Remember the inventory effect people like Roubini were trashing for boosting U.S. GDP growth during the last quarter? In case you don’t remember, inventory growth caused 1.44% of the 2% U.S. GDP growth figure.
Well, Goldman Sachs explains why the latest inventory growth isn’t something to be written off.
Goldman Sachs’ Andrew Tilton:
Inventories are coming off exceptionally low levels. The inventory-to-sales ratio in the US goods sector reached an all-time low earlier this year. Many companies may therefore want inventories to grow, perhaps even faster than sales for a while. This doesn’t change the fact that rapidly-rising inventories are ultimately unsustainable, but it may mean that producers can be more patient before adjusting output, leaving more time for true demand growth to pick up. Also, insofar as the increase in inventories results from more raw material inputs (rather than more finished goods), it does not necessarily signal that manufacturing firms are producing too much.
They also highlight how cost savings on imports from China and on raw materials may have spurred firms to boost inventory levels. Regardless, they highlight that companies are building inventories because they want to, and that this process could continue as low inventory-to-sales ratios bump up against demand growth.
Although we are unsure of how much weight to put on these explanations, one common theme connects them – they reflect desired increases in inventories, rather than an undesired buildup resulting from overly optimistic demand projections. This in turn would suggest that inventory growth only needs to slow to the rate of demand growth, rather than below it. So insofar as the inventory buildup is desired, it would imply less risk of a sharp slowing ahead than the inventory data might suggest on the surface.
(Via Goldman Sachs, Inventories and ISM, Andrew Tilton, 3 November 2010)