Industrial Production slowed in July, while stock prices were bubbling away. QE apparently caused a stock market bubble but it has not boosted production.
The Fed reported last week that seasonally adjusted Industrial Production was unchanged in July after having gained 0.2 percent in June (press release). The consensus estimate was for an increase of 0.4%.
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This is another instance where economists were overly optimistic about July data, while I had been reporting to Professional Edition subscribers that the drop in real time July withholding tax collections had warned of softness (chart updated weekly in the Treasury Update).
The actual, not seasonally adjusted number fell by 1.8% month to month. On a year to year basis it was up 1.4%, which was weaker than the June year to year gain of 1.6%. The annual growth rate has been trending down since May 2012 when it peaked at +4.8%. July is typically a down month for industrial production, but this year was also worse than July last year, which was only down 1.6% and in 2011 when it was only down 1%.
This slowing was concurrent with the Fed’s resumption of QE, with the cash hitting the system beginning in November of last year.
Industrial production, which is a unit volume based index and does not require adjustment for inflation, remains below the 2007 level. US population has grown by 6% since then, and the Fed has pumped trillions into the financial system, but US industry is still producing less now than it did 6 years ago. It is also now growing at a slower rate than during the 2009-12 period.
Looking at the historical precedent, in 2007 the Fed stopped growing the SOMA, which it had grown 5% annually since 2002. In the second half of 2007 the Fed actually began withdrawing funds from SOMA to pay for the TAF and other emergency alphabet soup programs that it cooked up in 2008.
By shrinking the SOMA in 2007 and 2008, the Fed starved the Primary Dealers of the cash they needed to keep the game going, and both the stock market and economy crashed. The situation has been exactly the opposite this year as the Fed added a net of $85 billion a month to SOMA while making gross purchases from Primary Dealers of $110-130 billion per month. In 2007 when this indicator was peaking along with the stock market, the Fed had already pulled the plug on growing the SOMA. That’s what ended the bull market.
The question today is whether reducing the amount of QE, or “tapering,” will have a similar effect. Industrial production has already been losing momentum since QE 3 and 4 cash began to hit the market last November. That’s clear evidence that the most recent round of Fed money pumping hasn’t helped the economy. When the Fed actually slows its money printing will that result in even slower industrial growth? It may.
Perhaps more importantly, with stocks in a bubble, the withdrawal of support for the stock market carries extreme risk. Bubbles end when the liquidity that supported them is withdrawn. And they never end well.
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Rick Santelli uses my Fed Cash To Primary Dealers Chart to explain how the Fed drives the market.
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