EMU PMIs Continue to Move Together...Mostly Lower Manufacturing Is Especially Weak

The data rankings since January of 2015 show extremely weak readings for EMU, for Germany, for France and for Japan (MFG). On this time line the Markit manufacturing PMIs has percentile standings at or below their respective medians (which occur at a 50 percentile standing) for all manufacturing sectors of countries in the table. Only France is ‘at’ everyone else is below. Service sectors are generally very weak too with the US at an 84th percentile standing and Germany at a 62 percentile standing. But EMU is at an 8% reading and that includes the weighted contribution of Germany (yikes!). France is at its lower 6 percentile.

Having drawn out the grim case, the good news is that as bad as the news is it did not get worse in February. The composite EMU German and French indices all rose by small amounts but they did rise in February. The US Markit composite also improved. However, manufacturing worsened month-to-month everywhere except in France. Only France and the US log manufacturing PMI values above 50 in diffusion terms which is an indication of expansion.

Meanwhile, both France and Germany are logging inflation metrics at an 11-month low. Golly, good thing central banks have been so worried about inflation at a time that inflation is nowhere to be seen and a modicum of growth has scared the willies out of them. Quick! Stomp out that growth before it creates some inflation!

How policy is made by what we fear more than what we know
This is a good time to remember HOW LITTLE we know instead of to revel in how much we know. At the Jackson Hole Fed meeting in 2015 a paper that was presented concluded that NONE of the major theories of inflation have worked particularly well. And so it is not surprising (??!!) that in the wake of that paper with oil prices falling and extremely weak that the Fed in the US decided that it was confident that it would hit its inflation target over the medium term and so began to hike rates.

Of course I am being sarcastic here. That approach makes no sense today nor did it that day… apart from the Fed betting on its own tunnel vision approach of making policy by only looking at the change in the price level over the past 12-months which it then calls ‘inflation.’ So with inflation low and oil prices low the Fed could see a coming rebound in oil prices which would raise the odds of higher headline inflation (over 12-months!). So the Fed could bet on higher ‘inflation’ in period marked by low inflation. This was its excuse to hike rates that it had long waited for…

It is quite strange to me that modern central banks refer to an historic rate of inflation as the prevailing inflation rate. But it’s the best we can do; or at least that is what the powers-that-be have decided. Of course we can extract inflation expectations in the US from TIPS and ordinary treasury securities’ spreads and we do have inflation expectations surveys as well just about everywhere. But central bankers always find problems with those metrics. Better to use something that is just down right wrong, eh?

One thing this episode makes clear is that central bankers decide what they want to do then they make up an argument to justify it. They make policy based on protecting against their worst fear which is almost always inflation. If they truly did objective analysis and let their policy flow from that, I think central bank policy would look very different. But central bankers have their biases and their memberships in various schools of thought and they must keep these ‘memberships’ ‘paid up’ by acting in a certain way.

Ignoring the operative model
The evidence of economic weakness in the West and that foreign economies, largely Asian economies, have been sapping growth and vitality from Western economies has been clear for quite a while. Yet, the Fed is still obsessed by the low rate of unemployment. The ECB has a hair-trigger view on the actual inflation rate despite years of undershooting. So the recognition of the foreign role has not been a key cog in any central banker’s policy framework. Just as Free Trade dominated thinking and talking and policy even though it was as observable as a leprechaun’s pot of gold at the end of the rainbow. Now, however, the attack on those non-free traders and their systemic manipulation is making a sham of policy as cluelessly having been based on some very strange domestic precepts.

Very clearly the attack on unfair trade is helping to illuminate the degree of weakness in the global economy once that blight is removed. But don’t celebrate the discovery of reality yet because many are still fighting to not recognize it. Economists still don’t seem to agree on what ‘Free Trade’ really is and all the elements it requires. It is not just about ‘no or low’ tariffs but also about firms facing the same rules, about market-determined prices AND having the correct exchange rates and many other subtleties. Also ‘Free Trade’ is only about efficient production and exchange it tells us nothing about innovation. But when a country moves nearly its whole manufacturing base overseas there is nothing left to innovate back home. Losses due to unfair trade can be far greater than the loss of the trade flows themselves.

All connected: for better and for worse
One thing that the PMI data show is that in the end everybody is connected. Asia needs the markets in the West. When those markets are closed or fettered with obstacles Asia slows. More to the point Asia should not be only a production center treating the West as a consumption center. That is not part of a Free Trade model. Comparative advantage is not about your production and my consumption! That is an exploitation model or a mercantilist model. For over 20-years the US has been urging Asia, especially China, to develop their own domestic demand. The response from Xi has been his vaunted "belt and road" program which is a grease-the-skids export program that also aims to subjugate many small country by ‘financing’ projects in their countries that they cannot afford. Sri Lanka has lost a port this way to China on a 99-year lease and new stories report on how Ecuador has a crumbling nonfunctional dam built by China that will cost it 80% of its oil production for some time to come. Such things are exploitation not part of free or fair trade and investment. There is a lot that has to change to put global growth on a path that is sustainable and fair. Making excuses for China’s behavior so it can grow faster is not going to get us there. Complaining that the push for fairness is costing us growth now, ignores the sense in which this cost is really an investment in a better future.