Money & Markets: Engineers will likely survive this round of inflation
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Governments’ response to the current high inflation should be to protect the industries that actually produce stuff, which is good news for the people who will refill the battered supply chains.
Do you remember when ‘spin’ was a new idea and ‘spin-doctors’ were a new concept? Well, here we are 25 or so years later and it has become hard to believe anything. This is a bad situation made worse by finding ourselves with a novel and worrying business configuration. What just happened and where are we heading?
As I am sure my audience of engineers love to do, I will try and simplify as much as possible. Covid and actions to combat it have brought us to a point where inflation is baked into the global economy and interest rates are going up. For some time to come, the sovereign deficits of the major global economies are going to grow, while that ‘real’ GDP - after adjusting for inflation - is set to fall.
You will likely hear the word ‘reset’ a lot going forwards when it comes to markets, economics and even politics, but there will be no such thing. We are not going back to a previous state, there will be rebalancing to get matters to a new equilibrium.
This will all happen through markets because they are the fastest, most transparent and cheapest way equilibrium is reached, but the set-up to reach that point will come from government via central banks and other financial engineers in government.
The key worry for most will be interest rates. When they go up, things get bad for people and business. Well, yes and no. In the past, rising interest rates were used as a blunt instrument to make it hard to borrow as much as it was to make it expensive to borrow. We’ve all paid 18 per cent interest on our credit cards. Was that a problem? Generally no, because the liquidity of the availability to borrow money in the moment was the key, not the interest rate.
If you take away the throttling of the ability to borrow, or roll borrowing when interest rates go up, not much changes. Theory suggests a key component of inflation is ‘inflation expectations’, so if you put up interest rates you tamp down on those expectations, even if money is on offer and even at the current low base rates.
So, a government flushes its economy with cash to bridge the Covid crisis. Then does it go in reverse and flush its economy down the drain? That’s obviously a rhetorical question. Instead, it does as much as it can to restrain it and rolls out the ‘spin.’
This is great news for engineers, who historically have been the first to be tipped into the shredder by a government's interest-rate tightening cycles. If government policy to kill inflation is not to kill the economy, then they will not be herded to the insolvency practitioners like in days of old. That is a good start.
Where are we? The supply chain is not disrupted simply because lorries and boats can’t get from A to B: it’s because it destocked from end to end. To get rid of inflation, supply must recover to get back to the deflationary ways of technology-driven production. That will take time - and loose money. Loose money is not the same as cheap money. That will drive more inflation, but it will drive GDP growth which will help repair government budgets.
Nonetheless, inflation stays (so engineers should be thinking about how they seamlessly raise their prices to escape the consequences).
Liquidity will be maintained and, as per the surprise of the US Federal Reserve statement earlier this week (May 4), liquidity tightening moves are suddenly going to run at half the proposed rate, even as interest rates went up 66 per cent, from 0.75 per cent to 1.25 per cent.
Liquidity is what causes inflation and it is liquidity that will be used to try and keep inflation at current levels for the medium term. The key to all this is that the pandemic punched a hole in the world’s wealth and right now continues to do so via lockdowns in China.
Rebalancing can’t replace that loss of wealth. It can hide it and inflation does a great job of that.
Back with our futures, if liquidity is going to be broadly maintained and the answer to our immediate problems is restocking and rebalancing the supply chain, then we are in the sweet spot.
You can’t fix this situation with words. You can’t fix it with financial engineering. A good haircut and a nice tie won’t make it better. Stuff has got to be made. Going forwards, for three to five years, processing stuff, turning one kind of stuff into another kind of stuff, doing the sort of things engineers do - often unnoticed and unsung - is going to be where it is at.
Of course, there is plenty of scope for the spin doctors with their nice coiffures, bright ties and financial engineers to mess it all up, but if they don’t, while the ‘phone sanitisers’ of Douglas Adams’ book The Restaurant at the End of the Universe may have a tough time of it, the people refilling the supply chain are going to have a good run - as will the shares of the companies they work for.
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