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The Retail Recession: A Demonstration Of Inflation's Destructive Nature
As Consumers Pay More To Buy Less, The Economy Shrinks
A point I have argued repeatedly on this Substack is that the true economic damage of inflation comes not from rising prices, but from distorted prices—that, because prices for goods and services rise at different rates, overall rates of consumption are reduced as price hikes force consumers to make more and more trade-offs between expensive necessaries and also-expensive discretionary and luxury items.
As the distortions increase, overall consumption decreases, as consumers quite literally find themselves paying more but buying fewer goods and services in total.
We see fresh evidence of this distortion and its consequences to the broader economy in recent moves by retailers, who are grappling with rising inventories and tighter sales margins, as inflation impacts their costs as well.
Retailers Take Drastic Action To Clear Excess Inventory
While retail sales overall have remained largely flat during the summer months, going unchanged in July after rising 0.8% in June, retail inventories have expanded over that same period, rising 1.9% in June and another 1.1% in July.
This stagnation within retail is occurring despite retail sales being significantly higher than June (8.5%) and July (10.3%) of 2021. On an annual basis, retail sales are doing better than in the pre-pandemic years.
Thus while retail sales have been nominally increasing overall, inflation means that the increasing sales are accomplished by relatively smaller movements of physical goods, with the balance accumulating in store stockrooms and wholesale warehouses.
In part inventory builds are an accident of timing, as the same supply chain dislocations driving much of the price inflation also caused lengthy shipping delays, with the result that retailers have been receiving shipments ordered weeks and even months ago, at a time when inflationary pressures are pushing consumer buying patterns away from those same goods.
Slowed spending came just as many companies were receiving orders placed months ago when demand was higher. As a result, retailers are now overwhelmed with a “sonic boom of inventory,” Urban Outfitters CEO Richard Hayne said on a Q2 call.
The resulting imbalance between sales and inventories is pushing retailers to engage in a variety of measures, such as clearance sales, cancelling future orders, and even pulling merchandise and putting it into long-term storage in hopes of selling it in a future seasonal cycle.
Businesses are employing a variety of tactics, including steep discounts, order cancellations and pack and hold strategies, in an attempt to clear their shelves of stagnant products and make room for holiday inventory.
“None of them is a perfect tool, but retailers have to resort to them for lack of better options,” Jie Zhang, a marketing professor at University of Maryland’s Robert H. Smith School of Business, said in an email.
There is but one reason for a retailer to engage in such inventory reduction tactics: merchandise is not getting sold. Sales are nominally greater this year than last, but the amount of physical goods is proportionally smaller.
This is what inflation does to retailers.
Walmart And Target Grapple With Shifting Margins
Two giants of American retailing, Walmart and Target, provide a case study in how inflation is shifting buying patterns, and the impacts that shift has on retail overall.
With food and energy price inflation running well ahead of headline consumer price inflation, consumers are left with fewer dollars to spend on items besides food and energy.
As a result of this forced shift in buying patterns, Walmart has been shifting its attention to grocery items and away from general merchandise.
With consumers shifting more dollars to food, Walmart Chief Financial Officer John Rainey noted that its general merchandise inventory growth rate is down more than 15 percentage points from Q1. General merchandise’s contribution to Q2 sales mix was down 350 basis points.
Target has been making similar moves, leading to declines in sales margins, as grocery items are typically lower-margin items than general merchandise categories.
Both Walmart and Target are grappling with slower and smaller unit sales of merchandise.
Hopeful signs aside, the wider retail market still appears to be struggling on the whole. According to a Cowen analysis, retail foot traffic was up sequentially in the second and third weeks of August but growth remains below 2019 levels by double digits.
In a separate note, Cowen analysts said that unit sales in retail “remain weak,” with “real sales” down from last year in sporting goods, department stores, and clothing and accessories. For most of the retailers Cowen covers, the sales to inventory spread has turned negative this year, with trends worsening in Q2 for those that have reported so far.
This is the reality of consumer price inflation: consumers are paying more but buying less.
Amazon Is Cutting Back On Warehouse Space
As noted the other day, Amazon’s warehouse plans are decidely in a retrenchment mode, rather than the expansion mode customary for this time of year.
In several markets, the warehouse retreat is not minor: Amazon is closing 5 warehouse facilities in Massachusetts alone, and is closing or delaying another 9 in California.
The closures are an ongoing response to an ongoing challenge for Amazon: declining online sales.
But as the pandemic receded and consumers began buying less online, the e-tailer found that it's now dealing with too much capacity. Excess capacity, together with productivity loss and inflation, cost the company $6 billion last quarter, Insider reported.
It must be noted that Amazon’s declining online sales concerns occur even as the company’s total revenue for the second quarter of 2022 increased over the first quarter as well as the second quarter of 2021.
While Amazon’s overall revenue streams comprise a good deal more than just online sales, the increases even in the face of declining online sales activity once again illustrates the practical reality of consumer price inflation: paying more to buy less.
The Inflated Shrinking Economy
As the Bureau of Economic Analysis confirmed last month, the US economy has been contracting for the first half of 2022.
A primary driver of the decline in real GDP has been the decline in the real consumption of goods.
Thus the broad macro-economic data reflects the real-world experiences of retailers large and small: consumers are buying fewer goods, forcing the economy to shrink in real terms.
This is a far cry from the “booming” economy touted last month by Joe Biden.
When you couple that with last week’s booming jobs report of 528,000 jobs created last month and 3.5 percent unemployment, it underscores the kind of economy we’ve been building.
We’re seeing a stronger labor market where jobs are booming and Americans are working. And we’re seeing some signs that inflation may be beginning to moderate.
This is a far cry from the “momentum” perceived by Fed Chairman Jay Powell at Jackson Hole.
While the latest economic data have been mixed, in my view our economy continues to show strong underlying momentum. The labor market is particularly strong, but it is clearly out of balance, with demand for workers substantially exceeding the supply of available workers.
The US economy is hugely inflated, grotesquely distorted, and yet, for all that, shrinking. The US economy has been inflated, distorted, and shrinking. The US economy continues to be inflated, distorted, and shrinking.
While the “experts” remain oblivious to these demonstrable realities, consumers and businesses alike are all too aware of them, as they are living these demonstrable realities every day.
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