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Meltdown 101: Industrial Production Offers Clues

By Stephen Manning, AP Business Writer Here are some questions and answers about the Federal Reserve’s monthly industrial production and capacity utilization report, a snapshot of the health of the nation's industrial sector and what it means for manufacturers.

WASHINGTON (AP) -- There's one easy way to measure how much the economy is suffering during the recession: America's factories are making far less stuff then they used to.

That means fewer cars, rolls of steel, computer chips, airplane parts, refrigerators, cans of beer, and the millions of other goods that come off U.S. assembly lines every year. With much lower demand for manufactured goods, factories aren't producing nearly as much as they can. Lower production has in turn led to the big layoffs that industrial companies have made in recent months.

In short, American industry is operating in low gear.

On Friday, the Federal Reserve released its monthly industrial production and capacity utilization report, a snapshot of the health of the nation's industrial sector. It provided clear signs of how bad things have gotten for the nation's manufacturers and industrial companies, and may hold clues to possible signs of hope for the future.

Here are some questions and answers about what the report covers and how economists use it.

Q: What does the report look at?

A: The Fed takes a broad look at the physical output of the nation's industrial sector. That includes some big manufacturers that have been in the news a lot lately because of their financial woes, like automakers, steel producers, companies that make equipment for the depressed housing market and plane manufacturers.

The report also includes everything that is produced by mines, like iron ore and coal. It measures the output of utilities, such as electric companies. This segment can be a bit volatile, since demand for energy is often driven by hard-to-predict factors like the weather.

Finally, it takes a look at the "capacity utilization" of the nation's factories, comparing their actual output with how much they are able to produce. For example, if a factory can produce 100 car engines each day but only makes 65, it is operating at 65 percent of its capacity.

Q: There's a mountain of economic reports that come out every month. How important is this?

A: It's a big one. The report gives a good sense of the health of the manufacturing sector, which has been shrinking in size over the past several decades but last year still accounted for about 11 percent of the nation's gross domestic product -- a measure of the value of all goods and services produced within the U.S.

So far, manufacturing has been suffering much worse during the recession. As credit dries up, factories can't borrow money to buy parts and raw materials they need to make goods. Cash-strapped consumers and business have scaled back on their spending, lowering demand for all sorts of manufactured products. Factories are cutting jobs at a fast pace to try to adjust, and manufacturing unemployment is running higher then the overall jobless rate.

The report is also one of several that the Fed uses when it sets its targets for interest rates. For example, a high reading on industrial output and capacity could be a warning of inflation, meaning the Fed could move to raise interest rates to cool down the economy. A low reading means the Fed could take steps to try to stimulate a sluggish economy.

Q: How have things looked in recent months?

A: Not good. Industrial production has dropped in 15 of the 17 months since the recession began in December 2007. It has fallen 16 percent during that period and is a major reason that the nation's overall economy is contracting, including the 6.1 percent fall in gross domestic product during the first quarter.

The industrial production reports show how bad things have been for some key industries, like autos. The output of motor vehicles and parts was down a whopping 25 percent from December to January.

It's a clear sign of the troubles of big automakers like General Motors and Chrysler, both of which are closing plants, cutting workers and racing to restructure while living off big injections of government aid. It also includes the thousands of smaller suppliers that make the parts for the cars that come off auto assembly lines.

Q: What about capacity utilization? How have the nation's factories been doing?

A: Not surprisingly, industry is running far below its capabilities. As of April, overall capacity utilization dropped to 69.1 percent, well below the 80 percent range that is common for a healthy economy. The April figure was the lowest recorded since the Fed started tracking the data in the 1960s.

It's even worse for manufacturing. The nation's factories were operating at only 65.7 percent of their potential.

The steel industry shows how bad things have gotten. Steel mills are operating at only about 40 percent of capacity as companies shut down the big blast furnaces that they use to create the metal. That's because demand and prices for steel have fallen sharply worldwide, driven by factors like lower demand from the auto industry and greater competition from steel mills in China.

Q: So how long will it be this bad?

A: Industrial production is still falling, but the rate of decline seems to be slowing. The April report showed a drop of 0.5 percent, which was better than the 1.7 percent contraction in March. Some economists say these may be hints that a bottom is near.

Even the struggling auto sector has showed some sign of a pulse in recent months, posting growth in the past three months. However, that may be stifled in the next few months as Chrysler and GM shut down their plants for long stretches during the summer.

Tom Runiewicz, an economist with IHS Global Insight, said the slowdown in the fall of industrial production is an encouraging sign. But even if the free fall is over, the industrial production and capacity utilization numbers are still at lows not seen for decades.

"Everybody is hungry for positive news," he said. "This isn't positive, but it is less negative."