Swan Song Of The Central Bankers, Part 5: The Flat Line Does Not Spell Recovery

The punk January industrial production (IP) report brought another reminder that the Fed has stimulated nothing at all on the output/employment prong of its dual mandate.

Indeed, as they celebrate a purported "mission accomplished" full employment recovery and confidently prepare to plow forward with an epochal pivot to QT (quantitative tightening), our Keynesian central bankers have remained absolutely mum on this stunning fact: To wit, there has been no recovery at all in US industrial production, and that's as in nichts, nada and nugatory.

In fact, January 2018 output in the manufacturing sector was still 2.2% below its December 2007 level, and total industrial production has barely crept forward at a 0.19% annual rate. And if you don't think that is close enough to zero for government work, just recall what a real historical recovery looks like on the IP front.

During the December 2000 to December 2007 cycle, for example, total IP grew at 1.4% per annum and manufacturing output rose by 1.9% per annum on a peak-to-peak basis. Prior to that during the 1990-2000 cycle, the figures were 4.0% and 4.6% per annum, respectively.

And if you want to dial way back in time to the Reagan-Bush cycle from July 1981 to July 1990, the peak-to-peak growth trend for total industrial production was 2.3% per annum and 2.8% for manufacturing output. And, by your way, that cycle also included a deep recession in 1982 that was only slightly less severe than the 2008-2009 downturn.

In short, when you don't get anywhere on industrial production over the course of 10 full years----the Great Recession notwithstanding---you are not succeeding. And while you are bragging, you at least ought to attempt to explain or rationalize what is otherwise a screaming aberration in the modern history of business cycles.

Needless to say, the Fed heads haven't bothered. While you absolutely cannot build an economy on Pilates instructors and bartenders alone, the Eccles Building has, apparently, simply deleted the entire industrial economy from its dashboard.

Nor is that the half of it. The overall IP stasis since December 2007 compared to the solid trend growth rates for prior cycles cited above actually masks the fact that the internals are even more damning: They show that the Fed's massive "stimulus" cannot claim credit for even the isolated impulses of growth that have materialized in the industrial economy since the pre-crisis peak.

To wit, domestic production of consumer goods is still 6% below its December 2007 peak. And, as also shown below, production of business equipment has inched forward by only 1% compared to where it was 10 years ago!

In fact, the only thing that has remotely held up domestic output is oil and gas production, which has soared by 78% from December 2007 levels owing to the shale boom.

Yet petroleum production is self-evidently driven by global supply/demand balances, not by where the Fed has pegged the Federal funds rate or by its conduct of a massive financial fraud otherwise known as QE.

The truth is, the machinations of the actual Red Politburo in Beijing----along with production control policy in Riyadh and the tremendous strides in fracking technology coming out of Houston----have been far more important in fueling the rising blue line in the chart below than the policies of the monetary politburo in the Eccles Building.

Thus, OPEC production has been cut by 1.8 million barrels per day, thereby driving prices higher and incentivizing US shale producers; China's debt-driven economic boom accounts for 5 million barrels/day of consumption growth since 2007 out of the worldwide gain of 10 million barrels/day--- further bolstering prices; and fracking costs have dropped from $75 per barrel or more to $40 per barrel or under, thereby fueling a spectacular 5X gain in domestic shale oil production since 2007.

In that context, fiddling with the funds rate has nothing to do with the leading sector of US industrial production. That is, except for the fact that the Fed's financial repression policies have dramatically cheapened shale-patch financing costs, thereby showering producers and land speculators with even more spectacular windfall rents.

The irony here is that the industrial production series is actually published by the Fed, and back in the day was one of the core metrics monitored by the FOMC. By contrast, not only has the Fed now studiously ignored its own IP data, but it also seems to have taken no note whatsoever of the chronic downward revision problem that has afflicted this series like most else coming out of the Washington statistical mills.

What we are saying is that one thing which has fueled the illusion of "recovery" is the fact that much of the data coming out of Washington has been impregnated with Keynesian bias. That is, there is a "trend cycle" bias in the statistical constructs which reflect the Washington belief that fiscal and monetary "stimulus" always and everywhere triggers rebounding economic activity.

That bias, in turn, gets expressed in the first prints (and often second) of monthly and quarterly economic reports, which are based on incomplete (and sometimes scanty) data collection and much formula-based extrapolation. Thus, as shown in the graph below, the initial prints for industrial production in the first half of 2015 (top light blue line) turned out to be 6% higher than what actually happened, as embedded in later, more complete data collection.

In this case, of course, the mini-global commodities/industrial deflation down-cycle of 2015-2016 was not supposed to happen---not after the Fed had jammed $3.5 trillion of liquidity into the canyons of Wall Street to insure a robust recovery from the Great Recession. So the trend-cycle bias in the initial prints quesstimates had to be revised out.

But here's the thing. We keep pointing out the horrible "recency bias" that has been fostered by the Fed's Bubble Finance regime, and that the FOMC and Wall Street speculators alike take their cues from the latest high frequency "data-deltas". Yet when a series like this gets revised multiple times, there is no trace of it in the headline monthly rate of change. The purported "good news" just starts from a lower base, yet what counts over time is where the level is, not the noise-ridden monthly deltas.

As we point out below, this isn't merely a matter of intellectual sloth or even honest error. There has been nothing remotely like a true "recovery", which means a snap-back to trend in the historical usage of the term; and which also implies that the deeper the downturn, the stronger the rebound---all things equal.

Obviously, something has gone haywire. The probability of getting back to anything that remotely looks like the prior trend after nine-years of tepid expansion is somewhere between slim and none from a purely statistical point of view.

But actually, we will take the "none" option. That's because the FOMC is so mesmerized by its own Keynesian models and groupthink that it actually believes full-employment prosperity has been essentially attained, and that it is both safe and necessary to now move full speed ahead with its QT pivot.

After all, the last thing our monetary central planners could abide is to be caught in an early recession with their Stimulus Pants down. At least they know full well that their extraordinary and plenary writ to control the US financial system with open-ended discretion depends upon their monetary Houdini act.

That is, the ability to slam the Federal funds rate lower in response to a recessionary downturn, and to then claim credit for the inherent regenerative powers of capitalism and it's inexorable, natural return to growth of output and employment.

Accordingly, they will stick with QT and not be troubled by the in-coming data in the slightest. Even though the underlying data trends----as crystalized dramatically in the case of IP---point to a rotten foundation, the monthly delta's are likely to remain positive until the stock market collapses.

As we pointed out in this series earlier, business cycle causation has been reversed in the era of Bubble Finance. The Fed now longer has the capacity to inflate the main street economy with unsustainable, credit-driven booms.

Its monetary stimulus, in fact, never escapes the canyons of Wall Street, where it fuels rampant speculation and pure financial wagering until the resulting bubbles finally burst. Then the main street economy is hammered by panicked "restructuring" actions in the C-suites involving drastic liquidations of inventories, excess labor and fixed assets.

Needless to say, these liquidations---desperate efforts to appease the trading gods by corporate executives and boards fearing for the value of their stock options----trigger a sudden contraction of the production chain.

That is, a recession that neither the FOMC or Wall Street sees coming because they are essentially focussed on the wrong data----the deltas, not the trends and levels----and because they mistakenly believe that monetary stimulus actually stimulates the main street economy.

Needless to say, the evidence for the Fed's absolute impotence with respect to stimulating output and employment growth never stops coming. Again today, another Data-Delta generated the typical "strong economy" headline: January housing starts were allegedly up by 7.3% versus last year.

Then again, what counts for GDP growth and jobs is the level of single family housing construction---which accounts for 85% of new housing output, and is not distorted by the wild monthly swings in the start rates for large apartment buildings. In fact, the entire headline was driven by annualizing and seasonally adjusting the 7,800 unit gain in Y/Y starts, of which nearly 40% were low construction value multi-family units.

By contrast, the actual level of single family starts in January 2018 was no higher than 27 year ago in May 1991 at the bottom of the 1990-1991 recession!

Of course, back then the population was 256 million compared to today's 329 million; and the number of households requiring shelter was also about 25% smaller.

Again, the chart below underscores the utter weakness of the housing construction component of GDP, not that the Fed has stimulated an awesome recovery.

It is frequently argued, of course, that none of this matters because housing and industrial production are apparently relics of your grandfather's economy. We will address Pilates Studio myth on another occasion, but even when you look at the totality of  GDP on a peak-to-peak basis for the present cycle, the flat-lining story remains the same.

Thus, during the 2000-2007 cycle, real GDP expanded by 2.5% per annum. Prior to that, real GDP grew by 3.5% in the 1990-2000 cycle on a peak-to-peak basis, and by 3.4% during the 1981-1990 Reagan/Bush cycle.

By contrast, during the ten-year peak-to-peak period from the pre-crisis level of Q4 2007, real GDP has expanded at just 1.45% per annum. Moreover, even a significant chunk of that tepid "growth" is accounted for by the runaway expansion of the health care sector.

As shown in the chart below, in fact, health services grew at nearly double the rate of real GDP during the past decade. If you remove health services alone, the real GDP growth rate drops to just 1.25% per annum.

And its probably not even that strong----given the fact that the GDP deflator is alleged to have increased at only a 1.6% rate over the same period. Give some allowance for real world inflation, and there simply isn't much real growth left.

We dwell on the health care sector, of course, because no one in their right mind would attribute the boom in that sector to 100 months of Fed funds on the zero-bound or $3.5 trillion of Fed bond-buying under QE. Instead, the motor force here is the $3 trillion per year of public sector fiscal subsidies including the $300 billion annual revenue cost of employer-provided health care.

In short, the vast expanse of the US economy has spent ten years on the flat-line or even below, as the 7% peak-to-peak decline in nondurable goods production (green line) in the chart below reminds.  That's actually what massive Fed Stimulus has brought to the main street economy: essentially nothing at all.

What the Fed has produced, of course, is a spectacular financial bubble that is once gain fixing to burst. And we are quite confident it will happen soon because our delusional Keynesian central bankers are now all-in on the business of making it happen.


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