Hostess bankruptcy: Blame Bernanke and then the unions.

Today Americans woke up to the news that Hostess, the manufacturer of products like Twinkies, Wonder Bread and other "food" items is shuttering.   The explanation provided is that their unionized strikers crippled production to such a point that it triggered an automatic contract clause.  To be sure, Hostess was already on the ropes and under private equity management due to filing for bankruptcy in January of this year (their second bankruptcy in a decade), but the death knell most certainly came earlier than expected.

The closing of Hostess is actually quite tragic,  because the job losses are in the many of thousands:

The closing will result in Hostess' nearly 18,500 workers losing their jobs as the company shuts 33 bakeries and 565 distribution centers nationwide, as well as 570 outlet stores. The Bakery, Confectionery, Tobacco Workers and Grain Millers International Union represents around 5,000 Hostess employees.

"We deeply regret the necessity of today's decision, but we do not have the financial resources to weather an extended nationwide strike," said CEO Gregory Rayburn in a statement.

What exactly were the unions striking over?  Hostess attempted to extend the company's life by lowering benefits and wages:

The new contract cut salaries across the company by 8% in the first year of the five-year agreement. Salaries were then scheduled to bump up 3% in the next three years and 1% in the final year. Hostess also reduced its pension obligations and its contribution to the employees' health care plan.

In exchange, the company offered concessions, including a 25% equity stake for workers and the inclusion of two union representatives on an eight-member board of directors.

The company is citing mounting medical and pension costs for crippling their margins. I assume this is true, but there is something far more insidious going on.

Regardless of what you think about their "food", something I find dreadful and can only refer to as food after stretching my definition of the term far and wide, the basic free market mechanics exist.  Company H, created product T because of demand from customer C.

Due to raised awareness of how harmful trans fats are (twinkies have trans fat), HCFS and other chemicals, the American consumer is most likely curbing their appetite for enriched white flour products and sugary carbohydrates.  However this decline in demand is perfectly normal and something all producers grapple with on a daily basis.  Hostess still outputs millions of products annually, so someone is buying, even if they are buying less.

Now Hostess finds itself squarely between two massive forces and both are threatening to pull the company apart.  The two forces are:  contraction of demand and inflation of higher order goods.

The first is rather simple, people are buying less product.  We can chalk this up to recessionary pressure, behavioral changes, consumer awareness, etc.  Does not really matter.

The company has exactly two choices: lower operating costs or lower final price.  

This is where the infinite liquidity pumping of our central bank and the Keynesian/Monetarist wizard known as The Bernank comes in.  Ben Bernanke has been on a kamikaze mission of pumping the American economy full of funny money for years, because we all know that adding more debt and more cheap money will provide wealth, prosperity and growth.  Oh wait, it does the opposite, who cares, Bernanke has a PhD in economics and I am just an idiot blogger.

This unpleasant experiment known as QE (Quantitative Easing) has caused a bit of damage on commodity prices.  More dollars, but same amount of goods equals rising prices.

What are the two primary ingredients of most Hostess products?  Wheat and corn (corn syrup).

Observe:

Commodity wheat prices.  Second highest in 12 years,  surpassed only by the 2007 credit induced bubble.

Commodity corn prices.

You have to ask yourself, how is it that in a global recession (or weak recovery if you prefer) that we have the highest corn prices in the past 8 years?

This increase in cost of higher order goods puts immense pressure on the Hostess bakeries.  In order for Hostess to cope with the loss of consumption, they can fix the problem by lowering final price.  However if they lower final prices while getting squeezed on raw ingredients they will lose money, back into debt they go.  So they do what is the most natural and obvious thing they can do, adjust final price in concert with rising raw ingredient prices.  This in turn discourages more consumers from buying the now more expensive product and the losses continue.

Meanwhile Time magazine slams Bernanke's mug on their cover and announce him to be the next best thing since sliced Wonder bread.

Lowering final price is out of the question, can they lower operating costs?  Most of the operating costs are labor.  Because the workers are unionized the labor costs are higher, on top of that there are numerous pension obligations and rising medical costs.  This where knowing the Great Depression helps.

In the Great Depression, prices were falling across the board however both the Hoover and FDR administrations gave political juice to big labor and legislation that propped up wages.  You would think this is utterly ass backwards since in an environment of falling prices, wages should follow suit, but they did not.  When we have state and federal minimum wage laws it creates an artificial floor for employers, if profits begin to shrink due to lowered consumption then the only way to solve the problem of labor costs is to fire people.  This is how price fixing of wages results in rising unemployment.

In the case of Hostess,  the management team proposed the only remaining alternative, lower wages and benefits.  Now, of course the unions should take a price cut, a job is better than no job, but we can be sympathetic to their plight.  This is where The Bernank comes in to play yet again. Unions are fighting the same price war that can be felt on the higher-order goods side!  Instead of grappling with rising wheat and corn costs, the average worker represented by the union is fighting rising costs everywhere; supermarkets, gas stations, clothing stores, etc.

Since the CPI is always slightly undervalued to absolve our Government of certain responsibilities, the MIT price project is more illuminating.

As can be sadly observed, priced paid are now substantially higher than they were even during the 2008 boom. So if you are a union representative and your job is to ensure that your workers are getting paid adequately, what choice do you have?  Without demanding raises, in the face of rising prices the workers are essentially getting a wage cut. The corollary of the Great Depression, is that with prices dropping the Government enforced minimum wage laws were giving workers wage increases. 

So while in the Great Depression case there was a gross violation of free market wage rules, in today's word we have a gross violation of pricing.  Under a healthy free market with the money supply remaining stable prices DROP. They have to drop because humans are always evolving and becoming more efficient.  So while we can blame the unions for many things, blaming the unions for trying to keep up with the Central Bank inflation is out of bounds.  

The root cause remains the expansion of cheap money and artificial interest rates. Policies of the Federal Reserve is hitting Hostess on the higher order goods side AND simultaneously forcing the union's hand on the wage side as they desperately try to compete with rising prices.  In an environment where capital formation and redirection of resources to healthy sectors is so badly needed,  our central bank is continuing to suppress rates and expand credit thus choking off recovery and prolonging the pain. 

Now that is food for thought.

P.S.  For those worried that their beloved junk is going away, rest easy, the company will be broken up and pieces of it will be sold off without the heavy weight of labor costs.