As stock markets continue to plunge and inflation forces central banks to keep hiking rates, China’s extended lockdown threatens yet another round of supply chain issues and Russia’s invasion of Ukraine keeps oil, gas, wheat, and nickel prices artificially high we must ask ourselves: not whether we are in a perfect storm or not but on how far through it we’ve gone and how much further we have yet to go.
If we want to know how far into the storm we are we need to know when we entered it. Precise dating is problematic because it seems more like a train wreck in the making: that is, people still do not see the economic storm even as it has hit. Many economies are still growing- recession hasn’t hit yet, inflationary pressure still is in the tolerable region of single digits, jobs are not being lost and demand has not collapsed. So, what indeed is the storm about at all? Isn’t the storm- in its current form, just a financial markets storm? No. The storm is more about the set of circumstances that are occurring in the real world that is vastly different to the events of the last two decades or more and will cause damage down the line. And the difference between this crisis and the others that preceded it gives us a clue as to when it started: that difference is inflation.
As stated in earlier articles the monetary and fiscal tools that were regularly followed to address earlier hiccups in the economy have been neutralised in this one- because the hiccup in this one is inflation. That is to say; inflation is running through the global system currently and central bankers are finding their hands tied in dealing with it because the drivers behind it are exogenous shocks which they cannot influence with monetary or fiscal measures. They can only use interest rates to curb demand and slow down economic growth just when they need the world to grow to recover from 2 years of disrupted production. The exogenous shocks have been enumerated right at the start of this article. None of them are affected directly by rising interest rates. They only get affected by killing the demand for the products by making borrowing for manufacture or purchase (either for production or consumption) more expensive.
Fig. 1: Global inflation 2016-2021
Source: statista.com
Inflation has been eating into the system now for a year or more. Price rises in commodities (particularly metals) have been masked by the subdued demand of a world in economic recovery mode. Many service industries have only just started to recover to pre-Covid levels. Supply chain delays caused by shipping holdups (particularly between China and the West Coast of the US) added to massively elevated freight costs (10 times the normal rates) and this was expected to feed through into landed costs. Again, this has been in the pipeline for over a year now. But the numbers became concerning mid 2021 when the inflation prints suddenly shot upwards as agriculture and commodity prices started getting overheated; it started spilling over into the retail end as companies both responded to rising input costs as well as took advantage of inflation to hike up prices (as one can see from record profit numbers being reported in earning season).
The rising incidences of countries falling into debt traps globally is going to be one of the consequences of the fight against inflation. One country has already fallen victim to it: Sri Lanka. And it is unlikely that it will be the last. It may be the canary in the coalmine as many less developed economies struggle with the rising cost of debt, the rising cost of food and energy and recovery from pandemic battered economies. And the economic weapon they have wielded to counter struggling economies- lower interest rates, are ineffective and even counter-productive in this environment. And the UN has said that, out of 107 countries facing one or another of these external shocks 69 were facing all three.
And it isn’t just that the damage will be limited to financial markets and less developed economies: the US just recorded negative GDP growth for the last Quarter on Quarter (at -1.4%). Another consecutive quarter of negative growth and this signals a recession. The UK is expected to go into recession by this summer by economists- pushed into it by rising energy costs subduing consumption spends. The fact that they’ve hampered themselves through an ill-thought-out exit from the EU will only make their recovery more painful and slow.
Even China, not suffering from the need to raise rates but critical for overall world growth, is finding itself caught between their zero tolerance to Covid and the need to let the economy grow. This could have been a saving grace for a struggling world but instead is yet another lame leg. We have not even considered the calamitous effect that climate warming is causing in many parts of the world. Between the heatwave in India and parts of the US (Texas mainly) food crops are being affected. India thought itself immune to the rising wheat prices globally because it is a surplus producer. It thought wrong as production has fallen sharply this year. And India, along with Brazil, Turkey and many others are finding inflation harder to deal with than they anticipated.
How far into the perfect storm are we? It’s difficult to assess at this point. Markets will not be as helpful in assessing risk as in earlier times because most market participants have no experience of being in a market situation with rising inflation tying the hands of the financial authorities. Neither have we seen a global meltdown on so many fronts before. Most countries took on massive debt to counter the effects of lockdowns and stalled production. Inflation has now started raising their borrowing costs. The Russian invasion of Ukraine has thrown a match into dry tinder and the whole world is feeling the heatwave from it. The solutions need Russia to withdraw from Ukraine and immediate efforts be made to help them recover agricultural production immediately. Oil prices need to fall in line with reduced risk and boosted supply (Venezuela and Iran?) and China needs to end lockdowns and restart normal production and shipping schedules and levels. Otherwise, this storm could persist for a lot longer.