Well, the Bank of England outcome was utterly boring, so let’s talk about something else.
Société Générale’s global strategy one-man-army Albert Edwards — always interesting, sometimes correct — has taken a typically-engaging broad tilt at the dynamics of inflation (which he says believes is largely a product of the extended period of ultra-loose monetary policy before the pandemic/war in Ukraine). He writes:
Instead of ranting about the current crisis I want to revisit a topic that goes straight to the hearts of both equity and bond investors, namely that the primary driver of this inflation cycle is soaring profit margins. Rather than calling this out as the primary cause of high inflation, central banks have instead chosen to focus on rising nominal wages as threatening to embed higher inflation – the so called ‘wage/price spiral’.
Edwards previously looked at this “greedflation” dynamic in November, pointing out then that the comeback from Covid had produced a rebound in profit margins despite them having never fallen during the early days of lockdowns:
As he wrote then:
How has this happened? Well, it was to a degree entirely predictable given extremely loose fiscal and monetary policy in an environment of supply constraints. But companies have also exploited the inflationary backdrop. Customers expect price rises because of what they see in the press about surging commodity prices. Companies have clearly ‘taken advantage’ of rising inflation expectations to put through rises well in excess of cost increases. And this has not gone unnoticed.
There’s also the similar framework of “excuseflation”, explored in a recent article from Bloomberg’s Odd Lots gang. In short, it’s the way in which input pricing shocks — such as the pandemic rebound supply snafus, and the Ukraine war (and, perhaps as importantly, the media coverage that surrounds them) — provides companies with the cover they need to raise prices without substantial customer pushback.
A recent academic paper — Sellers’ Inflation, Profits and Conflict: Why can Large Firms Hike Prices in an Emergency? — looked at these dynamics (Further Reading fans will have seen it last month). Author Isabella Weber from the University of Massachusetts Amherst, provided a precis of her findings on Elon Musk’s microblog site:
Second, sector-wide shocks can create tacit agreements between firms to hike prices, since all firms protect their profit margins and know that the other firms pursue the same goal. Firms that do not follow this rule can be penalized by financial investors. 6/
— Isabella M. Weber (@IsabellaMWeber) February 27, 2023
Fourth, firms navigate demand as a ‘portfolio of risks’ and prices as a social relation with retail partners and customers. Emergencies can create a pretext to legitimize price hikes. 8/
— Isabella M. Weber (@IsabellaMWeber) February 27, 2023
Weber and co-author Evan Wasner proposed a three-stage process (with overlaps) for how inflation occurs following a long period of price stability:
First, the impulse stage of initial price increases in systemically significant sectors;
Then, the propagation and amplification of the cost shock stage; and
Finally, the conflict stage when labor tries to regain real wage losses
Or, in flowchart:
The fourth stage here makes reference to the dreaded “wage–price spiral” that your grandma/local central bank warned you about. But Weber and Wasner focused much more on the dangers of what they called a “price–price spiral” – ie the third step in the flowchart. With our emphasis:
In the propagation stage sector-wide cost shocks resulting from the price increases in the impulse stage function as coordinating mechanisms for price hikes. Firms can safely increase their prices to protect profit margins thanks to an implicit agreement among competitors that passing on costs is the way to react to cost shocks. Daily news reports on supply chain issues and high commodity costs in this stage not only aid in the emergence of an implicit pricing agreement among firms, but can also develop understanding on the part of customers for higher prices and thus render demand less elastic. To protect profit margins firms must increase prices by more than costs. If firms do manage to increase prices to protect margins, the next firm in the chain will do the same but now starts from a cost increase that incorporates both the initial upstream cost hike and the higher markup for the second firm in the chain. If all firms behave like this, there is a cumulative effect that increases the nominal value of profits even while profit margins stay constant…
In cases where a sector furthermore experiences a supply-side bottleneck or a demand shock – granting firms within the sector temporary augmented monopoly power – profit margins may even be enhanced, thereby not only propagating but also amplifying the initial cost shocks down the supply chain…
Given the nature of the economy as a network of input-output relations, once an environment of price-raising has been established throughout firms along the value chain, all firms have continual justification for further price hikes to offset costs. If firms with sufficient market power in systemically significant sectors continue not only to propagate but to amplify cost increases, one can imagine a self-sustaining ‘price-price’ spiral persisting. Furthermore, if labor manages to overcompensate for its losses and increase its share in national income in response to price hikes during the conflict stage, this can create another impulse in the form of a new cost shock that restarts the propagation process, as firms react again by protecting profit margins through price increases.
That’s a painful dynamic, and one Edwards reckons could play out further in the current cycle, even as most places (ahem) see consumer price growth wane. He writes:
…companies [have] under the cover of recent crises, pushed margins higher. And, most surprisingly, they still continue to do so even as their raw material costs fall away. Consumers are still ‘tolerating’ this ‘excuseflation’, possibly because excess fiscal largesse has provided households with a buffer. My own view remains that headline inflation will collapse below zero as food and energy comparisons turn deeply negative through this year. But beware corporate ‘greedflation’ still lurking in the undergrowth.
