The return of the inventory cycle

The return of the inventory cycle

There was a time when levels of inventories, or stocks, drove the economic cycle. Before the era of cheap computing power, matching inventories to future demand was fiendishly difficult. When demand fell unexpectedly, as in recessions, companies ended up with unwanted inventories. They slashed orders, hitting producers, and reinforcing the downturn. When companies ordered too little, demand for new products surged, fuelling demand and inflation. Inventories yoyoed and so did demand.

• In this way inventories magnified, and indeed drove, the ups and downs of the economic cycle. The US economist, Alan Blinder, has estimated that in the eight US recessions between 1945 and 1982 falling inventories accounted for a remarkable 87% of the fall in GNP. No wonder economists pored over inventory data for early signs of faltering demand. Books and academic papers were written on the inventory cycle, economists built careers analysing it.

• That started to change in the 1980s. The share of the most inventory-heavy sector, manufacturing, was shrinking in most western economies. Supply chains became longer, more complex and more international. Improvements in computing power provided firms with more detailed and timelier data, enabling them better to forecast demand. High interest rates added to the cost of holding inventories and provided strong incentives to reduce inventories.

• All of these factors helped drive a shift to just-in-time supply chains which minimise inventories. That process was helped, from the 1990s on, by declining levels of macroeconomic volatility.

• Growth ran faster and was more stable. Unemployment fell and inflation hit multi-decade lows. The big problem of economic management – how to avoid recessions and maintain strong growth – seemed to have been solved. Economists variously attributed this happy period, what became known as the Great Moderation, to globalisation, the end of the Cold War, technological change, independent central banks and greater political consensus on economic management (this was the era of Bill Clinton and Tony Blair).

• In such a benign, predictable world companies could run even lower levels of inventories. Activity was easier to forecast and globalised supply chains could respond quickly to any unexpected shifts in customer demand or preferences. Macro stability made it easier to manage inventories, and, in turn, better inventory management contributed to lower levels of economic volatility. It was a virtuous circle.

• Then came the pandemic, an event that was in no one’s business plans. Just-in-time inventory models came under tremendous pressure. As economies reopened the chronic mismatch between low inventories and pent-up demand created shortages and fuelled inflation. The inventory cycle mattered again.

• That cycle has changed course, just as a 1950s macroeconomist would have predicted. The post-pandemic surge in demand has raised prices, brought forth new supply and dampened demand. Now shortages are starting to give way to rising, and in some cases excess, inventories, and lower prices.

• The Purchasing Managers survey reports that manufacturing delivery times across the developed world have fallen sharply from their peaks. Unprecedented shortages of shipping containers have been followed by a glut. A record backlog of 109 container vessels that had built up outside the ports of Los Angeles and Long Beach this time last year is no more. Soaring output of semiconductors has overshot demand creating a glut of memory chips, with prices halving from last year’s peak. In textbook fashion excess inventories have caused manufacturers to scale back production sharply, with South Korea’s chip output falling at the fastest rate since the global financial crisis. 

• The same story can be seen at a company level. Despite making progress in reducing excess stocks last year, Walmart revealed in November that its US operation was holding $1bn in excess inventory. Clothing retailer GAP has offered aggressive discounts to shift excess stock over the winter holiday period. Tesla, which struggled to meet demand as the economy rebounded from the pandemic, is facing an oversupply of new cars and has cut prices by up to a fifth in the US and Europe.

• There are some important exceptions. The supply of agricultural produce is constrained by the war in Ukraine and vulnerable to adverse weather. Bad weather or political developments in Europe or the Middle East could yet strain energy supplies.

• Yet outside these areas the inventory cycle is back, and with a vengeance. Inventories and supply chains have been tested as never before, and once again, they matter. Economists and policymakers are poring over supply and inventory data in the way they used to back in the 1980s.

• By and large the lean inventory system has coped well with swings in demand for which it was not remotely designed. But vulnerabilities have also emerged and not just in relation to unexpected shifts in demand. Rising tensions between western countries and China and Russia have created new risks to supply.

• The search for ever greater efficiency was behind the rise of today’s lean inventory system. Those supply chains were a product of a period of exceptional stability. With the Great Moderation behind us resilience is likely to play a bigger role in the evolution of tomorrow’s supply systems. Once again, inventories matter.

For the latest charts and data on health and economics, visit our Economics Monitor:
https://www2.deloitte.com/uk/en/pages/finance/articles/covid-19-economics-monitor.html

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 0.9% at 7,771.

Economics

• The US hit its debt ceiling, triggering emergency measures to prevent the risk of a default. US treasury secretary Janet Yellen warned that there was “considerable uncertainty” how long these measures would postpone a default
• Christine Lagarde, president of the ECB, said that the end of China’s  zero-COVID policy will be good for global economic growth but could give a fresh boost to inflation
• The International Energy Agency warned that a sharp rebound in Chinese growth could see a rapid rise in demand for oil later this year, leading to higher prices
• China’s economy grew by 3.0% in 2022, with the exception of 2020 when COVID drove the growth rate to 2.2%, the worst year for Chinese GDP growth since 1976
• The population of China fell by 850,000 in 2022, according to official figures, as deaths rose above births. The birth rate has fallen sharply since the beginning of the pandemic
• IMF managing director Kristalina Georgieva said that the economic outlook was “less bad than we feared a couple of months ago” but added “it’s not great”
• Harvard University professor Kenneth Rogoff said that he thought official Russian economic statistics overstated how well the Russian economy is performing. He predicted that Russia is heading for “incredible poverty” and argued that sanctions were important and could work
• UK inflation fell for a second month, down to 10.5% in the 12 months to December. Food price inflation rose to 16.9% however
• Bank of England governor Andrew Bailey said that “a corner had been turned” on inflation and predicted it would fall rapidly this year
• Average wage growth in the UK accelerated, 6.4% higher in September to November 2022 than in the same period in 2021. Despite this, pay failed to keep pace with inflation. Pay rose by 7.2% in the private sector and 3.3% in the public sector
• Although UK unemployment saw a slight rise to 3.7% and the number of vacancies fell by 75,000 to 1.161m, the labour market appears to remain tight, which is likely to be a concern for the Bank of England
• UK retail sales volumes unexpectedly dropped by 1% from November to December and were down 5.8% from a year earlier as consumers faced higher prices over the Christmas spending period
• UK consumer confidence fell in January after three months of modest improvements
• UK train companies offered unions a revised offer that included higher pay and the dropping of part of a modernisation programme in a bid to end strikes
• Nurses in the UK took a second day of industrial action in a dispute over pay. The Royal College of Nursing said that it would accept a 10% pay increase, down from its initial demand of 19%
• The UK lost more days of work to strike action during June to November last year than in any year since 1990
• Over a million people took to the streets or went on strike in France to protest against president Emmanuel Macron’s plan to raise the retirement age from 62 to 64
• ECB president Christine Lagarde and Fed vice-chair Lael Brainard both said that they would “stay the course” until inflation returns to 2%
• Japanese core inflation rose to 4.0% in December, its highest level in 41 years. Earlier in the week the Bank of Japan had announced it would not change its policy of yield curve control, which keeps monetary policy lose, despite market pressure
• The US dollar hit a seven-month low against a basket of currencies. Emerging markets have been a beneficiary of depreciation in the global reserve currency with stocks soaring in recent months
• US retail sales and industrial production both fell in December highlighting the risks to US growth
• China posted growth of 0.0% in the fourth quarter compared with the previous quarter. High frequency retail sales and industrial production data for December, a time when COVID restrictions were in force, were weak
• Inflation in Argentina hit 94.8% in the 12 months to December, its highest level since 1991. Money creation by the central bank and higher global commodity prices contributed to the increase in prices

Business

• Google announced it was cutting 12,000 jobs worldwide citing difficult economic conditions and Microsoft announced it was cutting 10,000 jobs citing as “customers optimise their digital spend”, highlighting the difficult conditions in the technology sector
• Figures from NHS England showed that 14,036 people were occupying hospital beds in England despite being fit for discharge, the second highest on record
• UK battery start-up BritishVolt entered administration
• UK retailer Paperchase put itself up for sale and said it was speaking to insolvency practitioners about its options
• UK retailer Marks and Spencer said it planned to open 20 new stores over the next year, creating 3,400 jobs
• US carmaker Tesla cut the price of some of its models by as much as 20% to the chagrin of customers who had just completed purchases at the previous prices
• The share of US workers who are members of unions fell to a record low of 10.3% last year. The rate has been falling for decades driven by the growth of the service sector where membership levels are low

Global and political developments

• Ukrainian president Volodymyr Zelenskyy reiterated his call for the West to supply heavy weapons. Germany is under increasing pressure to supply tanks, the UK has already committed to doing so
• A US defence spokesperson reiterated that the US would support Ukraine in reclaiming Crimea, a region occupied by Russia since 2014
• French president Emmanuel Macron announced a significant increase in French defence spending up until 2030, saying there was no longer a “peace dividend”
• New Zealand’s prime minister Jacinda Ardern announced she was standing down citing burnout. New Zealand has elections in eight months

 And finally… the Swedish government has proposed legislation that would remove the requirement for bars, nightclubs and restaurants to obtain a 700-kroner permit to allow dancing in a bid to reduce bureaucracy and costs for business – laws of the dance