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Rise in Inventories Sounds an Alarm About Inflation

As companies worldwide work to rebuild their stockpiles of goods, they are sending a message about inflation. The trouble is that message is far more worrisome than many people have concluded, and it poses a bigger-than-expected problem for policy makers and the markets. 

Consider last week’s release of U.S. gross domestic product numbers for the fourth quarter. Those who thought that inflation would moderate and that the Federal Reserve wouldn’t have to tighten monetary policy as much as some have feared, myself included, pointed out that some 4.9 percentage points of the 6.9% growth came from an increase in corporate inventories. This, the argument goes, reflected slowing demand. Growth and inflation were thus likely to falter, and the Fed would not have to be as aggressive. The only problem with this reasoning is that it is wrong. Around the world, in fact, the extraordinary thing about corporate inventories is not that they are going up but that they are, in many cases, at record lows. The effort to rebuild them is not just inflationary in itself, it also indicates how entrenched inflation has already become. 

The recent rise in inventories is clearly intentional rather than a consequence of being caught unaware by a shortfall in demand. In the past 12 months or so, companies have had the opposite problem: wholly insufficient inventories to satisfy demand. Survey after survey in country after country has told us as much. Consider this chart:

It shows that a survey of the members of the National Federation of Independent Business, more commonly known as the NFIB, reported that far more companies were dissatisfied with their low level of inventories than ever before. That number has improved in the past couple of months but is still historically high. The second chart, for the whole economy, shows why. The inventory-to-sales ratio — the amount of goods companies have to sell compared with the amount they are selling — has never been lower. 

Put another way, the total amount of U.S. inventories has fallen in absolute, not just relative, terms over the past 12 months — even after taking into account the move in the fourth quarter. This isn’t just a U.S. problem but a global one. As this chart shows, the inventories-to-order ratio in the euro zone is also at a record low:

More astonishing is that these historically low levels of inventories came when growth has been booming. Real year-over-year GDP grew 5.7% in the U.S. and 4.8% in the euro zone in 2021. But real GDP is not the world inhabited by companies or consumers. They operate in a nominal world, albeit one that can be divided into real growth and prices. The numbers that most people look at are more or less accurate derivations of those nominal numbers. U.S. nominal GDP, for example, rose 10% over the past 12 months. For much of that year, one can assume that many companies, just like policy makers, expected price increases to abate.

They didn’t. That is why the GDP deflator — the calculations about prices that convert the nominal GDP world into a real one — continued to climb and reached a year-over-year rate of 5.9% by the fourth quarter. Actually, it’s worse than that. The GDP deflator is the broadest measure of inflation. A more accurate picture comes from looking at the deflator for final sales to private domestic purchasers, a subset of the GDP numbers. This rose by a record 6.25% in the fourth quarter.

The most sensible way of looking at the sharp jump in inventories is that companies are only now coming to the realization that inflation is a more permanent feature of the landscape. And, just as important, they are finding that just-in-time delivery no longer works in a more fragmented world. Both of these surely argue for a sustained pickup in inventory ratios. Companies want more stock, not less, and the price of accumulating it only continues to climb.

Fearful that markets will plummet, central banks are horribly late in tightening monetary policy, and the longer they wait the higher the costs will be. Don’t forget, inflation is a lagging indicator. Slowing real demand is not the cause of lower inflation but the result of high inflation. Central bankers and markets have not yet fully grasped what it will take to wrestle the inflation beast to the ground.

More From Other Writers at Bloomberg Opinion:

• How Worried Should I Be About Soaring Inflation?: Erin Lowry

• Fed Knows What It Needs to Do. Now Comes Hard Part: Bill Dudley

• Be Warned  — the Turbulence This Time Is Different: John Authers

(Updates increase for 2021 euro-zone GDP in the sixth paragraph.)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Richard Cookson was head of research and fund manager at Rubicon Fund Management. He was previously chief investment officer at Citi Private Bank and head of asset-allocation research at HSBC.

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