Inflation Nation: Transitory Hiccup or Permanent Predicament?

By Joe Higgins, Quest 4 Quality

Now that inflation has landed on the doorsteps of our BrandSource dealers, it joins shortages, back orders and disruptions as part of the new normal in home goods. Let’s talk about the possible outcomes and probabilities of this current economic cycle.

The simplest definition of inflation comes from the famous economist Milton Friedman, who said, “Inflation is too much money chasing too few goods.” This has never been truer than what you are experiencing in this post-pandemic period.

In order to consider this cycle inflationary, it must be sustained over a period of time. If it is just transitory — say it lasts for a few months at average rates no higher than 2 percent — we won’t consider it to be inflationary. Federal Reserve chairman Jerome Powell and the other Fed leaders have been very clear that they are going to let the numbers run for a few months and see what happens. They believe markets will reach a balance in supply and demand by year’s end.

The Fed has only two mandates: Keep inflation in check and bring the U.S. to a level close to full employment. We expect them to act and possibly raise interest rates if inflation gets out of control.

Last week the Commerce Department reported that the Consumer Price Index (CPI) rose at the highest pace in 13 years in May, with Americans seeing accelerating prices across a broad array of products. The CPI rose 5 percent over last year, exceeding the consensus estimate of 4.7 percent. This was a considerable rise in CPI and nearly as high as the 5.2 percent gain at the early stages of the Great Recession in August 2008.

There are two ways to look at the CPI. The core inflation rate, which excludes food and energy prices, was up 3.8 percent, the largest increase in 30 years. In contrast, the main index rose 5 percent. This includes most of what we pay for every month, like rent, energy, produce, transportation, medical care and a predetermined list of goods that are common to most Americans. Indeed, more than 50 percent of last month’s increase in the CPI was due to rising prices for air travel, rental cars and used cars.

I will also point out that there is something we call the “base effect,” which means we are comparing numbers to last year when the country was shut down, consumers weren’t traveling, restaurants were serving takeout only, and malls were ghost towns. So when you consider that in May 2020, prices were at rock bottom for much of what is measured in the CPI, inflation looks overstated.

A great example of this period is the used car market, which accounted for a 29 percent of the rise in CPI. In April 2020 we lost 20 million jobs, highways were deserted, and the price of used cars hit all-time lows. This year prices for used cars and light trucks rose 30 percent, due to the lag in new car production as the result of the chip shortage and rental car companies selling off their fleets during the pandemic and then rebuying used cars in 2021. Before you travel, check the prices at the airport rental counters; Hertz and others have raised prices an astounding 110 percent from a year ago, and vacationers are actually finding it is cheaper in some instances to rent a U-Haul or order an Uber.

The Fed’s position does not match the reality that Americans are experiencing in the economy. As consumers are being confronted with increasing prices across a wide spectrum of goods, Chairman Powell is still suggesting that inflation is nothing to worry about at this point in our recovery. However, America could be sitting on a time bomb given the stimulus spending in the past 15 months. In 2020 the federal government spent $2.4 trillion for the Cares Act and other relief measures. So far this year we have only spent a portion of the $1.9 trillion in the American Recuse Plan Act. If you include quantitative easing, the 2018 tax cut and a possible infrastructure plan, the total stimulus could easily total over $10 trillion for the past four years.

As I write this, Americans have grown their bank accounts to all-time highs due to the unprecedented levels of stimulus. Savings have skyrocketed from $13 trillion a year ago to more than $17 trillion today. In my lifetime I couldn’t have conceived this level of stimulus. Economists believe this money will all be spent by the end of the year, effectively fueling higher prices, but that equilibrium will slowly return to the markets after the funds have been exhausted.

The way I see it, the Fed will run with its current policy to determine if the CPI continues its upward trajectory. If it gets out of control, they can and should raise interest rates to cool off the expansion. I will point out that when the Fed makes this type of decision, higher interest rates have often led to recessions in the past.

You might ask, what actions sustain inflation? The answer is complex but one answer is when consumer behavior moves Americans to start buying goods today for fear that prices will be higher tomorrow, at that point inflation turns from transitory to permanent. This mindset is what prolonged the recession in the late 1970s, when an extraordinary level of inflation caused a “double-dip” recession in 1980 and 1981.

The outcome in this scenario is an inflationary cycle that will only subside when the money in savings accounts dries up or we move into a recession. We are in the early stages of an inflationary cycle and consumers have not adopted this “Buy now before prices go up” mentality.

In the home goods industry, the big manufactures are suffering through supply chain disruptions, massive backorders and rising commodity prices. Your suppliers have raised prices on nearly everything you sell, and while this trend will moderate, supply disruptions are likely to continue throughout the year. Home equity is at an all-time high, so your customers will continue to invest in kitchens, bathrooms and laundry rooms, add the latest electronics, buy new furniture, and BrandSource dealers will continue to enjoy record sales.

I believe at some point the economy will rebalance itself as we move into the post-pandemic period. Corporations will increase capacity in the face of rising demand; backorders will slowly dissipate; retail will return to normal; and America will reemerge as strong as ever.

Joe Higgins is a 42-year veteran of GE and Whirlpool Corp. who brings his experience to bear as a business consultant, public speaker, AVB keynoter and YourSource News contributor. Visit his website, Quest 4 Quality with Joe, at www.q4qwithjoe.com.