Manufacturing Weakness

In light of an unbroken string of atrocious manufacturing survey data, we have decided to update a few of the charts we use to assess the economy. For a discussion of the details of the most recent manufacturing surveys see Mish (Empire State and Philadelphia) and Zerohedge (Empire State and Philadelphia). We would note to these data that the strong decline in new orders is especially noteworthy.

 

abgrund100~_pd-1440399414404_v-z-a-par-a-lPhoto credit: ard.de

 

To begin with, we want to point out that there is at least one data series that strongly suggests that the economy is not yet in recession, namely private non-residential fixed investment (it has a long history as a confirming indicator).

 

1-Non-res fixed investmentReal private non-residential fixed investment. This data series tends to decline or at least flatten out just prior to recessions and is definitely declining as soon as a recession is underway. As of Q2 2015, it was still rising, which suggests that a recession hasn’t begun yet – click to enlarge.

 

This is incidentally also confirmed by the Atlanta Fed’s “GDP Now” indicator, which currently indicates annualized GDP growth of 0.9% in Q3, which is quite weak, but not yet a contraction. Still, the indicator is currently mired in a downtrend and there are obviously quite worrisome developments underneath the “quiet stagnation”.

One thing that we cannot stress often enough is that the manufacturing sector is far more important to the economy than its contribution to GDP would suggest. Since GDP fails to count all business spending on intermediate goods, it simply ignores the bulk of the economy’s production structure. However, this is precisely the part of the economy where the most activity actually takes place. The reality becomes clear when looking at gross output per industry: consumer spending at most amounts to 35-40% of economic activity. Manufacturing is in fact the largest sector of the economy in terms of output.

Although we have no recent update on gross output yet, both manufacturing and mining output have turned negative in Q1 already, and given the survey data received since then, it is a good bet that this downturn has continued. In fact, the following chart of business spending, inventories and the inventories/sales ratio recently mailed out by our friend Michael Pollaro (keeper of TMS statistics) suggests as much – these data show the situation as of August. If we were to judge the state of the economy based on this chart alone, we would probably conclude that a recession has already begun:

 

2-Business salesAnnualized growth in business sales, inventories and the inventories to sales ratio – click to enlarge.

 

A Distorted Production Structure

There are good reasons to believe that the next bust will be a denouement of historic proportions, a.k.a. a real doozy. The enormous expansion of money and credit that has been in train since the gold exchange standard was abandoned following Nixon’s gold default (sorry, “temporary suspension” of gold payments) has over time created an ever more “top heavy” production structure. This phenomenon can be observed by looking at the ratio of capital to consumer goods production. The expansion in money and credit from thin air has continually suppressed interest rates below the natural rate, pulling more and more factors of production toward higher order goods production. Over time, the amplitude of the intermittent booms and busts associated with this has steadily increased. The current business cycle is unlikely to be an exception.

The chart below shows the relatively recent situation. What is remarkable is that the trend has begun to stall out in recent years, in spite of money supply growth ranging between 8-16% (currently approx. 8.5%). This is a strong hint that the succession of credit booms over recent decades has severely depleted the pool of real savings available to the economy (note that real savings, or the free capital actually available for longer term investment projects, are distinct from numbers piling up in bank accounts due to willy-nilly money printing).

 

3-Cap vs. consumer goods ratioThe ratio of capital vs. consumer goods production shows that in periods of artificially suppressed interest rates spending on capital goods production rises sharply vs. spending on consumer goods production. Recently the trend has stalled, in spite of brisk money supply growth – click to enlarge.

 

For comparison, here is a chart of money supply and credit growth, with the same time period highlighted above shown in a blue rectangle:

 

4-Money and credit growthAnnual growth rates of the broad true money supply and total bank credit – this indicates that in order to reignite boom conditions, ever greater money supply growth is likely required – click to enlarge.

 

It is also worth considering the difference between “then” (the time prior to Nixon’s gold default) and “now”. As the long term chart below shows, the ratio actually moved in a well-defined channel before the dollar’s last tie to gold was cut:

 

5-Cap vs consumer goods, LTPrior to the adoption of a full-fledged unanchored fiat money, the ratio between capital and consumer goods production moved within a well-defined channel. Recessions were more frequent, but also far less severe. It is to be expected that eventually, the entire move since 1971 will be “corrected” – click to enlarge.

 

In parallel to this, total credit market debt has exploded into the blue yonder. We would point out to this that the ratio between capital and consumer goods production would also rise if the pool of real savings were actually growing. In that case, an increase in economic growth should be expected to ensue, as the investment-consumption ratio would be in line with the actual wishes of consumers. The fact that economic growth has actually slowed quite noticeably relative to the pre-default era can be seen as empirical evidence that amassing all this debt and artificially distorting the structure of production has actually set us back quite a bit. One must always be careful with interpreting empirical economic data of course, as the ceteris are never paribus, but it is clear that we have very little to show for the explosive debt expansion chronicled below:

 

6-Total credit market debtTotal US credit market debt, which has gone “parabolic” after Nixon’s gold default. Unfortunately, this debt expansion has produced slower rather than faster economic growth compared to the immediately preceding time period (1945-1971) – click to enlarge.

 

How the vast money supply and credit expansion of recent decades has affected production is also shown by the following chart, which depicts the industrial production indexes of business equipment, durable, as well as non-durable consumer goods separately. Over time, the three data series have drifted ever farther apart.

 

7-Industrial production dehomogenizedIndustrial production of business equipment (capital goods), durable and non-durable consumer goods. Note how the beginning of the secular downtrend in interest rates initiated by the Volcker Fed coincides with the growing gaps between these production indexes (note that under Volcker, the biggest year-on-year money supply expansion in a single year of the entire post WW2 era occurred in 1982. Today Volcker is widely hailed as an “inflation fighter”, one of the many great absurdities peppering the establishment-approved version of economic history. In reality he was a super-inflationist) – click to enlarge.

 

We are not surprised that manufacturing data are weakening, given that the distortion of the production structure is at its widest ever. To put this in different terms: the economy is tying up too many consumer goods in long term projects relative to the amount it releases. Those engaged in long term investment projects that will only bear fruit in the form of goods ready for consumption after a very long time need to be sustained – and that means that their demand for the entire plethora of consumer goods needs to be satisfied during the waiting period (they will need more than just food and shelter). This is why an imbalance in the time structure of production cannot be sustained in the long run.

 

Reality vs. Fantasy

You wouldn’t know any of this watching the stock market, which is best described as “fantasy land” at the current juncture. Then again, the stock market is always the last market to notice that something is amiss; to wit, it made a new all time high in October of 2007, even though the credit and bank funding markets were already in an advanced state of panic.

In Thursday’s session, the Nasdaq and Russell 2000 indexes actually outperformed the broad market, which is normally a positive technical sign. However, if one looks at the ratio charts, one can still see that the Russell remains in a short/medium term downtrend relative to the broader market, and that is generally not a good sign – especially as it has been an upside leader for the bulk of the asset bubble progression since March of 2009. By contrast, the NDX and COMPX have maintained their relative strength trend so far, so in this sense we are looking at a mixed bag.

 

8-Ratio charts, stocksRUT-SPX ratio, NDX-SPX ratio and the SPX over recent months – a mixed bag of signals – click to enlarge.

 

We were greatly amused to learn via Reuters that the market allegedly rose because “[…] Of the companies that reported earnings so far this season, 67 percent have exceeded analyst estimates, compared with 49 percent in a typical quarter”. Earnings season not over yet, but this mainly indicates to us that the combination of lowering the bar (by analysts ratcheting own their expectations as the reporting season approaches) and financial engineering (on the part of companies) has likely reached fresh heights of absurdity. If the Yellowstone Caldera were to explode tomorrow while concurrently a three billion ton iron-nickel asteroid planted itself in the Pacific at 70,000 miles an hour, earnings would still “beat expectations” next quarter. The market would probably not rise under these circumstances, though we cannot rule it out either (the fact that trading would have to be conducted underneath a mountain of volcanic ash might complicate things a bit).

 

As an aside: the Reuters article also mentions the tired old “money on the sidelines” canard. This is not a variable (apart from the growth of money substitutes due to monetary inflation). Someone always holds all the money in the economy, and someone always holds all the stocks in issue. There are no unowned stocks floating about in the ether, and when stocks are sold, no new money comes into existence – the two merely change ownership.

When comparing the entire market (in the form of the Wilshire 5000, the broadest market index available) to new orders for capital goods, one can see that the designation “fantasy land” isn’t too far-fetched:

 

9-New Orders vs WilshireThe stock market hasn’t really grokked it yet – its celebratory mood is out of line with developments in the real economy – click to enlarge.

 

As many others have remarked (inter alia the above mentioned Michael Pollaro, as well as our regular correspondent BC), these days the stock market is the economy. This largely explains the extreme reluctance of the central planners to hike rates even by a measly 12.5 or 25 basis points from freaking zero.

 

Conclusion

There is no recession in train just yet, but it would be a grave mistake to ignore the growing weakness in the manufacturing sector. This weakness is all the more remarkable considering that money supply and credit growth remains brisk, which normally keeps malinvestments on artificial life support and allows them to expand further. The fact that this is no longer the case is evidence of the enormous structural damage the economy has suffered due to loose monetary policy and the succession of credit booms we have seen unfold in recent decades.

Stock market investors have so far been protected by the “central bank put” and the associated strong money supply growth. However, in the euro zone, where money supply growth is currently the strongest of the main currency areas, stocks have performed dismally of late, proving that even pumping up the money supply by 14% p.a. sometimes won’t do the trick. Moreover, there is no law that states that stocks have to be the main beneficiaries of excess liquidity. They have been in recent years, but that won’t necessarily remain so. If our ruminations about the sorry state of the economy’s pool of real savings are correct, one should actually expect this to change.

Lastly, this isn’t the first time the market has ignored a sharp deterioration in the economy. Sometimes it later turns out that market participants were correct in looking beyond the economic data of the day, but often enough they simply turned out to have woefully underestimated the dangers (as the chart above actually demonstrates). Caveat emptor.

 

Addendum: Gross Output Reminder

Just as a reminder, we reproduce the gross output chart below (gross output by industry is shown until Q1, new orders for capital goods are updated to August):

 

10-Gross OutputGross output by industry, plus new orders for capital goods ex aircraft. This chart also provides evidence for the correctness of Austrian capital theory: mining and manufacturing are the most volatile sectors, while retail is the least volatile. In other words, the further removed from the consumption stage industries are, the more volatile and boom-bust prone their output becomes. It is worth noting that the output of mining and manufacturing both have already turned negative in Q1 – click to enlarge.

 

Charts by: St. Louis Federal Reserve Research, StockCharts, Michael Pollaro

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

3 Responses to “Is the US Economy Close to a Bust?”

  • JasonEmery:

    Right now the USA is getting the best of both worlds, from lower oil prices. Motorists are getting an ongoing price break. And this ‘extra’ spending money is going mostly to the middle class and working poor, so it is being plowed right back into the economy.

    Domestic oil producers are getting lower prices for their product, but at least they getting something. And they are getting paid on a ‘dollar per barrel’ basis. Even though the price per barrel is low, they are getting strong dollars, and they are selling a record volume of barrels. So, good cash flow, even though are losing $40/barrel sold.

    The problem comes when, next year, volume tails off. That is when most of the small producers go bust. These tight oil shale wells produce most of their oil in the first year. So these guys will be out of oil in a year or two, so when prices ultimately rebound, it will go into the Saudi pockets, and the majors, not these domestics drillers.

    If, on the other hand, oil doesn’t rebound in price even after USA production rolls over in about a year, it will mean that China and the rest of the world has entered a serious recession. So I look for the American economy to hold up for at least another 6 to 12 months, then tank.

  • herepog:

    Does the (“Stock market investors have so far been protected by the) “central bank put” and the associated strong money supply growth” = the Fed tolerating $50 bil/day of US Treas fails-to deliver if the Fed is actually the buyer?

    fails data: Daily Total US Treasury and Agency Fails
    http://www.dtcc.com/charts/daily-total-us-treasury-trade-fails.aspx

  • rodney:

    This sucker could go down …

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • How to Survive the Winter
      A Flawless Flock of Scoundrels One of the fringe benefits of living in a country that’s in dire need of a political, financial, and cultural reset, is the twisted amusement that comes with bearing witness to its unraveling.  Day by day we’re greeted with escalating madness.  Indeed, the great fiasco must be taken lightly, so as not to be demoralized by its enormity.   Symphony grotesque in Washington [PT]   Of particular note is the present cast of characters. ...
  • Credit Spreads: The Coming Resurrection of Polly
      Suspicion isn't Merely Asleep – It is in a Coma (or Dead) There is an old Monty Python skit about a parrot whose lack of movement and refusal to respond to prodding leads to an intense debate over what state it is in. Is it just sleeping, as the proprietor of the shop that sold it insists? A very tired parrot taking a really deep rest? Or is it actually dead, as the customer who bought it asserts, offering the fact that it was nailed to its perch as prima facie evidence that what...
  • The Strange Behavior of Gold Investors from Monday to Thursday
      Known and Unknown Anomalies Readers are undoubtedly aware of one or another stock market anomaly, such as e.g. the frequently observed weakness in stock markets in the summer months, which the well-known saying “sell in May and go away” refers to. Apart from such widely known anomalies, there are many others though, which most investors have never heard of. These anomalies can be particularly interesting and profitable for investors – and there are several in the precious metals...
  • A Falling Rate of Discount and the Consumption of Capital
      Net Present Value Warren Buffet famously proposed the analogy of a machine that produces one dollar per year in perpetuity. He asks how much would you pay for this machine? Clearly it is worth something more than $1.00. And it’s equally clear that it’s not worth $1,000. The value is somewhere in between. But where?   We are not sure why Warren Buffett invoked a money printing machine of all things – another interesting way of looking at the concept is by e.g....
  • Business Cycles and Inflation – Part I
      Incrementum Advisory Board Meeting Q4 2017 -  Special Guest Ben Hunt, Author and Editor of Epsilon Theory The quarterly meeting of the Incrementum Fund's Advisory Board took place on October 10 and we had the great pleasure to be joined by special guest Ben Hunt this time, who is probably known to many of our readers as the main author and editor of Epsilon Theory. He is also chief risk officer at investment management firm Salient Partners. As always, a transcript of the discussion is...
  • What President Trump and the West Can Learn from China
      Expensive Politics Instead of a demonstration of its overwhelming military might intended to intimidate tiny North Korea and pressure China to lean on its defiant communist neighbor, President Trump and the West should try to learn a few things from China.   President Trump meets President Xi. The POTUS reportedly had a very good time in China. [PT] Photo credit: AP   The President’s trip to the Far East came on the heels of the completion of China’s...
  • Is Fed Chair Nominee Jay Powell, Count Dracula?
      A Date with Dracula The gray hue of dawn quickly slipped to a bright clear sky as we set out last Saturday morning.  The season’s autumn tinge abounded around us as the distant mountain peaks, and their mighty rifts, grew closer.  The nighttime chill stubbornly lingered in the crisp air.   “Who lives in yonder castle?” Harker asked. “Pardon, Sire?” Up front in the driver's seat it was evidently hard to understand what was said over the racket made by the team of...
  • A Different Powelling - Precious Metals Supply and Demand Report
      New Chief Monetary Bureaucrat Goes from Good to Bad for Silver The prices of the metals ended all but unchanged last week, though they hit spike highs on Thursday. Particularly silver his $17.24 before falling back 43 cents, to close at $16.82.   Never drop silver carelessly, since it might land on your toes. If you are at loggerheads with gravity for some reason, only try to handle smaller-sized bars than the ones depicted above. The snapshot to the right shows the governor...
  • Business Cycles and Inflation, Part II
      Early Warning Signals in a Fragile System [ed note: here is Part 1; if you have missed it, best go there and start reading from the beginning] We recently received the following charts via email with a query whether they should worry stock market investors. They show two short term interest rates, namely the 2-year t-note yield and 3 month t-bill discount rate. Evidently the moves in short term rates over the past ~18 - 24 months were quite large, even if their absolute levels remain...
  • Heat Death of the Economic Universe
      Big Crunch or Big Chill Physicists say that the universe is expanding. However, they hotly debate (OK, pun intended as a foreshadowing device) if the rate of expansion is sufficient to overcome gravity—called escape velocity. It may seem like an arcane topic, but the consequences are dire either way.   OT – a little cosmology excursion from your editor: Observations so far suggest that the expansion of the universe is indeed accelerating – the “big crunch”, in...
  • Claudio Grass Interviews Mark Thornton
      Introduction Mark Thornton of the Mises Institute and our good friend Claudio Grass recently discussed a number of key issues, sharing their perspectives on important economic and geopolitical developments that are currently on the minds of many US and European citizens. A video of the interview can be found at the end of this post. Claudio provided us with a written summary of the interview which we present below – we have added a few remarks in brackets (we strongly recommend...
  • Precious Metals Supply and Demand
      A Different Vantage Point The prices of the metals were up slightly this week. But in between, there was some exciting price action. Monday morning (as reckoned in Arizona), the prices of the metals spiked up, taking silver from under $16.90 to over $17.25. Then, in a series of waves, the price came back down to within pennies of last Friday’s close. The biggest occurred on Friday.   Silver ended slightly up on the week after a somewhat bigger rally was rudely interrupted...

Support Acting Man

Top10BestPro
j9TJzzN

Austrian Theory and Investment

Archive

350x200

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com