Industrial production in the United States remains caught up in the latest downward shift of the 2012 slowdown. The Federal Reserve estimates that overall industrial production contracted for the 10th straight month, falling 0.7% in June 2016. The degree of decline is relatively small, but as with so many other accounts the lingering of the condition for an only increasing period of time is highly concerning.
With another smaller contraction, it seems likely that US industry remains closer to fine-tuning production levels rather than the usual recessionary slashing. The problem with that approach is that despite an already-lengthy adjustment period the imbalance of inventory only remains. The fact that production levels are consistently declining shows, as does the increase in commercial bankruptcies noted yesterday, that the topline economic environment is unusually weak; even beyond the lack of recovery witnessed in the years before 2015.
The oil sector has for a few months weighed on overall production levels, but not disastrously so. The drag from declining activity in the mining sector is still relatively small, meaning that the struggles in domestic industry aren’t just this one factor.
The greater contribution to industrial weakness has been from domestic auto production. Auto assemblies in May were visibly weak, nearly 9% less than May 2015, but only partially rebounded in June. Year-over-year, motor vehicle assemblies were up 4.3% and thus not close to an offset to the prior month’s slow pace. US auto production has been off-trend since last summer, becoming more serious (though not nearly like a recession) by November. Despite June’s better estimate, production in the first half of the year is only 1.5% higher than the first six months of 2015.
It shows, as overall IP, that producers are actually responding to economic weakness but in smaller, measured production changes. The buildup of inventory in especially the auto segment on the wholesale level is itself recessionary, so it raises the question about why producers aren’t making more of an effort to better align industry output with slowing sales.
I believe the answer is, again, the nature of this economic condition as unlike any other. Recession is essentially capitulation; everyone knows something bad is coming so everyone drastically cuts back at the same time leading to self-reinforcing, spiraling effects. In these unprecedented circumstances, however, there truly is no consensus about the intermediate future. There is angst and uncertainty, to be sure, but almost as likely to swing violently to relief and euphoria as hold that way. It could be bad if sales continue to stall into a third year; it could be good if economists and policymakers are to be believed (and somehow they still are). The lack of clarity may be keeping real economic responses to the minimum necessary to achieve a balance between hope and reality.
Because this is an inefficient condition, cutbacks are still necessary even if not fully embraced.
There is also the possibility, one of the worst case scenarios actually, that manufacturing and industry have become numb to the weak environment. In the production of consumer goods, for example, the state of industry resembles a zombie-like condition nothing like recovery/growth or recession. It may be that industrial firms in that segment have, given the four years of this setting, kept their operations to those minimums so that any adjustments required due to variations in the economic baseline are by their nature relatively small. Recessions, to some extent by contrast, are products of great imbalance of suddenly big overoptimism that in this part of the industrial economy would not have been applied because the distinct lack of recovery never allowed it to.
This unusual condition may be more widespread compared to the auto industry. As one of the few bright spots of the past seven years, industrial production related to automobiles might be one of the few areas where recessionary imbalances might actually exist. This would actually be one of the worst results because it would suggest domestic industry locked into low-growth expectations casting further and further into the future as a self-reinforcing condition that a recession would, as a typical cycle, break up so that growth could start anew. Without recession, however, stagnation becomes only a hardened state. That would mean the economy becomes actually weaker than it appears because the true state of weakness is not obvious recession but continued lingering well-below trend for a very long time.
Given this low-growth scenario plus the dramatic inventory imbalance as sales continue to be insufficient, it seems reasonable to expect that US industry will, at best, continue to contract at a somewhat steady if small rate. The downside would be if those parts of the industrial base, such as autos, that do contain more recessionary imbalances start to react in more traditional fashion to heightened inventory. It is in many ways the range of scenarios that the “rising dollar” suggested when it first appeared in the middle of 2014 – where both the top and bottom ranges for future probabilities sink, the entire probability spectrum shifting down. After 10 months of IP contraction, it does seem as if we have reached just that kind of condition where, absolutely contrary to 2014 expectations, actual growth has become the big outlier scenario.