How can inflation be transitory if supply chain disruptions are here to stay?

Increased US-China rivalry, coupled with Covid-19, has caused unprecedented disruptions to supply chains, threatening global production
The last thing the world needs is for inflation to trigger a disastrous stock market or debt crisis

Anthony Rowley

Published: 3:30am, 23 Aug, 2021

Why you can trust SCMP

How often have we been told by people who cannot see beyond their noses that “everything is under control”? The latest example of such myopia is the attempt to brush off inflation as “ transitory” when clearly, it almost certainly is not.

The complacency and faux confidence exhibited by the US Federal Reserve and other central banks about inflation surely means their fear of alarming markets – and the possibly dire consequences for bloated asset prices and global debt – has overcome prudence.

The “transitory phenomenon” theory holds that the recent inflation surge in wholesale and, to a lesser extent, consumer prices in many countries is due to supply chain interruptions, caused primarily by the Covid-19 pandemic’s impact on activity and output.

Prices have risen alongside demand, driven by fiscal and monetary stimulus, even as output falls. This will right itself, say many economists, so just ignore it and it will go away. For central banks, this translates as “don’t panic, look through it and keep on pumping stimulus”.

Even respected figures such as International Monetary Fund chief economist Gita Gopinath argue that economic overheating is unlikely to push inflation well above central banks’ comfort zone. The past four decades, she says, have shown that inflation is unlikely to go above, and stay above, the Fed’s 2 per cent target.

Perhaps not, but past evidence hardly provides a good guide to recent events. As the Institute of International Finance (IIF) observed recently, “... the world has never seen the kind of global supply disruptions we are seeing now”.

A key reason that inflation appeared to be a thing of the past, despite massive monetary and fiscal stimulus to counter successive financial crises and the pandemic, is that global production has surged, underpinned by vital supply chains. But those links are being cut.

Well before Covid-19, former US president Donald Trump was throwing a wrench into the works of US-China trade with tariffs and other restraints. Supply chains that underpin global production, including supplies of manufactured goods to the US, began to suffer because, to employ a different metaphor, if you throw a boomerang at someone, you shouldn’t be surprised if it comes back and hits you in the head.

It did, and as US Treasury Secretary Janet Yellen acknowledged recently, Trump’s trade wars hurt America. And yet her boss, US President Joe Biden, has continued, even stepped up, supply chain wars with China despite the damage that Covid-19 has wreaked on them – both in and beyond the US.

As the IIF notes, a key question is “whether supply chain disruptions are a significant force to push inflation higher or are merely a short-lived blip”. More countries “are seeing companies mark up their prices due to long delivery times and the rising cost of inputs”, it said.

The IIF believes the personal consumption expenditure index (the Fed’s preferred index) will hit 2.6 per cent by the end of the year, against a Fed projection of 2.2 per cent. And this is subject to upside risk from “more pass-through into core inflation than historical mappings capture”.

Compared to past inflation episodes, this may not sound too scary. But what really matters is that the spectre of inflation is reappearing at a time of record high asset prices (in stocks, bonds and real estate) and global debt.

Financial markets have become like spoiled children, ready to throw a tantrum and scream their heads off if they do not get what they want. Central banks have been willing and able to indulge them safely while global supply conditions remained stable.

Inflation is coming, and the world economy’s fate depends on the Fed

If the supply of goods falters, as it is doing now, prices will rise, as they are doing now, and central banks will face a terrible dilemma over raising interest rates – as they are doing now. Smelling uncertainty, investors will try to cut and run, and it will be a case of après moi, le déluge (After me, the flood).

If there is a risk of panic among stock investors, that could be nothing compared to the despair of borrowers for whom even a modest rise in inflation and interest rates could spell pain, even disaster, given the sheer indebtedness of governments, companies and households.

What the IIF calls the “global debt mountain” was already US$281 trillion in February, of which US$205 trillion was in mature markets. “The non-financial corporates sector is increasing reliant on government support – exacerbating pre-existing vulnerabilities”, it said, with household debt also very high.

With the Covid-19 crisis intensifying again amid a building fear of climate change havoc, the last thing the world needs is a stock market or debt crisis.

This is not the time for America’s China hawks (or China’s US hawks) to be dictating geoeconomic policy on critical issues such as supply chains.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs