Global Supply Chain Management

Double-digit inflation is coming, unless we bite the bullet and get our supply-demand balance back in order with higher interest rates and a stronger dollar. Consider this quote from a Peter Coy article from BusinessWeek, June 11:

One thing Bernanke doesn't know is how businesses are going to react to the combination of higher oil prices and rising unemployment. Will they try to push up their own prices, or will they accept that customers don't have the money to pay more in a weak economy? As Bernanke noted on June 9, "Unfortunately, only very limited information is available on expectations of price-setters themselves"--that is, business executives.

Lots of talk about the inflation/recession balancing act circles around topics like the credit crisis and the Fed's role in forestalling an economic slowdown. As Mr. Coy noted, however, the real driver of price increases--business pricing decisions--is largely invisible to policy makers. Not so for AMR Research, where we see the tug of war between operational efficiency and input price increases first hand, as we warned just last month in "Inflation Reaction."

Now our predictions are coming true. Here's what we see: Food and fuel may get left out of "core inflation," allowing the Bureau of Labor Statistics to report 2.3% inflation on its home page. But these inputs are blowing the bank on manufacturing's and retail's ability to offer everyday low prices.

At our recent Supply Chain Executive Conference in Scottsdale, Arizona, Dow Chemical addressed the audience on the same day an across-the-board 20% price increase made front-page news in The Wall Street Journal. Dow has been a pioneer in devising ways to keep upstream costs from finding their ways into consumer prices. But, as VP of Supply Chain Jim Varilek told our audience, this game is over now. He showed how this huge price increase would just barely cover the increased costs of upstream inputs, especially oil and natural gas.

The audience had reason to care, since many were supply chain executives from consumer products (CP) companies, retailers, and logistics providers, all of whom are absorbing this price increase. What they saw sitting around them were peers wrestling with their own efficiency versus input cost battles.

The consensus emerging is that prices will need to go up, no matter how accustomed we are as shoppers to 1% to 2% inflation.

As Mr. Bernanke and the economists concede, inflation is heavily influenced by expectations. For almost two decades now, the combination of abundant cheap labor in places like China and the huge productivity gains driven by technology in the global supply chain have left us thinking inflation is dead--but not any longer.

First we see gasoline and other energy prices go up, and then food. Finally, all products shipped from afar, including traditionally deflationary items like apparel and electronics, start going up, mostly because of the high transport costs coupled with the weak dollar.

The next thing we know it's October--time to ask for a raise. Even staying put means looking for 10%-plus increases in salary. The wage-price spiral may not be headline grabbing as it was in the days of big unions, but white-collar workers are just as likely to press for cost-of-living adjustments (COLA). Before you know it, double-digit inflation is back.

My question is this: when will the Fed recognize what's driving business pricing decisions and realize that we have no choice but to accept higher interest rates, even if it starts a recession? The dollar is so weak that Belgian-Brazilian beer group InBev can credibly bid to take over Anheuser-Busch, while exchange-rate-supported exports falsely signal a healthy economy.

We are in a bad spot, and businesses--especially manufacturing and retail--know it. They are ready to raise prices en masse even if the underlying oil price is a speculative bubble. Before this dynamic gets rolling too fast to stop, Bernanke and company need to tighten money.

Operations executives have been holding back the flood for far too long and it's about to blow. Longer term, we expect productivity advances in the supply chain to keep inflation under control, but right now the risk of reigniting 10% to 15% inflation is very real. Stimulating demand with continued low interest rates is the wrong answer.

Let us know what you think at our blog--chainreactionblog.com.
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