Investing

Declining Capacity Undermines Economic Health and Recovery, the Return of Stagnation

When investors and the public hear about industrial production and capacity utilization, they might wonder what its place is when the United Stats has outsourced so much manufacturing and moved into a services and materials economy. This underlying manufacturing base still matters, as the United States remains one of the top exporters in the world. And a disturbing trend may be forming that signals some underlying weakness in the old core economy. This could be bad news for employment, growth, exports, revenue, capital spending and just about everything else.

Industrial production came in flat for the month of May rather than a 0.2% expected gain. The reading on capacity utilization posted an unexpected drop to 77.6%, versus a Bloomberg expectation for a 0.1% gain to 77.9%. To make matters worse, the 77.8% from April was revised to 77.7%. The peak cycle was 78.3% in March, which makes things look even worse. Now for the really bad news: the Federal Reserve chart shows that this 77.6% rate for May of 2013 was even lower than May of 2012 at 77.8%.

Manufacturing was static at 75.8% in May, versus 75.8% in April and 75.8% in May of 2012. Unfortunately (again) manufacturing had peaked above 76% in prior months. The point is that the United States is just not in any position resembling a great economy. Hopefully this is just a seasonal slowing for summer.

What the public needs to understand is that the 1988 to 1989 high cycle showed that capacity utilization peaked at 85.2%. It then reached 85.0% on average from the 1994 to 1995 high peak (a time when interest rates rose). To show just how bad things were, this fell to a low of 66.9% in 2009 during the peak of the recession.

A long-term chart from the St. Louis Federal Reserve tracks all of this through time, going back to the 1960s. If the United States wants an economy where we are really back at 6.5% and much lower unemployment, with growth averaging closer to 2.5% to 3% and with payrolls being created north of 250,000 or so, that will appear in the capacity utilization figures. Unfortunately, we are going the wrong way again, and that is not resembling anything healthy for the economy.

If you want a really healthy economy, the United States needs to get back above 80% capacity. It also has to stay above 80%.