Since it dawned upon markets, governments and financial authorities that - after 40 years of hiding - inflation came back with a vengeance, the focus is not on the ‘why’ anymore, but on how to best deal with it.
Central banks tasked to tackle inflation face a host of nationally varying, contributing factors. Yet the tool is but one: raising interest rates. The masters of money supply are acting like the driver of a car spinning out of control on black ice, counting on little more than luck when the crash comes.
With hindsight, we can see now how it happened – how an agglomeration of diverse and unconnected scenarios has catapulted us from COVID-frozen paralysis into red-hot growth, now threatened by cardiac arrest. Having incarcerated people for almost two years, governments felt obliged to support households and corporations financially.
This produced the unique situation of an economic standstill without the usual income and revenue destruction. When the economy got into gear again, individuals and corporations had the means to consume and to produce at almost any price.
Supply bottlenecks started to emerge in every sector: materials, components, transport and labour became scarce. First we bought more goods than usual and then we wanted more of the services we had craved for so long, from restaurants to holiday trips. Consumers and corporations were outbidding each other with ever higher prices.
COVID still casts its shadow. Workers went missing while enterprises scramble for hands. Airports, trains, hospitals and restaurants as much as any other enterprise cannot operate at full capacity without people rolling up their sleeves, but the shock of illness and death has changed work attitudes. Employers which had fired people without blinking during lockdowns cannot hope for their hands to return with eagerness.
Many employees have decided to strike a path on their own, not banking on job security anymore. Many have retired early suffering long-term ailments linked to COVID and paused medical care. And too many have died. Those which are still joining the workforce are fatigued, overworked, ill-motivated and often sick.
COVID is also affecting trade in negative ways. China, the world’s major supplier of consumer merchandise and high-tech components, is still suffering lockdowns and hence transport disruptions and factory closures. Hostile trade barriers and ‘re-shoring’, the relocation of cheap production in the hope of gaining more resilience, are increasingly adding to cost pressures.
Emerging and developing economies are squeezed by similar labour deficits and increasingly by food shortages and debt pressures. In aggregate, their weakening economies have an impact. Globally, logistics and warehousing is out of kilter. While deficits are painfully felt, overstocking becomes problematic too.
As in the 1970s – the last time inflation took centre stage in developed economies – the epicentre of our current cost of living crisis is energy, closely followed by a food crisis.
The sudden halt of economic activity in 2020 had reduced energy consumption to a trickle. No planes were flying, no cars were moving and offices were shuttered. Energy producers were looking into an abyss. In spring 2020, the cost of crude oil went negative. As storage got scarce, sellers were offering money to buyers willing to take their stuff.
The sudden restart of economic activity could not be met sufficiently by both renewable and fossil energy suppliers. Our disaffirmation of oil and gas investments, motivated by the now undeniable and increasingly palpable deterioration of our climate, is not helping.
Oil and gas producers, pressured by governments and activist shareholders, were understandably hesitant to put more money into upstream production. They will fear risking new investment now when exorbitant prices could kill off future demand.
Cold-shouldering nuclear power over many decades bereaved us of a source of energy which is carbon neutral, disconnected to soaring fossil prices, and which would solve the intermittency problem of wind and solar power generation, while creating a reliable back-up facility in times of unexpected and sudden demand spikes.
The moves of the Fed are forcing the hand of other central banks- Andreas Weitzer
Our reluctance to rely on nuclear power, grounded in fear of past accidents like Three Mile Island, Chernobyl and Fukushima, made green field construction of nuclear plants prohibitively expensive and made us dependent to the only experienced engineers around, China and Russia.
Particularly grating was Germany’s decommissioning of existing nuclear plants. As a consequence and in absence of sufficient alternatives, coal has grimly returned.
High energy costs inflate the price of food. Rising fuel and feedstock prices increase the cost of manufacturing fertilisers, of operating farms and transporting soft commodities. It augments the impact of climate change on food production and makes nutrition less affordable. The consequences will be hunger, distribution battles and mass migration.
The chances to alleviate food and energy shortages were massively reduced by the war in Ukraine, which is unlikely to end any time soon. The war excludes Ukrainian and Russian farming from world markets. Imposed sanctions curtail Russian energy and non-ferrous metals exports for the foreseeable future.
To continue making enemies of nations which could ease shortages does not help. Bringing in countries like Venezuela or Iran from the cold would bring much needed relief, but is geopolitically unlikely.
In face of a worrying cost of living crisis caused by rampant inflation, fiscal restraint is politically not feasible. The electorate needs help and to deny it is heartless. This leaves central banks alone with the task to bring inflation back under control. It does this by making credit ever more expensive, thus reigning in demand and economic growth.
It is the equivalent of repairing a malfunctioning radio with the blow of a hammer. It sometimes works, but comes with the risk of disproportionate destruction.
US-centred financial analysis sees four possible outcomes: inflation comes down, and the economy muddles through well enough; inflation comes down together with the economy; inflation cannot be reigned in, and the economy stays hot; inflation remains rampant and the economy flushes down the drain.
Sadly, the action of the US central bank has consequences for all other countries too: those which depend on US demand; those which have $US-denominated debt; US creditors which may see the worth of their bonds diminished; and all importers paying for goods with ever dearer dollars.
The moves of the Fed are forcing the hand of other central banks. When interest rate differentials between their currency and the US$ widens, their yen, euros and pounds will weaken and accelerate the import of inflation. It is unfortunate and even unfair. After all, this exorbitant bout of inflation was initially caused by red-hot US demand.
Even more grating is the fact that the US, fervently supporting the war in Ukraine without seriously contemplating an exit scenario, is not feeling the cost of the sanctions imposed on Russia in the same way Europe does.
Europe, according to modest estimates, suffers imported inflation thrice as high as the US. Imported inflation, in difference to endemic inflation, is beyond the influence of central banks. This is due to Europe’s much higher trade volumes with Russia. We will have to ration gas and electricity any time soon, while the US energy and defence industry has a field day selling arms and gas.
One could argue that we should have seen the writing on the wall. Since 2004, we were co-conspirators in turning Ukraine to the West. Why we continued doubling down on Russia at the same time is hard to understand. If one wished to pick an enemy, better to prepare well.
I have admittedly misjudged Vladimir Putin’s evolution from a corrupt Saint Petersburg civil servant to a bloody revisionist too. But at least I was wondering how long we thought to get away with poking his eye. It would have been certainly more rewarding to attempt the westernisation of Russia than loftily prolonging the cold war with a smirk.
We are where we are now. Putin, the land-grabber of 2022 must not succeed, or he will continue. He cannot envision a meaningful future for his country, only an imagined past. In the meantime, the European Central Bank can only chose between unhinged inflation and economic breakdown. We should envy the US for its marginally better options.
Andreas Weitzer is an independent journalist based in Malta.
The purpose of this column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice, or advice on the buying and selling of financial products.
andreas.weitzer@timesofmalta.com