When an inflation regime shifts, there’s only one question that really matters for your business model: do you have pricing power?
With apologies to the Monty Python troupe, I want to write about three forms of pricing power that often go unnoticed, but will be incredibly powerful as the great economic pendulum swings from deflation, falling rates and a wealth creation zeitgeist to inflation, rising rates and a wealth distribution zeitgeist.
Because if you don’t see that this is where we’re going – a sea change reversal of the supply-side narrative that dominated our political zeitgeist for the past 35 years, now becoming the MMT narrative that will dominate our political zeitgeist for the next 35 years – then you’re just not paying attention.
I think that both supply-side economics and MMT economics are BS “theories”, no more than post hoc rationalizations of the preferred policies of the Nudging Oligarchy in the former and the preferred policies of the Nudging State in the latter. I think that supply-side policies have been a disaster for anyone who values justice and an equality of opportunity, just as I think that MMT policies will be a disaster for anyone who values justice and a liberty of mind.
But what I think and $2.75 will get you a subway token.
These are the cards we’ve been dealt. Let’s play them as well as we can.
Pricing Power #1 – Client Ownership
Willie Sutton famously said that he robbed banks because that’s where the money is, and the same thing goes for business models when inflation expectations shift (in either direction) – you need to go where the money is.
Put more directly, I mean that you need to get closer to the end client – whoever is spending the money that drives your business ecosystem – even if that means getting farther away from developing the products or services that your business ecosystem is known for.
This is particularly true for the financial services ecosystem, which has been totally wrecked by financial asset inflation, a tide that lifts all boats and squeezes all margins regardless of skill or smarts.
It’s a wrecking inflationary flood that is coming soon to all service industries.
It’s a Monty Python parable for our times.
In the beginning there is the great Black Knight, most fearsome of all warriors.
This is the asset manager, most cartoonishly represented in the popular narrative by the Hedge Fund, but it’s just as much the long-only actively managed mutual fund complex.
Thou shalt pay me my toll of a 2% expense ratio!
None shall pass!
And then the wirehouse takes off your arm.
Tis but a scratch. I’ve had worse!
That’s the immediate asset manager reaction, of course, to being told that access to the financial advisory “platform” – the menu that the end client will see – is now going to cost you an arm.
But even so, the asset manager still believes that they are the great Black Knight. Just look at their long-term track record, for god’s sake! Pay no attention to their inability to beat a Fed-inflated benchmark for the past ten years.
Ooh, had enough, eh? It’s just a flesh wound!
At which point the financial advisory platform says, “what are you going to do? BLEED on me to death?” And there goes a leg.
I think this is pretty much the current state of play between product-facing companies and end client-facing companies in the financial services world. Asset managers have had two arms and one leg sliced off in squeezed margins, but they still think they can win this fight.
And they’ll continue to think that.
Until we get here. It’s not that far off.
Oh, alright, we’ll call it a draw.
Over time, this is what happens if you’re not close to the end client. This is what happens if you are on the product side of ANYTHING when inflation hits your world. Financial services is just the canary in this coal mine.
Pricing power in a services-based industry goes to whoever owns the end client relationship.
That’s where you want to put your investment dollars. And your career.
Next up … your mother was a hamster and your father smelt of elderberries … the pricing power found in intellectual property (and a legal system that lets you prosecute those property “rights”).
I spent a chunk of my career in academia, and as an academic economist, I was deeply frustrated by (1) the profession’s complete lack of understanding of how inflation is transmitted through the economy; and (2) its complete disinterest in even thinking about that question. As Romer wrote in his Advanced Macroeconomics text, a standard in that profession, “[I]nflation’s costs are not well understood. There is a wide gap between the popular view of inflation and the costs of inflation that economists can identify. Inflation is intensely disliked… [y]et economists have difficulty in identifying substantial costs of inflation.”
If it’s not real, then don’t worry about it, especially if you want a tenure-track job at a name-brand institution.
Intentionally or not, this note explains (in part) why inflation has real economic effects. It’s not because of “menu pricing” or some other silly explanation, but rather because actors in a given ecosystem have different access to that ecosystem’s exogenous source of funding. Therefore, inflation disrupts the ecosystem in all sorts of ways (maybe some of them are actually good, but a lot of them are definitely bad). It’s a super simple observation, but I think a profound one, and it compelled me to upgrade to a paid subscription. Thanks.
“If you can’t see how this relates to the legacy of the financial crisis; the legacy of quantitative easing; the deflationary impact of globalization and technological innovation–well, if you can’t see how all this interrelates, I’m not quite sure what to tell you.”
*BL…the vast majority of people can only be brought to beliefs other than those held by their society and peers either when they are young, or after prolonged and catastrophic failure–either of their personal method for living life or of their society’s way of running the world. We are now at the stage where these two forces are coming together. Our societies have failed to run themselves acceptably since 2008, and the youngs have no attachment to the status quo since it has never, ever worked for them.
Change is thus not only possible, it is now inevitable. But what sort of change it will be depends on the ideas lying on the ground.
*Deflation to Inflation…a Sea-Change coming, there’s always one coming, great use of buzzwords, fear-factor and pure hyperbole! Munger says dogma cabbages up ones mind, so true. What you see may not be…
*In theory QE reduces the yield on fixed income assets, encourages bank lending assuming banks find creditworthy borrowers, and increases the price of floating net asset value of other assets. The stock market goes up do to the re-balancing of risk portfolios and increased valuation of non-financial assets compared to risk free alternatives. QE causes a re-valuation upward of assets to counteract the downward re-valuation caused by deflation in a banking and credit market crisis. No one knows exactly how unwinding QE will impact asset valuations due to the complexity of the market sector responses to real economic data and central bank policy. Deficit spending that creates net financial assets should have a direct impact via net/lending borrowing however the exact details for statistical accounting methods for government sectors are not clear since deficits relate to other categories besides lending and borrowing transactions.
*The unwind is not tightening folks…its normalizing back to more healthy environment. Historically speaking rates up to 4% equates to a growing economy…just because QE in the front caused increased asset valuations does not mean the opposite on the back end! Inflation is controlled given a steady state by the Fed who is trying to get the country to a better place,whether asset managers know how to navigate is another issue….stop blaming others for what you choose to not see. My inclination is deflation is here for a long while and given inflation stays where its at with earnings and interests rates even at 3-4% is healthy and asset markets continue a steady pace…correlation is not causation. I do not care what God you believe or what your fucking politics are, but don’t let missionaries selling you something make you loose money! and Everybody is a Missionary SELLING something! Just like most narratives are environmental gossip, most everything else is utter BullShit…80/20 rule.
**Its not a lack of understanding inflation, they don’t even know how the economy works…you choose what you see, you choose what you understand and you choose what you appreciate…wrong-headed beliefs get us every time, because we are so smart…
***Bernie, MMT, and AOC are not the enemy, We are…
Spot on, Mike. As a former academic, too, I recognize my experience in everything you say here. Welcome to the pack!
“The FED is trying to get the country to a better place”…
You know, with LA teachers went on strike with average of 75K annual salary, and Yellow Vest all over Europe, my son can NOT even have a stable preschool teacher because of housing cost forced them to move around, and government workers tapped out after missing just TWO paychecks due to government shut down, I am NOT sure this country is going to a better place other than asset price rise and widening wealth gap.
Is Ben a missionary? Kind of, for the small crowd following his work. Does Ben move the narrative of the entire market or economic themes? No. Does Ben sell fear? No. He sells Epsilon Theory. Is Epsilon theory BS? I don’t know.
Back in 2014 days when I was confused and looking for answers, there were news letter sellers and media outlet promoting fear of inflation with 10 thousand $ gold and deflation depression with 600$ gold. Ben’s call was muddling through. Now he calls zeitgeist into real world inflation (NOT asset) based on Epsilon Theory’s monitoring of narrative. If your “alpha” (something you understand but everybody else fails) understanding of of how money, banking, economy works leads to low inflation or deflation for ever, so be it.
For myself, I do NOT know what’s going to happen. I think Ben’s take is he does NOT know either due to the 3 body problem. So let’s call it as it goes. Clear eyes, full heart.
When I initially read your question “do you have pricing power?”, I initially thought of my pricing power as an employee. While my answer as an individual to this question is “to some extent”, my answer as an employee is an almost emphatic “no”. The average worker has virtually no pricing power in today’s employment market and hasn’t for some time as made evident by the lack of real wage growth over the past few decades. I can only see this getting worse in the future as automation and AI reduce the demand for human labor.
So I guess the question becomes “how do we increase our individual pricing power?” We learn new skills. We gain knowledge and experience. We offer our services to the customer and not our employer. For many people, I think this means escaping from the employee/employer relationship. Start a small business, freelance on the weekends, sell wedding invitations on Etsy, write and record valuable content. Yes, it might mean a bit of suffering in the short term, but regaining our individual pricing power is worth it. So is regaining our personal sovereignty.
The winning coalition during the Glorious Thirty Years post-war comprised of Western governments and voters. (The coalition being the joint major beneficiaries of issuing money and financial assets by the West.) This was sold as a Keynesian-economics/great-society-for-all project.
When the glory faded from Western social democracy in the 70s (i.e. that particular bubble had burst,) the winning coalition went back to its age-old composition of top politicians and bankers. This was sold as a supply-side-economics/fiscal-and-personal-responsibility/globalized-economy project, and was heralded by the Reagan/Thatcher political revolution in the early 80s.
We’re seeing the end of this later bubble, with the Western populace up in arms for being left out in the cold for 30+ years, and inflation/redistribution (alone or in combination with something else) is definitely likely the next play by the elites.
A good sign of this is that The Economist, the last bastion of the state-bank alliance, has discussed but not vilified Universal Basic Income. Can you imagine this in the 80s and 90s?
This is labor thinking. This note is “capital” thinking. I think the goal is to identify businesses or resources that will survive the inflation while those who are lack of pricing power will die in inflation. Whether inflation will happen or NOT is up to debate. But if it does happen, I guess we all want to hold securities that can survive that.
I am proud of my skill and stuff that I design, but for labor pricing power, as you said, with globalization and AI, it will be harder and harder. Capital take all, Labor be damned. I think the W2 folks are fighting an uphill battle. Ignoring automation and globalization, just for the argument of what happens to labor negotiation power when “stagflation” arrives, I think Labor, the W2 middle class will be destroyed as well. Since price rise but economy suffocate and high unemployment rate.
I guess we all have to learn to grab a piece of good capital to survive as opposed to keep fighting the uphill battle of labor pricing power.
Continue the discussion at the Epsilon Theory Forum