I had occasion yesterday to be on The Call, a CNBC television show hosted by economist Larry Kudlow. Like other supply-side economists, Kudlow follows Milton Friedman in assuming that the inflation rate is driven solely by monetary policy.
My topic as a talking head: Where is inflation headed in the US? Inflation matters because it affects the stock market, interest rates and our real wealth and income.
I think horse racing is a good analogy for inflation predictions. A lot of people are betting on the horse called inflationary expectations: the Federal Reserve’s monetary stimulus will create higher inflation rates so let’s build that expectation into today’s interest rates and prices. Another horse is medical costs: pharmaceutical companies and health care providers are raising rates in anticipation pricing pressures once the Democrat’s national health care policy is enacted. Yet another horse is energy prices.
I’m betting on the horse called deflation, owing to the increasingly commodity-like economy coupled with recession-induced excess capacity. Those betting on inflationary expectations, I feel, are incorrectly assuming that the monetary stimulus will come on top of a traditional economic upturn. What they’re forgetting is that the only thing holding up the economy and prices today is stimulative spending and monetary policies of our government.
And we haven’t even seen the full effects of state and local government deficits, record-high office vacancies causing bankruptcies and further bank capital problems and a growing retail bankruptcy rate. Eddie Bauer declared bankruptcy yesterday. Who’s next?
In the end, most of the prices in our economy are set by individual business people and not by some mysterious mechanism. What will these business people do? We have record high unemployment and excess industrial capacity. Furthermore, customers increasingly see few if any differences between the products of the companies they’d consider buying from, making price the key driver of customers’ choices. The bottom line (or should I say my racetrack bet?) is that the forces for higher prices just aren’t strong enough in the near to mid-term to cause inflationary concerns.
Deflation does not bode well for corporate earnings. What are you to do? Engage in business model innovation. You’ll discover new growth platforms and, as a one-of-a-kind business, you’ll have much better control over pricing.
I’ve said it before in this blog. Every industry has its Walmart. If you can’t be your industry’s Walmart, avoid becoming its Sears, Shopko or K-Mart. Differentiate your business model.
For insight on business model innovation, read my recently released book, Beyond Price.