Thursday, July 10, 2014

The Boring Economics of the Next Recession

Polar Vortices,
non-compliant consumer confidence,
and just an utter lack of appreciation for what Obama has done for us aside,

excuses for the last quarter of -2.9% growth don't really focus on the boring fundamentals of economics.

One of those being (one of my favorites) the "Inventory to Sales" ratio.

This ratio compares corporate inventories to sales.  But before you fall asleep, allow me to explain why this is one of the better ratios you should be paying attention to.

Inventories are made by humans, namely employees.  Ergo inventory levels is a great predictor of employment.  If there is a glut of inventory you can expect companies to lay people off.  If there is a shortage of inventory, you can expect companies to hire people.  But how do you determine if there's a glut or a surplus?

You compare your inventories to current sales.

This shows you how much demand there is for a product (sales) versus how much is currently available (inventories). 

Naturally you'd like this ratio to be as low as possible.  You want inventory (the numerator) to be very low, not just because it would suggest future employment, but because it costs money to store inventory.  And you want sales to be high so that companies are profitable and there is demand for what is being made.

But an interesting thing has happened with the inventory to sales ratio in that it is perpetually decreasing.  This is because of improvements in inventory management, supply chain management, the internet (you don't even have inventory), JIT methods, and just generally improving managerial methods.  Ergo, you should not be concerned only when the inventory to sales ratio spikes, but you should be concerned when it flat lines or does not continue to decrease for a significant period of time, and that's what we have today.

Naturally you see just how crushing the Great Recession was where everybody just cut back on spending, causing inventory levels to soar.  But that outlier aside you can see jumps in this ratio correlate with recessions (and economic slow downs which aren't highlighted in gray) and, more pertinent to today, the slight and stubborn trend upward for the past 4 years.

It is here my Keynesian inferiors would demand more government spending, get that aggregate demand up, we haven't done enough, etc., etc.  But I will once again defer to my theory that these Keynesian geniuses fail to account for human psychology.  Namely the "smart money," consisting of people who pay attention the finances, budget, and economics of the country are scared stiff to spend, let alone invest, given the undermining of the country's finances.  Throw in a financially crippled 20-30 something generation that normally WOULD be buying houses, consumer goods, and starting businesses, but can't because of student debts and an insulting job market, and it's no surprise this ratio refuses to obey according to historical trends.

Sadly, ratios like the inventory to sales ratio are not sexy, exciting or make for good yellow journalism.  But if you are truly interested in how the economy works and want to predict the next recession, it's boring statistics like these that will help in that endeavor.


Peregrine John said...

See, this is why we like it when you do economic stuff. Why I do, anyway. I'm just an idiot creative: musician, designer. My biz major friends in college were always studying things that made no sense, with names for enormously different concepts that sounded almost exactly alike. So when explanations like this happen along - and I'll warrant it's really basic from your point of view - it not only helps my understanding of why things happen, it sharpens my sword for the ongoing battle against Keynesians who are objectively dumber than me but who have all those fancy terms to drop at random.

Anonymous said...

Small bites of economics is good stuff. Short not too long..informative. Keep posting the econ stuff once every now and then. Thanks

Robert What? said...

I agree with JP. I definitely like when you do the economic stuff, too. But then again, I'm an older dude, so maybe I am out-of-touch.

YukonCornelius said...


Long-time reader, first-time poster..Great blog, enjoy almost all of your stuff.

As a young and upcoming (I think?) millenial I get that the financial situation here is dire, if not downright apocalyptic. I also get that I am more or less fucked and that my generation is retarded..

My question is: for a relatively younger person with only minor skin in the game, what is the best way to make a buck and/or profit from all the uncertainty out there??

I constantly read on here about how the end is near, but the fact of the matter is (barring another Clinton presidency) I'm not going anywhere. If the US goes its all over anyway. I would prefer to be in position to pick up the pieces and re-build after TSHTF.

Assuming interest rates rise within the next 5 years (or sooner, obviously), prices in the bond market should tank, right? Is there a good way to catch this falling knife? Can you (or someone else) recommend some literature on shorting the bond market and/or working on yield spreads?

Any other ideas on possibly profiting and embracing the chaos, instead of the "duck and cover" approach?

- Yukon