Nebraska Furniture Mart Chairman Irv Blumkin says the price of one shipping container has jumped over the past six months to $10,000 from $3,500. Short on containers, his suppliers abroad are out of storage and halting production, exacerbating Blumkin’s order backlogs that are six times as long as they were a few months ago. Broadly, Blumkin says his vendors for all manner of goods and services have increased prices multiple times over the past three months, each ranging from 3% to 8%.
“Is this temporary? I would hope it’s that way. But the reality is that they’re putting surcharges and increases on, and some suppliers here and abroad are sold out for the rest of the year,” says Blumkin, whose grandmother started the company that operates in Nebraska, Texas, Kansas, and Iowa, and sold a majority stake to Berkshire Hathaway in 1983. “It’s the highest rate of inflation I’ve ever seen, except for in the ’70s.”
What is happening at Nebraska Furniture Mart is playing out across America. Yet monetary and fiscal policy remains on autopilot, geared to an economy stuck in recession, as the Federal Reserve’s favorite inflation gauge remains close to its longstanding 2% target. There is nothing to see here, say Fed Chairman Jerome Powell and other key central bankers, contending that inflation figures that have risen are about reopening bursts and comparisons to data gathered during pandemic-driven lockdowns, and will be, in that oft-repeated word, “transitory.”
For business owners and consumers on the ground, official inflation data and policy makers’ commentary are an alternate reality. Inflation is here, say grocery shoppers, home buyers, manufacturers, and retailers who insist that their dollars are buying less. They don’t have the luxury of ignoring the food and energy costs that are backed out of the price metrics preferred by policy makers, and they can’t help but notice the 17% jump in existing-home prices that isn’t directly figured into such gauges. For the average American household, food, energy, and shelter combined represent roughly 50% of income before taxes.
Nor do increasingly generous recruitment bonuses affect all key inflation measures on wages. As the economy recovers faster than expected, the government pays enhanced unemployment benefits until September, child care remains an issue, and big employers like Amazon.com (ticker: AMZN) recently raised starting wages to $15 an hour, companies across the country are scrambling to hire. In fact, businesses are offering sizable signing bonuses for everything from pizza-delivery drivers to truckers and dental hygienists.
The gap between reported price inflation and the experiences of businesses and consumers is a signal to investors that inflation is hotter than it looks. Implications of the disconnect are vast, affecting Social Security payments, tax-bracket adjustments, and economic growth calculations, in addition to investment returns, inflation expectations, and interest rates.
“All you have to do is open up your eyes to see there is inflation pressure everywhere,” says Ed Yardeni, president of Yardeni Research. “We are in stimulus shock.” For evidence, he points to the 26% year-over-year increase in M2 money supply, the largest gain since 1943, as fiscal spending in response to the pandemic has topped $5 trillion. M1, or very liquid money in circulation, is up by 316%. The Fed, meanwhile, has shown no signs of slowing the $120 billion in monthly purchases of Treasuries and mortgage-backed securities that it began in response to the pandemic.
It is possible that the Fed is right, and soaring prices in everything from lumber to labor will drop once Covid-19 fades, rendering inflation a head fake and current worries an overreaction. Inflation, at least as measured, could after a quarter or two go back to being as elusive as it was in the prior decade—especially if legislators rein in spending. Disappointing hiring numbers in April, when the 266,000 jobs added was far below the 975,000 that economists expected, is fodder for the view that a full recovery is distant.
The evidence, though, suggests that it’s risky for investors not to prepare for a Fed that is wrong—or only half-right. That would result in an economy that is weaker than it appears but with persistent inflation, portending the stagflation last seen a half-century ago.
“The trend is not the Fed’s friend,” says Apollo Global Management chief economist Torsten Sløk.
Reported inflation, even with its flaws, has started to rankle investors worried that the Fed might already be behind the curve. Consumer price index, or CPI, data from this past week show that prices rose 4.2% in April, or 3% without food and energy. The much higher-than-expected readings weren’t only because of the so-called base effect: From a month earlier, consumer prices surged at the fastest pace since 1981. In response, major U.S. indexes went sharply lower and bond yields higher, though subsequent bounces suggest that investors are taking Fed officials at their word on the nature of inflation and easy-money policies.
That is happening as a record number of businesses say they can’t find workers, inventories are ultralow, and a near-record number of companies say they plan to raise prices, as they predict costs rapidly rising. Household inflation expectations, meanwhile, are at the highest levels in a decade, as measured by the University of Michigan’s consumer sentiment index, highlighting a core, if inconvenient, macroeconomic truth: Real-world prices shape inflation expectations that wind up determining actual inflation. Here, perception becomes reality.
One feature of the great inflation of the mid-1960s to early 1980s was a buy-in-advance mentality, Yardeni says, where consumers fearing higher prices tomorrow buy today and reinforce pricing pressures. There is some evidence that such a psychology is returning.
Scott Taylor sells the wood pallets that companies across supply chains use to stack, store, and transport materials and finished goods. As the pandemic boosted online shopping and the housing boom drove lumber prices higher, the price of Taylor’s pallets has increased 60% this year.
“Six months ago, we started to feel the crunch of the demand. Now, it’s overwhelming,” the Indianapolis-based Taylor says. Customers have started renting additional warehouse space for the purpose of hoarding pallets, he says, with some reselling at even higher prices. “I’m watching pallets leave the Chicago market, where one is $7 to $7.50, and being sold to the West Coast for $11 to $12. Customers are looking to get any pallet they can get their hands on,” he says.
Nowhere is price inflation more visible than in housing, the best reflection of the combined forces of ultraeasy monetary policy, generous fiscal policy, supply-chain problems, and changing consumer preferences shaped by Covid-19.
For Mike Procopio’s family-owned real estate development company, lumber prices have reached a tipping point. Lumber yards will no longer guarantee prices, instead pricing and billing upon delivery, as prices—up 300% from a year ago—are moving too fast to predict. But it’s not just the price of wood.
“It’s been a rocket shooting to the moon for the past eight months,” says Procopio, a third-generation CEO of Massachusetts-based Procopio Cos., of prices overall, from lumber and steel to labor. He has canceled a fifth of planned projects and halted a tenth this year as the cost of constructing apartment buildings surged 20%. Returns on projects that haven’t gone bust have been clipped to about 15% from 25%.
“They say it’s temporary and there are supply-chain issues, but there is huge demand,” he says. “It’s a vicious cycle. If it costs me 20% extra to build, rents will have to go up 20%.”
Measuring housing inflation isn’t straightforward. People consume shelter, not homes, the logic goes, and so government economists calculate “owner-equivalent rent”—or how much homeowners say they would have to pay in rent—for inflation metrics like the CPI. Given housing’s 40% weighting in the core CPI, it is all the more awkward to watch the shelter component run around 2% as home prices explode month after month.
Even setting aside methodology complaints, there are red flags in the shelter numbers that we do have. Solid, consecutive monthly increases in the CPI’s owner-equivalent rent component have come five months earlier than expected, says Citigroup economist Veronica Clark. She says home prices lead rents and pull up the price of shelter with a lag time of roughly 12 to 18 months; home prices started climbing just over a year ago.
“We’re on the verge of a second-half phenomenon,” says Yardeni, warning of the growing risk that tighter rents and other consumer prices will trigger a wage-price spiral à la the 1970s.
Ask any Wall Street economist when to really worry about inflation and the answer is likely to center on wages. Labor is often a company’s biggest expense, and employers are typically reluctant to raise wages because reversing course isn’t realistic.
There are growing indications of wage inflation, even if official measures aren’t yet sounding alarms. As Hilton Worldwide Holdings (HLT) CEO Christopher Nassetta said on the company’s first-quarter earnings call, “It is very difficult, particularly here in the U.S., to get labor, and it is constraining [the] recovery...because you just can’t get enough people to service the properties.” Domino’s Pizza (DPZ) is offering some delivery drivers $1,000 to sign on plus $25 an hour, while FedEx (FDX) and Cardinal Health (CAH) are paying $500 sign-on bonuses, to name a few.
For small businesses, hit hardest by the pandemic and responsible for about half of U.S. employment, the pressure is more acute. At Procopio, six positions out of 30 remain open despite signing bonuses of up to $20,000. Plumbers on his jobs are making $170,000 a year, while construction estimators, who until recently earned $100,000, now command $150,000—if he can find one.
“I don’t know where all the unemployed people are,” Procopio says. “It’s almost impossible to hire.”
For Blumkin of Nebraska Furniture Mart, it isn’t any better, and he isn’t looking for skilled labor of the sort that Procopio is. For a while, Blumkin says, displaced hospitality workers were filling spots as business hummed during the lockdown earlier in the pandemic. But as the economy reopened, Blumkin has been left with 200 open spots, about 5% of total staff, to fill. Taylor, the pallet purveyor, has increased wages for warehouse workers three times in four months.
The unhappy scenario in the 1970s, Yardeni says, was that as food and other price shocks passed through to consumers, more pressure came from labor and resulted in a spiral where wages and prices chased each other higher. Granted, that was at a time when labor unions had more power. Still, Yardeni is increasingly concerned about a repeat, assigning a 25% chance of a new wage-price spiral. A year ago, he thought there was zero chance.
There are shock absorbers to potentially help cushion against the impact of such a spiral, economists say. Most notably, productivity has grown better than in past recoveries as companies incorporated new technology and other efficiencies in order to survive during the pandemic.
David Lamb, the owner of two Frutta Bowl restaurants in Alabama, launched a takeout app when lockdowns prohibited sit-down dining. He has more recently taken to shopping three times a week at his local Costco Wholesale (COST) for fresh fruit and other supplies, an efficiency driven by necessity, as they have become harder to come by through his supplier. For others, change is tougher. As Blumkin in Omaha puts it, “There are opportunities to automate. But that is not a short-term fix.”
Some economists argue that methodology flaws mean inflation is overstated in official gauges and current increases are less worrisome than in the past. In the mid-1990s, Stanford University economics professor Michael Boskin led a commission to evaluate the CPI and recommend ways to correct measurement bias. The Boskin Commission report concluded that inflation was upwardly biased by 1.1 percentage point a year because quality changes such as new car features weren’t accurately captured, new goods weren’t added to the basket in a timely fashion, and substitution bias—shoppers are more inclined to buy chicken when beef prices surge—was underestimated.
Twenty-five years later, Boskin says there is still an upward bias of roughly one percentage point annually, meaning that increases in inflation are coming off a lower-than-appreciated base. It’s unclear, though, whether technical factors matter insofar as most consumers probably don’t back out the cost of new features when buying a new car and adjust their inflation expectations accordingly.
For investors, the most important questions aren’t whether inflation is here, whether it is indeed transitory, and whether the Fed will have to tighten policy more quickly than telegraphed. Perhaps more crucial is whether the Fed actually can raise interest rates to sufficiently quell a price spiral. After all, the Fed was unable to lift rates above 2.5% during the last tightening cycle and had cut rates in several meetings before the pandemic prompted its emergency actions early last year.
Since then, U.S. households, businesses, and the federal government have grown more indebted, a result of an easy-money policy and a constraint in tightening.
Loans worth $2 trillion—a seventh of the U.S. consumer credit market—entered forbearance during the pandemic, allowing more than 60 million borrowers to miss $70 billion on their debt payments by the end of the first quarter of 2021, according to a group of economists led by Stanford’s Susan Cherry. That’s as U.S. corporate debt is at a record $11 trillion—half of annual gross domestic product—and government debt is on pace to reach 127% of GDP this year. Raising rates to tamp down inflation could have an outsize impact on this borrowing binge.
“The Fed says they’ve got the tools to deal with inflation,” says Yardeni. “The only tool I know is to raise rates and cause a credit crunch and recession. It’s not clear they will have the guts to do that.”
That would leave tightening to the bond market, which could come faster and more furiously than if the Fed were at the wheel. “Such a tremendous amount of debt makes the bond vigilantes more powerful than they’ve ever been,” Yardeni says. “They’ve recently taken a siesta,” but “they’re rising from the dead,” he says, referring to sharp runs in Treasury yields earlier this year and subsequent drops in rate-sensitive growth stocks as inflation concerns started to build.
Then again, the Federal Reserve remains a dominant force in the bond market. Economists don’t expect monthly purchases to taper before the end of this year. Asked in April if it was time “to start talking about talking about tapering,” Powell said it wasn’t.
The Fed declined to comment.
It will take time to determine whether current price increases are in fact transitory, though time isn’t on the side of the Fed: The longer even temporary inflation persists, the more likely it is to take hold. For the Fed to be correct, the right combination of supply-side relief—shortages, from chips to labor, need to abate—productivity growth, and cooler demand needs to materialize. The wrong combination would result in anything from inflation to recession to both.
As millions remain out of work and as economic growth remains reliant on extraordinary monetary and fiscal support, the Fed’s concerns about the recovery are well founded. If the Fed is right that the U.S. economy is still weak enough to warrant near-zero interest rates and quantitative easing, while wrong that pricing pressures are temporary, investors are looking at the threat of stagflation. Longer term, some investors and economists warn of a so-called debt jubilee, effectively a default through hyperinflation, and the risk of the U.S. losing its reserve-currency status.
Policy makers are walking a fine line. The costs of not getting it exactly right are high, already affecting bottom lines, wallets, and investment returns, while threatening to unleash economic forces not seen in generations.
Write to Lisa Beilfuss at [email protected]