The impact of inflation

This recovery has been slower than most probably because we have not had inflation to hide our mistakes. Some economists believe an inflation rate that's too low will slow down economic expansion. But for that to occur, we have to have a steady rise in both inflation and employment. There are three major parts to the inflation-supported hypothesis that bear watching this time around. The first part

This recovery has been slower than most — probably because we have not had inflation to hide our mistakes.

Some economists believe an inflation rate that's too low will slow down economic expansion. But for that to occur, we have to have a steady rise in both inflation and employment.

There are three major parts to the inflation-supported hypothesis that bear watching this time around.

The first part is that the future will forgive current and past mistakes by rewarding production and expansion with higher monetary gains. This means that equipment, systems and plant investments that are intended to yield a “hurdle” rate of return can fall short in the near term but meet goals as time marches on — and along with it, inflation.

Higher prices for goods as well as reductions in labor-to-capital ratios will help to retain and improve margins as goods and services become more expensive in the future. We saw this occur during the '90s when there was modest inflation and strong growth. As inventories went into the system they did so at the then-current cost levels but were sold at future dollar levels, often with an inflation premium.

The accounting difference between cost-of-goods sold and revenues represented a profit margin that continued to increase over time, with steady costs of production lagging behind increases in the retail prices for goods.

Since equity prices are based upon earnings projections, inflation, current interest rates and market volatility, the market can reward these inflated earnings with higher stock prices.

Significant rewards are often bestowed upon corporate management based on current profit margins and the market value of a firm's equity. Thus, there is an incentive to continue to increase production while hoping for increasing prices for final goods.

This factor will remain a force in the coming expansion and will be dampened only by the current efficiencies in the distribution system that will not accept a significant amount of overstocking.

The second part is that the financial markets will co-operate with the underlying economic trend. Both the money supply and the availability of capital must be expansionary in an aggressive way to keep the flow of capital moving into the hands of the producers of goods and services. This also assumes the regulatory climate does not become so restrictive that it prevents businesses from implementing strategies for growth.

Currently, the Federal Reserve is accommodating expansion. However, there are now more significant foreign uses for capital than in the past expansionary period.

Eastern Europe and Eastern Asia both provide significant investment opportunities with greater returns, despite any risk premium.

But with Western Europe, Latin America, South America and Africa lagging in economic growth, this time around there will be sufficient capital for inflation-boosted economic growth.

The third factor lies with the consumer, who must keep up demand for consumer goods while accepting any increased cost per item sold. This can only be accomplished with rising employment and rising wages. In the past, that has not proven to be sustainable, but it does provide “cover” for several years.

The growth we've seen in the last two years has not been fast enough for many. However, it would be better to have slower sustainable growth than the boom-bust cycles that are likely to occur with inflation-supported expansion.

TAGS: News
Hide comments

Comments

  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
Publish