Cottage cheese and how to take the fight against inflation into your own hands ✊

Arguably the better of two bad options ⚖️

Cottage cheese. (Source: Wikimedia Commons)

There are countless stories out there about Silicon Valley Bank, Signature Bank, Credit Suisse, First Republic Bank, and so on. (TKer’s written about them here, here, here and here.) And there will be plenty more written as the story of instability in the banking industry continues to unfold.

While the woes of these institutions can be tied to their own idiosyncrasies, most would argue that this wouldn’t be happening without interest rate volatility.

And this interest rate volatility can be attributed to the Federal Reserve, which has been tightening monetary policy aggressively in its fight to bring down inflation.

Inflation is clearly a big problem right now. So let’s talk about an unconventional idea for getting it under control.

The ‘consumer rebellion’ path 🤬

More TKer readers than usual messaged me about the March 9 newsletter: “Profit margins are becoming a key controversial issue in the inflation discourse 🤬.“

To my surprise, the feedback was less about the implication that margins may be too high and more about the idea that consumers could do something about getting prices down.

At the time, I said I was just spitballing. What do I know. I’m no economist.

However, UBS's Paul Donovan¹ is a legit economist, and he recently wrote about how this could work. From his March 16 note (link):

The alternative remedy for profit-led inflation is when consumers stop believing that price increases are fair (restoring the previous price elasticity of demand). This threatens the customer loyalty for a profiteering company. If consumers believe the price increase is not fair, they will stop buying the product by either delaying their purchase or switching to an alternative supplier. Loyalty card points will not prevent customers moving to another store if they feel they are being “ripped off” by profit-led price increases. Consumers may already be starting to question whether price rises are really fair, in particular in the wake of the traditional start-of-year price increases.

Remember, there was a time when higher prices seemed fair to everyone due to very visible supply chain issues, a phenomenon that Bloomberg’s Tracy Alloway and Joe Weisenthal dubbed as “excuseflation.” However, most metrics suggest the supply chain crisis is now largely behind us. From Donovan:

Aligned with consumer rebellion is the threat of political involvement. If consumers are upset, politicians are likely to notice. This may then lead to threats of regulation, or a competition inquiry. Political concerns about profit-led inflation have been gradually increasing in volume on both sides of the Atlantic.

Of course, no executive wants to be brought before Congress to testify. Not that Congress could necessarily force them to lower prices, but the PR surely wouldn’t be positive.

Here’s Donovan again, with an example of a price-fueled cottage cheese boycott:

Finally, it is worth considering what social media may do to profit-margin led inflation. It is certainly possible that companies have found it easier to spin stories justifying price increases in the modern social media world. Lurid tales of shortages and delays are just the sort of sensationalism that serve as clickbait—the media has effectively boosted the stories that companies want to tell. But it is also true that social media can increase the power of consumers to fight back against price increases that are perceived as unfair. After enough one-star comments criticizing poor value for money on a review website, the family-run restaurant may reconsider its margin expansion. On a larger scale, if a company is trending on Twitter alongside #boycott, it is time to review its pricing policy.

A real-world example of this is the Great Cottage Cheese Boycott of Israel in 2011. An increase in cottage cheese prices led to a social-media-orchestrated boycott, which was very effective (cottage cheese sales fell most aggressively where internet access was greatest). Politicians started to take notice, and within weeks the price increases were reversed.

So there’s some historical precedent for this.

To be clear, I’m not writing a call for action, which is why I’m reluctant to identify companies that have seen their profit margins expand from pre-pandemic levels. (You can do that on your own by going to SEC.gov or a company’s investor relations webpage, reviewing quarterly earnings reports, and comparing operating margins — i.e., operating income as a percentage of sales — over time. Most halfway-decent stock screening tools can help you with this, too.)

The better of two bad options 🤷🏻‍♂️

Intuitively, the idea of companies being pressured to rein in profit margins isn’t something that investors would welcome. Indeed, profits are the most important long-term driver of stock prices. Also, who knows what other unintended consequences could come from opening what could be a Pandora’s box.

However, we are currently living out the alternative path in which the Fed is using monetary policy explicitly to destroy demand.

Is it better for a handful of customers to voluntarily cut back on spending? Or should we continue on the current path that’s likely to see spending fall because people are out of work and suddenly can’t afford goods and services they need?

“Convincing consumers not to passively accept the price increases is a potentially faster and less destructive way of reversing profit margin-led inflation,“ Donovan wrote. “The risk in profit-led inflation episodes is that central banks focus too much on demand reduction, tighten policy too much, and create unnecessary unemployment.”

-

Related from TKer:

• Profit margins are becoming a key issue in the inflation discourse 🤬

• Are 'gravity-defying' profit margins finally coming to an end? 💸

• Same destination, but now a more treacherous path 🚧

• Here's what drives stock prices💰

1. I gotta give Donovan’s work a plug. His approach to “economics without jargon” makes for quick, readable insights. Sign up for his daily notes here.