Inventories becoming a drag

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 United States, brought on by the midyear surge in energy prices and a housing slump.


Reducing the glut will be painful, said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York.

"The faster companies clear out inventories, the bigger the hit to the economy," he said. "This could ripple through the economy, to jobs and consumer spending."

Companies as diverse as steelmaker Arcelor Mittal, retailer Williams-Sonoma Inc. and doll-maker Zapf Creation AG are cutting production and orders to bring stockpiles in line with lower sales.

The risk is that the cutbacks start to feed on themselves, dampening demand further through slower job growth and investment.

Economists such as Jan Hatzius, chief U.S. 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.

The adoption of just-in-time inventory management has enabled companies over the past 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 U.S. housing industry and the surprise mid-year increase in energy prices that undercut demand.

The problem seems most acute in the United States, where the economy grew at an annual rate of 2.2 percent in the third quarter of 2006, down from 2.6 percent in the second quarter and 5.6 percent in the first. Growth would have been even slower were it not for a $58 billion annualized increase in inventories.

U.S. manufacturers said their customers had excess inventories in November for a second straight month, after 64 months in which stocks were lean, according to a survey published Dec. 1 by the Institute for Supply Management of Tempe, Ariz.

The survey showed manufacturing in the U.S. contracted last month for the first time in more than three years.

"The payback will come in the fourth quarter as companies seek to cut excess inventories," says Ian C. Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, N.Y.

Roger M. Kubarych, senior economic adviser at HVB America Inc. and a former Federal Reserve economist, says the drag on the economy from inventory cutbacks may last through next year as commodity prices level off after their rapid rise, reducing the incentive for companies to stockpile raw materials.


Production cuts are 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 fourth and first quarters to 2 percent from 2.5 percent.

"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 midyear diminished demand for sport utility and other large vehicles. AutoNation Inc., the largest U.S. retailer of new and used cars, says it plans to reduce orders from U.S. automakers by as much as 30 percent in the fourth quarter.

Group 1 Automotive Inc., owner of 95 U.S. dealerships, says it is 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 maker of Bobcat backhoes, says its dealers were left with excess stocks after homebuilding slumped in the U.S.

Heavy-equipment manufacturer Caterpillar Inc. blames excess supplies for disappointing third-quarter profit. And chipmakers Intel Corp. and Texas Instruments Inc. head into the holiday shopping season with record inventories.


Technology companies in Asia are feeling the fallout. Morris Chang, chairman of Taiwan Semiconductor Manufacturing Co., the world's biggest maker of customized chips, said last month that customers may not clear up inventory backlogs until the second quarter of next year.

Steelmakers are also suffering. Arcelor Mittal, the world's largest steel producer, is cutting European flat-steel production to reduce supplies. In the U.S., 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."