Standard and Poors, a research service that tracks U.S. businesses, just reported blow-out first-quarter revenues and profits for America's 500 largest corporations.
Profits were 50% higher than the first quarter of 2020. The numbers surprised even Wall Street analysts, as 76% of the companies beat analysts' sales estimates while 86% beat earnings estimates. Both of these "beats" set new records. The average profit margin (profits as a percentage of sales) hit a record high of 12.7%.
This seemingly positive news contradicts the economic conditions all around us. Many businesses are still operating at partial capacity, and many others have shut down permanently. The business environment, while improving, is still obviously terrible. So how can sales and profits look so rosy?
The answer is not mysterious, nor is it good news. Much of the increase in revenues and profits came from "printed" money, by which I mean new money created by the government's actions.
The 2020 money bonanza was unprecedented. Congress, Treasury, and the Fed invented numerous new programs designed to inject vast amounts of money into the economy. They did this by making direct payments to individuals, encouraging government-guaranteed loans to individuals and businesses, and ramping up spending by federal agencies. As just one example, government transfer payments now account for 34% of personal income, compared to 16% one year ago.
To pay for all this spending, the Fed and the banking system created a record amount of new money. From January to December, the U.S. money supply increased from about $15 trillion to over $19 trillion, up 24%. There is no other one-year increase in the money supply even close to this magnitude.
A monetary injection of this magnitude will eventually result in rising economy-wide sales, but what caused the record profits?
To understand how monetary stimulus can make profits look so good, we need to remember that there's a time lag between business costs and business revenues. This time lag causes rising sales to have an outsized effect on profits.
For example, suppose a store owner typically spends $90 for inventory in January and sells it in December for $100. In this case, the owner has a $10 profit and a profit margin of 10% ($10 / $100).
Now imagine that during the year the government distributes lots of new money to the store's customers. Flush with cash, they will bid up the price of the store's products.
If the store receives $105 for merchandise that normally would have sold for $100, sales will rise 5%, while profits will increase from $10 to $15, a whopping 50% increase in profit and profit margin. However, the increase in profit is illusory. As input costs eventually increase due to the monetary stimulus, the store owner will have to pay more to replace his inventory.
The exact numbers will vary, but this mechanism applies to all businesses that pay expenses before receiving revenue during a period of increasing money supply. The surge in U.S. corporate sales and profits over the last 12 months is, in large part, the result of sales bloated by monetary stimulus. Much of the "good news" on profits is due to price inflation, not better business conditions.
The lesson is: Do not confuse swelling profits with an increase in actual production or a miraculous economic rebound. On the contrary, the first-quarter surge in sales and profits was primarily caused by what may be the most blatant act of inflation in modern times. Stay tuned for more inflation in the coming months and years.
[For more on the relationship between money supply and profits, see Reisman, George, Capitalism: A Treatise On Economics.]
HardmoneyJim No. 1
Thanks to both Jays for your comments. My view is that as long as the government does not impose price controls, we may see temporary scarcity in some items, but not long-term shortages. Vendors have been trained to refrain from raising prices unless absolutely necessary, so they resort to delays and repackaging items without changing the unit price. These are probably signs of impending price rises. I suspect the supply network is working fine, but vendors are having a hard time adjusting to changes in pricing and demand at various points in that network. If inflation is in our immediate future, as I believe it is, they will eventually adjust to a mindset of increasing prices.
I'm interested in this phenomenon in the housing market. Builders for median priced homes in DFW are increasing prices by about 3% per month. They cite lumber prices as the reason. I believe they are also profit taking, based on my observation that there seem to be at least 2 buyers for every new house that goes up for sale.
If the hypothetical shop owner in your article also experiences a shortage during increased demand, as in housing and autos of today's market, can they increase prices fast enough to keep up with supply costs?
Also, in the case of supply shortage, companies have no product to sell at all. Go to your local dealership or bike store and you'll wonder how they can stay in business with no product to sell.