Inflation is on everyone’s mind at the moment. Many are unfamiliar with how this particular bout of inflation came about or how bad it could get. Or worse, some people know just enough to sound like they know what they are talking about on the subject.
In this post, I will look at each of the major pain points in a little more depth. The hard close and staggered re-opening of the global economy has caused some pain points. However, the pandemic has also changed the way people spend and exposed some weaknesses in the global economy.
The Pandemic Shift of Consumption
During the lockdown, people were no longer going out and spending money on personal care, entertainment, or dining out. The lockdown freed up some budget for people sitting at home to start ordering goods. We witnessed a massive shift from services spending to goods during the middle of what would be a very brief recession.
Compounding the problem, producers went into their recession playbooks, cutting production, canceling orders, and running down inventory. Then, producers got caught off guard when orders increased. On top of it all, the government gave Americans about a trillion dollars instantaneously. People were stuck at home and had more money to spend on Amazon than ever.
Lumber might have been the canary in the coal mine for the supply chain squeeze as prices soared in the spring. In a few months, lumber futures soared to $1733 before falling back down to $450. The demand for more space in the form of housing drove lumber prices through the roof.
But, because everything is weird now, the price of lumber crashed back down. As it turns out, you need more than just lumber to build, and builders ran out of those things. The shortage of lumber turned into a glut of lumber as builders were unable to get other supplies. Producers ran out of places to even store lumber, much like that “negative oil” moment back in 2020.
Cars: New and Used
So, we have all read that cars are more expensive to come by at the moment. People are moving to bigger spaces further out, and need new vehicles for that.
Because new cars are harder to come by, the demand for used cars has increased. Interestingly, during a typical recession, the supply of used cars goes up as repossessions increase. However, because of the government stimulus checks, people could stay on top of car payments. Repossessions fell below what they would have been in a stable economy.
Big automakers are struggling to get the semiconductors to produce a finished product. Part of the problem is that automakers canceled their chip orders as the pandemic swung through the west. Managers of the automakers were going off their recession playbook, like others.
However, as the economy began to change and consumers demanded cars, automakers were left behind. Consumers were demanding all sorts of new electronics from phones, TVs, game consoles, and computers that required semiconductors. By canceling orders, auto manufacturers struggled to regain supply.
Aside from food, this is probably the most visible part of inflation. We see the rising cost every time we pass a gas station, and we also keep reading forecasts of an expensive winter for heating our homes.
The recent energy price spikes and other commodity spikes result from years of underinvestment in the sector in what Jeff Currie, commodity guru of Goldman Sachs, calls the “revenge of the old economy.”
He points out that profits were so poor for the Exxon Mobils compared to the Netflixes of the world that investors allocated vital capital away from fossil fuels to tech. Yes, the shift to green investment has exacerbated this problem, but the returns from fossil fuels have been terrible for a long time. Investors were not making money off of fossil fuels, so they left.
The lack of capital investment and shift away from fossil fuels set us up for problems. Prices had been so volatile in oil and gas for so long (think early-to-mid 2000s) that investors needed sustained prices to justify spending on adding capacity. It just never happened; investors lost money and never came back.
Reaping What You Sew
That brings us to today. China shuts down its toxic coal mines, reducing the global coal supply. China replaced this coal with natural gas and oil, putting pressure on international prices more recently. Tightness in the natural gas market forces Europe to also move into oil, putting on more pressure. Because the wind stopped blowing in the North Sea, the problem got worse in Europe. These higher energy prices have caused some shuttering of aluminum and zinc smelters, causing problems in metals.
Jeff, on the podcast, “It’s not that the coal price led to higher aluminum prices. What it was, was a lack of coal led to a shutdown of aluminum smelting and against strong demand that drove up the price of aluminum, which then feeds into more demand for copper as a substitute against aluminum. So, you know, you can think about it as being, you know, the supply chain, you know, working along that way. So it’s not that the cost of, you know, energy is driving the cost of everything. It’s demand pulling everything along.”
Source: Joe Weisenthal and Tracy Alloway of Odd Lots Podcast
Who Inflation is Hurting
Inflation will undoubtedly be a hot-button issue over the next year as we approach the mid-term elections, especially if it remains elevated.
For the bottom 20%, food, shelter, transportation, and medical care account for about 80% of their budget. For the top 20%, it is about 65% of their budget. The inflation we are seeing is hurting the poorer segments the most.
However, we need to add a lot of context to this fact. The new Child Tax Credit and stimulus checks will more than offset the rising costs for families in the bottom 20% of the income distribution this year. Adding this to the fact that many low-income workers have seen a disproportionate bulk of the aggregate pay raises this year.
It is also important to note that “inflation” can be overly broad, as we don’t all have the same shopping list, especially regarding income demographics. Claudia Sahm points out in her blog that the lowest 20% of income accounts for only 11% of spending on food and alcohol compared to 33% for the top 20%. The top 20% spends $1,000 on eating and drinking, almost three times as the bottom. The top 20% is undoubtedly paying the bulk of the higher prices.
The point is that the CPI line item political pundits like to point at is not entirely indicative of socioeconomic groups’ economic well-being. The problem is trying to get that point across in small sound bites when people are always trying to talk over one another.
Sources: BLS, Stay-at-Home Macro
Inflation is not going higher because of the Fed or stimulus checks, and US domestic policies do not cause a global supply chain crisis. The Fed, or any government entity, can’t do much about a commodity rally and a supply-chain-bottleneck bout of inflation.
This bout of inflation is an issue caused by shifting consumption and a lack of resiliency in the supply chain. In fact, if the fed were to raise interest rates right now, it might very well choke off capital needed to expand the supply chain, making inflation worse.
Inflation is way more complicated than many pundits suggest, and some casual research reveals how faulty some causal assumptions are. The Fed and administration (past or present) are not causing broad-based global inflation.
Years of underinvestment in supply chain resiliency and capacity expansion had left the world in a precarious place. When the pandemic hit, consumers had their budgets freed up from services and titled heavily towards goods. The shift in consumer behavior caught producers off guard, causing a strained supply chain to break.