U.S. economy: Whereto from here?

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U.S. manufacturing production is inching ahead and is likely to pick up by the end of the year. The same can be said about the economy as a whole. Although the Fed’s quantitative easing is likely to further boost the economy in the short term, the economy remains at the mercy of China and the Eurozone. The effective coupling of the yuan to the U.S. dollar has inflationary consequences for China as a lower dollar against the yen and euro effectively boosts commodity prices. This was already evident in China’s inflation numbers released a few days ago, which sparked fears of further interest rate hikes in China to slow demand. Slower economic growth in China will rub off on the U.S. economy with their PMIs interwoven. The ramifications of the debt-ridden PIIGS on the Eurozone’s economy will also impact on the U.S. economy.

Sources: ISM; Li & Fung; Plexus Asset Management.

Sources: ISM; Li & Fung; Plexus Asset Management.

Stronger GDP-weighted ISM composite price indices are not leading to higher CPI inflation.

Sources: ISM; I-Net Bridge; Plexus Asset Management.

The Fed’s aim to drive the CPI inflation rate higher to get consumer spending going hinges to a major extent on how things will pan out in the U.S. housing market as its weight in the CPI is approximately 40%. My calculations indicate that the housing haircut off the CPI inflation rate is approximately 100 basis points. The CPI inflation rate excluding housing is therefore just over 2%. With the housing market in a state of massive oversupply a miracle is needed to lift prices and increase rents.

Sources: FRED; I-Net Bridge; Plexus Asset Management.

The uptrend in inventories – actual and in comparison to sales – is particularly worrying as signs of a weaker economy may (again) lead to inventory liquidation and lower prices. The threat of deflation is therefore real.

Sources: US Census Bureau, FRED; Plexus Asset Management.

No new manufacturing capacity has been created since the third quarter of 2007, while a permanent gap has opened up between manufacturing output and manufacturing capacity due to overinvestment in the latter part of the 1990s. Added to that is the oversupply in the housing sector from 2004 to 2007, created by superficially low interest rates. Fixed investment has therefore been sterilised. The one crucial pillar of economic prosperity has gone AWOL and may not return in the years to come!

Sources: FRED; Plexus Asset Management.

Job creation continues to remain lethargic as the sterilization of fixed investment has also sterilized job creation to some extent.

Sources: ISM; FRED; Plexus Asset Management.

That appears to be the reason why job creation has turned out to be inelastic to aggressive monetary policy easing by the Fed. Added to that is the legacy of the implosion in the financial sector in the U.S. in 2008/2009. Jobs have been lost permanently.

Sources: FRED; Plexus Asset Management.

How will the expectation of higher prices lead consumers to spend more if they have nothing to spend while their homes are being repossessed? Will increased spending by the “haves” create jobs and better circumstances for the “have nots”? Where else in the U.S. will these forlorn souls be redeployed?

In my opinion the Fed’s QE2 is perhaps the last and final measure to get the economy going. I do not even want to think that China may sell its U.S. bond holdings in the QE2 process and retain the U.S. dollar proceeds – no cash ending up in the U.S. and the economy! If the QE2 fails, the next step is likely to be enormous infrastructural spending – which should have been the preferred course of action in the first instance.

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2 comments to U.S. economy: Whereto from here?

  • Paul Sandison

    Great ending here Prieur, and very very seldom said by economists, from 2008 to now:

    “If the QE2 fails, the next step is likely to be enormous infrastructural spending – which should have been the preferred course of action in the first instance.”

    AMEN!

  • Frank W

    Well, there it is! Oversupply in business infrastructure, expected reduction in migration due to no jobs and crippled spending by the general population due to deleveraging and lack of easy credit. Where’s the growth potential? QE2? As I understand it, the market had expected
    1 trillion $ worth of QE and it got 60% of that. If 1 trillion is already build into the market, then the market is overextended, because the participants must be disappointed. The economy is supposed to follow the market. So then what? Also, hope for QE2 to fail, because if it doesn’t the forward yield curve will flatten and the economy will go into a stupor, if it’s not there already. So far, it appears that yields are going the other way. As against this, we probably still have a fair amount of mindless speculation by no nothings built into the system, so maybe Bernanke will at least be successful in blowing some more bubbles. Also, I am thinking the same thing as Paul. The government will finally come to the conclusion that it has to get something for its money, crimp unemployment benefits and revive the Civil Conservation Corps of the 1930s, whose job it was to lay sidewalks, fix roads, repair bridges, etc..

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