BrookesNews.Com
Monday 9 May 2005
The March report from the Australian Industry Group & PricewaterhouseCoopers Australian Performance of Manufacturing Index (PMI) does not make for happy reading and lends credence to the general feeling that the economy is quickly slowing.
For the period March 2004 to March 2005 production fell from 61.1 to 55.5, a 9.2 per cent fall. Inventories rose from 47.9 to 49.7, a 3.8 per cent rise. (I should point out that a recession need not be preceded by rising inventories). Of particular interest is the 22.7 per cent rise in the cost of inputs which rose from 63.5 to 77.9. The report states that “… cost rises were strongest in basic metals, fabricated metals, transport equipment and clothing & footwear”.
Basic metals, fabricated metals and machinery and equipment were all down on February with the first two items showing a clear contraction. Moreover, there was a severe contraction in textiles with wood products and food and beverages also declining.
Of course Pollyannas could point to the index showing a rise in employment from 50.8 to 51.5 as proof that things are improving. This view overlooks the fact that employment tends to be a lagging indicator.
As I pointed out in my articles on the Clinton economy, unemployment would still rise even as rising costs in manufacturing signalled a forthcoming recession. A similar situation occurred after WW I. Four million military personnel were demobilised and absorbed into the economy with the peculiar result that in 1919 the production of physical goods actually fell compared with the 1918 level of output accompanied by a rapid rise in wages and the prices of inputs. The result was a profits squeeze.
But classical economists were very much aware of this phenomenon occurring at the peak of a boom. Marx himself noted that “…crises are precisely always preceded by a period in which wages rise generally and the working class actually get a larger share of the annual product intended for consumption (italics added).
In May 1920 the crisis struck with lightening speed. According to the Bureau of Labor Statistics Index wholesale prices stood at 241: by August 1921 the index had plummeted to 141. The rapid drops in prices and output were unprecedented in American history. But it was also in August 1921 that recovery began. By the middle of 1923 production had reached new peaks. Benjamin M. Anderson rather wistfully called this turnaround in the US economy “our last natural recovery to full employment”.
The lesson is that employment and wage figures can be highly misleading if examined in isolation from other economic data.
The following charts reveal the monetary situation. Chart 1 shows rapid expansion from January 1996. (The bottom line is currency, the middle line bank deposits and the top line represents M1). The second chart is particularly interesting. It shows that from January 2004 monetary growth has been virtually flat. A closer examination also shows that monetary growth has actually been declining since February.
The peculiarity here is that the economy appears to have remained buoyant despite the money supply remaining basically flat since December 2003. When a money supply is virtually frozen after a rapid expansion one would expect see manufacturing going into recession 6 to 9 months after the monetary brakes have been applied.
However, Dr Frank Shostak was kind enough to point out to me that the Reserve’s monetary aggregates are unreliable and tend to underestimate monetary expansion. Looking at the Reserve’s assets we see that from December to February they fell from $65.094 billion to $60.767 billion and then quickly rose to $67.656 billion in March, reaching a peak of $67.656 billion in June. From August to March they rose above $70.652 billion and averaged $68.355 billion for the period.
The above figures strongly suggest that monetary growth will probably have to be revised upwards. Furthermore, the figures from August to March indicate that for that period monetary growth may indeed have been relatively flat. This in itself would explain the slowdown.
I fail to see how a central bank can spend several years flooding an economy with masses of credit and then slap on the breaks and still avoid a recession. Even a sustained and significant slowdown in monetary growth rather than a sudden halt would still bring on a recession.
The important thing to note here is not so much monetary growth but changes in real factors. The Austrians point out that even if monetary expansion is sustained real factors will still move to terminate the boom.
Assuming that figures for incomes are correct and that the Australian Industry Group & Pricewaterhouse Coopers’ previous reports are accurate then we may very well have reached the end of the boom.
Further monetary injections at this point might very well be too late. Even if they do succeed in lifting the economy it would be basically no different from trying to save a drunk by giving him another shot of whisky.
I guess the next question is — when? I don’t know. Economics is not physics and does not deal with mathematical relations that can be applied to simple phenomena. Instead it provides what Hayek called “pattern prediction”. In other words, we predict the consequences of certain economic policies. What we cannot predict with precision, for example, is their timing and magnitudes. The same especially goes for the so-called boom-bust-cycle.
Perhaps I should finish with the Austrian observation, not that it will have any influence on our all-knowing economic commentariat, that monetary factors cause recessions but real factors constitute them.
Gerard Jackson is Brookes’ economics editor