Industrial Production: A Brake and a Gas Pedal

The Mouth looks at today's industrial production report: Capacity growth continues to decelerate, and production growth continues to accelerate.
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The Cat in the Hat

JACKSON HOLE, Wyo. -- The June

industrial production

report released this morning revealed Two Things.

Thing One is that industrial capacity growth continues to decelerate.

It peaked at 5.7% in 1996 (see table at left) and has been slowing ever since; the 4.3% year-on-year increase it posted last month goes down as the slowest in more than four years. Note that capacity grew at a 3.6% (annual) rate during the second quarter following a 4.2% increase during the first; these go down as the slowest back-to-back (quarterly) increases since 1994.

Thing Two is that industrial production growth continues to accelerate.

It grew at a 3.9% (annual) rate during the second quarter following a 1.3% increase during the first; the second-quarter gain goes down as the biggest since the fourth quarter of 1997. Production growth troughed (on a year-over-year basis) at 1.5% in December and has accelerated to 2.7% since.

Summing Things One and Two, then, produces the result that the gap between production growth and capacity growth has narrowed: It has slimmed by 2 full percentage points since it peaked at 3.5% in December.

Why is this important?

Our friend

Greenspan

puts it

this way.

The surge in business investment that began roughly five years ago not only has restrained costs, it has also increased industrial capacity faster than industrial production has risen. The resulting slack in product markets has put greater competitive pressure on businesses to hold down prices, despite taut labor markets.

And now the slack-in-product-markets portion of help on the price front is unwinding.

And keep in mind that it was a material deceleration in global demand that gave rise to the capacity glut. World

gross domestic product

fell to an average 2.3% a year during the 1991-1998 period from an average 3.1% during the 1981-1990 period; growth in Japan, which boasts the world's second-largest economy, crashed to an average 0.8% from an average 3.8%.

And keep in mind that it was the capacity glut that allowed firms to get away with paying sorry wages. Real wages have grown only an average 0.3% a year during the 1990s against an average 2.1% during the 1950s and 1960s.

And keep in mind that it was sorry wages -- along with a host of favorable supply shocks that sent prices for imports, commodities and energy goods plunging -- that helped constrain the broad price indices.

What goes up must come down.

And the converse?

Nah. Couldn't be.

Oh, the Places You'll Go! (or Fly Away)

You know what would be refreshing?

It would be refreshing to hear all of the folks who have been fundamentally bullish on bonds since October just shut the hell up already.

Indeed. Our good

friend

The Tool

has far and away been more wrong about bonds than just about anyone in the country, and yet he refuses to just go away. Check out this timeline.

October 1998:

The yield on the 10-year Treasury fell below 4.15% today, a low not seen since November 1964. ... Yields are likely to remain low and should fall further in the months and years ahead. ... History suggests that today's low interest rates are not an aberration. ... Bond yields could fall significantly further and the odds of a sharp spike upward in yields are minuscule.

January 1999:

Interest rates will head significantly lower in the months ahead as deflationary pressures and

Fed

easing make another comeback. ... We forecast 4.5% 30-year Treasury yields by midyear and 4.0% yields by year-end.

February 1999:

We continue to expect Fed ease and lower rates in the year ahead. ... We continue to forecast a sharp drop in yields during the months ahead.

March 1999:

The bottom line is that fears of Fed tightening and rising inflation were premature and overdone. Look for bond yields to begin falling as the reality of the New Era begins to sink in again.

April 1999:

We continue to believe that the next Fed move will be to ease policy, not tighten. ... We continue to forecast slower growth, much lower inflation, and Fed ease in the year ahead.

May 1999:

We continue to forecast that the next Fed move will be to ease monetary policy, not tighten. ... The economy is slowing, deflation remains a serious issue, and the Fed is too tight.

June 1999:

By taking out insurance against the "wealth effect" and the Phillips Curve, the Fed will actually increase the odds of deflation. ... No matter what the Fed does on June 30, 30-year bond yields are heading to the 5.0% to 5.25% range by the end of 1999.

Is that all not absolutely fascinating?

And that ain't all. The Tool has sired a stableful of

Tool Juniors

(do not ask what served as the mare) who drop forecasts as consistently and as crappy as his. The timeline below comes from the most pathetic of all the Juniors.

December 1998:

Given our belief that the economy is slowing and that there is a significant risk of a sharp stock market correction, we remain bullish on Treasuries.

January 1999:

The 30-year yield should trend lower toward the 5.00% mark.

February 1999:

Until and unless inflation reverses course and trends higher, the Fed will not tighten and bonds will not enter a long-term bear market.

The denial here is particularly rich, isn't it? Given the fact that the bear market began in November?

March 1999:

The fact is that all signs are still pointing to disinflation, which means that the Fed won't tighten and bond yields are not headed back to 6%.

April 1999:

The bottom line is that the friendly inflation data at home, deflationary forces abroad, international conflict and a bullish Q2 supply picture all bode well for Treasuries.

May 1999:

The market might not yet embrace our confidence that noninflationary 4% growth is possible, but bond yields aren't heading to 6% unless inflation does truly accelerate. ... Tightening will therefore remain a threat, but nothing more.

June 1998:

All of the big-picture trends argue for a greater risk of 4% bond yields than 8%.

Whatever.

In the Fantasy Land that Tool and Tool Juniors inhabit, there is no such thing as a bad forecast.

These guys are never wrong. They're just early.

Side Dish

We already knew that

Billboard Elway

was an endorsement whore. So one wonders. How much did

Coors

pay

Dan Patrick

to get him to do such stupid commercials?

Best condiment?

Mayo.

Mustard.

Ketchup.

Sugar (or Posh Spice).

Salsa (or Ricky Martin).