The recent gyrations in U.S. equities reflect confusion about how inflation works. Everyone wonders why, despite very low unemployment and a budget-busting combination of lower taxes and more government spending, we still see so little consumer price pressure. The underappreciated fact is that supply chain management, as driven by the will of digitally empowered consumers, won’t let inflation out of the cage.
Economics is Changing
When the consumer price index (CPI) data was released this Wednesday stocks plunged at first, only to rebound strongly as commentators unbundled contradictions in the data. One featured headline focused on apparel prices, which rose 1.7% in January for the biggest one month increase since 1990. The big issue, as always, was a miss at the top level where economists had expected a 0.3% rise while the actual ended up being 0.5%.
Amid all the discussion however, precious little attention was paid to the fundamentals of consumer price increases. In practical terms these boil down to the pricing power business has over consumers and the underlying impact of technology on costs. Ask any consumer products, electronics or automotive CEO and they’ll all say the same thing: customers won’t take price increases.
In today’s digitally transformed retail environment, consumers have instantaneous price transparency, nearly endless selection and a range of delivery options that grows more tentacles daily. Winning in this environment requires most businesses to look backwards at their operations and supply chain for cost savings rather than forward to higher prices.
Supply chain strategists therefore seek out alternative materials, cheaper fabrication methods and leaner working capital structures every single day. Agility that has been built into supply networks across nearly all industries allows executives to swap labor for capital, domestic for offshore, and in-store for online almost overnight. This kind of hand-to-hand combat has bred a level of resourcefulness that isn’t yet fully incorporated into macroeconomic thinking.
It’s as though economists are the redcoats expecting a clash of armies on the open battlefield, while the supply chain is a bunch of colonists fighting a guerilla war.
Expect Low Inflation Going Forward
Looking at the details of the CPI in terms of winning and keeping customers suggests that supply chain management will hold inflation in check in most areas. The first observation is that many spend categories with a high level of supply chain impact have seen very low inflation over the past year:
- Food at home: 1%
- Household furnishings and operations: -0.6%
- Apparel: -0.7%
- Communication: -4.9%
Second is the fact that by clustering categories together in terms of customer solutions (e.g. education, recreation and transportation) the data shows a split between the physical product components of what the consumer experiences and the information or personal service elements of the deal. The physical product elements (aka commodities) see very low inflation, while the service components experience higher inflation.
So far, the supply chain has been hammering away at these cost areas and in the process has been protecting consumers’ budgets. Going forward, and especially with the help of more artificial intelligence, sharing economy applications and cloud services, the labor cost drivers behind much of the price pressure on services should also abate.
The final piece of the inflation question for the future rests on the dynamics of content pricing. Netflix costs the consumer $10.99 per month. For anyone who binge watches Breaking Bad, the effective price per unit of time spent is very low indeed. Productivity data doesn’t catch this reality despite a consumer surplus that is massive. Pure content is a zero marginal cost product which means inflation has a very hard time taking root at the point of sale. As this kind of consumption grows we should expect still less price pressure going forward.
Add in the Bezos effect on healthcare and who knows how low inflation can go.
Beware the Vicious Circle
For all the good supply chain does inhibiting inflation there remains one big problem: housing. It is by far the largest spend category in the CPI and it is heavily driven by mortgage costs. Mortgage costs are driven by debt markets as well as the Federal Reserve, which is keen to keep inflation down by raising interest rates.
Let’s hope they keep their cool.
