In October, overall
Industrial Production rose by 0.1%, far below the 0.6% increase registered in September and the 1.3 increase registered in August. It was also well below the 0.4% consensus expectations.
To my mind, this is one of the most important economic reports, and one that does not get anywhere near the attention it deserves in the press. The September numbers were revised down from 0.7% growth, while the August numbers were revised up from 1.2%, so call it a wash on the revisions -- although they do make the slowdown more dramatic.
Of far more concern than just the raw slowdown in the numbers was the source of the meager increase. Industrial production has three major categories: manufacturing, mining and utilities. Of these, manufacturing is by far the most important. Mining is a relatively small sector in the U.S., and while utility output is important, it is as likely to be influenced by the weather as it is by the pace of economic activity.
Manufacturing production actually fell by 0.1% in October following a 0.8% increase in September (revised from 0.9%) and a 1.4% increase in August (revised from 1.2%). Over the course of the last year, manufacturing production is down by 8.0%.
Mining production also fell by 0.2% in October, partially reversing a 0.6% increase in September and a 1.1% increase in August, and is down by 6.8% over the course of the last year.
Thus, more than the entire increase in Industrial Production was due to an increase in
utility production output, which rose by a very large 1.6%. In September, utility production was down by 0.2% and it was up by 0.8% in August. On a year-over-year basis, utility ouput is down 2.0%.
All the Industrial Production numbers are seasonally adjusted, but the adjustments are most significant in the case of utilities, since power demand is so much a function of the weather. The graph below shows the year-over-year change in Total Industrial Production as well as that for manufacturing and utilities (mining was left off so the graph did not look like a plate of spaghetti).
Notice that utility production (green line) bears very little relationship with overall industrial production or the overall state of the economy. Manufacturing production is very tightly correlated, but a little bit more prone to extremes. Since the total includes utilities, I would argue that the manufacturing data is the part you really want to pay attention to. Since the Fed has been keeping records of production broken out by manufacturing, mines and utilities, only the 1973-74 downturn challenged the most recent downturn in severity.
Production of final products was unchanged in October following a 1.0% gain in September and a 1.5% surge in August. Final products are further broken down into production of consumer goods and the production of business equipment. Production of Consumer goods were unchanged in October following increases of 1.3% in September and of 1.6% in August.
A major factor in the surge in August and September was the rebuilding of inventories of autos by companies like
Ford (
F) and its suppliers like
TRW Automotive (
TRW) that were depleted by the Cash for Clunkers program. It looks like that bounce is over.
Production fo business equipment fell by 0.2%, following a decline of 0.4% in September and a 1.1% increase in August. On a year-over-year basis, overall production of finished goods is down by 4.5%. However, production of consumer goods has held up much better than that of business equipment, with consumer goods down byt 2.9% year over year and business equipment down by 6.8%.
Keep in mind that the consumer share of the overall economy surged to a record high 70.98% in the third quarter, while the investment share of the economy languished at a near record low of just 11.04%. Businesses simply see no reason to buy more equipment to expand production. The reason why businesses have no desire to invest in new plants and equipment is that they have so much existing equipment that is just sitting around and gathering dust.
The other information in the report is capacity utilization. The good news is that overall capacity utilization edged up to 70.7% in October, marking the fourth straight month of improvement. The bad news is that it is simply an awful absolute level. The long-term average total capacity utilization is 80.9%. Even after four months of increases, we are still below the all-time record low prior to this downturn of 70.9% set in December of 1983 (data on capacity utilization goes back to 1967).
The other bad news is that the rate of improvement is slowing dramatically. Overall capacity utilization bottomed out in June at 68.3%. It then gained 0.7% in July and 1.0% in August. The graph below (from
http://www.calculatedriskblog.com/) shows the history of Capacity Utilization as far back as the Fed has been keeping records of it. The rate of improvement slowed to 0.5% in September and was just 0.2% in October. That is not a good trend.
Further, over the past year, overall capacity has shrunk by 0.8%, which helps goose the numbers and makes them look better, although I don’t think that
Revlon (
REV) and
Estee Lauder (
EL) combined have enough lipstick to make this pig look good. All of the improvement was due to higher capacity utilization by utilities, which is the one area that has actually increased capacity over the last year (by 1.8%). Utility utilization rose to 79.0% from 77.9% in September. Since it is so weather dependent, utility utilization is by far the least important measure, and it is actually not too far below its long-term average of 86.8%.
Utilization of the nation’s mines actually fell slightly to 83.5% from 83.6% in September. That is up from a low of 80.8% in June, and like utilities, it is not all that far below its long-term average level of 87.6%. Mining capacity, though, has declined by 0.6% over the last year. Given the strength in commodity prices, it is somewhat surprising that mine output has not risen further than it has.
The real problem is in the capacity utilization for manufacturing, which was flat at 67.6% in October, although it was up slightly if you factor in the fact that the September manufacturing capacity utilization levels were revised up from 67.5%. Manufacturing utilization bottomed out in June at 65.1%, and from July through September was increasing at a very respectable rate of 0.83 points a month. A flat reading breaks that momentum.
Further, over the last year, as some factories have closed up shop for good, overall capacity has declined by 1.0%. Decreasing the denominator can make things go up just as much as increasing the numerator can, but the implications for the economy are not the same.
Thus with almost one-third of the nation’s factories sitting idle, it is not a huge surprise that companies are not rushing to buy more equipment, which explains why the output of business equipment has been so much weaker over the past year than output of consumer goods.
This huge amount of slack in the economy is the principal reason that inflation is not a problem now, nor is it likely to be so for the next year or so. Think of it as unemployment of capital. Companies are not going to try to push through price increases if they know that their competitors have all sorts of spare capacity and can ramp production immediately to take market share.
It is also the reason (along with unemployment of labor) that the Fed will keep interest rates low for a long, long time. If there is no inflation, then pumping money into the economy through low interest rates does not really cause any significant problems for the economy.
If that money is not flowing into the real economy -- by raising industrial production, by increases in inventories and of final consumption by either consumers of companies -- it will flow elsewhere. One of the places it first flows to is into the stock market. While the very slow progress we are making on overall Industrial Production, especially manufacturing production is not good news for Main Street, it is extremely good news for Wall Street. Yes, it also puts pressure on the dollar, but so what if it's not going to result in higher inflation.
Eventually this will help bring back Industrial Production and put that capacity back to work as it stimulates exports, and U.S. consumers turn to domestically produced goods since they are cheaper. Of course, as long as China keeps the Yuan pegged to the dollar, this sentiment does not apply Chinese goods, which make up a huge proportion of imported consumer goods. However, at the margin, it will help.
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