The Economist - UK (2022-06-04)

68 Finance & economics The Economist June 4th 2022

Sachs note that while “fun” spending cate-

gories with pent-up demand such as food

services, air travel and hotels have re-

bounded over the past year, others have

lagged behind. Services that cater to white-

collar professionals have been slow to re-

cover. Spending on public transport is

about 24% below where it would have been

without the pandemic; laundry and dry-

cleaning revenues, meanwhile, are 20%

below trend.

Even some essential services have been

slow to recover. Spending on doctors’ and

dentists’ services is about 15% below trend;

child care is down by 22%. Appetite for ma-

ny non-essential goods, by contrast, shows

little sign of abating. Spending on jewelle-

ry and recreational vehicles is 53% and 43%

above trend, respectively. Spending on

pets is up by 23%.

One question is whether the composi-

tion of consumer spending will return to

pre-pandemic norms. The hope is that this

eases bottlenecks and helps bring down in-

flation. Yet several uncertainties lie ahead.

The process looks likely to be slow. If re-

cent trends in America continue, goods

and services spending will not return to

pre-pandemic levels until perhaps the

third quarter of next year. And some habits

could stick: the rise of remote working,

say, may have permanently changed the

consumption mix, keeping the relative de-

mand for goods higher than it was before

the pandemic.

Hovering over all this is a potentially

souring economic backdrop, as people be-

come gloomier about their finances. Con-

sumers, especially those in America, po-

wered an extraordinary goods boom over

the past couple of years. What they do next

is much less certain. 

R

emember theGreat Moderation?

This refers to the period before the

global financial crisis of 2007-09 during

which there was a marked fall in the

volatility of gdpgrowth in rich coun-

tries. Explanations for it ranged from

wiser monetary policy (yes, really) to

globalisation. In fact, much of it was

down to something more mundane:

smaller inventories. One authoritative

study found that more than half the

improvement in the stability of rich-

world growth was explained by dimin-

ished inventory cycles.

The classic stockbuilding cycle, in

which inventory changes add to the

momentum of gdpon the way up

(through over-ordering) and on the way

down (through stock clearances), is

showing signs of a revival. Some big

American retailers, notably Walmart,

have reported large increases in stocks.

In part this is the result of errors in fore-

casting demand. But it also reflects an

increase in the desired level of inven-

tories. As just-in-time production gives

way to just-in-case stockpiling, the scope

for greater volatility in gdp, and in cor-

porate earnings, is increasing.

To understand why inventories are

rising again, it helps first to understand

why they fell. Improvements in comput-

ing mean that firms have more detailed

and timelier information about demand

from consumers. Such changes made

large precautionary stockholdings re-

dundant. A related factor is carrying cost.

Interest rates were high in the 1980s,

when businesses first began to favour

leaner inventories. And a dollar in stock

is a dollar that cannot be used profitably

elsewhere. Accompanying this was the

widespread adoption of just-in-time

manufacturing, with its emphasis on

flexible supply.

For the leanest companies, inventory

consists of whatever FedEx or upsis carry-

ing for them. Or it did until recently. The

tech-and-trade wars between America and

China challenged assumptions about the

security of supply. The pandemic (and

now the war in Ukraine) upset them com-

pletely. The pattern of demand suddenly

shifted as locked-down consumers could

not spend on dining out or live entertain-

ment; instead they spent more on goods

that could be ordered online and delivered

to their door. Meanwhile shortages of

workers and of key inputs, notably semi-

conductors, meant that some orders could

not be fulfilled. Businesses lost sales for

want of inventory. Logistical snafus be-

came a board-level discussion.

The result, inevitably, has been an

overcorrection. Having lagged behind

spending, inventories got ahead of it. The

share prices of Walmart and Target fell

sharply in mid-May when the two retailers

revealed they had been left with large

stocks of unsold goods, after misjudging

the strength of demand. Even the mighty

Amazon has been blindsided, as the e-

commerce share of retail sales, which

exploded in the pandemic, has fallen

back towards its pre-covid trend.

The cyclical effects of all this will have

to be reckoned with. Some retailers may

be holding the wrong stock for the time

of year. They will either have to store it,

mark down prices to clear it quickly, or

move it on to discount retailers that

specialise in selling out-of-season stock.

Inflation will be lower than it would

otherwise have been. Some companies

that have over-ordered will cut back on

purchases to allow stock levels to adjust

to the trend in spending. Albert Edwards

of Société Générale, a French bank, reck-

ons that the pain will be felt more in

China, as “demand for Chinese imports

gets hit hard just when the Chinese

authorities are struggling to revive their

moribund economy”.

Yet there is something more profound

at play. Just-in-time production assumes

a largely frictionless world—of open

borders, predictable demand and low

transport costs. This can no longer be

relied upon. Inventory is a form of insur-

ance against unexpected delays. And

though insurance is costly, company

bosses seem willing to pay for more of it.

The trade-off between efficiency and

self-insurance, between just-in-time and

just-in-case, has shifted markedly to-

wards the latter. And larger inventories

imply greater scope for inventory cycles

in the future.

There is a paradox here. The more

companies seek to self-insure by holding

more stocks, the more volatile gdp(and

thus corporate earnings) is likely to

become over time. American retailing

might thus be offering a preview of a

particular future—of jumpier revenues

and more frequent profit warnings. The

Great Moderation is going into reverse.

ButtonwoodThe inventory cycle returns

Why companies have become more prone to over-ordering stock