Less cash to splash: despite the spin, there’s nothing transient about inflation
Households now face a reduction in spending power, unless after-tax wage increases match accelerating price rises. In Australia, the September 2021 quarter consumer price index rose 0.8%, or 3% over the year. In the US, the corresponding measure has reached 6.2%, the highest in nearly 30 years. Official figures probably understate the true extent of cost-of-living increases.
Having underestimated inflationary pressures, central banking “soul searching’’ has yielded an emollient oxymoron: “longer-lasting transitory factors’’. Errant hobgoblins within nebulous supply chains are to blame. But there are three factors, two of which pre-date the pandemic, whose effects are overlooked.
First, higher prices reflect Covid’s long economic shadow, especially debt incurred to prevent economic collapse. In 2020, global government debt increased by 13% of gross domestic product to a new record of 97%. In advanced economies, it rose by 16% to 120% of GDP. With government spending running above tax revenues for the foreseeable future, debt levels will increase further. Corporate debt in advanced economies was 102% of GDP at the end of March 2021, compared with 92% before the pandemic. Much of the borrowing was to cover lost revenue due to lockdowns and border closures.
These debts will have to be paid for in higher taxes, where incurred by governments, or income, in the case of businesses. This will flow through into prices.
Businesses have to repay hidden crisis liabilities, such as deferred rents, debt payments or assistance. Some industries, such as travel, granted credits to avoid cash refunds. Providing the service will result in costs but no new revenue. Restarting operations as well as meeting post-Covid-19 occupational health and safety requirements will require new expenditure. Firms will price to recover these pandemic losses and higher operating costs.
Slow return of mobility will affect revenues for businesses, such as tourism and educational exports, as well as labour costs. Australia faces workforce shortages. The absence of about 300,000 holiday visa workers and international students is hampering agriculture and hospitality. A shortfall of skilled foreign workers affects major infrastructure projects central to the recovery. Higher wages and incentives may be needed to attract and retain staff.
Australia faces higher transportation costs due to freight capacity constraints, partly driven by a shortage of seamen from developing countries, where vaccination rates lag. This is one economic side-effect of global vaccine inequity.
Expansive government spending, low rates and central bank largesse (purchases of government debt) have driven up property prices, which feeds into housing costs and rents. Porno
graphic real estate and share prices have boosted wealth, encouraging some older workers to accelerate retirement plans exacerbating labour market pressures.
Second, the low inflation of recent decades was influenced by global trade, with its emphasis on cheap production in low-cost locations, such as China. Over recent years, rising global power competition, especially Sino-American wrangling, has led to trade barriers and sanctions which retard cross-border commerce and access to technologies and finance. This affects supplies of critical components, such as semiconductors and raw materials, creating shortages.
The pandemic-induced emphasis on national control over strategic supplies and products exacerbates this trend. The US wants to secure crucial supply chains for semiconductors, batteries, rare-earth elements and vital pharmaceutical ingredients, on grounds of national security and ensuring that jobs and production remain in America. The required industrial reshoring may result in less-efficient production driving a structural rise in costs.
Third, the inflationary effects of environmental factors and resource scarcity are largely ignored. Frequent extreme weather events, associated disruption of economic activity and damage to facilities is expensive. Commercial insurance availability and cost is increasingly problematic. Looming food and water shortages also affect price levels.
The poorly thought through energy transition, with underinvestment in traditional and new energy infrastructure, may mean persistent high energy prices. Carbon taxes, levies on carbon-intensive imports and compliance with greenhouse gas reduction targets will add to costs. Perversely, hoarding of commodities as a hedge against inflation creates further price spirals.
None of the identified factors are transient. Even Covid-19, considered temporary, may become endemic. The likelihood of substantial ongoing health costs (vaccinations or treatment) and intermittent interruptions to activity have not disappeared, as the recent resurgence in Europe shows.
Former German central bank president Karl Otto Pohl compared inflation to toothpaste; once out of the tube, it is difficult to put back. The problem is complicated by the limited policy tools available to deal with inflation. Lower interest rates or printing money can’t eliminate the virus to restore mobility, reverse trade barriers, create commodities or reduce weather extremes.
As US president Joe Biden’s waning popularity shows, hip-pocket issues and economic uncertainty are important to electoral fortunes. Facing an election, Australian politicians have taken note, each side bloviating as superior guarantors of stable prices.
• Satyajit Das is a financier and author whose latest books include A Banquet of Consequences – Reloaded (March 2021) and Fortune’s Fool: Australia’s Choices (due for release in March 2022)