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Money & Markets: Supply chain problems are caused by money supply

The Covid pandemic has pushed too much money into the global financial system, causing inflation and creating the current supply problems.

Hysteresis was a word bandied about by the Fed chairman at the beginning of the Covid pandemic. It’s a word engineers will immediately grasp but not one generally understood. To me that was an especially scary word to use in the circumstances. A situation so dramatic that might throw a systemic switch in global society is tantamount to suggesting that a revolution might take place, and those things generally end up very badly and take generations to sort out. Happily, the overwhelming of barriers seems to have been limited to economics.

As we find ourselves at the exit of the pandemic (at least we hope this is where we are), hysteresis is back with a vengeance, this time as the lag and resistance needed to be overcome to get the world economy running smoothly again rather than as a barrier breached by dramatic events.

In my first novel way back in 2005, one of the characters says the world economy is like one of those fancy £50,000 complicated watches, in that with one bad knock the whole thing can stop ticking.

The book wasn’t called 'The Armageddon Trade' for nothing, but the premise was that the global, practically invisible, supply chain that makes everything work in our world so smoothly and cheaply, and is vital to our comfy way of life, might not be so robust as we think.

As I write, this reality is coming to the fore.

‘Just in time’ is a wonderful thing, except when things go wrong. ‘Not in time’ can be a nightmare on any scale, and as the world economy revs up after global Covid lockdowns, the global economic engine is not spinning up as smoothly as could be hoped for. It is backfiring like an old-fashioned internal combustion engine as it is cranked into life.

With 20:20 hindsight it’s pretty obvious there was and is going to be major disruptions and we are now seeing them appear as gaps on shelves, queues at petrol pumps and shocking home energy bills.

With luck, capitalism will find a way out of the mess quickly, even within an environment of almost unprecedented and inflexible regulation. There is, however, more to these conniptions than meets the eye.

Markets have and are catapulting various commodities to new heights. As I write it is natural gas, and soon we could well see oil nearing $100 a barrel. Prices of commodities could get a lot higher and for a lot longer than expected. The transitory inflation we have been reassured by central banks is all we will suffer, is suddenly looking baked-in for a decent amount of time to come. Energy prices are appearing front and centre in this trend and energy shortages are popping up around the world and most surprisingly in China, even after they have shut down the phantom menace of Bitcoin mining.

You will read how last winter was cold, how Asia wants more gas, how supplies are tight, how x is doing y to z, it’s the Russians, it’s China, it’s (invent your own narrative here). It might be true and, when the wind doesn’t blow up a gale this winter and that is to blame for a shortage of electricity, it might just be nothing to do with that and all to do with too much money in the financial system.

What has money supply got to do with it?

Energy is work. That is what, in essence, energy is: latent work. Work is not a particularly fungible thing. It takes a long time to get more work out of a unit of energy by engineering and technology. Money, on the other hand, can be typed into the world from a keyboard at a central bank. When more money is made, if it has no application, it becomes worth less. Meanwhile work remains immutable. So as money devalues so the notional price of energy goes up because a joule is a joule and can’t be bought on the cheap without consequences.

Energy is denominated in dollars and the dollar is being debased and so energy is being rebased upwardly in dollars.

When you offer to pay people in debased currency they won’t play along.

So there is a shortage of lorry drivers not just in the UK but in the US and in Europe, where the narrative says drivers will come. There is of course no shortage of drivers, just a shortage of drivers prepared to haul themselves into a cab. Quadruple their pay and the shortage will vanish soon enough. But then up will go prices and everyone else will strike for more pay and up will go prices.

The supply chain disruption is created by inflation, and supply chain disruption is creating inflation. This is of course a vicious circle but what is powering it is excess money in the system.

The Covid pandemic has created much more money while destroying quite a lot of wealth and, to rebalance that, the price of things will have to reach a new equilibrium. There is no ‘reset,’ no going back. The world is poorer. It has a lot more money in nominal terms, and governments are in pivotal fiscal straights with the future unresolved. It’s a cocktail for volatility and disruption.

Let’s hope capitalism isn’t dead, because in the past it has been shown to be the best doctor for these types of post-traumatic periods.

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