Supply chain disruption and the hidden realities behind inflation

[6 min read]

Dear Reader,

Although the war began in February, supply chain disruption is hitting home now, as are many other knock-on effects from Russia’s invasion of Ukraine.

The war in Ukraine began with the Russian invasion on 24 February 2022. US, EU, and allied nations’ economic sanctions were announced in stages from late February through March. New sanctions are being announced almost daily. Some have delayed effective dates and are just coming into effect now. That much is apparent from the headlines.

What isn’t apparent is how the economic impact plays out. The effects aren’t immediate. Some shipments were literally on vessels and trucks when the sanctions were announced, and those deliveries were completed.

Certain dollar payments on Russian Government debt were allowed to be made even after Russian banks were kicked out of SWIFT and other international payments systems. This was done to avoid losses for holders of that Russian debt, which includes giant asset managers such as BlackRock and individual 401(k)s that have Russian debt buried inside ETFs touted by Wall Street in recent years.

In some cases, suppliers and intermediate manufacturers had inventories they could use to keep assembly lines running, even though new supplies weren’t arriving. So, despite the formal severity of the sanctions, much less has changed in the economy than many assume.

Now, the real impact is beginning to emerge.

This article reports that Germany has announced the ‘early warning stage’ of its multi-stage emergency plan to deal with natural gas shortages. The early warning stage involves intense monitoring of natural gas usage, supplies, and new gas sources. As the shortage becomes more severe, Germany can cut factory output, require citizens to turn down thermostats, raise prices, and implement other more extreme measures. In the worst case, Germany will ration natural gas so that hospitals and essential services receive what they need. Other users will be required to shut down.

This shows the folly of most sanctions. They’re supposed to be economic weapons aimed at Russia, but the big loser will be Germany, which faces hardship and economic recession because of its dependence on Russian energy.

Sanctions aren’t very effective weapons. They’re more like boomerangs returning to hit the person who launched them.

With inflation, reality is hidden behind the numbers

Inflation isn’t a guessing game anymore — it’s here. Every time you buy petrol at the pump, groceries at the supermarket, or book a plane ticket, the price increases are staring you in the face. That much is clear.

What is less clear are the thousands of ways that inflation hurts you that are invisible. The most important of these is that inflation is a tax.

The government borrows dollars, and you earn dollars. Taxation is one way that governments take money from citizens to pay off government debt. But taxes are unpopular and hard to get approved by Congress.

Inflation works much better. It reduces your real income since the dollars you earn are worth less. And it reduces government debt because the money the government owes is easier to repay for the same reason — the dollars are worth less. So inflation works the same as a tax increase, except that you can’t see it and Congress doesn’t have to lift a finger.

Another damaging effect of inflation is described in this article. It has to do with the difference between nominal income and real income. Nominal income is the amount of money you make measured in dollars. Real income is the amount those dollars are worth when adjusted for inflation.

For example, your wages might have gone up 5% (that’s the latest annualised wage increase in the US as of 1 April, according to the US Labor Department). That’s a nice gain, but with inflation of 7.9% (also the latest data we have), your real wages went down 1.1% (5 - 7.9 = -1.1). You got a raise in nominal terms, but you took a pay cut in real terms.

[Editor’s note: The original article from which this piece was adapted was written in early April.]

Many people aren’t familiar with this simple formula for converting nominal gains to real gains. But everyone is familiar with how long your paycheque lasts.

More and more Americans are finding that by the time they pay the rent or mortgage, put gas in the car, buy groceries, and pay some medical bills, they’re out of money. They’re waiting for the next paycheque. Nothing is left over for a dinner out, a new pair of shoes, or a visit with family members.

The economic consequences of this decline in real incomes are huge. If you buy coffee at the grocery story instead of going to Starbucks or go jogging instead of paying a visit to the gym, then service and retail industries all around the country start to suffer. This can be followed by layoffs at some of those outlets and even more cuts in discretionary spending as the laid-off workers tighten their belts.

A lot of inflation today comes from the supply side, not the demand side. It has to do with supply chain disruptions and the cascade of consequences from the economic sanctions because of the war in Ukraine. None of these situations will show any improvement in the short run.

There’s practically only one way for the Fed to stop inflation. That’s by raising rates until they cause a recession. It’s a fair question whether the cure (recession) is worse than the disease (inflation). The one thing that is certain is that consumers are fed up and will be taking their frustration out on politicians at the ballot box this November.

All the best,

Jim Rickards,
Strategist, The Daily Reckoning Australia

This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.

Dear Reader,

‘Pound Crashes to All Time Low’ is the headline at Bloomberg:

‘The pound plunged almost 5% to an all-time low after Kwasi Kwarteng vowed to press on with more tax cuts, stoking fears that the new Chancellor of the Exchequer’s fiscal policies will send inflation and government debt soaring.’

The pound is down against the dollar. But why? Our own Tom Dyson asks:

‘Why is the dollar so strong when the economy is entering recession, the stock market is in correction, and the government is $31 trillion in debt?’

He might have added that the dollar is losing value at an 8.3% annual rate.

What is the meaning of it? Is Britain headed toward more inflation? Mr Kwarteng is the UK’s new treasury secretary. His tax cut policy is similar to Donald Trump’s tax cut in 2017. It is designed to light a fire under the economy.

Investors expect that it’ll light a fire under inflation instead; they’re selling pounds and buying dollars.

The dollar is still the world’s go-to currency. But as the go-to dollar goes up, other currencies are looking like goners. Especially those from emerging markets. They borrowed cheap dollars. Now, they’re expected to pay it back in much more expensive currency.

And what about Americans? Didn’t they borrow dollars too? And doesn’t each rate hike make their dollars dearer and their debts harder to pay? Are they goners too?

The sneaky tax

Last week, we took up a provocative subject. Maybe inflation isn’t so bad for everyone. And maybe the feds — in the UK as well as the US — are not as eager to fight it as they appear.

But let’s back up.

There are universal rules. And there are policies. The rules — don’t kill, don’t steal, drive on the right side — benefit just about everyone. The policies (regulations, programs) always benefit a few at the expense of the many.

And inflation?

Inflation is a policy. It’s a tax. Like all taxes, it lands on some harder than others. And the farther you go down the wealth mountain, the harder it falls.

For the first 20 years of this century, inflation was a gift to the elite. The Fed inflated the currency and bought bonds, putting US$8 trillion in new money into Wall Street. This new money drove down interest rates and increased asset prices while leaving consumer prices scarcely touched.

But the Fed’s claptrap zero interest policy caused people to borrow far too much money. That excess is now embedded in debt — US$30 trillion for the US Government, US$60 trillion for business and households. Somebody’s got to pay that debt.

And this may be the only thing the Republican and Democratic elite agree on — it ain’t gonna be them.

Right now, the Fed is raising the carrying cost of debt. Stocks and bonds have come down — 15% to 20%, some of them even more.

Jerome Powell says he will keep at it, openly discussing a Fed Funds rate north of 4%. With every step, Powell believes he grows taller, following in the giant footsteps of Paul Volcker, and positioning himself for a Nobel prize…or at least the cover of TIME. He will be the man who saves the planet by defeating inflation.

But getting control of inflation will require more exertion. Paul Volcker had to put the Fed Fund rate all the way up to 20% — fully 700 basis points ABOVE consumer price inflation (CPI) — in order to bring inflation under control.

The Fed has a long way to go.

Survival mode

Remember, it’s either inflate…or the Bubble Economy dies. And if it dies, the graveyard gets crowded…with bonds, stocks, businesses, loans, mortgages, real estate — almost all assets. Much of the wealth of the elite gets buried.

And while asset prices go to Hell…the federal government goes into purgatory. Not completely dead, but with much less room to manoeuvre.

From my colleague Dan Denning:

‘The US government cannot afford to pay $1 trillion in interest on its trillions of dollars’ worth of debt that must now be refinanced at much higher interest rates.’

Expenses would have to be cut back — drastically. No more ‘stimmies’. No more giveaways. No more unemployment incentives. No more cheques to Ukraine. No more ‘green energy’ transition; the feds would be in survival mode.

The rest of the economy would be backpedalling too…reeling from much higher interest expenses. ‘Liquidity’ (ready cash when you need it) would disappear. Lenders would see defaults coming from every direction. The US would enter a deep depression, probably accompanied by riots, strikes, social chaos, and political violence.

Is that going to happen?

We don’t think so. An honest man when he can’t pay his debts, admits it, and accepts the consequences. He tightens his belt. He goes meekly into Chapter 7 or Chapter 11. He tries to make amends.

But a man with US$30 trillion in debt and a printing press in the basement? He has another option: inflation. Every year, inflation reduces his debt burden.

He’s happy to print money. He pays his debts with his phony notes. And everyone wonders why things are getting so expensive.

Regards,

Bill Bonner,
For The Daily Reckoning Australia