THREE REASONS WHY THIS ECONOMIC SLOWDOWN IS TEMPORARY

Although the gloom and doom brigade has been out in force in recent weeks and the markets now reflect a new sense of impending doom, this slowdown is only temporary and not the start of another breakdown in the economy. Why?

A manufacturing industry economist says although the gloom and doom brigade has been out in force in recent weeks, and the markets reflect a new sense of impending doom, the slowdown is only temporary and not the start of another breakdown in the economy. “Admittedly, some of this reaction is justifiable when one looks at the numbers released lately,” says Dr. Chris Kuehl, economic analyst for the Fabricators & Manufacturers Association, Intl. (FMA; Rockford, IL). “The housing market is still skidding, the consumer has retreated in the face of more inflation threats, and the jobless rate has worsened. The manufacturing sector in particular seemed to lose its position as the engine of the recovery.”

Yet Kuehl asserts this downturn is just a blip and cites three reasons why it won’t last. “Perhaps the most important factor is the unexpected surge in inflation that occurred at the start of the year,” notes Kuehl. “This is not yet an increase in the all-important core rate that motivates the Fed to make decisions, but when the real rate of inflation spikes there is an almost instant consumer reaction, when the inflation comes from hikes in commodity prices.”

Kuehl continues, “The emergence of the ‘Arab Spring’ took the world by surprise. Within days the price per barrel of oil had thrust ahead by almost $20, and the price of gas jumped by 70 cents. The consumer was fresh off the memory of 2008 and assumed that it was only going to get worse, and the talking heads reinforced that perception. The result was a rapid withdrawal of consumer confidence which took a big chunk out of overall demand.”

According to Kuehl, the price of oil may be heading down soon, and gas prices have already eased a little. More important, the inflation threat is not yet manifesting in a way that will shift consumer behavior permanently. “The three factors that beget inflation are hikes in commodity prices, shifts in the wage structure, and an overall abundance of money in the system,” he explains. “At the moment, only commodity prices have become a factor. In other words, the inflation pressure felt by the consumer is coming from fuel and food, and there may be some modest relief on the way for both of these sectors. If the consumer thinks that the threat of much higher pricing is not so immediate, they will likely relax and get back to their old patterns.”

A second reason the downturn might be short-lived is that much of the decline of the last few weeks has been related to the issues stemming from the Japanese earthquake, Kuehl maintains. “The flow of parts and supplies for the world was interrupted and many manufacturers felt the pinch,” he says. “The Japanese are already starting to recover, most of those parts will be flowing soon, and by the end of the year there will be a return to some semblance of normal.”

The third reason for only a temporary slowdown: Some of the conditions that led to the expansion of the recession are fading and these improvements will start to show up in the months ahead, according to Kuehl. “Observers are a little baffled that banks and corporations have more money on hand than they have had in years, but that cash is not going anywhere,” Kuehl says. “The banks are sitting on it in part to contend with the wave of rule changes that stemmed from the Dodd-Frank legislation, and partly because they have returned to their old-school ways. Slowly but surely, the new system is settling in place and banks are interested again in expanding their business through loans.

“Credit is still far from loose, but it isn’t as tight as it has been,” he adds. “The business community is holding on to cash more aggressively as well, uncertain about what they can count on from the banks and partly because they are just more cautious. The need to spend that money is not pressing as yet, but if the competition starts to move or there appears to be more demand, they will start to less loose that cash, and the economy will be stimulated again.”

And what about the industrial sector, which has been pulling the economy along on the strength of expanded exports and the need to rebuild inventory? “It is likely the export demand will return, although in fact it has not declined all that much in the past few months,” Kuehl says. “The big drop has been in inventory build, and until the consumer gets more aggressive there will not be a drawdown sufficient to provide much impetus for the manufacturer.  “As in most other recoveries, the consumer will hold the key.”

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