Taking a long view on the effects of inflation
October 1, 2008
There have been plenty of articles in the media lately on inflation.
One of this industry’s dirty little secrets is that distributors tend to benefit from escalating prices.
The recent spurt in metal prices 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 the industry. I recall it as a time when inflation dominated the business headlines.
The years 1977 and 1978 were among the most prosperous ever for HVAC and plumbing 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 in 2004.
Inflation, as measured by the Consumer Price Index, had never topped 2 percent between 1958 and 1965. In 1966, it jumped to 3.5 percent, and wouldn’t get below 3 percent again for another two decades. The 1973 Middle East oil embargo set off a steep recession spanning 1973-1975, accompanied by a quadrupling of the price of oil that reverberated in a 12.3 percent hike in the index for 1974.
‘Stagflation'Thus was born the previously unheard-of phenomenon economists began referring to as “stagflation” - economic stagnation coupled with rising prices. An economic recovery took place in the last half of the decade, though it was 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 index. This exacerbated inflationary pressures but got the politicians off the hook with the voting public.
In the HVAC industry, wholesalers were on a buying binge. I spoke with at least a dozen of them each month while 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 for a lot higher than they bought them. Copper tubing in particular was subject to periodic speculative frenzies.
In 1979, the overheated economy started slowing down. The Federal Reserve System kept pushing interest rates up to dampen inflation until borrowing costs eventually surpassed the inflation rate. Mortgage interest rates approached 20 percent, and the housing market collapsed to about half of its peak level.
Distributors suddenly found themselves with inventory bought high that they could only sell low.
New directionsVoters reacted to our country’s staggering economy by replacing Democratic President Jimmy Carter with Ronald Reagan, a California Republican, who took office in 1981. After a rough start that led to a two-year recession, inflation receded to less than 4 percent from 1982-1985, and dropped all the way down to 1.1 percent in 1986.
Looking back, I recall the giddy demeanor of this industry and society 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 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.
The 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 1990s, 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 three years ago that worrywarts in the news media were warning we could be headed into a worrisome period of deflation. 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.
Jim Olsztynski - pronounced Ol-stin-skee - is editor of Supply House Times, a sister publication of Snips. He can be reached at (630) 694-4006, or e-mail email@example.com.