Consciousness of Sheep
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Let’s talk about supply shocks. Cast your mind back to the beginning of March 2020. Remember how everyone panic bought pasta and toilet paper? Except that it didn’t really happen – at least on a large scale. What happened was, in their usual underhand way, the establishment media paid supermarket managers to hide the toilet rolls just out of shot while they photographed the empty shelves. And then there was that time when the photographer got one of his mates to load a shopping trolley with multi-packs of toilet rolls to give the impression that this was commonplace. But there were shortages. Not from panic buying, but simply from the additional demand as we all added one or two extra items to our weekly shop. In a just-in-time supply system, that is all it takes to create a shortage.
There was more though. When lockdown began, there was a massive switch from what we might call the wholesale supply chain into the – usually much smaller – retail supply chain, as big consumers like schools, offices, factories, hotels and restaurants dramatically cut consumption even as a newly created army of homeworkers sought to increase theirs. For example, most eggs would previously have been consumed in the wholesale sector, where they are packaged in cartons of thirty or more. In the retail sector, eggs come mostly in half-dozen and dozen cartons. So that, at the beginning of lockdown there was an egg shortage because of the shortage of egg cartons. Toilet paper was affected in a similar way as demand for the large, wholesale rolls used in offices and factories slumped even as demand for household size rolls rocketed.
What we underestimated at the time was the speed with which supply companies could respond to the changed circumstances. Within a matter of days of the imposition of travel bans, for example, airlines quickly stripped the seats out of their planes, and were using them as additional freight transport at a time when global shipping was disrupted. Similarly, despite there being just three egg carton factories in Europe, wholesale cartons were quickly scaled down and retail cartons scaled up so that egg shortages disappeared within days. In the same way, toilet roll manufacturers were soon able to reassure us that there was no shortage.
Deeper changes were afoot though. We had an indication of this in the sudden uptick in people moving out of the city and buying property in rural areas. But even those who stayed put, changed their habits considerably. Companies like Netflix, Zoom and Peloton enjoyed a bonanza as people were forced to approximate at home what they had previously done elsewhere – no longer able to go to the gym? Get an exercise bike; can’t go to the cinema? take out a cable TV subscription; can’t meet at the office? Invest in virtual meeting software. And the downside, of course, is that the companies that had been providing those things outside the home lost money hand over fist.
This was the first supply shock. Lockdowns so distorted our patterns of consumption that companies which should never have been quite that profitable were suddenly booming, even as those who ought to have been doing far better were looking into a financial abyss. Although the various state funding schemes were meant to take the sting out of the situation, they often served to further distort the economy. For many people, working from home cost far less than commuting to work. And the saved income which might otherwise have been spent on fuel, lunches and work clothing, fuelled a boom in online sales.
Had it just been “two weeks to flatten the curve,” as was promised, things might not have been so bad. But the lockdowns and restrictions went on for the best part of two years – with the possibility of further lockdowns an ever-present threat. And so, the second supply shock resulted from malinvestment as capital fled from previously profitable sectors into those which had experienced a consumer boom. Oil – actually oil futures – for example, fell so low that at one stage the price went negative. Less obviously, oil production and oil refining were cutback to the level required by an economy in which a large part of the workforce no longer needed fuel.
On the other side of the equation, companies enjoying what should have been a temporary boom, began to act as if it was permanent. Beyond the retail sector, manufacturers saw demand spike upward. Moreover, the outflow of capital from sectors like oil, allowed for additional borrowing to invest in expanded production. Perhaps paradoxically, even as global shipping began to seize up, shortages coupled to higher consumer demand served to fuel even more demand for wholesale production. It became a huge bubble… and unlocking the economy would likely be the pin that burst it.
Another result of lockdown was a huge labour shortage – exacerbated by the over-50s leaving their bullshit jobs and taking early retirement – further disrupting supply chains. Formerly booming metropolises like London, experienced a big fall in population, causing huge labour shortages when businesses attempted to re-open.
Energy became the next crisis to wash over us after restrictions were lifted. In the UK there was a strange, self-fulfilling fuel shortage generated almost entirely by media and PR spin. In a sense, filling stations are like banks – they fail if everyone turns up at the same time. A couple of clickbait media stories about a month after the lockdowns had ended, proved to be enough to create long queues at the pumps. So that, when the pumps ran dry, the initially false fuel shortage was made real. Gas shortages, however, proved to be the point of crisis – sudden additional industrial demand sent prices soaring. And while much of the media focus was on the consequences for domestic consumers, the bigger problem was in agriculture, where gas is the main feedstock for fertiliser. Later, as demand for oil outstripped supply, the oil price rose above the psychological £100 per barrel mark – although never reaching the highs either side of the 2008 crisis. Nevertheless, and even without the later Russian invasion of Ukraine, this marked the start of supply shock three.
While an increase in the price of laptop computers, Netflix subscriptions and home exercise equipment may impact the inflation figures, it is unlikely to result in an inflationary crisis. This is because these items are discretionary. So that, as the price increases, we cease buying them. As the old adage has it, “the answer to high prices is high prices.” Oil, gas, electricity (because we depend upon gas to generate it) and fertiliser (and the food we grow with it) are a different matter entirely. In many cases these are essential – not just to households, but also to transport, industry and agriculture, whose higher costs are also reflected in higher prices across the economy… Supply shock four.
Outrage over the Russian invasion of Ukraine is understandable, but there was nothing inevitable about the European technocracy’s decision to use sanctions to undermine the European economies. Nevertheless, that decision was taken and, apparently, remains popular even with people who are struggling to feed and warm themselves this winter. But we need to be clear eyed about this, it took a bad situation of falling access to oil and gas and multiplied it – and despite the high demand and high prices, producers are now attempting to cut production in anticipation of an unfolding recession… supply shock five.
In a prior age, western central banks were given the task of maintaining a stable economy with inflation rates no higher than three percent and no lower than one percent. For more than a decade after the 2008 crash, they failed, as the rate of inflation lay below one percent. Government spending during lockdown – the cause of the initial supply shock – reversed the situation, with inflation jumping up well above three percent. And this was compounded by the further energy supply shocks as the economy opened up once more. And so, instead of sticking to their correct initial view that (monetary) inflation was temporary, the central banks blinked. Using the discredited Phillips Curve as a guide, they have embarked upon the fastest increase in interest rates in modern history to generate a recession, to create high unemployment, in order to crush economic demand.
The danger inherent in doing this – as we discovered to our cost between 2005 and 2008 – is that, eventually things start to breakdown in a way which threatens to collapse the whole economy. The 2008 crash didn’t start with sub-prime mortgages, it started with a dollar shortage caused by banks and shadow banking organisations ceasing lending because of a perception that counter-party risk was too high. And the reason for that perception was global oil production falls and the price spike over $100 per barrel… in other words, a very similar situation to today.
Sub-prime borrowers, borderline profitable businesses, and eventually the banks themselves, were all victims of higher energy prices and the central bank reaction to them. In the same way, we are already witnessing the early stages of a crisis today – pension funds struggling to remain solvent, banks struggling for liquidity, businesses laying off workers or cutting workers’ hours, households dramatically switching spending away from discretionary goods in order to cope with higher food and energy prices, even as energy prices remain high.
The problem is what some commentators are already calling “deflationary inflation” – a distant cousin to stagflation. That is, the central banks have probably already succeeded in deflating the discretionary economy, but can do nothing to prevent prices in the essential sectors – food, energy, transport, etc. – from continuing to rise, as these are the result of the ongoing – and likely worsening – supply shock rather than too much consumer spending.
Eventually, of course, sufficient damage will be wrought on the economy that supply will finally overtake demand – although if China decides to stop playing Covid silly buggers and opens up its economy, we face an even greater supply shock. But even if supply and demand could be brought back into balance, analyst Lyn Alden raises an essential – but currently ignored – question… what then? As Alden points out, unlike after 2008, when we enjoyed a decade of growing oil production, today there is no additional capacity and, because of lockdown and ESG investing rules, there has been a failure to invest. And so, the moment the central banks stop raising rates, energy prices are going to spiral upward again – Alden uses the analogy of trying to hold an inflated balloon below the water… the moment the pressure is released, it comes flying up once more.
This is why I am reminded of that South Park episode in which gnomes are caught stealing underpants. Pressed on why they are doing it, it turns out that their plan to turn a profit is a little sketchy on – and so they don’t speak about – Phase Two. The same appears to be true for the central banks and, in Britain at least, the political class:
A combination of rate rises and austerity spending cuts may crush demand to the point that energy and food prices begin to fall – just like they did during lockdown – but the moment we attempt to restart the economy – just like we did after lockdown – prices will spiral upward once more. Furthermore – just like with lockdown – once the economy is in recession, further supply shocks are going to be generated.
There is no Phase 2, because any alternative to a system of infinite growth on a finite planet is so unpalatable to the ruling elites that they would rather crash their economies into a new dark age than to change course. There is though, an alternative pathway, as Alden argues. Instead of using the 1970s playbook, we might look to the 1940s, when inflation and supply shocks were all too common. But because the economies of the west were on a war footing, governments were able to intervene to a much greater extent to curb the excess of private banks, to return central banks to their role as servants – rather than masters – of the people, and to ensure that sufficient currency was given to those in the bottom half of the income distribution so that at least nobody starved. The war may be different this time – we are fighting energy and resource shortages that require us to radically reshape our economies – but the emergency is real enough… Phase 2? Most likely some kind of currency reset.
As you made it to the end…
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