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 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.