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40% of US GDP growth since 2012 due to inventory build

Consumer demand
By Paul Hodges on 01-Aug-2014

US GDP Jul14Wild swings in key data make for great Twitter feeds.  But they don’t help the rest of us to understand what is really happening.  This week’s report on US GDP for Q2 is a good example:

  • Q2 saw GDP up 4%, after Q1’s 2.1% decline and Q4’s 3.5% gain (blue column)
  • But as the chart shows, the main factor is actually inventory changes, up and down (red)

Even more important is that the data shows inventory build has been a major component of reported GDP growth since 2012:

  • GDP has risen a net 3.9% over the 2.5 years
  • Inventories have risen a net 1.6% over the same period
  • Total inventory growth is thus 40% of total GDP growth

The key is that personal consumption is more than 2/3rds of total GDP.  And the data shows that companies have been building inventory in advance of a recovery which never comes.  Once we focus on this, the pattern becomes clear:

The cycle starts:  Companies build inventory because they expect better demand in the future.  They have to have product in the shop or warehouse before they can hope to sell it to the consumer.  And they keep being told by central banks that recovery in demand is just about to happen.

Demand disappoints.  But then the expected demand doesn’t actually arrive.  Now they have piles of unsold goods that need to be sold quickly.  So they reduce prices, and cut back future orders.

Lower prices drive sales growth.  Consumers see the lower prices and decide they can now afford to buy the product, and so the inventory reduces.

In turn, companies assume demand must finally be starting to improve, and central banks announce recovery is now inevitable.  So the cycle starts again.

The US auto industry provides a classic example of this pattern.  It is a major source of consumer demand, and companies normally expect increased demand as they launch the new model year in August.  But demand did not take off last August as expected, leading to an inventory build in Q4 2013.

Companies then watched inventory sit at dealers and in factories through Q1.  So they decided to cut this inventory via major price cuts. By July, these were $2.8k, up an average 8.4% from a year ago, and at the highest level since July 2010.

The blog highlighted this in real time back in March.  It seemed rather obvious then that these price cuts would drive major sales growth as consumers rushed to capture the bargains on offer.  It thus headlined the post:

US automakers increase incentives as sales fail to boom”. 

And it suggested now was a good time to buy a new car:

“The reason is that auto manufacturers had believed that a recovery in consumer spending and the economy had become inevitable.  Thus they had built inventories of new cars in anticipation of the sales rush.

“These are now at a 9-year high according to analysts Ward Autos, with those for cars at nearly 95 days of sales.  Total inventory of 3.6m was the highest since the 3.9m seen in January 2005.”

This type of basic analysis is surely not rocket science.

The problem seems to be that it doesn’t fit into the 140 character limit of a Twitter feed.  That demands “instant analysis” instead.

And policymakers certainly won’t explain what is happening, as they would then have to admit their policies have failed.

Total GDP growth of just 2.3% over the past 2.5 years, after deducting inventory build, doesn’t seem a great return for the $10tn spent so far on stimulus