Knowing and acting accordingly are two different things. We know that inflation has long been at the top of the Eurozone (in March and on the podium), but a smart reaction to minimize its impact is another matter. This requires analysis and learning from the past.
It is precisely on these foundations Dino Giergia, Prime consulting, crafted the Inflation Atlas, a detailed overview of the causes, consequences, reactions, winners, and losers of inflation from World War II to the crisis we have been experiencing since the time of pandemic lockdowns.
– The idea to create the Atlas comes from the need to understand what is happening in the market and how to react once the crisis arrives. It is not a question of whether it will come but when. It is concerning that we cannot find information on how to react in a crisis in one place. That is why I made an overview of all energy-related crises in the last hundred years. I was primarily interested in how my industry (pharma) behaves. I wanted to know how other industries react. How do asset classes behave – when gold gains, when stocks do, and what is the connection with inflation. After answering that, I wanted this not to be a theoretical discipline but to have a ‘playbook’ on how to behave. Adjusting and building margins, getting out of fixed costs, postponing CAPEX if it does not pass scenario analysis – explains Giergia, who adds that it is extremely important for entrepreneurs to understand what phase our economy is in.
Economies have a conjuncture, a natural process of growth and decline, and according to all indicators (PMI, inflation, employment, interest rates, GDP growth projections for 2027 and 2028), we are in late expansion with signs of slowing down. Investments and cash reserves should be planned according to this information.
– That is the key to analysis – Giergia is categorical.
Can we then learn anything specific from past crises? Since the Atlas covers a really long period, we took two events as a ‘sample’ – the oil crisis/shock of 1973, which many analysts still take as a ‘benchmark’ for today’s crisis, and the post-COVID period, which has been compounded by wars and the disruption of energy chains.
The day that changed the economy
As Giergia details, October 19, 1973, is a date that changed the global economy. OAPEC (Arab Oil Producers) imposed an embargo on the USA and the Netherlands due to their support for Israel in the Yom Kippur War. In four months, the price of oil jumped from $3 to $12 per barrel (a 300 percent increase). Gas stations had miles of lines. Some introduced an alternative system of alternating car use based on even and odd license plates.
– But oil was not the only problem. Inflation was already high due to the costs of the Vietnam War and Nixon’s abandonment of the gold standard in 1971. The oil embargo was the trigger that ignited an already loaded gun. The Fed reacted, but too late and too cautiously. The result was something that economists at the time considered theoretically impossible: stagflation. Inflation and recession and unemployment simultaneously. For company directors, stagflation was the worst-case scenario. In a normal recession — costs fall, you can adapt. In normal inflation — you raise prices. In stagflation, costs rise because everything is more expensive, but you cannot raise prices because customers are losing jobs and have no money. Margins are squeezed from both sides like a jaw in a trap – specifies Giergia.
Who were the big losers? The American automotive industry, specialized in ‘gas guzzlers’. Ford, GM, Chrysler lost market share to Japanese and German cars. The industry never fully recovered. Then there were the ‘Nifty Fifty’ stocks — IBM, Xerox, Polaroid fell between 60 and 90 percent, with high P/E ratios, inflation, stagflation. The airline industry also fared poorly — fuel exploded in total costs. Airlines were in free fall, with no ability to raise ticket prices appropriately.
Companies with variable-rate loans saw interest rates rise from an average of 5.75 percent to 12 percent in one year. Every firm with high leverage and variable interest rates was in an existential crisis. Also, importers of energy-intensive inputs whose import prices exploded could not raise domestic selling prices in the same proportion.
Oil companies profited
As someone always sees the light, this crisis changed the global economic picture. Oil companies profited; for example, Exxon’s profit grew 17 percent annually for an entire decade. The energy sector was the only stock category that grew in real terms. The Japanese and German automotive industries grew — small, fuel-efficient cars suddenly became a hit. Toyota, Honda, VW took market share that America never regained. Gold rose 2300 percent in the decade, commodities 586 percent. Pharmaceuticals and food, due to inelastic demand, had the ability to pass costs onto consumers (health and food are always a priority). Newly industrialized countries — Korea, Taiwan, Spain, Mexico benefited as they attracted investments due to lower energy costs. Globalization, Giergia claims, was born precisely then, on that fact.
What should the reaction be under such conditions, more precisely, what should the ‘playbook’ for companies look like? Energy efficiency should have been a strategic investment, not a cost measure.
– Companies that invested in energy efficiency from 1973 to 1975 reduced operational costs while the competition paid the full price of oil. This was not a ‘green’ decision; it was purely financial. Every kuna invested in reducing energy consumption returns multiplied during an energy shock. Today, the equivalents are solar energy, LED lighting, thermal insulation, optimization of industrial processes. One should never rely on a single source of supply; supplier diversification is mandatory. The embargo suddenly cut off the supply of entire industries that depended on a single source of oil. Companies that had alternative suppliers and alternative inputs survived. The same is true today; at least two to three alternative suppliers are necessary for each critical input – says Giergia, adding that it is crucial to conduct a Pareto analysis of energy costs by SKU (stock keeping unit) — to delist ‘energy losers’, or to ask the question ‘which products in the catalog consume the most energy relative to the margin achieved?
In stagflation, these products are a burden that consumes capacity and money without appropriate returns. Delist or freeze the production of energy-intensive, low-margin products. Focus resources on high-margin, low-energy SKUs. Recommendations include forward contracts for energy and key inputs or — buy the future at today’s price. Companies that had the ability to fix energy prices or key raw materials in advance (forward contracts, long-term supply agreements) protected themselves from volatility. The supplier gains volume security, the company gains price security.
– Both win in an uncertain environment. Today, energy forward contracts, fixed raw material prices, long-term logistics contracts are also recommended, but all this is worth negotiating when prices are relatively low – he recommends.
The second shock
Soon after the oil shock of 1973, a second one occurred in 1979 when the Iranian revolution brought down Iranian oil production. Inflation, which had practically not decreased until then, jumped to nearly 15 percent, forcing then-Fed Chairman Paul Volcker to raise interest rates above 20 percent. However, although crises regularly hit the somewhat globalized economy, inflation was a forgotten topic until the lockdown.
As Giergia specifies, Covid-19 halted the global economy in the spring of 2020. Governments and central banks responded with massive monetary and fiscal expansion — the ECB buys bonds, interest rates go to -0.5 percent, government money goes directly to consumers. Global supply chains were paralyzed. Ships full of containers waited for weeks in ports.
Chips disappeared from the market. Demand exploded as people saved money at home and suddenly wanted to buy everything after reopening. – Inflation began to rise at the end of 2021. The ECB and Fed said — ‘it’s temporary, shortages will be resolved’. They did not react. And then in February 2022, Russia attacked Ukraine. Natural gas, on which Europe was dramatically dependent, suddenly became a geopolitical weapon. European gas prices rose 300-400 percent in a few weeks.
