Descent into Depression

Factory contagion

Across the world, production lines are shutting down and factory workers’ hours are being cut. A dearth of demand has fallen back on goods producers, suggesting the global slowdown will not turn around soon.

Market Watch,

2 August, 2012

Wednesday brought news that factory activity either downshifted significantly or outright contracted in July. The euro-zone factory recession worsened last month. China posted its weakest official manufacturing reading since November. Readings from Australia and the U.K. were the lowest in at least three years. The Institute for Supply Management said the U.S. factory sector contracted for a second straight month.

The culprit for manufacturers is falling demand.

Germany, a factory powerhouse, reported machinery orders fell for a ninth consecutive month. In Brazil, the orders index dropped for the fourth month in a row. In the U.S., new orders dropped for a second consecutive month.

The problem is that falling demand feeds upon itself. Concerns about the euro-zone debt crisis and China’s past tightening action to slow inflation have led consumers and businesses around the world to cut their spending. Less global demand leaves less work for global manufacturers who, in turn, order fewer supplies and commodities from other producers.

Bradley Holcomb, who oversees the ISM’s survey, suggests future production trends in the U.S. will be determined by the backlog of unfilled orders. But the backlog index has already been contracting for four months running.

The weak state of factories is boosting expectations of central bank action. The Federal Reserve ends its two-day policy meeting Wednesday but economists expect any future action will come later this year. Hopes are higher for the European Central Bank, which meets Thursday, but it is unclear what actions policy makers may initiate.

The problem for the U.S., at least, is that any move by the Fed may do little do boost demand directly. The rise in stock prices that usually accompanies quantitative easing may help consumers and businesses feel wealthier. But unless that euphoria is followed by increases in actual sales and jobs increase, it won’t last.

Pimco’s El-Erian Says World In Serious Slowdown

Pacific Investment Management Co.’s Mohamed El-Erian called recent declines in purchasing manager indexes in Europe and Asia “frightening” and said the world economy is suffering its severest slowdown since the global recession ended in 2009.

Bloomberg,

3 August, 2012

El-Erian, who is chief executive officer of the Newport Beach, California-based Pimco, predicted global growth of 2.25 percent over the next 12 months. That’s down from the 3.9 percent in 2011 and 5.3 percent in 2010 recorded by the International Monetary Fund. The world economy contracted 0.6 percent in 2009.

“This is a serious, synchronized slowdown,” El-Erian said in an interview today.

His forecast highlights the troubles the global economy is facing as the euro area struggles to contain its debt crisis and growth in the U.S. and China slows. 

Separate surveys of purchasing managers released yesterday showed manufacturing in the 17-nation euro area shrinking by the most in 37 months while Chinese factories teetered on the edge of contraction.

The global slowdown is weighing on the U.S. at a time when its economy is already struggling, El-Erian said. He sees U.S. growth of 1.5 percent over the next 12 months, dangerously close to what may be considered “stall speed,” and puts the odds of an American recession at roughly 25 to 33 percent.

“While a recession is not my baseline forecast, it certainly is a serious risk,” said El-Erian, whose firm manages the world’s largest bond fund.

U.S. Economy

The U.S. economy slowed last quarter as consumers curbed their spending while state and local governments cut back. Gross domestic product expanded at a 1.5 percent annual rate in the second quarter, down from 2 percent in the first, according to Commerce Department data.

El-Erian said he expects the euro area’s economy to contract by 1.5 percent over the coming year. It grew 1.5 percent in 2011, according to the Washington-based IMF.

European Central Bank President Mario Draghi said at a press conference in Frankfurt today that the region’s economy looks to have stayed weak in the second quarter and into the third after being essentially flat in the first three months of the year.

He told reporters that the central bank may wade forcefully into bond markets in tandem with Europe’s rescue fund, stepping up its efforts to fight the area’s financial crisis.

The euro declined and Spanish bond yields rose on disappointment that Draghi didn’t signal imminent ECB action.

El-Erian said that Draghi had good reasons to postpone action. The ECB chief wants to pressure governments into taking more steps on their own to resolve the crisis and may want to conserve the central bank’s limited resources.

Draghi, though, risks allowing the crisis to worsen by not acting now, El-Erian suggested.

“When they act in a month’s time, they will be less effective than if they acted today,” he said.

He put the odds of the currency zone breaking apart over the next six months at 35 percent.