Some people benefit from higher inflation, but not millions. What is your situation ?
Inflation and interest rates are rising.
Next month, the Fair Work Commission will announce whether it wants the minimum wage to rise so low-wage workers don’t fall back too far.
But how will businesses cope with a higher minimum wage?
Won’t this fuel inflation further and send businesses to the wall?
This is the type of problem that could have ramifications for our faith in the system itself.
Inflation has risen sharply
If you think of Australia’s inflation cycle, it lags well behind that of the United States.
Consumer prices here are rising at an annual rate of 5.1%, which is the fastest in 20 years.
But in the United States, prices are rising at an annual rate of 8.3%. They jumped above 5% in the middle of last year.
Thus, the United States is well ahead of us.
That’s why a whole slew of stories have popped up in the US media – which we haven’t seen in Australia yet – devoted to explaining how businesses can take advantage of rising inflation.
When was the last time you saw a lot of stories like this in Australia?
Rapidly rising inflation was not something we had to think about until recently.
Why? Because between the financial crisis of 2007-09 and the start of 2020, we lived in an environment of falling interest rates, sluggish inflation and weak wage growth.
But now things have changed.
After the 2020-21 shutdowns, inflation started to pick up a bit in the middle of last year and it has accelerated in recent months, taking the Reserve Bank by surprise.
At this point, our inflation is still not as bad as US inflation, but the authorities are getting nervous.
Now, an inflation rate of 5.1% might feel like an understatement, as the prices of some key goods are rising much faster than that.
If you drive a car that runs on gasoline or diesel, you’ll know what I mean.
Right now it’s costing me well over $100 to fill my tank. This has never happened before. Before, it was $70.
The hit to my weekly budget was significant and the ripple effects were immediate.
Walk into a supermarket, and it’s a similar experience.
This is why the “cost of living” is such an issue in this election campaign.
Voters are hurting.
In fact, over the past 12 months, the wages of millions of Australians have not kept pace with inflation, so the “real” value of their wages has deteriorated.
It is becoming increasingly difficult to pay for necessities, especially for low-income households.
That’s why a political argument has erupted recently over whether or not to raise the minimum wage by 5.1%, to help it keep pace with inflation.
He would see the minimum wage increase by $1 an hour.
But while some economists think it would be sustainable and necessary, others say it would be economically detrimental.
So where are we?
Some people profit from rising inflation, and others lose
Well, our goal today is to start thinking a bit more about dynamics.
We lived for so many years (pre-pandemic) with anemic inflation that we didn’t really have to think about these things.
So let’s keep it simple.
When the rate of inflation increases, did you know that some groups in society can benefit greatly while others lose out?
There is a famous essay that explains how.
In 1922, The Guardian newspaper in the UK began publishing a series of 12-part monthly supplements on a single subject: the problem of rebuilding European economies (after the devastation of the First World War).
The supplement was edited by economist John Maynard Keynes.
Keynes wrote an article for this series titled “The Consequences for Society of Changes in the Value of Money”.
He expanded on this article in a small book published the following year, in which he explained why stable currencies were so important for societies to prosper.
What did he say?
He said money was only important for what he could buy.
And for economies to work well, people had to have faith in money, and that faith depended on the assumption that the real value of money was “nearly constant” over a period of time.
However, he said, since contracts were written in monetary terms, it meant that when we signed contracts (which could not easily be changed), our fate was tied to them.
Why? Because when the value of money changes, through inflation or deflation, it changes the relative value of pre-existing contracts.
And these shifts in the relative value of pre-existing contracts can create windfall fortunes for some people and cause significant damage for others, he said.
For example, think of a business owner.
When prices increase month by month, some companies may make a windfall profit.
“Whether he is a trader or a manufacturer, he will generally buy before he sells, and on at least some of his stock he will bear the risk of a change in price,” Keynes wrote.
“If therefore, month after month, his stock appreciates in his hands, he always sells at a better price than he expected and secures himself a windfall profit on which he had not calculated.
“In such a period, business matters become excessively easy.”
Think of how big oil and gas companies and mining companies have made extraordinary profits in the age of the pandemic thanks to soaring prices.
Or think of companies closer to you.
Right now, consumer prices in Australia are up 5.1% and wages are up 2.3%.
These higher prices will generate bigger profits for some companies who happily watch the real value of their payroll decline – without management having to do anything.
This won’t happen for all companies, of course.
Many companies are currently struggling with rising prices, particularly in construction where material prices have risen so rapidly that they have turned old contracts into financial bombs that have exploded and caused waves of bankruptcies.
However, when nominal wages increase more slowly than inflation over a long period, it means that wealth is transferred from workers to certain employers.
And then the question becomes: will this transfer of wealth have social or economic consequences? Will there be benefits?
This is something the Fair Work Commission is considering right now, as it plans to raise the minimum wage next month.
Should he raise the minimum wage (by $1 an hour) to match inflation to ensure that those wages don’t lose purchasing power?
Should he let inflation exceed the minimum wage so that companies benefit from a reprieve on wage costs?
Will demand in the economy suffer if the value of people’s wages continues to deteriorate for another year? Some economists think that a deterioration will be necessary, for the good of the economy, while others argue that it would be unjustifiable.
The FWC should weigh these scales carefully.