U.S. business inventories plunge record 1.5 percent

U.S. businesses continue to reduce excess inventory as they cut costs and re-align their operations with consumer demand: business inventories plunged a record 1.5 percent in August, the U.S. Commerce Department announced Wednesday, led by a decline in retail and auto inventories.

The 1.5 percent August inventory decline ties a 17-year record dip. Business inventories also declined 1.5 percent in December 2008 and in October 2001.

Economists surveyed by Bloomberg News had expected inventories to decline 0.9 percent in August. Inventories fell a revised 1.0 percent in July and dropped 1.4 percent in June. Further, inventories have fallen 11.8 percent in the past year, and have declined for 12 straight months. However, these leaner inventories should boost GDP when businesses re-stock shelves during the recovery, most economists agree.

In August, retail inventories fell 2.3 percent and are now 15.1 percent lower than a year ago. Also, auto inventories sank 7.9 percent in August -- a statistic that reflects sales activity stemming from the federal government's recently-completed cash-for-clunkers program.

In addition, in the past 12 months manufacturing inventories have plummeted 11.4 percent.

Meanwhile, sales rose 1.0 percent in August, after rising 0.1 percent in July and 0.9 percent in June. Sales have declined 15.0 percent in the past 12 months.

Businesses: adjusting to new era

Further, in August the inventory-to-sales ratio declined again -- a trend that reflects both typical, cyclical caution that one normally sees during economic troughs, 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, fell to 1.33 in August from 1.36 in July and 1.38 in June. Roughly a year ago, in August 2008, the ratio was 1.30.

In general, economists prefer to see business inventories decline during a recession, as it has historically indicated that businesses are bringing inventories back in line with reduced demand, taking excess supply out of the system. That drawdown has historically set the stage for both production increases and some job additions, as the economic recovery progresses.

Economic Analysis: Although August's 1.5 percent drop in inventories tied the one-month decline record, the overriding trend remains the same and is the key item in the August report: leaner inventories amid a modest uptick in sales. Hence, most likely, the sharp, prolonged decline in business inventories will boost U.S. GDP in the quarters ahead once businesses start to replenish those inventories as the recovery progresses. In fact, some sectors could be "product-short" if the recovery intensifies. If the latter occurs, that would suggest that businesses pared-back inventories too much. But given the depth and length of the recession, it's easy to see how businesses could make that mistake: given an uncertain recovery timetable, many did not want to be in the unenviable -- and costly -- position of having products that no one wanted to buy amid a struggle economy weighed-down by high unemployment.

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