Monday, September 13, 2004

Richard Berner at Morgan Stanley, the perennial "good cop" to Stephen Roach's "bad cop" (thanks to AngryBear commentor Mark S. for the metaphor), thinks the rise in inventories is much ado about nothing.
The recent pace of inventory accumulation is unsustainable, but in my view, stocks were too lean at the beginning of the year, and producers have scrambled to replenish them by expanding production slightly ahead of demand. Moreover, unlike in the late 1990s, prices are accelerating, giving producers an incentive at least to hold inventories, if not add to them. And, most important, final demand seems to be quickening again. Consequently, I think producers will continue to maintain growth in production at least in line with that of demand. And while our latest forecasts do not show any contribution to second-half growth from nonfarm inventory accumulation, there is now upside risk to that prognosis.
The General said a month ago that it was too soon to come to any conclusions about the big 2004:II rise in inventories. First, it was off of exceptionally low levels. Second, one quarter does not a trend make. Berner is saying little more. What is more worth noting is that Berner thinks two other factors are driving the US economy toward a rosy future.

First of all, according to Berner, "prices are accelerating". It's not clear in which universe Berner is living. Core inflation is up to a whopping 1.8% annual rate, but the three month percent change in July was down to 0.4% from 0.8% in May. Core commodities inflation -- the kind of things you can actually store up in a warehouse -- is still experiencing deflation (-1.1% annually). There was a little burst of actual inflation in the first half of 2004, but July saw a return to outright deflation in core commodity prices.

Prices of durable goods have fallen every month since March and the three-month rate has been negative for three months running after a brief burst of actual inflation in February through April. For nondurables there is actual inflation, but the three-month figure is down to 1.7% in July from 2.2% in May. More importantly, nondurables minus food and beverages saw absolute price declines in July. With food prices at the producer level falling dramatically, it's only a matter of time before retail prices begin declining again as well.

This is a long way of saying both that Berner is ignoring all the evidence of price deflation and that any price "acceleration" we've seen is already past.

But the most important thing to Berner is the "quickening" of final demand. The evidence for this is supposedly
upward revisions to merchandise and services exports and construction outlays boosting second-quarter final demand. Partly as a result, we expect that second-quarter GDP growth will be revised up by as much as 0.6 percentage points to 3.4%. Moreover, consumer spending and exports � two key areas of weakness in June � rebounded sharply in July.
Well, 2004:II GDP was initially 3.0%, then revised down to 2.8%. That would be a hell of a revision for Berner to be right. Sure total exports in July were higher than June, but June was such a total bust that Berner's working with a low bar. July exports were still lower than May's levels, whereas July's imports were far higher than May's. Consumption was up in July, but rooted in unsustainable processes. As the General said two weeks ago,
personal saving as a percentage of disposable personal income was a barely visible 0.6%. In real terms it was the lowest monthly total and the lowest savings rate since December 2002 and the third lowest under the Bush administration.
This is hardly cause for celebration -- or for a sanguine view of US inventory levels.

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