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What Will Drive Manufacturing?
From The Daily Capitalist
This article is a look at the US's recovery, Europe's recovery, Asia's (China) recovery, and how they all tie together.
Tuesday the ISM manufacturing report came out for the US and showed more positive results. The index was at 59.7 down just a tad from April's 60.4, and showed a continuation in the steady gain in manufacturing since the bottom in November of 2008.
The rise in US manufacturing has been driven largely by exports. The EU and Asia have been strong buyers of US goods, especially since the dollar is down relative to the euro and other currencies. A cheap dollar make US exports more attractive to those countries with higher value currencies. The ISM export index rose to 62 in may, up from 61 in April, the highest level since 1988. The driver of exports has been inventory restocking as inventories are being replenished. The same factors are driving manufacturing here.
Exports have been strong in technology, construction and mining equipment, aircraft and transportation equipment, manufacturing equipment, and commodities. Manufacturing is usually a sign that the economy is recovering. As new capital equipment is manufactured, companies spend more on raw materials, hire workers, the workers spend the money, it stimulates consumers spending, demand for consumer goods rises, and off we go.
There is a big if here. What if the growth in manufacturing is actually a false economic signal? In other words, what if manufacturers are increasing production based on orders that do not signal a recovery of consumer demand? What if the perceived consumer demand is just fiscal stimulus money directed at bailing out industries that were already failing because consumers decided they didn't want those goods anymore (houses, for example)?
I think what is happening in manufacturing is not the result of consumer demand (Personal Consumption Expenditures, or PCE), but instead is the result of fiscal and monetary stimulus undertaken by governments worldwide in response to the economic bust. Keynesians would argue that this is exactly what was intended by stimulus and as a result, the economy will recover. Since we are in a liquidity trap, as they say, government-directed spending will re-start the economy by creating consumer demand.
This is not what happens in the real world. Unless economic growth comes from real, organic economic demand, the stimulus will fail. Let's look at a typical situation with a US manufacturer of, say electronic parts for manufacturing equipment. It receives an order for a Chinese company for parts and it increases production to meet the demand. All well and good. But let's say the Chinese company received stimulus funds from the government for the purpose of hiring new employees to increase production of, say farm irrigation regulators. It spends the money, workers are paid, they send money back to the village, mom and dad buy a new bed, and everything is fine. Right?
No. Unless there is real demand for the irrigation regulators, not because some bureaucrat decided the factory should increase production, once the stimulus money runs out, the factory will lay off workers, and production will decline. Stimulus is not self-sustaining unless consumers are willing to buy goods. It works the same here. Just because the government directs stimulus money into industries it deems should grow, doesn't mean it will ultimately result in increased consumer demand. We know that in the US, consumer demand is weak. Much of the growth we see is a result of stimulus programs such as Cash for Clunkers and the housing tax credit.
In fact worldwide consumer demand and manufacturing seems to be flattening out as stimulus subsides. It's the same in China or Germany or France or Japan; the laws of economics are the same worldwide. The latest numbers for manufacturing in Asia and Europe are showing signs of slowing down. If demand falls in China and Europe, that will set US manufacturing back.
There are several things going on that will affect US exports.
1. A strong dollar will reduce exports. Europe has been a good market for US exports. Before the euro crisis, a cheaper dollar aided exports. With money flowing into the relatively safe haven of the US because of the sovereign debt problems in Europe, the dollar has strengthened relative to the euro. I think the EU's problems are more serious than most analysts believe, and that it will not be able to paper over obvious weaknesses. A Greek default is probable. The large banks in Germany and France who lent to PIIGS sovereigns are facing serious default issues, and there is no clear solution that would lead to a positive outcome.
Also, while the stimulus in the EU was less that in the US, it was substantial, and it has basically run its course. These factors, a strong dollar, serious banking/debt issues, and dwindling effects of stimulus will hurt US exports to Europe.
2. China has a serious problem with its over-inflated real estate market. It shows all the classic signs of a typical property boom. The result will be a bust. In Monday's Financial Times, there was a warning from a central bank insider:
The problems in China’s housing market are more severe than those in the US before the financial crisis because they combine a potential bubble with the risk of social discontent, according to an adviser to the Chinese central bank.
Li Daokui, a professor at Tsinghua University and a member of the Chinese central bank’s monetary policy committee, said recent government measures to cool the property market needed to be part of a long-term push to bring high housing prices under control.
He added that there were still signs that the economy was overheating and recommended modest increases in interest rates and the level of the currency.
“The housing market problem in China is actually much, much more fundamental, much bigger than the housing market problem in the US and UK before your financial crisis,” he said in an interview. “It is more than [just] a bubble problem.”
China's Premier Wen Jiabao also warned the rest of the world not to turn off fiscal or monetary stimulus too soon because the EU crisis could affect the world.
China, as I have said, will lead no one out of the crisis. With an export-driven economy, they need the US and Europe to lead them out of a recession. China, Australia, Taiwan and South Korea all showed slower growth in manufacturing in May than in April which I believe will be a continuing trend.
With China facing a real estate bust, with real demand weakening in Asia, with the same dwindling effects of stimulus in each of these countries, continued strong demand for US goods seem unlikely. China is a special case because of the size of its economy and the fact the yuan is tied to the dollar. Thus they are not affected as much as other countries by a strong dollar, but the effect of the real estate bubble as well as less consumer demand from Europe and the US will set their economy back.
3. Governments are tapped out financially and when the stimulus runs out, don't expect them to do much more.
Europe’s banks will have to write off 195 billion euros ($237 billion) of bad debts by 2011 and their ability to sell bonds may be curtailed as governments finance fiscal deficits, the European Central Bank said.
With governments facing “heavy financing requirements over the coming years” there’s a “risk of bank bond issuance being crowded out,” the Frankfurt-based ECB said in its biannual Financial Stability Report yesterday. “The risk that this implies for bank funding costs also raises the possibility of a setback to the recovery in banking sector profitability.”
The report reflects the aftershocks of a global financial crisis that led to more than $1.7 trillion in writedowns and credit losses since early 2007. In Europe, governments increased borrowing to fund bank bailouts and stimulus programs to haul the economy out of recession. Now they are trying to shrink bulging budget deficits that triggered a sovereign debt crisis.
“The consolidation measures can be expected to have some short-term negative impact on growth and employment,” ECB Vice President Lucas Papademos, whose term ended yesterday, said at a press briefing to discuss the report. Still, “I don’t think we should be too pessimistic about the impact on the economic performance,” he said.
Without a domestic US recovery demonstrating rising wages and rising employment, the US economy is headed for a slowdown. Exports will not drive the economy as most analysts anticipate. The only thing that will drive a recovery is the liquidation of overvalued assets, the write down of bad debt by banks and consumers, and increased savings by consumers. The government is doing everything they can to prevent that from happening.
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The damage has already been done in purchasing bad debt. Between the FED, GSEs, and FDIC backing, the peoples wealth has been squandered. The money saved insolvent banks behind the false cause of liquidity, and did nothing to provide real sustainable gains for the economy.
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World de-leveraging is one aspect of the global deflation, especially in housing. However, the world, and especially the US, has a bigger problem, and that is financing sovereign debt.
We see Warren Buffett talk about Europe's troubles as if we are unconnected to investors around the world. But the finite and quickly shrinking discretionary funds to finance sovereign debt, even through trade offsets, should be the primary focus of our ability to finance Government, and by extension, the dangers of uncontrolled deficit spending.
Fore when we lose enough buyers, the Treasury will not be able to pay the bills without direct continual debasement from the FED.
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So, Mr. Buffett we should be very concerned about what effects the world capacity for sovereign debt. The US is accutely sensitive to any loss in buying. I feel that the US sovereign bond market could collapse much quicker than what the CBO is telling congress.
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I am continually amazed by the performance of T auctions relative to fiscal policy decisions by US politicians. It is clear that, at times, the waste is so massive that you would expect some indicator from the T market. But, there is only tepid decline in participation.
How is this possible? It happens time and time again. No real negative response.
There is nothing attractive about long term US debt. Especially the return on 30 year bonds relative to US fiscal performance.
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Based on tax receipts in April it is clear that stimulus is not working, and governmnet investment is not echoed in tax receipts. Could it be that the investments are going to de-leverage debt, and not increase hiring? If so, is this not clearly weakness at the state fiscal level. How can there be overall sovereign health when the states are in such bad shape.
Can we really separate a bond rating for California from our sovereign bond rating? No, not really. So how is it that US sovereign debt buyers seem to ignore fiscal problem at the state level?
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What outside buyer would purchase a 30Y Bond for the rates offered given the fact it will not be paid back in equivalent worth? The FED will be forced to monetize within 6 Months let alone years.
Who are these long term uninformed buyers with so much extra cash?
Mark Beck
Bingo! It's IMPOSSIBLE for productivity to increase when our money is being allocated to products/industries that we have already rejected. "Eat it, it's good for you." "But I'm not hungry." "Eat it anyways." "But I'm not hungry." "Eat it or I'll tie you down and force this Menudo down your throat!"
THE demand side solution to this sick supply side world.
The kind of vision that should be driving manufacturing.
www.squareandc.net
If this site is about money, I sincerely suggest some brainiacs take a look.
Especially see the Automotive presentation.
We're gettin there. That's why I went into biz for myself. :)
Awesome Kali.
Small will rule again when TBTF actually F's!
:-)
manufacturing requires investment ,, it requires return on investment ,, until as such time as manufacturing can compete on the world stage ,, with 3 buck an hour labor ,,
the great sucking sound will continue .
a person can not wish this stuff along ,
the world is hard competition .. and why would a local investor put capital into a non competitive situation .
if we put import dutys on the car, the maufactured items ,, refrigerators, clothes , the stuff that make american consumers buyers .. is price
government must put import taxes on to compete with the low lwvel cost world wide.. but the giant corporations have no loyalty they will manufacture where they profit the most,,
charge um a differential tax,,a tariff and watch the cows come home to graze
I recall a video presentation on youtube that compared us to Japan's lost decade and stating something like this....with a significant portion of the working population retiring the old farts stop spending, saving and investing and start to live off their savings and the social programs, if any. With out the large expenditures (homes, cars, furniture, kids to kollege) and investments in the stock market, retirement, and savings accounts, there must be significant decline in manufacturing and decline in the stock markets...leading to a lost decade. No matter how much stimulus money into the economy, the stimulus is no match for the lost invetments and expeditures. They guy's arguement was that this is what happened to Japan and with out with out the crash from the housing market and derrivitives, this is now happening to us, so there is no chance of a recovery for at least a decade. Damn those old people !
Thank the old folks. They may have reduced their consumption a little, but they reduced their labor supply even more. On balance, see it as a job opening.
the solution to such demographic problems is immigration, but old people don't like new, different people....
How will increased savings drive the economy? Like up to the 8-10% rate of the 1960s & 1970s? It would certainly be desirable, but would be somewhat painful getting there.
provides funds for capital investment.
"anyone remember how to make a net?" - How an economy grows and why it crashes by Peter Schiff, check it out.
How will increased savings drive the economy? Like up to the 8-10% rate of the 1960s & 1970s? It would certainly be desirable, but would be somewhat painful getting there.
i don't know that savings in 60s and 70s resulted in good times, but good times, lots of good jobs, resulted in savings. Guy with high school education could support non-earning wife and two kids, get health care, buy house, have fairly new cars, get a pension, have kids educated by local public school...in fact he could buy house, get healthcare and have kids at age 25 by simply being a line worker at local plant. And lo and behold...he also saved, paid off mortgage, took vacations, all the while his wife did not work.
I found Elizabeth Warrens research on the income versus expenses of middle class family of four in 70s (one wage earner) and 2000s (two wage earners) very very interesting. Relative to income, food got cheaper (even factoring in more eating out by two working adult families), cars and appliances got cheaper....but the 2000s family got totally taken out compared to the 70s family by the cost of three things: housing, health care and education...housing being the biggest thing...these 2000s families had a much greater amount of their income dedicated to less non-discretionary items, like housing and health care, compared to 70s family, so 2000 families save less, and living on the edge of being in the red, more likely to declare bankruptcy.
Check out her books or speeches about this on youtube...its only now are we realizing how good we had it in the 50s, 60s and 70s.
"Without a domestic US recovery demonstrating rising wages and rising employment, the US economy is headed for a slowdown. Exports will not drive the economy as most analysts anticipate. The only thing that will drive a recovery is the liquidation of overvalued assets, the write down of bad debt by banks and consumers, and increased savings by consumers. The government is doing everything they can to prevent that from happening."
In one word: clusterfucked.
I heard some guy going nuts last summer that this recession was over and everything was coming up roses because of some proprietary indicator based largely on manufacturing that had worked well in predicting end of recessions in 70s and 80s, his call would have been a little better if it was in spring rather than summer....but the thought occurred to me, didn't manufacturing used to be a much much bigger percentage of overall economy and may not be as great an indicator if housing, FIRE etc are all still slowing. Just wondering.
I see NO U.S. recovery, I see "QE" pushing the sled...........
Once removed, fergidabout it.
True and I don't see any realistic way around this dilemma. The short-term view is shared by government, business, and citizens alike. A consumer-based recovery is absolutely possible but it could take years of frugality before their finances have recovered to the point where a return to self-gratification and impulsive spending can be safely resumed. Meanwhile manufacturing, services, and sales will remain at the minimum level that will keep society functioning. Years of self-denial and minimalist living standards? No goverment that tries to lead us on this path will be tolerated.
I don't even think it would take years of self-denial...just wipe out debts, and move on, save the organaztional capacities of banks, businesses even if bankruptcy protection, and move on...just plain old bust it...then and only then, intervene for a few months just to allow for orderly transition short of anarchy or civil war. Once people are debt free, and costs of assets next to nothing, economy would hum.
If almost all mortgage holders were underwater and strategically defaulted and rest of homeowner lost much of their equity...would this be bad to general population of US. Sure, mostly older people with savings and equity would lose otu big time, many many small and big banks would fail....but people could easily afford housing, even with a modest job. Lord knows we have an excess supply of housing, and demand is much lower, prices should be less than what just the residence building cost to build (like Cisco had to sell against its equipment being sold on Ebay for way less than it could be made after dotcom bust) and yet in most cities price of housing to income is still real high.
The thing I think is a real drag on pushing the rest button...student loans. We are wiping out the economic life of students that cannot bankrupt from hellacious loans and little income hope in this economy
Most of the increase in consumer spending was from the richest segment, since they now have all the rest of our money.
"Labor Department surveys show that the top 20% of U.S. households in income account for about 40% of all spending.
In recent months, the wealthiest Americans apparently have been driving an even more disproportionate share of consumption.
According to estimates from Economy.com, they've also contributed an outsized share of the corresponding decline in saving, which has worried some analysts and policymakers. After rising to about 5% in the second quarter of last year, the personal savings rate fell below 3% this spring."
http://www.latimes.com/business/la-fi-consumer-spending-20100516,0,4184055.story?page=2
So the question is if 1% of the population can keep up with employing most of the 70% of us in the service economy while we deleverage for years so we can become reindebted. If you think so, I guess there's hope. Except that the spending of the plutocrats is highly dependent on a rising market - that situation has changed recently.
According to McKinsey, Romer and Reinhart, deleveraging takes 6 to 7 years.
1-2 down, only 5-6 to go!!
I would argue we've been deleveraging since 2006, or at latest 2007...but we are doing our best Japan act...and they are still coming down from 1989
I think you are incorrect. EURUSD went from 1.51 to 1.22 over the past 6 months. It is the EU that now finds itself in a profitable export situation.
It really crashed April-May, but you are correct, and this is why a weak euro will negatively impact US exports.
seems local diversified international manufacturing companies are saying they haven't seen a significant change in sales from Europe...but as you note, I suspect these things lag...
The way I see it, there are two things they are trying to accomplish with all the spending. First, and foremost, is the confidence game. If they can pad numbers and have the propagandists on their networks tout it as organic growth/recovery, it will instill confidence in those who do not care to understand any further. Second, even if the demand is only there due to the stimulus money, the jobs are being created/saved. These are real people earning income. The hope, I suspect, is that they will use the money to buy things and/or go further into debt, thus perpetuating the machine. If they can "prime the pump" enough, even if only through temporary census jobs and the like, it may lead to something meaningful.
However, as you demonstrate in the article, it's far from a sure thing. I know a lot of older people (50+) that lost their job and a hefty portion of their retirement income. They are out of investment for good. Most just want to make it to that first SS check, and are paying down debts any way possible in the meantime. The younger people I know (21-26ish) don't care about investment, and really don't know anything about it. They're happy to spend their meager earnings on rent, intoxicants, and in a few cases, education.
Your closing paragraph sums everything up nicely. Always appreciate your articles. Cheers!
In my early 40's, paying down debt equals 31% of my net income monthly, not insubstantial. I don't "save" other than pay down this debt and have no retirement savings. Never eat out, eat cheaply at home, only buy things when absolutely needed, things being new external hard drive, shoes, windshield wipers. Drive a 95 Chevy Blazer with 90,000 on it, will drive it into the ground. I have no plans for saving for retirement, simply cannot see that day coming. Day-to-day life is stressful but handled, have a decent job in the wine industry with a boss I respect and who respects me. I'm adding what I perceive to be close to zero to "growing" the economy, I just consume what I need to get by. Am I in the minority? Dunno. I don't really discuss these sort of matters with my friends, it's deemed in poor taste methinks.
I don't know exactly your personal situation and the various debt situations you are paying off. it does make a real difference.
The greatest thing going on for the small investor right now it the very cheap rates for long term financing of real estate. Get your other debts under control and spending, then buy something that cash flows at 1% above the mortgage rate. It will not make you the investment champion next week. If you can do one of these for the next 20 years you will own the braggers.
My credit rating couldn't be worse and I have no money for down payment. The monthly payment goes to a debt consolidator due to my past as a profligate "true American patriot." These payments should end in a year or so. I will make around $25k this year with no wiggle room (new radiator for the car, etc.). My rent in a "humble" apartment building is $425/month, less than the monthly debt payment. Wish I were in a position to be a "small investor," perhaps "sub-microscopic investor" one day! I suppose it is my fault for not doing much with my vaunted Ivy League education. And to think of all my friends working at places like JPM, Citi and Fortress. Sigh.
+1 ... That's a comment I could have wished I wrote!
I hate to be so gloomy, but the only thing the U.S. is manufacturing these days are fascists great and small.
Chear up - we're still leaders in the asset bubble market.
we make a lot of guns for export to MX, and Wall Street makes a lot of fraud, some of which gets exported...
I think there is a lot of misconception here. The U.S. is the most capable manufacturer on the planet but much of that capability is in hybernation. Also, automation is affecting manufacturing employment in a similar but slower way than it affected farming a few generations ago. The US is the largest food producer in the world yet we have very few farmers.
Unfortunately, this gives the fascists great and small time to scheme.
Hey good points. I know squat about manufacturing but from reading stories of guys having products made there, it seems Chinese have gotten very good making lots of things and there have significant advancements in parts, component manufacturing. I'm sure cheap labor still is a drag against some innovation and automation but its not like they don't have sophisticated systems that are hard to build from scratch but rather have to be grown over time. When our manufacturing towns in OH, MI are being vacated, while their manufacturing gets more expert every day, I have a hard time seeing how we are the most capable manufacturing.
Good point on the automation thing, my understanding that one of the reasons our farming got efficient is we didn't have cheap slave labor.. even Mexican field workers organized by the likes of Cesar Chavez were an impetus for further development of farm machinery.
So its interesting, if workers get paid a good middle class salary, then their more costly labor makes investment in machinery and innovation of automation even more appealing, and then less jobs to grow food or make things are needed. This should mean things get cheaper, people have more money to spend on other things besides basic goods and food....but then price of the other things needed, shelter/housing, and education (low skill workers not needed) get inflated and of course, rich, powerful people capture much of the extra wealth provided by automation.
I wonder how sustainable our agriculture is. We take much more from the land than we put back. We use chemical fertilizers and pecticides to maximize yield but in the long run, this leads to soil exhaustion. As it is, the nutritional quality of American fruits and vegetables is very low. Thus, you have to eat more to get the required nutrition, which goes a long way in explaining why so many Americans are so fat.
There has been a bounceback in manufacturing not so much because of exports but because manufacturing is more necessary for modern life than services. Manufacturing got pounded, but sooner or later, people need to drink, eat, drive, heat and cool homes, etc. This is the part of manufacturing that is a necessity and has come back.
There is a much smaller part of the service sector that is as necessary.
The necessary part of domestic manufacturing is not big enough to grow us out of our problems.
1. Low tax.
2. Less regulation
3. Removal of welfare burden
Less regulation would be a disaster - that is what got us into this mess. No regulation on mortgage originaion, mortgage sales, CDS sales, etc.
Yes, but over regulation on the parts of the economy that produce real stuff, not paper. Its ass backwards.
Regulation is exactly what created the disaster.
Lenders were required to buy junk. Then everyone had to be treated the same.
I'm paying someone not to work and having to buy from a $3 and hour offshore competitor.
These F==kers on the dole will have to do something to get my money when this all shakes out. Shine my shoes. Cut my grass. Iron the shirts with no scorch on the starch. Speak American.
Good commentary.
We are nowhere near on a path to recovery. Only the great crash has been forestalled so far and if TPTB are very lucky, central control and widely-implemented austerity measures will have time to be put in place before the sheeple realize their world has changed permanently.
Marx would be proud.