Inflation, currency and supply bottlenecks


“The constant refinancing of the debt of companies of questionable viability also leads to the perpetuation of overcapacity as a key process of economic progress, such as creative destruction, is eliminated or limited.”


One of the arguments most used by central banks regarding rising inflation is that it is due to bottlenecks and that the recovery in demand has created tensions in the supply chain. However, the evidence shows us that most commodities grew in tandem in an environment characterized by a high level of spare capacity and even overcapacity.

If we analyze the rate of utilization of industrial and manufacturing production capacities, we see that countries like Russia (61%) or India (66%) are at a clear level of structural overcapacity and capacity utilization of production which still remains several points below. than that of February 2020. In China, it is 77%, still far from the pre-pandemic level of 78%. Indeed, if we analyze the main G20 countries and the largest industrial and raw material suppliers to the world, we see that none of them has production capacity utilization levels greater than 85%. There is a large capacity available all over the world.

Inflation is not a transport chain issue either. Surplus capacity in the shipping and transportation sector is more than documented and in 2020 new capacity has been added in both freight and air transportation. Ships delivered in 2020 added 1.2 million Twenty Foot Equivalent Units (TEUs) of capacity, with 569,000 TEUs of capacity on Ultra Large Container Ships (ULCVs), vessels with a capacity of over 18,000 EVP, according to Drewry, a shipping consulting firm. International Air Transport Association (IATA) chief economist Brian Pearce also warned that the capacity problem is increasing in calendar year 2020.

One of the important side effects of the chain of monetary stimuli, low interest rates and fiscal stimulus programs is the increase in the number of zombie companies. The BIS (Bank for International Settlements) has highlighted this phenomenon in several empirical studies. Ryan Banerjee, senior economist at the BIS, identified the constant policy of lowering rates as a key factor in understanding the exponential increase in zombie companies, those who cannot cover their debt interest bills with profits from ‘exploitation. The constant refinancing of zombie corporate debt also leads to the perpetuation of overcapacity, as a key process of economic progress, such as creative destruction, is eliminated or limited. Low interest rates and high liquidity have perpetuated or increased the global installed excess capacity in aluminum, iron ore, petroleum, natural gas, soybeans and many other commodities.

Why does inflation increase if overcapacity continues and there is sufficient transport capacity?

We have forgotten the most important factor, the monetary factor, or some central banks want us to forget it. “Inflation is always and everywhere a monetary phenomenon”, explained Milton Friedman several decades ago. No more money supply directed towards scarce assets, be it real estate or commodities. The purchasing power of money is decreasing.

Why did they tell us there was “no inflation” before COVID-19 if the money supply was also increasing massively?

The big difference between 2020 and previous years is that before, the Federal Reserve or the ECB increased the money supply to a level equal to or below the levels of money demand (measured as demand for credit and use of money). ). For example, the increase in the money supply in the United States has been close to 6% with global demand for dollars increasing between 7 and 9%. In fact, the world maintains a $ 17 trillion dollar shortage, according to Luke Gromen of Forest for the Trees. This keeps the dollar or euro relatively stable and the perception that inflation is low. However, there were red flags before Covid-19. There have been protests all over the world, including in Europe, against the rising cost of living. Global reserve currencies export inflation to other countries.

What happened in 2020?

For the first time in decades, the Federal Reserve and major central banks have increased the money supply well above demand. The response to the forced shutdown of activity with the massive printing of money generated an unprecedented inflationary wave. The economy did not collapse because of a lack of liquidity or a credit crunch, but because of the lockdowns.

The 2020 monetary tsunami launched a global boomerang effect with three consequences: Emerging market currencies fell against the dollar because their central banks “copied” US policy without the global demand for the US dollar. The second effect has been a disproportionate amount of funds to risky assets plus more flows to take overweight positions in scarce assets. This excess money pushed investors from underweighting commodities to overweighting, generating a synchronized and abrupt rally. The third key factor is that extraordinary measures typical of a financial or demand crisis have been taken to mitigate a supply shock, generating an unprecedented increase in money without additional demand for credit. More money in scarce assets is not an increase in price, but a decrease in the purchasing power of money.

What’s the risk?

The history of money since the Roman Empire still tells us the same thing. First, the money is aggressively printed with the excuse that “there is no inflation”. When inflation rises, central banks and governments tell us it is “transient” or due to “multi-occasional” effects. And when it grows, governments present themselves as the “solution” imposing price controls and restrictive measures on exports. It is not a theory. All of us who lived in the seventies know this.

This is why it is dangerous to pursue conglomerate actions as an inflationary bet… Because when price controls and government intervention increase, margins collapse.

The risk of stagflation is not low and so-called value stocks are not a good bet in this environment. In stagflation, commodities with tight supply dynamics, gold and silver, high margin sectors and stable currency bonds support a portfolio. However, most sectors are underperforming as we saw in the 1970s, where the S&P 500 delivered very low returns, significantly below inflation.

What can be different from other episodes?

Only a drastic reaction from central banks can change it. However, the question is:

Will central banks tighten their policies when public deficits soar? Even a slight increase in sovereign yields can generate a debt crisis.

Will they react to what is clearly – as always – a monetary inflationary process?


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