Friday, January 16, 2009

Industrial Production and Inflation

The St. Louis Fed shows a graph of industrial capacity utilization with recession overlay:

In addition to this graph, see the Federal Reserve press release with the raw numbers on industrial production and capacity utilization.

It strikes one that at the left of the graph, the tremendous inflation during the "surge" in Viet Nam and the inflation that followed the victory of the Communists was in part caused by and presaged by the very high capacity utilization numbers. As the graph goes to the right, one sees a series of "lower highs". If this were a chart of a stock or a commodity, one would see downside risk and no clear bottom, given that the latest % utilization, 73.6%, is near that of the 1982 low, but the 1979 high in utilization of about 87% was not even approached this decade. It is possible that a "test" of the 1982 low in % utilization is baked in the current economic cake. Whether a definitive new low below 70% will be made will be important to see.

In any case, the hypothesis here is that the secular disinflation/deflation trend is intact and will be strongly supported should capacity utilization break to a new low below the 1982 low. Utilization levels below 80% have not been associated with significant ramp-ups in inflation.

As more factory space opens up in the U.S., China and other low-end exporters will have to cut prices and shipping costs will have to remain low, or else economics (plus domestic U.S. politics) will cause more production to remain home or come home.

This chart is a major negative for bulls in the China shop. The "surprises" continue to be on the downside, as predicted by Nouriel Roubini. When they stop, any stock rally that may well occur after Mr. Obama gives his inauguration address and the economic stimulus/recovery plan is signed/hyped will be outweighed many times. Unfortunately, if Dr. Roubini is correct, there are months of dreary and depressing economic numbers to come.

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