Supply Chain Management is Killing Inflation

One Dollar Bill over a graph

The Wall Street Journal, among many other media outlets, recently reported with typical bemusement the low inflation that “Defies a Growing Economy.” The article describes the situation as a “soft trend that is puzzling Federal Reserve officials who expected an improving economy to be pushing up consumer prices at a faster rate.”

Economists don’t seem to understand the micro-level truth behind these macro numbers, which is that supply chain management is killing inflation in the cradle.

Too Much Money or Too Few Goods?

Inflation comes from too much money chasing too few goods, or so say the fundamental principles taught in freshman economics courses. One huge part of this is, of course, monetary policy, and in particular the money supply. Hyperinflations as seen historically in 1920s Germany or 1980s Argentina can be created by simply printing too much currency. In the United States this sin has been largely avoided.

Kudos to the Fed for a job well done.

US Inflation Rate graph

The other half of it, however, is all about supply. In the 1970s, inflation got pretty serious in the U.S. because of OPEC constraining oil supplies and, to a lesser degree, union power as expressed in strikes. The economy at the time wasn’t engineered to adjust as quickly as it is today, and passing along price increases to consumers was natural.

Supply constraints then drove up prices as consumers, in effect, blessed inflation by accepting the increases. For a while (remember Gerry Ford and “Whip Inflation Now” buttons?), consumer expectations fueled this dynamic, risking the kind of self-fulfilling hyperinflation cycle that doomed Weimar Germany.

Too Much Money and Too Many Goods

The past decade has seen a market crash, a deep recession and a steady recovery. Government borrowing was supposed to create inflation, and yet, near-zero interest rates and significant deficit spending still hasn’t moved the needle. Even unemployment levels close to 4% and gradually-increasing wages seem unable to wake the inflation monster. Cash on corporate balance sheets, booming equities prices and a resurgent real estate sector mean money is everywhere.

Meanwhile, our supply of consumer goods is flourishing. That’s true not only for electronics, which we’ve come to assume will fall in price even as they improve in performance, but also for clothes, food and all manner of consumer products.

Consider, for example, daily nutrition in the U.S., which rose from 2168 calories per day in 1970, to 2405 in 1990, and 2673 by 2008. Average home size also grew dramatically over this period, from about 1600 square feet in 1970 to 2500 square feet in 2008. That extra 900 square feet of space is pretty much full of furniture, appliances, shoes, toys and more.

We are awash in stuff, and that makes inflation a tough sell.

Supply Chain Management as Inflation Firefighter

Today we take for granted that Amazon offers low prices on an essentially endless selection. Before that, we had Walmart defining the American retail experience with “everyday low prices.” If that’s not enough, we have the newest champions-of-cheap, Aldi and Lidl, doubling down in U.S. grocery. These retail players have trained suppliers not only to forget about price increases, but also to look for incremental cost reductions every year.

This pressure is felt everywhere in supply chains, as branded consumer goods companies turn around and push for savings upstream in their supply bases for raw materials, components and logistics services. The top concern of supply chain leaders across industries since at least the 1980s has been cost reduction. Meanwhile, technology-driven productivity gains in agriculture, oil and gas extraction, and semiconductor fabrication have dramatically softened the power of commodity pricing.

The price of a dozen eggs in 1970 was $0.62. Today it is often just over a dollar, or about twice as much in nominal terms. Average household income, meanwhile, has risen from $8,734 to $56,516 in the same period — a six-fold increase.

The truth about inflation is that it must get through the supply chain management gatekeeper, whose job is to find another 5% in savings each and every year. Sometimes it manifests as corporate profits, sometimes as consumer surplus.

Either way, inflation just can’t get started.

Author Kevin O'Marah

Chief Content Officer, SCM World

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