Global Economy: The PMI and Glimmers of Expansion

Sratfor

Summary

The Purchasing Managers’ Index, a widely used economic indicator, continued improving in July for many of the most important industrial economies of the world. Although manufacturing in some countries and economic blocs continues to decline, according to the data, in others it has stabilized and seems poised to grow. Analysis

Over the past several days, research firms have released an abundance of manufacturing data on the world’s leading economies, and reasons for guarded optimism have begun to emerge. The data, specifically the Purchasing Managers’ Index (PMI), points to a dramatic slowing in the decline of manufacturing activity and, in some cases, the first glimmers of expansion.

The PMI is a key leading economic indicator that measures how businesses are doing month to month. In the United States, the PMI is based on a survey by the non-profit Institute for Supply Management of some 400 purchasing managers across a broad spectrum of industries, both manufacturing and non-manufacturing. Different organizations conduct similar surveys in other countries, from Brazil to Hong Kong to the Czech Republic, and produce the same kind of monthly index.

The index reflects purchasing managers’ ever-changing assessments of production levels, new orders, supplier deliveries, inventories and employment levels, based on their intimate working knowledge of their companies. Their answers are mathematically compiled into a single index number on a scale of zero to 100. A reading of 50 percent indicates economic equilibrium, while anything below 50 percent indicates contraction and anything above 50 percent indicates expansion.

In order for manufacturing to expand, businesses must first place new orders for manufactured goods. Reasons for placing these orders vary, but they generally fall under two categories: building new business capacity (capital goods like heavy machinery or telecommunication equipment) or restocking depleted inventories (consumer goods like cars and dishwashers). Ultimately, though, consumers’ preference either for spending or saving will drive business decisions to place new orders.

Global PMI Trends
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PMI figures for July show that the manufacturing sectors in the surveyed countries have slowed their decline in the last six to eight months, depending on the country. In China, manufacturing contracted late in 2008, then climbed back into positive territory in March as more than $1 trillion in stimulus lending by commercial banks started to hit the economy (along with stimulus funds disbursed by the government). July marked the fifth consecutive month that the PMI has indicated an expansion in Chinese manufacturing.

However, other industrial economies have endured protracted stays below the 50 percent mark. For Japan and the United Kingdom, July marked the first time the countries’ PMIs have moved into positive territory since the first and second quarters of 2008, respectively. Rather than signaling a renewed period of growth similar to the years preceding the global financial crisis, the reading signals that the countries’ steep slide in manufacturing activity has, at least temporarily, come to a halt.

For the United States and Europe (specifically the eurozone), where the PMI has remained below 50 percent for 12 and 14 months, respectively, the contraction has continued through July. However, the PMI readings for the two regions have steadily risen to just below 50 percent, meaning that the rate of contraction has eased to the point of relative stability.

In the case of the United States, there is little doubt that the aggressive government and central-bank rescue packages enacted since the onset of the financial crisis — such as the Troubled Asset Relief Program and various lending programs at the Federal Reserve — have driven the recovery. The same explanation holds for the eurozone, although the European Central Bank has acted far more hesitantly than the Fed.

And while the aggressive stimulus policies implemented in the United States have supported American industry, they have also driven U.S. debt to extraordinary levels. Though the United States has had little trouble financing this debt, the debt has put pressure on the dollar as investors and other nations alike become nervous about Washington’s ability to rein in its spending and repay its loans. The net effect of this is that American exports look cheaper than European exports, and markets respond by shifting buying patterns to the United States. Thus the recovery in European manufacturing has been hampered somewhat by the strength of the euro relative to the dollar.

Despite individual dissimilarities, the broad trend outlined by second quarter PMI readings indicates an easing of the global recession. When more of the major manufacturing centers surmount the key 50 percent level, the odds will be good that the global recession is indeed ending. Later, as lagging indicators like employment stabilize and ultimately turn positive in response to renewed growth in manufacturing, the world will realize that the recession has been over for some time.