26 Mar 2021
INFLATION – WHAT THEY TEACH YOU AT SCHOOL
I remember from economics lessons at school that there were supposedly two categories of inflation, namely cost-push and demand-pull. This was simple enough for anyone, even a pubescent schoolboy, to understand.
Now I can see that this was something of an oversimplification (for which I was no doubt grateful). Supply and demand do not happen in isolation. They respond to each other over time. It is instructive to remember that the price of anything will rise when the current supply is insufficient to satisfy demand and of course it works in reverse.
Yet the demand element of inflation is what occupies most “informed” chatter. That’s probably because we have a more immediate feeling for it. At present there is said to be a dam of spending waiting to spill out as soon as the first world countries are released from lockdown (I’m assuming it will happen one day – stock markets are impatiently celebrating it already).
Consensus says that this will give a transitory boost to inflation which will then subside because private sector unemployment is too high – in short, the poor sods who have been screwed by lockdown will exert a deflationary effect that prevents the economy from overheating. This in turn is offered as a justification for the probability that central banks will not raise interest rates. Well, yes.
Given that the US, European, UK and Japanese economies are all funded by the state balance sheets, I think we can reasonably act as if the date for the next increase in official interest rates is approximately never.
SUPPLY SIDE INFLATION
But supply side inflation – now that’s a story. Energy, commodity and shipping prices are really moving this year. Given that most of the world’s major economies are still in recessionary territory that’s quite impressive.
SAMPLE OF PRICE CHANGES IN THE LAST SIX MONTHS
| Carbon steel | 107.8% |
| Container rates | 81.4% |
| Oil | 49.2% |
| Lumber | 44.7% |
| Soybeans | 39.8% |
| Iron ore | 38.8% |
| Copper | 31.7% |
| Coal | 31.4% |
| Cotton | 31.3% |
| Sugar | 23.1% |
| Aluminium | 22.9% |
| Natural Gas | 21.1% |
| Wheat | 12.9% |
| Rice | 8.1% |
IN THE PAST, TECHNOLOGY HAS BOOSTED EFFICIENCY AND CUT COSTS
So what is going on? I believe the answer lies in a brief reflection on innovation.
Technological advance has served two purposes in human history. The first regrettably has been to allow people to wage war and to kill each other in greater numbers. The second has been to improve productivity and reduce costs.
In the nineteenth century there was the horse, then the canal, then the steam engine and finally the combustion engine. Then WWI (hello to the tank and chemical weapons). In the twentieth century came mass production and WWII (radar and splitting the atom). Then consumer durables and then computer chips.
Wars aside, greater efficiency and falling prices meant that economies could grow rapidly without significant inflation. Innovation was able to enhance standards of living while exerting a deflationary influence on prices.
Have you noticed that everything has changed now?
BUT NOW IT IS BEING ASKED TO DO THE OPPOSITE
Technology is not generally being asked either to kill people or to improve productivity and reduce costs. Quite the opposite, in fact.
The green or net zero project is ostensibly aiming to save the planet and, by implication, lives but more shockingly its intention is to curb productivity and to make consumption more expensive. This is not a question of how much it will cost by 2030 or 2050 – this is happening now.
Extinction Rebellion, in the person of Greta Thunberg, is quite open about the choice, as she sees it.
“We are at the beginning of a mass extinction and all you can talk about is money and fairy tales of eternal economic growth.”
Elected politicians are unsurprisingly inclined to skate over this and to talk about exciting new job opportunities.
TESLA – COMPULSION INSTEAD OF COMBUSTION
Tesla has managed to become the world’s largest car company, by market capitalisation. The key to its mind blowing valuation is the idea that people will be forced to buy electric cars. The idea that any Tesla, in terms of price, convenience and performance, could compete with the 1987 VW Golf GTi (the reference wheels of those Yuppie years) seems at present far fetched. In the UK, despite the fact that globally 99.3% of existing cars are powered with combustion engines, all new cars will be electric from 2030.
The share price of Tesla is symptomatic of inflation in ecological assets.
THE MORAL HIGH GROUND ATTRACTS MONEY
Much investment has been attracted into so-called ethical or ESG (Environmental, Social, and Governance) funds in recent years. It is easier for these funds to avoid so-called unethical investments than to find “safe” places to put their money.
Prices of woodland in the UK have been shooting up since 2018, from around £3,500 per acre to perhaps £10,000. This is what happens when large amounts of ESG money is chasing finite supply. Why would environmental funds want to invest in woodland? In short, because it looks blameless. And badgers might live there.
More seriously, offshore wind licences are also gapping higher, potentially endangering the claim of wind to be the cheapest source of energy. Until recently, the price of UK offshore wind leases was around £80-90,000 per megawatt per year. Then it was £154,000, a rich price paid by….ironic drum roll,,,,,,BP, a company that is of course a pariah to the ESG community.
For the best part of ten years, Donald Trump aside, the oil industry has been a political punch bag. The value of its reserves has been challenged as false accounting and the point of new exploration questioned. Little wonder that capital expenditure at Royal Dutch has fallen from $40 billion in 2014 to $17 billion in 2020 and from $25 billion to $12 billion at BP over the same period. Despite their public claims to be reinventing themselves as renewable energy companies (see above), it is as if they are being slowly wound up by popular demand.
In addition Joe Biden seems to have a personal mission to penalise the use of oil and gas. He has blocked Keystone XL, much to the irritation of Justin Trudeau, and he even wants to stop Nord Stream 2, which is a gas pipeline from Russia to Germany.
THE DOWNSIDE OF THE HIGH GROUND
Given that, as noted above, almost the entire world’s land, sea and air vehicles are powered by oil-based fuel, the resumption of economic activity might just be ideal timing for a major rally in the oil price. The price of Brent crude has more than doubled in the last year (from $30 to $64) which is a start. This is with most of the first world in various states of lockdown. What might happen when we all start travelling again? It could be a perfect storm resulting in $100+ oil.
We appear to have what is known as a double whammy. ESG asset prices are being inflated by an excess of investment and old economy assets are moving the same way due to years of underinvestment in capacity.
I accept that many people, and most of the people who seem to matter, will have no problem with this. But it would be helpful if we accept that this is the kind of inflation that, yet again, benefits owners of assets and hurts those who are merely consumers. It not only makes most people poorer but also makes economic equality worse. We should be careful what we wish for.