Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / Why Stagflation Is Crushing Small Business Margins
Transcript
- Lucas: We talk a lot about stagflation at the macro level — the GDP print, the CPI number, what the Fed might do next. But I think we sometimes miss what this actually feels like if you're running a small business. Luna: Yeah, because for a small business owner, those macro numbers translate directly into: can I afford to keep my staff? Can I raise prices without losing customers? Lucas: Exactly. And right now, the data suggests they're getting squeezed from both sides. Let me give you a concrete example. A regional furniture chain — I won't name them because they're in Chapter 11 right now — filed for bankruptcy last month. They'd been in business for over forty years. Luna: What happened? Was it just inflation? Lucas: Partly. But the story is more specific. They'd locked in supply contracts two years ago at lower prices. When those expired, their cost of goods sold jumped by about 18 percent almost overnight. At the same time, their customers — middle-income households — were pulling back because their own grocery bills were up. The chain tried raising prices 6 percent. Sales dropped 12 percent. They couldn't pass through the costs. Luna: That's the classic stagflation trap. Slowing demand, but costs are still rising. And a small business doesn't have the pricing power that, say, a Procter & Gamble has. Lucas: Right. Big companies can absorb commodity shocks better, they have hedging programs, they have brand loyalty. A regional furniture store? People will just go to IKEA or wait for a sale. Luna: So what does the broader data say? We have the unemployment rate at 4.3 percent, which is still low historically. But job openings are declining — JOLTS was down to about 6.9 million in March. That suggests businesses aren't expanding. Lucas: And the NFIB Small Business Optimism Index — the May reading came out last week — it's at a multi-year low. The component that really jumped out at me was the net percent of owners expecting better business conditions in the next six months. That number is deeply negative. Luna: What about profit margins? The NFIB also tracks that. Lucas: They do. And the net percent of owners reporting higher nominal sales over the past three months actually ticked up a bit. But the net percent reporting higher earnings per share — that's been negative for several quarters in a row. Costs are eating the revenue. Luna: Which aligns with what we're seeing in the CPI. The April CPI came in at 332.4, up from 330.3. Core CPI also rose. So input prices — materials, energy, transportation — are still climbing. Lucas: And don't forget labor. Average hourly earnings for private workers are up to $37.40. That's about a 2.8 percent annual increase. For a small business with, say, 15 employees, that adds up fast. Luna: Let's talk about one specific sector that's really feeling it: food service and hospitality. After the pandemic, everyone said 'nobody wants to work.' Now the issue is more that restaurants can't raise menu prices enough to cover higher food costs and higher wages simultaneously. Lucas: And consumers are pushing back. There was that CNBC article this weekend about Americans feeling inflation's pinch heading into Memorial Day. Consumer sentiment hit a fresh record low in May. So restaurants are in a bind — they're seeing lower traffic, but their cost structure hasn't come down. Luna: There's one store near me — a local bakery — that had to close three days a week because they couldn't find enough staff at the wage they could afford. And their ingredient costs went up 15 percent last year. The owner told me she's basically working for free. Lucas: That's the human-level impact. And it's not just mom and pops. Look at the Russell 2000 — that index of small-cap stocks. The RUT is up about 3.4 percent over the past five days, but on a year-to-date basis, it's lagging the S&P 500 significantly. Investors are pricing in margin pressure. Luna: Right. The S&P 500 is at 7,473, up 1 percent in five days. Big tech is driving that. But the broader market is less enthusiastic. Lucas: So what can small businesses actually do? Some are turning to automation. I spoke to a small manufacturer in Ohio that makes industrial gaskets. They've invested in ai powered inventory software to reduce waste. That's helped them shave about 4 percent off material costs. Luna: But that requires upfront capital. And right now, borrowing costs are high. The Fed hasn't cut rates, and the ten-year Treasury is still elevated. So a small business can't just go get a cheap loan to buy new equipment. Lucas: Exactly. A lot of them are using retained earnings — if they have any. Or they're taking on more debt at higher rates. The NFIB survey shows that borrowing costs are increasingly cited as a top problem. Luna: There's also the psychological factor. If you're a small business owner and you see headlines about a potential recession — even if the data is mixed — you're less likely to invest. You hunker down. Lucas: And that creates a downward spiral. Less investment means less productivity growth, which means wages stagnate, which means consumers have less spending power. That feeds back into weaker demand for small businesses. Luna: You know, speaking of the psychology of the economy — if walking through the economy with us has made something click, or helped you frame what's happening in your own business or career, we'd love you to consider supporting the show. A couple of dollars a month is genuinely what keeps these going — buy me a coffee dot com slash fexingo, if you've gotten something out of them. Lucas: Yeah, that's really appreciated. It keeps us independent and ad-free. Luna: Okay, back to the margin squeeze. One thing I've been watching is the divergence between large and small firms in terms of pricing power. We mentioned big companies can pass through costs. But is that starting to change? Lucas: It might be fading, actually. In prior episodes, we talked about corporate pricing power more broadly. But there's new evidence that even some big consumer brands are seeing volume declines as they push prices too far. That could actually help small businesses if it forces big players to moderate price increases. Luna: Or it could hurt them if the big brands start discounting aggressively to win back customers, and the small guys can't match those discounts. Lucas: Right. It's a knife edge. Let me throw out a number that stuck with me: the breakeven inflation rate on the ten-year is at 2.40 percent. That's up slightly. The market is still pricing in persistent inflation. So the Fed is unlikely to cut rates soon. That means small businesses are looking at a high-rate, high-cost environment for at least another year. Luna: What about the real GDP growth number? The annualized rate for Q1 2026 came in at 2 percent, up from 0.5 percent the previous quarter. That's actually not terrible. But it's uneven — a lot of that growth is from government spending and services. Lucas: Yeah, and if you strip out the big tech and ai related investment, the rest of the economy is maybe growing at 1 percent or less. That's the stagflation pattern: pockets of strength masking broad weakness. Luna: So where do we go from here? Can small businesses adapt fast enough, or are we going to see a wave of closures? Lucas: I think we're already seeing it. The furniture chain I mentioned is one. I suspect we'll see more in retail, hospitality, and construction — sectors where margins are thin and competition is intense. The ones that survive will be the ones that can either find a niche with loyal customers, or dramatically reduce their cost structure. Luna: Or both. There's a lesson in here about the resilience of small businesses. They've been through a lot since 2020. But stagflation is a different beast — it's not a shock, it's a slow grind. Lucas: Exactly. And that grind is what we'll keep tracking. Next episode, I want to look at how the AI economy is changing labor dynamics for these businesses — because there's a narrative that AI will save everyone, but the reality might be more complicated. Luna: Sounds like a plan. For now, if you're a small business owner listening, we see you. It's tough out there. Lucas: Thanks for being with us. We'll talk again soon.