“A narrative about the world is always a tool – a rough map with which to navigate the complex territory of reality. But the map cannot be mistaken for the territory: if that happens you get stuck in your story, and the story – rather than the reality it points to – begins to dictate your actions.” – Paul Kingsworth
The “transitory” narrative about inflation melted along with the Spring thaw. It had been preceded by “supply chain issues” and has recently settled on Russia’s invasion into Ukraine. Unfortunately for those mindlessly repeating the latest explanation, the facts don’t quite sync up. Below is a table that illustrates the components of inflation. Putin invaded Ukraine on February 24th of this year (the last month in the table). It is clear that cost increases were in play well before then. What is interesting is that energy (light green bar) was actually a net deflator of prices until February of 2021 along with transportation related expenses (dark purple bar). Beginning in March of 2021, prices in all major areas of our economy were on the rise, including energy, which flipped dramatically in the first quarter of last year.
So if Vlad is not to blame for the genesis of price increases, what was the root cause? Five Trillion Dollars.
That is the amount of new money that was created in the US to “fight Covid” (it is estimated that a third of the dollars currently in circulation in the US were printed in the past 24 months). At the same time, a significant amount of goods and services available was taken offline, and many have failed to return. In Economics 101 you learn about the supply demand curve. When demand outstrips supply prices increase until the point at which prices get so high that demand falls and equilibrium is re-established.
I’m not going to weigh in here on the immediate and tragic consequences of the war started by Vladimir Putin. The humanitarian toll and the destruction of capital are almost beyond belief. It seems every day the images coming from Ukraine are more horrifying than the day before. God help the Ukrainian people.
The irony of the “Putinflation” narrative, is that although it completely misses the mark in explaining the current inflation, it goes a long way in explaining the coming onslaught.
As we are all learning, Russia and Ukraine had provided substantial raw materials for our modern world. Russia had supplied 12% of the worlds oil production. It is also an important provider of iron ore, copper, and nickel. Ukraine is was one of the largest grain suppliers (corn, wheat, seed oils) for global consumption. The disruption of these inputs from the supply chain will be felt in dramatic and long-lasting ways.
With the exit of international companies from Russia (more than 1200 at last count), and the embargo on Russian oil, Russia is rapidly heading toward collapse. The impact of this, however, will not be isolated to Russia. As countries continue to decline to purchase Russian oil, it will begin to back up in their pipelines all the way back to the well heads. At that point, they will be faced with the potential of having to shut down these pipelines, and the oil fields that supply them. The last time this occurred was after the collapse of the Soviet Union. It took 32 years to recover to pre-shutdown production levels. China will be of no help to Russia here. The pipeline that services China is already running at capacity, and the ports that are available in Russia are all shallow water ports not allowing long range vessels capable of reaching China to access them. The net effect of removing something on the order of double-digit world oil production will be profound, as it cannot be replaced quickly by other producers.
Along with oil and raw metals Russia provides a substantial amount of grain and fertilizers. Ukraine is the “breadbasket” of Europe. Any sustained disruption in these areas will cause, at a minimum, global inflation, and at worst, famine to countries already vulnerable to food shortages – Africa, Brazil, the Middle East, and Southern Asia.
As countries, including our own, re-evaluate their supply chains, many have come to the conclusion that depending on others for critical goods and services, like medical supplies from China, or petrochemicals from countries that are considered “less than friendly,” might not be in their best interest. This, paired with dramatically increased transportation costs, has caused globalization efforts that had been building for decades to unravel at break-neck speed.
The de-coupling of supply chains and “re-shoring” of production capacity will inevitably cost everyone more. Moving from low-cost producers like China, India, Viet Nam, and Thailand will inevitably raise the cost to produce products. Additionally, countries that lack raw materials within their shores, like China, will be faced with significantly higher prices for critical inputs as countries move back toward nationalism.
All of the above suggests that the current inflation may be with us for some time. Between the excessive money printing here in the US, and the disruption of our own supply chain, the Federal Reserve will undoubtedly continue on its current path in trying to slow price increases. They announced that they will reduce their bond purchases in an effort to allow long-term interest rates to rise. The effects are already being felt. As of this writing 15-year mortgage rates are approaching 4%, up from 2.3% in January. The challenge for the folks at the Fed will be to engineer a “soft landing” – to slow inflation without causing a recession. This will call for skillful and well-timed moves. Unfortunately, their previous record on both counts is not good.
In the meantime, we continue to look for ways to protect your portfolio from the impacts of inflation, Putin’s war, and any knock-on effects of either.
Please pray for the Ukrainian and Russian people.