Are you sure?

Growth, employment may lag amid a global glut of unsold goods

Just-in-time inventories are turning into just-too-much at companies around the world.

From Dodge Ram pickup trucks to Sanyo mobile telephones, unsold goods are piling up around the world. That may become a drag on global economic growth as companies idle workers and production lines to clear out the excess. Factory inventories worldwide rose faster than sales last quarter for the first time since 2001, according to economists at UBS AG in London. Behind the build-up: an unexpected slowdown in demand, especially in the US, brought on by the mid-year surge in energy prices and a housing slump. Reducing the glut will be painful, says Joseph LaVorgna, chief US economist at Deutsche Bank Securities Inc. in New York. “The faster companies clear out inventories, the bigger the hit to the economy,” LaVorgna says. “This could ripple through the economy, to jobs and consumer spending.” Companies as diverse as Rotterdam-based steelmaker Arcelor Mittal, San Francisco-based retailer Williams-Sonoma Inc. And doll-maker Zapf Creation AG of Roedental, Germany, are cutting production and orders to bring stockpiles in line with lower sales. The risk is that the cutbacks start to feed on themselves, damping demand further through slower job growth and investment. Already, economists including Jan Hatzius, chief US economist at Goldman Sachs Group Inc. in New York, and Peter Hooper, chief economist for Deutsche Bank Securities, have reduced forecasts for economic growth to reflect lower output.

Central bankers brush aside concerns about the slowdown, arguing the production cutbacks will be self-correcting rather than self-perpetuating, allowing companies to raise output again once they've worked off the excess supplies. Federal Reserve Chairman Ben S. Bernanke said in a November 28 speech in New York that US economic growth will strengthen next year as the housing slowdown and auto-production cutbacks exert less of a drag on the economy. Bank of Japan Governor Toshihiko Fukui told reporters in Melbourne on November 17 that a build-up of high-tech product stockpiles in his country was “temporary,” and monetary policy wouldn't be “restricted” by it. European Central Bank President Jean-Claude Trichet has signaled the bank will raise interest rates again this week, even after the French economy unexpectedly stagnated in the 3Q as companies sought to reduce inventories.

The adoption of just-in-time inventory management has enabled companies over the last 15 years to shrink the stockpiles they hold in relation to their sales. But it hasn't eliminated unwanted bulges in inventory entirely, especially when economic growth and demand slow abruptly, says Nariman Behravesh, chief economist at Global Insight Inc. in Boston. That's what happened in mid-2000, when manufacturing companies found themselves with too much inventory as exports and capital goods spending tailed off unexpectedly. Nine months later, in March of 2001, the economy slipped into recession. This time, companies have been caught by the steeper-than- expected slump in the US housing industry and the surprise mid- year run-up in energy prices that undercut demand. The problem seems most acute in the US, where the economy grew at an annual rate of 2.2% in the third quarter of 2006, down from 2.6% in the second quarter and 5.6% in the first. Growth would have been even slower were it not for a $58 billion annualized jump in inventories.

US manufacturers said their customers had excess inventories in November for a second straight month, following 64 months in which stocks were lean, according to a survey published December 1 by the Institute for Supply Management of Tempe, Arizona. The survey showed manufacturing in the US contracted last month for the first time in more than three years. “The payback will come in the 4Q as companies seek to cut excess inventories,” says Ian Shepherdson, chief US economist at High Frequency Economics in Valhalla, New York. Roger Kubarych, senior economic adviser at HVB America Inc. and a former Fed economist, says the drag on the economy from inventory cutbacks may last through next year as commodity prices level off following their rapid rise, reducing the incentive for companies to stockpile raw materials. Production cuts are already affecting employment, with manufacturing companies reducing payrolls by 39,000 in October. And there's more to come, says Goldman Sachs' Hatzius, who has reduced his forecast of growth in the 4Q and 1Q to 2% from 2.5%.

“You're going to get further sizable declines in manufacturing employment,” he says. The automobile industry has been hard hit as the surge in oil prices at mid-year diminished demand for sport utility and other large vehicles. Fort Lauderdale, Florida-based AutoNation Inc., the largest US retailer of new and used cars, says it plans to reduce orders from US automakers by as much as 30% in the 4Q. Houston-based Group 1 Automotive Inc., owner of 95 US dealerships, says it's aiming to reduce its inventory of vehicles from U.S. automakers in 2007 to 75 days' supply from 100. Not only the auto industry is suffering. Ingersoll-Rand Co., the Hamilton, Bermuda-based maker of Bobcat backhoes, says its dealers were left with excess stocks after homebuilding slumped in the US Heavy-equipment manufacturer Caterpillar Inc. Of Peoria, Illinois, blames excess supplies for disappointing 3Q profit. And chipmakers Intel Corp. of Santa Clara, California, and Texas Instruments Inc. of Dallas head into the holiday shopping season with record inventories.

Technology companies in Asia are feeling the fallout as the US economic slowdown ripples through the global corporate supply chain. Morris Chang, chairman of Hsinchu, Taiwan-based Taiwan Semiconductor Manufacturing Co., the world's biggest maker of customized chips, said in a November 18 interview that customers may not finish clearing inventories until the 2Q of next year. An unexpected 1.6% increase in Japanese industrial production in October helped alleviate concerns that a big buildup in stockpiles there would lead to immediate cuts in output. Inventories of electronics parts and devices rose 0.1% in October after soaring 7.3% in September. “Persistent high-tech inventory increases are a major concern, but should not prove problematic so long as final demand progresses as planned, including for the US Christmas sales season,” says Takehiro Sato, an economist at Morgan Stanley in Tokyo. Steelmakers are also suffering. Arcelor Mittal, the world's largest steel producer, is cutting European flat-steel production to reduce supplies. In the US, Charlotte, North Carolina-based Nucor Corp. expects shipments to fall this quarter as its distributors work off inventories. “This cuts across a pretty broad swath of industries,” says Michael Feroli, a former Fed official and now an economist at JPMorgan Chase & Co. in New York. “Just-in-time is not necessarily the panacea.” (Bloomberg)