Recessions themselves were once almost exclusively set up by inventory levels, as the difference between production and sales caught up within the supply chain, eventually working out toward alignment.
Companies are willing to hold inventory for shorter periods as the sales environment is more volatile, but there comes a point when that patience finds a limitation and production suddenly and rapidly dwindles.
That makes determining the inventory imbalance difficult, especially with imprecise measurements. The Census Bureau gives us one account, as does the Bureau of Economic Analysis in its report on gross domestic product. There are some discrepancies between them, but by and large the raw, generalized account of inventory through either method right now is extreme.
On the GDP side, the annual benchmark revisions last month weren’t as large in the inventory component as in GDP overall, which shows just how over-optimistic the trend cycle was in relation to actual “demand.”
The most striking aspect of the revisions was the inventory increases in the past two quarters – record levels.
Inventory accounting in terms of GDP being what it is, the second highest inventory build in the entire series actually ended up subtracting a small amount from second-quarter GDP because it immediately followed the highest.
The new estimate for first-quarter inventory was an increase of $127.3 billion, followed by $124 billion in the second quarter, according to the advance estimate.
These amounts are typically what you would expect at the trough of recession, where depleted stocks of goods are refilled in rapid activity.
Together, those were the largest inventory accumulations in history, which isn’t really surprising given the contraction in sales, even as far as GDP accounts for them. And that is really the problem going forward, as inventory has been accumulating to a high level not just recently but going back to the third round of quantitative easing by the Federal Reserve.
In historical context, this uninterrupted accumulation is by any count extreme. Using a four-quarter summation, the last time inventory was this high, scaled by real GDP, was just prior to the Asian financial crisis in 1998.
Using an eight-quarter accumulation, the same is true — how rare it is that inventory would build up so much without pause for so long.
Without a large and sustained pick-up in sales, at some point production levels need to adjust. It is clear by now from a range of economic data — from factory orders to capital goods and beyond — that businesses in the supply chain, wholesale in particular, are starting to develop the contours of that realignment. But even with these cutbacks inventory remains historically elevated.
That suggests that businesses are already in the frame of mind to have begun cutting but are still not quite ready to unleash the full fury — not yet giving up that this “slump” is temporary.
This is a major problem for future growth, one that has been building for more than a year. The constant mainstream references to the great recovery are very unhelpful in this context.
Anyone inclined to believe in the fantasy only makes this process more drawn out, and in the end, susceptible to that much greater of a downside to restore productive balance. We already have the outlines of recession with the full weight of recession processes yet to be released.
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