Steve Kline is the Director of Market Intelligence for Gardner Business Media (publisher of  Modern Machine Shop and other media serving manufacturing since 1923). Steve’s work at Gardner gives him a unique perspective on the US economy, since he studies and reports on very specific manufacturing subsets of it – capital equipment, machine tools, and the economic performance of associated manufacturing technologies & their impact on the companies that sell and purchase them. His work is published regularly on Gardner’s Manufacturing Economic News Blog, and he regularly works with manufacturing groups and associations on research of the US  & global manufacturing economies.

I sat down with Steve to discuss the current state of the manufacturing technology economy, and its vitality in the coming years.

Q: We see a lot of economic numbers around manufacturing – the PMI, BLS economic numbers, reports from the Federal Reserve – that point to recovery. Do you agree with them – are we in the midst of a recovery in manufacturing? And if so, what kind of recovery is this?

A:  I think in metalworking, machine tools, capital equipment, & durable goods manufacturing, we’ve definitely had a recovery. If you look at industrial production, or our (Gardner’s) own Metalworking Business Index (MBI), if you look at any of these you can see there’s been a pretty dramatic recovery in durable goods manufacturing. Now, we’ve kind of hit the peak of that, I think for the moment. And I think we are starting to see it slow a bit the last couple of months. It’s not a huge, dramatic slowdown but there is a bit of slowing – in fact, the MBI has contracted each of the last 3 months. I believe some of that contraction could be election-related. And I think that people are waiting to see what happens. Not that the ultimate election results will make much difference going in either direction. But I think people are waiting to see what happens & then once it’s done we’ll see things begin to move along again. I think there’s a kind of nervousness that, at the moment, may be causing the slowdown. But I do believe there’s actually been a very dramatic recovery in manufacturing, in metalworking … but as far as the rest of the economy? We’re still hearing mixed signals, that it’s not that good. But the leading indicators that I follow are still very positive for durable goods, industrial production, and machine tool (capital equipment) sales. The only real negative I’m seeing – other than our MBI – is the exchange rate. The (US) dollar has been gaining value relative to other currencies and that usually tends to be a negative indicator with regard to machine tools and capital equipment sales. Although the Fed just announced a new round of quantitative easing which should bring the dollar back down, so we may see the end of the rising dollar hurting machine tool sales.

Q: What are the leading indicators you look to? You mentioned the 2 above (Gardner’s MBI and currency), but what are the specific leading indicators you use primarily for future capital equipment & technology sales?

A: The very best indicator is industrial production.

Q: Where do you get those numbers?

A: I get those from the Federal Reserve reports (which use BLS productivity reports as their foundation). You can pull it off their Web site. More specifically, the industrial production numbers I look for are those for consumer durable goods. That’s by far the most important that I use for metalworking and machine tool sales. Now many people say that we don’t make many consumer durable goods in this country anymore. But we still make a whole lot of that, and it is kind of a general manufacturing, best-look at machine tools & capital equipment sales. You can look at more specific industrial production numbers for motor vehicle parts and construction machinery. But that (industrial production) is the number one leading indicator for our space. Operating capacity or capacity utilization are pretty much analogous to industrial production, but both of those are very good as leading indicators too. Probably the next best leading indicator is the exchange rate of the US dollar. So, right now we have those two contradicting each other. Industrial production is absolutely booming at the moment for consumable durable goods. So I see that overwhelming the negative aspects of the exchange rate. Those are actually the best two. And our MBI has been very good – but the problem with that is that we only have 5 years of history to work with, so it’s hard to recognize any false indications, for example. We just don’t have the data to spot trends over multiple business cycles. While it looks very good over the last few years, maybe we just got lucky (laughs).  If you’d like to step a little further ahead in the cycle away from industrial production, then spending on consumer durable goods is also a good indicator. Here, you’re moving one more step beyond when capital equipment, cutting tools, workholding, and other manufacturing technologies are purchased – and you’re getting a few more months of lead time of industrial production to pay attention to.

Q: From your perspective right now, what do you see that can be done to stimulate the manufacturing economy, and technology consumption, that can get us back to levels at or above those seen prior to the downturn?

A: The problem with that question is that it’s nearly always answered with an eye on the short term. So, what can we do ‘now?’ We can allow permanent 100% depreciation on capital equipment. But the problem with that is if you do that now, then all you’re really doing is pulling demand forward. So you’re encouraging someone to buy something now that they would’ve bought in a year and a half or two years from now anyway. So, that’s a short-term fix, but it doesn’t really gain anything in the big picture over time. To me, a lot of things that are implemented to stimulate the manufacturing economy are of that short-term nature. It makes a difference at the margin, which is what most economists worry about – making a difference in the short-term. But it doesn’t have a lasting impact. The thing I’ve been stressing mostly this year is that when we’re making more product, they’re going to buy more machines (laughs). And when they’re making less products, they’re going to buy fewer machines. Everything else is just tweaking numbers. To make a real difference, we have to foster more production. And ultimately, what fosters more production is savings. I think we need to have policies in place that don’t discourage savings. Today, there are so many things that are discouraging savings – with interest rates at historic lows, the Fed’s interest rate at 0%, and low bond yields, there are few incentives to save. Of course, the Fed is intentionally doing all this to encourage spending. But the problem with that – long-term – is that the only way you can fund new production methods and increase production is to have savings to pull from. So, we need savings. Now, we’ve gotten around the lack of savings for the last 30 years by using debt to fuel those increases in production. But we’re quickly getting to the point where we’re not going to be able to use debt anymore to fuel production growth. To me, that is the number one thing we can do – big picture – to stimulate manufacturing in this country – get back to a mode of encouraging savings and investment.

Q: But recently, we’ve been hearing of corporations and companies all over – including in the US – that are sitting on huge cash reserves. How does that factor in with what you describe as a current spending environment and that you propose regarding savings?

A: Well, there are two sides to a balance sheet. So, cash is the good side – and they certainly have a lot of cash right now. But we also have a lot of debt. And they’re holding onto that cash out of nervousness – over politics, the economy, the banking industry, and having FUTURE access to cash. If you look back, the cash that they’ve had access to to spend over the last few decades are from bonds and other debt instruments – lines of credit, those sorts of things. So they’re holding onto this cash and nervous about having access to sources of cash that they’ve been used to in the past. So if you looked at kind of ‘netting out’ that cash – in other words, what do companies REALLY have as ‘cash,’ that would be an interesting exercise. I suspect if you started subtracting all the lines of credit and short-term maturity instruments, maybe those cash positions don’t look as good as we might think. But I also think there’s concern over another ‘Lehman Brothers 2008’ scenario happening again, and not having the cash to run their businesses through another cycle like that.

Encouraging savings will go a long way in revitalizing the manufacturing economy.

Notice how any time savings start declining so does GDP. Also notice that when the Fed manipulates interest rates lower that the savings rate declines. As the savings rate declines you can only fund future production increases/improvements through debt, which eats further into the savings rate as debt is a tax on future production. It’s the Austrian Business Cycle in one pretty chart.

Q: They are hording cash, but you’re saying it’s not unreasonable?

A: Yeah, because they’re trying to be prepared for another downturn. But the problem at this point is that the type of downturn they’re preparing for – there’s no way of forecasting when that will happen. You can say that it’s going to happen, just like there were people saying 10 years before Lehman Brothers collapsed that it was coming, that there was going to be a banking crisis. The issue is that you can forecast ‘what’ and you can forecast ‘when,’ but you can’t do both (laughs). Because you’re gonna be wrong when you try to do both. So, it’s awfully hard to plan for that. And now, I see people planning for a worst-case scenario, whereas in the past they weren’t.

Q: It sounds to me, from what you’ve shared, that we’ve about come full-circle, that confidence (or lack of it) is actually driving those leading indicators you’re watching. How do you see confidence in the manufacturing industry and for manufacturing technology consumption through 2013?

A: Right now, it looks fantastic. The average machine tool market for each of the last 40 years in real dollars is right at $6-billion, and our projections for 2013 is that we’re going to be about 10% above that average – so, around $6.6-billion. To this point, 2012 appears like it will just about match that historic average. We’re just entering a period, I think, where we’re going to have above-average machine tool and capital equipment sales that I think will last for 2-5 years. One of the reasons we’re making this prediction is if you look at operating capacity, right now it’s at 80% – which is historically very high. Over the last 20 years, there have only been 4 years where we’ve had a higher operating capacity than we have now. As we all know, these markets are also very cyclical, so we go through periods where they buy more machine capability & capacity than they need and then work their way into it. Then, they under-buy what they would theoretically need based on their production levels over a period of years. So there’s always been this ‘over-buying’ – ‘under-buying’ cycle. And I see us entering an ‘over-buying’ phase in manufacturing, despite our high operating capacity figures. After capacity utilization and industrial production have peaked, that’s when machine tool sales really grow their most, historically. And we’re getting very close to another peak rate of growth.

Q: What do you see as the impact of the emerging ‘reshoring’ trend on capital equipment & manufacturing technology economics in the coming years? Any at all?

A: For the last two years, consumer durable goods industrial production has grown faster than consumer durable goods spending. This means that we are making more of what we are consuming now than we were two years ago. While we are making a greater percentage of the products we are consuming, based on historical data there is still plenty of opportunity for us to make even more of the goods we are consuming. The Top Shops Survey we did in early 2012 showed that 18% of metalworking facilities had gained new work through a reshoring initiative. Also, our recent capital spending survey showed that making instead of buying the end product is an increasing motivation for buying new machine tools. I think that all of this is evidence that reshoring will continue to boost production levels and, consequently, capital equipment sales. This is more than a one or two year phenomenon. This is the pendulum swinging back.