Global food prices jumped by 40% in May, the
biggest jump in a decade. The year-on-year rise in the Food and Agriculture
price index was the largest since 2011 and might be signaling that inflation which was
initially stoked by pandemic disruption is accelerating. The cost of used cars and trucks jumped 10
per cent month-on-month in April, and prices were up up 21 per cent over a year earlier,
making it one of the main drivers of the 4.2% year-on-year surge in the consumer price index. Core inflation, which is inflation excluding
food and energy prices, hit 3 per cent. Adding to the confusion is the fact that Inflation
is measured using a basket of goods and services which is meant to represent what people typically
purchase. As the pandemic took hold, people stopped
spending on certain items, started spending on others, meaning that the official calculation
of the consumer price index underestimated the price changes the population experienced
in their day-to-day lives over the last year. If you look around, you can see all sorts
of prices soaring. The price of lumber has taken off and of course,
the internet has taken notice. “Not even one police escort,” a Twitter
user commented showing a photo of a lumber truck driving down the highway. Another showed a photo of a pile of lumber
in a doorway, remarking, “Wow, neighbors just casually flaunting their wealth in the
hallway.” Over the year we have seen a string of surprising
shortages and unusual price activity. There was the great run on toilet paper, negative
oil prices, the crypto bull market, meme stock short squeezes and even the $100 million dollar
deli in New Jersey. We are seeing price spikes in wages too, but
it is not yet clear how that will work out. U.S. labor market signals are conflicting
to an "unprecedented" degree according to the San Francisco Fed, who published a paper
this week looking at 26 labor market measures that typically move in tandem that are now
giving wildly divergent signals about the health of the job market during this recovery. The job openings rate, suggests that employers
are struggling to hire even as the economy still has 7.6 million fewer people working
than before the pandemic. The U.S. unemployment rate was 5.8% in May,
bringing it below 6 per cent for the first time since the start of the pandemic. A number of good explanations exist for the
labor shortages. They include enhanced unemployment benefits
that might provide a financial disincentive to take low-wage jobs, closed schools and
a lack of child-care availability keeping parents home, and of course an ongoing fear
of catching Covid-19. While many economists agree that the inflationary
pressures are likely to be temporary, they also acknowledge that uncertainty over the
economic outlook is huge; as the pandemic recedes, consumers are flush with savings
and government payments while supply chains are strained by bottlenecks. We are seeing a level of stimulus that is
unprecedented in the last 50 years, plus other forms of support for spending. A lot of the commodity inflation that we are
seeing right now relates to supply chain disruptions. Let’s use the lumber market as an example. Timber and lumber are different things: Timber
is the raw wood from the forest; lumber is the manufactured finished good, it’s been
cut to size, dried and it is ready for use, like what you’d buy at Home Depot. There are plenty of trees, but, someone needs
to cut down the trees, transport them to a sawmill and process them into a finished product. The lumber industry had been struggling since
the housing crash of 2007. After twelve bad years, many sawmills shut
down or cut back their output. 2019 was a terrible year for the industry
and they were in no way prepared for a sudden surge in demand. The same boredom and extra cash that inspired
some people to start day trading inspired others to fix their homes, or to build new
ones. The lumber industry was prepared for a slowdown,
but instead saw a huge surge in demand. This trend helped drive great sales numbers
at home improvement stores. Finding lumber workers was a challenge during
the pandemic, not only because of Covid-related restrictions and safety measures but also
because a lot of people didn’t want to work those types of jobs. The extra $300 a week that has been added
to unemployment benefits until September 6, may be a factor — though, of course, sawmills
right now are making so much money that they can afford to pay workers more and lure them
back. The whole lumber supply chain is tight, from
the trucks and railcars moving materials, to lumber yard and sawmill workers, to the
logs themselves. A new sawmill today is a $100 million investment
and takes two years to build. This is why, in the world of commodities,
supply always lags demand. No one wants to make a $100 million investment
only to see prices revert to their old levels by the time the new facility comes online. Producers have to see sustained demand before
making an investment like that. Many of those who weren’t busy fixing up
their homes went looking for new ones. And where they couldn’t find preexisting
homes, they started to build. Residential housing starts — a metric of
when new construction projects start — have consistently climbed, hitting rates not seen
since before the credit crunch. The hot housing market helped heat up the
lumber market, which in turn, made new home prices higher. The spike in lumber prices added around $36,000
to the price of an average newly built American home according to the National Association
of Home Builders. Toll Brothers, one of the largest publicly
traded homebuilders said on its recent earnings call that they are delaying putting new homes
for sale until they're 50% built, in part so that they don't commit to a price only
to have their costs explode while they're in the process of building the homes. While some people have pointed to lumber prices
as a sign of increasing inflation and a sign that the economy is overheating, there’s
really not much that the Federal Reserve can do about these prices. Increasing interest rates, might discourage
people from building homes, but it might also deter lumber producers from making the investments
to up their sawmill capacity. We are seeing similar dynamics in the auto
industry, which is constrained by a shortage of semiconductors needed to build modern cars. Automobile inventories hit a record low in
March, as buyers snapped up all of the new vehicles while manufacturers struggle to get
the semiconductors they need to produce more. Used-vehicle prices have surged, suggesting
that conditions have not yet eased, and rental car companies started buying used cars at
auction as they couldn’t get the new cars they need to rent out. Automakers will sell fewer vehicles in the
second quarter than they would if they had the vehicles to sell, but just like with housing,
all this means is that those vehicles will eventually be sold later, whether it's in
the second half of 2021 or sometime in 2022. While good data is available for housing and
cars, there's reason to believe that this is an economy-wide dynamic. In the first quarter of the year, low inventories
trimmed 2.6% from real economic growth. Depending upon how long it takes supply chains
to ramp up and how long demand stays strong, it could take until 2022 for industries to
have time to restock their shelves. There might even be a bit of an overcorrection,
where companies decide to keep more inventory on hand than they did before the pandemic
— at least for key components that might be harder to source. Supply chain problems can be seen wherever
you look right now. An obvious example is the number of ships
at anchor in the waters off the coast of Los Angeles. The Port of Los Angeles recently began disclosing
the number of days specific container ships are spending at anchor. The numbers show that some vessels are spending
almost as much time at anchor as it takes to cross the Pacific Ocean from China. A year ago, there were occasional holdups,
but nothing like this. Some of the reason for this, is that people
have been doing more online shopping than ever before and container traffic into the
United States has increased almost 50%. At the same time, dock workers have been out
sick a lot or in quarantine due to the pandemic. A friend messaged me back in March to say
that after years of reading about credit derivatives, cryptocurrencies, reddit short squeezes and
other confusing financial news, it was refreshing to see that global commerce is now in peril
because a big boat got stuck in a canal. To a certain extent some of the inflation
we are seeing right now is driven by similar issues. What we have seen in the lumber market, where
producers were not set up for a huge surge in demand might shortly appear in other industries
in the coming months as the economy bounces back. Oil wells and pipelines which were shut down
a year ago will need to be reopened which is not as easy task as it sounds. Commitments for the transportation of oil
are typically arranged more than a month in advance. Many mineral rights leases in the United States
are lost by the operator if production is shut down for 90 days, meaning that there
could be legal issues around the re starting of existing oil wells. Some good oil wells once shut in for a year
will be very difficult if not impossible to bring back into production, wax and other
constituents begin separating out, bacteria begins to grow, water and sand get into the
well, some of these wells will be beyond repair. Oil producers have struggled over the last
decade, their drilling equipment is old and in rough shape. They will have to invest in new drilling equipment,
which may take a year to build in order to bring new supply to the market. While there are signs of inflation everywhere,
a lot of it is due to supply chain disruptions. If you look at the consumer price index and
its components, you are seeing inflation in automobiles, airlines, hotel rooms, exactly
what would be expected in a re-opening economy. I guess we’ve learned that it is easier
to shut down than to re-open an economy. Other things are causing inflation too, it
is not just supply chain disruptions. A lot of people suffered economically over
the last year, but many others saw their savings grow. They saved money on their commute, on clothes
and didn’t get to go on holiday. Now that the economy is reopening they are
willing to spend these savings to enjoy themselves, even if that involves occasionally overpaying,
but that is a temporary effect. We’ve never had a coordinated global recession
like this, where every country is affected all at once and then recovers all at once
too. Central banks are better prepared to deal
with more standard economic slowdowns. The transmission of monetary policy depends
to a large extent on the housing cycle. This is because residential property prices
are important determinants of banks’ willingness to lend. Central banks typically stimulate the economy
during an economic slowdown and then cut the stimulus as the economy strengthens. Right now economies are recovering from a
shock that was not economic in nature, and they are recovering very rapidly as vaccinations
are rolled out. Congress and the Fed worked together to combat
the negative economic effects of the pandemic with an unprecedented mix of fiscal spending,
near-zero interest rates and subsidized loan programs. Those efforts, designed to help businesses,
keep workers on payrolls and ease the impact of layoffs, kept consumer spending afloat,
but, critics argue that “printing money” to juice the economy may backfire and cause
inflation. Right now, banks are filled with reserves
that could, in time, flow into the economy through credit and loans. While an expanded money supply could set the
stage for inflation, the relationship between M2 money supply and inflation has been questioned
over the years. After the global financial crisis, rates were
very low and central bank balance sheets (and money creation) surged. But the added liquidity just sat in the banking
system. The rate at which money is exchanged in an
economy is known as the velocity of money, this can slow during recessions as corporations
and families elect to save more of each dollar they earn. Money creation needs to translate into increased
lending and spending in order for it to be inflationary. If businesses and customers aren’t inclined
to spend the additional dollars, the cash just sits idle, not contributing to GDP or
inflation. An output gap is the difference between an
economy's actual output and its maximum potential output expressed as a percentage of GDP. The output gap is closing quickly right now,
but, inflation expectations remain muted. The final possible cause of inflation is structural. According to my friend Manoj Pradhan whose
book The Great Demographic Reversal was listed as the best Economics Book of 2020 by the
Financial Times, recent demographic changes can be expected to be inflationary going forward. Manoj was one of the first economists to predict
an uptick in inflation, and argues that upward pressures on prices should be expected even
without the additional stimulus as an ageing population made up of more retirees consumes
more and produces less. More people spending and fewer people producing
is inflationary. I’ll put a link to my interview with Manoj
in the description below. A lot of the inflation that we are seeing
right now is just down to supply chain disruptions, if the federal reserve were to withdraw stimulus
because of this it would do nothing to restart oil wells, process lumber, or manufacture
new semiconductors. Central banks generally target price stability,
which they think of as an inflation rate of around 2%, they aim for low positive inflation
mostly to avoid deflation which is hugely economically destructive. Low and steady inflation also helps to grease
the wheels of a modern economy. There are some tentative signs that inflationary
pressures could be easing. Recent data releases from the housing market,
such as new and existing home sales, housing starts and building permits, have all disappointed
relative to expectations. If the housing market calms down, it would
ease some inflationary fears. In addition, the backlog of ships waiting
to offload goods in California has been cut in half from the peaks in February. We can’t paint the picture for all prices
with one broad brush. For many agricultural commodities, the story
centers on weather-related factors or a massive swell in demand. For copper, the surge in prices reflects the
global recovery and the rise of “green demand.” Markets are telling us that most commodities
are likely to see their prices moderate by year-end as supply gets back to normal and
post pandemic demand starts to cool off. September brings the end of supplemental unemployment
benefits, and the new school year will gets kids out of the house, allowing parents to
return to work. Goldman Sachs predicts core inflation will
peak at 3.6% in June, drifting down to 3.5 per cent by the end of the year and averaging
2.7 per cent in 2022. My friend Manoj thinks inflation will be a
bit higher in the 3-4% range over the next few years. If you want to hear his thoughts in greater
detail here is a link. See you guys later bye.
