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CONTEXT: Inflation is like a silent tax

WHY IT MATTERS: Inflation is impacting purchasing - To mitigate it we need to understand it

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Until recently, the subject of inflation wasn’t exactly dinner-time banter. We’ve all heard about it. Mentioned here and there by various economic types. Buried amongst financial jargon that most of us sort of understand. The general census is that current inflation rates are concerning. But hang on, don’t economists also talk about having an inflation target? If inflation is concerning, why are we targeting it in the first place? Whether the average consumer understands how it works or not, most understand that high inflation is an important economic indicator. Some inflation seems to be the goal, but high inflation is something to be avoided. So why are we talking about it and how does it impact your organisation?

For decades, the US has been familiar with annual inflation rates of between c. 0-3% (Generally that is. Yes, it has been higher or lower). But when the pandemic hit, many governments scrambled to stimulate their economies. This was due to most of the world being confined to their homes - to limit the spread of a virus we knew little about. No doubt their actions, had a positive impact on public health and mortality, especially for the vulnerable. But with so many confined, the world’s economic output took a hit. Just think of the implications of millions of workers being at home:

⁃ Airplanes were grounded
⁃ Factories halted production
⁃ Transport services operated a skeleton shift
⁃ Hospitality businesses shut the doors

Except for essential services and those that could work from home, businesses ground to a halt. This was the world over. Globally, a large % of the population was ‘tools down’. With governments enforcing lockdowns, businesses were stuck between a rock and a hard place. Through no fault of their own, workers were housebound. So, it seemed morally fair that wages would need to be paid.

On the flip side, with no boots on the ground producing, revenues almost immediately plummeted to uncomfortable levels. After all, how could a business charge customers and clients if they weren’t providing products and services because workers were at home? Businesses from New York to New Delhi - from Washington to Wellington - were in the war room trying to figure out how to run a business with flatlining revenues and the same cost base. It doesn’t require a master’s degree in mathematics or accounting to figure out that losses can only be supported for so long before a business ends up on life support.

Enter from stage left - Governments. With the stroke of a pen, they created out of thin air, the drip needed to pump life back into businesses. The drip was government stimulus - or ‘stimmys’ as they became known. These stimmys provided much-needed relief for businesses. With no certainty on when the pandemic would end, governments become the largest customers on the planet. You could say that Governments were essentially buying goods from businesses - with the only exception being that there weren’t any goods. A one-way transaction. Free money as they say. But how could the governments afford such a baller move? Enter from stage right - Central Banks. Central banks the world over purchased government debt to support the program and fund the stimulus. Problem solved right?

With personal incomes somewhat shielded and supported, consumer spending stabilized. With the government footing the bill for lots of the money in circulation, consumer spending was constant. Demand was there. But with businesses producing fewer goods and services, the same couldn’t be said for the supply. You will recall that the world came to a standstill - including the goods and infrastructure that ferried it from place to place. Products became hard to get hold of. Topping up inventory was always going to be difficult when businesses were closed. So, goods became scarce. People were confined to their homes with little to do. And many had ‘free’ money courtesy of the government. What could go wrong?

True to the principles of supply and demand, prices were bid up in response to limited inventory. In a globally connected world, one missing link in the global supply chain had domino effects. Take microchips for example. With producers of chips shut down, how could businesses that relied on them keep up with demand? The answer is they couldn’t. So, with fewer computers being produced, fewer phones arriving on shelves and fewer new cars in the parking lot, what impact would it have on the market?

Naturally, you look for any alternative. With fewer options, consumers were left with no choice but to pay more to secure a purchase. Like a snowball, and rather ironically, this situation started to spread like a virus. Prices crept up and free market principles took over. The same demand but less supply leads to higher prices. It really is that simple. But with production and services resuming, surely supply would increase, and prices would drop - right?

If only it was that simple. At the heart of the issue is where the money or stimmys came from. Anyone that has seen a money printer meme in the last year probably has a good visual representation of what we are talking about. When a government utilizes fiscal stimulus - they are essentially printing money out of thin air. Wouldn’t you love one of those printers? While printing money sounds like a neat trick, it has ripple effects. With governments dishing out made-up money, the money supply increases. The same couldn’t be said of goods and services. In fact, not only did supply not remain constant, it went backwards.

So, fewer goods and services but significantly more money floating around. Sounds like a game of monopoly, where all players agree to start with double the funds that the rules outline. If it’s even for all players, it can’t hurt, right? Nominally everyone is ‘richer’. But are there more properties to buy? No. It doesn’t take long to realize that properties are being bought and traded at faster and higher rates than was designed. Increased money supply leads to a wealth effect resulting in players being comfortable paying higher prices. With the same amount of stuff to buy, prices shoot up resulting in ‘diluted purchasing power.’ Remember that phrase. Your money no longer buys as much property as it did in the last game. Yes, inflation even exists in rigged, family renditions of monopoly.

In the case of the global economy, the money supply was artificially increased. Supply went backwards. The result is that everything is 10% more expensive than it was this time last year. A 10% tax so to speak. Except this one has snuck up on us. Silently. Like the way, those extra kilos appeared on everyone’s stomach under the cover of our pandemic sweatpants.

Like our post-pandemic, exercise and diet routine, the economic path out of the pandemic must do some heavy lifting. All those additional days watching Netflix and snacking instead of working and training must be worked off eventually. It means we train a lot harder and eat a lot lighter to claw back those extra pandemic kilos. It’s not a permanent regime. But it is necessary to eventually fit back into those favourite trousers.

The same is true with the money supply and inflation. Like those ‘unearned’ snacks we enjoyed while bingeing, our purchases during the ‘stimmy’ phase of the pandemic, were in some respects ‘unearned’. Globally, we weren’t making as much stuff, but we were still buying it like it was going out of fashion - funded by the government with their finger on the print button.

So, inflation is here. It’s high and it’s eroding everyone’s purchasing power. Central banks are doing their best to combat it. But the road back to ‘target inflation’ doesn’t look like it will be here anytime soon. Kind of like those trousers that will take time to squeeze back into.

So how can organizations mitigate the effects of inflation’s tax-like power? The key could lie in the answer to these questions:

⁃ Does your current pricing reflect a pre-pandemic or post-pandemic world?
⁃ If increased pricing will be detrimental to your business model, can you introduce new products or services with a 2nd tier pricing model?
⁃ If pricing is already at a ceiling, can you reduce the goods or included services in some way to claw back margin?
⁃ Can new technologies help to do the heavy lifting in terms of producing goods and services?
⁃ Does your business model need to be reset or rebuilt to ensure longevity in a post-pandemic, high-inflation environment?

Get in touch with us to discuss how to protect your business against the tax of inflation. Ensure your business model fits right into a post-pandemic economy - just like those favourite trousers.

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