Friday, December 4, 2009

The other side of depleted inventories

I mentioned in my last post that inventories have been so depleted that maintaining current consumption will require an uptick in production. That still holds.

However, tax revenue and corporate earnings may have been inflated by this. Many, many US companies use an inventory system called LIFO - last in, first out. The inventory values they carry on their books are thus the costs required to produce the first units that entered their books. These often happened a long, long time ago, and thus way underestimate the actual cost of production.  These lower costs are recognized when inventory is depleted, however, which has just happened. This would a) goose profit margins, making earnings look higher than they actually are, and b) increase tax revenues, because profits look higher.

A recovery may improve jobs quite a bit, but accounting earnings may not reflect the extent of improvement actually observed, and corporate tax receipts may not improve at the rate the corporations do. This is something to keep an eye on.

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