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August 29,1975

Inventory Tim e
Many observers (including this
one) have argued for years that
inventory control was becoming
an exact science because of the
advent of computers and modern
management techniques. But
1974's experience belied all that.
Overnight, it seemed, an econo­
my of shortages was transformed
into an economy of gluts, and
every warehouse and storage yard
in the nation became filled to
overflowing. Hard on the heels of
a severe consumer recession, the
worst inventory recession in a

generation struck in full force,
causing a $38-billion cut in GNP
(annual rate) between the second
half of 1974 and the first half of 1975.
It wasn't anyone's fault in particu­
lar. Businessmen's orderbooks
were bulging—how were they to
know the extent of double- and
triple-ordering involved?—and in
an inflationary atmosphere, they felt
impelled to buy feverishly to beat
ever-impending price increases.
Worse still, the official inventory
statistics turned out to be mislead­
ing, as 1974 data revisions showed.
Analysts found that the usual
inventory - sales ratio had under­
stated the massive 1973-74 buildup,
not only because of the weakness
of the underlying data but also
because of the impact of inflation.
In the traditional formula, the
inventory stocks in the numerator of
this ratio are valued in prices of
earlier periods, while sales in the
denominator are valued in
(much higher) prices of the current
period. This inflation-caused unDigitizld for FRA SER


derstatement was largest in the
case of the last-in-first-out (LIFO)
accounting technique.
Better measure
This experience has led forecasters
to place more reliance on the
ratio, in constant-dollar terms, of
the total stock of business inven­
tories to final sales in the business
sector of the economy. The ratio
represents physical relationships
that are not influenced by relative
price changes. Also, this measure
is broader than the conventional
manufacturing-and-trade ratio,
since it covers the entire business
economy, including agriculture,
mining, construction, and the
service industries.
This broad inventory ratio trended
irregularly downward between
the late 1940s and the mid-1960s,
giving strong support to the theory
of ever-increasing efficiency of
inventory management. There
were wide cyclical swings, with
the ratio falling in booms as stock­
rooms were stripped clean and
rising in the early stages of reces­
sion as unwanted inventories piled
up. However, the trend was
clearly down, with inventories
amounting to about 34 percent
of final business sales in early 1947
and only 29 percent of business
sales in early 1966. But then a
reversal occurred. The ratio rose to
almost 32 percent in the 1970
recession, fell again to the 29percent lowpoint in the early1973 boom, and then soared to 33
percent in late 1974. Despite 1975's
severe cutbacks, real inventories
(continued on page 2)

Opinions expressed in this newsletter do not
necessarily reflect the views of the management of the
Federal Reserve Bank of San Francisco, nor of the Board
of Governors of the Federal Reserve System.

still amounted.to 3V/2 percent of
final business sales this spring, or
higher than at practically any other
time in the last two decades.
This evidence is supported by
detailed data available for durablegoods manufacturing, where most
of the problem is now centered.
(Liquidation of durable stocks
began late in the first quarter,
somewhat later than in trade or in
nondurable manufacturing.) Al­
though the data are stated in
current-dollar instead of real terms,
and thus distorted somewhat by
inflation, they provide useful in­
formation by permitting an anal­
ysis of durable-goods stocks by
stage of fabrication.
The level of raw-material and
goods-in-process inventories,
when related to unfilled orders of
durable goods, is one indication
of the continuing glut. This ratio (in
current-dollar terms) jumped
from 52 percent in mid-1974 to 64
percent in mid-1975, as manufactur­
ers watched their stocks pile up in
the face of rapidly falling backlogs.
The same problem has been
evident at the final production
stage. The ratio of durable
finished-goods inventories to ship­
ments has risen from a relatively low
46 percent to a relatively high 61
percent over the past year, with
stocks continuing to climb in the
face of falling sales to final buyers.

Digitized for FRA SER


Conflicting pressures
The wild cyclical swings revealed by
all these ratios are an important
part of the inventory problem, but
equally critical is the apparent
reversal during the past decade of
the postwar trend toward lower
inventory ratios. Several factors
have continued to put downward
pressure on shelf-space require­
ments. The greatest efficiencies
have come from innovations in
operations-research and compu­
ter techniques, which have
helped to conserve inventories
by speeding up stock control and
improving the locational efficiency
of plants and warehouses. Long­
term changes in the composition
of the economy have also tended
to reduce the required level of
stocks. Service industries, whose
inventory requirements are much
lower than those of other indus­
tries, have grown half again as fast as
manufacturing industries over
the past decade and a half.
By the late 1960’s, however, these
forces began to be offset by other
factors generating higher invento­
ry ratios. One was a Vietnam-related
buildup of inventories of defense
products, especially aircraft. At all
times, inventories are quite large
in the durable-goods sector, since
manufacturers must hold on to
large quantities of goods in process
because of the long time-span
between order-taking and deliv­
ery. During the Vietnam buildup,
this was especially true for air­
craft and other products with long
manufacturing lead-times.

Another factor generating everlarger inventories has been the
force of inflation, which in 1973-74
led purchasing agents to ignore
the heavy cost of inventory finan­
cing and to participate in a head­
long flight into goods. In this
period, purchasers steadily built up
their stocks of materials and
finished goods, acting on the
assumption that their sales would
continue to expand at ever-higher
prices. Yet another factor aggra­
vating the situation has been the
cyclical pattern of purchasing habits.
As sales picked up in the recent
boom, purchasing agents all in­
creased their orders simultane­
ously, and hard-pressed suppliers
stretched out their delivery times.
But with longer delivery times,
purchasers decided to increase their
desired levels of inventories and
thus expanded their orders even
more. This feedback process
built on itself and created massive
order backlogs.
Shifts in *75
The latter factor was reversed in
early 1975. With the sales reduc­
tions of the past year or so, order
backlogs have gradually been
worked down. With inventory
goals achieved, purchasing agents
have reduced their orders, and the
result has been a significant
decline in lead times and in
shipments. Only 24 percent of all
major firms were reporting slower
deliveries this spring, compared
with 88 percent of the total in early
1974. With lead times shrinking in
this fashion, and with sales falling

Digitized for FRA SER


relative to current production
levels, purchasing agents have
pared orders even more to reduce
inventories; this in turn has cut
lead times further, giving
another push to the downward
cycle.
The inventory liquidation, the
worst of our generation, should
come to an end in the latter part of
this year as desired inventory
positions are restored and as rising
final sales create the need for new
inventories. Even with no net
increase in stocks, the snapback
from the first half's steep decline
would mean a $25-billion boost to
the GNP totals. Moreover, the
recent increase in defense pur­
chases, with prime-contract awards
rising 13 percent over a year ago,
should expand the needs for
goods-in-process inventories.
And finally, the recent price
acceleration, exemplified by July's
(and August's?) double-digit rate
of increase in wholesale prices,
could generate another wave of
advance ordering in coming
months. This may be the crucial
near-term determinant of invento­
ry behavior. In the absence of
renewed inflation, purchasing
agents could concentrate on the
cost-cutting, profit-enhancing
aspects of inventory management,
and thereby create the atmos­
phere for a solidly based business
upturn.
William Burke

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BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
Large Commercial Banks

Amount
Outstanding
8/13/75

Loans (gross, adjusted) and investments*
Loans (gross, adjusted)—total
Security loans
Commercial and industrial
Real estate
Consumer instalment
U.S. Treasury securities
O ther securities
Deposits (less cash items)—total*
Demand deposits (adjusted)
U.S. Government deposits
Time deposits—total*
States and political subdivisions
Savings deposits
Other time deposits:):
Large negotiable CD's

84,797
63,785
1,070
22,826
19,568
9,906
8,234
12,778
84,519
23,379
315
59,441
6,145
20,667
28,954
15,135

Weekly Averages
of Daily Figures

W eek ended
8/13/75

Member Bank Reserve Position
Excess Reserves
Borrowings
Net free (+) / Net borrowed (-)
Federal Funds—Seven Large Banks
Interbank Federal fund transactions
Net purchases (+) / Net sales (-)
Transactions of U.S. security dealers
Net loans (+) / Net borrowings (-)

+

Change
from
8/06/75
-

+
+
+
+
+
+
-

+
-

+
+
+

18
5
13

55
131
89
180
22
14
35
41
32
35
135
258
138
14
268
313

Change from
year ago
Dollar
Percent
+
754
- 2,231
89
878
179
+
345
+ 3,255
270
+ 4,569
+
920
+
2
+ 3,805
+
192
+ 2,857
+
376
250
-

W eek ended
8/06/75

+

+
-

+
+
-

+
+
+
+
+
+
+
-

0.90
3.38
7.68
3.70
0.91
3.61
65.37
2.07
5.71
4.10
0.64
6.84
3.23
16.04
1.32
1.62

Comparable
year-ago period

34
10
24

-

29
226
197

+ 1,752.7

+ 1,474.2

+ 1,276.9

+

+

+

554.2

294.9

530.3

■"Includes items not shown separately. ^Individuals, partnerships and corporations.

Information on this and other publications can be obtained by calling or writing the Public
Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120.
^ x
__r.Phone (415) 397-1137.
Digitized for FR A SER '
'
http://fraser.stlouisfed.org/

Federal Reserve Bank of St. Louis