The decline of the most acute stage of the pandemic is placing economic systems at the forefront of one of Milton Friedman’s postulates: “inflation is only a monetary phenomenon.” After months of confinement and compressed incomes, consumption skyrocketed to a level that could not be supported by the supply chains , they ran out of oxygen, and thus created the breeding ground for the highest inflation in decades in the developed economies.
The United States, the world’s leading economy, is one of the best examples of this. The Bureau of Labor Statistics of that country (BLS, for its acronym in English) reported that at the end of January the annualized price index rose to 7.5%, the highest level recorded since February 1982. Another data that reflects the persistence of this phenomenon that is going through the world economy is the subjacent inflation in that country, which in January increased more than half a percentage point (0.6%) for the seventh time in the last ten months.
In the case of the North American nation, the monetary mass has increased due to the stimuli of the federal government to reduce the effects of the pandemic, including the increase in wages that during 2021 increased at the fastest rate in two decades. The data in this regard are more than eloquent, between February 2020 and December 2021, the total monetary base soared 85.6%, indicate data from the Board of Governors of the United States Federal Reserve System reported by the Bank of the St. Louis Federal Reserve .
The monetary expansion, together with the aforementioned disruptions in the supply chains, is creating an imbalance between supply and demand, the consequence of which is being reflected in prices and is expected to be so, at least for the next semester, and that may lessen towards the end of the year.
In January, the International Monetary Fund (IMF) increased the expectation it had in October about inflation in the world for this 2022. For the IMF, the advanced economies will experience an advance in the price index of 3.9%, while for the emerging markets the projection is 5.9%, to finally be controlled in 2023.
As the imbalances between supply and demand are corrected, and central banks adjust their monetary policy throughout 2022, the rise in prices will subside, estimates the IMF. Meanwhile, the problems in the supply chains, the rise in the price of energy and the restrictions that still exist due to the persistence of COVID-19 (especially in emerging economies) will serve as fuel for inflation in the world .
Likewise, once the developed countries increase their interest rates, risks to financial stability, the flow of capital in emerging markets, their exchange rates, as well as fiscal policies may increase. “Many countries will need to maintain a tight monetary policy to curb inflationary pressures. While fiscal policy, more limited than at the start of the pandemic, should prioritize spending on health and social support for those most affected,” the IMF said in January in its World Economic Outlook update for 2022.
Jerome Powell, president of the United States Federal Reserve, has already announced that in March they will begin to tighten monetary policy, and in total at least three rate increases are expected in 2022. Emerging nations such as Mexico have already responded to pressure on their prices, and at the beginning of February the Bank of Mexico (Banxico) raised its reference rate to 6%, which is the second increase in less than two months, and the fourth in the last year. However, the price index is at its highest point in a decade in that country.
In order to avoid negative effects on the financial systems, it is essential that the monetary authorities clearly communicate the transition to a more restricted stance, so that there are no disturbances in the markets. Probably for this reason, since December Powell has stated the intentions of the FED for this 2022.
However, in those economies that have not yet recovered from the effects of the pandemic, monetary policy can remain accommodative, without neglecting the behavior of inflation and the risks that are seen in the short term. Special attention should be given to developing countries with a high percentage of their debt in foreign currency, as well as high financing needs; therefore, they must prepare for possible turbulence in the markets, by refinancing in their maturities and containing discrepancies in the values of the currencies.
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Why Is There Inflation?
With the pandemic, the world economy was practically paralyzed, and with it a good part of spending by consumers. With the opening that has been taking place, thanks to advances in vaccination, consumption has returned, but supply has not recovered in the same way.
After years of very low inflation, the economy quickly opened up, restaurant dining, travel, social and sporting events resumed, and some of the spending pent up during the onset of the pandemic began to come into effect. With the difficulties in supply chains, companies still have problems to meet this sudden increase in demand.
There have been problems such as the shortage of merchandise containers, which makes their transportation more complex and costly. The pandemic has also affected the type of goods that are in demand, a clear example is the interest of people in goods for home remodeling, adoption of the home office or homeschooling , or electronic devices to make staying at home more comfortable, everyone is required at a level that was not anticipated, the demand cannot be satisfied and, therefore, prices rise. Another well-known example is that of semiconductors, demanded by various industries, including the automotive, electronics, and even electrical industries.
While the European Central Bank is optimistic that the balance in supply chains will come sooner rather than later, the IMF is more cautious about their evolution, but companies see it as a problem that will take much longer to resolve.
According to a survey conducted by the technology company Coupa Software of more than 600 supply chain leaders in companies in the United States, United Kingdom, France and Germany, 91% of those consulted consider that problems in supply chains they are a long-term challenge that will continue to weigh on revenue through at least the first half of 2022.
After seeing the consequences that the pandemic was leaving on the economic systems, “bottlenecks” were expected in the supply chains , but not at the level that they have experienced. These problems have resulted in shortages of raw materials, increases in operating expenses, delays and cancellations of projects, in addition to the aforementioned consequences on price indices around the world.
Although the persistence of this problem is being paid for by the final consumer in the form of inflation, retailers are also suffering the consequences. The aforementioned survey indicates that retailers anticipate revenue losses of between 5% and 20% in the last 18 months, caused by problems in the supply and distribution of their products.
More than half of those consulted foresee losses of more than 5%, while 26% expect losses of more than 10%. Finally, 5% of those surveyed (approximately 30 companies) estimate that their revenue losses will exceed 20%.
One of the reasons that leads these companies to anticipate that the situation, as well as its impact on income, will not be resolved in the short term is that the increase in demand occurred before the pandemic ended; therefore, restrictions related to the health contingency were maintained. Specifically, at ports, manufacturing facilities and distribution centers, operations have not returned to normal to respond to the sudden demand.
To meet this boom in demand, it is necessary to increase the maximum load capacity of the system (production and logistics), for which investments, time and state-of-the-art technology are necessary to improve logistics systems so that they can anticipate peaks and distribute the flow in the orders.
But companies have not been passive. According to JP Morgan Chase in a perspective survey of small and medium business leaders, companies have made changes in their business models to face the challenges that have been presented in the supply chain.
To alleviate supply chain disruptions , 65% of midsize companies have drawn on their strategic inventories, and 51% have added suppliers from new geographies. While 48% have also allocated more funds to cover increases related to the mobilization of their products or supplies, 32% have changed materials or their manufacturing processes; finally 30% have been forced to take more drastic measures, such as replacing or stopping business with certain suppliers.
For JP Morgan, the worst of the supply chain bottlenecks are probably behind us. It even reports that several consumer goods and technology companies already reported on standardization and distribution capacity at the end of last year. However, the threat that new variants of COVID-19, such as Omicron or others, may appear in the coming months remains latent.
Energy For Inflation
The last element to take into account when evaluating the current behavior of the world economy is the price of energy commodities . Oil, for example, has risen more than 50% in the last year to close to 100 dollars per barrel; Twelve months ago, North Sea Brent crude was trading slightly above $60 per barrel, while during the second week of February 2022 it was as high as $97 per barrel.
The prices of oil, gas and electricity are responsible for approximately half of the inflation in the world at the moment, so the fluctuation in them is key to understanding the behavior of the price indices.
And, although the volatility in the prices of energy raw materials is no secret to anyone, they are currently at their highest level in more than seven years. The already mentioned increase in demand, coupled with climatic factors, came together for the rebound that has been seen in the value of energy.
From the climatic point of view, last year the winter in the northern hemisphere was particularly cold, which led to the use of natural gas and oil reserves. In the United Kingdom the few winds paralyzed the wind power producing mills; and in Brazil the drought affected the generation of hydroelectric plants. In these last two cases, they are clean energy sources that have not been able to form part of the energy supply, which is why even more pressure has been placed on the demand for fossil fuels.
The bad news for consumers is that the outlook is for fuel prices to remain high for geopolitical and economic reasons. Isabel Schnabel , a member of the Executive Committee of the European Central Bank, argued at a meeting earlier this year that the combination of insufficient renewable energy production capacity in the short term, investments in fossil fuels, as well as the increase in the prices of such raw materials, raise the risk that the transition to renewable and less expensive energies will be more prolonged.
In addition, the rise in carbon prices encourages investments in it, which in turn continues to impact the climate whose stability is necessary for electricity based on renewable energies to flourish. If this stability does not exist, episodes such as the droughts in Brazil or the few winds in the United Kingdom may be more common, discouraging investments in these types of green energies and maintaining dependence on the volatility of carbon.
Finally, another factor that directly affects fuel prices is the geopolitical tension between Russia and the countries of the North Atlantic Treaty Organization (NATO), and the possible invasion of Ukraine by the former. A war in Europe would drive fuel prices even higher, gasoline would continue to fuel inflation in the world , and the recovery in the world economy would be threatened.
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