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- It's the Economy, Stupid
Good morning,
U.S. consumers have thrown the towel in with inflation expectations, the average 30-year mortgage rate now exceeds 7%, Biden is getting cold feet on the US-Saudi relationship after the OPEC+ oil cut, the Bank of England’s governor gave pension funds a full three days to rebalance their positions, and the Swiss National Bank casually slashed overnight deposits by ~$30B.
Let’s dive in.
Bottom Line Up Front
Contribute something new to the news you’ll coffee chat over
Uber and Doordash shares plunged after the Labor Department’s proposal to change gig worker and company rules (NPR)
Peloton co-founder John Foley was repeatedly faced with margin calls from Goldman Sachs as its stock slumped (WSJ)
The Bored Ape creators, among other NFT projects, are being investigated by an SEC probe (Bloomberg)
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Deep Dive: The Economy, Stupid
Only three times in MLB postseason history has a team come back from 7+ runs: the Philadelphia Athletics (1929), Boston Red Sox (2008) and Seattle Mariners (2022).
Market crash confirmed? Let’s discuss.
In case your favorite rapper glossed over this part of recent history in favor of a Monica Lewinsky lyric, the subject line comes from a campaign slogan used by Bill Clinton in the 1992 Presidential Election. “It’s the Economy Stupid!” resonated well enough with Americans to elect Mr. Clinton to office. “Inflation is transitory” – not so much.
It resonated because it was hitting on the simple truth that the health of the American pocketbook mattered — above all else. Whatever other metrics may be trending positive (crime, education, international relations), the economic health of the individual was king. Now, thirty years later, that slogan still matters. And U.S. consumers’ inflation expectations eased to 5.4% this month – their lowest in a year.
It further applies to Corporate America and to the supply chain. Cash is king, and Corporate America and its supply chains will soon be prioritizing cash above all other metrics. As we head deeper into the last quarter and its earnings, as well as this month’s CPI report and FOMC minutes, let’s review why cash is crucial to consumers and Corporate America.
Impact on Corporate America
As a brief history, over the past ten years, supply chains have prioritized two metrics:
Customer Fill Rates (get the right order to the right customer, and in the right away)
Marginal Costs (reduce the operating expense per order in order to drive higher quarterly profit)
These basic metrics worked well in the 2010s when America enjoyed low inflation and the lowest interest rates in 50 years. As a result, the “opportunity cost” of holding inventory was also low.
So, supply chains loaded up their warehouses with inventory to meet Metric #1 (Customer Fill Rates). As a bonus, the added inventory did not affect #2 (Marginal Costs). In fact, high inventory levels can cover up the negative effects of inefficient operations, so high inventories helped with Marginal Costs as well.
More and more warehouses were built to hold all of that inventory, and substantial cash went into automating those warehouses. Now, supply chains are over-bloated with inventories. In one example, Nike recently announced it is discounting its inventory ahead of the holidays, and reactions like this are happening at other companies as well.
The profit bottom line is now being affected by inventories. And as inventory is cleared at a discount, or written off as unsold, stakeholders will take notice. And they will require a change.
Once inventories are cleared, it will be difficult for supply chains to revert back to buffering inventory. In course with history, they will still need to deliver on supply chain metrics #1 and #2, but now they will have a #3: Preserve Cash. That is because the world is currently an uncertain place, and cash is no longer free. Interest rates are the highest they have been since 2008, and the Fed may be too slow to come to the rescue.
Cash preservation will have a number of effects on our supply chains beyond just reduced inventories. This entails a reduced capital investment in warehouses, supply chain automation, and other long-term improvements. One example of this is the rise in predictive software to include cash planning metrics (such as cash-to-cash cycle and inventory holding costs) in supply chain planning. At this stage, many CEOs are reorienting their supply chains to enable profitable operations. They must act to build cash reserves for the next opportunity to capture market share and growth opportunities.
This focus on cash preservation will first affect companies and their supply chains. But, inevitably, it will affect the individual consumers and the level of service they expect versus what they actually receive.
Impact on Consumers
It is no secret Jerome Powell came late to the conviction that inflation was a problem that needed to be tackled. Hard. For most of 2021 he argued that inflation was a “transitory” problem that would resolve itself in time. But the irony of his efforts to channel Paul Volcker as his inflation-slaying role model ran far deeper.
After all, Volcker was picked to lead the Fed by Jimmy Carter to tackle inflation that had become a chronic problem in the wake of the sustained expansion of the money supply by the Fed over the decade preceding Volcker’s appointment. Volcker inherited a double-digit growth in the money supply. 2020 saw a far more dramatic growth in the money supply when the Fed’s coronavirus response led to a massive increase.
The expansion of the money supply under Powell’s leadership had no precedent in recent history. As much of the country shut down in 2020, the Fed pumped $5 trillion into the economy, ultimately resulting in a 40% increase in the money supply. By way of comparison, in the wake of the 2008 financial collapse, the increase in the money supply barely exceeded 10% in any one year.
In the view of monetarists — economists who view growth in the money supply as the most important factor leading to inflation — it was only a matter of time before this massive increase in the money supply impacted price levels across the economy. In simple terms, they would argue that Jerome Powell is now fighting a problem of his own making.
Traditionally, there is a significant time lag between a central bank’s monetary policy and when the impact of those actions ripple across the economy. It is regardless of whether those efforts are targeted at stimulating the economy, which the Fed sought to do by expanding the money supply in 2020, or stemming inflation, as it is now seeking to do. The emergence of inflation in the second quarter of 2021 appeared to be a case in point. It was the first surge in the rate of inflation — 2.6% to over 5% from March to July 2021.
Jerome Powell is an enigma. Four years ago, he compared making Fed policy to walking through a room full of furniture in the dark, “What do you do? You slow down. You stop, probably, and feel your way.” Managing a complex modern economy with the blunt tools available to a central banker, his words suggest, is an art as much as a science. We’re not buyers.
Lit's Pick
Inflation is real, and so is client gifting season. That's why we're betting the CPI's inflation reading will be >0.2% in September (tomorrow lol). That's all for today, see you Sunday!
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