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Up in Smoke Stacks
The old economy is on fire.


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Larry Kudlow

The much-maligned factory sector is booming. Not rising. Not improving. Booming.

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According to just-released data from the Institute of Supply Management, which tracks the manufacturing sector, new orders, production, order backlogs, export orders, and employment were very strong in May. The industrial sector is so strong that the speed of supplier deliveries has hit its highest level since April 1979. This means that firms cannot produce fast enough to meet rising demand, which is why commodity prices continue to climb. As a result, capacity use keeps growing and inventories are still too low in relation to skyrocketing sales.

Meanwhile, new factory hiring has jumped to a 31-year high, the best since 1973. Of more than 400 industrial firms surveyed, 36 percent added workers in May while just 7 percent had fewer workers. This is another nail in the coffin of the jobless recovery. As the inventory-rebuilding process ratchets up over the next year, expect even more job creation to follow.

Election-year battleground states in the Midwest industrial heartland are reporting significantly lower unemployment rates compared to one year ago, according to the U.S. Bureau of Labor Statistics. In April, Michigan registered a 6 percent jobless rate compared to 7.2 percent in April 2003. Ohio’s jobless rate fell to 5.8 percent from 6.2 percent. Pennsylvania’s dropped to 4.9 percent from 5.4 percent. West Virginia reported 5.4 percent from 6.6 percent a year earlier. Missouri’s jobless tally dropped to 4.5 percent from 5.5 percent.

In view of the political significance of these states, it’s surprising that administration officials are not loudly commenting on the remarkable ISM manufacturing report, including its sensitive jobs component. Did anyone say outsourcing? Did anyone say “hollowed out”? The naysaying is nonsense. The ISM numbers are consistent with 7.3 percent breakneck growth of gross domestic product.

Rapid productivity gains in manufacturing — 5.3 percent over the past year — have enabled this sector to produce more with fewer workers. But while the manufacturing share of employment has declined over the past decade, the manufacturing share of GDP has risen.

With the economies of China, India, Japan, and the U.S. booming, the so-called “old” manufacturing sector will be a major contributor to American economic growth. So will the sector that produces basic materials.

Meanwhile, the energy-price boom is completely a function of surging world growth — not deliberate supply shortages such as occurred in the 1970s. Today’s fuel-price story is not an economic negative. Jobs and incomes are rising along with energy prices. Personal income has increased by an outsized 5.7 percent over the past year, while 1.1 million new payroll jobs have been created since last August. Higher profits are already attracting new investment that will increase energy production — especially if government policies keep out of the way. Attracted by big international profits, the Saudis, Russians, and others are rapidly expanding production.

In the U.S., low tax-rate and monetary-reflation policies have been the key stimulants to the boom. These pro-growth policy levers are not changing anytime soon. Neither will the booms in Asia.

Economists who today predict a second-half slowdown because of high oil prices and reduced tax refunds are out of their minds. Tax-rate incentives, not tax-refund cash flows, have created large pro-growth rewards to those who supply investment funding to the industrial sector (along with all the other sectors). It’s this funding that results in job creation.

As for money-creation and liquidity, there is good evidence (e.g., the steeply upward-sloping Treasury yield curve) of monetary abundance in the economy. A few quarter-point hikes in the Federal Reserve’s basic policy rate won’t change this.

Is there an inflation threat to the old-economy boom? Yes, but it’s mild. If the Fed doesn’t remove some of the emergency liquidity they created since late 2002, industrial price increases from production shortfalls in relation to rising demand will be monetized into a generalized inflation. The Fed must act to prevent this. They should remove emergency liquidity that is no longer needed by the booming economy.

That said, tax cuts, record productivity, and the growth inherent to the sparkling recovery of America’s smoke-stack industries are significant economic developments that are intrinsically counter-inflationary. The headline story is that global competition and technological innovation are creating the biggest old-economy revival in twenty years.

There is no need to fear foreign trade. Nor is there need to worry about outsourcing jobs — there are no Benedict Arnold corporations out there. There is also no need for protectionist penalties. Nor is there a place for big tax hikes on investment.

The economic patient is recovering beautifully. Senator John Kerry’s European-style witches-brew policy elixir of trade protectionism and tax hikes would be exactly the wrong shot in the economy’s arm. If it ain’t broke, Sen. Kerry, don’t try and fix it.

— Larry Kudlow, NRO’s Economics Editor, is CEO of Kudlow & Co. and host with Jim Cramer of CNBC’s Kudlow & Cramer.



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