If you’ve been following the news lately, you’ve definitely heard one word repeated ad nauseum…
Inflation hit a 40-year high earlier this year: over 8%.
It has stayed above that level ever since.
But it’s not just on every reporter’s lips. It’s everywhere you look.
Fuel, food, homes, everything is more expensive for everyone – consumers and businesses alike – and it’ll likely still get much worse.
So today I want to dig into this inflationary trend and discuss how it affects startups and startup investors like us.
What’s Driving Inflation Today?
At a high-level, this wave of inflation is thanks to two factors: the effect of the COVID-19 lockdowns and record low interest rates.
The pandemic lockdowns immediately unbalanced the demand-supply equilibrium globally, resulting in shortages of many items and increases in the price of many goods.
At the same time, the pandemic changed our spending patterns significantly. Suddenly the demand for fuel dropped precipitously (because travel to the office was curtailed) while the demand for laptops and headsets skyrocketed as everyone bought equipment to work from home.
While production lockdowns are no longer in place in most part of the worlds, that is not true for one country – China.
As the world’s biggest producer of goods, China is a critical part of the global economy. Yet, thanks to its Zero-COVID policy, numerous cities all but cease to function as new waves sweep through.
In fact, it’s estimated that the global economy has taken a $30 billion hit from just the lockdown in Shanghai alone.
Companies such as Apple, General Electric, Adidas, and Amazon are warning that they expect the supply of many of their goods to be disrupted significantly.
Continued supply crunches plus growing demand?
Another major driver is the War in Ukraine.
Russia is the world’s biggest commodity exporter and, like China, is a key part of the global economy.
The U.S. and Europe have imposed numerous sanctions on Russia and have banned or will ban in 2023 and beyond the supply of Russian oil, gas, coal, and more. These bans are seriously disrupting the supply and prices of numerous commodities, which are key inputs in the manufacturing of all things.
Oil prices have been particularly severely affected, roughly doubling since December 2021.
Unfortunately, the lockdowns and war will continue to drive inflation for the foreseeable future.
The Federal Reserve: The Inflation Firefighter
The Fed’s inflation target is 2%.
The current 8% is way above that so the central bank has pulled out the interest rate hose to fight the fire. So far this year, it’s raised its benchmark borrowing rate (known as the Fed Funds Rate) twice.
And Fed Chair, Jerome Powell, warns that they will not hesitate to raise rates until inflation is under control.
The stock market has clearly shown its disapproval of this situation. Investors have had a terrible year, with the Nasdaq down close to 30% from its high last November.
But what about startup investors?
How Inflation Affects Startup Investing
Inflation has both positives and negatives for startups and startup investing.
The positives include:
- Products that cut costs or increase efficiency are significantly more appealing to businesses and consumers. Most startups have products with these value propositions.
- Rising costs force startup teams to be leaner and more disciplined with how they allocate their capital.
- Startups grow their revenue significantly faster than the inflation rate every year. So, investing in startups is an indirect inflation hedge.
The negatives are:
- Employees demand higher salaries.
- Production inputs are more expensive, reducing margins.
- Buying power of businesses and consumers is lower.
But, what startups have that most other companies don’t is their nimbleness. They can adapt fast.
Obviously, startup founders will have to carefully navigate the positives and negatives of inflation to achieve success.
And, as startup investors, we must be conscious that inflation won’t likely end soon. We must also pay attention to the Fed’s actions and the risk of worsening economic pain ahead.
Here’s the thing though: Challenging times are often the best times to build companies… and invest in them.
Just look back at the Dotcom bubble or the Great Recession. Many of today’s big shot companies got their start during those hard times.
Hardship breeds innovation.
In short, when times get tough, startup investors must be even more on the lookout for the fantastic opportunities available to them.
Until next week!