The month of May was supposed to bring good news for the government: a lower energy price cap from Ofgem, a more optimistic verdict on our economy from the International Monetary Fund and a return to single-digit inflation. These things were delivered, and Rishi Sunak announced: “The plan is working.” The bond markets, however, disagreed.
On 24 May, as the Chancellor Jeremy Hunt congratulated himself on having “acted decisively to tame inflation”, bond traders looked at the Office for National Statistics data and began a rapid sell-off of UK government debt. Gilt yields – which reflect the amount it costs the UK to borrow from financial markets – rose at a speed seen only twice in recent decades: following Liz Truss’s disastrous mini-Budget, and during the financial crisis of 2008.
Why the sudden panic, when inflation had fallen? Bond prices measure how optimistic investors are about the fortunes of the country or company issuing them. While the UK’s headline rate of inflation fell on 24 May, investors were concerned that it was higher than most predictions. More concerning was that “core” inflation – which takes out volatile prices and is considered a better indicator of the economy’s real temperature – had risen.
By 26 May the UK’s biggest mortgage provider, Nationwide, had already hiked mortgage rates. Hunt was asked by Sky News if he was comfortable with the Bank of England raising rates further still – markets now expect a peak of 5.5 per cent, which will double the mortgage payments of many homeowners – even if this precipitated recession. “Yes,” he answered.
Some force has gripped our economy, making it feverish, and even strong medicine (administered as 12 interest-rate rises in a row) doesn’t seem to be working. The truth is that while inflation is portrayed in headlines as one number, it is more diffuse. Like a pandemic, it arrives in waves as new types develop. The first wave was caused by an overdose of demand: in 2020 people saved money by not going anywhere, and spent it on tat from Amazon (“durable goods”, in economese). Just as this demand had begun to ebb, a second wave arrived, caused by a lack of supply: an energy shock sharply exacerbated by Russia’s full-scale invasion of Ukraine. That influence, too, has waned – wholesale energy prices are below pre-war levels – but at the end of 2022, a third wave arrived. This time, the force driving prices upwards is one many economists find difficult to model: greed.
Beyond the checkouts of every British supermarket, a row of boxes waits to take the items that the occasional shopper will drop in for the food banks. The number of donations has fallen in recent months as inflation erodes the spending power of even the more affluent customers, but they are more vital than ever: in the past year the Trussell Trust, Britain’s biggest food bank network, has distributed almost three million emergency food parcels. A million of them were for children.
What donors of pasta and beans may not appreciate is how much money the companies that make the products, and the shop itself, are making from their generosity. Tesco made £2.6bn in adjusted operating profit in the 2022-23 financial year, £1bn more than it made in 2018 and the highest it has made in any year other than 2021-22. The operating margin of the UK’s biggest supermarket was 4 per cent – healthy for the sector, and better than the company’s average over the past five years.
It is not only British supermarkets that are, as the governor of the Bank of England, Andrew Bailey, describes it, “rebuilding margins”. If you buy a Coke in the UK, it’s made by Coca-Cola Europacific Partners (CCEP). CCEP sold about the same volume of products last quarter compared to the same quarter in 2022, but its “revenue per unit case” has increased by 10 per cent. Growth, its trading statement notes, is being “driven predominantly by favourable underlying price” (the price of cola has risen 12 per cent in the past year).
The world’s biggest coffee chain, Starbucks, increased its operating margin to 19.1 per cent last quarter (takeaway coffee is up 11 per cent). McDonald’s is making higher profits on higher prices (burgers are up 17 per cent). The Restaurant Group, owner of Wagamama and Frankie & Benny’s, reports not only an increased operating margin but a plan for the future in which “a slowdown in customer spending influenced by the current cost-of-living crisis” is “offset by planned price increases”. At Tate & Lyle (which no longer makes the sugar of the same name, but supplies the wider food industry) profits have risen by 22 per cent in the past year.
The operating margins of British workers, meanwhile, have collapsed. Wages are growing at 5.8 per cent but shop prices are rising faster than at any time since the British Retail Consortium began recording them in 2005. The most serious component of this is food prices, which rose by more than 19 per cent in March and April, the highest levels for 45 years. The inflation is worst in staple foods: baked beans are up 41 per cent, sliced white bread is up 28 per cent, dried pasta 22 per cent. The price of a bag of sugar has risen by 47 per cent in a year. Heinz ketchup can now be found at £4.50 a bottle, having risen by 30 per cent in a year (Kraft Heinz reported earnings growth of more than 10 per cent in the first quarter of this year, “primarily driven by higher pricing”). In one supermarket, jars of instant coffee (£10.50 each) have been replaced by empty containers to prevent shoplifting (shoppers who want coffee have to ask staff).
According to the retail data analyst Kantar, groceries now cost the average household an extra £833 a year. For a low-income family, that is already unsustainable. A recent YouGov poll of 10,000 adults found that one in five people in the UK has recently reduced the amount they are eating or skipped at least one meal due to the high price of food.
This is not only unusual and unfair, it is dangerous. As Hunt acknowledged in a recent TV interview, “inflation is a source of instability”. To fight it, the Bank must drive interest rates ever higher, subduing business investment and the housing market, and pitching the country into a recession.
The cosy assumption of equilibrium economics is that rational self-interest is a constant, like gravity or entropy, that leads systems to find a balance between price, supply and demand. Yet greed is not a stable value. It is a biological imperative that ebbs and flows, following opportunity. Like mould, it flourishes unseen.
Sometimes, like mould, it becomes horribly apparent, as it did to Albert Edwards at the beginning of April. Edwards is head of global strategy at the French multinational bank Societe Generale and has been working in finance for more than 40 years. For his weekly note to clients on macroeconomics, he created a chart on which he plotted unit and non-unit labour costs against the profit margins of American companies over decades.
Since the middle of the last century, these variables have been governed by what he calls an “iron law”: when costs rise, profit margins fall. Towards the end of the chart, however, something unusual happens: the relationship is broken. The line showing company margins climbs upwards even as costs rise. “The normal laws of economics, which say that corporate margins go down when costs go up – they just don’t seem to apply,” he told me.
It is, he said “shocking, how high margins are” in the US, where companies are “not just maintaining their margins and passing on all the cost increases, they’re expanding them… I’ve never seen a period where this has happened like this before.” The breakdown of accepted economics the graph displays led Edwards to ask a question rarely posited in investors’ notes: “Is capitalism dead?”
A similar worry afflicted economists at the European Central Bank (ECB), who concluded in March that “the effect of profits on domestic price pressures has been exceptional from a historical perspective”, and that profit margins had become the main driver of inflation, accounting for two-thirds of real-terms price increases in 2022.
After announcing the ECB’s seventh interest rate rise in a row – with indications that more are to come – the bank’s president, Christine Lagarde, said that “in some sectors firms have been able to increase their profit margins on the back of mismatches between supply and demand and the uncertainty created by high and volatile inflation”.
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In Britain, the impact of so-called profit-push inflation can be most easily observed in the price of milk (up 38.4 per cent). For most products it is hard to say where price increases creep in, because we don’t know how much prices change along the supply chain. With milk, however, the Department of Environment, Food and Rural Affairs collects the price at the farm gate and the Office for National Statistics collects the prices charged in shops. For most of 2021, the mark-up on a pint of milk was 25p; it has been in the 25p-30p range for three decades. At the end of last year, it rose abruptly to more than 40p.
How are all these companies getting away with it? Paul Donovan, the chief economist at UBS Global Wealth Management, said profit-push inflation is enabled primarily by “the ability to sell this story that it’s not our fault we’re raising prices – the price of wheat’s gone up, so we’ve got to raise the price of bread”.
Real cost increases have occurred across the economy, Donovan said, but profit-push inflation is caused by companies raising prices more than they need to, and consumers accepting that the hikes are unavoidable because the news has contained so many stories (some of them by me) about energy prices, the war in Ukraine, supply chain disruption during Covid, Brexit, the wage-price spiral, and the nebulous threat of inflation itself.
What did any of these factors do to double the price of a box of cereal? In energy, Brent crude oil is down more than 30 per cent year on year; agricultural indices and industrial metals are down more than 20 per cent. Despite the Ever Given’s blocking of the Suez Canal in 2021, global trade that year reached a record high; and it is hard to argue that Brexit is responsible when food price inflation has been higher in the euro area. As for a wage-price spiral, “No one’s facing higher labour costs,” said Donovan. “Real wages have been catastrophically negative for two years.” Edwards agrees that food prices should already be “rattling down” after plunging commodity and wholesale prices, and that when politicians and central bankers talk about wage-price inflation they are “gaslighting workers into believing they are responsible for this”.
Profit-push inflation is also being sustained by some workers being a great deal better off than others. Inequality was exacerbated by the pandemic: across the world, affluent white-collar workers stayed at home, their savings grew and their assets (especially their houses) were inflated by monetary policy. Many people – especially business owners – also made the most of fiscal stimulus. Consumers across the US, UK and Europe aren’t happy about higher prices, but the better-off can, for the moment, afford them. In doing so they are imposing more inflation on the people who risked their lives to clean their hospitals and deliver food to their houses.
As greedflation drives a wedge between affluent consumers and people who can barely afford to eat, it also divides people with money in the bank and people in debt.
The reason for this is that banks, too, are boosting their margins. Mortgage deals jump the moment the Bank moves its base rate, but savings are slow to follow. A bank’s “net interest income” is the money it makes from this difference (the interest it charges borrowers, minus the interest it pays depositors) and at every high-street bank this number is rising fast. NatWest – whose largest shareholder is the government – increased its net interest income by 43 per cent last year.
Again, this isn’t just a rip-off: it is the exact opposite of what the Bank of England wants people to do with their money. By raising its base rate, the Bank plans to make borrowing more expensive (so people with less money cut up their credit cards) and saving more lucrative (so people with money keep it in the bank). In both cases this reduces demand and therefore prices. But if the bank on the high street keeps the difference for itself, there’s no incentive to save, and the spending of the affluent forces more price rises on to the people least able to afford them.
As inflation persists, the Bank has no option but to deploy what Edwards called its “one tool – to smack the consumer around the head until they’re on their knees” with higher rates and more expensive borrowing. This will eventually bring demand down, but it is a process he describes as “punishing the consumer, and especially the most vulnerable consumer, for what corporates are doing”. It also increases the risk of financial fallout.
In the past year a series of worrying events – the crisis in liability-driven investment strategies that threatened British pension funds in September, and the failure of three US banks that were larger, by assets, than the banks that failed in 2008 – has shown what happens when interest rates are repeatedly hiked, as they have been across the West. Decisions made in the low-risk, cheap-money era – such as Silicon Valley Bank’s uninsured bet on cheap, long-term debt – have proven disastrous.
“The last few deep recessions have been caused by interest rate rises blowing up financial markets or asset markets,” said Edwards. “So to the extent central banks have been forced by greedflation to increase interest rates higher than they otherwise would have done – it runs the risk of a deeper recession, and financial market calamity.” The International Monetary Fund has agreed that “risks to bank and non-bank financial intermediaries have increased as interest rates have been rapidly raised”.
Even without an abrupt crash, said Donovan, greedflation is essentially a process of “transferring money from consumers to shareholders”. It is not something economists regard as evil in itself, but when it has to be addressed by higher interest rates, it becomes “more damaging” because it means “consumers spend less money in total – and that harms employment in other parts of the economy”.
It’s important to ask where the money ends up. In many cases, companies are using profits to repurchase their own shares on the open market (“buybacks”). Tesco has bought £1.8bn of its own shares since October 2021; Shell’s recent announcement of a $9.6bn profit (in three months!) was accompanied by a $4bn buyback. A buyback boosts the company’s earnings per share, simply because earnings are now divided by a lower number of publicly traded shares, and this pumps the share price. Alternatively, a company might reward its shareholders more directly, via a dividend. Either is good news for investors, and for the CEO, whose performance (and pay) is decided using these variables.
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British companies have been doing this at record levels. In 2022 they paid out £94.3bn in dividends, which was an 8 per cent increase on the previous year. The only reason this figure wasn’t higher was that they also spent a record £55.5bn on buybacks. Accordingly, CEOs of FTSE 100 companies are among the only groups to have enjoyed above-inflation pay increases, with an 12 per cent raise (as estimated by Deloitte) from an average of £3.72m in 2021 to £4.15m in 2022.
This, too, is a risk to the economy, because every pound returned to shareholders through buybacks or dividends is a pound not spent on hiring or training staff, buying equipment and developing products. Faced with a choice between improving the company and engineering the balance sheet, executives have chosen the latter. Buybacks and dividends also mean a company has less liquidity to weather tough times, because that pound handed to the shareholder is also a pound not spent paying debt or held as cash. With fewer assets, fewer jobs that can be cut, and more debt, companies are making themselves – and collectively, the wider economy – more fragile. Developed economies are slowly bleeding themselves dry for the benefit of financial markets and the managerial class.
This is not just expected but demanded; if shareholders do not see earnings growth and increased margins, they will invest elsewhere. A recent paper on “seller’s inflation” by the economists Isabella Weber and Evan Wasner at the University of Massachusetts notes that in 2021, when the US retailers Target and Walmart announced plans to absorb price rises rather than pass them on to shoppers, the market didn’t wait to see if the strategy paid off in increased customer loyalty and market share. Analysts concluded, correctly, that other retailers would raise their prices, and both companies – despite strong earnings growth – were punished by shareholders who took their money elsewhere. Target’s stock fell by almost 5 per cent.
“Shareholders are very happy that each individual company is able to raise their margins,” said Edwards. “But it leads to a deeper recession, and financial market implosion… that’s a catastrophe for the stock market. So shareholders are clapping away at individual companies that are raising margins, but not seeing where that ends up.”
This is the true nature of the “shareholder democracy” (later rebranded “stakeholder capitalism”) envisaged by Margaret Thatcher: a shared commitment to greed and disaster. Even if a publicly traded company wants to go against inflationary pressures, its path will be corrected by the banks, pension funds and asset managers who manage our deposits and our debts. Social relations are replaced by fiduciary duties; this is not shareholder democracy, but shareholder tyranny.
Not for the first time, Sunak has had to borrow from John McDonnell, who recently told the New Statesman that price controls are the right response to greedflation. Sunak’s aides are now working on an agreement with supermarkets to place optional price caps on basic foods (a similar system has already been implemented in France), but the economists I’ve spoken to say such measures are of limited use because retailers tend to “rebuild” their profits elsewhere. Food prices can’t be capped in the same way as energy, because energy providers sell commodities that are priced by a global market (you might be angry about Shell’s profits, but Shell itself doesn’t control the price of crude oil). In the UK food and drink sector there are more than 8,500 manufacturers, serving supply chains that go into thousands of retailers and restaurants, and every price is debatable.
There is broad agreement, however, that the competition regulator should step in. The Liberal Democrat leader, Ed Davey, told me that if an investigation of the largest supermarkets and food companies by the Competition and Markets Authority (CMA) was announced, it would have “an immediate impact” on prices: any capable board would want a “top to bottom review of how they set prices to make sure they will not be caught out”.
The government is also looking at the problem: on 23 May Hunt met with food companies and the CMA at Downing Street, and the MPs of the Environment, Food and Rural Affairs Committee have launched their own inquiry into fairness in food prices.
Urgent action is needed. The least-worst option, says Paul Donovan, is that consumer demand collapses. There is already evidence for this: own-brand products are more popular than ever (another win for the supermarkets), and people are buying less, even as they spend more. Albert Edwards warns that more pessimistic scenarios are not inconceivable: “We talk about Tiananmen Square being all about democracy; it was because they had runaway inflation. The French Revolution wasn’t about liberté, fraternité, egalité, it was about rampant food price inflation.” No one should underestimate how serious the threat posed by high food prices is to the social fabric, Edwards said. “We generally accept the semi-free market system we’re working under. This is an existential threat to it.”
In his first speech as Chancellor last autumn, Hunt described our predicament as “a recession made in Russia”. It was a clumsy attempt to shift the blame for the UK’s economic woes from the Conservative Party to Vladimir Putin, but it contained a grain of truth. The war in Ukraine had posed a challenge to the economies of the US, UK and Europe: who should pay? Our answer has exposed us, for all our social progress, as participants in a grasping and predatory system, in which the CEO of Tesco can be paid £4.4m to “rebuild” his company’s profits while millions of British people go hungry. In passing the bill on to those who can least afford it, our society shows itself at its worst.
This article appears in the 31 May 2023 issue of the New Statesman, The Rise of Greedflation