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Sunday, September 18, 2011

Transcript 459: Forecast Capacity Utilization

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The forecast today: Capacity Utilization, trending down for 45 years and going to record lows, is our projection. First a note on “Leadership.”

We’re looking for leadership these days, I’m told by the newly anxious. Leadership is what you call for when things are going wrong and people need to step up and do the right thing. We have been calling for leadership for the past three and a half years.

I suppose what the right thing is depends on who you are. When you ask for leadership, you want people to do what you want them to do, not what anybody else who is calling for leadership wants them to do. And here’s another take, right off the top of Bloomberg.
TOM KEENE:  Greg Anderson starts us off from Citigroup FX.  Greg, good morning.

GREG ANDERSON:  Hi, how are you?  Good morning.

TOM KEENE:  Very good.  Well you have in your very fine print in your statement on the dollar.It says here there are few alternatives to the U.S. dollar.  There are also few alternatives to a coordinated response to European crisis.  This is the Market simply telling the political leaders and financial elites what to do, isn't it?

GREG ANDERSON:  Ah.  It is.  And they don't necessarily like to be told what to do.  But yeah, the Markets will force the hands of politicians in reducing debt burdens and in resolving Europe's situation one way or another.  I would say, look, it lets you know that policy makers are gearing up for the potential of major volatility like we saw in 2008, and they're sort of proactively going back to 2008 type measures.

The 2008 measures they are talking about is TARP. Bail out the banks. Yes, folks, we’re back. The issue is not liquidity, so what the central bankers did early last week is as much the precursor to bad things as it was in the dark days of the subprime crisis. It is solvency, not liquidity. The banks want another bailout. “We lost a hand, no fair, we’ve used up our chips. If you want us to keep playing, you’d better give us another stack.”

It’s not Greece. As we’ve said since late last year. The default that is on the minds of the markets is the banks. It is Soc Gen, Deutche Bank, and yes, Citigroup. Greece is, on the great scale of things, even smaller to Europe than the subprime sector was to the U.S. On whose minds? Who is worried about default in the great mega-banks of Europe. It is the megabanks of the U.S. U.S. banks have withdrawn their short-term funding, and the long-term bets of their European brothers (or competitors) combined with the credit default swaps that link them all together have made banks too fragile to survive and to interconnected not to bail out.

Wall Street is worried. They sent their emissary Tim Geithner to the finance ministers meeting in Poland at the end of the week. Tim got a chilly reception. The Europeans don’t want to hear about it. They have a problem to solve, and it is the problem Wall Street, the world’s Wall Street, and Lombard Street made.

Are we going to bail them out again? Angela Merkel is is on the political hot seat. Germans still think it’s the Greeks. Maybe they’ll never figure it out. The best thing for the Euro would be if Germany left it. Then there could be a rational revaluation. German capitalists would never let it happen. They are the major beneficiaries of the weak euro. They don’t even have to peg it like the Chinese do to the dollar.

Pretty soon Barack Obama will be sitting in Merkel’s seat. Not only are the banks connected to the European mess, those in the U.S. are still holding a lot of the bad mortgages, with more coming as former customers demand their money back on shoddy securities unloaded during the 2008 crisis. Will Obama really ask for another bailout? Where will the leadership be? Carrying the flag for …. You ask. Wall Street, the banks, or a real economy that needs a rational financial sector, not a casino.

Now the forecast.

It is capacity utilization.

Of course, industrial capacity will be used less as the economy flags, according to the Demand Side projections, even though no more capacity is being built. It’s part of the debt-deflation cycle. The point with capacity utilization is that it’s been grading down for forty years, and this illustrates a primary mistake made by the orthodox economists in charge of the current muddle.

That point is made clearly by Steve Keen in the paper of the week. At Real World Economics Review, it’s
Economic growth, asset markets and the credit accelerator (link on the transcript) (http://www.paecon.net/PAEReview/issue57/Keen57.pdf)

Keen says
“Firstly, and contrary to the neoclassical model, a capitalist economy is characterized by excess supply at virtually all times. There is normally excess labor and excess productive capacity, even during booms. This is not per se a bad thing, but merely an inherent characteristic of capitalism – and it is one of the reasons that capitalist economies generate a much higher rate of innovation than did socialist economies. The main constraint facing capitalist economies is therefore not supply, but demand.”
And that is what you see in the capacity utilization numbers.

Since the total index was begun in 1967, the trend has been down. You can see it on the transcript. Prior to 1967 there was no total index, but there was a manufacturing index of capacity utilization. That index has tracked the total index fairly closely since, although manufacturing utilization has sunk a bit from the total index as time has worn on. In any event, we append the earlier series so as to get a reading back to 1948.

As you can see by the trendlines, prior to 1967 the trend was up. This reflects the privileged place America found itself in after the Second World War. During the war the industrial capacity of Europe and Japan was decimated. This left a virtual monopoly for American industry, which benefitted further from the Marshall Plan and the rebuilding of Europe. Once other capitalists came on line, that monopoly eroded. Footnote: It also marks the heyday of American unionism, which split the take with the capitalists in the monopoly economy.

But today is long past 1967, and the point is, unused capacity in the private sector has been growing for decades. Excess productive capacity means investment has been redundant. Particularly since a lot of productive capacity has moved overseas, where Chinese and Germans are making things and shipping them into the American market.

Not to say there isn’t a need for productive capacity, but it is just not in the satiated consumer economy, the private economy dominated by consumerism. So returns to capital came down and investors went looking for yield in the financial sector and in a housing bubble.

Yes, we have need. This is the ultimate frustration. No more frustrating, I suppose, than when the one of the supply side talking heads complains about government deficits in one breath and then in the next says, “But I just came back from (fill in the blank of Asian or European country) and when I came back, it was obvious that the U.S. is falling behind in infrastructure. We are approaching Third World status.” Often they add, “The budget will have to come out of entitlement spending.” How that follows from the European example, I’m not sure, but it often does.

Yes, we have need. But need is not demand unless, as Keen says, it comes with money.
Secondly, all demand is monetary, and there are two sources of money: incomes, and the change in debt. The second factor is ignored by classical economics, but is vital to understanding a capitalist economy. Aggregate demand is therefore equal to Aggregate Supply plus the change in debt.

and he goes on to explain how a capitalist economy buys not only new goods and services, but also bids up the value of existing assets.

But we have a mixed economy, a capitaliist private sector and a public sector charged with providing the structure and groundwork for capitalism and the public goods and social insurance capitalism by itself will never provide. Monetary demand can come from an agency able to borrow at near zero or tax from its privileged citzens and spend on useful, even vital – though not consumer – goods and services.

Let’s take an example. Transportation infrastructure. The U.S. depends on a tremendous fleet of trucks utilizing the public highways. Other nations have built up their rail systems, which are lower maintenance and lower cost per mile. Our system requires lots of fossil fuels, a semi wears at the road surface at the rate of 16,000 tiimes that of a passenger car, and the privately operated railroads ship bulk commodities like grain and coal or intermodal containers. It is parallel to the health care industry, where the profitable portion of the operation is segregated for the private corporations to maximize, and the remainder is shunted onto the public sector.

So, forecast, trending down, below the trendline, not in a gradual line, but in the dives and surges typical of this index. The 2008 dive was to a historic low, and we expect to see another record low by 2014. Capacity utilization in the form of private industrial capacity will, in fact, be lowered, not raised by tax incentives for private investment. We don’t need it any more than we needed McMansions. Capacity in the form of public infrastructure, education, and preparation for climate change is not on the horizon.

You figure it out.

1 comment:

  1. I have been looking at the issues of debt in Greece and deleveraging in general. One thing that has struck me and may not have been considered by many is the secondary impact on creditors. Though it does explain the withdrawal of US funds from Europe for the last year.

    I will use Greece as an example. If it were to become a total default its losses to the UK would be $15 billion, to Germany $45 Billion both manageable. The losses by France would be $75 billion. Which would make a huge dent in the balance sheets of its banks. These already weak banks would be in trouble so would recall as much funds from elsewhere. Italy owning French banks $511 billion would be an obvious start, but such huge withdrawals from the Italian economy would set it into recession and a much greater chance of default. So the issue is not Greece but France. What will politicians and the ECB do about France? The ramifications of a French default would impose losses of up to $257.1 billion on UK banks and $196.8 billion on German banks. These are not trivial sums and if governments bail out the banks they could destroy the sovereign balance sheets at the same time imposing austerity for decades to clear these debts. This also ignores the impact on the US as many creditors will have credit default swaps and a wave of french banks collapsing could trigger trillions in payouts. This will mean huge problems for the Fed and Congress.

    The other alternative is a chain of cascading bank defaults, as governments refuse to bail out the banks further. This would mean nationalising virtually every big bank in the countries concerned. The only ones being saved being small depositors.

    Longer term one solution is for an end to interstate banking much like the US's McFadden Act of 1927. This would end contagion risks but end the single market for EU banking. The alternative would be all bank regulation to be centralised by the ECB.

    In the end the politicians need to decide what Europe will look like in the decades to come. They do not have long.