08.02.2023

Stagflation

We are now hearing the word stagflation more and more often in economic summaries. But what is it in practice and how much does it affect everyone? Essentially the term stagflation stands for two different phenomena – stagnation and inflation. Stagnation is the recession of the economic cycle, the slowing of all processes and decline, when inflation usually accompanies economic growth. It is a huge problem when there is no growth and yet there is inflation. In a nutshell, stagflation is when the economy is in a global phase of recession, which is accompanied by rising prices. 

It is quite difficult to name the causes of the process unambiguously, because there are many of them. Our economy, which became global in nature about 50 years ago, is experiencing one of the biggest disasters since the fall of the Bretton Woods system. Perhaps even now we will see a paradigm shift from the Jamaican to some kind of new one, but that can only be guessed at. For now, let’s get back to the facts.

Let us begin perhaps with inflation. Inflationary processes in the civilised world are for most economically active agents some almost academic theses on a par with Marxist theories. Most adults who now represent households in the economy, people aged 20-45 have never experienced serious inflationary shocks, living in the U.S. and Europe, where inflation has been dangling from 0 to 3% for the past 20 years. There are actually many different similar indicators in economics, in particular inflation and the CPI (Consumer Price Index) are not identical, but here we will take the CPI. So when calculating the CPI, we usually take the consumer basket of households, which includes bread, gasoline and clothing. Thus, for some states it is possible to manipulate the index. That is, if you suddenly take a food basket, whose median growth rate is 20%, and shove in a product that grows in price by 0.1% and say that on average households consume it for half the basket, we get inflation of only 10%. This is the method mostly used by the authoritarians if they have a problem with public opinion. Normal statistical institutions, on the other hand, aim to provide the real picture in order to react quickly to the situation.

So why are the prices of individual products going up? Much of it has to do with the balance of supply and demand. When demand outstrips supply, the cost of a product goes up. However, our economy, as mentioned earlier, is now very complex and almost any product includes labour or goods from multiple countries and sources. Even growing potatoes now cannot be limited to seeds and water. Agrarians, because of the rising cost of human resources, are trying in every way to automate processes and use many modern means, such as satellite monitoring of crops, automated machinery to collect and analyse big data to determine what fertiliser is needed. All this is supplemented by the analysis of weather phenomena on the ground by local weather stations, as well as by satellite systems and analysis through supercomputers. So even this process is a very complex chain of interactions between companies and people from different countries and regions. At each step, labour costs are added, allowing products to continue to be produced and volumes to increase. Thus, an engineer who develops software for satellite systems invests his labour, which then falls on him in the form of an increase in the price of potatoes on the market. The price of potatoes goes up, and the engineer values his labour more expensive. And the result is a cycle of inflation. The example is very linear, of course there is always (almost always) competition, equalising prices, etc.

So, even without an increase in demand, the cost of the food basket can rise. And without inflation there is no production. If you can’t increase the price of products along the production chain, then there is no incentive to increase production and production as such. But rising CPI lowers our account balances. $100 today doesn’t equal $100 tomorrow. In a year’s time, an engineer may not be able to buy the same potatoes for his $100, which means he must invest these funds to at least keep up with inflation, or better yet, to outpace it.

Taking a strictly manufacturing economy – the secondary sector, we can assume that this 100$ should go to the development of some kind of production. That is, the engineer should give credit to, say, the production of harvesters for harvesting crops. But he will want a fee for the use of his money. And this fee will come back again in the form of additional costs to the farmers for harvesters. It’s a cycle again.

However, the secondary economy is not as critical in increasing the value of the final product and thus accelerating the CPI. The service sector spins up the inflation problem more acutely. The US, the largest economy in the world, is a tertiary economy whose GDP is more than 50% services. It is essentially something you cannot touch with your hands. These are services from hairdressers to financial advisers. And such things – particularly technology patents exported from Europe – are enough to drive inflation throughout the global economy. 

Previously, the appetite of Western suppliers was compensated for through growth in developed countries such as China and India. However, for some years now China and India have slowed down their growth and so cannot absorb global inflation as effectively. And now we are moving from healthy mature inflation to a phase of double-digit inflation, even in developed economies.

Usually, when prices run up, households try to get rid of reserves by diverting the funds to investments. Through buying property, businesses and eventually televisions and fridges that will be more expensive tomorrow. But what can you do if you have two fridges and you only use one anyway, property prices have already hit all imaginable limits, and there are no new avenues for investment? Nobody has managed to discover America a second time, or rather not yet reached Mars in this century. 

This whole situation is compounded by the amount of money in the global economy. In the last couple of years the Fed has printed 4 times as many dollars as it did in all the years before. The balance sheet of the ECB is already over 8 trillion euros. So in the case of the ECB it is just money in accounts. In other words, cash withdrawn from the economy. Or hidden inflation. Most of the free money in the market has rushed into the stock market, as in the real sector there is either less profitability, or simply no room for new money, no new markets. 

We’ll discuss the reasons for printing so much money in another article.

A combination of factors – a lot of money, not enough resources to use it in, rising resource costs, logistics, and saturation of markets – all this has contributed to inflation and slowed down production at the same time. 

Above is a picture of congested markets. Datastatic gives an example of how much retailer inventories have increased in the US. But the issue is not just in the US, it rather reflects the global picture, just the US data is bigger as always. Amazon sells all over the world and its inventory is up 46% when its sales are only down 7.6%, some retailers have had a serious decline in sales. This inventory situation is typical of a peak cycle or recession. However, everything is weighed down by inflation. If, in theory, people can start to eat more to consume ahead of inflation, they will not buy a tenth refrigerator. 

Under such conditions, households and their capital start looking for new opportunities. These opportunities are usually in new markets. The Chinese and Indian markets are in many ways not as interesting as they used to be. That leaves Africa, with its enormous population growth – which is a key market indicator. But, Africa is the poorest region. So are many of the big emerging economies in Asia. Accordingly it is clear that they will not buy cars, they need to sell them something that they would be able to buy. 

Just as conveniently, last year Facebook became Meta and set its sights on the meta universe. This reality doesn’t need railways, infrastructure or complex supply chains. All that matters is getting the cable to the user and making it cheap. The important thing is to give the user an immersive experience – most likely VR glasses.

Until recently, Taiwan was the only manufacturer of microelectronics chips. But today a colossal chip manufacturing plant is being built in America. Production is migrating to a calmer haven, away from the risks of authoritarian regimes and probably given all the above facts – not for nothing. We may soon be witnessing the momentous reopening of a new market, as happened in 1492. And perhaps we won’t have to fly to Mars to do it, just put on VR glasses.