see at the ports. Now the system becomes worse and worse, and that's an example of a positive feedback loop that might have the same amount of input leading to longer and longer delays, so that's something I'm very worried about is trying to identify as many of these is possible to see, can they be addressed, are there market solutions, is there an opportunity for public policy, is there ways to address these types of market failures that you're looking at.

Phil Levy: Yeah, and that's definitely something that's worth thinking about. Let's go to the next slide. We've already started.

Scenario 2

I think into a little bit of the, it can get worse for, basically the steady state is we avoid it getting worse. So, one thing I wanted to ask you and get you, so I would say from an economic standpoint and it can get worse, here's a couple things that I'll flag. One, and this is, I'll just claim this for economics, but a health situation that gets dramatically worse where you have closures and people aren't able to man ports or factories that definitely does this. There's a problem which is that sometimes you get a response to that as we saw with the fiscal response earlier which is, well then let's, we're worried about the overall economy, so let's try to stimulate things so at the same time the ability to move and produce things goes down, the demand for things goes up, that would be a worsening.

There's another thing which is probably on the horizon, which we should at least flag, which is, among the groups that have to think about how they do things, you've got workers at ports and we've got port labor negotiations coming up. So, maybe you could say a word Ryan, first about what it looks like if things get worse although you've already described that a bit, but also what role did interruptions play, and how was there that random chance, we saw a number, we say Yantian, we saw the Ever Given, why are those important in a system like this?

Ryan Petersen: Yeah, and there's, well to answer that question directly, is because, the Ever Given for example where the ship got stuck, it wasn't just that ship but there were hundreds of ships behind it that got stuck and they all missed their scheduled and not just the ships but all the containers on board are not moving and not ending up in the position where they're supposed to be and leading to shortages and cascading problems that are almost impossible to predict, at least in the current level of access to data and where GPS positioning of all the world's containers.

In theory you might be able to feed all that data to some sort of machine learning model that could adapt and predict things, but we're not at that state as an industry to know where all the assets are, certainly not the assets that we don't own and control. So, and the port closures, China's had a very strict and I think very successful from a health management policy of zero tolerance for Covid, so if a port worker gets Covid they'll shut down the port for a couple weeks, well it leads to the same types of cascading effects that you see, in fact even more so. The Chinese ports are so important to the world economy that if one of them, Ningbo has, both Ningbo and Yantian, which are two of the top three or four biggest ports in China, probably in the entire world. When those shut down for two weeks because of Covid cases, it's just cascades through the system in really unpredictable ways.

So yes, that would be one example is you could have more outbreaks like that and more shutdowns of major arteries of trade like those ports. So those are kind of unknown unknowns, you might call them. Known unknowns, we do have July 1st of next year on the West Coast, the International Longshore and Warehouse Union, their contract expires July 1st of 2022, and last time that happened was 2015 they had a three month port strike where nothing shipped on the West Coast the United States. That's a west coast union, it doesn't, but it does extend up into Canada, so all of the ports on the west coast were are at risk that next summer of either absolute shut down with a strike or slowdowns as negotiations take place and labor relations is a really unknowable, it's a known problem but it's kind of unknowable result of how it's going to play out.

So those are definitely major factors that need to be on the radar and companies should, we're going to get to what companies can do about it, but while I'm talking about that I think companies are starting to make contingency plans, maybe routing through the Panama Canal talking about maybe shipping to Mexico and bringing things up by rail or truck. A lot of different planning taking place around that, but yeah, those are definitely scenarios in the, it can get worse category.

Phil Levy: Okay great, and we'll come, we definitely will come back to, for what companies can do. Let's move on, let's try and be optimistic, be cheerier.

Scenario 3

Although I will note that for the supply chain reprieve we, it's worth making a distinction, if we thought that some of the problem was this excess demand for goods that was really weighing on a system that's being pushed beyond capacity. The reprieve for the system may not feel that great for the economy, I mean in general a boom feels really good right, maybe not when prices start coming up with inflation, but you know you got money in your pocket, you're ordering goods, this feels nice, pulling back doesn't tend to feel as nice, so it's it's worth making that distinction.

And actually I'm going to sort of weigh in and so what are these big factors to watch that comes up with this, in terms of, how do you pull back on demand? So if we can switch to the next slide for a second.