In the last two days, some major leading indicators have been released for the US and Europe, which have suggested the world is heading rather quickly for recession. It seems that the disruptions to global trade arising from the tariff war is impacting on US export orders rather significantly. The so-called ISM New Export Orders Index fell by 2.3 percentage points in September to a low of 41 per cent. The ISM reported that “The index had its lowest reading since March 2009 (39.4 percent)”. This is the third consecutive monthly fall (down from 50 per cent in June 2019). Across the Atlantic, the latest PMI for Germany reveals a deepening recession in its manufacturing sector, now recording index point outcomes as low as the readings during the GFC. Again, exports are being hit by China’s slowdown. However, while export sectors (for example, manufacturing) are in decline and will need the trade dispute settled quickly if they are to recover, the services sector in Japan, demonstrates the advantages of maintaining fiscal support for domestic demand. Japan’s service sector is growing despite its manufacturing sector declining in the face of the global downturn. The lesson is that policy makers have to abandon their reliance on monetary policy and, instead, embrace a new era of fiscal dominance. With revenue declining from exports, growth will rely more on domestic demand. If manufacturing is in decline and that downturn reverberates through the industry structure, then domestic demand will falter unless fiscal stimulus is introduced. It is not rocket science.
In economics, when analysing time series movements in relation to the economic cycle, we talk about leading and lagging indicators.
We often focus on lagging indicators, which reflect the manifestations of cyclical movements, because they are ‘output’ measures that are readily available. For example, unemployment shows up after the cycle has turned down.
Leading indicators reflect changes that typically are predictive of the direction of the economic cycle rather than reactive.
The various Purchasing Manager Indexes that are produced around the world are leading indicators.
The latest – IHS Markit / BME Germany Manufacturing PMI (October 1, 2019) – is a train wreck story.
The key findings are:
Headline PMI slips to 41.7 in September
Faster decreases in output, new orders and employment
Output charges fall to greatest extent since March 2016
The following graph from the publication shows what has been going on with the ‘headline PMI’, which is “derived from indicators for new orders, output, employment, suppliers’ delivery times and stocks of purchases”.
The related commentary leaves no-one in doubt:
Germany’s manufacturing sector recorded its worst performance since the depths of the global financial crisis … contractions in output and new orders accelerated. Job shedding also intensified, with factory employment falling to the greatest extent for almost a decade …
the survey revealed a growing number of firms cutting output prices amid increasing competitive pressures, and a sustained decline in the cost of raw materials.
Output fell for the “eighth month in a row” and the “rate of decline accelerated”.
New orders “fell even faster … dropping to the greatest extent since April 2009 and leading to a further reduction in backlogs of work.”
And as we know, employment intentions follow output trends and “the pace of staff shedding accelerating to the quickest since January 2010”.
The outlook is bleak.
While the trade disruptions are implicated, the irresponsible policy position of the German government (refusal to run fiscal deficits) and the European Union overall is exacerbating the external weakness.
Germany is especially reliant on external conditions, given its suppression of domestic demand. It is now paying the price of that imbalanced growth strategy.
US manufacturing now in trouble
The Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) is a leading indicator and is derived from monthly surveys of “purchasing and supply executives in over 400 industrial companies”, which ask a series of questions relating to “New Orders, Backlog of Orders, New Export Orders, Imports, Production, Supplier Deliveries, Inventories, Customers Inventories, Employment, and Prices” (Source).
The way the PMI is a ‘diffusion index’ which has the property of “leading indicators and are convenient summary measures showing the prevailing direction of change and the scope of change.”
The ISM tell us that:
A PMI® reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally declining.
The following graph shows the movements from January 1970 to September 2019 in the overall US Manufacturing PMI (the shaded bars are NBER-classified recessions).
The series is quite erratic but it seems that the turning point came about a year ago and it has been mostly heading downhill since then.
For the last two months, the overall index has been predicting contraction.
The US PMI has a good track record as a leading indicator.
The US Federal Reserve will probably join in the interest rate cutting charge, which will once again show the ineffectiveness of monetary policy.
Further, if the US manufacturing sector is now in a significant decline, then nations that export into the US such as China, Canada, Mexico (to name a few important ones) will be hit hard.
That is how a global recession spreads through the supply chain linkages reducing orders and employment, which in turn, reduces workers’ income and impacts negatively on consumption expenditure, which then feeds back onto production.
I won’t comment on what this all means for prices of financial assets (shares and bonds) but you should be able to work it out yourself (hint: shares down, bonds up, yields further lower).
But before we make to much of the PMI result, which is bad for Manufacturing, other data is not suggestive of a major recession looming.
For example, the Federal Reserve Bank of Philadelphia publish a – Leading Index for the United States – which is a composite of the individual leading indexes compiled for each of the 50 US states.
The Federal Reserve Bank of Philadelphia’s index combines various variables including “state-level housing permits (1 to 4 units), state initial unemployment insurance claims, delivery times from the Institute for Supply Management (ISM) manufacturing survey, and the interest rate spread between the 10-year Treasury bond and the 3-month Treasury bill.”
The following graph shows the evolution of this series since January 1982 to August 2019.
The Bank’s – Current Report: August 2019 – says that the US coincident index “is projected to grow 1.4 percent over the next six months.”
That would not suggest a recession is imminent.
And in Japan?
The – Jibun Bank Japan Manufacturing PMI (published October 3, 2019) – showed that:
Japan’s manufacturing sector remained under pressure at the end of the third quarter as firms cut production amid sustained weakness in demand. A sharper drop in output was accompanied by quicker declines in new orders and purchasing activity, while inventories were also reduced. Selling charges were discounted to encourage sales, but global trade frictions and concern towards domestic economic health led to a subdued business outlook …
The headline Jibun Bank Japan Manufacturing Purchasing Managers’ Index PMI … – a composite single-figure indicator of manufacturing performance – fell to 48.9 in September, down from 49.3 in August, its lowest mark since February. Overall, the PMI signalled a modest, but sharper deterioration in the health of Japan’s manufacturing sector.
The survey revealed that “Firms link export weakness to lower sales to China, US and Europe” and the “Strength in the trade-weighted yen so far this year has also meant that the currency has not been able to mitigate the impact of the global trade slowdown.”
The commentary indicated that “the service sector’s ability to weather the sales tax hike in the fourth quarter will be crucial to keeping the economy afloat into the year-end.”
I wrote about the consumption tax hike that came in on October 1, 2019 in this blog post – Japan about to walk the plank – again (September 30, 2019).
Up to this point, the services sector in Japan has been performing well.
The – Jibun Bank Japan Services PMI (published October 3, 2019) – showed:
… a thirty-sixth month of expansion in Japan’s service sector, with panellists reporting solid order book volumes as a key driver behind sustained growth …
The seasonally adjusted Business Activity Index recorded 52.8 in September. This was down from August’s 22-month peak of 53.3, but was above the average across the current three-year stretch of services output growth …
Greater inflows of new work were registered by Japanese service providers in September …
Employment was expanded by Japanese service providers in September …
… latest survey data indicated that businesses expect activity to be higher than present levels over the coming 12 months. Confidence strengthened to a three-month high in September, lifted by expansion plans and forecasts of stronger demand. Nonetheless, a number of firms expect the sales tax hike to have an adverse impact on the economy.
With the export sector (manufacturing) in trouble as a result of the world slowdown, the last thing that the Japanese government should have done was to introduce a destabilising negative force into its domestic sector (such as the consumption tax).
We will see in coming months how damaging that move will prove to be.
The policy settings of governments around the world, biased by neoliberal austerity thinking, are delivering difficult conditions for manufacturers at present.
Combined with the ridiculous trade war that Donald Trump is fighting (and losing) then we have the environment for a world recession.
Wasteful and totally avoidable with some shifts in policy.
Not the Nobel Prize
I have received a lot of E-mails about this so-called prize and voting is apparently going on at present.
I don’t know anything about it other than some Tweets I have seen but many readers want to know about the process. Further, I was told in London the other day that I had been nominated for this “Not the Nobel Prize” by several different people.
However, my name never appeared among the nominations that were published. I was asked why that would be.
My answer – I have no idea what the process was but it was claimed on the sponsoring site that “You can nominate as many people as you like” among the conditions and then a final list would be culled according to some voting process.
It seems though, that the organisers conducted an unspecified cull of nominations to avoid certain people appearing on the voting list. Hence my name never appeared.
Which, if true, makes this ‘Prize’ more of a fraud than I thought.
I know nothing more than that and would not have accepted the nomination anyway, given the rule of framing, that in negating a frame we reinforce it (Not reinforces Nobel Prize).
And what a scam that is.
That is enough for today!
(c) Copyright 2019 William Mitchell. All Rights Reserved.