The Other Side of This ‘Inflation’ Is Inventory

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Commentary 

If you had to describe last year using only a single word, for most people the world they’d choose would probably be “shortages.” Everything from new cars to chicken tenders seemed to be in short supply. There were the not-infrequent social media outbursts flooding people’s screens with images of bare grocery store shelves, the search-term #emtpyshelvesBiden repeatedly trending.

This snapshot of life in 2021 America was equally consistent with the way in which overall consumer prices performed. The cost of living, the amount Americans paid for pretty much everything shot up last year. Basic economics, when goods are hard to come by their price will rise; the harder it is to find whatever, the more whatever will cost.

Contrary to popular belief, this doesn’t necessarily count as inflation. There are various reasons why consumer prices might be rising, including the supply squeeze or shock scenario we’re all still trying to get through as 2022 really gets going.

Textbook inflation, however, is always and everywhere a monetary phenomenon. And while, again, public perception has linked skyrocketing costs of living with the concept of “money printing”—either from the Federal Reserve’s quantitative easing, called QE, or the federal government’s gross handouts in the early part of 2021—neither of those had actually been.

The Fed only creates bank reserves, a form of interbank token which can’t be used outside of the banking system. Our federal government borrowed in the Treasury market to fund essentially “helicopter” payments directly to U.S. citizens as well as stipends/grants paid to all kinds of businesses (along with wasting untold billions on any number of illicit scam arrangements).

At most, Uncle Sam’s “generosity” had the effect of temporarily shifting the demand curve out to the right. What that means is U.S. consumer demand for goods was increased since, from the consumer’s perspective, everyone had just been handed what sure looked like free money.

While some of it may have been helpful and even necessary given just how badly too many had been harmed by the same government’s response to the pandemic, quite a lot was simply used to finance purchases of durable goods in particular.

The same goods had become increasingly hard to produce, such as new cars when semiconductor chips weren’t available. Putting this in economic terms, too, while the demand curve shifted to the right, the supply curve had become rigidly inelastic.

Inelastic supply is a situation when producers, suppliers, or even shippers are not able to meet an increase in demand as they typically would by raising production; or so easily moving goods from producers to end market. Just as the buying in goods reached a feverish pace, manufacturers (globally) struggled mightily in 2021 to ramp back up from having been shut down in 2020 while at the same time the transportation system bogged down by any number of gross inefficiencies.

Worse still, as this whole supply chain jammed up, U.S. retailers and wholesalers responded to the jam by intentionally over-ordering. As the Christmas shopping season approached, and transportation issues remained unsolved, companies began to double- even triple-order on goods just to assure something got through to them—which only made things worse on ships, at port, in containers, basically everything.

Vice President Kamala Harris had even warned the public last August, “The stories we’re hearing now about the warning that if you want to get Christmas toys for your kids, now may be the time to start buying them, because the delay could be several months.”

Though Christmas presents thankfully were not canceled by West Coast port delays and railroad snafus in Chicago, the issue did not end for retailers or wholesalers who survived November and December with only minimal setbacks. Eventually, everything they had requested in the runup to the season, was all going to show up at some point.

According to the latest Census Bureau’s estimates, retail and wholesale inventories had skyrocketed in an unprecedented fashion over the final months of 2021, and have spilled over, so far, into January and February 2022. In fact, retail inventories (excluding automobiles) grew by a record-shattering 3.9 percent in December alone—a single month’s increase of more than double the rate of the previous record.

This was followed by a 1.7 percent month-over-month rise in January, the second most in the data’s history dating back to 1992.

Wholesale inventories have exploded, too, especially when you factor out low inventories of petroleum and automobiles. For all other types of goods, the buildup is immense.

While this may at first appear to be at odds with #emptyshelves, it really isn’t given how difficulties and inelasticity in supply had shifted more toward shipping than producing as time progressed.

In other words, manufacturers in many industries caught up with demand, or had at least substantially closed the gap. Any grocery and department stores displays left bare by January weren’t vacant because there wasn’t enough product, rather even now it’s too much of a chore to move this looming mountain of goods so nimbly from wherever it might be currently to where it ultimately needs to go to get into consumers’ hands.

As a result of this combination of factors, The Logistics Managers Index (LMI) for February 2022 increased to its own record high, mainly due to the surge in its Inventory Level subcomponent. This was noted to be, “the highest value ever for the index as a combination of over-ordering to avoid shortages, late-arriving goods due to supply chain congestion, and a softening of consumer spending has created a logjam.”

These are classic signs of the downside to the supply shock case, clear symptoms that consumer prices last year hadn’t been inflation, rather a temporary imbalance between artificial demand and inelastic supply that would, given time, inevitably work itself out … and then some.

“Late-arriving goods” can very easily become way too many, just in time for the “softening of consumer spending” and record accumulation of inventory which causes everyone to pull back—retailers stop ordering from wholesalers who in turn might even cancel some of their own orders from manufacturers that are then forced to slow maybe even contract production levels all over again.

These are possible cyclical even recessionary challenges and they are trouble for any economy, even more so for our current American situation given that consumer spending on goods has been its lone bright spot. Contrary to another popular misconception, the overall U.S. economy outside of goods hasn’t been (pardon the pun) good.

The services sector has not yet come close to recovering from 2020; a fact hardly anyone includes in their “inflation” analysis.

Should the goods part of the economy weaken, with services continuing to struggle mightily, the downside risks to the whole economy build as much as inventory does. And this is one key reason why the credit market—including eurodollar futures—is betting more and more against the Fed’s rate hikes. Though consumer prices accelerated wildly, it was never really inflation.