More [Fairly] Good News

So far we have managed to avoid reducing the size of our economy in the name of austerity. That makes us better off than the UK where the government decided, for reasons best known only to itself, to make everything much smaller. In view of the news so far this week we may even be lucky enough to get away without too much silliness, although judging by the posturing over debt limits I doubt we will avoid lunacy altogether.

Was the news good?

Pretty much. As usual there’s a mix. And also as usual you can find facts to fit any economic narrative you want to weave.

The biggest surprise was today’s Institute Of Supply Management Index. This provides us with the results of monthly surveys conducted by the ISM, and measures levels of activity in various stages of production. Today’s release focused on manufacturing. The jump from December’s 58.5% to January’s 60.8% caught most people off guard. Given the anecdotal data floating around the general view was that there would be no increase at all. So the uptick caused quite a wave of euphoria on Wall Street which is already in the throes of an optimistic rise. Basically this ISM index, they have others, gives us the proportion of manufacturers who report they are expanding their operations. So any reading over 50% means activity in general is picking up. The January performance was the eighteenth straight month over that 50% mark and is the highest since May 2004.

Most importantly, the sub-indices have now shifted into growth mode as well. So the entire structure of manufacturing seems well set. One of those sub-indices is for employment, and has now shown expansion for sixteen months in a row. It is rated as accelerating, and hit the 61.7% mark in January.

One other, perhaps more cautionary, sub-index to note is that for prices, which has shot up to 81.5% in January, from 72.5% in December. Obviously as activity expands pricing power shifts around and raw material costs creep up. Whether this will show up in finished product prices is debatable. Profits are at all time high levels and so there seems to be plenty of margin to be eroded before producers feel the need to pass along higher prices to consumers. This is especially true as long as consumption remains fairly weak. Still, this is something to watch.

Speaking of consumption: we saw the data on December and the fourth quarter yesterday. It, too, was fairly strong.

Personal consumption rose 0.7% in December, up from 0.3% in November. Adjusted for inflation December’s rise was 0.3%. The fourth quarter as a whole saw annualized growth of 4.4%, which is the most rapid since early 2006.

Obviously consumers are back spending.

The problem is that they are back spending at a rate faster than incomes are growing. This puts a limit on expansion since household debt levels are still relatively high and one of the themes of recent quarters has been the desire to reduce debt. Incomes grew only 0.4% in December, the second straight month at this pace. The savings rate reflected the shift by dropping from 5.5% of disposable incomes to 5.3% in December.

One last number to ponder: construction spending dropped -2.5% in December, following a drop of -0.2% in November. This was a small shock since many people who follow construction more closely than I do had predicted slight growth. What can I say? Construction is going nowhere fast.

So what story do we weave from these dry numbers?

No great shifts. They confirm what we already know. The economy is now growing and is likely to stay that way throughout the year. That will slowly have an impact on unemployment, but probably not a dramatic impact. Conversely, lingering high unemployment and underemployment limit the extent to which the economy can truly “take-off”. Personal incomes are not growing fast enough to set things on fire. And even though profits are very high, businesses still refuse steadfastly to re-hire at anything other than a glacial pace.

Apart from our unstable financial sector, the biggest threats are now policy driven. As more states shift towards austerity the cumulative effect will be to dampen growth. We could see similar problems emerge at the Federal level as well where fractious politics and the early beginning to the 2012 election may well create confusion and could even produce damaging spending cuts.

The economy is just not well enough healed to withstand a round of demand reduction.

If you want to know what is likely to happen if we cut spending too soon, just look at the UK.

On second thoughts don’t, it’s not too pretty.