Stagflation has cast a long shadow and pall on the global economy and this economic phenomenon has become increasingly thematic on the news and for very good reason.
This is the first time the globe has had to contend with stagflation in nearly half a century. The first notable bout of stagflation appeared on the global scene in the 1970s when the oil price increased sharply, and the global economy was generally stagnant.
It is universally agreed that stagflation is a wicked problem because of its adverse effect indiscriminately on businesses, nations, and individuals. Stagflation is defined as an economic phenomenon characterized by rising inflation and static or even negative economic growth. It has also been universally agreed that it is not desirable for a country to go through stagflation, especially for prolonged periods of time.
- Oracle Net Suite advises that businesses with the right kind of strategy can survive the current bout of stagflation plaguing the global economy.
- Stagflation is when an economy experiences negative growth and inflation simultaneously.
- Investors can profit from the current bout of stagflation by purchasing currencies that strengthen and selling depreciating currencies. According to Oracle Net Suite, this business and investing strategy will ensure they stay above the water and optimize their portfolios.
Solving the problems caused by stagflation requires deliberate efforts by the government to intervene on the supply side of the economy to increase productivity right across the board. Through its EUR 65 billion plan, Germany has shown the rest of the world how the world should deal with stagflation. Its plan spearheaded by new chancellor Olaf Scholtz will be channelled towards subsidizing living expenses for citizens and providing social and cushioning allowances to German citizens. This intervention by the German government should result in businesses not folding and increasing their productivity.
This current bout of stagflation which has plagued the world is a result of rising energy and food costs. Its origins are two parts. The first is the disruption to global supply chains caused by the COVID pandemic which saw goods failing to reach their intended destinations in time, resulting in supply restrictions. This, coupled with increasing demand, meant that prices would be pulled up by unsatisfied demand. The second part is the rise in the cost of energy and food. This has been sparked by geopolitical tensions emanating from Russia’s invasion of Ukraine.
Russia provides Europe with the energy it needs for heating while Ukraine is a key player in the supply of wheat, a daily staple for most countries. Energy, which encompasses oil and gas, has been weaponized by both sides of the Russia-Ukraine conflict. Russia has decided to turn off the gas taps to the rest of Europe, leaving the continent which is heavily dependent on those supplies in a lurch. Opponents of Russia’s campaign in Ukraine have placed economic sanctions on Russia and placed embargoes on its energy products.
The conflict between these two European countries has had a far-reaching impact beyond their respective borders. The onset of the war sent the price of oil through the roof, reaching its highest level since 2008. The contagion effect of a rising oil price is that it results in price inflation for just about every good and service there is. Does this economic development leave the question open of how businesses and investors respond to stagflation? Are there opportunities in the chaos that stagflation creates?
- Covered interest arbitrage and carry trading are investing and business strategies investors and entrepreneurs can use to stay ahead of the stagflation curve.
- Businesspeople and investors alike can borrow in depreciating currency and invest in an appreciating currency. Other strategies they can implement to enhance returns and value for their portfolio include margin trading and short selling. These strategies are for seasoned and sophisticated investors, however.
- Entrepreneurs and businesspeople are advised during times of stagflation to implement strategies that fortify and strengthen their balance sheets. This Oracle, Net Suite says, should include paying down debt which tends to be expensive in periods of stagflation while business revenues flatline.
On the investment front, the circumstances of stagflation has created afford shrewd and savvy investors with opportunities to optimize their portfolios. Firstly, central banks around the world have responded to inflation by raising interest rates. The Bank of England and the Federal Reserve of the United States have taken the lead in raising interest rates sharply to stamp out inflation. This development makes investments in government-issued paper and other fixed-income investments appealing.
The United States dollar began to strengthen by rallying against other major currencies and the currencies of emerging market economies.
This development reflects the movement of investors all over the world from other currencies into the US dollar or greenback which they perceive to be a safe haven in times of volatility. This strengthening of the greenback has coincided with multiple sovereign debt crises in emerging market and low-income economies. A good number of these economies that have come under severe strain from unsustainable debt levels are in Africa, including Ghana, Kenya, Zambia, and South Africa. The high-interest rates on their loans, coupled with the fact that most of their loans are denominated in US dollars, makes the likelihood of default more and not less inevitable. For investors, higher US interest rates make it possible for them to earn riskless returns from carrying trading and covered interest arbitrage strategies.
This is where investors borrow in depreciating currencies, whatever they may be, and purchase securities in appreciating currency. For foreign exchange traders, the predominant trading strategy should be to be long on the greenback and short on emerging economy currencies. The more risk-tolerant investors should also be short on the sovereign debt of emerging economy governments. Those investors whose stomachs are lined with razor blades in the sense that they have an abnormally high tolerance for risk can go as far as to short-sell sovereign debt of countries that are likely to default on their obligations.
Short selling security is when an investor or trader anticipating that a particular security will fall in price, borrows the security from his or her broker and then immediately sells that security at the going price.
- Oracle Net Suite goes on to advise that cash is king during stagflation. Therefore, its management is paramount. Business strategy should be focused on shortening the time debtors take to settle their accounts and extending the period that the business must settle with creditors.
- According to Oracle Net Suite, Oracle Net Suite’s website says that other business strategies to weather stagflation include reducing costs, implementing innovative ways of increasing prices, and being selective with acquisitions.
If the security falls in price, the investor or trader will purchase the security from the market at the prevailing low price and deposit the security back with the broker. The profit for the investor or trader is the difference between the price at which they would have sold at the initial phase of the trade and the price at which they buy back the security when they close out the trade. A strong warning is in order here: this kind of trading (margin trading and short selling) is strictly for the sophisticated investor or trader.
It should never be attempted by a novice or a person with a low tolerance for risk. These trades involve the use of leverage and the use of margin which means that should the trade go sideways the investor or trader stands to lose much more than they would have invested.
In the example given, should an investor decide to short sell the debt of a certain emerging market economy currency believing that the country is in financial distress and is likely to default on its loans sending the price of its sovereign bonds through the floor, that investor would be in a world of trouble if for some reason the price of the said bonds rallies instead of falling! That investor would be at risk of receiving the dreaded margin call from their broker.
On the business front…
Oracle through its Net Suite offers eight ways businesses can mitigate the impact of stagflation on their operating activities. According to Oracle, “Businesses operating in stagflationary times face two large headwinds: rising costs and declining customer demand. During stagflation, managers should search for ways to improve productivity, often by harnessing technology. They can also reevaluate pricing schemes, improve supply chains, reduce debt, and consider acquisitions. Those who successfully adapt to stagflation may find themselves better positioned for the economic boom times that inevitably follow.”
The software giant says, “Stagflation is a tough environment in which to run a business. On one hand, inflation is driving up expenses, with the price of raw materials and wages often jumping sharply. On the other hand, the economy isn’t growing quickly — if at all — and unemployment is rising. The difficult economy makes it tough to pass on higher costs to customers. Revenue may fall as consumers pull back their spending. Many small businesses go out of businesses in an economy besieged with stagflation.”
Businesspeople looking to ride the wave of stagflation need to take Oracle’s advice and do the following:
- Improve productivity through technology to automate processes and minimize costs.
- Cut costs in some areas of their businesses to offset the rising costs of doing business in other areas.
- Evaluate prices in terms of assessing pricing policies. Oracle says businesses should consider offering products or services in a bundle or change packaging in a way that increases price per unit sold. Doing so may allow you to offset rising costs and remain profitable without alienating customers by a blatant price increase.
- Boosting quality, this is especially important when businesses have no option other than to raise prices. If a company is going to ask customers to pay more for a product, it should be sure the quality is as good or better than it was before the price increase. This might involve an increase in research spending to improve the product. Consumer product companies are often able to raise prices on products that are new and improved.
- Strengthen the balance sheet, this can be done by building a cushion of reserves or a war chest of cash to meet unexpected costs. This means keeping debt at a minimum. Debt in periods of stagflation tends to be expensive, whereas revenues flatline. A wicked problem.
- Tighten up accounts receivable and payable, this can be achieved by shortening the time debtors have to settle their accounts and extending the period before the business can settle its obligations to suppliers should improve cash flow. In periods of heightened inflation cash is always king.
- Buy real estate, Oracle advises that during periods of stagflation businesses should consider becoming landlords. This is because in such times rents tend to increase whereas revenues are static if not negative and if businesspeople have cash available, they should purchase the building in which they operate.
- Lastly but not least, businesses should be opportunistic about acquisitions, stagflation poses a real existential threat that not all businesses will survive. Oracle advises if your company is among the survivors and has the financial flexibility, consider bargain shopping. Companies that are going out of business or need to raise cash may sell property or equipment at fire-sale prices. Consider acquiring property, equipment, assets, brand lines or staff with needed skills. Likewise, consider merging or acquiring a competitor if doing so allows both companies to reduce overhead and expand into new markets or offer an expanded array of products or services.
This is good advice, by the way.