Inflation is ravaging shoppers' wallets and the Federal Reserve has responded by instituting a regimen of painful interest rate hikes that could land the economy in a recession. But corporate profits are surging. US profit margins have reached record levels not seen since the immediate aftermath of World War II.
How did that happen?
Some economists are pointing to "greedflation," the idea that companies are using high inflation rates as an excuse to price-gouge their customers while they bring in record profit margins.
Société Générale's global strategy economist, Albert Edwards, wrote in a note last week that "the primary driver" of high inflation is companies taking advantage of customers by charging more to make an extra profit.
Customers expect price rises because they read about inflation in the press, wrote Edwards, but companies have "clearly taken advantage of rising inflation expectations" and have increased their prices even as their costs have remained the same, adding to their bottom line.
Edwards says that instead of "calling this out as the primary cause of high inflation, central banks have instead chosen to focus on rising nominal wages as threatening to embed higher inflation -- the so-called 'wage/price spiral'," referring to the central bank's theory that wage growth has to slow down for prices to ease.
Between the end of 2020 and the third quarter of 2022, employee pay rose by 14%, but corporate profits grew by a whopping 28%.
Isabella Weber, an economist at the University of Massachusetts Amherst outlined in a recent academic study what she calls a "price-price spiral," where companies hike prices beyond an increase in their costs.
Companies have recently "pushed margins higher. And, most surprisingly, they still continue to do so even as their raw material costs fall away," wrote Edwards.
In a January speech, Lael Brainard, former Fed vice chair and current director of the National Economic Council of the United States, expressed worry that a price-price spiral could ultimately tank the economy by turning consumers off from spending. "The compression of these markups as supply constraints ease, inventories rise and demand cools could contribute to disinflationary pressures," she said.
Other analysts, including UBS Wealth Management's chief economist Paul Donovan, have also taken issue with the current strategy. "Powell's failure to explain the philosophy behind their policy—how will rate hikes curb profit margin expansion?—adds uncertainty," he said in a recent episode of his podcast.
What's next: The first quarter of 2023 officially comes to an end this week and corporations will soon begin to report on their earnings. Those reports will provide key insights into the reliance of consumer spending, supply chain inefficiencies, inventory levels and perhaps more importantly: Profit margins.
But price-price spirals can't last forever, said Annabel Rudebeck, head of non-US Credit at Western Asset. A recession will chip away at companies' abilities to charge more.
"There will be a point where the ability to push price over volume becomes more challenging," she said. "Presumably that would happen if we do see a big correction among higher-earning people."
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