Wednesday, January 14, 2009

Involuntary Inventory Accumulation

The Lehmann Letter ©

Today the Census Bureau released November data for business sales and inventories:

Here’s the Bureau’s summary:

Sales. The U.S. Census Bureau announced today that the combined value of distributive trade sales and manufacturers’ shipments for November, adjusted for seasonal and trading-day differences but not for price changes, was estimated at $1,057.0 billion, down 5.1 percent (±0.2%) from October 2008 and down 8.9 percent (±0.5%) from November 2007.

Inventories. Manufacturers’ and trade inventories, adjusted for seasonal variations but not for price changes, were estimated at an end-of-month level of $1,485.1 billion, down 0.7 percent (±0.1%) from October 2008, but up 3.3 percent (±0.5%) from November 2007.

Inventories/Sales Ratio. The total business inventories/sales ratio based on seasonally adjusted data at the end of November was 1.41. The November 2007 ratio was 1.24.

Note that sales were down 8.9% from a year ago while inventories were up 3.3%. Consequently the inventory/sales ratio (inventories divided by sales) rose from 1.24 to 1.41.

The Bureau’s chart illustrates the ratio’s rise.

The recent rise interrupted the long-run downward trend. Over the past decade businesses have required fewer and fewer inventories to support their sales. That was a measure of improved efficiency.

But the ratio’s recent rise is ominous because it’s a symptom of involuntary inventory accumulation. If sales fall and inventories rise – as they have over the past year – that’s a sign that unsold goods are piling up on shelves. Businesses have not been able to reduce production and orders swiftly enough to prevent the involuntary accumulation of unsold goods. In other words, the drop in sales was worse than business anticipated and caught business by surprise. Hence: Involuntary inventory accumulation.

Business will, of course, eventually be able to bring its inventories under control. But, in a world of declining sales volume, that implies a drastic reduction in output and orders. When the ratio stops rising and begins to fall, the recessions full downdraft will be upon us.

© 2009 Michael B. Lehmann

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