Some Signs Of A Slowdown Turn Out To Be A Mirage

Now you see it, now you don't. Thanks to the magic of government revisions, which can change the meaning of economic data with a computer keystroke, a budding inventory problem apparently has vanished. In its place stands a much better balance between production and demand that brightens the first-half outlook.

When the Commerce Dept. issues its update on fourth-quarter gross domestic product on Mar. 1, the composition of GDP is likely to garner more attention than the revision in the headline number on economic growth. When the government reported its first estimate showing growth of 4.5%, at an annual rate, much of the December data were still unknown. With those numbers now in hand, it appears that Commerce far overestimated inventory growth at yearend, while the trade deficit actually narrowed instead of widening.

Presto! A slimmer trade deficit, mainly reflecting more zing in exports, means much stronger growth in final demand than the 3.7% pace first reported. And fewer goods on hand indicate a much less alarming rise in stock levels than the original increase of $68 billion (charts). So much for the notion that overproduction was a problem.

THE NEW NUMBERS suggest that the economy may not be slowing down in early 1995 as much as the Federal Reserve would like. With inventories at manageable levels, businesses will continue placing orders, and manufacturers will keep cranking out goods and adding to their payrolls. That means, despite the recent slowdown signals from housing and retail sales, Alan Greenspan & Co. may have more rate hikes on tap for the spring.

Fed Chairman Greenspan sounded as hawkish as ever during his semiannual congressional testimony on monetary policy on Feb. 22. "The jury remains out on whether the slowing that is in train will be sufficient to contain inflation," he said.

The Fed's latest forecast sees consumer inflation in 1995 picking up slightly into the 3%-to-3.5% range, while growth slows to between 2% and 3%. That unusually wide range suggests that the Fed is still unsure about how well past moves to cool the economy will work.

One particular area of uncertainty that Greenspan noted was inventories. The Fed chief expects businesses to build their stocks more slowly this year than last, but the degree of the resulting drag on economic growth "remains to be seen."

That's because the monthly data show no sign of an inventory problem at factories, wholesalers, or retailers. Stockpiles in manufacturing and trade rose a slim 0.2% in December. For its first GDP calculation, Commerce had assumed that inventories for the month increased more than twice that much, and it overestimated November stock levels as well.

THE MOST CONVINCING sign of the lack of excessive inventories is the recent pattern of business sales. They jumped a sturdy 1.3% in December, pushing the ratio of inventories to sales down to 1.38, the lowest reading in the data's 27-year history.

To be sure, inventories grew rapidly last year. In fact, it was the fastest pace in a decade. But since March, 1994, when stockpiles began to zoom, the 5.8% growth in stocks has been overwhelmed by a 6.6% advance in sales. That hardly suggests overblown inventory growth.

Stock levels at factories remain exceptionally lean relative to demand. The ratio of inventories to sales fell to a record low in December. In addition, factory orders rose nearly twice as fast in the fourth quarter as they did in the third, and the backlog of unfilled orders is rising. All this suggests little need for manufacturers to throttle back their production lines.

The inventory-sales ratios for wholesalers and retailers look underwhelming as well. The only hint of overstocked shelves shows up in nonauto retailing. In the fourth quarter, the ratio in this sector increased to the highest level since 1986, suggesting that many retailers were left with a lot of unsold holiday items that needed to be heavily discounted in January and February.

But a lot of those goods came from overseas. Greenspan told Congress that perhaps a quarter of all wholesale and retail inventories are imported. So working off any excess, he said, now has a more muted effect on U.S. production than it has in the past.

But it's not just a more sanguine view of inventories that gives the outlook a lift. Foreign demand is growing faster at the same time that imports are coming ashore at a slower clip. The result is improving prospects for the trade deficit in 1995, which will add support to overall demand.

Commerce was undoubtedly surprised at the sudden shrinkage in the trade gap in December, as were most economists. The deficit in goods and services dropped from $10 billion in November to $7.3 billion, the lowest in a year. Of course, the monthly numbers are erratic, but the December data suggest that the deterioration in the deficit has run its course.

Exports surged broadly in December, rising by 3.2%, while imports fell by 1%, the first decline in seven months. Goods accounted for nearly all of December's trade improvement, but for the year, the merchandise deficit hit a record $166 billion.

THE DEFICIT in real net exports, the trade measure in Commerce's GDP accounting, now looks to have hit bottom in the third quarter of last year, instead of widening further in the fourth. Indeed, the poor trade performance last quarter appeared to have subtracted half a percentage point from growth. The revisions will show that did not happen.

For 1995, exports will keep the trade improvement going. True, the crash in the Mexican peso and the weakness in the Canadian dollar will limit U.S. exports to those two key trading partners this year. However, demand in Europe and Asia should pick up. That's even true for Japan, as the U.S. benefits from Japanese rebuilding after the Kobe earthquake.

Stronger foreign demand will offset some of the slowdown already in progress in domestic demand. This cooling off is most notable in housing. Starts slumped 9.8% in January, with the key single-family sector down 12.3% (chart). The drop is even more impressive considering that starts were down in all regions and that the weather in the East and the South in both December and January was unusually mild.

Clearly, Fed tightening is squeezing homebuilding. That fact is corroborated by other demand measures, including sales of new homes, mortgage applications, and builders' surveys. Residential construction will probably subtract from first-quarter GDP growth, as it did in the third and fourth quarters.

But if fourth-quarter GDP sports the new look that the monthly numbers suggest, then this economy is still carrying the fundamentals for growth greater than the 2.5% pace the Fed would like to see. If so, there will be nothing magical about the Fed's response. It will simply reach into its hat and pull out another rate hike.

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