Who benefits from inflation? Who is injured? David Moon responds
In itself, inflation is neither good nor bad. If consumer prices increase by 10% in a year when everyone’s wages increase by exactly 10%, inflation has nothing to do with everyone’s daily budget. Of course, the economy doesn’t work that way, including the fact that for most people, incomes don’t rise as consumer prices change.
Neither corporate earnings nor stock prices. And just as the effect of inflation depends on whether you’re buying a house, taking your first job out of college, or just trying to fill up your car with gas, the implications of inflation are complicated.
Obviously, inflation puts pressure on the spending of entities that buy things, which includes most businesses and all people. Corporate profit margins are shrinking and consumer budgets are squeezed.
Profitable entities with large, long-term, fixed-rate debt actually benefit from inflation, because they pay their bondholders with dollars that are worth significantly less than the dollars they previously borrowed. The greatest example of this type of beneficiary of inflation is the federal government.
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Anything that suffers from higher interest rates is hit by rising inflation. This includes entities and individuals who plan to borrow significantly – a group that also includes the federal government.
Higher interest rates also reduce the value of virtually all cash flow-based investments, including stocks. Rates go up, P/E ratios and bond prices go down.
But higher inflation is not bad for the profits of all companies. Companies that can pass on inflationary price increases to their customers without hurting their business volume should be much less affected by rising costs. Credit card companies and real estate sales fit this description. Since these companies are essentially taking a percentage off each transaction, as prices go up, so does their revenue. This explains why these stocks have lost far less than the overall market – and are still priced high relative to their earnings and almost every other industry.
At the other end of the spectrum are low-margin companies that lack the power to set prices to pass on rising costs to customers. In these companies, increased labor costs are rarely, if ever, reimbursed. Additionally, for capital-intensive companies, plant and equipment replacement costs end up being much higher than historically amortized, creating both profit margin pressure and a situation where profits can overestimate the true economics of the business.
When inflation is higher than the rate available on savings accounts (like now), inflation is devastating for savers. With annual inflation of 3%, the purchasing power of a dollar will be halved in 24 years. At the March 2022 CPI figure of 8.5%, that figure drops to nine years.
David Moon, President of Moon Capital Management, can be reached at [email protected]