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Economic train wreck ahead…

The remarkable feature of the unfolding stagflationary crisis is the speed with which it is happening.  Just six months ago, our political class was congratulating itself for successfully steering us through the pandemic.  Rises in gas and oil prices were merely a transitory re-adjustment of supply and demand as economies unlocked.  The labour market was booming, with vacancies growing across the economy.  Demand for labour, – at least in some sectors – was helping to generate new, demand-led growth.  Those churlish enough to point out that energy shortages and rising commodity prices were all too reminiscent of the crises of 2005-8 and 1973-81, could be dismissed as unpatriotic doom-merchants.

Energy price rises were not transitory though.  For while prices have dropped back slightly from their winter high point, they reflect the reality of production that has fallen significantly from the November 2018 high water mark.  Globally, the economy is running on four million barrels of oil per day less than it had been in November 2018.  Reserves which might have been developed had it not been for two years of lockdowns remain in the ground.  Worse still, according to the Dallas Fed survey, the US oil producers who became the de facto swing producers of the 2010s, do not anticipate production growth and – most worryingly – are no longer responding to price signals.  Investment in further oil drilling is drying up precisely because high oil prices have proved unsustainable.  Every time the price rises to a level that favours producers, demand crashes and prices fall.  Having been through this three times between 2008 and 2020, investors are in no hurry to get burned again:

Whether the rest of the world has additional reserves which could make up the supply gap is a moot point.  Oil analysts such as Matthew Simmons had been pointing to discrepancies in OPEC reserve figures long before the 2008 crash.  And many more today doubt OPEC’s ability to raise production much higher even if they wanted to.  And since they benefit from the higher price, they have few incentives to raise production anyway.

We didn’t quite get to the $200 per barrel oil predicted by the World Bank after the 2008 crash.  But that is only because the grossly unequal economies of the western states could not sustain demand at that price.  Indeed, at the beginning of the 2010s, a Brent oil price below $40 per barrel (roughly $53 today) was required if economies were going to grow, while a price above $80 ($105.50 today) would cause a recession:

Since oil is involved in the production and transportation of just about everything else in the economy, increasing oil prices have been followed by general price increases.  However, this time around, disrupted post-lockdown supply chains together with a massive gas shortage have amplified oil-based price increases to the point that inflation is now running at 1970s levels (and, of course, if inflation was still measured in the way it was in the 1970s, the numbers would be far worse).

It is a truism that “inflation is always and everywhere a monetary phenomenon” – that is, if there wasn’t any money then we couldn’t have inflation.  But this banality obscures a more fundamental truth that, in the absence of sufficient surplus energy the cost of everything has to rise… no matter which unit of currency you choose to weigh it against.  In every previous supply-side crisis, salvation has come in the form of a new supply of low(ish)-cost surplus energy.  After World War Two, it was the absolute shift from coal to oil in Japan and western Europe.  In the 1980s it was the relative addition of oil from Alaska, the North Sea and the Gulf of Mexico.  This time there is no obvious absolute or relative source of new surplus energy to save the day.  And so, depression is baked in.

Early warning signs of the crisis which is about to overtake us are popping up everywhere as the economy finally emerges from the darkness of winter.  Predictably, as incomes have fallen behind inflation, we have seen a big shift away from discretionary spending as people adjust their budgets to deal with the higher cost of essentials like food, heat and transport.  As Camilla Canocchi at This is Money reports:

“Nearly a quarter of people said they were struggling to pay household bills last month, according to the latest survey by the Office for National Statistics.

“A bigger proportion – two in five – said they found it ‘very or somewhat difficult’ to afford their energy bills in March – and that’s even before the increase in the energy price cap came into force at the start of April.

“To cope with the rise in the cost of living, large numbers of families are cutting back on spending – both essential and non-essentials – while some are dipping into savings if they have them, and others are taking on debt.  The most common action was spending less on non-essentials, like going out for dinner or clothes, with over half of Brits saying they did that in March.  Turning off the heating and cutting back on electricity use was the second most common move by those trying to cut back on spending – 45 per cent of households did so last month.

“Some 39 per cent also said they had reduced their non-essential car journeys to save on petrol, while a similar percentage shopped around more to find better deals and a third are cutting back on essentials like food.  Meanwhile, nearly a quarter of people dipped into their savings, 11 per cent said they were borrowing more than usual and some 7 per cent asked friends and family for help.

“Only 12 per cent of people in Britain said they were not doing anything in response to the cost of living crisis, the survey shows.”

This split between the bottom 88 percent and the top 12 percent of earners is also reflected in the latest Deloitte Consumer Tracker, as Céline Fenech, consumer insight lead at Deloitte, explains:

“Essential spending has increased significantly in the first quarter of the year, but so too has discretionary spending; unveiling a clear divergence in consumer spending patterns.

“Higher spending on transport and on everyday household items have seen the biggest quarter-on-quarter leap amongst essential categories. This increase is mainly due to price inflation and is affecting the lowest income households the most. By contrast, within the discretionary categories the highest income households were more likely to have been spending on holidays, going out, and eating in restaurants. For these higher-earners, pent-up demand for socialising and travelling – following the end of all COVID-19 restrictions in Q1 – is possible due to savings accumulated over lockdown when spending opportunities were limited.”

For an economy based upon mass-consumption though, continued spending by the top ten percent or so is of little comfort, since what we have been witnessing is a loss of critical mass in an economy which depends upon consumption growth to avoid collapse.

Getting out from under the yoke of the various subscriptions we have tended to buy in better times is an obvious first step to take as the cost of living rises.  And so, it should come as no surprise that businesses with subscription models have been among the first to come to grief this time around.  Most visibly, Netflix recently reported a loss of some 200,000 subscribers earlier this year.  Now, according to Wendy Lee at the Los Angeles Times, the company has turned to staff cuts in its marketing arm to balance its books.  A similar story is unfolding on this side of the pond, with Lloyds Banking Group reporting a massive drop in subscriptions and memberships in the UK according to Kalyeena Makortoff at the Guardian:

“Lloyds Banking Group has raised concerns about the UK economy’s ‘uncertain’ outlook, warning the cost of living crisis had already forced customers to cut spending on services such as streaming and gyms and could mean more defaults on its loans…

“The chief financial officer, William Chalmers, said the bank had already seen customers start to count their pennies, cancelling about 1.2m[illion] gym memberships and video streaming contracts over the past six months, as inflation soared to 7% in March.”

While the establishment media has talked glibly about households facing a “£271 rise in annual food bills,” that’s not how this plays out in practice.  Shoppers aren’t going to spend £271 more on food.  They are going to switch to cheaper food – including a return to cooking from scratch and away from pre-prepared foods – thereby depriving the supermarkets and food producers of the £271 per customer needed to cover their additional costs.

Rising costs and falling sales are about to cause the crisis to morph into a new stage as we witness widespread business failures and the rapid reversal of the apparently good post-pandemic employment figures.  As the BBC reported this morning:

“A growing number of UK businesses are at risk of going under, as costs spiral… a report has found.  Construction and hospitality are the sectors struggling most, according to insolvency firm Begbies Traynor…

“In the first three months of this year there was a 19% rise in businesses in critical financial distress compared to the start of 2021… Begbies Traynor’s research highlights a sharp rise in County Court Judgements (CCJs), an early sign of future insolvencies, because they show creditors are making legal claims.  CCJs were up 157% compared to a year ago…

“Begbies Traynor, which publishes regular health checks on the state of British businesses, said its ‘Red Flag Alert’ research reflected the strain two years of extraordinary financial pressures have had on thousands of companies. It said 1,891 firms now fell into the category of critical, suggesting their outlook is precarious.”

This is how stagflation will develop.  Rising costs are irreversible because, for the first time since the industrial revolution, the world faces irreversible shortages of energy and key commodities.  But, also for the first time, the developed western economies have no means of offsetting those costs.  And since the companies which are incurring those costs cannot operate at a loss, closure and redundancies are the only options remaining on the table.

It is worth noting at this point that the economic indicators referred to above measured the period before the western states embarked on their ill-advised economic war on Russia.  Moreover, the two essential Russian exports to the west – oil and gas – continued to flow for now, as they are exempt from sanctions.  Meanwhile, the impact of fertiliser and grain shortages will only hit home when the northern hemisphere harvest comes in later in the year.  So, despite the western political class wanting us to believe that our current economic woes are “Putin’s inflation” or “Putin’s cost-of-living crisis,” in reality, they are very much woes of our own making.  Putin’s invasion of Ukraine and the west’s response to it merely adds a new, hungrier and colder dimension to trends which were already unfolding.

This response from the political class is, in its way, the most fascinating aspect of an overall crisis which, in energy terms, is simple enough to understand.  As John Stepek at Money Week notes:

“I’m sure that the Bank of England realises that not every problem is a nail. However, it has been given naught but a hammer to wield against said problem.  Interest rates are a blunt instrument, and maybe inflation targeting should adjust to underlying secular conditions rather than be set at one level the whole time. But it’s kind of late in the day to be having this revelation.”

In other words, the political class will continue to do what discredited textbooks tell them to do, even though they no that this will bring the house down… because there is no alternative.  Or rather, as Tim Morgan puts it:

“In this situation, prognosis can become more than just unpopular, if prognosis lacks an effective prescription.

“As just one example, the lack of practical alternatives means that, whilst the political Left might advocate imposing ever greater taxation on ‘the rich’, such proposals ignore the fact that much of the supposed wealth of the wealthiest is a notional product of market distortion, and cannot be monetized into taxable cash. 

“We can reasonably infer that there can be no soft landing from a choice between market collapse and soaring inflation, and that the public cannot be expected to go on buying implausible long-term answers to worsening short-term economic hardship…

“How, though, does any of this help those burdened with responsibility for decisions?…

“It might seem almost heartening that, in the absence of logic and evidence, TINA has become the sole prop retained by the consensus ‘narrative’.

“We need to beware, though, that TINA may have a far less forgiving sibling, with the confusingly-similar acronym TINAR – There Is No Acceptable Reality.”

We are, like the passengers on Edwin J. Milliken’s Clattering train, careering toward catastrophe unaware that we are running on automatic pilot:

Who is in charge of the clattering train?

The axles creak, and the couplings strain.

At every mile we a minute must gain!

A hundred hearts beat placidly on,

Unwitting they that their warder’s gone

For the pace is hot, and the points are near,

And Sleep hath deadened the driver’s ear

And signals flash through the night in vain.

Death is in charge of the clattering train!

As you made it to the end…

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