THE FIVE ECONOMIC FACTORS THAT MATTER MOST TO METAL FABRICATORS

There are some dirty little secrets about the economics profession that many business people are blissfully unaware of. Under most circumstances this is a good thing, but not when the business owner or CEO sets about trying to make sense of all the opinions and all the analysis these commentators provide. Today the average business owner is bombarded with a constant stream of assessments, forecasts and economic minutia that serve little function other than to confuse.

What in all of this really matters? What should the executive/owner be paying attention to when trying to figure out where his or her business is heading?

The first step in deciphering all of this is to understand that economics is essentially a philosophy wrapped in statistical analysis. The numbers that are collected may all be the same (although even that can be questioned), but the analysis will be through a filter of what that economist believes. A free market economist will look at the rising rates of foreclosure and conclude that this will bring home prices down to more reasonable levels, yet a Keynesian will want to interrupt the process to some degree and protect the greater economy from the damage caused by all these people losing their homes.

This doesn't mean that a business person needs to take sides in these arcane philosophical debates, but it is useful to know where the given economist is coming from in terms of his or her analysis. In the interest of full disclosure, this author is drawn to the Chicago school of Milton Friedman and the Austrian school of Ludwig Von Mises. In other words – I am a believer in free markets and very limited government engagement in the economy.

The second step is knowing where to focus most of your economic attention. Every industry has some unique indicators that allow a person to understand what is happening in that sector, but when it comes to the larger economy there are several that stand out as the most useful in determining direction. Five important indicators tell the most important parts of the story for the majority of businesses.

NUMBER ONE: ACTIONS OF THE FEDERAL RESERVE

If you're going to follow the actions of the Fed, then you need to follow all of them – not just its decisions about what the interest rate should be. This includes items like its determination of member bank's reserve ratios, its measurement of real money supply and the decisions it makes about bank access to capital.

The Federal Reserve is the central bank of the U.S., with the mandate to control the supply of money in the U.S. The traditional mission of the central bank is to control inflation and, in most cases, where the choice is whether to stimulate growth or fight inflation, it will opt to focus on the latter. The Fed does this by setting the rates that banks will use to borrow from the Fed, as it is the banker's bank. That rate then becomes the underpinning for all other interest rates – prime rates, mortgage rates, car loans and so on. It is a bit of a blunt instrument, as it doesn't force anybody to do anything. It just sets the stage.

The Fed has always had an easier time fighting inflation than pushing growth – it is easier to stop somebody from doing something by making it more expensive than it is to get somebody to do something – often referred to as pushing a string. The Fed has many other tools at its disposal to set the supply of money, but in the majority of cases all of these tools are pushing in the same direction. It's easier to see how serious the Fed is by watching how many tools it takes out of its tool box.

The casual observer needs to look at two or three items to monitor the Fed. The Beige Book is its assessment of the economy from one region to another and tells you what it thinks is happening out there. The second item is the minutes of its last meeting that describe what was discussed when the decisions on interest rates were made. The last set of things to look at are the comments that the Fed Chair makes to Congress, as this is his report to the country and the policy makers.

NUMBER TWO: TRENDS IN EMPLOYMENT

Second in consideration is employment trends – not just the jobless rate, but the distribution of jobs in terms of growth sectors, shrinking sectors and demographics. The unemployment rate tends to be a blunt instrument for measuring the economy, as it fails to provide information about who is getting work and where. The information needed is deeper than that as 95 percent of the eligible population is employed. What makes up the ineligible and where are they?

The collection of employment data is as much art as science and is infinitely more complex than it would appear. It isn't that easy to figure out where everybody works as reports from smaller, family-run companies are often delayed, part-time people are traditionally hard to count, and so are the seasonal workers. The complexity is endless, but the main point is that it is an inexact measurement. It is not usually very productive to obsess over fractions of a percent change in unemployment, but the analysts tend to do so anyway.

The more important aspect of employment is that which applies to your business and your customer's business. It is generally pretty easy to see what is happening in your own industry and many companies report job shortages in the middle of periods of high unemployment. It doesn't matter that an unskilled worker is looking for a job when your need is for a worker with specific skills that are in short supply. The real issue of unemployment is sectoral, and regional and national numbers are only the loosest of guides. Not unlike reporting at the end of a football weekend that the winners scored 376 points and the losers scored 278. Nice to know, but specifically which teams won and lost?

The more important employment factor yet is that which concerns your customer. If that industry is shedding jobs, it is not a good sign. If you are selling to the people who are losing those jobs, that is an even worse sign. The first indication that a company is struggling comes when layoffs start, as this is always the fastest and easiest way to reduce costs. When your top customer starts to issue pink slips, it's a good time to consider alternative sales channels.

The Labor Department collects the raw data and is a source of good national trends, but many of the private payroll management companies issue their own assessments and they are useful as well. The most effective way to watch your key customers is to note their local papers – they will always report a decline in employment.

NUMBER THREE: DURABLE GOODS ORDERS

The third indicator is manufacturing orders for durable goods, those goods that last longer than three years and are also referred to as capital goods. The purchases of these products are better indicators of where people and businesses think they will be in the future, as it often takes a long time to pay for them and, thus, they become investments in the future.

The analysis of durable goods has some advantages over other items. They are easier to count since they are big purchase items, they are rarely items purchased without due consideration (meaning orientation to what one thinks will happen), and they generally signal that more production of something else is imminent. These are the machines that get counted as capital expenditures and these are the goods that promote productivity.

There have been times when the economy has slowed even while non-durables go up, and there are times when the economy slows despite consumer activity, but it is very rare to see an economy slow for long when those non-defense durables are getting snapped up. The data releases are mostly from the Conference Board – a private organization that collects and interprets the data that makes up the foundation for the leading, lagging and concurrent indicators. Few of the leading indicators have more potency as a predictor than those durable goods orders.

NUMBER FOUR: CONSUMER EXPECTATIONS

Factor number four is consumer expectations about the performance of the economy and their own actions. Given that 80 percent of the U.S. economy is fueled by consumer spending, the attitude they have is critical to projecting what happens next. The consumer is compulsively fickle and changeable and rarely answers questions accurately or honestly, so it becomes important to focus on actions as opposed to words.

This is one of those indicators that drive many analysts out of their mind, as consumers are notoriously inaccurate when asked about their spending intentions. The two most reliable studies are conducted bv the University of Michigan and the Conference Board, but there are many hundreds of surveys conducted by private organizations and individual retailers. The basic idea is the same – ask consumers what they think they are going to do with their money in the future and forecast on the basis of these opinions.

The consumer reacts to the most immediate input, so if the survey is conducted the day that gas prices jumped past $4, the consumer tends to answer in a negative direction, but if the price per gallon fell that day they are in a better mood. The accuracy of the surveys rests on large numbers and extrapolating these trends. The crucial thing for a business is understanding there is a close relationship between the mood of the consumer and how much they choose to spend. It is also important to note that consumers react to future spending decisions based on what they think their finances will look like in the next year – and that has a great deal to do with their sense of job security.

Be prepared to see wild swings in consumer response and even contradictory behavior. When threatened with inflation, people tend to feed the problem by buying more now – assuming that prices will only go up. This is called a self-fulfilling prophecy.

NUMBER FIVE: INFLATION

The last factor is inflation, both the headline rate and the core rate. The headline rate is the one we all confront every time we buy gas or groceries these days, but this isn't the rate that determines the actions of the Fed or other policy makers. Prices for food and fuel are too volatile to plan around and are thus eliminated when looking long term.

The key inflation rate is the core rate – one that eliminates the highly changeable prices to see what the long term trends might be. It is also important to look at wage driven inflation, as this is the most dangerous type of inflation and the hardest to deal with. Wage driven inflation is what saddles an economy with stagflation if left unaddressed.

Lots of things create inflation and, from an economic standpoint, it matters which of these factors are dominant. The worst kind of inflation is the "dog chasing its tail version," when wages keep trying to catch up to inflation and usually result in more price hikes. The U,S. rarely sees this kind of inflation as it has abandoned the wage indexing that led to stagflation back in the 1970s.

The next kind of inflation is that which comes from hyper growth. This is the inflation that plagues China and many of the other fast growing Asian economies. There is too much money chasing too little supply and prices start to spike. In some respects the U.S. was going through this period during the housing boom as prices for houses inflated to ridiculous levels. The hangover the U.S. economy is now going through is related to the spikes in pricing that occurred then.

It is the third kind of inflation the U.S. is contending with now – inflation driven by specific price hikes that then start to work their way through the economy. In this case it has been the price of oil, commodities like steel and the price of food. This has been a blow to the U.S. consumer, but this type of inflation generally lasts for a shorter time than the others. In most cases, the supply situation changes in reaction to the demand increase. This is happening with food and to a certain extent with some other commodities although there has been less action in the oil sector.

In watching inflation, it is important to pay attention to both the "headline" rate, as that is what is costing your company most directly. But to understand what the Fed is thinking, the core rate matters most. This is the rate that subtracts volatile sectors like oil and food to settle on more long lasting trends. If one expects the Fed to react to inflation, it will be the core rate that will motivate them.

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The author, Dr. Chris Kuehl, is managing partner of Armada Corporate lntelligence and the economic analyst for the Fabricators & Manufacturers Association International (FMA). Dr. Kuehl is the author of Fabrinomics, a biweekly economic analysis e-newsletter for members of the FMA.