Australian, Chinese Manufacturing Moving in Opposite Directions

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It’s been a mixed week in the world of manufacturing.

Despite China’s industrial sector floundering in January, it was another good month on the domestic front.

According to the Australian Industry Group, the PMI remained above the 50 point mark. The PMI simply measures the level of activity for any given month. Anything above 50 points suggests a sector is expanding, and vice versa.

In truth, the figures are a bit misleading. Australia’s PMI actually declined by 0.4 points last month. But in staying above 50 points, it ensured the sector was still expanding, albeit more slowly.

Better than that, it represented the seventh straight month of manufacturing growth. Not since the turn of this decade has the sector been on such a hot streak.

Better still, the AI Group said that new orders point to more growth in the future. We can expect to see manufacturing expand again over the coming months. For an economy like Australia’s — crying out for diversity — that can only be a good thing.

Of course, there’s always more that can be done. The AI Group says we’re still some way from manufacturing fulfilling its potential. But if the Aussie dollar keeps dropping, we may not be far from that point.

Why? Well, a weak dollar allows manufacturers to export their goods more cheaply overseas. Equally, since it’s expensive to import goods, it opens up more opportunities domestically as well. So manufacturing clearly benefits from a dollar at 69 cents. You suspect the dollar will have the biggest say in where manufacturing goes in the months ahead.

The manufacturing recession China had to have

While it was a good month for Aussie manufacturing, we can’t say the same for China’s sector.

China’s (much bigger) manufacturing industry dipped below expectations last month. It wasn’t altogether surprising, in part because of weaknesses across both construction and exporting sectors.

What was surprising was just how far it fell below expectations. The PMI fell to 49.4, which was the lowest reading since mid-2012. As above, a reading of below 50 points to a contraction.

Unfortunately, that was only the start of the bad news. This reading was based on the government’s ‘official’ figures. They’re official in the sense that they typically overstate the health of the sector.

Luckily, we have the more independent Caixin PMI to give us a better insight into the true state of the industry. The Caixin PMI reading came in at 48.4 points. This was 0.3 points better off than expected. And it actually improved by 0.2 points from last month.

Despite this, Chinese manufacturing remains in a rut. And that’s how markets will see it too. Considering the sector accounts for 40% of China’s economy, it’s not hard to see why. Anytime Chinese manufacturing slumps, people start worrying. These figures have a habit of spreading market panic. Even if the PMI bucked expectations, the sector is still contracting. That’ll only reinforce market’s belief that the Chinese economy is slowing faster than expected.

Is that rational?

Markets have always had an air of irrationality about them when it comes to China. These figures are concerning on some level. But they’re also expected, which is an important point to remember.

We know that China’s economy is in transition. We know that consumerism will play an ever bigger role in that shift. Why then are we surprised when manufacturing activity falls? This is the point that a lot of people overlook. China’s economic transition is the reason why manufacturing is down. Raising our arms in despair, when we expect Chinese consumers to take up more slack, makes no sense. We either want one or the other; we can’t have both.

The only question then is whether China’s service sector is pulling its weight. Are people consuming enough to offset the decline in manufacturing? Well, answering that depends on what you think constitutes ‘enough’. Look at the evidence at hand.

China’s non-manufacturing PMI slowed during January. It recorded a reading of 53.5, down from 54.4 in December. So the sector is growing, only at a slower pace.

Is that good enough? It might not matter even if it was. There are few grey areas when it comes to how markets react to news. Things are either going well, or they’re going to hell in a handbasket. Some will see slowing non-manufacturing PMI as a reason to panic. Others might see it for what it really represents. The way I see it, these are natural ebbs and flows that we should come to expect by now.

None of that is to say that China’s economy is out of the woods just yet. But we should keep some perspective in choosing how and what to panic about. Not everything is a sign of apocalypse. If anything, manufacturing is likely to continue falling in the coming months. It can’t help but decline. It’s a necessary by-product of China’s ongoing readjustment.

At the same time, Chinese policymakers won’t help matters if they start interfering too much. If their single alternative is to push rates lower and pump the economy with cash, that’ll only add fuel to the fire. Unfortunately, with their track record, they’ll likely do exactly that.

Policymakers might argue that they need to smooth out the kinks in the economic transition. But good luck convincing markets of that. They’ll panic, as they are wont to do. And it’ll make things much worse than they’d otherwise need be.

For now, manufacturing is moving along as expected in both China and Australia. Industrial activity will decline in China as the service sector grows in importance.

Meanwhile, the Aussie economy should continue benefitting from a lift in manufacturing. Hopefully we’ll see more of it in the future.

Manufacturing and the Aussie dollar

The fate of manufacturing in Australia will depend on where the Aussie dollar goes next.

There was a time when the dollar was trading as high as $1.10 against the greenback. These days, it’s hovering around the 70 cents mark. You’ve lost 45% of your purchasing power in a few short years.

The Daily Reckoning’s Greg Canavan thinks the dollar is heading further south. He predicts the dollar falling to as low as US$0.50 this year. Everything you buy from overseas will become more expensive. And yes, that includes your beloved Amazon shopping, to say nothing of holidays.

Greg believes there are more economic woes in store for Australia as the dollar declines. And that these factors could be harmful to your wealth. But there are steps you can take right now to protect your wealth from the coming Aussie dollar crash.

In a brand new Daily Reckoning report, Greg will not only show you why the Aussie dollar crash is inevitable. He’ll reveal a unique ‘crash protection’ investment to shield you from the sinking dollar. To download the report, ‘Why the Aussie Dollar Will Crash in 2016’, click here.

Mat Spasic

Junior Analyst, The Daily Reckoning

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