Is Something Heating Up Under the Blanket of Snow?

As you may know, both real and nominal GDP growth were a bit disappointing in the fourth quarter, especially nominal growth.  On the other hand real final sales rose at the fastest rates in more than 20 years.  This led David Beckworth, Bill Woolsey and Marcus Nunes to suggest QE2 was already working (recall it started strongly raising stock prices and reducing the value of the dollar as early as September.)

I was a bit skeptical about the final sales numbers, partly due to issues raised by Jim Hamilton and his commenter “rootless” (at 3:49pm.)  I see the optimists as making an implied prediction that production would rise strongly in 2011:1, as firms restock depleted inventory.  And now we have the first indication that the optimists may be right:

WASHINGTON (AP) — Factory activity expanded in January at the fastest pace in nearly seven years, as manufacturers reported a sharp jump in new orders.

Still, builders spent less on projects in December, pushing annual construction spending down to a decade low.

The Institute for Supply Management, a private trade group, said Tuesday that its index of manufacturing activity rose last month to 60.8, from 58.5 in December. The sector has expanded for 18 straight months, and January’s reading was the highest since May 2004. Any reading above 50 indicates expansion.

People who have brains that are “wired Keynesian” often ask me where will the extra demand (from QE2) come from.  Businesses have lots of slack and don’t need to invest, and without more investment how will cash-strapped consumers have enough income to spend?

They are essentially arguing an economy can’t be raised up by its bootstraps.  This is because they don’t understand how nominal shocks can have real effects.  There’s an old movie line “build it and they will come.”  In this case it’s more like “provide the extra NGDP, and the RGDP will come” (when there’s lots of slack.)  The transmission mechanism is asset prices.  Here’s some more info from the article, which explains where the demand is coming from:

Consumers are spending more on autos, appliances and other goods, while businesses have invested in more industrial machinery and computers. Those trends boosted economic growth to a 3.2 percent pace in the October-December quarter, the Commerce Department said last week.

Duesterberg said orders for mining and drilling equipment and for airplanes and airplane parts are also rising.

Factories’ healthy pace of expansion is likely to continue in the coming months. Manufacturing firms surveyed by ISM said their backlog of orders jumped in January, pushing an index measuring that activity to 58 from 47.

U.S. factories are also benefiting from rising overseas sales. The index of export orders jumped to 62 in January, from 54.5 the previous month. That matches a recent peak reached in May and is otherwise the highest level for that index since December 1988.

The employment index rose to its highest level since 1973, a sign that manufacturing companies are hiring more workers. But Duesterberg cautioned that the ongoing boom in productivity in manufacturing would likely limit hiring.

We’ll need a few months more data, but so far it looks like the recovery is going from almost nonexistent during May through August, to moderate.  That’s progress.

• Become A Funded Futures Trader