Investors and consumers are convinced inflation will continue to rise even higher, much like it did in the 1970s. Few realize the dollar is slowly gaining strength and is going to slow the rate of inflation, perhaps significantly, as it did during the Great Financial Crisis.
While there are times both producer and consumer prices rise at the same rate, there are many instances where producer prices are rising at a faster rate than consumer prices. Often, when producer prices rise faster than consumer prices, a recession is imminent.
The explanation for the ensuing recession is rather simple, as producers are unable to pass their rising costs to consumers. Without equivalent increases in wages to absorb higher prices, consumers reject higher prices by being forced to consume less.
Over time, inventories begin to rise as goods start collecting dust on shelves. Retailers, who have bills to pay, start to discount, and put pressure on wholesalers and retailers to dip into their margins to move the stagnating inventory. As inventories back up, the entire supply chain slows as manufacturers cut production and employees. This cascading effect through the supply chain leads to even less consumption and ultimately causes the economy to slow.
Currently, producer prices are rising at the fastest pace compared to consumer prices since the Great Financial Crisis. While rising producer prices were not the catalyst for the last major crisis, it has become a foregone conclusion that consumer prices will surge higher.
The biggest and most unforeseen factor that will break inflation is the U.S. dollar. Despite consumer and producer prices continuing to rise, the dollar has been slowly gaining strength since early 2021. The value of the dollar has a direct impact on commodity prices and in turn on producer prices that are highly sensitive to changes in input prices.
The dollar remains the most important factor to determine if inflation will persist or if it will come crashing down as it did during the Great Financial Crisis. As the dollar continues to gain strength, the probabilities diminish that inflation will persist.
It’s more likely we’re on the eve of a replay of the Great Financial Crisis where in a similar fashion producer prices rapidly rose and consumer prices did not, since consumers could not afford higher prices then just as they cannot now. A rising dollar broke inflation during the Great Financial Crisis and is likely to do the same again should it continue rising.