Category: inventory

Economic Puzzles

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November 6, 2022

by Stephen Stofka

Many people compare today’s inflation with that of the 1970s. A better comparison might be with a much earlier period. This week’s letter will be about the change in the inflation rate. Inflation is like the speed on a speedometer. If I accelerated from 50 to 60 MPH over a certain time period, perhaps 10 seconds, the change in the speed is 10 MPH. The time period I’m looking at is one year. If inflation rose from 1% to 5% in a year’s time then the change is 4%.

I’ll start with the current year. The one year change peaked at 6.1% in the first quarter of 2022. As the Fed raised rates, that change moderated. It’s like accelerating to 60 MPH and realizing that the speed is over the speed limit and reducing speed by easing up on the gas pedal or braking.  

Most of the time the inflation rate changes by less than 2% up or down. During and after recessions it can become more volatile. In 1980, inflation soared above 14% and the one year change peaked at 5.8%, slightly less than our recent experience.

There has only been one time in the past 70 years when the inflation rate rose faster than today. That was in 1951, shortly after the Korean War began. For the first six months of 1950, prices sank – deflation – then war was declared in June 1950 and the U.S. again ramped up defense production. The one year change in inflation peaked above 10% as Federal defense spending shot up 45%.

If you would like to explore this period in more detail Tim McMahon (2014) presents 1950s inflation data in an easy to read format. A hundred years ago, a period of persistent deflation – not inflation – followed the last pandemic.  See Tim’s second link below. The Federal Reserve was still fairly new and the U.S. and European nations had adopted a gold standard that would eventually lead to the Great Depression. That’s another story. Today the world’s commerce is interlocked and pandemic shutdowns continue to deliver a series of supply shocks. Getting policy right is more difficult when circumstances are this unusual.

Volatile Inventories

Inflation rises when there are inadequate resources to meet demand. In 2021, real private gross domestic investment rebounded quickly, rising almost 32% on an annualized basis in the 4th quarter. One component, inventories, was responsible for much of that surge. Even under normal conditions, this series is a volatile component of GDP (BEA, 2019) and the BEA publishes a figure called Final Sales of Domestic Product which excludes the change in inventories. Real final sales is approximately close to inflation-adjusted GDP.

During the pandemic manufacturing and retail goods sat in container ships off the port of Los Angeles and other ports. While the goods were in transit, they were not added to inventories. In the 2nd quarter of 2021, businesses began to open again but the ports were slow to unravel their logjams. Empty truck containers sat in parking lots and on neighborhood streets near the L.A. port while ships waited in line out on the water.

Sales surged as economy reopened

In the 2nd quarter of 2021, real final sales increased 2%, finally reaching pre-pandemic levels. In the first half of the year, real food and service sales shot up 10%. Normally that increase would occur over three years. However, within months that initial surge subsided. Over the next two quarters, real final sales barely increased. Real food sales declined slightly. This confirmed a temporary response to a post-pandemic recovery. With so many items out of stock, customers were willing to pay higher prices to get products. Some businesses had orders shipped from Asia by air. In the 4th quarter 2021, the floodgates opened and real private inventories rose by a record $197 billion.

Profits Surge

Real retail and food services sales fell slightly. In the last six months of 2021 inflation topped 5% but people were not buying and selling more stuff. Where were the price pressures? During the inflationary second half of the 1970s, profits increased a whopping 12% per year in those five years. In 2021, corporate profits rocketed up. Supply disruptions and repressed demand during the pandemic gave businesses pricing power. In 2021, corporate profits increased 18%. If demand was relatively flat, that pricing power had to fade but profit growth was still strong in the first quarter. Like the 1970s, rising corporate profits and pricing power were major contributors to inflation. This week the House Committee on Oversight and Reform (2022) came to a similar conclusion. What is the source of that pricing power?

War in Ukraine

In February 2022, Russia attacked Ukraine, sending energy prices higher. XLE, a broad energy ETF, gained 35% by early March. Two months later, the BEA reported another record rise in real private inventories of $214 billion. However, real final sales fell 2.5%. Some economists pointed to low unemployment and rising wages but ECI wages of private workers were on the same trend as before the pandemic when inflation was low. Most of the rise in the inflation rate was in housing, food and energy prices. The pandemic and low interest rates had contributed to the rise in housing costs. The war in Ukraine was responsible for volatile energy prices. There was no increase in real food sales but food prices were rising. Four large meat producers had profit growth of 134%, the committee reported.

The Puzzle

Historians still argue about the causes of World War I a century ago. Economists still cannot agree on the inflation mechanism of the 1970s. Contributing causes were rising corporate profits, shifting demographics in the work force, oil supply shocks, a shift in the international monetary regime and an evolving trans-global economy in the post war era. Economists do agree that it was a gestalt of market, fiscal and monetary forces, complicated by geopolitical and policy shocks that shaped expectations of future inflation. When people expect further price increases, they buy more now, aggravating inflationary pressures. Those expectations helped entrench inflation in the economy of the 1970s. Paul Volcker, chairman of the Fed in the late 1970s and early 1980s, raised interest rates so high that it wrung inflation out of the economy but at great economic cost to many families. The high interest rates caused two recessions, one of them the worst since the Great Depression.

The Korean War

In answer to the surge of inflation in 1951, the Fed raised rates slightly but rates stayed below 2%. The government did the heavy lifting. In September 1951, President Truman started a regime of wage and price controls administered by the Economic Stabilization Agency (ESA) and Wage Stabilization Board (WSB). There were loud protests against the controls and President Eisenhower ended them after he took office in 1953. Several months later the Korean War ended. In 1971, President Nixon instituted wage and price controls and demonstrated the failure of controls. Monetary policy is the weapon of choice to combat inflation but rising rates disproportionately affect the most vulnerable workers.

Conclusion

Infrequent events are an intersection of many factors that make each one unique. As economists pull apart the tangle of causal narratives, they develop new theories or modify existing ones. Economists usually cling to a favorite – either supply or demand. I’m watching profit growth. If Republicans take the House and possibly the Senate in the coming election, they will try to further enhance corporate profits at the expense of social programs like Medicare and Social Security. Republicans continue to sell a “trickle down” narrative but decades of evidence shows that the trickle is but a few drops. What goes to the top stays at the top.

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Photo by Ana Municio on Unsplash

BEA: Bureau of Economic Analysis. (2019). Chapter 7: Change in private inventories. Retrieved November 4, 2022, from https://www.bea.gov/resources/methodologies/nipa-handbook/pdf/chapter-07.pdf

The House Committee on Oversight and Reform. (2022, November 4). Subcommittee analysis reveals excessive corporate price hikes have hurt consumers and fueled inflation, while enriching certain companies. House Committee on Oversight and Reform. Retrieved November 5, 2022, from https://oversight.house.gov/news/press-releases/subcommittee-analysis-reveals-excessive-corporate-price-hikes-have-hurt

McMahon, T. (2014, April 23). Inflation and CPI consumer price index 1950-1959. InflationData.com. Retrieved November 3, 2022, from https://inflationdata.com/articles/inflation-cpi-consumer-price-index-1950-1959/. Inflation data for 1920-1929 is here https://inflationdata.com/articles/inflation-consumer-price-index-decade-commentary/inflation-cpi-consumer-price-index-1920-1929/

Glootch or Glut?

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March 15, 2015

Retail

Indicators of business activity and confidence have all been strong.  The Purchasing Managers Index, the monthly employment report, and the NFIB small business index have shown exceptional strength in the past several months.  A week after a strong employment report came the worrisome news that retail sales declined for the third month.

A 2% drop in auto sales was the primary driver of February’s decline but the lack of demand is evident in the broader economy.  Excluding auto sales this is the second three month period of declining sales since the recovery began.  Following the slump in 2012, the SP500 sagged about 7%.  The market’s response to this slump has been muted so far.

American businesses had hoped that their customers would spend the dollars saved at the gas pump but consumers may be tucking away some of that cash. The slowdown in retail sales may be partly due to the harsh winter in the east, or a lack of income growth.  The strong dollar has made American products more expensive to export so businesses are especially dependent on domestic demand. Since last summer, prices at the wholesale level have declined steadily.  Commodities other than oil are also showing slack demand.

The inventory to sales ratio has climbed abruptly in the last half of the year.  Businesses make their best guess in anticipating future demand.  A capitalist economy is based on the decision making of millions, not a central committee of a few.  If inventories continue to mount, we can expect that businesses will adjust to the new environment and rein in production and expansion plans.

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Retirement

Twenty years ago I read articles on portfolio diversification like this one and was glad that I wasn’t old enough to be concerned about that kind of stuff.  Then one morning I was shaving and noticed that I was developing a slight turkey wattle in my neck, the same thing I had noticed in my Dad. OMG! I was getting old!
A Bankrate.com blog post features a chart of savings goals that a person at each stage of life should have accumulated to ensure that they can maintain their living standard in retirement.  The benchmarks are based on one’s current income.  Many Americans do not even meet these modest goals.  According to the chart, a person making $60K  who retires at 67 should have $500K in savings and investments.  
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Apple
Telephone and radio were the high tech firms of the early 20th century.  In 1916, ATT was added to the Dow Jones Industrial Average (DJIA), acknowledging that the company had become a pillar of the American economy. 
At the close of trading on March 18th, almost a hundred years later, ATT will be dropped from the DJIA and replaced by Apple, a high tech firm of the 21st century.  Apple’s projected earnings growth for this year may cancel out the anticipated negative earnings growth of the DJIA but Apple is a more volatile stock than stodgy ATT so daily price changes in the index are likely to be a bit more dramatic.
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Budgeting
Last week, economist Greg Mankiw wrote a piece in the New York Times explaining the recent change from static to dynamic budget scoring in the new Congress.  These are two different methods for estimating the effects of proposed tax changes on the budget over the following ten years.  Static scoring, the previous system, has been in place for decades and assumes no changes to the economy resulting from the proposed tax changes.  Dynamic scoring estimates changes in GDP and revenues resulting from the tax changes. Several examples illustrate differences between the two types of scoring.  The article is well written and easy to understand without the use of complicated economic models.

Wild Ride

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October 19, 2014

On Monday, Mabel met for lunch with several friends, both active and retired teachers, to celebrate a new inductee into the Million Mistake Club.  Mabel had once explained it to George, “It started a few decades ago when Mr. Densmore – he taught trigonometry at the school – commented one day in the break room that he had passed the two million mark.  He was probably in his late fifties, early sixties at that time. I had only a few years of teaching under my belt at that time and was still trying to get comfortable in the job.  Mr. Densmore – funny, I don’t think I ever called him by his first name and I can’t remember what it is right now – anyhow, he just seemed to flow so easily into the job.  It was like he wore the job as easily as he wore those old suit jackets he had.  Students that I had discipline problems with in my class behaved well in his class.  I was still trying to figure out the quiet command thing that can make or break a teacher.  He just seemed to make it all look so easy.  I asked him what the two million mark was.  He said it was the number of mistakes he had made in his lifetime.  It didn’t seem possible because it just seemed to me, being fairly new to the job, that he didn’t make any mistakes.  Well, except for his taste in clothes.  He would sometimes wear brown pants with a gray jacket which seemed to emphasize his age.  Mr. Densmore calculated that he made at least a hundred mistakes a day.  Joan – she taught sociology – said that no adult could survive if they made that many mistakes in a day.  Gary, the biology teacher, said that at the cellular level, our bodies probably made at least that many mistakes a day but we correct most of them before the mistakes turn into cancer or we get sick.”

Mabel had paused then, a catch in her throat. “Anyway, on my 28th birthday, several of the teachers, including Mr. Densmore, chipped in for a catered lunch.  Roast beef, some wonderful Italian pastries, potato salad, ice cream.” Mabel paused on her trip down memory lane.  “Security in the schools today.  Probably couldn’t have caterers come in without some planning weeks in advance.”  She went on with her story.  “Instead of wishing me a happy birthday, they inducted me into the million mistake club.  For the first time in my short career at the point, I felt like I was going to make it.  It changed how I taught.  I was no longer trying so hard to get everything just right.  I would discuss the wrong answers on tests with the students.  Why was it wrong?  No, Lee was not the general of the union army that won the battle at Gettysburg.  But what if Lee had been the general of the union army?  How did each army differ and so on.  The A students who were good at memorization stretched their imaginations, their analytical skills.  The C students started taking more interest in the class, participated more in discussion.  The stigma of wrong answers was less.  It became more about learning from our wrong answers.  I would occasionally take time to review episodes in the history of wrong answers, like phlogiston.”

“What’s that?” George asked.  “For a long time people speculated that it was the substance that caused things to burn,” Mabel responded.  “Wow,” George nodded.  “They didn’t know about oxygen yet.  You know, that’s the heart of risk assessment.  Learn from our mistakes.  The insurance business is just one long rocky path through mistakes in figuring out where the risk is, the degree of risk and how to reduce the risk.”

Monday was the Columbus Day holiday and there wasn’t much good economic news to stem the deepening pessimism in the market. Fears over the spread of Ebola just added to the darkening mood.  Mabel would be furious with him if they lost any more money so George sold the two remaining ETFs he hadn’t sold a week or so before.  If he had anticipated this pessimism, why hadn’t he bought an ETF that shorted the market?  The really good employment report in the beginning of October had made him less sure about his earlier forecast of lower prices.  Then he considered – again – buying the 20 Year Treasury ETF but everyone else had been doing that for the past ten days or so and the price was near $121 a share, up about 6% – 7% in the past few week.  Geez, George thought. The buying demand for safety has gotta slow down pretty soon.

Tuesday dawned brighter than Monday’s close but then came the release of a report  from the International Energy Agency forecasting that oil demand in 2014 would be 22% less than previously forecast.  Industrial production in the Eurozone was tepid.  George was surprised that the market finished near Monday’s close.  Maybe this was the end of the downturn in prices.  Like so many retail investors, George had probably sold at the bottom on the previous day.  Of little note to the world that day was the fact that George finally cleaned up the wasp nests above the door to the shed.  There were only two wasps buzzing around so George didn’t feel like a mass murderer.  Where did wasps go for the winter?

On Wednesday morning, George forgot to check the market or economic news before going out to clean up the rock garden.  With all of their money now in cash, George had turned his attention to his seasonal chores.  The climbing vine had shed most of it’s leaves.  The ash tree nearby had shed half of its leaves as well.  As George picked leaves out of the ground cover and other perennials in the garden, he wondered whether he should cut down the climbing vines.  He had planted them years ago to prevent the neighbor’s dog from jumping the fence during lightning storms in the summer.  The dog had died and the vines had spread.  Before lunch, Mabel came out onto the back deck. “George, honey.  The market is going crazy.”  “It’s OK,” George replied, assuring her, “we’re out of the market.”  “Oh,” the worry in her voice evaporated. “Well, just thought you’d want to know.”  Yeh, just wanted to let me know, George thought wryly. He wondered how many money managers had been fielding calls from clients who were worried about a meltdown like the fall of 2008. “Mrs. Jones, the SP500 is only down about 5 or 6 percent from its September peak,” they might tell their clients.  “But I heard that the Dow had dropped 200 points yesterday,” the client might say.  To older clients, anything more than 100 points was big. “Yes, but 200 points is just a bit more than 1%.  And remember, the Dow is only a part of the stock market.”  Yes, the firm is taking prudent care of your money, Mrs. Jones.   Put phone down.  Next phone call from another worried client.

Employment and retail sales are the top two economic reports that consistently set the tone of the market.  When the mood is pessimistic, it doesn’t take much negative news to send things into a tailspin. Wednesday’s retail sales report wasn’t bad but it wasn’t good.  Strong auto sales in August had led to expectations that total retail sales would decline in September.  The decline was just a teeny tiny more than expected, contributing to the wave of selling.  The core retail market without auto sales showed 3% year on year growth.

Part of the decline was because gas prices had been falling, producing less revenue.  What the market wanted to see was that the American consumer was taking that money saved on gas and spending it on back-to-school items, or a fall wardrobe.

The Census Bureau released manufacturing and trade sales data for August that showed a 4.5% year-over-year increase in sales but a 5.7% increase in inventories.  People were not buying as much as distributors were anticipating.  This only seemed to confirm fears that growth in consumer spending might be slowing down.  As though being routed by an opposing army, traders ran for the rear lines.  The SP500 dropped 4% by midday.  As George checked quotes on the SP500 ETF, SPY, he saw that it had climbed up from a bottom near 182.  He was tempted to put a buy order in, taking advantage of an afternoon rally.  Transportation stocks were bouncing up as well.  IYT, the iShares ETF, was bouncing off a midday bottom, indicating that money managers were buying in after the 14% decline from the mid-September highs.  Then George remembered that he had already tried his hand at these really short term trades.  From genius to dunce in a day, he had found that it was not good for him temperamentally.  Plus it took an hourly vigilance that he wasn’t willing to give.  One more report of Ebola in the U.S. could send this market into a dive within a few minutes. He closed the lid of his laptop.  By the end of the day, the Dow Jones had swung more than 600 points. After dropping about 4% during the day, the SP500 closed down only .7% from its previous day close.  Fresh troops in the rear had rallied at the end of the day.

Thursday’s release of October’s Housing Market Index from the National Assn. of Homebuilders showed a reversal of six months of rising sentiment.  More data from the Eurozone indicated that the entire region might be headed back into recession.  Sound the retreat alarm!  The market opened up about 1.5% lower.  Once again the troops in the rear pressed forward to the battle line as attention turned to several positive reports.

New claims for unemployment were near historic lows, prompting a discussion that had been missing for several years: when would unemployment get low enough to generate some wage growth?  George remembered Mabel’s Million Mistake Club earlier in the week.  Decades ago, unemployment levels below 5 or 5-1/2% were thought to be inflationary. This target level was called NAIRU, the Non-Accelerating Inflation Rate of Unemployment. At low levels of unemployment, workers could bargain for higher wages which pushed up the cost of products which pushed up prices which led workers to demand more wages, ad infinitum.  Like the “law” of gravity, this theory of unemployment and inflation had been regarded as solid by both investors and policy makers.  Theories are tested in the passage of time.  During the 1990s, unemployment dropped and did not spark inflation.  Economists scrambled to explain the phenomenon with global trade adjustments to their models. In the 2000s, unemployment fell below 5% and inflation remained tame by historic standards.  More adjustments to the models, more explanations of how the theory was still true. It is still a controversial topic.  (1998 article on NAIRU by Nouriel Roubini )

In addition to the positive employment news, Industrial Production grew in September, notching a 1% monthly gain, and rising back into the sustainable growth zone of 4 – 5%, year-over-year.

“Fix Bayonets, men!” came the call as the greenies beat back the morning onslaught from the reds. Greenies were days when the market closed higher than it opened, red the opposite.  George wondered if some set or prop designer for CNBC would come up with a Civil War soldier set for the talking heads to play with on camera when the market clash over valuation was particularly intense. As a kid, he’d been so disappointed that all the great battles like the Alamo had already been fought.  Santayana’s Mexican legions had rushed forward on the plains of Texas as the small band of brave Texans like Davey Crockett and Jim Bowie prepared for the onslaught.  The good ole days when life was exciting – and much shorter.

Friday was the last day of October option trading. The release of new Housing Starts for September, and strong earnings from G.E. and Morgan Stanley prompted a flood of buy orders at the opening bell on Friday.  The previous months housing starts had been volatile, rising up strongly in July, then falling a lot in August, and now up more than 6% in September.  On a year-over-year basis, September’s starts were up almost 18%.

George was not as awed by the housing data.  The declining peaks of year-over-year percent gains in new housing starts would probably continue.  Friday’s upswing continued shortly after the open when the latest consumer confidence numbers revealed a rising sentiment based on  improvements in employment and lower gas prices.  The price had crossed above both the open and closing prices for the past two days.  Could be a fake out but George hit the buy button. The earnings season would be in full swing next week.