Lots of people have theories about who’s responsible for high inflation, but few have come up with ideas for how to ease the pain – and for good reason. There are so many variables that determine prices that there is not much you can do, other than create a recession, to bring inflation under control.
And we imposed high inflation on ourselves. How? Thanks to our responses to the COVID-19 pandemic.
First, governments around the world have shut down their economies due to the coronavirus outbreak. Was it wrong? The stark choice was either to risk overwhelming the healthcare system or to shut down and create significant economic distress while reducing death rates.
Governments chose to close and then decided to do everything possible to support households, businesses, religious institutions, associations, municipalities and local authorities.
As is the case with public policy, there is a risk of doing too much or not enough. Fearing a recession, governments around the world, but especially the United States, decided to do too much.
Before criticizing our politicians, remember that these massive stimulus packages were largely bipartisan.
Unfortunately, no good deed goes unpunished and the huge influx of funds has lit the flame. Large amounts of government subsidies have hit the economy, leading to a surge in demand. Meanwhile, businesses have reopened, but at a much slower pace. Result: excess demand and rising inflation.
But that was just the beginning. The conflagration we face today was the result of what followed: a flood of issues beyond the control of decision makers.
First, there was the tangled supply chain. Remember when just-in-time inventory, powered by a global supply chain, was the mantra of cost-conscious businesses? Well, it worked great until it didn’t. The US supply chain is heavily dependent on Chinese production, which has fallen.
But the global supply chain hasn’t gotten tangled up or stuck around just because China is a mess. Increased demand has created labor shortages across the economy, making it difficult to unload ships entering the United States and transport these goods to manufacturers, wholesalers and retailers across the country. Cargo ships were stacked for 30 miles, waiting to unload their cargo at the ports of Los Angeles and Long Beach alone.
Without global supply, the prices of producer and consumer goods must have skyrocketed, and they have done so in almost every industry.
Growing labor shortages have not only affected the supply chain, they have also altered the employee/employer relationship. For the first time in decades, workers had bargaining power and they used it to get higher wages. The result: Wage inflation kicked in and the continued existence of COVID variants kept labor force growth low, limiting the supply of labor and further increasing jobs. wages.
With labor and material costs soaring, companies realized they had to raise their prices. And wonder of wonders, they found they had pricing power, something they hadn’t had in decades.
So companies decided to raise prices, and when they had little or no recoil, they raised prices a little more, and then even more. The companies behaved like children in a limitless candy store.
Just when we thought things couldn’t get any worse, Russia invaded Ukraine.
The Russian invasion triggered a spike in energy costs, jeopardizing the supply of petroleum products from Russia to Europe. Geopolitical factors often create wild swings in energy prices. Although supply has not changed, the threat of Russia cutting off the flow of oil and gas to Europe has sent global energy costs skyrocketing.
We probably won’t return to more reasonable prices until the war is settled. But we could have.
Markets are pricing in a potential reduction in Russian supply. However, OPEC could have turned on the tap and alleviated the supply problems. It seems that our friends at OPEC prefer higher prices. By not increasing production, OPEC is subsidizing the Russian war effort, as Russia also reaps the benefits of high energy prices.
Ukraine is also the breadbasket of Europe. Grain shortages affect the price of agricultural products ranging from baked goods to meat, pork and poultry, which use grain as animal feed. And to add insult to injury, there’s the resurgence of bird flu, which is devastating chicken and turkey flocks and increasing the cost of poultry and eggs.
Is it any wonder that food prices have skyrocketed?
But it does not stop there. The Fed went to sleep, believing inflation was transitory and would just go away. Still wrong.
Interest rates have stayed too low for too long, which has also helped support a surge in house prices and rental costs. To catch up, the Fed may have to raise rates so high and so quickly that a recession results. He might have to kill the economy to save it from inflation.
So, let’s sum up. Massive stimulus, coupled with China’s COVID policy and the slow reopening of businesses, sparked the fire. Ongoing global supply chain issues added fuel to the fire. Labor and goods shortages have created worker and corporate pricing power that has fanned the flames. The Fed’s failure to heed the inflation fire alarm allowed inflation to pick up. And the Russian invasion of Ukraine and OPEC’s reluctance to increase supply have driven up energy and food costs, further compounding the problem.
This is how the current inflationary storm was created, and almost none of the driving forces could (or cannot) be controlled by US policymakers.
Joel L. Naroff is president and founder of the consulting firm Naroff Economics in Bucks County.