I Can Feel It Fading

JACKSON HOLE, Wyo. -- Woo hoo!!

Industrial production grew faster than industrial capacity during each of the four years through 1995. That drove capacity utilization to 83.4% from 80.3%. Why? Because capacity utilization equals industrial production divided by industrial capacity. Utilization therefore rises when production grows faster than capacity and falls when capacity grows faster than production.

Utilization zigzagged during the 1996-1998 period. Last year, a 5.0% increase in capacity combined with a 3.6% increase in production to produce a level of utilization 0.3% lower than its 1967-1998 average.

On Tuesday, the

Fed

reported that utilization fell to 80.3% in February from 80.4% in January to land at its lowest level since August 1992. Is this number important? Absolutely. It is one of two key utilization rates -- the unemployment rate is the other -- that the Fed monitors to help guide monetary policy.

Yet although the February utilization number speaks volumes about the past and the present, it has absolutely nothing to say about the future.

A look at the trajectories of both capacity and production might provide a peek.

Capacity growth is on a firm deceleration track. It has decelerated for two years running. It has decelerated for two straight months for the first time since early 1997 (note that in 1998 it produced a 5.0% year-on-year increase 12 straight times). And owing to a downward revision to January data, its projected first-quarter increase of 4.3% will go down as the smallest three-month capacity gain since a 3.8% increase during the fourth quarter of 1994.

The capacity glut is rightly cited as the biggest obstacle to keeping firms from even trying to raise prices; that, in turn, explains the inability of firms to pay materially higher wages. As Paul Kasriel of

Northern Trust

points out, it is hardly a coincidence that real (inflation-adjusted) hourly compensation has grown only an average 0.8% a year during the current expansion against an average 2.6% during the 1961-1969 expansion and an average 1.6% since 1947.

No points for guessing what happens to prices and wages as the glut becomes less and less severe.

Industrial production just might finally have put in a bottom. On a year-over-year basis, it peaked at 6.7% in October 1997, three months after the Asian crisis hit. It did manage to turn in a decent 1998 increase, but that belies what happened between January and December: Growth began the year at 5.9% and ended it at 1.6%. The first two data points for 1999, however, suggest an end to the carnage.

The February uptick might well prove anomalous. But that seems unlikely for four reasons. One, manufacturing output has now risen for five straight months. Two, the

NAPM's Purchasing Managers Index

has risen for two straight months to land at a level (52.4%) not seen since April 1998. Three, the math of the IP series is now working such that even relatively modest production increases will be enough to preserve an upward trend in its year-on-year growth rate. (Remember the oil-price

example? Same kind of thing applies here.)

And fourth, Brazil and Russia, which together account for a whopping 2.8% of all U.S. exports, do not stand a snowball's chance in hell of inflicting even one-tenth of the damage on our manufacturing sector that the Pacific Rim countries, which account for 26.0% of U.S. exports, already inflicted. (Here the wing nuts in the audience will protest the exclusion of Ecuador and other countries terribly vital to U.S. prosperity. Include them if you must. But do keep in mind that all of South America accounts for only 9.5% of all U.S. exports.)

It will be some time yet before utilization rises; production growth is unlikely to exceed capacity growth anytime soon. But that isn't the point. The point is that if you wait until it does, you'll have missed the ride. You'll be standing in the dust surrounded by idiot economics correspondents (present company, uhh-hmm) and dimwit forecasters.

So come on aboard. There's lots of room for you. I promise you won't hurt the horse.

We treat him well; we beat him well.

Side Dish

Best college drinking slogan?

Yabba Grabba Brew.

Friends don't let friends beer-goggle.

One Tequila, Two Tequila, Three Tequila, Floor.

I've got a drinking problem: Two hands, one mouth.

Everyone should believe in something. I believe I'll have another beer.