Global recession has begun
LONDON (Reuters) – Yesterday’s bleak reports on the state of U.S and European manufacturing confirmed that a global recession has already begun.
The Institute of Supply Management (ISM)’s composite business activity indicator plunged for the second month to 38.9 – far below the 50-point threshold dividing expanding activity from a contraction, and the lowest level since September 1982 (see chart https://customers.reuters.com/d/graphics/US_ISM1108.gif).
The 11-point plunge in the index over the last three months (August-October) has been equaled on only four occasions since 1945 (1949-50, 1959-60, 1974 and 1980-81).
It dispels any remaining doubt that the United States has already entered recession – which the National Bureau of Economic Research (NBER) defines as “a significant decline in economic activity, spread across the economy, lasting more than a few months”.
The economy has been in trouble for more than a year. Manufacturing output peaked in July 2007 and had fallen 2.3 percent by August 2008 according to estimates published by the Federal Reserve. Private sector jobs peaked in November and were down 0.7 percent by August.
Repeat claims for unemployment insurance had risen almost 1 million over this period, and the number of people in desperate poverty receiving help under the federal government’s Aid to Families with Dependent Children (food stamp) program surged almost 2.5 million.
But until the last two months, problems had been largely confined to the motor manufacturing and construction sectors. While production of cars and light trucks declined 28 percent between July 2007 and August 2008, output of other durable items intended to last at three years or more actually rose, albeit by a marginal 0.4 percent.
Nonfarm businesses eliminated 815,000 positions on a net basis between November 2007 and August 2008. But most job losses were recorded in construction (-360,000) and motor manufacturing (-105,000) with fairly modest losses spread across the rest of the manufacturing and service industries (-349,000).
THE DOWNTURN SPREADS
In the last two months, however, the downturn has widened to the rest of the economy as growing financial turmoil and a darkening outlook have caused households and businesses to prepare for a long and deep slump by retrenching.
Retail sales have fallen in each of the last three months (July-September). But the Census Bureau measures sales in cash terms rather than by volume, so the headline numbers tend to be distorted by changes in the price of gasoline, as well as financing programs and deep discounting designed to shift auto inventories.
A better guide to the underlying strength of the consumer sector is “core sales” of items other than autos and gasoline. Core sales fell in both August and September, the largest cumulative decline since the immediate aftermath of the attacks on the World Trade Center and Pentagon, the first consecutive monthly decline in more than a decade.
Core sales have risen on average just -0.12 percent in each of the last 12 months. Since even core inflation has been running faster than this, sales volumes have been flat or falling for a year. But the pace of decline has accelerated sharply in recent weeks.
Slowing consumer spending and business investment is now working through to falling output. Manufacturing production slumped in September (-2.7 percent) and for the first time losses were concentrated outside motor manufacturing (-3.0 percent) as producers responded to falling orders by slashing output to prevent a build up of unsold inventory.
ISM reports that 46 percent of survey respondents reduced production and 40 percent cut employment last month. Even so, 52 per cent of manufacturers reported a fall in new orders and 50 percent reported shrinking order books.
The pace of job losses picked up sharply in September, with private-sector employers eliminating 168,000 positions (net basis) and most of the job cuts coming from industries other than construction and autos (-115,000). The market is braced for a further big fall in nonfarm employment when data for October is published on Friday.
The downturn is now spreading internationally. Purchasing surveys show declines in output, orders and employment in all three of the major eurozone economies last month. The European Commission has already accepted that the eurozone economy is in recession.
In the United Kingdom, with its construction and financial-services dependent economy, real gross domestic product fell 0.5 percent during Q3. Japan’s economy was already shrinking in Q2 and the slide looks set to intensify during Q3, with the purchasing index falling further and further into negative territory.
The main bright spot in an otherwise gloomy picture is continued growth in China and some of the other emerging economies of Asia and the Middle East. But even here, there are signs that export-led economies are slowing as the recession hits their main customer-base in North America and Western Europe.
The other bright spot is a sharp reduction in inflationary pressure as the price of energy and other raw materials pulls back sharply from the summer’s highs. For the first time since October 2006, the ISM’s survey found more commodities declining in price (12) than rising (5) last month (see chart https://customers.reuters.com/d/graphics/ISM_CMD1108.gif). ISM reported widespread falls in the price of energy (diesel and natural gas), steel (stainless and cold-rolled coil), and base metals (aluminum, nickel, zinc and copper products).
Falling commodity prices will ease some upward pressure on manufacturing and transportation costs, and relieve the squeeze on margins. But it is unlikely to provide a substantial cushion for corporate cash flows amid a steep fall in demand, and further substantial reductions in output and employment appear inevitable in the next 3-6 months, intensifying the recessionary dynamic.
The swift turn in the business cycle has banished fears of inflation and enabled central banks to focus policy on supporting the banking system and restarting growth. The global rate cycle has clearly peaked, with rate reductions in the last month across the United States, Canada, Eurozone, United Kingdom, Japan, Switzerland, Australia, New Zealand and China.
But with the massive overhang of debt inherited from the boom years (especially in the United States and the Anglo-Saxon economies), bank balance sheets severely impaired, and extreme uncertainty about the outlook, demand for credit and lending activity looks set to remain weak, despite reductions in policy rates.
A broad-based recession has already begun across the advanced industrial economies which looks set to be the worst since 1980-81, if not 1945. Sharply falling demand for energy and other raw materials used in manufacturing and construction has already pushed most markets from oil and refined products to steel, copper, aluminum, nickel and ocean freight into surplus.
For the next 18 months, commodity markets will be shaped by an environment of weak demand and incipient surpluses.