Inflation is a grim phenomenon. It essentially represents a devaluation of the purchasing power of money. For a given amount of money, in effect, you’re able to buy less and less over time.
This means anyone passively holding cash is basically getting poorer. Unless your assets are generating wealth at a higher rate than inflation – say, by working your capital harder – they’re decreasing in value.
The levels of inflation now being witnessed in the UK and elsewhere haven’t been seen for more than 30 years. We have to go back to 1992 to find anything remotely comparable in terms of severity and prolongment.
As a result, there’s a whole generation of businesspeople who have never encountered this problem. Many don’t necessarily understand what it really means, and many don’t know how to change their behaviours and refine their decisions accordingly.
Moreover, economies of scale and technology-enabled productivity rises have allowed a lot of people to grow accustomed to goods and services generally becoming cheaper, not more expensive, for decades. This is why what we’re encountering now constitutes such a monumental shift.
So, what does it mean?
Ultimately, high levels of inflation mean the economy is out of control. Politicians and economists don’t want inflation of this type, so the very fact it’s here tells us things have gone badly wrong.
The principal reason for today’s extraordinary rate is the massive increase in monetary supply used to support the economy during Covid-19. History suggests the effects of such interventions can take years to fully work through the system.
Another contributor is the raft of ongoing restrictions stemming from the pandemic, which are forcing capacity reductions within many global supply chains. The uncertainties introduced by the conflict in Ukraine have also exacerbated the situation.
Thanks to these and other issues, prices are now being driven up – and the uncomfortable reality is that many of them might never fall again. This is a key aspect of inflation and its wealth-eroding characteristics: what goes up doesn’t invariably come down.
Some asset classes – such as those affected by temporary shocks – may recover, but the prices of most assets are likely to stabilise at a new level and fail to revert. Fundamentally, this is because any given amount of money has simply become less valuable.
What can you do about it?
Businesses need to acknowledge that this amounts to a challenge quite unlike those of recent years. Crucially, it would be unwise to expect a temporary blip and an eventual return to “normality”.
The main objective, then, must be to put money and assets to work to generate wealth and counter the devaluation that inflation causes. This is vital if overall purchasing power is to be maintained – and, by extension, if quality of life is to be preserved.
With its bottom line under pressure from mounting costs, a company should perhaps first ask if it can raise its prices. This may be possible in some cases, but it might not be an option in industries that are notably competitive or where prices are fixed – in which instances cost management becomes paramount.
There’s also a need to judge whether a recession is likely and what could be done to hedge against or mitigate the risks that such a development would bring. Similarly, it’s imperative to consider which assets are likely to stay high and which factors – for example, new purchasing policies and other supply issues – could help offset escalating costs.
This is why business forecasting can be such a powerful tool. Even the simplest forecast can be used to “flex” parameters under different scenarios in order to see what the impacts on your company might be.
Tough times and the wisdom of experience
According to European Central Bank data, many smaller firms in the UK can be classified as “discouraged borrowers” – which is to say their expectations of rejection are so overwhelming that they refrain from applying for loans. Inflation certainly won’t reverse this trend.
Inflation is usually followed by higher borrowing costs, so anyone not already “locked in” with a low-cost provider will take a hit from rising Bank of England interest rates. In addition, should the economy stagnate, a spike in loan default rates will make borrowing trickier still.
This further underlines the importance of making the capital within a business work harder. Remember that cash is losing value, so it must be put to better use – through investment or other means – to encourage it to grow. At the same time, of course, investment must be balanced against risk.
Finally, don’t forget we’ve had periods of double-digit inflation before – albeit many years ago, as remarked earlier. This means there’s plenty of experience and knowledge available if you’re willing to seek it out.
“Been there, done that” counts for a lot, especially when times are unusually tough. Getting advice from businesspeople who have successfully worked through an inflationary environment might therefore be the single best investment you can make today.
David Falzani MBE is a Professor at Nottingham University Business School’s Haydn Green Institute for Innovation and Entrepreneurship (HGIIE) and president of the Sainsbury Management Fellowship.