What Do Inventories Mean for the Economic Forecast?

Businesses cut inventories again, according to the latest data released here.  Inventory swings are tremendously destabilizing.  I'm actually kind of proud of the explanation of this that I wrote in Businomics.  (If you are adamant not to buy the book, take a look through Amazon's Look Inside feature, searching for the phrase "Magnified Effects on the Supply Chain.")

The latest data show the stark decline in inventory levels:

Here's a simple example of how bad this is.  A store used to sell, before the recession, 400 shirts per month.  Now they only sell 300 shirts per month.  So they might cut their monthly order with the shirt manufacturer by 25%.  However, if they are not only selling fewer shirts, but desiring to stock fewer shirts in inventory, they will not order 300 shirts, but maybe only 240.  Their 25% drop in sales has translated to a 40% drop in orders.  No wonder manufacturers are hurting.

When sales turn up, however, this will work to the economy's benefit.  Stores will not only sell more shirts, but decide to stock higher inventories.  At that point in time, each dollar that you spend will trigger more than one dollar of production.

How close are we to an economic turnaround thanks to the inventory swing?  Here's an historic perspective on inventories:
Past inventory rebounds have not been "V-shaped" but more "plate shaped."  For some months it will appear to be "L-shaped."  However, the economy will get a significant boost when inventories simply level off.  In the first quarter, flat inventories would have led to only half the GDP decline that we actually saw.  But do not expect a sharp upturn in the economy because of the inventory swing, at least not in the next few quarters.