Inflation is ravaging shoppers’ wallets and the Federal Reserve has responded by instituting a regimen of painful interest rate hikes that could land the economy in a recession. But corporate profits are surging. US profit margins have reached record levels not seen since the immediate aftermath of World War II.
How did that happen?
Some economists are pointing to “greedflation,” the idea that companies are using high inflation rates as an excuse to price-gouge their customers while they bring in record profit margins.
Soci?t? G?n?rale’s global strategy economist, Albert Edwards, wrote in a note last week that “the primary driver” of high inflation is companies taking advantage of customers by charging more to make an extra profit.
Customers expect price rises because they read about inflation in the press, wrote Edwards, but companies have “clearly taken advantage of rising inflation expectations” and have increased their prices even as their costs have remained the same, adding to their bottom line.
Edwards says that instead of “calling this out as the primary cause of high inflation, central banks have instead chosen to focus on rising nominal wages as threatening to embed higher inflation – the so-called ‘wage/price spiral’,” referring to the central bank’s theory that wage growth has to slow down for prices to ease.
Between the end of 2020 and the third quarter of 2022, employee pay rose by 14%, but corporate profits grew by a whopping 28%.
Isabella Weber, an economist at the University of Massachusetts Amherst outlined in a recent academic study what she calls a “price-price spiral,” where companies hike prices beyond an increase in their costs.
Companies have recently “pushed margins higher. And, most surprisingly, they still continue to do so even as their raw material costs fall away,” wrote Edwards.
In a January speech, Lael Brainard, former Fed vice chair and current director of the National Economic Council of the United States, expressed worry that a price-price spiral could ultimately tank the economy by turning consumers off from spending. “The compression of these markups as supply constraints ease, inventories rise and demand cools could contribute to disinflationary pressures,” she said.
Other analysts, including UBS Wealth Management’s chief economist Paul Donovan, have also taken issue with the current strategy. “Powell’s failure to explain the philosophy behind their policy — how will rate hikes curb profit margin expansion? — adds uncertainty,” he said in a recent episode of his podcast.
What’s next: The first quarter of 2023 officially comes to an end this week and corporations will soon begin to report on their earnings. Those reports will provide key insights into the reliance of consumer spending, supply chain inefficiencies, inventory levels and perhaps more importantly: Profit margins.
But price-price spirals can’t last forever, said Annabel Rudebeck, head of non-US Credit at Western Asset. A recession will chip away at companies’ abilities to charge more. “There will be a point where the ability to push price over volume becomes more challenging. Presumably that would happen if we do see a big correction among higher-earning people.”
Silicon Valley Bank’s downfall sent waves of panic through the financial system earlier this month, setting off a chain reaction of chaos with which regional banks are still grappling.
Now, lawmakers are in the midst of an investigation into what led to the second-largest and third-largest bank collapses in US history — and how to prevent something similar from happening again.
On Tuesday, members of the Senate Banking Committee probed federal regulators: Martin Gruenberg, chairman of the board of directors of the Federal Deposit Insurance Corporation; Nellie Liang, under secretary for domestic finance at the US Treasury; and Michael Barr, vice chair for supervision at the Federal Reserve, about the tumultuous events that sent financial systems into a frenzy.
Here are three of the key issues that arose from the hearing:
1. Silicon Valley Bank customers
New details that emerged underscored the enormity of the bank run at SVB as it became the second-largest bank failure in American history.
Panicked customers attempted to withdraw a staggering $100 billion from Silicon Valley Bank on the day the tech lender was shut down by regulators, Barr revealed on Tuesday.
Officials have previously detailed that customers successfully pulled $42 billion from Silicon Valley Bank on March 9, the day before it was shut.
2. Mismanagement led to SVB’s failure
In his testimony, Barr also detailed how SVB leadership failed to effectively manage interest rates and the risk of running out of cash.
SVB’s failure is a “textbook case of mismanagement,” Barr said.
The Fed official pointed out that SVB’s belated effort to fix its balance sheet only made matters worse.
“The bank waited too long to address its problems and, ironically, the overdue actions it finally took to strengthen its balance sheet sparked the uninsured depositor run that led to the bank’s failure,” said Barr, adding that there was “inadequate” risk management and internal controls.
“Social media saw a surge in talk about a run, and uninsured depositors acted quickly to flee,” he said.
3. More regulation is needed
Democratic Sen. Elizabeth Warren of Massachusetts grilled federal regulators on their commitment to tightening banking rules.
“Executives at SVB and Signature [Bank] took wild risks and must be held accountable for exploding their banks,” Warren said. “But let’s be clear, these collapses also represent a massive failure in supervision over our nation’s banks.”
All three federal regulators called to testify agreed with Warren that the government needs to strengthen the rules for banks to help prevent future bank collapses.
“I anticipate the need to strengthen capital and liquidity standards for firms over $100 billion,” said Barr.
Republican Senators repeatedly insinuated on Tuesday that the recent US banking turmoil came as a result of the Federal Reserve’s focus on climate change.
The Federal Reserve announced in September that the six largest banks in the United States would participate in a voluntary pilot program to test what effects disastrous climate change scenarios could have on their bottom lines.
During Tuesday’s hearing, some Republican lawmakers appeared to blame the Fed’s focus on that program and on addressing climate change in general for a lack of regulatory banking oversight.
In his opening statement, Republican Sen.Tim Scott of South Carolina, the ranking member of the banking committee, called the Fed’s focus on climate change a waste of time.
“The Fed should focus on its mission and not the climate arena. This is a waste of time, attention and manpower,” he said. “All things that could have gone into bank supervision.”
Republican Sen. Steve Daines of Montana said President Joe Biden’s stimulus plan contributed to the downfall of Silicon Valley Bank by failing “to prioritize clear and present risks of the inflationary environment, rising interest rates and what they would do to bond values,” and “instead opting to focus on climate change.”
Daines also accused the Federal Reserve Bank of San Francisco of prioritizing climate change over the risks presented by higher interest rates.
“Senator, I’ve been focused on risk throughout the system, both short-term and long-term risks,” replied Michael Barr, the Fed’s vice chair for supervision. “Interest rate risk is a bread and butter issue in banking. It’s what our supervisors do all the time.”
In an interview with Montana Public Radio in 2014, Daines said that “the jury’s still out” on whether climate change is real. His campaigns have received more than $600,000 in donations from the oil and gas industry.
Fed Chair Jerome Powell has said repeatedly that the central bank would not become a “climate policymaker.”
“Today, some analysts ask whether incorporating into bank supervision the perceived risks associated with climate change is appropriate, wise, and consistent with our existing mandates,” Powell said in January.
“In my view, the Fed does have narrow, but important, responsibilities regarding climate-related financial risks. These responsibilities are tightly linked to our responsibilities for bank supervision. The public reasonably expects supervisors to require that banks understand, and appropriately manage, their material risks, including the financial risks of climate change.”