Inflation Rising

The stories of supply chain disruptions are many and diverse; food, gas, shelter, silicon chips, electricity, building materials, and the list goes on.

The end market results are situations where consumers are not able to go out and buy what they want, when they want it. In turn, the growth in the economy is slowing even though demand is still present.

This is new territory for most of us living in North America. Even the poorer segments of our society are used to being able to go to the store and find the things they need on demand.

The question I put forward today is: Are these bottlenecks temporary or are they a sign of things to come for the longer term?

My guess is that lack of supply in many areas of the economy is going to stick with us longer than most economists care to admit.

The present economic slowdown is not happening because of lack of demand. It is being triggered by lack of supply.

The chart above depicts the Citi Economic Surprise index, updated to September 22^nd.

The most recent sharp decline is largely driven by the weak car sales data.

It clearly is not the case where the number of purchasers looking for cars has declined. There are simply not enough cars available to fill demand.

I’m going to share with you two themes that are derived from the problems the supply chain disruptions cause:

1. Interest rates rise in response to inflation, yet the economic data is sluggish due to the inability to carry on business without the supply chains intact.

This is an incredibly challenging problem at the best of times, but it is a nearly impossible problem when the past 40 years has been made with artificial demand solutions enabled by monetary policy.

The downturns of 1987-88, 1998, 2001, 2008 and 2020, were all deflationary shocks, of varying degrees, that the central banks rode to the rescue in, by infusing ever larger amounts of capital at lower and lower interest costs.

Now, however, the problem is not a demand problem, it is a supply problem.

Here is a question for you to consider: We know the Fed can print money to create demand but how does the Fed print a barrel of oil, a pound of copper, or a bag of potatoes to increase supply?

Doesn’t work does it?

You can print the money needed to buy all of those things when their supply is greater than the demand to buy them, and that’s exactly what the central banks did in all those years listed above.

This time it is the other way around, and presents an entirely new problem for central banks.

2. The supply chain shortages are global in nature and are no longer “transitory” in terms of duration.

Bank of America Merrill estimates “shortages in many areas could last out through the end of 2022. And now a new problem is compounding the supply chain disruptions. Fearing manufacturing and shipping delays, firms are pre-ordering goods for the holiday season and attempting to stock up inventories in the face of a supply shock.”

Buying all of the inventory available to “stock up” is not going to help the situation one bit in coming months.

The natural result of points one and two, are rising interest rates against the backdrop of a sluggish economy.

To keep this short and relatively easy to understand, I’ll leave you with one more thought:

The central banks go-to plan of printing money and lowering interest rates is not only ineffective against a supply-side economic problem, they actually exacerbate the problem by creating more demand to compete for the limited supply.

For example, if there are not enough silicon chips to build the number of vehicles to meet present demand, but the central banks leave interest rates at zero and the government issues financial incentives to spend, the deficit inventory of vehicles will grow, not shrink.

You have to go back to the 1970s, to get a whiff of how the present supply-side challenges may have to be handled. It took much higher interest rates to finally tackle inflation to the mat.

Higher interest rates in the indebted world of 2021, are not an option, and someone with a paygrade higher than a retail investment advisor in Nanaimo, is going to have to come up with a new solution.

Each day I watch the financial news to see if those in power are even identifying the correct problem yet. The talk of “trillion dollar stimulus programs,” and “more QE,” tells me they don’t have a clue where to start.

We continue to watch carefully.

As always, your feedback is always appreciated, and ask that you please reach out if you would like to set a time to chat.