Monday, September 13, 2010

Optimistic Wholesalers Increase Inventories

Inventories keep increasing, anticipating a recovery in consumer spending that isn’t on its way. In July, wholesale sales went up 0.6 percent, possibly an encouraging sign. Inventories rose twice as fast, though. Inventories have been larger than any economy justifiable level for at least the last three years, so any increase at this point is a sign of the economy’s persistent sluggishness. Inventories increase when spending is going slower than manufacturing, so an increase in inventories is often an early sign of a slowing economy.

In this case, it is not that the economy is about to slow down suddenly, but an optimism on the part of wholesalers as they anticipate faster sales in the months ahead. If the sales materialize, of course, that’s a good thing. But if sales slow or hold steady, it can force manufacturing to slow down to get things back in sync.

Another possible explanation for the increase in inventories is that they represent a hedge against inflation. If price increases are expected, it makes sense to take deliveries sooner, to beat the price increases. Increases in the prices of manufactured goods themselves are not expected in most cases, but an increase in the cost of delivering them is not at all unlikely, with energy prices showing signs of creeping up. This alone, in a time when there is not much else going on, could be enough to speed up orders and increase inventories. But if this is the case, the implications for the broader economy are no more encouraging than if inventories are increasing because of errors in sales forecasting.

To try to clarify this, these are examples of “good” and “bad” increases in inventory that happened this summer:

  • “Good”: A new consumer electronics retailer is opening locations in some of the stores vacated by the failed Circuit City chain. The new stores could lead to an increase in sales.
  • “Bad”: Some of the excess supply of milk, produced after government forecasts called for an increase in milk demand when demand was actually declining, is being made into cheese and ice cream. Inventories of cheese and ice cream are possibly the highest they have ever been. Milk production will have to decline to bring inventories (and prices) back into balance.

Increases in inventories are the main thing that has stabilized the economy over the past year, but inventories cannot continue to increase indefinitely. Something else has to occur to make the economy expand, or financial pressures will start to push inventory levels down again.