Is it a supply chain problem or the Fed’s problem?
It seems that everybody is talking about supply chain problems: from wars in Ukraine to Covid-19 outbreaks in China. It seems the fault always lies in so-called “autocratic” side of the world. But is it really?
To understand this issue, we need to divide the possible explanations of the inflation into two categories: one possibility is that world’s supply is diminishing (a.k.a. Supply Push) and the other possibility is that the world’s demand is increasing (a.k.a. Demand Pull).
On the supply side, wars in Ukraine decreases the aggregated supply in Ukraine for sure, but definitely not the supply in Russia. Most of the Russian supply is merely redirected - to China, India, Vietnam and other developing nations, potentially stabilized the prices in the global south. Russia’s economy is expected to grow 3.7% in Q1 2022 (not verified yet). Covid-19 pandemic halted certain regions in China creating societal pressures in some cities in eastern China, destroying newly rebounded service economy, but the manufacturing output has largely remain intact, which does not contributing to much of the “supply chain” issue that every mainstream media and CEO is talking about (or blaming their problems on).
But people in many developing countries are demanding the change of government due to skyrocketing inflation - something must be wrong, right?
Yes. Let’s look at the demand side of the equation. During the pandemic, the Fed printed large sum of, trillions of dollars of, helicopter money - money that goes directly to American citizens’ pockets. The money goes into two places: personal spending and stock market speculation which in turn becomes business spending. Trillions of dollars, coupled with near-zero interest rates, exponentially increased the aggregate demand of the U.S. - the largest economy in the world, sucking up world’s resources including food and commodities from all over the world onto the U.S. soil. This sudden increase in world’s aggregate demand hit the supply chain like a shock wave - stretching waiting lines in Los Angeles port miles after miles and jacking up American wages like never before. The latter became all the talking points of the Biden administration.
But there’s a catch. Demand-pull inflation will bump wages in the absence of productivity growth. By adopting this method of fighting the pandemic, U.S. further pushes up the price of U.S. produced goods without quality improvements. That is why you see the headline number from yesterday that U.S. GDP contracted by 1.4%, driven by a 3.2% net export contraction.
What’s next? The Fed will likely continue tapering and aggressive rate hikes, resulting in international capital flow back to the U.S. promoting U.S. dollar strength and reduce U.S. aggregate demand. This definitely solves the demand issue but clearly won’t solve the negative trade balance issue in short term. We are not professional economists on U.S. economy and stock-listed corporations but we believe they will likely face strong headwinds in the coming quarters for this reason.
What about the rest of the world? Like what we discussed in the last episode, many country will face scarcity in food and commodities, resulting in political upheavals all around the world. Especially for those countries running a non-internationalized currency, and, at the same time, runs net trade deficits, a dump in local currency, a stronger dollar and the sudden increase of U.S. purchasing power will outbid the people in those countries, leaving them with no food to eat.
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