The U.S. has actually gone through many brief periods of deflation, but in general, economic progress is accompanied by inflationary pressures. Inflation may occur when there is too much money in the system, which leads to an escalation in the price of goods. Of course, if a household’s two primary sources of wealth creation—asset and income appreciation—rise at a rate equal to or greater than inflation, the negative effects of inflation are neutralized.
Businesses that manufacture hard goods tend to be hit by inflation sooner than service or retail businesses. Energy and material shortages prevent finished goods from rolling off the production lines. Even though smaller businesses with less purchasing power tend to get hit harder by inflationary shortages, huge companies with billions of dollars on hand can find themselves hamstrung by inflation.
Major car manufacturers like GM and Ford have thousands of vehicles sitting outside of factories that can’t be delivered due to computer chip shortages. Companies that have perfected zero-inventory, “just in time” manufacturing methods might be suffering the most right now.
Inflation is often referred to as the “worst tax” because its effects go unnoticed by most people. Hypothetically, earning 4% in a savings account while inflation grows at 7% makes many feel 4% richer. In fact, they are 3% poorer.
That’s why it’s important for households and investors alike to understand the causes and effects of inflation, and how to plan so as to ensure that their assets maintain their purchasing power.
Small businesses are generally in a much weaker position to adjust prices when inflation kicks in. Many small businesses are already weakened by the prolonged recession and are hesitant to raise prices right now.
How can small businesses prepare for the onslaught of inflation that seems almost inevitable?
Now that inflation has begun to heat up, it is time to become aggressive with frequent small price increases. This is generally a much better strategy than waiting and trying to catch up at some point with one big jump. For some businesses that post prices, such as restaurants with printed menus, this will create a challenge. But it is worth the effort, as customers are more willing to accept smaller price increases.
The challenge for all businesses will be managing through uncertain business cycles. Higher average inflation usually means a less stable real economy. For example, from 2010 through 2019 U.S. GDP grew in a very narrow range, with a low of 1.6 percent growth and a high of 2.9 percent.
During this period inflation averaged two percent. But back in the period 1973-1982, when inflation averaged 8.8 percent, GDP ranged from -2.7 percent to 4.6 percent. We had three recessions in that high-inflation period.
The correlation between higher inflation and more economic volatility has been found in international studies covering many different countries in many different time periods. If, in fact, U.S. inflation increases and remains high for a decade, companies across all industries will experience more booms and more busts.
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