National international issues threaten local economy

July 16, 2012
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Still growing, but slowing. That’s how the industrial economy looks in the Greater Grand Rapids area, according to data collected in the month ending June 30. Our index of business improvement, which we call New Orders, remained positive at +9, but was lower than last month’s +20. The Production index remained virtually unchanged at +6, up from +5. Because of seasonal hiring, the Employment index rose to +25, up from +12. In June, 32 percent of the respondents reported staff additions. Activity in the purchasing offices remained unchanged at +11.

Overall, the statistics are still positive but less robust than we would like to see. Even though the local economy is growing, the future is starting to look less certain than a few months ago.

Looking at local industrial groups, it is apparent that our numbers would be negative if it were not for automotive. Strong auto sales are keeping the assembly line humming and local automotive parts producers are at high levels of output. A mood of caution throughout corporate America has resulted in the office furniture business continuing to soften. For the industrial distributors, business conditions tapered off from previous months, although part of the effect may be seasonal. The positive performance by automotive firms continues to keep the capital equipment firms stable, at least for now.

At the national level, the results are more ominous. The July 1 report from the Institute for Supply Management, our parent organization, saw the index of New Orders go from +23 to +1, the greatest point loss we have seen in more than three years. Inventories, new export orders and production all raised concern about the economy. ISM’s overall index fell from 53.5 to 49.7. Since any reading below 50 is considered negative, the June report constitutes the first negative report since July 2009.

The June report for the international economy is also foreboding. The JP Morgan Global Manufacturing report dated July 2 continues to depict the world economy as slowing much faster than anticipated. The index of New Orders fell to 47.8 from 51.5. The Production index also turned negative to 49.3 from 51. The Global Index fell to 48.9 from 50.6. Almost none of the 31 countries in the survey provided a source of strength, and the pace of the decline accelerated in China, Brazil and most of the Eurozone.

The financial situation in Europe remains one of the greatest threats to the world economy, as well as our national, state and local economies. The recent Greek election, which resulted in the presumed reaffirmation on the bailout program, was good news, although the euphoria only lasted a day or two before financial people around the world began taking another look at the situation. Over the last several months, money has been flowing out of the Greek banks at an alarming rate. New investment, from both inside and outside the country, is virtually nonexistent. A large portion of the population still believes that raising taxes on “the rich” will solve the problem, but the rich are the people who are moving their money out of the country. In short, the bailout that the Europeans have promised will probably go through after some minor renegotiation, but the current estimates for future growth are far too Keynesian and optimistic. The world is now realizing this bailout is just a stop-gap measure and will require another Greek bailout in less than a year.

The banks in Spain are another recent problem. Just like the U.S., Spain had a housing bubble, leaving the banks with a huge quantity of bad mortgages. The Spanish government did its best, but unlike the U.S., Spain lacked the ability to simply print more money to bail out the banks. Most recently, Spanish officials turned to the European Investment Bank. Unfortunately, the bank (still currently rated AAA) did not have nearly enough money, so Germany had to be coerced into adding 120 billion euros to the reserves. In the meantime, Cypress, one of the smaller Eurozone members, also has requested funds. More countries are sure to follow. The European situation therefore remains precarious.

On the domestic economic scene, the Supreme Court has upheld the Affordable Care Act by a 5-4 decision. The political and economic implications are enormous. Although the high court has ruled that the law is constitutional, there is still no agreement that the act is here to stay and cannot be overturned. It has already become a major campaign issue for the November election. Although it is now only four months until the election and six months until the new Congress meets, the ACA is still a major element of uncertainty for the economy. Unfortunately, investors and potential employers don’t like uncertainty. With this cloud of ambiguity, the implications of the ACA are almost impossible to assess until after the election, and will contribute to economic stagnation over the summer months.

Two other uncertainties are the potential confrontations looming over the debt ceiling and proposals for another extension of the Bush tax cuts. All of these uncertainties have resulted in tepid expansion by some businesses, and in many instances, the decision to hold tight until after the election. The absence of further investments by businesses could result in the unemployment rate rising higher as we approach late summer.

It is obvious that excessive industrial inflation is a problem for most firms, given that rising costs are difficult to pass along and often cut into profitability. However, falling prices can foreshadow an economic downturn, as well. In the latest ISM report, the index of Prices fell to -26, the same level as October 2008. Confirming the national index, Prices in the Grand Rapids survey fell to -16. At the international level, the JP Morgan international index for Prices fell to its lowest level in 37 months, dropping sharply from 50.2 to 44.2. Almost all major countries in the 31-nation survey reported lower prices. Locally, the list of commodities falling in price has grown considerably, and includes most of the big ticket items such as copper, corrugated steel, plastic resins, aluminum, nickel and even freight. At the distributor level, some firms have reported that inventories are being cut in anticipation of an economic slowdown and falling prices. This is not good news.

In summary, the worldwide slowdown is growing more severe than originally anticipated. Almost all of the problems still stem from the consequences associated with the European debt crisis, and the realization that the problems are far from over. Every time there is good news from Greece, Spain, Italy, or any of the other PIIGS countries, the euphoria only lasts a day or two until financiers realize that almost all solutions enacted are temporary fixes.

In addition to fears of Europe drawing the U.S. into its mess, our domestic economy continues to suffer from uncertainty over the cost and viability of the Affordable Care Act, the cost of the regulatory environment, and the tax situation for 2013 and beyond. The many economic statistics for June were far below expectations, and July remains uncertain.

The remaining strength of the Michigan economy is still related to auto sales, but it is almost impossible for the current growth rate of 22 percent to be maintained. We are still expecting auto sales to flatten out late in the summer. However, if sales turn negative, so will the Michigan economy.

Brian Long, Ph.D., is director of Supply Chain Management Research, Seidman College of Business, Grand Valley State University.

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