Publish date:

New Procedures May Be 'Just-in-Time' to Stave Off Inventory Fears

Despite this economic slowdown, all the news from corporate America is not bad.

The swiftness of the U.S. economy's slowdown caught just about everyone flatfooted.

Over the past few weeks, economists have been busily ratcheting down their growth forecasts, with some going so far as to say we've already entered recession. The

Federal Open Market Committee's half-point cut, between meetings, was a tacit admission that it, too, had been surprised by the sudden depth of the downturn.

But if the economists on Wall Street or at the

Fed feel sheepish, at least they know they're in good company. All across the country, companies of every stripe got blindsided by the rapid cooling, leaving them with a ton of merchandise on their hands that they're pretty desperate to unload.

Consumers don't have to go very far to find evidence of America's inventory problem. That PC makers have been aggressively cutting prices, trying to clear their shelves before their current stock becomes obsolete, has been well publicized. A trip to the mall shows how desperate retailers are to unload their wares. If one is looking for harder evidence,


(INTC) - Get Intel Corporation (INTC) Report

fourth-quarter earnings report provides it -- the chipmaker's inventory-to-sales ratio tacked on 43% over the year-ago period.

The November data on

business inventories

, released Tuesday, showed, for the second month in a row, a slight decline in U.S. inventories. That wasn't enough however, to keep pace with cooling sales. The inventory-to-sales ratio, which has climbed steadily since March, hit its highest level in 19 months. One sign that the slump is over and the economy is reaccelerating will come when sales begin to sap inventories, reversing the recent trend.

"There's an excess that has to get worked off," says

Morgan Stanley Dean Witter

TheStreet Recommends

chief U.S. economist Richard Berner. "How aggressively that gets worked off, how long it takes, is going to be the question here."

This is where the good news comes in. Since the last recession, nearly a decade ago, there have been some pretty serious changes in the way businesses do things. Just-in-time practices, where manufacturers only bring production materials in as they need them, have become de rigueur. There have been tremendous advances made in warehousing, production flow and shipping -- in short, inventory control. As a result, the U.S. inventory-to-sales ratio has declined by more than 10% over the past decade.

Tighter inventory control has allowed managers to respond more quickly to slowing demand. The suddenness of the economy's deceleration may, in fact, have had something to do with this -- in a just-in-time world there is little lag between weak auto sales and automakers cutting their, say, ball-bearing purchases. It also means that the whole inventory adjustment process can happen much more quickly, though, and that could lead to the economy healing quickly.

"It will require less time to liquidate inventories," says

Credit Suisse Asset Management

managing director Stanley Nabi. "You can tell that it's already happening. Auto companies are cutting production very quickly. And I'm told that retail inventories were liquidated right after Christmas and that by the time we get to February they'll essentially be in balance."

That jibes with the

National Association of Purchasing Management's

December sounding of manufacturers. Its Inventories Index fell to 39.8, its lowest level in over four years, showing that companies are aggressively working down inventories.

Although economists generally agree that inventory reduction should help speed the economy toward recovery,

Goldman Sachs

director of economic research Bill Dudley does warn, "You have to keep your eyes out to see if there's any second-round effect."

Inventory reduction in a slowing economy generally means cuts in production. Cuts in production often mean job cuts, and a higher jobless rate has a way of making demand for goods even weaker. Think about this long enough and suddenly it seems like the U.S. is spiraling downward into some widening maw -- a good demonstration of why economics is called the dismal science.

In fact, such an aftershock is more worry than likelihood, says Dudley. Sometime in this or, more likely, the next quarter, the inventory-to-sales ratio will begin to rise again. "That will be a sign that you're getting to the end of the process," says Dudley.