The economy has sent the Fed a signal, and that is, quantitative easing, ZIRP, and Twist don’t work. Yet the Fed doesn’t realize that and with the economy stagnating and unemployment climbing, it is likely that they will persist with more of the same despite their failures. The manufacturing reports coming in, on the heels of rising unemployment and declining GDP, make it a certainty that the Fed will be pressured into doing “something.” Here is a look at the most recent manufacturing reports and why they are declining.
One of the key things to follow to understand about the economy is manufacturing, specifically what economists call “higher order” goods, which means production of things that make other things such as consumer goods. Austrian economic theory says that when the Fed manipulates interest rates (money supply) to produce artificially low interest rates, it sends a false signal to producers of higher order goods to start making things. What this means is that consumers really aren’t ready to buy the products that their machines will eventually make and the result is that capital is malinvested in these things.
Under the more modern view of the theory, it applies to things that take a long time to produce, such as chemical factories, oil processing plants, machine tool production facilities, mines and mining equipment, and housing. As we saw in the mid-2000s, housing was the primary target of these false signals, and the result was the overproduction of housing and the current recession/depression.
So, it is a curious thing when we see factory production (all types of goods, from higher order to lower order [consumer] goods) declining. We have record setting low interest rates worldwide, yet this production is falling. Here are the numbers:
U.S. new factory orders in April were down 0.6% on top of March’s downward revised 2.1% decline. —
The private ISM report on purchasing managers index of new orders has been flat to negative since May, 2011.
This is not an isolated factor: it is occurring worldwide:
Markit’s PMI report for the Eurozone was at a three year low:
The UK, ditto. Greece, is still collapsing. China is seven months into a manufacturing decline.
The world is awash in money and credit thanks to the worldwide cooperation of central banks, yet the decline in manufacturing defies their attempts to turn things around. I would also say it defies their economic theories as well.
Keynesian economists such as Paul Krugman and Joe Stiglitz say governments should not mess around in view of a potential worldwide economic disaster and that they should spend massively to revive their economies, hang the long-term costs, and central banks should back up this spending with unlimited credit facilities (print money as need; repeat as necessary).
The only problem is that these nostrums don’t work and never, ever have in history. You may view this brand of Keynesian economics a kind of fundamentalist faith-based approach to economics. It is dogma. [cf., Japan, 1989 to present].
The timing is also seems curious in that these events are occurring almost at the same time, as if the business cycles of each country are somehow aligned with the others. And you would be correct in this assumption. Post-2008, central banks have more or less coordinated their monetary policies to create liquidity in their economies.
The lesson they haven’t learned is that central banks cannot print wealth. Wealth is created only from real savings which are savings of profits or wages from the actual creation of goods and services. And, such savings cannot come from activities created by an inflated money supply. They have to be from organic production of goods and services in non-boom activities. The dearth of such real savings is the reason economies are stagnating. Every time central banks inflate the money supply they further destroy such savings by diverting them to assets that will ultimately become unproductive (malinvestment).
With the current mantra of quantitative easing being the only tools left to the central banks (especially the Fed), it is almost a certainty the more money printing will occur. Be it another round of Twist or QE (both is my guess), it’s coming.
Jeff: Thanks for another good piece. Other indicators like the Baltic Dry are also tracking down.
“The economy has sent the Fed a signal, and that is, quantitative easing, ZIRP, and Twist don’t work. Yet the Fed doesn’t realize that…..”
A fundamental and common error is made here, the comforting thought that the Fed banksters don’t realize what they are doing. They are seen as fools who are failing to fix the economy, but they are in fact criminals who are highly successful at looting the economy. Pretending that they are well-intentioned fools serves them as a disguise and it serves their victims who prefer thinking that they (the victims) are smarter than the looters who are robbing them. By this pretense, the looters continue looting and their victims hang on to a bit of their self respect while being looted.
Jeff: yours and Bruce’s site don’t differ on this analysis. However, I am surprised that you don’t do more work in showing the contrarian analysis that QE is not going to work.
The reason it’s not working is that during a boom, the amount of leverage represents money ‘freely’ entering the economy, as a result of the fictional reserve policies. That is, the banks will make the money freely available and investors and consumers respond in malinvestment, that yields positive returns for a short duration. The average leverage during the 1995-8 and 2003-6 booms with fed and bank fractional leverage was around 60:1. As an investor joining the herd of free money with fictional leverage, for every dollar you invest you CAN have as much as $59 other dollars INVESTING with you from other investors. Hooray, every early investor is RICH.
Now in 2012 the Fed is at 50:1 (they claim ‘less’ because their ‘gold’ reserves are not marked to market, this is fallacious, most gold is being purchased on margin) and the Banks taking the Fed money are claiming 13:1 (the number is closer to 30:1) for a leverage of 650:1. So why, oh why are we not in a hyper inflationary boom? It’s simple, the consumer / investor class is not responding to the signals and MOREOVER the banks ARE not lending. They are using the leverage to TRY to CLEAR their malinvestment inventory, in the event of the prudent ones. The banks and their proxies are also using this leverage on consumable commodities and physical goods, such as farmland. The investor / consumer, knows, that while the numbers are unbelievable (low interest rates, leases at cost, etc), he / she cannot invest or buy long term. Why, because now for every dollar you ‘invest’ there is the real possibility of %649 betting AGAINST you. The individuals have been fleeing everything with leverage, except maybe gold. The staggering numbers hide the fact that the current environment investment strategy is using fictional reserve, primarily to deleverage. In the 1930′s, when the strategy failed the answer to the depression was to go to war and force austerity.
With these kind of numbers, can the argument finally be made for the FED not to QE. Are we going to wait until the JPM event (my guess is that with the leverage they have their losses are around 650 Billion, similar to Lehman)? Why aren’t Austrian economists putting ACTUAL numbers that can PIN the blame squarely where it belongs? By definition, the population behaves in an Austrian, not Keynesian way and the people believe these numbers without the deltas, alphas and betas used by economists. WE ARE NOT putting the NUMBERS out. Are Austrians in fear of being called ‘fear’ mongers? This is clearly happening in Argentina right now. During 2008 the Cafe Hayek site claimed that no one knew the size of the problem. Austrians can not make the same mistake over and over again. We have the math to show it!
I have written about this so many times that I don’t think I need to repeat it every time. While I agree with your basic comments, I think it’s not as simple as looking at money and credit and drawing simple conclusions.
When Austrians say that it’s difficult to determine the size of the problem, there is much truth in that. What they are looking for is a way to determine the extent that real savings are destroyed (along with money steroid malinvestments). There are some proxies for this, but it is difficult to determine. Many Austrians point to the lack of investment in higher order goods as the key determinant. Real savings are the key to such investment and bank credit may be an indicator of that. That is the key to understanding stagnation. Presently the only way to determine money and credit expansion is to look at the numbers provided by the Fed and OCC on money supply and bank credit. Those factors, especially bank credit, tell us the most about the destruction of capital and money supply.
I disagree on QE. But I have explained my position on that many times.
I don’t think Austrians are viewed as fear mongers, but rather as pesky gadflies outside of the mainstream. Our job is to change that view.
I don’t know who “Bruce” is.
Thanks for your comment.
The issue at hand, today, is are there sufficient citizens working and are they generating any real disposable income.
In my opinion the polices of the federal government over the past dozen years have made it more and more difficult for any goods producing industry to exist in this country. (My background is engineering and production management) To test that theory last I developed a metric last year using the federal government tax receipts as shown in the Monthly Treasury Statement coupled with the BLS employment numbers issued monthly statement on employment Table A-1.
Since I was looking for “Jobs” I excluded corporate related taxes and then I divided the remaining tax receipts into two categories one based on Social Insurances such as Social Security and the other based on income. The next step was to divide both by the number of people reported as being employed e.g. for May 2012 142,287,000. Plotting that data back to 1999 showed what seemed to be a pattern but there was a lot of variability so I controverted it to a 6 month moving average.
A very clear pattern showed up but two more adjustment were needed the first being to use constant dollars and the second was to adjust for the recent FICA withholding reduction. The resulting chart showed a very clear and stable pattern that tracked economic growth until 2010. But by the end of 2010 the pattern was broken indicated a major structural change, however income did continue to increase until mid 2011 when the pattern seemed to top out and then head down — both in the social insurances and in income. Data for May is not yet available but I would be surprised if the pattern has changed.
I did one other thing and that was to simulate various changes in wages and employment and the only pattern that I could come up with that would duplicate the observations was where there were a growing percentage of temp style jobs and that in addition, the top wage earners were taking a beating as well. I can’t post the chart here but I can say that the pattern is very striking — We have clearly already entered a second recession.
David,
I would be very interested in seeing your data & analysis.
- Ken
I’ll send you the chart if you give me an email — I can post it here.
John Howard: awesome comment! That is exactly what all this Fed chicanery is actually about.