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April 27, 1 979 Inventory Excess? The nation's economic activity remained practically flat in the first quarter of 1 979, except in the area of inventory spending. According to preliminary GN P data, real inventory investment increased 45 percent over the preceding quarter, and this information was buttressed by earl ier monthly reports from manufacturers and. distributors. The National Association of Purchasing Management, for instance, noted 'that purchasedmaterials inventories increased sharply in March, and the percentage of members reporting higher stocks was the highest since last July. This raises several questions: 1. Is the stock buildup basically speculative in nature? As such, it could be a sign of an ongoing inventory boom, wh ich wi II be followed by a sharper than expected economic slowdown. 2. Is the inventory accumulation largely involuntary, the resultofweaker than anticipated first-quarter sales? If so, the undesired stocks may be signalling the beginning of a classical inventory cycle, with this buildup to be followed by a sharp cutback later on. 3. Is the first-quarter buildup largely a voluntary effort to replenish stocks after an unanticipated fourth-quarter surge in sales? If so, current inventory behavior does not necessarily indicate any economic weakness, but simply represents another stage in the series of mini-cycles which have characterized this four-year-old business expansion. No speculativebuildup Recent data do not indicate any substantial speculative buildup, on the basis of movements in the three different types of factory stocks materials and supplies, work in process, and finished goods. During the 1974 speculative binge, manufacturers built up very large inventories of materials and supplies, in anticipation of higher prices and major shortages in the future. Altogether, materials and supplies constituted 48 percent of the entire buildup in that year. In contrast, materials and supplies constituted only 29 percent of the inventory buildup in the first two months of 1979. Indeed, during the past few months, the distribution of inventories by stage of fabrication was closest to the pattern existing in 1978, a period characterized by conservative inventory policies. Some analysts suggest that the buildup was not purely speculative, but was related to a desire'to build up stocks in anticipation of a lengthy Teamsters' strike. There may have been some of this, but it was probably minor. In fact, a weekly Labor Department survey on the strike's impact provided no evidence that businesses had stockpiled materials to any significant degree in anticipation of the strike. The second possibility was that business firms accumulated inventories involuntarily, because of the weakerthan-expected pattern of final sales (continued on page 2) (total GN P less inventorv soendingL This may have been true some nnes, but the aggregate statistics show little evidence of such a buildup. If this had been true, manufacturers' finishedgoods inventories would have increased sharply. However, finished goods accounted for only 26 percent of the total buildup in January and Februaryin contrast to the situation during the heavy 1 974 buildup, when they accounted for almost 30 percent of the total increase. Deliberate buildup The third possibility-a conscious desire to replenish stocks-seems to be the most likely explanation on the basis of available evidence. At the beginning of 1 979, stocks were at historically low levels relative to sales, because of the unexpectedly rapid pace of sales during the final quarter of 1978. Consequently: the strong first-quarter accumulation " did nQ more than return stock/sales ratios to the average level maintained throughout most of the 1 977-78 period, when cautious management policies kept atight leash on inventories. Th is pattern of conservative inventory management shows up in the ratios, no matter whether they are calculated on a constant-dollar or book-value basis . (see chart). The book-value figures should be discounted because of their downward bias during periods of inflation. (Under this measure, inventories are valued at a mix of current and lower past prices; while sales are valued at current prices only.) But the ratios when calculated on a book-value basis are sti II usefu I for short-term comparisons, and for that matter, are Publicatnons Available Copies now avai lable of two recent speeches by John J.Balles, President of the Federal Reserve Bank of San Francisco. "U. S. - Japan Economic Relations" outl i nes steps that shou Id be taken by the two nations to stabi Iize the dollar and reduce barriers to world trade and finance. "Inflation - Causes and Prospects" discusses the role of monetary and fiscal policy in the current inflationary situation. Free copies of these and other Reserve Bank publications can be obtained by calling or writing the Public Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 941 20. Phone (41 5) 544-21 84. 2 widely used because they are ava!!ab!e on a more timely basis than the constant-dollar ratios. derivedfrom the GNPstatistics,suchas On a constant-dollar basis, adjusted for inflation, the very low stock/sales ratio of fourth-quarter 1978 was matched only by the ratio reached in fourthquarter 1972 and first-quarter 1973 -a period of materials shortages and rapidly rising final sales. Despite the recent increase, from 1.52in fourth-quarter 1978 to an estimated 1.55 in firstquarter 1979, the ratio still remains in line with the average maintained throughout most of the cautious 197778 period. And from early indications, the same holds true for other ratios On balance, inventories have remained at relatively moderate levels in recent months. This has favorable implications for the national economy. Five of the past six business cycles have been characterized by an unintentional buildup and subsequent liquidation of stocks. But if business firms continue their conservative inventory policies of . the past two years, they can help ensure". that any future softening of the economy will not degenerate into a more severe decline. the inflation-adjusted ratio of total inventories to final sales. RoseMcElhattan Ratio INVENTORY - SALES RATIOS 1.8 1.6 Book Value .." 1.4 Manufacturing 1969 3 and Trade 1971 1973 1975 1977 1979 uOl8U!45PM• 4Pln • uo8aJO • ppPi\aN • o4PPI HPMPH • P!UJoJ!lP::)• PUOZ! N • P>j5PIV CG> 'jll\\!:> 'OJSPU\\!J;j ues lS":::'ON 11W2I3d OIVd :J!lV1 S0d 's'n llVW SSVl:>1S2II:I JJ BANKINGDATA-TWIELFTHFEDERAL RESERVE DISTRICT (Dollar amounts in millions) Selected Assetsandliabilities largeCommercialBanks Loans(gross,adjusted)and investments* Loans(gross,adjusted)- total# Commercial and industrial Realestate Loansto individuals Securitiesloans U.s. Treasurysecurities* Other securities* Demand deposits - total# Demand deposits - adjusted Savingsdeposits - total Time deposits - total# Individuals, part. & corp. (LargenegotiableCD's) Averages of Daily Figures MemberBankReserve Position Amount Outstanding 4/11/79 123,760 101,030 29,873 36,012 20,883 1,571 7,992 14,738 43,683 31,904 30,131 49,841 40,570 17,562 Weekended 4/11/79 ExcessReserves(+ )/Deficiency (-) Borrowings Net free reserves(+ )/Net borrowed(- ) Change from 4/4/79 - - - Changefrom yearago @ Dollar Percent + 17,123 + 16,913 + 3,885 + 7,664 148 181 184 157 86 298 137 192 184 943 88 50 18 102 + + + + + + Weekended 4/4/79 16.06 20.11 14.95 27.04 -NA NA NA NA 100 1.24 310 + 2.15 3,553 + 8.85 2,241 + 7.55 413 - 1.35 8,674 + 21.07 8,144 + 25.12 2,861 + 19.46 Comparable year-agoperiod + + + + 52 11 41 48 65 17 55 16 71 + 2,701 + 1,506 + 1,951 FederalFunds- Sevenlarge Banks Net interbank transactions [Purchases(+ )/Sales(-)] Net, U.s. Securitiesdealer transactions [Loans(+ )/Borrowings (-)] + 737 + 222 + 111 * Excludestradingaccountsecurities. # Includesitemsnot shownseparately. @ Historicaldataarenot strictlycomparable dueto changes in thereportingpanel;however,adjustments havebeenappliedto 1978datato removeasmuchaspossibletheeffectsof.thechanges in coverage. In addition,for someitems,historicaldataarenotavailabledueto definitionalchanges. Editorialcommentsmaybeaddressed to theeditor(WilliamBurke)or to theauthor.... Freecopiesof this andotherFederalReserve publicationscanbe obtainedby callingor writingthePublic InformationSection,FederalReserve Bankof SanFrancisco, P.O.Box7702,SanFrancisco 94120.Phone(415) 544-2184.
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