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.