S&P Flash PMIs-Services Worse, Manufacturing Better

S&P flash PMI statistics for March show very little change in the composite which has been plugging along at 51.4 in January, 51.4 in February and now 51.5 in March. These are readings from unweighted averages from the eight reporting countries and the European Monetary Union. The manufacturing composite is crawling its way higher from 49.1 in January to 49.5 in February to 49.9 in March, putting manufacturing nearly to a breakeven reading after a long period of showing sector contraction. Service sector readings monthly log 52.0 in January, 51.9 in February and 51.6 in March, a steady but very minor trend to erosion.

The sequential growth rates on the quarterly average readings that exclude March are performed only on hard data. They show that the composite reading has also been very stable at 51.6 for the 12-month average, 51.3 over 6 months and 51.3 over the most recent hard 3 months’ worth of data. Manufacturing has also been stagnant with a reading of 48.4 for the 12-month average, 48.4 for the six-month average and 48.6 for the three-month average for the period ended in February. Services show the same minor slippage we see in the monthly data from 52.5 over 12 months to 52.2 over 6 months, to 52.0 over the most recent three-months of hard data. These trends show minor improvement in manufacturing and minor deterioration in services. Manufacturing continues to show minor contraction as services continue to show minor expansion. Neither sector performs particularly well and neither sector has any particularly notable trend to it. The diffusion data across countries show a great deal of variation.

However, these readings can only tell us so much because things are beginning to change in the United States, as President Donald Trump is shaking things up considerably. He's also shaking up global trade by threatening and implementing tariffs on a broad scale although his setting of tariffs has been a little bit on-again off-again. It is a policy that has been mercurial and that has injected a clear note of uncertainty into U.S. policy. And the U.S. is an important trade partner for many countries.

Trump is particularly vexed that the US has run large trade & current account deficits and while a lot of economists blame the U.S. own policies for these events, I think it's unfortunate that more people don't take the gist of the argument from Trump more to heart. For example, the U.S. has run current account deficits for 33 straight years. According to the economic theory, when a country runs a current account deficit, its currency is supposed to fall to help set in place the forces that will put the current account back into balance. Those forces will cause the currency to fall, which will make import prices higher and cause exports to be cheaper in foreign currency terms. However, after 33 years, this process has not taken hold in the U.S. The criticism from many is that the U.S. simply spends too much money and doesn't save enough and if we had higher savings, we wouldn't be sucking in all this capital from abroad. As always when economists make these arguments, there's some truth to that, but it's also true that because imports have remained so cheap there's been a tremendous incentive for the U.S. consumer to continue to overspend on imports because their prices have remained so cheap compared to prices of other services and goods in the United States. The inability or unwillingness of the dollar to fall is undoubtedly bound up with its reserve currency status. There we have to ask whether this is a benign event, a cost of being the reserve currency, or whether countries have gamed the system by buying dollars and keeping the dollar strong so that they can have their currencies cheaper and exploit the U.S. as an export market. Since the U.S. is a relatively high-income country, it is a clear target for foreign exporters. These questions unfortunately do not see the light of day and in part because Trump has been so bombastic and aggressive in his pursuit of tariffs, we have not really had a very fair hearing on the issue of trade and whether the U.S. has been put at some disadvantage.

Free trade? Economists tend to defend free trade and oppose tariffs without looking at any of the facts because there's this knee jerk willingness to support free trade since it's so well known that free trade is such a superior condition to any other form of commerce. However, the conditions necessary for free trade do exist and produce these sought-after qualities simply do not exist. Exchange rates are not competitively determined; there are over $12 trillion in foreign exchange reserves that have been acquired by central. banks, clear evidence that they have not stayed out of markets and that currency values have been affected by these purchases. Also, a great deal of U.S. trade is also with China that's a communist country and has state owned corporate enterprises doing business. They get support from the government and possibly even conduct their business under directions from the government. In addition, China's exchange rate clearly is not market-determined.

Second best There is a little talked about theory in economics known as the theory of ‘second best.’ It tells us that if you're not in a first-best world, which is a world in which all of the assumptions for your theory hold, then in the second-best world and you shouldn't do what you would have done in the first-best world. You should do something different. However, when it comes to trade, economists don't want to admit that there’re any flaws in their trading system and they want to continue to pursue the policies that they would as if free trade exists. As an economist who specializes in international trade, I can only look at this and shake my head at the low order of academic integrity that prevails among all parties and discuss this phenomenon. You really do see almost nothing in any news service that provides a defense of the approach that Trump has taken- it is prima facie wrong! Like carbon is bad and the Pfizer vaccine is good. No argument please. The criticisms that people have of this trading system not being a free trade system and being one that is slanted against the U.S. is untouched. Just about everything that you read is in favor of free trade and against any tariff in any form.

Role of Tariffs It’s true that whether we're in a free trade system or not, a system of tariffs is a much less friendly system than a system without tariffs, but the U.S. has been facing tariffs from other countries for years; they have larger tariffs on our goods than we have on their goods! But that’s ok...let sleeping dogs lie. Donald Trump and his ‘America first doctrine’ has been reinspecting these various relationships from trade to mutual defense pacts and has found that the United States has borne the lion's share of the burden and has undertaken to reset some of these relationships. This ah ruffled a lot of feathers and entrenched interests. I'm not going to attack or defend anything that he has done except to say we are very far into the post-war period and it makes a lot of sense to craft relationships based on the realities that we have today rather than the alliances that we carried coming out of World War II. One of the reasons the U.S. carried a greater burden after World War 2 was that the United States was the economy that emerged from the war pretty much unscathed while other countries were war-torn literally; however, after all this time, it does make sense to take another look at things.

Friendly or confrontational We can argue whether Trump should engage in a much friendlier climate of trying to get change or whether it's that ‘friendlier’ climate that has been wholly unsuccessful in the past. Let's remember that Donald Trump was not the first to approach Germany to get it to pay more into NATO; it started with Barack Obama-they stonewalled him. And no matter how civil or how nice the United States was and no matter how much it was pointed out to Germany that they weren't carrying their fair share, they didn't budge. So right or wrong Trump has gotten them to budge. Had the Germans wanted to pay the least amount possible for their own defense, it would have been much better for them to pay a little bit more into NATO than to be emersed in the world they find themselves in today with a hefty military budget looming. But, of course, hindsight is just that kind of thing.

The road ahead So, we're in a different world. Past trends are going to be changing. Europe is going to be spending a lot more money on military this should cause the industrial sector and manufacturing to pick up considerably more. It should help to ignite growth across Europe, and probably more broadly. It may also have an impact on this low inflation environment that we have been in, and it might cause central banks to have to be more vigilant than they've been on inflation. Times are certainly changing in a way that you're not going to find by looking at the trends. There's only so much we can say about what this report tells us about the economy and how it's performing since we know there's a lot more in the hopper that's going to change that isn't embedded in trends. It's a good time to look a little bit more closely at the recent data and try to decide what's happening that's going to be lasting and perhaps what is dissipating that's not going to be coming back. The times definitely are changing.