Retail’s Pending Recession Is Fueled By Inflation With Seeds Of Stagnation

While everyone awaits the release of the Consumer Price Index (CPI) on Tuesday April 12, those who follow the retail roller coaster are fixated on the train slowly ascending the hill, as retail executives wonder about the next curve and the bottom of the dip. The coaster may (or may not) be modeled after the Cyclone at Coney Island, but the ride and the thrills are definitely cut from the same piece of cloth.

Robert Frost nailed it when he wrote: “some say the world will end in fire, others say in ice. From what I’ve tasted of desire, I hold with those who favor fire.” In the context of Frost, retail doesn’t exactly know how their consumers will perform as they face a barrage of skyrocketing price increases. Will 2022 be fire or will it be ice? Perhaps the predictive indexes (like the CPI) will tell the story.

The Federal Reserve (Fed) prefers to look at the Personal Consumption Expenditure Index (PCE) for inflation guidance and those recently published numbers were disastrous. The next jolt arrives as the Consumer Price Index (CPI) is released and that is unlikely to be attractive. The CPI measures out-of-pocket expenditures, while the PCE measures the change in goods and services. The last PCE report indicated 6.4% inflation over a 12-month period (including groceries and gas). This was the highest year-over-year inflation jump since January of 1982 and a clear indicator that pricing is on the rise and ready to spin out of control.

Focusing on fashion for a moment, most of the current retail chatter tries to avoid the inflation conundrum. Conferences and conversations revolve around the environment, sustainability, e-commerce, supply chain, or Ukraine. In general, retail interactions are relatively calm right now, but that may change as the return to bankruptcy alley could be around the bend. Certainly, the financial markets are worried about a potential downturn for retail, even the XRT retail index has dropped about 16% year to date. The product supply side continues to take a hit, with retail flashing lights blinking furiously. There are lockdowns in zero-COVID China which are delaying shipments to the U.S.A. and the backlog continues on the California docks. In addition, there is the possibility of another longshoreman’s strike at the end of June that could cripple 29 West Coast ports if talks between the Pacific Maritime Association (PMA) and the International Longshoreman and Warehouse Union (ILWU) fail. The price of fashion’s raw materials also continues to rise – whether it is cotton (which has more than doubled in the last two years), or the price of polyester (which is derived from oil). To make matters worse, the federal government is poised to check for Xinjian products at the borders, and former President Trump’s China tariffs are still in place – which adds pressure to retailers trying to conduct business in the face of costs that continue to rise.

Whatever the case, retail prices (for sure) are going up, and inflation is likely to continue well into 2023. Consumer prices won’t be able to roll back to pre-COVID times, and the adage kicks in that – as prices go up, sales will go down, and jobs will eventually get lost.

Former Federal Reserve Chairman Alan Greenspan used a credible theory about how to measure the state of the economy (in recession or in recovery). He targeted sales of men’s underwear using the MUI (Men’s Underwear Index) as a guide with the fairly accurate belief that when the economy gets stressed, consumers are slow to buy staple products like men’s underwear. Other analysts may look at different inflation or recovery guides, but the truth tells us that retail is usually the first to head into a recession, and the first to head out.

Analysts looking towards the concept of a potential recession like to talk about inverted yield curves, but that scares some peoples away – because it sounds too complicated. Simply put, when the yield on the two-year treasury is higher than the ten-year rate, investors believe that short-term trouble is brewing. Other recession watchers will focus on the price of gas, because filling up a car takes real cash out of people’s pockets and leaves them less to spend on other consumer items. The popular Ford F-150 pick-up truck (for example) has a 26-gallon gas tank. One year ago, the national average for gas was $2.86 a gallon and today it is $4.11. That means it cost $74.36 last year to completely fill the truck, and it costs $106.86 today. The difference is $32.50 or 44% more for a full tank of gas. Obviously, this is painful for those that drive to work every day.

The Government is sounding the alarm about inflation, but (deep down) they also realize that their early COVID economic policies were probably too aggressive and they helped spark the inflation fire. Clearly, the Administration was warned by the likes of Former Treasury Secretary Larry Summers who, in retrospect said to the Harvard Gazette: “We had an economy where income was running short by $50 billion a month because of the pandemic, and we injected $150 billion to $200 billion a month into that economy. It’s perhaps not surprising that that’s led to an overflow of demand, which has generated inflation.”

In Government speak (the jargon language that flourishes in Washington, D.C.) the word “transitory” has apparently been banned from the official economic lexicon. The Fed probably should have acted earlier to rein in inflation but that didn’t happen, so now we are faced with a rapid and steep interest rate-hike. While they are trying to fix the money-machine, the Government could also move a bit faster to renew trade programs that would act to lower costs like the Generalized System of Preferences (GSP) and the Miscellaneous Tariff Bills (MTBs) that have been stalled since the first day of the Biden Administration.

On top of all these issues, there is also the looming worry of Stagflation, which is the Feds worst nightmare because the tools in their arsenal often run contrary to the problem. Stagflation occurs when wages can’t keep up with inflation and unemployment persists. The economy is skirting the problem right now because unemployment is low, but if inflation remains high and retail sales start to fall off, then the unemployment numbers will rise. If the Fed lowers the interest rate to counter the unemployment, the inflation picks up again and that’s why this is so difficult.

Looking at all the inflation gauges, it remains clear that some analysts prefer the PCE and some the CPI. Alan Greenspan liked the MUI. Perhaps the best index of all – is what each individual feels with their own hands and sees with their own eyes. Some could give it a name like the Lemon Index (LEMIX) because it is an individual option that you can fabricate yourself. As a somewhat fictious example, there is a fruit stand in Manhattan run by a man who has his hair tied in a knot at the top of his head, and some customers might call him “Manbun” by name. He runs a simple retail fruit & vegetable stand, but is quite adept when it comes to bundling products to reduce price or (to use the retail vernacular), he utilizes a form of “Shrinkflation.”

A year ago Manbun sold bright yellow lemons at 4 lemons for a dollar (25 cents each) or 50 cents each – if you only needed to buy one.

Three months ago, Manbun adjusted the price to 3 lemons for a dollar (33 cents each) or 50 cents each – if you only needed to buy one.

Yesterday, he was charging 50 cents for a lemon – with no bundling option.

In a typical New York interchange, the conversation might have sounded like this: “hey Manbun – you doubled the price of lemons in just a year.”

Manbun possibly replied: “my lemons are still 50 cents each and you can buy your lemons somewhere else.”

You can’t win for losing in New York City, but one thing is clear – prices are going up, inflation is here to stay, and everyone hopes to avoid a recession.