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Home | Wire | Governments Can't Blame Inflation on Energy and Putin Anymore

Governments Can't Blame Inflation on Energy and Putin Anymore

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TAGS Money and Banks

03/29/2023Daniel Lacalle

At the end of February 2023, the price of oil (WTI and Brent), Henry Hub and ICE natural gas, aluminum, copper, steel, corn, wheat, and the Baltic Dry Index are below the February 2022 levels.

The Supply Chain Index and the global supply-demand balance, published by Morgan Stanley, have declined to September 2022 levels. However, the latest inflation readings are hugely concerning.

Considering the previously mentioned prices of commodities and freight, if price inflation were a “cost-push” phenomenon, it would have collapsed to 2 percent levels already. However, both headline and core inflation measures, from the Consumer Price Index (CPI) to Personal Consumer Expenditure Prices (PCE) show extremely elevated levels and rising core inflationary pressures.

We have mentioned numerous times that there is no such thing as “cost-push” price inflation. It is only more units of currency going toward relatively scarce goods and services.

The monetary aspect of inflation has been proven on the way up and in the commodity correction. The Federal Reserve’s rate hikes have deflated the price of commodities despite rising geopolitical tensions, supply challenges, and robust demand growth. Rate hikes make it more expensive to store, take long positions, and finance margin calls. Powell offset the entire supply-demand tightness impact on prices.

Governments cannot blame price inflation on Putin’s war or the so-called “supply chain disruptions” anymore. Printing money above demand is the only thing that makes prices rise in unison. If a price rises due to an exogenous reason but the quantity of currency remains equal, all other prices do not rise. A PCE index of 4.5 percent in January 2023 with all the main commodities below the January 2022 level shows how high inflationary pressures are.

Price inflation is accumulated, and the narrative is trying to convince us that bringing down inflation from 8 percent to 5 percent in 2024 will be a success. No. It will be a massive destruction of more than 20 percent of purchasing power of citizens from inflation in the period.

However, rate hikes are not enough. Broad-based money growth needs to come down rapidly. So far, in the United States, broad money growth is flat and has declined to more reasonable levels in December 2022. However, the latest European Central Bank reading of broad money growth in the euro area points to a 4.1 percent increase, which is very high compared to modest gross domestic product (GDP) growth and certainly very high compared with the estimates for 2023.

Broad money growth was too aggressive in 2022 and it may take some time to ease the inflationary pressures to a level that does not make citizens even poorer.

Two recent papers published by the Bank of International Settlements remind us that money growth was the main culprit for the price inflation surge. Claudio Borio, Boris Hoffmann, and Egon Zakrajšek conclude that

a link can also be seen in the recent possible transition from a low- to a high-inflation regime. An upsurge in money growth preceded the price inflation flare-up, and countries with stronger money growth saw markedly higher price inflation. Looking at money growth would have helped to improve post-pandemic inflation forecasts, suggesting that its information value may have been neglected.

(Does money growth help explain the recent inflation surge?). Reis explains that “Inflation rose because central banks allowed it to rise. Rather than highlighting isolated mistakes in judgment, this paper points instead to underlying forces that created a tolerance for inflation that persisted even after the deviation from target became large” (The burst of high inflation in 2021–22: how and why did we get here?)

The supply chain and Ukraine war excuse has vanished, but inflation remains too high. Many market participants want rate cuts and money supply growth to see higher markets, with multiple and valuation expansion. However, rate cuts are very unlikely in this scenario and central banks know they have caused a problem that will take more time than expected to correct.

Governments cannot expect price inflation to correct when public spending is rising, which means higher consumption of new monetary units via deficit and debt.

Citizens are suffering these inflationary pressures via weakening real wage growth added to much higher cost of living as the prices of nonreplaceable goods and services—education, healthcare, rents, and essential purchases—are rising much faster than the headline CPI suggests.

We are all poorer, even if headline price inflation is slightly lower. Slowing inflation growth does not mean lower prices, just a slower pace of destruction of the purchasing power of currencies.

Someone will invent another excuse to blame price inflation on anything except the only thing that causes prices to rise at the same time: printing currency well above demand.

Author:

Daniel Lacalle

Must-read on UK productivity gap

 

The UK’s growth stagnation

• Doug McWilliams
• March 22, 2023

via Treasury Flickr

 

 

 

 

When the Chancellor stood up to deliver his budget last week, the latest quarterly GDP data showed UK GDP 0.8% lower than pre pandemic three years earlier while we remain pretty well at full employment. 

The problem of dealing with stagnation existed even before the banking crisis became apparent. Since then, with liquidity now in short supply, the issue is even more pertinent.

In the event, Hunt applied at best a sticking plaster to the gaping wound of growth stagnation.

He produced some costly plans for increasing the size of the labour force (which should add about ¼% to GDP according to both Cebr and the OBR) and produced a new regime for 100% allowances on some investment.

The latter will do a bit for investment but both the OBR’s estimates and those of my own organisation, Cebr, are sceptical that it will do much. One of the reasons why the tax changes won’t do much  is that most IT spending in the UK is already treated as operating expenditure and indeed accountants encourage this. On the latest figures which are for 2020, though the proportions were scarcely affected by the pandemic, £63.3 billion of IT spending on systems, software and services was expensed and only  £32.5 billion treated as cap ex. This doesn’t include IT hardware but that is normally a relatively small part of IT investment.

So the Budget did little for growth stagnation.

Repairing the UK’s growth problems is difficult without addressing the country’s productivity problems.

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Many are unaware how severe these problems are compared with other countries. 

The UK has been moving backwards for a quarter of a century now, compared not only with the high fliers in Asia and Eastern Europe but even the US. 

Between 2000 and 2021 productivity measured as output per hour has risen by 16% in the UK, 17% in France, 21% in Germany but by more than double, 37%, in the US. 

And just to illustrate the gap in productivity growth between UK and the really fast growing economies, the equivalent figure for Korea is 116%, for Turkey 102% and for the fast developing Eastern European economies range from 64% for Hungary to 137% for Latvia. Meanwhile the equivalent figure for Ireland is a staggering 135%. 

The UK’s productivity gap with the US was only 7% when Tony Blair became Prime Minister. It is now 21%.

When Gordon Brown became Chancellor he commissioned a study by the McKinsey Global Institute into the causes of the productivity gap. The McKinsey report rejected the simplistic explanations of under investment and lack of skills and instead blamed lack of exposure to global best practices and low competitive intensity. 

McKinsey argued that these were often the result of product market barriers such as trade restrictions, price constraints, and land use regulations which in turn were the causes of low investment in capital and skills. It was a good report that was more insightful than most such. But it didn’t say what the then Chancellor wanted it to say and so got buried.

We need to focus on underlying causes, not symptoms, if we want to get the economy back to growth.

A significant part of the productivity problem is in the public sector. The latest data shows productivity in government a staggering 6.8% lower than pre pandemic. Admittedly productivity in government is hard to measure and the statistics are experimental but the data on increasing costs does suggest that spending is out of control. The gap between the productivity growth we are estimated to have had and that we would have had if the pre pandemic trend had continued has added about £70 billion to government spending.

Meanwhile white elephants like HS2 continue to roam around the jungle. With HS2 the route keeps being shortened while the cost and timetable keep getting lengthened. 

Unless the UK gets back to productivity growth, we are unlikely to get back to GDP growth to any significant extent.

Without GDP growth we might well temporarily fall into a vicious circle of revenues failing to grow fast enough to pay for expenditure and then rising taxes leading to even slower or negative GDP growth. This will eventually fail (a bit like companies who try to combat falling sales by putting prices up!). But a lot of damage will done while the strategy is being tried out.

Getting spending and taxes down is only one part of an agenda to end growth stagnation. The agenda needs to boost competition and reduce unnecessary regulation.

Without restoring growth, not only will our relative (and possibly absolute) living standards continue to decline but also we will be unable to pay for not just the levels of public service to which we aspire but even the levels of welfare and public services we already have. The need to turn this round is urgent

China's Belt & Road programme - Feb 2023 update

 Please click on this link:

China’s Massive Belt and Road Initiative | Council on Foreign Relations (cfr.org)

SMRs - a rather muddled approach by UK government?

 

US firm agrees to sell 24 mini nuclear reactors to UK customers

The American company’s direct route to market negates the need for government subsidy

ByHoward Mustoe20 March 2023 • 6:55pm

Last Energy £100m modular units can output 20MW of electricity, enough to power 40,000 homes CREDIT: Last Energy

A US-based developer of small nuclear reactors has signed a deal to sell 24 of its power plants to UK customers, putting pressure on rival makers including Rolls-Royce.

Last Energy said the £100m modular units, which are two-thirds the size of a football pitch, can output 20MW of electricity, enough to power 40,000 homes. They will be deployed in 2026 with no government funding required.

Several companies are developing small, factory-made nuclear power plants. It is hoped that making smaller units will lead to lower prices through “economies of scale”, by spreading the cost of development over many units.

For heavy energy users with 24-hour operations like steel mills and data centres, nuclear power is attractive because it consistently provides power, compared to wind and solar generation.

Nuclear plants can also provide heat which can be used in many chemical and industrial processes like cement making. Last Energy’s design can output 60MW of thermal energy.

The US company still needs to win UK regulatory approval for its designs and secure suitable sites before the deals are finalised and customers pay up.

But it still expects its first plant to be delivering electricity in about three years.

Last Energy said it has sought no government funding and many of the components will be bought from existing suppliers.

Mike Reynolds, the firm’s UK boss, said: “Our private-sector led approach to delivering new nuclear power supports the wider Government efforts to promote growth and investment in the green industries of the future.”

The plants have been sold via power purchase agreements, which lock buyers into long-term energy contracts and mean that Last Energy can seek more funding for clearing the designs and eventually building them.

Rolls-Royce has ambitions to build a fleet of small module reactors in the UK CREDIT: Rolls-Royce

Dozens of other firms are vying to bring a large-scale nuclear plant design to market, including Rolls-Royce, GE-Hitachi and several smaller start-ups.

The UK is seen as a key market because of Britain’s long history with nuclear power and its favourable approach to foreign investment.

Last week, Jeremy Hunt unveiled a new government unit, Great British Nuclear, which aims to get nuclear projects off the ground, focusing on the development of small, modular reactors.

Last week the Government dealt a blow to the ambitions of Rolls, which wants to build a fleet of the reactors in the UK, by opening the process up to competition. The British engineer’s £1.8bn models generate 470MW of power.

While Rolls could press on with foreign or private orders, the move left executives at a loss to explain why the Government would part-fund development to the tune of £210m and then raise the prospect of not buying its models themselves.

Last Energy has shunned this process and gone directly to customers and investors to fund its smaller units, which with a smaller price tag can be afforded by a wider range of customers.

Let's take a look at jobs and wages:

 

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JULIET SAMUEL

Now is the time to change our economic model

The budget may not reverse our shrinking workforce but higher wages could just be the spur firms need to innovate

Juliet Samuel

Wednesday March 15 2023, 5.05pm, The Times

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It was billed as the “back to work” budget. Jeremy Hunt promised to solve one of the most pressing problems holding back growth: “labour supply”.

There is a good reason why Hunt is worried about Britain’s shortage of workers. Wages are on the rise as employers struggle to fill a million vacancies. All else equal, wage rises exacerbate inflation, prompting consumers to bid up the cost of everything, which in turn raises pressure to increase wages. What results is the dreaded wage-price spiral, last seen in the 1970s.

So the government is right to worry about inflation, which erodes living standards and savings. But is it right to think the solution is to expand the workforce to strangle wage growth? I’m not so sure.

The conventional view is that rising wages caused by labour shortages are a very bad thing. Workers are one of the main costs employers face (the others being capital and raw materials). If these costs go up, the argument goes, innovation is harder and productivity suffers.

Economists point to the 1970s and successful modern economies to argue that keeping a lid on wage rises — as Germany or China have done encourages investment so wages can rise sustainably. “Good” wage rises, they’ll tell you, come only after you’ve put in the hard work of efficiency improvements.

If this model is universally true, it’s bad news for the world, not just the UK. Across the OECD, the share of the population that is working age has been falling since 2011. These market economies are also having fewer and fewer babies, so this trend will accelerate. High levels of immigration have not offset either trend despite generating political backlashes that make more immigration a hard sell.

The UK has an additional problem not seen in most other countries: a cohort who simply stopped working during Covid and haven’t come back. Hunt unveiled a plethora of measures designed to lure these people back into the workforce: removing the pension savings cap, changing the disability system so the disabled do not lose benefits if they work, toughening benefit requirements for the non-disabled and offering free childcare for babies (from next year). These measures will address “the two biggest barriers that stop business growing: investment incentives and labour supply”, he said.

In truth, although these measures may help to slow the workforce shrinkage, they will not reverse a trend decades in the making. In financial circles, it is easy to find pessimists who believe wage inflation is the new norm and that taxes on the working-age population will inexorably rise to meet the growing needs of the elderly.

What if this analysis has it all backwards, though? Wage inflation, rather than being a harbinger of decline, could just as easily be the incentive businesses finally need to invest in labour-saving technology. For years, our economy has been saddled with a long tail of firms that have failed to adopt basic productivity improvements, from new housebuilding techniques to bookkeeping software or automated seed-sowing devices. Many of these improvements do not require huge outlays or unimaginable new advances in technology. So why haven’t they happened? The likeliest explanation is surely that, with wages stagnant and the demographic cliff-edge yet to hit, companies simply have not bothered to upgrade their equipment or lay on training to improve workforce productivity.

Now, after a decade of ignoring the inevitable workforce crunch, employers have a pressing need they cannot fill in the usual way. This is a very different backdrop to the wage inflation of the 1970s, which forms the basis of the modern economist’s dread of high pay. Back then, the industries leading the charge to put up salaries were state-run and beholden to overwhelming union power. The working-age population was growing strongly and Britain was saddled with a whole backlog of useless capital stock, which had not been written down to its proper value. It could not have been innovated into profitability, even if the government had been the right vehicle to do it.

The situation now is different. The workforce is shrinking and will continue to do so even if the budget has its intended effect. This is happening in rival economies too. And the demand for new technology and workers who can deploy it is high, whether it’s heat pump installers, administrators or engineers.

What’s more, until the last year or so, the fear haunting many Davos panels and business-school essays was that automation would lead to mass unemployment. The solicitous intellectuals fretted: what were all those laid-off workers going to do?

Now, automation looks like the solution to our woes and high wages the trigger to spur investment in it. Those jobs that cannot be automated, such as social care, can soak up the workers whose jobs have been replaced by more efficient technology. There may be a mismatch between the skills required in our economy and the skills available, but that is not the same thing as a high wage problem. It is an education problem rather than a labour shortage.

Instead of asking how we bring wages down and fill the worker shortage, we should ask how we unleash the economy to fix this problem. If energy costs, poor access to training, shoddy infrastructure and planning regulations get in the way, the process of innovation could easily get stuck, replicating the barriers to progress that fed the 1970s wage-price inflation spiral. But that is not an inevitable.

In the mid 18th century, English and French glassmakers engaged in a competitive fight for market dominance. Delaunay Deslandes, the director of a French firm, thought his position secure because the English “could never make [glass] that would enter into competition with ours for the price. Our Frenchmen eat soup with a little butter and vegetables . . . Your Englishmen eat meat and a great deal of it and they drink beer continually.” English labour, in short, was just too expensive.

Deslandes was wrong. England’s high labour costs and cheap energy (coal) created the perfect incentive structure for innovation. Within a decade or so, English glassmaking was operating at a sixth of the cost of the French, despite paying workers more. What seemed to be our Achilles heel instead formed part of the formula for success. There is no reason why it should not be the case again today. If this government is serious about changing Britain’s economic model, now is its chance.