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Tuesday, June 16, 2009


the producer price curve

via bloomberg:

Industrial production in the U.S. fell in May for the 16th time in the last 17 months, reflecting declines in consumer goods and business equipment that signals the manufacturing slump remains broad-based.

Output at factories, mines and utilities decreased 1.1 percent last month, in line with forecasts, after falling a revised 0.7 percent in April, Federal Reserve data showed today in Washington. The amount of industrial capacity in use dropped to a record-low 68.3 percent.

The fallout from bankruptcies at Chrysler LLC and General Motors Corp. may ripple beyond auto-related industries in coming months. Without a rebound in manufacturing, any recovery from the worst economic slump in half a century will take longer to emerge.

“Production is still falling and that can only mean that this recession isn’t over yet,” Chris Rupkey, chief economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said before the report. “The consumer is still on a buying strike so many companies are scaling back their output to adjust for the reduced demand.”

this massive idle capacity will squelch nonresidential business investment -- with business investment being of the four primary components of GDP -- for some considerable time to come. calculated risk presents one of his trademark charts for context -- and, for good measure, a sober look at the smoking crater of residential investment.

as one might suspect, idled factories and excess supply mean slack in producer prices -- and that is just what was reported for may. via bloomberg.

Prices paid to U.S. producers rose less than forecast in May as food expenses dropped, leading to the biggest 12-month slump in wholesale costs in a half century.

The 0.2 percent increase in prices paid to factories, farmers and other producers followed a 0.3 percent gain in April, the Labor Department said today in Washington. Excluding food and fuel, so-called core prices unexpectedly fell.

for what it's worth, bloomberg rather glosses over the scarier bits. year over year finished goods are now deflating at a (-5.0%) rate of inflation. monthly changes in PPI have also becomes seriously subdued. some months ago, this was easily attributed to the crash in oil prices affecting the energy component -- but now oil has rebounded smartly (in spite of massive storage, thanks mostly in my view to terrifying speculative activity in the commodities markets) and is lifting PPI. the 'core' PPI, ex-food and ex-energy, is now showing month-over-month deflation.

a look at the intermediate and crude goods offers precious little solace from deflation. while prices here tend to be more volatile, there's no doubting that a (-12.5%) change year-over-year in intermediate goods prices and (-41.1%) for crude goods prices is stunning.

there's a positive ramification for manufacturing profits, of course -- if input prices have crashed harder than outputs, particularly in a period of wage stagnation, margins increase. now if only volumes would pick up... but volumes continue to decline, as evidenced by capacity utilization. this is also, it might be noted, distinct from the squeeze on profitability that crushes business in the worst downturns. the great depression was notable, as are all recessions to a lesser degree, for the inability to move final goods at decent prices while input prices, though deflating, fall less than outputs and turn manufacturing into a loss-making machine. one can observe the history of PPI back to 1979 as separated into stages of production to see that the crude and intermediate goods indeces tend to rise above the finished goods index, thereby indicating heavy pressure on margins and profitability, in advance of recessions -- and conversely that periods of expansion characterized by fat manufacturing margins are coincident with the widest spread of finished goods over crude.

the most recent period preceding the current depression -- the famous "jobless recovery" -- was characterized by a protracted period where crude goods pressured margins almost throughout the "recovery" from the 2001-2 recession, thanks at least in part to the emergence of china and india. it wasn't however until the third quarter of 2005 that intermediate goods also inverted finished; and thus began the slowing of the economy that was also seen in a peaking of house prices around that time.

it's important to note that, even following the massive crash of crude input prices, the spread of finished goods prices over either intermediate or crude is barely there -- and this indicates that, in spite of massive idled capacity, manufacturers in most industries still cannot operate with the decent margins that tend to promote recovery and inspire expansion and therefore hiring. an observation of the employment ratio in relation to the PPI component indeces shows a rough correlation between occasions of narrowing or inversion of spreads, particularly of intermediate goods to finished, and deteriorations in employment.

i would expect that we have further to go in idling capacity before there is a return of anything like higher margins as indicated by this "producer price curve", and i would therefore expect (as many do) further deterioration in employment. but the initial condition of "negative margins" has at least been rectified even if "positive margins" have yet to appear.

UPDATE: pragmatic capitalist further forwards observations on retail data:

Although much ignored by the maintream media, the consumer data was very very weak. June retail sales are off to a very poor start. After a 0.2% last week the ICSC retail sales report showed a week over week loss of 0.6%. The year over year decline was 1.5%. The Redbook was unusually weak again. This week’s 4.8% decline is setting June up to be a huge disappointment on the consumer front. This remains the most important leg of the economic stool. To say it is not looking good is a bit of an understatement.

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