Is manufacturing the canary in the coal mine? The ongoing trade war, coupled with the imposition of new tariffs on Chinese goods and the threat of additional tariffs later this year, have slowed U.S., Chinese, European and Asian economic growth.
Consumer prices haven’t surged, but we do have the first casualty in this war: The manufacturing sector.
Is a recession next?
While the early trade skirmishes started as far back as October 2017, the trade/tariff war broke out for real in March 2018. That is when the president tweeted “…trade wars are good, and easy to win.” Soon afterward, tariffs were implemented on our trading partners, followed quickly by a serious shooting war between the United States and China.
The trade war has clearly affected growth in both the U.S. and China. The U.S. economy had been expanding by 3% or more. That pace has receded to one in the 2% range. Although the Chinese economic data are questionable, it is clear that a significant slowdown has taken hold there, as well.
That said, it is wrong to focus just on the U.S. and China. We don’t live in a world where the impacts of policies remain within borders. We operate in a global economy that has interrelationships between most countries, developed and developing. Thus, any war will create collateral damage and this one has already done that.
Consider the major trading partners of the U.S. and China.
When it comes to the total value of exports and imports, the EU is the largest trading partner of the U.S. We sell more goods to the EU than to any other place. We buy more from the EU than anywhere else.
Meanwhile, China’s biggest trading partner is the European Union (EU). It is Europe’s largest market for its goods. Only the U.S. exports more goods to the EU than China.
China and the U.S. also have major trade relations with Japan. They are essentially tied as the second largest market for Japanese goods. China is the second largest exporter to Japan.
Very simply, what happens in China and the U.S. doesn’t stay in China and the U.S. And once economic growth declines in a major economy, let alone the four largest, the entire global economy feels the chill.
And that is happening now, especially when it comes to manufacturing. The value of manufactured products constitutes the largest portion of trade for industrialized nations. For some countries, it is more than 90%. And trade is slowing.
The result: Manufacturing in the U.S. and around the world is going into a downturn. We saw that recently when the Institute for Supply Management’s Index of Manufacturing Activity turned negative for the first time since August 2016.
The details of that report are distressing. Orders are weak, export demand is disappearing, production is declining, hiring is faltering and order books are thinning. Also, the Federal Reserve’s industrial production index has declined for five of the past seven months. In other words, U.S. manufacturing is hurting.
But it is not just the United States where industrial activity is waning. J.P. Morgan’s Global Manufacturing Index has been negative for four consecutive months. The U.S. has simply joined the Eurozone and Japan in having a manufacturing sector in decline.
However, all these negative numbers don’t necessarily imply the U.S. or the world is now or will be in the near future in recession. Manufacturing can decline for an extended period without the overall economy flat lining.
That has happened before. Between May 2015 and October 2016, industrial output was below the previous year’s level, but the economy still expanded. Granted, it was slow, but we didn’t go into a recession.
Manufacturing is the first sector to feel the ill winds of the trade war. It is an indicator but not a guarantor that a recession will follow. But if the next shoe drops, then you might want to start worrying.
If manufacturing keeps faltering, the burden on consumers to continue carrying the U.S. economy will only increase. Businesses are not going to invest, not with the massive uncertainties created by the trade war.
Consequently, the key to whether or not we go into recession will be the labor market. As long as job growth and wage gains remain solid, households will have the money to spend and the confidence to spend it. If households start worrying about their economic situation because of a softening employment situation, everything changes.
So watch the labor market carefully and hope manufacturing is not the canary.