Earlier this year, Odd Lots talked about the idea of companies taking advantage of bottlenecks and other disruptions to raise their prices. Since then, the notion of this type of corporate-led inflation has burst into the public discourse with central bankers and politicians all taking a closer look. But how does this type of inflation differ from more traditional economic interpretations of prices, and what are the implications for monetary and economic policy? In this episode, we talk once again to Isabella Weber, the UMass-Amherst economics professor who dubbed this phenomenon "sellers' inflation" in a paper published earlier this year. She talks about how the way we think about inflation is changing and her own experience of seeing public attitudes shift in real time. This transcript has been lightly edited for clarity.
Key insights from the pod:
Why it’s important to correctly identify the causes of inflation — 04:29
What is sellers’ inflation? — 6:50
How sellers’ inflation is different to more orthodox definitions of inflation — 11:14
What can stop sellers’ inflation? — 13:56
Windfall profit tax — 17:50
How do rate hikes play out in a world of sellers’ inflation — 19:07
How does sellers’ inflation apply to services? — 21:54
Would windfall taxes reduce investment? — 24:01
Do corporations want to get off the price-profit treadmill? — 26:04
The impact of sellers’ inflation on capitalism — 28:01
What does China tell us about how inflation works? — 31:32
Shock absorbers and strategic pork and petroleum reserves — 32:30
How it feels to see her ideas becoming more mainstream? — 38:43
---
Tracy Alloway (00:10):
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe Weisenthal (00:14):
And I'm Joe Weisenthal.
Tracy (00:16):
Joe, do you remember the episode we did, I think it was just a couple months ago, with the Corbu strategist, Samuel Rines, about how companies are telling us the real reason they're raising prices?
Joe (00:27):
Yeah. That was great episode that sort of helped me analyze corporate earnings calls from then on and really think about, particularly in the consumer space, where he had this thesis that companies are very explicitly willing to sacrifice volume expansion in favor of higher prices and higher margins.
Tracy (00:43):
Right. He called it “price over volume.” And since that episode, so we actually wrote an article based on that episode and we had a lot of quotes from Sam. We also cited a research paper from an Odd Lots favorite Isabella Weber. And we talked about this phenomenon, we called it “excuseflation.”
So this idea that companies are using all these one-off emergencies as an excuse to raise prices. But since then, this whole idea has exploded into the public consciousness in various ways under different umbrella terms. So Isabella used the term “sellers’ inflation.” I've seen “profit-led inflation,” “greedflation” -- although I think that's a bad term for it personally. But it's everywhere now.
Joe (01:31):
And it's funny because it's one of these things where, you know, economists are sort of scandalized by sort of alternative ideas about inflation. And it's like they have certain things -- like some people say money supply, they say [it’s] labor costs and wages, but it feels like on Wall Street there's kind of less mystery. It's like no, at least you know, according to the people [who] read the calls, it's like no, they're telling us they're willing to push price. And I guess the question is, you know, well there's lots of follow on questions, but I think there's some really interesting policy ramifications from some of this identification.
Tracy (02:03):
Totally. And it is funny, Pepsi isn't talking about like “Oh the money supply is increasing, therefore we're raising our prices.” They're talking very explicitly about “well, we have these one-off reasons maybe to raise our prices and so we're going to see how far we can take it with the consumer.” So anyway, everyone is talking about this, whether you call it greedflation, excuseflation, profit-led inflation, sellers’ inflation. We need to go back to one of our favorite guests who's done a lot of academic work on this topic. We specifically cited her work in the piece that we did. We're going to be speaking with Isabella Weber.
Joe (02:37):
I'm psyched [that she’s] on set.
Tracy (02:39):
All right. Isabella Weber, economics professor at University of Massachusetts Amherst, thank you so much for coming back on!
Isabella Weber (02:45):
Thanks so much for having me back and it's a true pleasure to be here in person.
Joe (02:48):
Yeah. This is a treat. I didn't realize up until like five minutes ago that you were going to be on set. I thought we were going to look through the video. So great to finally meet you.
Tracy (02:55):
Oh, the first time we're actually meeting in person. Have you been surprised at all by how quickly this seems to have become, I hesitate to call it “mainstream” because people are still debating it, but it's in the Wall Street Journal. It's in the New York Times. It’s certainly in Bloomberg coverage.
Isabella (03:10):
Yeah. I think it has been very surprising, especially since some of the key data on the profit margins actually already came out in the fourth quarter of 2021. So, and you guys have actually been covering that at the time, you were covering the profit margin explosion that happened at the same time as inflation started to take off.
And in this, by now, probably, infamous Guardian piece that I wrote, I actually started by saying there is a so far pretty much undiscussed phenomenon, which is an explosion of profit margins that coincides with inflation and we should take a closer look at that. So I think in many ways when our paper came out at the beginning of this year, it has kind of been something that had been going on for a long time and companies have been saying this on earnings calls for a long time. The groundwork folks have been calling this out for a long time, but now it really took off.
Joe (04:03):
So I guess, one of my questions -- and I have many -- is, you know, there are different factors that people talk about driving inflation and obviously the tight labor market, fast wage growth, high levels of consumer demand, a lot of the supply chain bottlenecks that we've talked about over the years on the show, the supply side factors. Why is it important -- let's start with that -- to sort of think about correct identification of different causes?
Isabella (04:29):
Yeah, I mean when economists talk about causation, they have very high standards, right? So I'm not yet there to say like what I did it’s like a causal analysis -- just to put this out there. It's kind of a disclaimer, but I think this is kind of part of the challenge that we face because we are in an really unprecedented moment in the world, in the economy, in the global economy, right?
And inflation is kind of part of that whole unprecedented moment. So you are getting these pieces of data that are coming out and you kind of have to reason on them, however incomplete the data might be, right? And if you just look at it from the perspective of your standard inflation paradigm, then you basically just look at money supply, aggregate demand, and maybe wages. And you don't look at all these other stuff that you guys have been reporting about for months and months and months.
But if you sit in a corporate boardroom, then you are actually looking at all this other stuff. So then from your perspective, prices present themselves as something very different. So what we are doing with this research, I think is to kind of say, let's take the information that we have, however incomplete it still may be, and try to make sense why we are seeing what we are seeing.
What we are seeing is that on earnings calls, time and again, corporate leaders are saying that they can take pricing and that they can increase prices in ways that they might not even have expected and that they can increase prices even when volumes are going down, which is just against the logic of basic supply-demand, right? Where we would expect with demand going up, the price is going up and not the other way around.
Now you might say, well it's about the bottleneck and then demand is strong so therefore it's still a demand kind of story. But then I would say, well if I look at the earnings calls in the latest quarter, right, where clearly the bottlenecks for the most part have ceased and they're still “I'm taking price when volumes are going down,” then clearly this is also not a pure kind of bottleneck type of story.
Tracy (06:22):
Well, maybe just to step back for a second, talk to us about what sellers’ inflation, this is the term that you use, actually is and how maybe it differs to traditional conceptions of greedflation? Because this is one reason -- I remember when we were writing that piece, Joe -- this is one reason why I wanted to call it something other than greedflation because it's not like everyone woke up in March 2020 and suddenly decided to become more greedy.
Joe (06:47):
Which is a common critique of that, yeah.
Isabella (06:50):
Yeah. And quite frankly, I think that everybody agrees on that. No one is saying that there has been this sudden greedy impulse, where firm leaders just became more greedy than they used to be, right? That is just not a good theory.
So the question is how can it be that in incredibly concentrated industries, we had decades of surprising price stability, right? Even deflation in some periods. And now in this same highly concentrated kind of setup, we suddenly get this price over volume type of pricing behavior, right?
And what we are arguing in our paper is that there's basically different components that coordinate price hikes in ways in which they could not be coordinated without these emergencies happening, right? So one prominent thing is a cost shock. I mean, we have had gigantic cost shocks coming out of energy, right? That kind of send a signal to firms, okay, now is the time to increase prices, which means that they can be fairly sure that their competitors are also increasing prices because the way that they're pricing is to protect their profit margins. So the first goal is to make sure that their profit margins are not going to collapse, which means that if costs go up, they are going to increase their prices.
Now this is kind of the most benign form of coordination, but there can also be bottlenecks that can then coordinate pricing behavior and that can coordinate this pricing behavior even when the actual bottleneck might already start to seize because there's still this signal to the whole sector that something different is going on. And then there is, I guess the component that the excuseflation label is getting at, where from the perspective of the consumers, it's also more legitimate to see prices going up when there are clear reasons why they're going up.
If you imagine you go to your favorite coffee shop every day, and then from one day to the next coffee costs twice as much, then you would probably say like “oh, somehow the guy who's running the coffee shop went nuts.” Right? If this guy has been telling you over and over again that they are expecting a rent increase and then you come back and the price of coffee goes up, you'll probably go like “oh yeah, of course. Makes sense.” Right?
And something like this, but on a sectoral global level I think has been going on, for example, in the food sector where no one can judge, I mean you had this amazing episode on grain prices and prices of food items that use grain, right? And I mean as a consumer, I don't know how much is the cost component of grain in my pasta or my bread, but if I hear on the news, on the radio, on TV that grain prices are exploding and I see [the] pasta price going up, it kind of makes sense.
So there is, in other words, also component of legitimacy in pricing behavior, right? It's something that in economic theory we have a very hard time capturing. It's not like people walk around with a budget constraint and a given set of preferences on their mind and like robots, they react to the price that they see, but they look at the context, right?
So if in normal times there are basically two things that would constrain firms in their pricing behavior, -- on the one hand, competition, that is fear of losing market shares to their competitors, right? Which would happen if they start hiking prices in kind of a unilateral action, then that fear is kind of gone once these price hikes start to be more or less coordinated due to these emergency situations. And the second constraint would be fearing that customers are just not willing to pay these prices, right? Like whether they are they actually can pay these prices or not, they might just be deterred if prices suddenly go up for no obvious reason.
Now, if they are obvious reasons, they seem to be more willing to accept these price increases. So therefore both of these constraints quite dramatically softened in this emergency situation that we have been living through.
Joe (10:35):
So some economists might listen to the story and nod their head and say “yeah, this makes sense, but for whatever reason prices are going up and workers are going to demand higher wages to compensate for the higher prices.” And you get this self-sustaining, you know, increased more demand and they're like, “okay, I can fit this into the typical inflation expectation story and therefore the Fed should be hiking rates regardless.” Could this fit into a typical inflation expectation story? This is how it becomes entrenched? Maybe it's a different thing than 1970s inflation, but it's still the thing and ultimately the Fed is [going] to respond the same way.
Isabella (11:14):
Yeah. I mean first on the wage part of that story, what we are seeing is basically eventually labor is trying to fight back against collapsing real wages as workers are basically losing purchasing power, right? But this is a very different story. If you have an initial cost shock that comes from the energy market, that comes from commodity markets, comes from shipping and so on, basically comes from upstream stuff and then you have a propagation amplification of that shock as firms react by price over volume type of behavior, right?
And then eventually labor goes like “wait a minute, my purchasing power has collapsed and I'm trying to fight back to regain some of this lost territory.” Then this is a reaction to inflation rather than the origin of inflation. I think this really matters for how we think about what to do against inflation.
But secondly also, I mean when we talk about expectations and expectation anchoring and so on, we somehow think that firms look at the Fed and they kind of read these signals from the Fed to anchor or de-anchor their inflation expectations. I'm not saying none of this is going on, but when I am reading the earnings calls, I don't see them talk about the Fed a lot.
I see them talk about what their competitors are doing. I see them talk about rational pricing environments. I see them say things like, with this new force majeure like the Winter Storm Elliott, this has made our pricing environment even more conducive. So they are looking at their immediate environment.
They are looking at are customers accepting of these price increases, which is a completely different set of expectations than what we think of when we talk about expectations in this kind of central bank-centered type of fashion.
Tracy (13:10):
So throughout economic history, the classic worry about inflation has always been this wage price spiral that you kind of just outlined. But if that's not what's happening here, or if it's not the actual cause of higher prices, if instead we have I guess a profit-price spiral of some sort, what should we do?
What actually arrests this behavior? Because again, if you listen to the company earnings calls, you can see the executives talking about how surprised they've been about how strong customer demand has been, how far they've been able to push up prices, and also you see the share price reactions -- they're getting rewarded for raising prices. So it seems like there's very little incentive or a catalyst for this to actually stop.
Isabella (13:56):
Absolutely. And I would actually say that the investors’ expectations is another set of expectations that is probably more immediate from the perspective of people taking pricing decisions, right? When representatives of let's say Morgan Stanley, just to pick a random example here, are asking questions on earnings calls about pricing, they are also asking on behalf of a player that is actually going to invest quite substantial amounts of money, right? So there's that layer to the expectation story too.
But to actually go to your question, I think first of all, we need to stop these impulses, right? I mean these gigantic cost shocks that then coordinate these kind of price hikes. If they can be arrested kind of in the onset, that I think would have made a huge difference.
I think something like the Strategic Petroleum Reserve, which of course eventually was mobilized in 2022, if that had been mobilized sooner because there was a mindset on the part of policymakers to say “oil prices going up -- as they started going up in 2021 -- is a real problem and has the potential to undermine price stability and economic stability,” then they might have acted sooner and they might have acted more decisively.
Now it's of course not only about oil, it's also about gas, other sources of energy, it's about other forms of raw materials and importantly also about grain. I think for grain actually, we ideally would need some sort of a coordinated international buffer stock, which is an idea that Keynes had for the Bretton Woods institutions, something that he wanted to see as one of the Bretton Woods institutions. But that did not materialize. And they have been proposals like this in the seventies when, I mean obviously there were also very major commodity price cycles going on at the time.
So I think these type of ideas are pretty important. And they are important not only looking back and saying, “oh yeah, the last three years somehow weren't great, but now we are back to normal life. So this is a nice historical anecdote or something this, but they're important because we are living in an age of overlapping emergency. And as far as I understand, people in the grain market are saying things like, “we are basically one major weather you meant away from another price spike in grain,” right?
And if there are bad harvests that are related to climate change happening much faster than many of us might have thought -- tipping points being reached much, much sooner than climate scientists still projected not that long ago, right? Then I think this is something that is quite likely to happen.
So what I'm thinking about here is really a form of economic disaster preparedness so that we have shock absorbers, where shocks to these systemically-important things like grain, like energy, can be absorbed locally so that we don't even get this gigantic impulse in the first place.
Now for this like propagation and amplification that comes as firms react to these shocks, I think what we basically need is some sort of a windfall profits tax that both kick in whenever there is a major emergency.
Because we have now learned that in these emergencies, these pretexts that happen can present situations where prices can go up very quickly. And I think that if corporate leaders had to learn this this time, then next time around they have a playbook in hand, right? They know how price over volume works, they know what to look for, they know what they did last time.
And if this is a coordination issue in the sense that it depends on what your competitors are doing and last time it worked out really well because everybody kind of implicitly agreed to be doing exactly that, then next time around they just have to look back at what they did last time.
Joe (17:33):
Windfall profits tax, how does that fight inflation? Because some people would hear that, it's like “oh, you're going to add taxes, you're going to add costs.” Maybe there's some redistribution element or punishing the rich or punishing the success. What is the mechanism via which this is an inflation fighting tool?
Isabella (17:50):
Well, it's a mechanism that basically takes away the incentive to do a price over volume strategy, right? Because price over volume makes sense. If you can increase prices so much that even when you're selling less, you still end up making more money because you have hikedprices so much. Right?
Now of course there can be situations where price over volume happens to just protect profit margins. So windfall profit tax would not happen for that. But we have seen situations where firms actually have managed to quite dramatically increase their margins with this kind of pricing behavior. So it would kind of cut off the edge of that process, right? It would cut off what we are calling in our paper “amplification.” So you have this initial shock and the then this shock is actually not just propagated through your system, but it's amplified as as it coordinates these additional profit increasing price hikes.
Tracy (18:43):
So traditional ways of fighting inflation, how do they actually play out in a seller's inflation world? So for instance, the Fed hikes interest rates. In theory that's supposed to curb demand and therefore prices start going down. But what's your instinct on how that actually plays out in a world where companies are the driving force behind prices?
Isabella (19:07):
Yeah, I mean at best in a very roundabout way. I mean, in any case it's always a very roundabout instrument, right? We have to keep in mind that this is a very, very indirect tool of fighting inflation. Which by the way, if we are in a situation where we are already at the edge of a recession where we are already at the edge of a banking crisis, where we have had a pandemic and we have a war, and now let's say we have another major climate shock, right? And let's say we have already hiked interest rates to a point where even hawkish people feel like “okay, really shouldn't go higher.” I mean what are you going to do? If you have another shock that unleashes this kind of process?
So first of all, I would say it's too blunt of a tool to deal with frequent extremely sectoral shocks, as I think they have become more likely. Of course no one hopes that they will happen. I don't hope they're happening, but I think they have become more likely. So I don't think we are prepared to actually achieve price stability with the tools that we have in terms of just relying on the central bank.
I also think that if it is the case that there is such a big energy shock, which then central banks would say, “oh we are actually looking through this,” right? Then your mindset is like “oh yeah, this is something that is not part of the core inflation. I'm just looking through this like la la la that's not happening,” right? I think this is not the right mindset that we need because this is a very, very dangerous impact.
So in that sense it's kind of leading us in the wrong direction. But also at the end of the day, what happens with interest rate hikes is that it's designed to cool down the labor market, right? Now, if it is a case that inflation erases purchasing power and rate increases were not the origin of this inflation, this means that the majority of wage-dependent people are actually being hurt by inflation and then they're actually punished a second time by cooling down the labor market, right? So I think even from a kind of justice perspective that is hugely problematic, but it's also not very effective because it's kind of getting at the wrong thing.
Joe (21:05):
So I take your point about things like the Strategic Petroleum Reserve and how the logic of these sort of buffer stocks, particularly of commodities, could be used in future shocks as buffers in both directions. But how do you think about this idea with respect to services? Because it's hard to believe, okay, maybe we keep a lot of oil that we don't use in tankers. It's hard to believe we would say, you know, we're not going to underbook, you know, have all flights be 80% booked or all hotels be 80% booked or all veterinarians like carve 20% of their time and services in terms of right now even , you know, in spring 2023, services inflation is particularly what the Fed is like focused on. So how do you like think about some of these things outside of the sort of pure goods commodity realm, like applying some of the same insight and logic?
Isabella (21:54):
Yeah, so I think if we look at services, shipping has probably been the most important service that had a very large price explosion that I would see as part of the import stage. And I think what we saw there is that basically you had, I mean, a literal bottleneck, right? If you think back to how the port of LA looked, I mean this is the image of a bottleneck, right? And shipping companies could increase their freight rates several times over. So prices went up and they had actually the largest profits in years and years, right? So they were in a situation where, I mean, if I was a leader of one of these large shipping companies, I was in no rush to get out of this bottleneck, right? Because it's the best of times for me, right?
So for example, for shipping, I think A) we need protocols like, I mean how do you unblock a port? and B) some sort of a price gouging legislation of the type that the New York State Attorney General is currently introducing, also for essential stuff that is further up the value chain rather than just the essential consumer-facing stuff, I think could be really helpful. Because this is not to say that prices cannot go up at all if this kind of emergency happens and shipping companies have higher costs because things get complicated.
But it's to say that they don't get these perverted incentives of having freight rates that increase multiple times over, which I think would actually also give them more incentive to get out of the blockage as opposed to basically profit from from the situation. So this is an example of a very specific service industry, but I think one that matters quite largely.
Tracy (23:28):
Wait, so just on this point, can you talk to us a little bit about investment? Because the classic argument against some sort of windfall tax or price control would be, well, you don't want to artificially bring down the prices, you want people to make a ton of money and that way they'll invest more in their business and build out capacity and eventually the additional production is going to be the thing that maybe starts to resolve the bottleneck and bring down prices. How does that work and is that a viable critique of some of the measures that you're talking about?
Isabella (24:01):
Well, I mean, first of all, I would say that hiking interest rates is a recipe designed to bring down investment, right? So if we are talking about different ways of fighting inflation, then I am more worried about the interest rate hiking policy than I am about an emergency price gouching law or a national emergency windfall profit tax or something that, but also we have to say that if we are talking about price over volume, then we are in a situation where with lower volumes firms can make more money, right? Which means that they are basically contracting their capacity.
And I think that if we look at the oil sector, which in my mind has been a very important element in this inflation story, that it's quite clear that they are saying very explicitly on the earnings calls that they are taking a disciplined approach to investment because they are reaping record profits as they have reduced capacity.
Tracy (24:51):
Everyone remembers 2013 and the big expansion and they don't want to repeat that.
Isabella (24:56):
Exactly. Exactly. So it's not necessarily the case that, I mean if you have learned that you can actually reap record profits when your supply is constrained, that this then encourages you to have a lot of redundant extra capacity or to hugely expand your capacity and therefore go for big investments.
Where there are areas where we are particularly worried about curtailing investments with these kind of policy measures, I think you could have a policy that basically stipulates that if you are investing in, let's say, green technologies, let's say you are using the crisis as a moment to upgrade your technology to become a low carbon manufacturer or something this, then you could have a tax write off for these kind of investments that we really want, that we want for a green transition, which that would not count towards the ways in which your windfall profits tax is calculated.
So that in this kind of situation, these firms might still have an incentive to do price over volume, but at least they would use the money that they get to invest in the stuff that we really need to make our economy more resilient rather than to buy back shares or do these kind things.
Joe (26:04):
You know, it's interesting going back to this point that part of the impulse or part of the expectation comes from investors themselves and these sort of expectations: “You're going to push price too. You're going to push price too.” Do you think there's any element here where corporations themselves would like to get out of this game that you this that a sort of third-party administrator of supply, of price, of investment, comes in and actually solves a problem for corporations so that they get off this treadmill? Because one thing that I think about sometimes is any individual company may benefit from higher prices and higher margins, but on the whole a series of Fed rate hikes to [halt] inflation is not great for stocks, which is how, you know, a lot of executives get paid.
Isabella (26:47):
Yeah, absolutely. I think there is on the one hand a lot of coordination, right? With these price hikes. On the other hand, there's a lot of coordination failure if you want. Because there are outcomes of this process that are in some sense not sustainable, right? And actually if we look at what happened after World War I, when you had kind of price hikes coming out of a bottleneck kind of transition from war to post-war economy, you had a very short-lived boom that was very inflationary and then a sharp turn into a deflationary recession.
I don't think that such a sharp turn is in the cards because now we have these very concentrated sectors for most of the economy, which means that in these sectors firms are price makers and they tend to not lower prices in these kind of sudden ways in which we would see it in commodity markets or price-taking markets. So I'm not so worried about this sudden turn as I would've been in a different setup, but nevertheless, yes, it does trigger rate hikes, it does create a situation where I think a lot of corporate leaders are also nervous. Like how hard can we take this? It's like, it's a bit like you're in this gambling game, you keep winning but you kind of don't trust [it will keep going]/
Tracy (27:57):
And everyone seems surprised that it's actually paid off this much for so long, right?
Isabella (28:01):
Yeah. Everybody seems to be really surprised. Yeah. So the degree of coordination on that front has been totally surprising. But then you can also not chicken out, right? I mean we saw when Wal-mart and for very short blips of time was making announcement that they are a discounter and that they are not going to play this price hiking game and then they had this share selloff, right? So I mean, there's also kind of a discipline from financial markets to keep doing this, but at the same time it's kind of clear that maybe it cannot keep going. But also we have to see that if we look at the data of changes in profit margins, it's very roughly speaking, about two thirds of of sectors that benefited and one third or so that did not benefit.
I don't have a very clear picture yet, how this distribution works, but in any case, we know that there are also sectors, and that there are firms that are suffering pretty badly from this, right? And if we think of a capitalist economy as being coordinated by the profitability of different things, right? As the most important signal for capital allocation and this profitability gets kind of random because in some sectors firms can play this price of a volume game and in some other sectors it might be more difficult to pull this off. And this doesn't have reasons that are necessarily tied into the entrepreneurial genius of one firm versus the other or the necessity for society for production of one thing over the other. But it just has to do with whatever specific consolation enabled these kind of price hikes. Then I think we also really have a problem, right? If profitability becomes random.
Tracy (29:41):
Right? So maybe the egg companies do really well for some reason because everyone's heard about bird flu, right? For instance, we did a whole episode on it and so all the egg companies raise their prices at the same time and make a lot of money, but meanwhile there's some, I don't know, software startup doing something really cool but they can't push through the same kind of price increases.
Isabella (30:01):
Absolutely. And even between product lines in individual firms, if you look at what happened in the car sector, right? Where suddenly, I mean there you actually had a real physical bottleneck and car companies decided to only — I mean not only but predominantly — produce higher-end models, then that resulted in a situation where all these cars that normal people are driving became basically not available on the market, right? Which is an outcome that is in many ways undesirable because then maybe people can't make it to work because they can't afford a car, which then kind of makes the labor market less fluid in a situation where we already have labor shortages certain areas. So yeah.
Tracy (30:57):
So since we're on the topic of capital allocation and capitalist economies and how it's supposed to work, can we maybe talk about a slightly less capitalist country, but the first time we ever had you on the show it was to talk about China and I'm wondering if you contrast and compare inflation in the West — in Europe and the US — with what's going on in China, it does seem like (although there are some pockets of high prices in the east) it does feel like on the whole it it's less of of an inflation story. So what are you thinking about in terms of that comparison?
Isabella (31:32):
Yeah, I think it's really an important thing to look at. I think we haven't discussed this like generally enough that there has been really this pretty dramatic divergence between Europe and the US with this high inflation in China with almost a deflation kind of problem in some stretches. I think of course it has to do with the different timeline of Covid. I mean, no question about that, right?
I mean they have had shutdowns when we were not in shutdown and they were open when we were in shutdown and so on, right? So clearly macroeconomically speaking, they are at a different point. They also did not have the kind of stimulus packages that they had in the global financial crisis and so on. So certainly the macroenvironment is different, but I think there's still the question of how did the global food and energy price shock arrive in China, right? And why did this shock not unleash similar kind of dynamics there?
Tracy (32:26):
Right, it didn't seem to get propagated as much as it did elsewhere.
Isabella (32:30):
Yeah. So I think that like different layers, so first of all, I mean for grain, which I think is an important one for food, they have of course a gigantic national reserve system, right? And they basically have to a certain degree buffered their domestic prices against international prices. So Chinese prices used to be, for important grains like rice, used to tend to be higher than the international prices, but stable.
And when the international prices exploded, they kind of stayed broadly speaking where they were. And the way that they have managed that is that first of all they have a very high self-sufficiency rate, but I don't think this is enough because I mean the US has a very high self-sufficiency rate, right? It's even a major export. Germany for example, also has a very high self-sufficiency rates. Its also an exporter, but still these international price movements have arrived, right?
In China, they have not, because the import quota is very strictly managed. And it's basically a situation where most of the imports are managed by a very large state on company— COFCO — and then domestically. So in that sense, the international-domestic prices are not really as interlinked as they would be in other situations and domestically they still have a minimum purchase price. So that they basically ensure that wherever it's reasonable to cultivate with this minimum purchase price, grain is being cultivated.
And then they have these grain auctions where they would be adding supply to the grain market if there is a shortage from basically a state-owned reserve system. So in some sense they have for grain, what the US has with the Strategic Petroleum Reserve, just on a probably even much more gigantic scale. And I'm saying probably here because we don't really know the size of the reserve. It's a state secret.
Tracy (34:13):
Yeah, I think there's a strategic pork reserve as well, right? This is my favorite.
Isabella (34:17):
There is.
Joe (34:20):
The other SPR.
Isabella (34:21):
Yeah. So there's actually, I mean there's actually also a live pig reserve. In other words, they're like state-owned pork farms, sorry, you can't have a pork farm, you only can have a pig farm. Sorry, the state-owned pig farms. They're frozen pig reserves and there are also kind of attempts of the state with again, these auctions and I mean purchases and auctions to basically send signals into the market.
So it's not really just about the physical supply, but it's also about, let's say there's a price hike for pork and then there's an announcement that the state is now doing a major auction of frozen pork, then this is send sending a signal to all market players that this price hike might not continue, which then should encourage people to get rid of the inventories and thereby also add supply.
Joe (35:11):
It sounds like, I mean we have our SPR and it was never really used as a price stabilizer. So in addition to all these vehicles like the strategic pork supply and the other grains, it seems like they also have practice in this. That actually, unlike our SPR, which was sort of pivoted — “Oh, we don't have to use it just for strategic purposes” — that this is more ingrained in macro management there.
Isabella (35:33):
Absolutely. And I mean the pork example is actually one where it doesn't work that great because hog cycles are a thing, right? And they're a thing in China too, and you have like millions of small holders farming pigs. So you have very intense hog cycles. So you can smoothen the cycle, but you never get rid of it. But it's technically not at all simple, right? I mean you need to have basically a system that can store that stuff in a way that the pork that they sell is the pork that you want to buy and eat, right? You need to have agents that are able to purchase this on a relatively large scale.
You then have to have these auctions that have to be professionally organized and you also have to understand the market really well. I mean, remember when there was an announcement earlier this year that the US was going to buy back oil to replenish its Strategic Petroleum Reserve and then oil prices started spiking, right? So you have to have a very good handle on how to communicate with the market, when to say something about what you're doing and when not to say something about what you're doing. So it's quite demanding and a lot of things can go wrong.
Tracy (36:35):
Yeah. And even in China where they do have practice doing this, I mean, I remember with pork specifically after the African Swine Fever outbreak, they actually made the cycle even worse because they told everyone “Ramp up production!” and then it was too much and then prices collapsed and everyone got out. And so it's just been like seesawing ever since then.
Isabella (36:55):
Absolutely. And it's actually been for the first time a situation where European pork importers have had difficulty selling in China because suddenly the prices collapsed in China and in Europe they were going up with the very high grain prices. So yeah, absolutely.
Tracy (37:11):
I didn't mean to make this a pork discussion, but can I ask a personal question?
Isabella (37:19):
Can I say one more thing? Sorry, this was awkward. So actually, I mean, you're saying you didn't want to make this a pork discussion, but the funny thing is, while I was in China, I was doing many interviews with people on inflation including folks from the World Bank, from the IMF, from major banks and so on. And eventually every single economist that I talked to started to talk about pork. And they even have all these like jokes on pork and they say like the CPI in China actually stands for the China Pork Index.
Tracy (37:48):
I love that all the economists are viewing inflation through the lens of pork,
Joe: (37:53)
What we do with the oil here in this country.
Tracy: (37:55)
It's true. But can I ask a personal question, which is, you mentioned, well, we started off this conversation talking about how this idea of seller's inflation has really gathered steam in recent weeks. And you mentioned The Guardian article where you talked about price controls and I remember when that came out, you got a ton of criticism online, lots of Twitter people calling you various names, Paul Krugman said some not very nice things. But since then we've seen price controls in Europe, we've seen — on the subject of sellers’ inflation and maybe windfall taxes — we've seen the UK, for instance, talking about capping grocery items and things like that. How do you feel about how this is sort of seeping into the mainstream?
Isabella (38:43):
Yeah, I mean maybe to add to your list, we have also of course seen the European gas price cap is an international, I mean transnationally coordinated kind of price cap and the oil price cap against Russian oil, which I mean in principle could be for all oil, right? I mean just in terms of the technicality of the price control mechanism.
So yes, absolutely. It's been a totally astonishing to me. The reason why I wrote this article at the time was because I felt that the debate amongst economists was polarized between those who were saying like “Oh, we don't have to worry about inflation too much, it's just transitory.” And those who were saying “Oh, inflation's really a problem, therefore we have to hike interest rates yesterday.” And I felt like there was a position missing there, which is, yeah, we have very large price spikes and they're a problem.
But if you have a fire in the kitchen, you don't set your whole house under the water, but you try to put out the fire in the kitchen, right? So not as an apologist of price controls, but to say, “hey, there is something sectoral that we can do.” And direct means of price stabilization can be an emergency measure to buy time when you are faced with these kind of crazy price spikes.
Now the key word here I think is “emergency measure.” And my sense is that the more urgent the emergency became, the more acceptable these kind of measures ended up being. And I think that in Europe you can see this very clearly in terms of the reactions to the war, but then also like basically as it became colder, right? And the fear of winter just became very real. The perceived emergency became more intense and the willingness to take these kind of measures became greater.
The seller's inflation story, I feel like is related but also kind of slightly separate in the sense that the price control debate is really about emergency measures that you take, right? And the sellers’ inflation paper is really about how do we understand this kind of inflation.
But I think the shift that we are seeing now that of course is not complete and so on, but that at least it's becoming more acceptable to think about other ways of understanding how inflation came about, is kind of the first step that we need to take to move towards a different kind of economic stabilization paradigm that I personally think we really need in this age of overlapping emergencies.
So it's been quite a wild ride, but I guess talking today — and it has been very wild, so god knows what's going to happen next — it looks like there has been some movement in a good direction in the sense that the discourse is becoming more open. And I think that an open discourse is really what we need if we are faced with these unprecedented situations because you cannot respond to an unprecedented situation by saying “we have always known how exactly it works.”
Tracy (41:43):
Yeah. Isabella Weber, thank you so much for coming back on Odd Lots. Really appreciated having you — in person as well!
Joe (41:51):
Really fun. Thank you so much. Thank you so much
Isabella (41:53):
Thank you.
Tracy (42:06):
So Joe, I always enjoy talking to Isabella. Me too. It is crazy to see how quickly things seem to be changing in this particular area of discourse.
Joe (42:15):
Totally. And I know we didn't really get into it, but I also just think that like the internet and Twitter, it sort of cuts in both directions because you could put out an idea and get tons of abuse and backlash, but there's also like a really rapid way which ideas proliferate in a way I don't think would've happened in, you know, a different era where you would wait like five years to get a paper, you know, refereed in a journal or something like that. But I'm fascinated, as I think we both are, by how ideas can move so fast and like, especially in an age of crisis.
Tracy (42:46):
Absolutely. And the other things that stood out to me are one, you mentioned this treadmill idea of like, you know, it sounds great — companies raising prices in order to pad their profit margins, but at some point you have to imagine like there are some executives who get nervous about how far they can actually push this.
Joe (43:01):
Yeah. I liked Isabella's point about the gamble, right? Because at some point, you could imagine where you go in with a pricing strategy and you really mistime it and suddenly you really do lose share in like a meaningful way. Or you damage your brand, which seems plausible. It’s like “Oh, this company is greedy.” And it sort of depends on the sort of coordination. And I do wonder whether executives would ever like off the treadmill.
Tracy (43:28):
Right. They're sort pulling the lever every quarter and so far it's paid out, they’ve won each time, but maybe one day it won't. The other thing that really stood out to me was, I mean, what we're talking about is basically the need potentially for more interventionist government in the economy in one way or another, whether it's, you know, trying to smooth out some of those production cycles, trying to smooth out big price spikes. And I feel like that's always going to be controversial...
Joe: (44:00)
And political.
Tracy (44:00):
It's always going to be political, particularly in the US. But, you know, that said, we have seen some inklings of it with, for instance, the Strategic Petroleum Reserve.
Joe (44:10):
And I think this is really the key. My takeaway from all this is — people look at this, like the greedflation story, whatever — and they're like, “yeah, but inflation is still really high,” right? And so the Fed’s gotta do something about it. And I think to Isabella's point, it's important by looking at different dimensions and now you're saying “oh, it's because of wages” or not just because of rates or money supply — it allows us the sort of mental space to open up.
And some of them, we may not have the tools, like we may not have the tools right now to keep grand prices stable. We don't have the sort of equivalent, but in thinking about like are rate hikes really going to be the best way here? Is the cost in terms of like general welfare and employment worth it? If this is really not what the story's about. I think it's still like very useful from that perspective as “okay, how good are these tools?” And if we're going to use a blunt tool, how much damage are we going to do with this like mediocre tool?
Tracy (45:02):
Yeah, well again, going back to the investment point, if the issue is a bottleneck in production, then maybe, maybe you don't want to raise the cost of investment and production.
Joe (45:13):
You want to raise the cost of a real estate developer at a time when rent is [at the] highest?
Tracy (45:18):
Yeah. You know what Joe, I've decided I'm going to base my entire personality going forward on campaigning for a Strategic Pork Reserve in the US.
Joe (45:25):
But it's hard there, it's hard too, I guess. Even that isn't foolproof, but yeah, I support that.
Tracy (45:30):
Bringing home the bacon. That's my motto.
Joe (45:30):
Stabilizing the bacon.
Tracy (45:34)
Shall we leave it there?
Joe: (45:35)
Let's leave it there.
You can follow Isabella Weber on Twitter at @IsabellaMWeber.