Olsztynski Editorial: Inflation's Nasty Legacy
This month's cover story identifies commodity price inflation as the number one issue on the minds of PVF distributors. Yet, it gives them as much cheer as consternation. One of this industry's dirty little secrets is that distributors tend to benefit from escalating prices.
Last year's metal price spurt presented certain difficulties, but also brought with it some windfall profits. Inventory bought low could be sold high. Margins could be nudged a little beyond the increases passed along by vendors. Certainly not in all cases; in many transactions, distributors ended up eating all or part of price increases. But overall you don't hear many distributors cussing inflation.
That's something I learned in my earliest days covering this industry, going way back to May 1977. Among my duties as a young associate editor with this magazine was to produce a department titled “Industry Pulse,” which covered economic trends pertinent to our industry. I recall it as a time when inflation dominated the business headlines.
A brief economic historyThe years 1977 and 1978 were among the most prosperous ever for PHCP distributors. Housing starts nudged 2 million units in 1977 and topped that milestone the following year - a level never again attained, although it was approached last year. Wholesalers also benefited from an inflationary spiral that had been building ever since the Johnson Administration's “guns and butter” policy during the Vietnam War.
Inflation, as measured by the Consumer Price Index (CPI), had never topped 2% in a year between 1958 and 1965. In 1966, it jumped to 3.5%, and wouldn't get below 3% again for another two decades. The 1973 Arab oil embargo set off a steep recession spanning 1973-75, accompanied by a quadrupling of the price of oil that reverberated in a 12.3% CPI for 1974. Thus was born the previously unheard-of phenomenon economists began referring to as “stagflation,” i.e., economic stagnation coupled with rising prices. An economic recovery took place in the last half of the decade, though accompanied by some of the highest sustained inflation rates in U.S. history.
Rising prices were offset more or less by income gains. It was during this era that Social Security, union agreements and many nonunion compensation policies began to get indexed for inflation, with automatic annual increases hinged to the CPI. This exacerbated inflationary pressures but got the politicians off the hook with the voting public.
In this industry, PHCP wholesalers were on a buying binge. I spoke with at least a dozen of them each month in performing my duties, and began to think they all belonged to a cult whose mantra was, “You can't sell out of an empty wagon.” Spot shortages were a recurring complaint, but any goods they could get, they could sell lickety-split for a lot higher than they bought them. Copper tubing in particular was subject to periodic speculative frenzies.
The big letdownMeantime, the CPI registered a 9.0% gain in 1978, 13.3% in 1979 and 12.5% in 1980. Stories appeared in the news media wondering whether the United States was verging toward the kind of hyperinflation that helped turn Germany's Weimar Republic into a Nazi nightmare.
In 1979, the overheated economy started slowing down. Following economic logic, the Fed kept pushing interest rates up to dampen inflation, and borrowing costs eventually surpassed the inflation rate. Once the trend lines crossed, it didn't take long for the booming economy to plunge like the first drop of a roller coaster. Mortgages approached 20%, and the housing market collapsed to about half of its peak level.
Distributors suddenly found themselves with a surfeit of inventory bought high that they could only sell low. “Can't sell out of an empty wagon” cultists turned into inventory atheists. To this day, I don't think inventory service levels industry-wide have ever recovered to what they were in the late '70s, although I'm not aware of any data available to prove the point.
Voters reacted to our country's staggering economy by replacing President Jimmy Carter with Ronald Reagan, who took office in 1981. A strong monetarist policy by holdover Fed Chairman Paul Volcker and relative fiscal restraint by the new administration led to the so-called “Reagan Recession” of 1981-82, our nation's worst economic decline since the Great Depression.
The Reagan Administration caught hell in the press for that, but to their everlasting credit their strategy worked. Inflation receded to 3.8-3.9% for the years 1982-1985, and dropped all the way down to 1.1% in 1986. There was a brief spurt upward during the rest of the decade as the economy heated up, peaking at 6.1% in 1990. The CPI has not risen beyond 3.4% in any subsequent year. Severe though it was, the Reagan Recession lasted less than two years and set the stage for the unprecedented growth and prosperity our nation has enjoyed with only a couple of brief interruptions ever since.
Giddy timesLooking back, I recall the giddy demeanor of this industry and society at-large about inflation during the years 1977-78. Economists kept warning about dire consequences, but most people were reasonably content because they were keeping up with annual double-digit pay increases.
Like today, politicians of the era could not muster the discipline to rein in spending. Liberals were wedded to the Keynesian philosophy that looked to the government to stimulate the economy, and saw virtually any amount of inflation as preferable to economic sacrifice, no matter how temporary. Conservatives, then as now, paid more lip service than liberals to spending restraint, but for the most part simply shoveled government money in different directions.
Last year's price spurt is dissimilar in many ways to that of a quarter-century ago. For one thing, runaway inflation isn't a universal problem throughout the economy, just in certain commodities. Importantly, our present era has been characterized by strong business productivity gains driven by technology. As long as productivity outpaces inflation, as has been the case almost every year since the early '90s, we're in pretty good shape. The opposite held true through most of the 1970s and '80s. Also, powerful forces of globalization are holding down prices, and this is likely to continue for the foreseeable future. In fact, it was only about a year ago that worrywarts in the news media were warning we could be headed into a worrisome period of DE-flation. That now appears unlikely.
Deflation would be devastating to distributors, yet inflation is no more than a fair-weather friend. What it gives will eventually be taken back, because inflation distorts economic behavior. Rational purchasing decisions turn into speculation. Price trumps quality and service as a rationale for buying. Inflation can delude businesses into thinking they're doing a lot better than they are, and thus postpones needed cost controls.
We are much better off as a society and an industry since Ronald Reagan and friends slew the inflation dragon. Enjoy the windfall while you can, but be careful what you wish for into the future. <<