The Ugly Secret That’s Going to Kill Inflation

We’ve been talking a lot about inflation these past weeks and months. So much so I kind of feel like the dead horse I’ve been beating is about to get up and walk away.

But this nasty bout of inflation has been a fact of life — and very real. One that’s impossible to ignore. We’ve been getting pounded with the numbers.

CPI has been informing us how badly consumers like you have been getting hammered…

CPI Inflation


While PPI, on the other hand, shows how bad businesses have been getting hammered.

PPI Inflation


In previous updates, I’ve explained how these measures of inflation run in tandem. How higher producer prices (PPI) invariably get passed on driving consumer prices (CPI) higher. This past April we looked at Germany as proof. 

In January, Germany’s inflation rate was posted at 4.9% — down from 5.3% the previous month — and well behind the U.S.’s recent print of 7.5%.

At the same time wholesale prices — the prices charged at the supplier level — rose 16.2% year over year. These are the prices that retail merchants pay for the goods they sell.

What is driving this increase? The prices paid by manufacturers for raw materials — producer prices  — which spiked a staggering 25% year over year in January.

What’s happened since then? 

Most recently German producer prices rose a profit-crushing 32.7% (slightly slower than the 33.6% increase in the previous month). And as you’d expect consumer prices have followed suit currently reaching a multi-decade high of 7.5%

Looking at the charts above, you can see that here in the US we haven’t been immune to the same trend of inflation stinging both businesses and consumers alike.

But if you look closely, you can see an even more disturbing trend…

When Inflation Flips Upside Down

If you net those two rates of inflation from a business perspective, subtracting producer prices (cost) from consumer prices (revenue), you come to a pretty striking realization…

For the past year and a half, producer prices have been significantly outpacing consumer prices. In other words, as bad as it’s been for you, businesses have actually been bearing the brunt of this inflation throughout most of the last year and a half. 

This calculation is one put forth by macroeconomist Stephanie Pomboy. She calls it the “Profit Margin Proxy.” It’s a sharp insight. And frankly I don’t think it’s a particularly good sign.

This inversion suggests that forward corporate earnings — earnings yet to be realized — are likely to be worse than what’s been reported recently. According to Pomboy…

Just because input costs are going up faster than corporations’ ability to pass [them] along, doesn’t mean this immediately hits current earnings reports. It takes a while for it to show up in the actual earnings numbers. So it will take time for the commentary from companies to filter into Wall Street strategists’ forecasts.

And this is a problem because…

No one is looking ahead. They just take whatever the companies say as gospel until they say otherwise. Wall Street focuses only on what the companies say. They wait for them to say [for example], “Here’s our guidance for the next quarter.”

So as mediocre as earnings might be right now, there is a strong likelihood that they’re going to get worse in the near future.

Just Another Name for Deflation

Let’s extend this data back and take a look at it prior to the economic crisis in 2008…

As the global financial economy stood at the brink of collapse, consumers took cover. Personal spending cratered…

Personal Spending


Which led to a deflationary collapse in both consumer and producer prices.  (CPI went from 5.6% in July 2008 to a NEGATIVE 2.1% in July 2009.) Producer prices followed in line until the profit margin proxy righted itself

This is how economies react at the extremes… which, unfortunately is our world today.

The situation today is only slightly different. We’re not on the brink of financial collapse, but the fake economy we’re living in is coming to a head.  Consumers are tapped. Personal savings are at near record lows and consumer credit card usage is soaring. People are going into hock just to keep up with prices on necessities. 

As this contraction continues from the consumer’s end, it’s going to keep putting pressure on business. Corporate profits will continue to get squeezed just as hard. At some point there will be a capitulation. And when that happens, the entire economy will likely contract in a deflationary spiral.

Deflation is the Answer to Inflation (Unfortunately)

Unfortunately there is one truth about inflation that the Fed, for all their PhDs can never seem to get their collective heads around. (I’ve said it before and I’ll say it again…) 

The cure for high prices is… high prices. 

We’re seeing it right now. Gas prices have been coming down slightly over the past couple months. (Paying $3.90 a gallon is sure a lot better than $5.00 a gallon… but really, who’s celebrating paying $2.00 more than they were paying two years ago?) 

The Biden administration will be having a field day touting that their release from the Strategic Petroleum Reserve has beaten back Putin’s price hike and saved the day.  But the truth is, it’s been nothing of the kind.

The reality?  In the face of massive price hikes, people have altered their driving habits. From AAA…

New survey data from AAA finds that drivers are making significant changes to cope with record pump prices. Almost two-thirds (64%) of U.S. adults have changed their driving habits or lifestyle since March, with 23% making “major changes.” Drivers’ top three changes to offset high gas prices are driving less, combining errands, and reducing shopping or dining out.

They also noted that many Americans were postponing taking vacations this year. Remember the last time gas was near $5 back in 2008?  The same thing happened then which gave rise to yet another great economic euphemism — the “staycation.”  

All kidding aside, this is as sure a sign as anything that people are struggling to keep up with the necessities of life.  

Less spending by consumers means less revenue (and ultimately less profit) for business. I know, I know the likes of President Biden and Elizabeth Warren would say that greedy capitalist motives have been driving inflation and they should do what’s right for the country, but business is still business.  And when you consider the beating they have been taking from the margin squeeze we saw above… it’s not hard to see what is likely in the future.

Inflation has taken a break for the moment. But we’re far from out of the woods. And the ride ahead could get mighty bumpy…

Make the trend your friend,

Bob Byrne
Editor, Streetlight Confidential