A "New Normal" Business Era

The inventory-to-sales ratio remained flat in September, but its nearly year-long decline nevertheless reflects both typical, cyclical caution that one normally sees following an economic trough, and most likely an awareness by businesses that consumer spending during the next expansion may not return to previous growth rates, due to the "frugal consumer" era. The ratio, an indicator of demand, remained at 1.32 in September. In April, the ratio was at 1.43.

In September, a decline in manufacturing and merchant wholesale inventories was only slightly offset by an increase in retail inventories, with the latter primarily boosted by the re-stocking of auto inventories depleted by the government's "cash-for-clunkers" program.

In general, economists prefer to see business inventories decline during a recession, as this has historically indicated that businesses are bringing inventories back in line with reduced demand, taking excess supply out of the system.

However, the long draw-down in inventories during the pronounced recession should help boost the U.S. economy in the immediate quarters ahead, assuming demand is sustained. That's because businesses will need to restock shelves to avoid being product-short as the expansion continues, with those orders for new goods increasing manufacturing activity, boosting GDP.

Economic Analysis

Given the year-long inventory decline, the evidence now suggests businesses have slashed inventories more than they should have -- that is, they've overreacted regarding worries about having product they couldn't sell and cut inventories too much -- and this is going to boost commercial activity. What's more, this will require an increase in jobs at the manufacturing level. True, manufacturers are more efficient today than at the start of the last economic expansion in 2002, but any protracted increase in demand over one year will have businesses scrambling to restock shelves to keep up with both retail and wholesale (business-to-business) demand. Eventually, this has to result in a net increase in jobs at the producer level.