Why High Inflation Is Not Going Away — Ever
At least not in the Lifetime of Anyone living Today.
In January, the inflation rate for the US climbed to 7.5 % from a year earlier — the highest rate in 40 years. As a result, the consensus among every economist I have read or listened to is that it is time to raise interest rates to rein in inflation. Most financial analysts expect this to bring inflation down to the 3 % range by the end of the year.
It’s probably true that with the right monetary policy, every peacetime economic crisis in North America from the 1920s to 2008 was solvable (at least in hindsight). But financial engineering will not work this time because this is not primarily a financial crisis. Economists don’t get that. Yet.
Why the Old Tools won’t work
Yes, many of the causes of present inflation are transitory, brought on by supply-chain disruptions due to the pandemic. But some of those causes are not related to the pandemic, and they run deeper and will last much longer. The forces that will propel high inflation for years to come are more related to changes in the earth’s natural environment than monetary policy, wages, transitory supply-chain disruptions, or consumer demand. These deep-current inflationary forces include the dwindling of natural resources and, of course, the continued acceleration of climate change. Raising interest rates will not slow down desertification, rebuild roads and bridges destroyed by floods, restore drought-inflicted farmlands, or extinguish wildfires. On the contrary, higher interest rates may pour fuel on a fire as the world scrambles to keep up with the consequences of a changing natural environment.
British Columbia (BC), where I live and which supplies much of North America’s lumber for building housing, is running low on harvestable wood. We have pretty well reached the limits of what we can (or should) take from old-growth forests. Another major limiting factor is the massive pine beetle kill that has devastated our forests over the last couple of decades. These forests have not had time to grow back to become harvestable timber. The pine beetle kill has been directly linked to global warming because the winters here have ceased getting cold enough to kill off most of the beetle larvae. Lumber prices are now up more than double from just two years ago.
Last fall, an atmospheric river caused extreme flooding, which destroyed roads and bridges and devastated farmlands in southwestern British Columbia. But this sort of environmental catastrophe has not been confined to BC. California, an important source of fruit and vegetable produce for both the US and Canada, continues to suffer from drought. Parts of the US have been hit harder than usual recently by tornados and hurricanes. During the last few summers, wildfires raged in several US states. Natural disasters formerly thought of as once-in-a-century events are now becoming commonplace.Both the cost of rebuilding (damaged infrastructure, factories, and homes) and the beefing up or relocating to accommodate environmental changes, will inevitably and inexorably be passed on to consumers.
Lumber is not the only resource that is in short supply to sustain the world’s ever-increasing population. The price of oil is rising almost daily now. The switch to renewables is happening too slowly, but even if there was more political will tospeed it up, there are difficulties in overcoming resource limitations. For example, the price of lithium, an essential ingredient for electrical storage batteries, has risen fivefold in the last year.
As I write this, the price of oil is over $90.00 a barrel. This hits not only your gas tank but every item you purchase made of plastics — your fleece jacket, a new carpet for your home, a new toothbrush, hundreds of items in your home, many of which will require replacing eventually.
The US is now the world’s biggest oil producer, but fracking is environmentally and financially expensive.
China, home to factories that manufacture essential components for industries worldwide, has several problems that will keep world supply-chains constrained. The first, which is relatively near term, likely affecting the next couple of years, is Covid. The highly transmissible Omicron variant presents a new challenge to China’s zero spread policy. The tools China used to contain the previous variants will be severely tested by this one.
Will China be able to continue with its zero-spread policy? There are two likely scenarios. The first is that the government will loosen its policies, in which case the virus will surge through the population as it has elsewhere. Workers will get sick, and factories will slow down or even shut down. This scenario is unlikely. The government has too much face invested in the present policy. The more likely alternative is for the government to continue enforcing lockdowns wherever the virus is detected. That will most likely be akin to a kind of whack-a-mole for years to come. Like the first one, that scenario would also incur factory slowdowns, lockdowns, and supply-chain disruptions.
The longer-term problem that China has is water. Despite monumental projects to divert water from the more rain-rich south, the diminishing northern China fossil aquifers remain essential for agricultural irrigation. The Chinese wells are drilled deeper every year, and more arsenic comes up with the water. When these aquifers run out, and they will, they can’t be replaced. I don’t know how this can be managed. If China has to begin importing a lot more food, it will be expensive and add to the cost of their outputs.
The Economists are stuck in the Last Century
Dr. Paul Krugman, a Nobel Prize-winning economist, wrote early last year that inflation would be transitory. He has since admitted that he was wrong on that one but still believes that inflation can be curbed with the right monetary policy. His view now, along with the vast majority of economists and financial analysts, is that Fed chairman Jerome Powell will have a tough time getting the timing and level of raising interest rates just right — enough to stifle inflation without causing a recession. Many commentators have likened the process to walking a tightrope. It might be more realistic to compare it to walking on air without the tightrope. I cringe to think what will happen when the analysts (and the stock market) realize they are striding over an abyss.
Mohamed El-Erian, a well-known investment manager and commentator, has been berating chairman Powell for some time for not raising interest rates sooner. Much as I respect the intelligence of Dr. Krugman and Mr. El-Erian, I believe they are both somewhat blinded by financial orthodoxy; this is not merely a financial crisis, and it can’t be solved with merely financial tools. I can’t fault chairman Powell too much for being hesitant. No matter which button he pushes, the outcome will not be good. And he will likely be blamed.
Unlike manufactured products and groceries, some asset classes will decline in price, at least in the shorter term. There is a frenzy in the real estate market right now, as buyers know that this will be the last chance to get in on the present ultra-low mortgage rates. The average home price in both the US and Canada went up 18% last year. For the US, it was the biggest annual increase in 45 years. The average assessed value of homes in my small town located on the west coast of Canada went up by a staggering 30%, perhaps influenced by people abandoning big-city living to seek refuge from Covid and climate change.
But what happens when interest rates do go up? How many people will be able to stretch even further to buy a home and make payments? Many homeowners may not even be able to afford to refinance after their term expires. I remember watching the panic selling by real estate speculators in the early eighties when interest rates rose to combat inflation. And I recall the ensuing crash in the elevated Canadian housing market. Now I see a similar likelihood in the US as well. Home prices in Canada back then declined by about 40%. The coming real estate price pullback may be worse. Or better, however one looks at it. Cash, usually an eroding asset during inflation, may trump most others for a while. Speculators (offshore and domestic) who got themselves overextended may have to sell at discounted prices.
But longer-term, with the limiting supply of raw wood for building materials, the price of housing will remain expensive. After the next pullback, grabbing a home to live in will be like musical chairs. When the music stops, the divide between owners and renters in North America will become even more extreme. It doesn’t have to be that way. Renters in several European countries — where homeownership is much less common than in North America — don’t have to worry about being evicted or facing arbitrary rent increases. Vienna is often touted as the most livable city in the world. Yet most people there live in public housing, which is nothing like it is here or even like anything most North Americans can imagine. But that is the subject for another essay.
The Fate of Lytton, BC — The Shape of Things to come
Last June 29, the town of Lytton BC, located north of latitude 50, set a new Canada-wide temperature record with an incredible 49.6 C (121.3 F). The next day the village, built on a site that has been inhabited for more than 10,000 years by indigenous people, burned to the ground. Some 85 % of the buildings were destroyed as a wildfire raged down the valley.
Calling in the Tab
We have been running a tab with planet earth for some time now. The bill is coming due. Our factories and farms (especially meat farms) have been pumping out products with little regard to long-term environmental consequences. Yes, most of us have become concerned about pollution and future global warming. But what most still haven’t realized, and economists seem entirely blind to, is that we are already beginning to pay the costs. We have incurred a debt that will now be added to every household product we purchase. And it’s a debt that is not going away soon. It will be handed down for generations to come.
Is there an upside to all of this? Maybe. If enough of humanity wakes up to see that we can’t keep recklessly exploiting nature indefinitely. But as a species, we are in denial, so I’m afraid it’s going to have to get worse before that can happen. Are there possible solutions? Yes, I believe so. We’ll explore that subject in future essays.