EC Current & Future Supply Side Inflation Shocks

Surging inflation is currently hitting the United States - but it isn't the kind of inflation that many people believe it is. Inflation can arise from a number of different sources, and money creation is only one of the sources.

Cost, Money, Debt, Finance, Economy

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The source of this particular bout of inflation is not money creation but supply side shortages. What we are seeing is a fundamental problem that is a separate problem from money creation. Now, that doesn't mean that we won't see inflation that results from money creation, but if we do - we will have two separate fundamental sources of inflation that are multiplicative in combination, with potentially explosive consequences.

There is another particular issue with supply side inflation - despite all their public assurances, the Federal Reserve does not currently have (and never has had) the monetary tool kit to deal with supply driven inflation. The supplies have to physically increase - and the Fed has no ability to do that.

This creates a situation for the 2020s that is more complicated - and more dangerous - than is commonly realized. Current government and political goals call for what is effectively the inducement of supply side inflation over the coming years, through restricting oil production, reducing pipelines, making energy more expensive, making labor more expensive, making cars and homes more expensive, and potentially raising the cost and reducing the supply of anything that requires the emission of carbon dioxide.

At the same time, the fiscal solvency of the U.S. government and current investment prices are effectively based upon ongoing abundant dollar creation by the Federal Reserve (with an equivalent situation in Europe). As we will explore in this analysis, keeping the dollars increasing and the spending up while the physical supplies shrink is like writing out a prescription for a particularly powerful kind of inflation.

This analysis is part of a series of related analyses, which support a book that is in the process of being written. Some key chapters from the book and an overview of the series are linked here.

Shortages Driving Price Increases

The 12 month rate of inflation as measured by the Consumer Price Index (CPI-U) rose to 4.2% in April of 2021, the highest seen in 13 years. On a seasonably adjusted basis prices rose by 0.8% between March and April, this is the equivalent of a 10% annual rate of inflation when annualized (if compounding is taken into account).

A somewhat ominous development that should be getting more attention is that the price of imported goods rose 10.6% between April of 2020 and April of 2021, as the pandemic shutdowns created many kinks in the global supply chain. A nation whose standard of living is based on consuming what it can't produce should keep a close eye on the price of imports, and the increase in import prices accounted for a disproportionate share of the total increase in the CPI.

Gasoline prices rose by 49.6% in 12 months - and this is before the price increases caused by the shutdown of the Colonial Pipeline in May.

The shutdowns associated with the pandemic have created numerous supply kinks when it comes to groceries in particular, with shortages jumping between products even as prices rise. The government reports that the 12 month increase in food prices was only 2.4% - but let me suggest that number is hard to reconcile with most people's actual experience in buying groceries over the last year.

According to the Kelley Blue Book, the average price for a new car reached $40,857 by January of 2021.  The reason for the skyrocketing car prices is a shortage in new automobiles that is being driven by a global shortage in the microchips that are critical for producing modern automobiles, along with other supply issues created by the pandemic shutdowns.

The shortage in new cars has spilled over into the used car market, as many buyers who would otherwise be buying new are buying used instead, either because of the shortage in supplies, or the higher prices caused by the shortage in supplies. This has led to an extraordinary 21% increase in average used car prices for the year ending in April of 2021.

An acute shortage of single family homes led to a 12.9% one year increase in home prices in the United States by March of 2021, as measured by the Freddie Mac Home Price Index.

A major contributor to the shortage and the increase in home prices, is the shortages of building materials and labor for building new homes, with the price of softwood lumber climbing 121% in the year ending in April of 2021.

To see so many inflationary price increases in so many categories at the same time is somewhat shocking, and quite different from what was seen in the 2010s. The unifying word is shortages. Pandemic shutdowns created shortages in the food supply chain, the global supply chain and other domestic supply chains. Shortages of computer chips created a shortage of new automobiles that then created a shortage of used automobiles. A shortage of existing single family homes created fast rising prices, even as this was exacerbated by a shortage of building materials helping to create a shortage of new homes.

This is what known as supply driven inflation, where it is shortages of supplies relative to demand that create rising price levels.

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Disclosure: This analysis contains the ideas and opinions of the author. It is a ...

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