Why smart government action is needed to solve pandemic-induced inflation


“Furious greed which, without any thought for the human race, hastens for its own benefit.” So, Roman Emperor Diocletian described inflation in his edict of CE 301 setting maximum prices for over a thousand commodities.

Without the help of modern economists, Diocletian was unaware that the rise in prices was due to the upheavals caused by half a century of civil war, barbarian invasions, the plague, the flight of precious metals for Eastern luxury and the debasement of the currency.

The Western world must have learned a similar lesson in the early 1970s, with the contraction of energy prices, the deterioration of the American balance of payments and the end of the convertibility of the dollar into gold. Attempts to freeze prices and wages have failed, and the price cap on oil and gas has led, as one would expect, to shortages.

Queues at petrol stations are the emblematic image of this era. Stagflation has married economic recessions with rising prices, a challenge to mainstream economic orthodoxy.

Inflation was thought to have been defeated after the early 1980s. Independent central banks, tight monetary policy, weaker labor rights, globalized supply chains, free trade and the rise of China as a global low-cost manufacturing center have all played a role.

Inflation rates in Europe hovered around a target of around 2% during the 2000s and frequently fell to around zero after the global financial crisis. The concern then turned to Japanese-style deflation and economic stagnation.

2021 has radically reversed that picture. Year-on-year inflation in November was 6.8% in the United States and 4.9% in the euro area. Traveling across the United States provides glowing evidence: unavailable hotel staff, expensive food, empty shelves and almost inaccessible Covid-19 testing.

Global raw materials are in the foreground. In the past year, the prices of liquefied natural gas have tripled, coal has doubled, petroleum has increased by 50 percent, aluminum by 40 percent and copper by 25 percent. Electricity prices in Europe have reached record highs, forcing industries to shut down.

Asset inflation is also significant, with the S&P 500 stock index gaining 27% over the year. In dollars, the price of oil rose by 50% during 2021, but in Bitcoin it fell by 6%. A Bitcoin would have bought 673 barrels at the end of December, against 635 barrels at the beginning of last January.

However, we are not in a stagflation like the 1970s: on the contrary, because the economy is booming. Shortages of goods in Western countries are shortages of wealth, and insignificant compared to those in Venezuela, Lebanon or the former Soviet Union towards its end. But the factors behind low inflation are, at least temporarily, reversed.

The immediate driver is the pandemic. An unprecedented drop in travel and work was followed by an almost equally striking surge. Government relief programs put money in their pockets; it was spent on physical goods more than on services, driving up the costs of materials and shipping.

Health restrictions worsened maintenance delays and bottlenecks: 2,200 flights were canceled around the world on Monday due to lack of crew. Employees have been more willing to quit their jobs for better terms and higher pay, amid falling unemployment and greater acceptance of online work.

10% to 15% increases for steel, field staff and drilling rigs will hamper an increase in shale oil production next year. Even though oil prices have fallen since late November, the administration of US President Joe Biden will continue to pressure Opec + to increase production.

Echoing Diocletian, best-known Democratic Senator Elizabeth Warren wrote to US oil companies that “these price increases are driven by greed and profits from energy companies.”

New energies are also affected: Supply chain problems and rising polysilicon prices have pushed up the prices of solar PV modules by 50%, after a decade of steep declines.

But longer-term factors are also at play: a growing hostility to migration that causes labor shortages and a desire for “managed commerce” to protect advantaged voters. The era of expanding free trade may have come to an end, with the rise of Sino-American hostility, the refusal of the United States to adhere to the Asian trade pact, which the country itself had orchestrated and the absurd quagmire of Brexit.

The experience of the slow recovery from the 2008-09 financial crisis, a decade of near zero interest rates, and massive pandemic-induced stimulus packages combined with the heterodox economics of modern monetary theory to increase the comfort of high levels of government spending. .

As the century progresses, climate change will cause more damaging weather events, requiring greater resilience and spare capacity, and the unpredictable shutdowns of energy systems, mines, ports, roads and railways.

Meanwhile, the push for a low-carbon economy means the early retirement of polluting but still productive assets like coal-fired power plants and diesel cars. Despite rising electricity prices, Germany closed three of its last six nuclear power plants on Friday, in line with its ideological anti-nuclear policy. Until now, restrictions on investment in fossil fuel production have preceded the drop in demand.

The green transition will also require huge amounts of materials such as rare earth minerals, copper, silver, tin, lithium, cobalt and nickel. These are often extracted or processed in a very limited number of countries, especially in China. Attempts to “relocate” the production of future energy systems such as batteries and electric vehicles to the United States and Europe will increase costs.

Yet there can be a middle ground between ever higher inflation and a recession. The government’s choices in terms of spending and money creation will be crucial.

Over time, supply chain frictions will ease and energy costs will moderate as expanded and improved low-carbon systems are used at scale and critical bottlenecks are overcome. . Smart government action to improve productivity will prove superior to imperial edicts.

Robin Mills is Managing Director of Qamar Energy and author of The myth of the oil crisis

Update: January 3, 2022, 3:30 a.m.


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