Gold News

Say's Law Predicts Recession

If supply creates its own demand, the latest data don't bode well...

AT THE start of every month we see the release of manufacturing indexes around the world. The data from China and the US usually grab the headlines and in the month of August, these two manufacturing giants were barely keeping their heads above water, writes Greg Canavan for the Daily Reckoning Australia.

In China, the HSBC Manufacturing index moved to 49.9 (from 49.3) in July. The country's official index was 50.9. (Note: A reading below 50 indicates contraction.) So China's manufacturing sector is basically stagnant.

Apparently this is good news because it indicates China is headed for a soft landing. Maybe. But the sharp slowdown in other parts of the world – which has really only become evident in the August data, but has been on the cards for a while – could spell future trouble for China's export machine.

Over in the US, the headline manufacturing number was 'better than expected' at 50.6. Digging beneath the surface though, an increase in inventories boosted the result. Rising inventories indicated a slowing of final demand. And actual production fell to 48.5. That indicates that US manufacturing output is shrinking.

On a global basis, manufacturing output shrank in August too. So the global economy is slowing down – again. Keynesians will blame this on insufficient stimulus. But those who use common sense to read the economic tealeaves know there is something fundamentally wrong with the way the global economy 'works'.

That is, it is over-managed. If you put a bunch of motivated and intelligent people together to sort out a problem or achieve a goal, the chances are they will work it out. But if you put a bungling manager in charge of the group, one who constantly leads them in the wrong direction, then you'll get an unfolding debacle.

We have an unfolding debacle.

Many years ago... Before rampant credit growth and misallocated resources retarded the global economy... A guy by the name of Jean-Baptise Say said, 'products are paid for with products'. You might know it in its more popular phrase, 'supply creates its own demand.'

'Say's Law' spoke a basic economic truth. You can only spend (demand) what your own output (supply) allows you to. Supply creates the income, which in turns leads to demand.

But back in the boom years, debt augmented income. Income plus debt created a big increase in demand. Because individual economic actors weren't good at discerning whether demand for their product was the result of debt (phony demand) or income (real demand) they increased output regardless.

That was then. Now, with the effects of global stimulus fading, manufacturing is close to contracting again. And debt growth is no longer augmenting income. So if Say's Law holds – and supply does create its own demand – then a global recession is not far away.

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Greg Canavan is editorial director of Fat Tail Investment Research and has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as and the Sydney Morning Herald.

See the full archive of Greg Canavan.

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