The Great Squeeze in Profit Margins

People shop at a grocery store in New York City on May 31, 2022. Samira Bouaou/The Epoch Times

Commentary

It’s beyond me why the Consumer Price Index (CPI) garners so much attention from the press, but the statistical release the following day barely makes a dent in the news cycle. That’s the Producer Price Index (PPI).

In many ways, the PPI is more important because it forecasts the plight of the consuming public, reveals much about profit margins, and gives a picture of the real costs along the production structure that sustain prosperity as we know it.

The PPI for June is out and, as we might expect, it’s terrible. It’s the second-worst rate of increase on record, with the first being March this year. It also shows the trend line isn’t good. The year-over-year rate of increase came in at 11.3 percent. This is well ahead of the CPI and reveals that we’re nowhere near done with inflation. There’s much more to come, and something much worse too: a serious margin squeeze in profitability.

It’s unclear why there’s so much focus on CPI and so little on PPI. It isn’t like the stuff in the stores drops from the sky. Nor does the gas in the pump magically appear. Everything we consume has to be produced, and that requires a structure of investment, risk, employment, and myriad transactions along the way, along with a careful balancing act at each stage so that everyone can avoid losing money in the process.

Once you examine the intricacies of the market, especially the global market, you can’t help but be awestruck by its sheer complexity. No one designed the whole. It emerges organically from human choice, judgment, and intelligence. It’s a robust system, provided that everyone can work together with a common and dependable unit of account. When the unit of account goes kablooey, everything becomes very vulnerable.

Back in the summer of 2020, things were looking pretty good. Prices weren’t increasing for consumer goods. For producer goods, they were falling. That meant something truly remarkable. The economy overall was an utter wreck due to lockdowns, but the producers who were allowed to operate were thriving as never before, with falling prices and rising demand. What could go wrong?

The trouble was the lag. All the while, the illusion of profitability was being boosted by the largest credit and money expansion in our lifetime, fueled by congressional spending and backed by the Fed’s seemingly magical way of writing infinite checks that don’t bounce. This problem, built throughout 2020, only began to reveal itself after 2021.

At this point, the trajectory of consumer and producer prices flipped. Suddenly, producers were facing an even tighter squeeze than consumers. Here were the very first signs that recession was a genuine risk. You can’t have a viable economy in which producers face a higher level of rising costs than consumers are willing to accept. At some point, the margins will begin to bite. The announcement on July 14, that producer prices are rising at 11.3 percent and consumer prices are at 9.1 percent, reveals what we need to know.

The squeeze is illustrated by the distance of the price pressure between consumers and producers. Data: Federal Reserve Economic Data [FRED], St. Louis Fed; Chart: Jeffrey A. Tucker

From this we can forecast a profitability crunch among the highest ends of the corporate structure that profited so much during lockdowns. The profits were largely illusory or temporary at best. Now, they’re faced with a huge administrative overhead that they’re all incentivized to cut before attempting to pass on the vast new costs to consumers. They know they can’t do that and survive competitive market pressures.

Hence, job cuts are both happening and intensifying. They’re affecting especially the white-collar, six-figure professional class. We won’t see this showing up in the overall unemployment numbers, because there’s still a massive shortage among the lower-wage, physical work sector of the labor market. That’s why this recession won’t be characterized by high unemployment—the first one in more than a century not to have this as a primary feature. This is due to the labor shortage.

A quick story to illustrate the point. I asked my Uber driver what he does in real life. He said that this is what he does in real life since having been laid off by a large grocery chain where he had worked a high-paying job at the management level. He and hundreds of others were told that they were being repositioned to do gritty, manual jobs such as stocking shelves and managing inventory for things people are buying. They had to reshuffle, but their new jobs would pay a third less.

That’s one thing that seems nearly impossible to do in a modern economy: cut existing wages. So the man left. He went from high executive to Uber driver in short order. And here’s where it gets depressing. He knows he needs another job, but this time he’s going to make sure it’s one from which he won’t be fired. So he has applied to be a corrections officer with the government. Good pay. High benefits. Can’t be fired.

Ouch. Can you imagine if this trend were broad, one in which the private sector is drained of managerial workers who then immediately flip and populate the public sector as employees? If that’s the future of the labor trajectory in white-collar America, we’re in very deep trouble.

But the problem hardly stops there. Average real weekly earnings—that is, adjusted for inflation—are down 4.4 percent, and hourly earnings are down 3.6 percent. These are wage cuts in the sneakiest form. Small businesses, too, are facing the great margin squeeze, and they'll cut as much as possible before choosing to go out of business. Thus, workers are facing a downgrade in their standard of living from two directions.

What’s the Biden administration doing about this? In a phrase, making it worse. They’re increasing costs to business, failing to inspire investment, punishing wealth creation, and intensifying command and control in a way that harms economic growth. Inflation will have to become endemic one way or another, and the only way to soften the blow is with wealth creation and economic growth. Increases in the federal funds rate will only drive recession without fixing the inflation problem in the near term.

What’s more, there’s very little, if anything, that a new Congress can do about this. We’re truly looking at 30 more months of absolute disaster unfolding on the economic front, and right in the thick of a health, educational, and cultural crisis. What a time to be alive!

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.