Shelves Won't Stay So Bare

But an inventory upswing has risks

Although shifts in inventory demand usually play a big role in business cycles, their impact has been subdued in recent years. Now, with consumption coming on strong for two quarters in a row, that situation is about to change.

"There is no doubt that inventories will boost growth in 1997," says Edward E. Yardeni of Deutsche Morgan Grenfell Inc. He notes that the overall inventory-to-sales ratio fell to a record low in January, with manufacturing stocks the tightest in memory and with retail inventories, except for early 1994, the leanest they've been in a decade.

Indeed, to many observers, the current picture stirs memories of the first half of 1994. That's when a sharp pickup in inventory investment seemed to ignite an inflationary surge in growth--spurring the Federal Reserve to boost interest rates for four months in a row.

For the moment, the consensus is that history will not repeat itself. Yardeni is looking for only a moderate increase in inventory building. "In 1994," he says, "we were coming out of a weak recovery, there was strong pent-up demand for cars and houses, Europe seemed to be on an upswing, and commodity prices were exploding." In 1997, he notes, pent-up demand has been satisfied, Europe is sluggish, and the strong dollar suggests that inventory needs will be met with rising imports.

Similarly, David Kelly of Primark Decision Economics argues that today's apparent inventory tightness is in part a reflection of the widespread adoption of just-in-time inventory control techniques. And that development plus the general expectation that consumption will soon slow again is leading many forecasters to predict that any inventory buildup will be relatively modest.

Still, one sign of rising inventory demand--an upturn in raw-materials prices--has recently surfaced. And as economist Paul Kasriel of Northern Trust Co. observes, "inventories are a notoriously volatile animal." If they start to act up, it's a safe bet the Fed will snap its whip to bring them back in line.

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