But Pensabene was only echoing what Steve Slifer, chief economist at Lehman Brothers, said about the US economy in January 2001:

It’s really an odd-looking slowdown. The manufacturing sector is, in fact, in a recession but not the overall economy. At least not yet.

So how can the economy being adding jobs while manufacturing is losing them and forecasts for consumption are so bullish? This is exactly what happened to the last American boom. Manufacturing output fell and employment rose even as consumption raced ahead. In fact, consumption did not even falter during the recession of 2000-01. It was the investment-side of the economy that felt the full force of the downturn, just as I had predicted. In Economic clouds are turning black for US economy (The New Australian, 6 December 2000) I warned, once again how

…the capital goods industries are the first to feel the pinch, as they find their profits squeezed between rising costs and falling demand for their products which then results in rising unemployment, even as the demand for labour appears to be rising in the consumer goods industries.

This phenomenon is one of the hallmarks of trade cycle, as is the rise in the cost manufacturing inputs. The RBA index for producer prices makes it very clear that there is a very strong upward trend. This has been confirmed by firms’ complaints about raw material costs. The PricewaterhouseCoopers’ survey for July showed input prices at 76.9 against 67 for the previous year. For August it 77.5 against 69.6 and for September it was 77.5 against 69.6.

Let us know turn to the 1999 slowdown. Investment was falling and manufacturing costs were rising. Come 2000 and every commentator in the country was talking recession. Missing from the economic chatter was any mention of money supply.

From January 1996 to December 1996 M1 rose by 16 per cent. In the following period it rose again by 16 per cent. Then in 1998 it quickly dropped to 7.5 percent, a 53 per cent fall. I believe this sudden deceleration hit manufacturing the following year. However, during 1999 M1 rose by 9.5 per cent and for January 2000 to December 2000 it rocked by a stunning 22 percent.

As M1 began to accelerate in 1999 the terms of trade started to quickly rise early in the year. The rising terms of trade had the effect of reducing pressure on input prices. For instance, from 1988-99 to 2003-04 the index of domestic materials used in manufacturing rose by 19 per cent. But the Australian Bureau of Statistics points out that a dollar appreciation forced the index down, otherwise input costs would have rose by more than 30 per cent. However, by March this year producer prices were rising at over 4 per cent a year. This should have acted as a storm warning for economic commentators.

The RBA is in an obvious bind: if it raise rates to dampen the rise in prices and imports it will surely strike a blow at manufacturing and then the rest of the economy. On the hand, if it does nothing inflation will surely accelerate. Whatever the case, the RBA will eventually have to slap on the monetary brakes.

At the moment, however, wage rises are outstripping prices (the RBA’s wage price index rose by about 12 per cent from June 2004 to June 2005), productivity has been falling for 12 months, manufacturing output is falling along with employment –– but overall employment is still rising. In the meantime the Treasurer Peter Costello is grinning like a Cheshire cat. Is it me or is there something seriously wrong with this picture?

What might wipe the grin of Costello’s chops is a nightmare scenario in which the Liberal Party finds the country in recession while having to fight a rejuvenated Labour Party running a successful anti-labour market reform platform while simultaneously promoting an attractive tax reform policy.

Gerard Jackson is Brookes’ economics editor