Capital Spending Points To Growth, At Least For The Time Being

Among other signs of economic recovery, the Commerce Department has added a positive report on capital spending.  Orders for capital goods from business and industry surged in November. Growth was more pronounced in some areas than others, but the general strength was undeniable and offers economic encouragement on three fronts: First, the spending will directly buoy economic activity. Second, it will enlarge the economy’s capacity to produce over the longer term. Third, it speaks to business confidence, a necessary component of any economic expansion. 

There is, however, a darker interpretation of this news. The surge in capital spending may also reflect fears among business leaders of an order backlog or that the ongoing inflation will raise the costs of capital equipment. If either is operating, then the recent spending surge is simply a way to get ahead of the shipment and/or cost curve. The recent orders surge then only warns of a future plunge in such spending.

Capital goods orders overall jumped a smart 5.5% in November, more than reversing small declines during the previous two months so that the entire three-month span showed a 9% annual pace of advance. This more recent growth added handsomely to the annual picture, which showed a 35% gain in overall new orders over the last 12 months.  There can be little doubt that American business and industry are adding rapidly to their productive facilities.

The biggest surges occurred in defense equipment and civilian aircraft. Orders from the Pentagon jumped more than 16% in November after falling for months, allowing the 12-month growth to come in at 4.5%. This pattern of off-again, on-again orders flows is not especially surprising.  Because the military often orders big-ticket items, like aircraft carriers, the month-to-month movements are what statisticians call lumpy. 

The surge in civilian aircraft orders stands to reason. With the economy recovering from the pandemic strictures and air travel picking up on balance (if not every month) commercial airlines have a powerful need to rebuild and refurbish their fleets. 

Non-defense, non-aircraft orders were about flat in November, but that is hardly a sign of weakening. Their growth over the September-November period averaged better than 9% at an annual rate, while 12-month orders growth exceeded 15%. Both measures are historically strong.

On their face, these statistics suggest the three positive interpretations already cited. But supply chain problems and recent inflationary pressures cloud such a welcome view.  Some of this surge may well reflect the need for businesses to order earlier than usual and for tendency for inflation to telescope future spending of this kind into the present. If managers otherwise think their businesses demand additional facilities or modernizations, they, seeing the effect of inflation on pricing, might order the new equipment sooner than otherwise to avoid higher future prices. If such thinking has taken hold, and there is ample reason to believe it has, then today’s orders may include spending planned for one or two or more years hence. The effect might make things look very strong today, but it means that once that planned buying is realized, orders will fall precipitously, with all the negative implications for the economy.

As much as the optimistic interpretation temps, the sudden turn in November, the month in which the Federal Reserve (Fed) began to take inflation seriously, says that at least a part of this orders surge reflects efforts to get ahead of anticipated price increases. This concern over the effect of inflationary thinking does not contradict the possibility that business is correctly confident about continued recovery. Nor does it contradict the possibility that business and industry correctly see a need to enlarge and modernize their productive facilities. All these motivations for spending can exist simultaneously. But to the extent that the order surge reflects worries about delivery delays of inflationary thinking, the news warns of an order drop in the not too distant future.

Source: https://www.forbes.com/sites/miltonezrati/2022/01/17/capital-spending-points-to-growth-at-least-for-the-time-being/