Commentary: Inflation above 4% could become a reality | Comment
Federal Reserve Chairman Jerome Powell will be challenged to bring inflation down to 2% and keep it there.
During the decade between the global financial crisis and the COVID pandemic, inflation averaged below the Fed’s target, but all the stars were aligned. It is unlikely to happen again.
Coming out of a severe recession in 2009, the global economy sported substantial excess industrial capacity, fracking dramatically increased US oil and gas production and depressed prices, a very efficiently transported agricultural commodities from major producers to all corners of the globe, and US monetary policy was well managed by Fed Chairman Ben Bernanke.
Competition has spurred factory consolidations, just-in-time logistics and wage arbitrage, but the risks have been laid bare by the semiconductor industry. Fires at two factories – in Japan and Germany – would have caused a global shortage of chips even without a pandemic. Similarly, the infant formula crisis was largely caused by a factory closure.
China’s mishandling of COVID is driving production cuts from low-tech manufacturers in Vietnam that rely on Chinese components for behemoths like Apple and Toyota.
The Shanghai COVID lockdown highlights the vulnerabilities inherent in a heavy reliance on China, and businesses and governments are scrambling to diversify and improve the resilience of supply chains.
Treasury Secretary Janet Yellen calls it “friend shoring.”
Clothing retailers like Gap are buying more from Central America. The US government is seeking to diversify sources of lithium, rare earth minerals, medical supplies and semiconductors away from China and Taiwan. If successful, all of this will make America safer, but is terribly expensive and fuels inflation.
Climate change is increasing temperatures and causing droughts and floods in the western United States and around the world. These lead to shortages of affordable grains, vegetables, dairy products and cooking oils.
The disruptions caused by the Russian invasion of Ukraine, the resulting sanctions and embargoes on exports, such as India for wheat and Malaysia for chickens, have accentuated the adverse consequences of rising temperatures worlds but barely created them.
NATO’s policy of avoiding direct confrontation with Russia and limiting arms and intelligence supplied to Ukraine prolongs the war – possibly to a stalemate – driving prices into crisis in oil markets and food increasingly permanent.
The private sector is moving away from fossil fuels as quickly as emerging battery technologies and scarce and vulnerable reserves of lithium and other critical materials allow. However, Biden administration policies that limit U.S. oil producers’ access to leases unnecessarily raise gasoline and natural gas prices and fuel inflation.
In Europe, eliminating dependence on Russian oil, gas and coal by developing alternative sources of fossil fuels and accelerating wind and solar development will be costly, but what will happen to Russian oil and gas that he does not buy will be more important.
Russian oil can be rerouted, but its natural gas will be much harder to sell elsewhere. Some will be disconnected, which will increase the long-term prices of liquefied natural gas around the world.
President Joe Biden’s refusal to engage the UK and EU in meaningful free trade negotiations that eliminate tariffs and re-enter the Trans-Pacific Partnership weakens our most loyal and effective allies. This will cause Asian countries to question the sustainability of the US commitment to countering Chinese expansionism and limiting trade and supply chain investments that would optimize the relocation of friends.
Domestically, rising interest rates may slow, but will do little to halt the secular rise in house prices and rents. He is overly driven by restrictive zoning for land near cities and working from home and the resulting demand for more residential space.
The pandemic has prompted US and European governments to overspend and print too much money. Witness the nearly $3 trillion in additional post-pandemic bank deposits and cash held by U.S. households and nonprofits that incentivize consumers to spend even as interest rates rise.
The West’s rearrangement to counter Chinese and Russian expansionism must be paid for with higher taxes, less spending on social programs, or larger budget deficits enabled by central banks printing more money.
My bet is on more money, more demand, more inflation.
But our Federal Reserve Chairman tells us that money supply doesn’t matter. He is aiming for a soft landing, but remember that 11 of the 14 tightening cycles since World War II have been followed by recessions. His words do not inspire confidence.
Paul Volcker is best known for killing double-digit inflation in the early 1980s. It is often forgotten that over the next 10 years the annual rate of increase in the consumer price index was in average of about 4%.
We’re more likely looking at 4% inflation than 2% over the next decade – if we’re lucky.
Pierre Morici is an economist and professor emeritus of business at the University of Maryland, and a national columnist.