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Critical Economic and Market Commentary – August 27, 2009

Posted At : September 2, 2009 2:42 PM

Economic Update – The recession ends…feel any better?

For all intents and purposes, the recession is over…statistically that is. Between the “Cash for Clunkers”, first time home buying incentives and various other stimulus give-aways, whether it is this quarter or next, GDP is likely to show at least some sort of gain. Remember, all of these programs positively affect GDP.

The real key will be when “Capacity Utilization” makes a comeback. Capacity utilization is a concept in economics that refers to the extent to which an enterprise or a nation actually uses its installed productive capacity. Thus, it refers to the relationship between actual output that is produced with the installed equipment and the potential output that could be produced with it, if capacity was fully used.

At the moment, capacity utilization in the US is at an all-time low, around 68%. That means that with the equipment we already have in place we could produce almost 50% more goods than we are now producing. However, most analysts think that 80% capacity utilization is a very good number. On the bright side, there was a small uptick in last month’s data. Whether or not this is the “bottom” remains to be seen. But if it is not the bottom, it is close. You can only shut down so much production before inventories fall to levels that require restocking. And we are getting close to that level in many industries.

With most analysts feeling that a capacity utilization of 80% or more is pretty indicative of solid growth, we have a long road back. To get back to that level, we would have to see an almost 20% rise in manufacturing. That is unlikely to happen all that fast, for several reasons. First, consumers are retrenching and saving. We just simply are not going to need or want as much stuff. Second, unemployment is crimping the ability of consumers to spend. The recovery we are likely to see is going to be sluggish and not produce new jobs for quite some time. Again, that stifles demand. The country (and the world) is adjusting to the New Normal. It is some level of overall economic activity that is different than what we have enjoyed during the reigning paradigm of the last 30 years.

What few understand is that we are in a massive generational cycle that only comes around every 40 years (a generation) and a compounded generational cycle that happens every 2 generations, or 80 years. Is it any wonder that consumer spending is the lowest since 1967, yes about 40 years ago and through a massive deleveraging process that happened two generations ago, yes 80 years ago in 1929? That’s because people reach their peak spending in their late forties (48 on average) and slow down spending and start saving, hard! It’s just a natural demographic cycle. (I discuss this in depth in my Economic Tsunami special report. Readers can request a free copy).

What’s going to happen is that manufacturers are going to ramp up more slowly than in the past, especially as many companies have the ability to tailor their production to consumer demand much faster now, due to automation. As I have repeatedly said, the world is awash in excess capacity. We simply built too much productive capacity to be utilized in the New Normal. Too many malls, too many shoe stores too many Harley Davidson’s. One way of dealing with too much capacity is to simply close the plants. That is what is happening in the paper and memory-chip industries. Other industries are engaging in mergers to reduce or “rationalize” capacity. While that process is a good thing, it does mean that unemployment rises or stays higher longer.

The building of inventories counts as a rise in GDP. Conversely, reducing inventories gets counted as a lack of growth. We have just about reduced inventories all we can. As companies begin to rebuild inventories, that will translate into a statistical increase in GDP. But if capacity utilization rises even to the low 70’s, it still shows a weak economy with not many new jobs and reduced corporate profits, compared to a few years ago. It will be a rather long time before the jobs that have been lost this cycle will come back. Will the statistical comparison of data from a year ago look positive? Are things improving? The answer will be yes. But it will not feel like it for those who are looking for new jobs or higher income or more sales.

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