Thursday, July 16, 2009

TOTAL Capacity in Economy Shrinking

I'll play my own devil's advocate regarding my initial conclusion to capacity utilization. To rewind... in my post about used cars and the inflation / deflation tug of war, I concluded (re: excess capacity):

To me this is deflationary over the longer run, with one HUGE caveat / concern... supply destruction.

This story shows what can happen when there is a significant change in supply (lower supply = higher prices). My fear is that the global economy has another downturn and supply is permanently destroyed when the government finally accepts that they cannot save every GM, Chrysler, etc... At that point I do feel that inflation, even with reduced demand, is a real threat. BUT, until then, deflation is my concern...
The "until then" may be coming sooner than I thought. The following chart shows the annualized monthly change in TOTAL CAPACITY (not capacity utilization) in the economy today.

While of limited concern in an environment with as much excess supply as we currently have, it may be of increasing importance as the economy comes back going forward.

Source: Federal Reserve