US Industrial Production Continues to Expand

The US economy continues to grow but the pace of expansion is still modest.  Industrial production expanded in June at a 4.7 year-over-year pace.  This put the average rate of expansion for the quarter at 4.7 percent, year-over-year, up slightly from a 4.4 pace of the first quarter. 

Since the current economic recovery began in July 2009, the highest quarterly increase in industrial production came in the third quarter of 2010.  At that time industrial production was increasing at a 7.1 percent, year-over-year rate. 

As can be seen in the accompanying chart, the rate of increase dropped off from that date and seems to have settled in the three-to-five percent range, a rate that is rather anemic for this time in the business cycle, but a rate that is consistent with other current measures of economic growth.

Real GDP, for example, grew at a 2.0 percent year-over-year rate of growth in the first quarter of 2012, and has only average in the 1.5 percent to 2.0 percent range for the past year.

As reflected in almost all of the data, economic growth is taking place but not at a very rapid pace.

There are three reasons for this slow pace of economic growth in my mind.  The first reason is the huge debt overload that exists within the US economy.  I have written on this in "The Debt Crisis Goes On and On."  Individuals, businesses, and state and local governments, overloaded with debt at not able to spend as abundantly as in the past because they are attempting to get their balance sheets back in line.

Second, there is a great deal of uncertainty in the world these days.  Washington, D. C. is in a mess and there seems to be no leadership around, especially in the White House.  As Larry Summers stated during his recent term in Washington, “the parents are not at home.”  This lack of leadership in the US, combined with the economic crisis in Europe and the lack of leadership there, leaves us all wondering what is in store for us in the future.  And, unfortunately, what we contemplate for the future is not very optimistic.

Third, there are some serious structural matters in the economy that still need to be resolved.  For example, I believe that underemployment in the United States is still around 20 percent.  That is, one out of every four individuals of working age are either unemployed, employed in a part-time job but would like to work full time, or, have left the work force.  The workforce participation numbers are now back where they were in the 1960s.

And, we continue to get stories about how the American society is bifurcating.  David Brooks writes of "The Opportunity Gap" emerging in our country, a gap in which “the children of the more affluent and less affluent are raised in starkly different ways and have different opportunities.”  The ramifications of this split has been researched and discussed by numerous people now and it indicates that we need more than just economic stimulus and good intentions to solve the structural problems that are growing worse every day.

This structural problem is also seen in the data on the capacity utilization of American manufacturing.  The data just released indicate that industry is using just under 79 percent of its capacity.  Thus, capacity utilization continues to increase in the current recovery.

However, note in the accompanying graph that capacity utilization was around 90 percent in the mid-1960s and has trended downward every since.  In fact, this trend matches, to a high degree, the increase in the underemployed in the United States.

Most obvious in the trend is that the peak utilization in every cycle seems to be lower than that achieved in the previous cycle.  Capacity utilization continues to increase in the current recovery but is still below the peak achieved in the 2003-2007 period…which was below the peak of the cycle in the mid-1990s. 

There are significant structural dislocations in the United States economy and a policy of government intervention and economic stimulus is not going to correct the situation.

Mr. Bernanke, in testimony before Congress today, seemed to be cognizant of the problems the US economy is facing.  “Mr. Bernanke’s cautious testimony underscored the Fed’s reluctance to ride once again to the aid of a plodding economy. The central bank has intervened repeatedly when the economy appears at risk of sliding back into recession, and Mr. Bernanke’s testimony Tuesday included his standard promise to maintain that vigilance. But the Fed has not acted with similar urgency to reduce the persistently high rate of unemployment when growth is merely lackluster.”

To me, this is about all the Federal Reserve can do right now. (See my post on "The Fed is Doing Enough For Now.") The economy is recovering but not at the speed we would like.  However, sometimes there is only just so much that can be done in terms of aggregate economic policy. 

The Federal Reserve is Doing Enough...For Now

The economy is recovering.  It is not recovering as fast as we would like, but it is recovering.

Within this recovery there may be only so much that government can do to speed on this recovery.  In my mind, we need to keep this thought in mind when considering what else the Federal Reserve can do at the present time. 

Fed Chairman Ben Bernanke takes pride in the fact that he has increased he openness of the Fed and has helped to provide greater transparency into the understanding of what the Federal Reserve is doing with regards to monetary policy.

Right now, however, I believe that he is not saying much because he has said enough for the time being. 

The market is concerned about whether or not the Federal Reserve is going to engage in another round of quantitative easing…QE3.

I believe that Mr. Bernanke is staying quiet at this point because he believes that the Fed is doing enough…for now! 

One part of the Fed’s dilemma right now is that if jumps into an overt position on implementing QE3 it will be accused of acting for political reasons.

The Republicans will jump all over a Federal Reserve that seems to be “pumping up” the economy right before the election.  Should the Federal Reserve begin a QE3 before the November election, it…the Fed…will be accused of supporting a desperate president in his bid for re-election.  How political can this be?

But, some members of the Federal Reserve’s Open Market Committee are concerned about the weakness that still exists in the economy.

The Fed has published the minutes of its last Open Market Committee meeting and the discussions within the committee showed mixed feelings about starting up a QE3.  But, even the weak economic information released in the last week or so have not been severe enough to change the minds of the decision makers…and, especially Bernanke.

The minutes do reflect that the Fed is keeping a watchful eye on the economy.  The Fed has promised to act strongly if the economic situation gets much worse.

There are other concerns at work, however.

There is real concern over just how much monetary policy can do at this particular time.  First, there is the concern that it can do little to impact the unemployment rate.  The unemployment rate is a “real” economic variable and is determined by “real” economic variables.  Monetary polity does not work with “real” economic variables.

Second, there is the time lag in the effect that monetary policy has on the economy.  One can argue that the Fed has done all it can do to impact the economy over the next six- to nine-months and that anything else done now would have next to no effect on the economy before the November election.

This presents the question to Open Market Committee members: “Why start out now on a major monetary initiative like QE3 which would bring about tremendous political criticism when this initiative would have next to no impact on the economy before the election?”

The most the Federal Reserve can do at this time to generate confidence is to assure the financial markets that “if the economy gets worse” that it would take appropriate actions to combat a worsening situation.  And, Fed officials must continually provide evidence that it is “on the watch” and ready to move. 

The release of the minutes of the Open Market Committee serves this purpose.   The essence of the minutes was the split between committee members over whether or not the Fed should engage in further easing.

The other major issue besides the state of the economy, which will not go away is the condition of the banking industry.  Readers of this blog know my position on this:  the banking system is still quite fragile with many banks still unsure about the value of their assets, especially in the areas of residential real estate and commercial real estate. 

I believe that the Federal Reserve feels comfortable that it has done what it can to keep the banking system functioning and that the injection of $1.5 trillion in excess reserves into the banks allows the banking system to continue to function smoothly so that the FDIC can continue to close banks without creating significant disruptions to the industry.

Through the first half of 2012, more than one bank is still being closed every week at least one other bank per week is acquired and hence is merged out of existence.  The banking system continues to shrink!

There is little else the Federal Reserve can do at this time with respect to the health of the banking system.  

My belief is that Mr. Bernanke has already told us all that he is going to tell us at this time.  Mr. Bernanke has told us that the Federal Reserve is not going to act in a political way.  In other words, for the near term, the Fed is going to do pretty much what it has been doing in the recent past.  It will continue to try and “twist” interest rates, but no new excess reserves will be created in this effort.  And, the Federal Reserve will continue to watch the economy closely and stands ready to act if it appears as if the economy is sinking into another recession.  But, don’t expect anything more.

In terms of the economy, the Fed has done about all it can do right now.  The major thing it has done…at least for the time being…is to stop any cumulative movement in the economy to a period of price deflation.  This is the big theoretical concern that exists in a period like this, the possibility that the economy will decline into a period of debt-deflation.

However, protecting the economy from a period of deflation does not eliminate the problem I discussed earlier this week, the problem of the extensive debt buildup in the economy.  The deleveraging of the economy is still something that needs to take place.

The deleveraging of the economy will still take some time.  For now, I would argue that the Federal Reserve has done and is doing about all it can to keep the expansion going.  The economy is recovering.  It certainly is not recovering as rapidly as we would like it to recover, but it is recovering.  Sometimes only so much can be done to assist a recovery and the rest must be accomplished by letting the system do its own part.  In the current situation, reducing the debt load is what the economy needs to do and it takes time for an economy to achieve this.