Bill Mitchell— Leading indicators are suggesting recession

In the last two days, some major leading indicators have been released for the US and Europe, which have suggested the world is heading rather quickly for recession. It seems that the disruptions to global trade arising from the tariff war is impacting on US export orders rather significantly. The so-called ISM New Export Orders Index fell by 2.3 percentage points in September to a low of 41 per cent. The ISM reported that “The index had its lowest reading since March 2009 (39.4 percent)”. This is the third consecutive monthly fall (down from 50 per cent in June 2019). Across the Atlantic, the latest PMI for Germany reveals a deepening recession in its manufacturing sector, now recording index point outcomes as low as the readings during the GFC. Again, exports are being hit by China’s slowdown. However, while export sectors (for example, manufacturing) are in decline and will need the trade dispute settled quickly if they are to recover, the services sector in Japan, demonstrates the advantages of maintaining fiscal support for domestic demand. Japan’s service sector is growing despite its manufacturing sector declining in the face of the global downturn. The lesson is that policy makers have to abandon their reliance on monetary policy and, instead, embrace a new era of fiscal dominance. With revenue declining from exports, growth will rely more on domestic demand. If manufacturing is in decline and that downturn reverberates through the industry structure, then domestic demand will falter unless fiscal stimulus is introduced. It is not rocket science....

The US is running an unusually high deficit, indicating that fiscal flow is counteracting what would otherwise be a contractive condition. However, the expansion is dampened by the Fed's monetary policy. Adding "liquidity" to the financial system by increasing bank reserves is not stimulatory like adding spendable funds to bank accounts through fiscal policy. The latter increases demand while the latter restricts bank lending owing to Basel III requirements.

Europe on the other hand is still stuck in erroneous thinking about expansionary fiscal austerity. Mario Draghi finally warned about this as he prepares to leave his position as the head of the ECB.

Bill's point about the decline in the manufacturing sector and increase in the service sector offset each other to some degree. But manufacturing is about production and profit from production. When the profit rate falls, then so does investment in productive activity. This weakens an economy as the life-support system of the society going forward. It can also be inflationary if production falls behind fiscal injection. Moreover, it tends to increase the trade deficit as more products are imported.

Trump is concerned about the strength of the dollar and apparently believes that this is a result of Fed policy being too tight. But in a floating rate system, the policy rate does not have the same effect as in a fixed rate system. Moreover, as expectations of global recession mount worldwide, more funds flow into US Treasuries as the safest haven.

The trade war is also beginning to take its toll both as a result of expectations and also based on rising uncertainty and unsettled geopolitical conditions. The US and American economy (American consumer) were considered the anchor of the world economy. That assumption is now waning for good reasons on one hand and rising fear on the other.

We are not there yet, but the trajectory is not encouraging. Moreover, a socially and politically divisive battle is underway in the US over impeachment of the president. Banana republic stuff that further undermines confidence in the system.

Bill Mitchell – billy blog
Leading indicators are suggesting recession
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

See also

Angry Bear
Once again, two sharply contrasting reports to start the month
NewDealdemocrat