Let’s add the potential for an inventory cycle to our list of things to worry about. Today’s report from the Census Bureau shows another increase in total business inventories:
To put this in context, let’s look at the history of the inventory-sales ratio:
The downward trend reflects improvements in inventory management, thanks to bar-coding, scanners, real-time information systems. More improvements should be on the way as this technology spreads further, and we add improvements from RFIDs, etc. (Nice summary of RFID developments at the RFID Weblog.)
If businesses cut back on their inventories, we’ll see production decline independently of demand, which can have ripple effects (multipliers to you Keynesians) in other sectors of the economy. On the positive side, it’s possible for inventory-sales ratios to fall through increased sales. Also, there’s nothing written in stone that says the I-S ratio must continue falling. It’s just a good bet.
At this point, I’m not ready to change my forecast that the U.S. economy avoids a recession in 2007, but I’m sticking to my risk assessment of one chance in four of a recession.
Business Strategy Implications: If you sell goods (as opposed to services), watch your sales and inventories very carefully. This would be a particularly bad time to run into an unforeseen inventory buildup.