We are rapidly reaching the moment when leaders of democratically elected governments will realize that the electorate really cares about one thing more than any other: their standard of living. After all the cultural wars in the US, UK, France, India, Australia even, the bottom line will be delivering succour from this global inflationary surge before the electorate responds with its own stinger- electoral defeats. Australia has already witnessed a change of direction with their Labour government. Who’ll be next? More importantly: what can they do to bring down this inflationary hydra soon?
I refer to inflation as a Hydra because it seems to have many heads, and this is key to breaking down what can be done to tame it. There’s the Russia-Ukraine War which has caused spikes in food, oil, energy and metals prices; there are the Chinese Covid Lockdowns which have exacerbated the supply chain issues which have led to shortages and consequent price hikes, there is the matter of Record Corporate Profits in the petroleum, shipping and energy businesses which point to unwarranted price hikes over and above a justifiable explanation of rising input costs; and finally, there is the matter of rising wage demands by workforces to offset the rising inflation seen by the working class. Naturally, the calls from leaders in the US and UK have been to tell the workers to demand less wage hikes. Meanwhile, there are calls from the left-wing of the political spectrum for imposing ‘Windfall’ Taxes on unusually high corporate profits made during the pandemic era and the UK has already announced a 25% windfall tax on oil and gas firms that would raise GBP 5 billion for the government. This could be a template for other governments to also target companies that raised prices to take advantage of the inflationary environment rather than because of it.
The fallout of the Russia-Ukraine War will be harder to manage because of their criticality to overall output. Even if the oil shortage- which really isn’t an oil shortage, can be managed the real crisis to the globe is the food shortages that could arise thanks to the blockading of Ukrainian ports. The oil shortage is manageable and artificial. There is the same amount of oil production as before: some of it is just going to select buyers- mainly China and India. So, their demand from the rest of the world falls correspondingly. Furthermore, US shale companies are back at a point where their output becomes profitable. The US is producing more oil under Biden than under Trump. The US has also allowed Venezuela to supply oil to Europe despite the US sanctions placed on the Latin American country. But there is no clear substitute for the lack of grain reaching North Africa and the Middle East from Ukraine. If, as some commentators are suggesting, this is part of Putin’s policy to create a wave of economic migrants fleeing food shortages flooding into Europe and creating political instability then there is little that be done except recognize this possibility and redirect surplus production (from Australia and Canada if not from India) to ensuring that a situation like Sri Lanka does not arise.
The Chinese Covid lockdown is another exogenous element that cannot be controlled from the outside. Currently, there are measures being undertaken to reduce and replace the reliance on China as the world’s manufacturing hub. To that extent, countries from Vietnam, Bangladesh, India are all looking to eat into the pie that China baked. Moreover, the US is looking to ‘reshore’ essential component manufacture- such as Semiconductor Chips but this will not alleviate the problem until well into the second half of this year. The Chinese strict adherence to their Zero Covid policy may bear fruit in helping it keep its infection rates low, but it is damaging its own economic growth in both the short and medium term. The results from shifting production centres away from China and closer to home or in different locations will pay dividends only in the medium term for the rest of the globe; the fastest way to remove this cause of inflation is for China itself to raise the restrictions as early as possible and resume full scale production and exports.
The financial markets have arrived at a few fundamental realizations: firstly, that the persistence of inflation will impact global growth and that governments are frightened of the prospect of stagflation- high inflation and low to zero growth. This means that they are committed to the path of high rates and tighter liquidity. This applies equally to the UK, Europe, India as much as to the United States. The US has begun its well-publicised taper of liquidity, but Europe will also have a run-off of EUR 500 billion by year-end. India has committed to remove excess liquidity by August. All of this will help drain the puss that makes this bout of inflation so sticky. This is why the Japanese Yen is faring so poorly: they committed themselves to continue pumping liquidity into the system. The draining of liquidity is also answering another question: what was holding cryptocurrencies up? It was initially thought to be a hedge against inflation but that isn’t turning out to be true at all. It was really just a hedge against excess liquidity or, more accurately, institutions used the excess liquidity to invest in something of limited supply. Now that the excess liquidity is being drained, cryptos are going down the same drain.
The financial markets are responding to the fact that there may be no Fed ‘Put’ this time around. Electorates are tiring of the bailouts and lifelines constantly offered to the markets in crisis after crisis. This time the pain is affecting them directly and the political czars are having to take heed of the likelihood of the potential fallout. The UK government has offered GBP 15 billion in subsidy towards household energy bills- part funded by the windfall tax. There are increasing predictions that the world is headed towards a recession by next year. If this is coupled with runaway inflation and possible continuing food shortages, then the nature of problems confronting governments may be far more existential than anything they’ve faced in decades. That is the true sting in the tail.