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Slow fuse burning

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It is, perhaps, easiest to blame all of Britain’s ills on Brexit.  Failing this, the global pandemic – and our response to it – is a good candidate for blame as the economic consequences of global lockdowns and restrictions begin to emerge.  There are though, slower and deeper processes which are also coming home to roost; and which will undermine the UK economy even further.

Brexit is by far the least of our worries.  As Britain’s former EU trade advisor Sir Ivan Rogers once put it; “Before Brexit, Britain was half in and half out of the EU.  After Brexit it will be the other way around.”  On Friday 13 December 2019, Brexit ceased being a political issue and became instead, a technical matter.  Just over a year later, Britain’s formal exit from the EU marked not the end of a process, but the beginning of an ongoing series of negotiations through which the trading relationship between the UK and the EU will evolve.  In this respect, any disruption is temporary, and any serious disruption will be given priority in future negotiations.

Our response to the pandemic is far more disruptive; and is about to have far more profound consequences.  On the one hand, our behaviours have been changed permanently – home working and online shopping, for example, will not be returning to December 2019 patterns when the various restrictions are finally lifted.  Public transport, air travel and cruises are also unlikely to attract the same volume of travellers than had been the case before the pandemic.

On the other hand, the pandemic restrictions have served to amplify trends which had already begun long before SARS-CoV-2 was a thing.  Global oil extraction, for example, reached its all-time peak sometime between November 2018 and December 2019.  The addition of new, smaller and harder to reach deposits and a new round of quantitative easing funding of fracking might, perhaps, have cushioned the blow for a few more years had it not been for the lockdowns.  By squeezing twenty percent of the demand for oil out of the global economy however, the lockdowns and restrictions resulted in a dramatic shutdown of oil extraction, transportation and refining.  This infrastructure is not like a kitchen tap that can be turned on and off at will.  Prolonged shutdown or slowdown does enormous damage, and will require considerable maintenance before returning to 100 percent production.  And, of course, the expensive wells, least profitable refineries and already scrapped tankers are not going to be able to take up the slack when governments attempt to restart their national economies.

In April 2020, as demand for oil plummeted, the WTI oil futures price fell to just $17 per barrel – well below the break-even price for producers.  At the end of this week, the price had risen to $66, as futures traders began to price in the anticipated shortages later in the year.  This is because it will take a good six months to bring production back up to where it would have been were it not for the lockdowns and restrictions.  The one saving grace is that insofar as we are less minded to fly, go on cruises or commute to work, our demand for oil may prove to be lower than it was in 2019.  Nevertheless, you don’t need a crystal ball to see increased fuel prices at filling stations in the near future.

Less obvious long-term trends can be teased out of current news of disrupted supply chains and the accelerating retail apocalypse.  As with gathering oil shortages, these are trends which predate the pandemic – and Brexit – but which our recent actions have dramatically worsened.

Among the concerns exercising Britain’s metropolitan middle classes this weekend is a shortage of garden furniture.  This is particularly concerning as one of the first stages in relaxing Britain’s current lockdown involves being permitted to meet selected family or friends in your garden (assuming you can afford one).  As Leanna Byrne at the BBC explains:

“People hoping to spruce up their gardens, ready for when we can socialise in them again, may face problems with their seating plans due to a lack of outdoor furniture…

“The Leisure and Outdoor Furniture Association, which represents 70 manufacturers and wholesalers, said all of its members are having problems with garden furniture supply…

“Ikea says the shortages have been caused by both a huge rise in demand through the pandemic, as people spend more time at home, and problems with its global supply chain.  However, the retail giant says it hopes to have things back to normal by the time its stores re-open.”

Garden furniture is just the latest example of supply chain disruption resulting from the pandemic restrictions.  However, the underlying cause of the problem can be traced all the way back to December 2001, when China was admitted to the World Trade Organisation.  China’s “economic miracle” in the ensuing twenty years was built upon the West’s waste.  That is, its primary energy source – coal – was largely unwanted in western economies which had offshored manufacturing and switched to gas to generate electricity.  In addition to this, China chose to import the West’s garbage as the cheapest means of accessing the additional raw materials its growing economy demanded.

While you and I were signalling our virtue by putting plastic, glass, cardboard and paper in the green bag to go off for recycling, most of us did not realise that it was being shipped off to China for processing.  At the time, China was prepared to put up with a large quantity of unusable waste because the proportion which could be re-used was of value.  In any case, by far the biggest form of waste sent to China was metal waste – particularly crushed vehicles – which became the steel for reinforcing the concrete in China’s gargantuan infrastructure building.

All good things come to an end though.  As China’s need for recycled resources waned, its desire to act as the western world’s garbage disposal evaporated.  On 16 August 2017, China announced that it would no longer import 24 categories of waste; including several types of post-consumer plastic scrap, one grade of unsorted paper, several types of used textiles and metal slags containing vanadium.  The waste import ban is expected to be extended to all waste from this year.

The obvious headache here is that European states like the UK lack the facilities to recycle waste; lack the land to dump it; and face public hostility to burning it to generate electricity.  Instead, western states have begun dumping their waste in poorer Asian states such as Thailand, Malaysia, and Vietnam.

This though, does not resolve the less obvious economic consequence of China’s import ban.  One of the reasons China was able to emerge as the global economy’s manufacturer of choice is that the price of its exports had been subsidised to an extent by the recycling trade.  That is, by paying for filling shipping containers full of waste, China was subsidising the return journey of a 27,616 mile sea voyage from Shanghai to Europe.  This helped keep the cost of Chinese exports to Europe far lower than would otherwise have been the case.

Having captured the market in various key manufactured components – as the pandemic revealed – China has been able to pass the increased cost of shipping onto importers who – for now at least – have no choice but to pay.  The result is that shipping costs have risen dramatically in the last year; exacerbated by older ships being scrapped and demand patterns changing as a result of the pandemic restrictions.  The only question remaining is who gets to eat the additional costs.

Thus far, suppliers have been attempting to absorb the additional price of shipping.  But this is likely to become untenable as shortages become more commonplace.  As Harry Holmes at The Grocer reports:

“Gaps could soon emerge on supermarket shelves unless retailers accept a greater share of soaring global shipping costs, suppliers have warned.

“The cost of shipping containers has risen from around $2,000 per container to $14,000 on routes from China and Southeast Asia over the past three months, driven by a global shortage as a result of the pandemic…

“Stephen Barlow, CEO of Euro Food Brands, said the shortage had left ‘manufacturers fighting for containers and having to pay crazy prices’, yet not all retailers were sympathetic to the issue…

“While shipping costs previously made up around 5% of the product price, added Barlow, this had now risen to over 20%. ‘The net margins of businesses like ours are tiny. So when you have swings of this size, unless you can get the price up, you have to stop doing the business.’”

This is where the problem goes full-circle and feeds back into the retail apocalypse which has been gathering pace for years.  The reason retailers cannot shoulder some of the additional shipping costs is that their profit margins are too tight.  Retail and hospitality outlets are already lobbying government for an end to the UK’s antiquated Business Rates system in which businesses are taxed according to the size and location of their premises, rather than their profits.  At the same time, many of those in supposedly prime locations – which attract the highest tax – are engaged in negotiations with commercial landlords in an attempt to lower rents which were set long before the pandemic began.

According to Emma Simpson and Daniele Palumbo at the BBC, the dramatic increase in retail and hospitality outlets closing in the last 12 months is merely a starter for what comes next:

“The coronavirus pandemic has thrown Britain’s High Streets into crisis, yet the full force of its impact has yet to be felt, according to accountants PwC.

“More than 17,500 chain stores and other venues closed in Great Britain last year, according to new data. That’s an average rate of 48 closures a day…

“However, the full impact of the pandemic has yet to be felt, according to Lisa Hooker, head of consumer markets at PWC, so the picture is likely to get worse before it gets better.  These numbers, for instance, only include store closures which are known to be permanent. Many outlets which have closed ‘temporarily’ may never re-open.”

Paid optimists, such as Bank of England Governor Andrew Bailey, believe that sufficient currency has been saved during the pandemic, that spending will bounce back once the restrictions are lifted.  This was not, however, the experience last summer; when a brief spending spree was followed by people returning to their homes and keeping their heads down.  This time, moreover, the awareness that the end of the various government support schemes is likely to end in widespread job losses is likely to deter people from spending any savings they have gained.  Prior to the pandemic, more than a quarter of British households lacked the savings to pay for a modest emergency; such as replacing a household appliance or repairing a boiler.  With the exception of “essential workers” who have continued to work through the pandemic, this group is unlikely to have saved much by working from home.  This is because employees on the government’s furlough scheme are on lower pay.  Savings, then, are most likely to have been built up by those who need them least; and who are less likely to spend them.

To add to the problem, there are several additions to the cost of living from April 2021 which cannot be absorbed elsewhere.  Utility bills, rail fares and council tax are all rising above the rate of inflation; eating into any savings people may have accumulated, and further impoverishing those at the bottom.  And while government support has been extended to the autumn, millions of us will want to hold onto any currency we have saved against the day when support is withdrawn.

The real danger here is not so much a spending spree in the immediate aftermath of the lifting of restrictions, but some months later if – as expected – shortages and price increases become inevitable.  For the first time since the 1970s, we could well be facing a combination of supply-side and demand-side shocks which result in stagflation – inflation and mass unemployment appearing at the same time.  In such circumstances, people may well use their savings to “buy for the future” as a means of avoiding the loss of value of the currency.  Paradoxically, this increase in the volume and velocity of currency would serve to make the problem worse.

Far more deadly, however, is the likely response of the central banks and government.  In 2006, central banks responded to an oil-based rise in prices across the economy by raising interest rates.  This proved a double-whammy for people who had only just been able to repay so-called sub-prime mortgages.  In addition to the generalised rise in the cost of living, they suddenly had to stump up the additional interest on their mortgages.  Many couldn’t; and began posting their keys back to the mortgage companies.  And so the whole banking and financial sector house of cards unravelled.

Although the US Federal reserve has promised not to raise interest rates for several years to come – and most central banks will take their lead from the Fed – faced with a large rise in prices in the near future, this promise may be difficult to sustain.  Not least, because governments are likely to learn the wrong lessons from the recovery in the 1980s.

What really saved the western economies in the 1980s was the development of new oil deposits in Alaska, the North Sea and the Gulf of Mexico.  The hard currency returned from these fields helped to underwrite the development of the financialisation of the western economies.  While industries that actually make things were shipped abroad, for example, British consumers could apparently borrow their way to a higher standard of living; with the sale of oil and the privatisation of public assets tacitly underwriting the Ponzi scheme.

Politicians and mainstream economists do not see it this way though.  According to their playbook, it was the combination of high interest rates and mass unemployment which cut away the deadwood and allowed new, leaner and more flexible businesses to grow in its place.  Oil – a resource that costs less than coca cola – barely registered.  It seems likely that today’s politicians will attempt a repeat performance; only this time without the oil which underpinned the 1980s recovery.  As the old saying has it:

“First time tragedy; second time farce!”

As you made it to the end…

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