Thursday, February 03, 2011

Scary Company Behavior In Anticipation of Inflation

Inflation has been a recent topic in my blog posts, such as here and here. Today's edition of the Wall Street Journal contains one of those quintessential articles on the topic that is destined to be cited in the future as a clear warning sign.

In the piece, several examples are given of companies scrambling to buy large amounts of inventory in advance of vendor price increases. From cotton t-shirts to spices to metal for mufflers, retailers and middlemen are noting the difference between interest rates on financing for inventory and expected price increases for that inventory, then buying the larger-than-normal amounts of the goods for future sale.

Sure enough, the article discussed how this distorts inventory-based measures for purposes of assessing economic cycles and trends. As well as noting that many companies were already trying to slim their inventories in order to manage risk amidst economic uncertainty.

However, this article provides some evidence that an economic conundrum may soon be at hand.

Just this week, we saw positive employment-related numbers suggesting a slowly-expanding economy with job growth finally appearing, albeit at modest monthly levels.

But if commodity input costs are rising, that will result in either lower margins and a curtailment of job growth, or higher prices which will cause lower quantity demand by consumers in the face of so much inflation.

Thus, the very inventory bloating behavior now underway by many companies might come back to haunt them when demand slows in reaction to the rising prices. Then we'll have overextended companies with unsalable inventories for which they are paying interest to fund. In retrospect, will they look foolish for having so aggressively bought real inventory, rather than used some type of financial hedging, to manage cost increases?

Or is it even possible that companies which simply accept the higher-cost inputs and raise prices with expectations of lower demand will avoid this entire mess?

One is somehow left feeling that there's considerably more economic turmoil ahead than many pundits would have us believe. We're seeing the first reactions by businesses to known inflation in input costs. How and where those costs, and the actions they have spurred, find their way into consumer prices, and how consumers react with their buying behavior, isn't being widely discussed.

However, with job growth still anemic, and US unemployment still uncomfortably high, will the Fed dare to raise rates? And would that not result in a stalled economy and job growth as higher rates choke demand?

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