Inflation in America - Part I: Five signs of inflation, from rising prices, to shrinking candy bars, to increased fees
How to avoid an inflation-induced household budget crisis that may be creeping up on you now
by Eric Janszen (iTulip.com)
Inflation is unfamiliar to Americans who are not old enough to remember the horrors of disco. Not since the 1970s has America seen the kind of price inflation that is rampant today, in all its many forms. In the first part of our inflation primer Inflation in America we give you the basics. Like a frog heating slowly in a pot of water, if you’re not aware of how inflation works its corrosive effects on your budget you may find yourself financially cooked.
For over a decade you have seen high, often double-digit, annual inflation rates in college tuitions, housing prices, and health insurance. More recently you’ve witnessed gasoline, heating oil, natural gas, and food price inflation. Soon you will see prices go up at the local Made-in-China big box mart, thanks to rising wage rates and a strengthening currency in China.
The primary cause of our inflation is the depreciating dollar, now off more than 50% against the euro over the past several years. We will go into that sorry process in Part II of our series. In this part we reveal stealth inflation and its impact on the quality of your life and your household budget, and what you can do to protect yourself.
Inflation: Level versus rate, what is versus what shall be
Inflation Sign #1: High and rising prices. Inflation is not only higher prices but high and rapidly rising prices. Understanding the difference is key to understanding the nature and process of inflation. A recent Harper’s Magazine article by Kevin Phillips "Numbers Racket" ($ubscription) argues that the true annual inflation rate in the first quarter of 2008 was closer to 12% than the official 4% reported as the government’s consumer price index (CPI-U). Twelve percent is a very high inflation rate by any standard, and when it comes to inflation the rate of change in prices is more important than a high versus low but stable price level. Here’s why.
Let’s start by looking at the impact of a high inflation rate on a household budget. At a 12% annual rate of inflation income earned in December one year and saved has 12% less purchasing power by the following December. You can see this in gasoline prices. A gallon of regular gasoline in the US cost $2.88 at the start of 2007 and $3.39 by mid-April this year. That means the $50 that purchased 17 gallons of gasoline a year ago buys only 14.5 gallons today. If your ride gets 24 miles per gallon, as the average US car does, a year ago $50 took you 408 miles but only 348 miles today, or one less round trip daily commute for the average commuter. That’s what “loss of purchasing power” means; the same dollars earned from your labor purchase fewer goods and services than before. You are working just as hard but you can afford less, at least with cash. Your credit may expand to fill in the goods and services affordability gap, and with it your debt, and that is why the current inflation is not hitting households as hard today as in the 1970s.
In the two recessions of the 1970s, consumer credit growth peaked about six
months before the CPI. Consumer credit declined through the recession and inflation
after. During the most recent recession in 2001 both consumer credit and CPI inflation
increased in tandem during and declined after the recession. At this writing both
inflation and consumer credit are moderating. However, during the 2001 period the
US dollar was not weak and in a period of structural readjustment as it has been
since 2001. Consumer credit is likely moderating due to the credit crunch that is
spreading across the financial system while a weakening dollar continues to
push energy prices up and inflation through the economy.
As goods and services prices are rising the US economy is slowing. Jobs are beginning to dry up. Competition for the remaining jobs prevents workers from to demanding salary increases. Rising household expenses and stagnant wages result in a household cash flow squeeze.
The relief valve? For consumers with the best credit the result of more borrowing to cover expenses is increased debt and reduced savings. With prices of goods and services rising while incomes stay flat, households attempt to make up the difference in the loss of purchasing power by borrowing more to purchase the same quantity and quality of goods and services as in the past – to maintain the material quality of life to which they have become accustomed. Households drain savings and increase household debt as inflation cuts into household cash flow.
If you are not careful to adjust to inflationary conditions you may find yourself with more debt than you can handle and not enough savings for your future needs even if you remain employed and earning the same salary as before.
Rising inflation is slow and subtle. Like a frog heating in a pan of water, you need to be aware of the following signs that inflation is cooking your household budget. If you have not increased the frequency of travel, eating out, or other spending over the past six months but your savings account is dwindling and your credit card bills are rising, you may be on a path to an inflation-induced household budget crisis.
There is no painless way to cope with inflation and get your budget back on track. The steps you can take are much like those you’d take if you decided to take a pay cut and economize. What makes adaptation to inflation tricky is that your income may be flat or even rising – but not as fast as price inflation is rising around you.
To manage the impact of inflation on your budget short term, target those items in your budget that you can control and are your largest expenses. For most Americans that is transportation, food and groceries, utilities, and entertainment.
Inflation’s impact on business: Your local restaurant
- One week gas rule: Set a cut-off price for filling up the tank once a week and only drive as far as you can travel on that tank of gas
- Take public transportation: Grab a train or bus when you can
- Carpool to work with friends: It's more fun than you think
- Clip joint avoidance: Set a cut-off price for entrees at trendy, over-priced restaurants
- Eat out less, cook at home more: Home cooked food is better for you anyway
Have you noticed prices on the menu going up at your local restaurant even though it's not as crowded? To a business like a restaurant that cannot increase exports like IBM or Cisco can to take advantage of a falling dollar to boost revenues, inflation means higher input costs resulting in less positive cash flow and declining real profits. Here’s what is happening to your local eatery as a result of today's inflation.
Let’s say in April 2008 the restaurant's monthly gross revenues are $100,000 and expenses $70,000, so gross profits are $30K for the month. The owners take $10,000 as personal income and add the remaining $20,000 to the cash account to pay taxes and other expenses later. If that cash account held $40,000 at the end of March at the start of May it holds $60,000. Payments for raw ingredients, labor, and other ongoing expenses in May will come out of this cash account and also out of cash flow from sales.
Now lets dial in the 12% annual inflation. The purchasing power of the $60,000 balance in that account is declining 1% per month, eating away at it like termites, bit by bit turning last month's profits into less purchasing power to buy materials and labor for the following month to run the business. The owners will find that over a year the cash account has dwindled even though revenue appears to be as robust as before. What is happening is that input costs the business are rising faster than the output prices and revenues, the prices of plates of food and glasses of wine. Through this insidious process, the business is gradually going cash-flow negative. The restaurant must either lower costs or raise prices, or both, or fail as a business.
At first, to avoid price hikes that will deter customers management may respond to inflation by trying to lower unit costs (cost per plate of food) by substituting cheaper for higher cost ingredients. It’s a gamble that customers are less likely to be deterred by marginally lower quality than marginally higher prices. Portions may also shrink. You will start to notice fewer shrimp in the shrimp egg foo young at your favorite local Chinese take-out joint.
In spite of these cost reductions, eventually your local restaurant is forced to raise prices to cover rising input costs. Unit volumes decrease because customers’ incomes are not rising to cover the added cost of items on the menu. Customers will also notice the cheaper ingredients and the restaurant’s food quality reputation will suffer. Management tries to lower fixed expenses (versus per plate of food unit costs) by reducing staff. Customers experience this as slowness and crankiness among the remaining overburdened wait staff.
If your wait person is cranky and unresponsive, count how many tables they are covering before passing judgment. These days it's probably too many.
This is how a business goes out of business in an inflationary recession. In an inflationary recession the most profitable operations, if they have maintained a large cash cushion and especially if they hedged inflation in their cash account with sound investments, can survive by letting inflation grind down competing businesses with weaker balance sheets by forcing them to raise prices and reduce product and service quality. By not raising prices and taking the profit hit, the stronger competing company steals the weaker company’s customers. If they have enough cash to keep it up, it's a matter of time before the stronger business has enough of the weaker business's customers that the weaker business fails.
Then guess what the surviving company gets to do? That’s right: raise prices. This is part of the dynamic of an inflation cycle.
Inflation: More than high prices
Rising prices is inflation sign #1. But four-dollar gasoline and $25 entrees at a restaurant where they were $15 two years ago is only one sign of inflation. Watch for these as well.
Inflation Sign #2: Smaller sizes, volumes and portions
Food makers are starting to reduce the size of items like candy bars and cutting back on the number of chips in a bag of chips. Expect food that fits into a box or a bag to decline in volume. Notice that bag of corn chips that used to be full is now one quarter empty, that jug of laundry detergent that used to be good for 30 loads will now do 24, and so on.
The way to defend against this form of inflation is to note the per-unit costs at the grocery store versus the per-package price.
Inflation Sign #3: Substitution of lower cost and quality ingredients
This inflation sign is the most subtle of all. Unless you have been going to the same store or restaurant for a long period of time you won’t not notice the change. Using cheap versus expensive tequila in your margarita, for example, or regular antibiotics fed chicken versus organic chicken like it says on the menu.
Inflation Sign #4: Poor service due to cutbacks in personnel
Long lines can be a sign of inflation. As businesses cut service staff to reduce personnel costs, waiting times rise. Over time you may notice it takes longer to find someone to help you at the local Home Depot, or you are waiting longer on the phone to speak with technical support, or the experts you talk to turn out to not be so expert as you are put through layers of less expensive and lesser trained personnel before you get to talk to the one high cost expert who actually knows what they are talking about.
You will also notice sales people becoming more assertive. They will try to sell you more expensive products and will try to add on options.
Inflation Sign #5: Fees, fees, fees
As costs rise, towed behind many once reasonably and simply priced products or services you will find a giant load of new fees. Checked out your bank statement lately? Your cable bill? Your cell phone bill? It pays to look at these carefully every month as most service providers are not required by consumer law to notify you when a new fee is added. You may be surprised to find many fees large and small hitched up to a service that was sold to you at a fair starting price. Look at them now.
Inflation is more than higher prices, it is also a lower quantity and quality of goods and services for the same price, lower quality services, and new fees.
What is causing inflation? The falling dollar. Our the second installment of our Inflation in America series we explain how the weakening dollar is creating cost-push inflation. In our third part of the series we address the question, Will the dollar appreciate and US inflation abate? Only structural change will cause the dollar to strengthen and end the weakening dollar inflation cycle.
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