Inventory to Sales Ratio and Labor Force Participation Rate (1992-2013)

Posted by PITHOCRATES - November 12th, 2013

History 101

Just-in-Time Delivery lowers Inventory Costs but risks Manufacturing Interruptions

Carrying a large inventory is costly.  And risky.  First of all you have to warehouse it.  In a secured heated (and sometimes cooled) building.  With a fire alarm system.  A fire suppression (i.e., sprinkler) system.  A security alarm system.  You need lighting.  And people.  Safety training.  Safety equipment.  Forklifts.  Loading docks.  Delivery trucks.  Insurances.  Property taxes (real and personal).  Utilities.  Telephone and Internet.  A computer inventory system.  Etc.  It adds up.  And the larger the inventory the larger the cost.

Then there are the risks.  Fire damage.  Theft.  Water damage (say from a fire suppression line that freezes during the winter because some kid broke a window to let freezing air in that froze the water inside the sprinkler line with the expanding ice breaking the pipe and allowing water to flow out of the pipe onto your inventory).  Shrinkage (things that disappear but weren’t sold).  Damaged goods (say a forklift operator accidentally backed into a shelve full of plasma displays).  Shifts in consumer demand (what was once hot may not be hot anymore which is a costly problem when you have a warehouse full of that stuff).  Etc.  And the larger the inventory the greater the risks.

In the latter half of the 20th century a new term entered the business lexicon.  Just-in-time delivery.  Or JIT for short.  Instead of warehousing material needed for manufacturing manufacturers turned to JIT.  And tight schedules.  They bought what they needed as they needed it.  Having it arrive just as it was needed in the manufacturing process.  JIT greatly cut costs.  But it allowed any interruption in those just-in-time deliveries shut down manufacturing.  As there was no inventory to feed manufacturing if a delivery did not arrive just in time.

A Rising Inventory to Sales Ratio means Inventory is Growing Larger or Sales are Falling

There are many financial ratios we use to judge how well a business is performing.  One of them is the inventory to sales ratio.  Which is the inventory on hand divided by the sales that inventory generated.  If this number equals ‘1’ then the inventory on hand for a given period is sold before that period is up.  Which would be very efficient inventory management.  Unless a lot of sales were lost because some things were out of stock because so few of them were in inventory.

Ideally managers would like this number to be ‘1’.  For that would have the lowest cost of carrying inventory.  If you sold one item 4 times a month you could add one to inventory each week to replace the one sold that week.  That would be very efficient.  Unless four people want to buy this item in the same week.  Which means instead of selling 4 of these items you will probably only sell one.  For the other three people may just go to a different store that does have it in stock.  So it is a judgment call.  You have to carry more than you may sell because people don’t come in at evenly spaced intervals to buy things.

We can look at the inventory to sales ratio for the general economy over time to note trends.  A falling ratio is generally good.  For it shows inventories growing as a lesser rate than sales.  Meaning that businesses are getting more sales out of reduced inventory levels.  Which means more profits.  A flat trend could mean that businesses are operating at peak efficiency.  Or they are treading water due to uncertainty in the business climate. Doing the minimum to meet their current demand.  But not growing because there is too much uncertainty in the air.  A rising ratio is not good.  For the only way for that to happen is if inventory is growing larger.  Sales are falling.  Or both.

The Labor Force Participation Rate has been in a Freefall since President Obama took Office

When inventories start rising it is typically because sales are falling.  Businesses are making their usually buys to restock inventory.  Only people aren’t buying as much as they once were.  So with people buying less sales fall and inventories grow.  Rising inventories are often an indicator of a recession.  As unemployment rises there are fewer people going to stores to buy things.  So sales fall.  After a period or two of this when businesses see that falling sales was not just an aberration for one period but a sign of worse economic times to come they cut back their buying.  Draw down their inventories.  And lay off some workers to adjust for the weaker demand.  As they do their suppliers see a fall in their sales and do likewise.  All the way up the stages of production to raw material extraction. 

Retailers typically carry larger inventories than wholesalers or manufacturers.  To try and accommodate their diverse customer base.  So when their sales fall and their inventories rise they are left with bulging inventories that are costly to store in a warehouse.  They may start cutting prices to move this inventory.  Or pray for some government help.  Such as low interest rates to get people to buy things even when it may not be in their best interest (for people tend to get laid off in a recession and having a new car payment while unemployed takes a lot of joy out of having a new car).  Or a government stimulus program.  Make-work for the unemployed.  Or even cash benefits the unemployed can spend.  Which will provide a surge in economic activity at the consumer level as retailers and wholesalers unload backed up inventory.  But it rarely creates any new jobs.  Because government stimulus eventually runs out.  And once it does the people will leave the stores again.  So retailers may benefit and to a certain degree wholesalers as they can clear out their inventories.  But manufacturers and raw material extractors adjust to the new reality.  As retail sales fall retailers and wholesalers will need less inventory.  Which means manufacturers and raw material extractors ramp down to adjust to the lower demand.  Cutting their costs so their reduced revenue can cover them.  Which means laying off workers.  We can see this when we look at inventory to sales ratio and the labor force participation rate over time.

(There appears to be a problem with the latest version of this blogging software that is preventing the insertion of this chart into this post.  Please click on this link to see the chart.)

(Sources: Inventories/Sales Ratio, Archived News Releases

Cheap money gave us irrational exuberance and the dot-com bubble in the Nineties.  And a recession in the early 2000s.   Note that the trend during the Nineties was a falling inventory to sales ratio as advanced computer inventory systems tied in over the Internet took inventory management to new heights.  But as the dot-com irrational exuberance came to a head we had a huge dot-com economy that had yet to start selling anything.  As their start-up capital ran out the dot-coms began to go belly-up.  And all those programmers who flooded our colleges in the Nineties to get their computer degrees lost their high paying jobs.  Stock prices fell out of the sky as companies went bankrupt.  Resulting in a bad recession.  The fall in spending can be seen in the uptick in the inventory to sales ratio.  This fall in spending (and rise in inventories) led to a lot of people losing their jobs.  As we can see in the falling labor force participation rate.  The ensuing recession was compounded by the terrorist attacks on 9/11.

Things eventually stabilized but there was more irrational exuberance in the air.  Thanks to a housing policy that put people into houses they couldn’t afford with subprime mortgages.  Which lenders did under threat from the Clinton administration (see Bill Clinton created the Subprime Mortgage Crisis with his Policy Statement on Discrimination in Lending posted 11/6/2011 on Pithocrates).  Note the huge spike in the inventory to sales ratio.  And the free-fall of the labor force participation rate.  Which hasn’t stopped falling since President Obama took office.  Even though the inventory to sales ratio returned to pre-Great Recession levels.  But there is so much uncertainty in the economic outlook that no one is hiring.  They’re just shedding jobs.  Making the Obama economic recovery the worst since that following the Great Depression.


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Falling Oil Prices will lower Gas Prices, if the Fed stops Printing Money

Posted by PITHOCRATES - May 9th, 2011

Falling Oil Prices and you at the Gas Pump

Here’s something you don’t see every day.  Oil prices have fallen (see Special report: What really triggered oil’s greatest rout by Matthew Goldstein, Svea Herbst, Jennifer Ablan, Emma Farge, David Sheppard, Claire Milhench, Zaida Espana, Robert Campbell and Josh Schneyer posted 5/9/2011 on Reuters).

Never before had crude oil plummeted so deeply during the course of a day. At one point, prices were off by nearly $13 a barrel, dipping below $110 a barrel for the first time since March.

Apparently the speculators aren’t all that eager to buy and hold oil right now.  Something must have spooked them.  Because it’s May and the summer driving season is about to ramp up.  People driving around to enjoy their summers.  Some 3-day holiday weekends.  And a vacation or too.  Demand for oil should be up.  Not down.  So what happened?

A routine report on U.S. weekly claims for unemployment benefits spooked investors, showing the labor market in worse shape than expected. That fed a growing pessimism about the resilience of the global economy after industrial orders slumped in Germany and the massive U.S. and European service sectors slowed. Then the European Central Bank surprised with a more dovish statement on interest rates than expected, signaling its wariness about the euro zone outlook. The dollar rose sharply.

Oh.  So that’s what spooked them.  Recession.  Which is another name for continued high unemployment.  Looks like people will be taking more ‘staycations‘ this year.  Just like last year.  Which means people won’t be gassing up the family car for those long trips.  Instead of gas they’ll be buying more expensive groceries.  So the speculators don’t want to buy oil.  Demand for oil will drop.  And something with low demand has a low price.

A range of factors, both economic and political, were also at play. The recent rise in raw goods has been fueled in part by the U.S. Fed pumping cash into the markets by purchasing $600 billion in bonds. This program has pushed interest rates extraordinarily low, making borrowing essentially free once adjusted for inflation. Investors have been using the super-cheap money to buy into commodity markets. But the Fed’s program is slated to end on June 30.

The U.S. Fed in their infinite wisdom printed more money to entice business owners to expand business and hire more people.  Unfortunately, this also created inflation.  Made our money worth less.  And this raised prices.  So we bought less.  And if we’re buying less, businesses aren’t going to expand.  They’re going to contract.  To reflect the falling consumer demand.  So where did all that printed money go?  Wall Street.  Investors borrowed the money ‘for free’ and invested in commodities.  Which drove the prices up.  And oil is a commodity.  Now that the Fed is shutting off the ‘free money’ spigot, they’re not buying anymore.  They’re selling.  Hence the fall in oil prices.

China, the world’s fastest-growing consumer of commodities, also is tightening monetary policy to tamp growth rates and control inflation, raising the prospect of a slowdown in demand for oil.

And one of the big things that triggered the huge run up in oil prices back in 2008, an explosion of Chinese demand, is reversing itself.  They are trying to control inflation.  By slowing their economic growth.  And, of course, slower growth requires less energy.  And less gasoline for cars.

Put all of this together and it explains why oil prices are falling.  Which is typically what happens in a recession.

Recession and Tight Monetary Policy always lowers Gas Prices

The greatest factor in the cost of gasoline is the cost of oil.  Oil goes up and gas soon follows.  Oil goes down and gas follows.  Eventually (see Just say no to $5 gasoline by Myra P. Saefong posted 5/6/2011 on MarketWatch).

Despite Thursday’s drop, crude futures are still more than 9% higher, year to date. Crude oil makes up 68% of the price of gasoline at the pump, according to the EIA.

Overall weakness in the dollar is also to blame for rising gasoline prices. “The U.S. dollar has an inflationary impact on U.S. buyers, while also triggering increased buying in equities and commodities to stave off lost currency value,” said Telvent DTN’s Milne.

And there’s an “overlap” between refinery maintenance and a cluster of bad luck for Gulf Coast and Midwestern refineries, including electrical outages and storm-induced shutdowns, said Kloza. “This is the catalyst for the last leg [of the gasoline-price rise], which may take us to $4-$4.11, but also should soon stall.”

So we’re not going to see a corresponding fall in gasoline prices right away.  But it’s coming.

Still, gasoline prices may hold a $5 average in California, where a strict gasoline formula makes the state more susceptible to higher prices, and in New York, due to tax issues, he said.

Of course, there’s always concern over the start of the Atlantic hurricane season, which begins on June 1, given the potential for disruptions to oil production and refineries in the Gulf of Mexico.

Be grateful you don’t live in California or New York.  At least, when you’re buying gas.  The environmentalists have added about $1 a gallon to the price of gas in California.  And New York is just tax-happy.  Add that to the recent storm damage, heavy rains and Mississippi flooding, prices won’t be coming down anytime soon.  But they’ll be coming down.  Because they always do during a recession.  As long as the Fed stops printing money (which was President Carter‘s problem.  Prices stayed stubbornly high in the Seventies despite recession until Paul Volcker finally tightened monetary policy).

Drill Baby Drill

Supply and demand determines the price at the pump.  That’s why prices go up during the summer driving season.  And down when much of the world is shoveling snow.  Oil is the biggest factor in the price of gas (68%).  Therefore, the less oil on the market the higher gas prices go.  And the more oil on the market the lower gas prices go.  Simple supply and demand.  Which provides a very easy solution to bring gas prices down.  Drill, baby, drill.  The next best thing we could do to keep prices down is to increase refinery capacity.  The more capacities available to refine crude oil the less storm damage will affect the price at the pump.  Finally, roll back environmental regulations and cut taxes.  Californians could easily see a drop of a dollar a gallon.  Even with current oil production and refining capacities.

Energy policy can be very easy if only you can separate the politics from it.  But when your political base is defined by those politics, that ain’t going to happen.  So get use to high gas prices.  Because they’re being kept artificially high for political reasons.  And enjoy your staycation this year.  And next year.


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Earthquake and Tsunami Devastate Japan

Posted by PITHOCRATES - March 11th, 2011

Have they no Shame?

It’s started.  Even before the aftershocks stopped.  The global warming crowd is blaming man for Japan’s earthquake (see Some respond to Japan earthquake by pointing to global warming by Amanda Carey posted 3/11/2011 on The Daily Caller).

Hours after a massive earthquake rattled Japan, environmental advocates connected the natural disaster to global warming. The president of the European Economic and Social Committee, Staffan Nilsson, issued a statement calling for solidarity in tackling the global warming problem.

“Some islands affected by climate change have been hit,” said Nilsson. “Has not the time come to demonstrate on solidarity — not least solidarity in combating and adapting to climate change and global warming?”

“Mother Nature has again given us a sign that that is what we need to do,” he added.

Of course, he is counting on that the rest of the world being as ignorant as he is.  Global warming doesn’t cause earthquakesTectonic plates shifting along fault lines do.  It’s a completely different science.  If you can call global warming science.  Which, based on his statements, you can’t.

Shame on these people.  Rubbing their hands together in glee whenever some horrible act of nature occurs that they can politicize.

8.9 Magnitude Earthquake hits Japan

The 8.9 magnitude earthquake is the biggest yet to hit Japan.  Since they’ve been keeping records, at least.  It’s caused some incredible devastation.  And a tsunami.  But it’s something Japan was prepared for.  And she will survive.  Because she has done it before (see Daybreak reveals huge devastation in tsunami-hit Japan by Edwina Gibbs and Chisa Fujioka posted 3/11/2011 on Reuters).

The quake surpasses the Great Kanto quake of September 1, 1923, which had a magnitude of 7.9 and killed more than 140,000 people in the Tokyo area.

The 1995 Kobe quake caused $100 billion in damage and was the most expensive natural disaster in history.

This time the death toll will not be anywhere near what it was in 1923.  Thank God.  The cost will be severe, though.  But it’s better to face that then hundreds of thousands in deaths.  Like they had in Haiti.  With their 7.0 magnitude quake.  Over 300,000 thousand died there.  Why?  Because of their poverty and political corruption.  For poverty is the leading cause of death in the world. 

Japan is an advanced nation.  A nation of laws.  With a strong economy.  Her people are prosperous.  Making life better for everyone.  Because of this, her people worked in buildings designed to withstand the power of earthquakes.  And a lot of them did.

Free-Market Economies are Safer to Live In

In advanced nations with strong, free-market economies, people come first.  These economies, after all, respond to consumer demand.  Safety matters.  So they build things safe.  Because the people matter.  And they demand it.

Contrast that with a command economy.  In National Socialist Germany (i.e., Nazi Germany), the state came first.  And the state didn’t hide that fact.  People were expendable.  Their needs were subordinated to the state’s.  Ditto for their enemy.  The Soviet Union.  In fact, when the Red Army was on the move, the infantry advanced ahead of their tanks.  To protect their tanks from land mines.  You see, with their vast population, it was easier to replace people than tanks.  For their people were an expendable resource.

This mindset no doubt played a role in the Soviet economy.  And their nuclear program.  What happened at Chernobyl could not have happened in the United States.  The Chernobyl nuclear reactor design was flawed.  And there was no containment vessel.  Safety was not a driving design criteria.  That’s why during testing the reactor core heated beyond control.  And exploded.  Without a containment vessel, that explosion threw up radioactive waste into the atmosphere and across Europe.  This did not happen at Three Mile Island.  Because in our free market economy, people come first.  So we build things safe.

Japan’s Nuclear Power Plants Overheating

Some of Japan’s nuclear reactors are having problems.  They’re overheating.  It’s nothing to do with their design.  In fact, it’s their design that has kept them this safe so far after an 8.9 magnitude earthquake and up to 7 (and still counting) aftershocks measuring 5.2 or stronger.  It was the one-two punch of mother nature.  The earthquake took out the primary electrical power.  Then the tsunami washed out their backup generators (see Report: 2 Japanese plants struggling to cool radioactive material by the CNN Wire Staff posted 3/11/2011 on CNN World).

The International Atomic Energy Agency said Friday on its website that the quake and tsunami knocked out the reactor’s off-site power source, which is used to cool down the radioactive material inside. Then, the tsunami waves disabled the backup source — diesel generators — and authorities were working to get these operating.

A double failure of low probability.  In power redundancy, it is common to have two electrical services from two independent electrical grids.  The plant can operate split over both or entirely on one or the other.  That’s one level of redundancy.  Should both of these sources go out (which in itself is a low probability), then there are on-site diesel generators.  Completely independent and self contained.  So no matter what happens with the offsite electrical sources, the generators can provide electrical power.  That is, unless they’re submerged in seawater.  Nuclear power plants may also have a battery backup as well.  Of course, batteries only last so long.  And don’t do well submerged in seawater.

Nuclear reactors boil water to make steam to produce electricity.  The boiling of this water is what cools the reactor core.  Even with the reactors shut down there is still residual heat that will grow unless the cooling pumps keep running to circulate water around the core.  And this is the problem they’re having.  The cooling pumps aren’t running.

This won’t be another Chernobyl

The disaster that hit Japan would have destroyed a lesser nation.  They need help.  And we should give it.  Whatever they need.  But in the end, they will shake this off and go on with life.  Because they are a people who can take pretty much whatever life throws at them.  Let’s just hope they can get those cooling pumps running again.  They have good designs.  Good operating procedures.  Good safety measures in place.   And some of the best nuclear people in the business.  This won’t be another Chernobyl.

Let’s help Japan.  And keep the Japanese in our prayers.


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