Monday, August 21, 2006

Pricing power and inflation

Inflation cannot rise because firms don't have pricing power, goes one of the anti-inflation arguments I come across quite often.

It seems like a sound argument- If firms can't raise prices, inflation cannot occur. Yet, I lived through a period of time (the late 90s) in a region (SE Asia) where pricing power was very limited, but inflation rose dramatically anyway. The flaw in the argument recalls the over my dead body argument. The response being...if that's the way you want it.

If a firm cannot raise prices without severely reducing unit sales but the firm's input costs are rising it goes bankrupt depending on the amount of cash it can get its hands on. Other firms, whose financials are geared toward lower volumes or with deeper pockets will make up the slack, at higher prices.

With that thought in mind, I'm keenly watching the US auto industry. Bankruptcies could signal a round of inflation as competition declines, i.e. the pricing power of the industry as a whole gets divided amongst fewer hands.

Speaking (actually writing) of pricing power, it seems the Fed fears it no longer has any. They may be correct in that view. For the first time since 2000 (when the Fed removed $20 odd Billion from Dec. 1999 to Feb 2000), the monetary base is contracting, albeit slowly (less than $5B from the May peak).

Funny how rates could rise substantially (thus inflating interest profits at the banks) for many quarters without much complaint but when the monetary base contracts, people begin to worry.

The former action is, in my view, the Fed, i.e. the OPEC of money, acting as an agent for the banks, and giving it some room to cut later, the latter action is the Fed trying to keep a lid on inflation, or perhaps just trying to gin up a little equity/housing market sell off, which would get the world crying for some more money. (Gosh, I start writing about the Fed and I get verbal inflation, no simple sentences, just run on and on and ons).

Fortunately, Helicopter Ben will be there to bail us all out, likely to popular acclaim.