The Monster Called Inflation

Dear friend,

Inflation is probably the hottest and most discussed topic across the world at the moment. It is also one of the most confusing topics, confusing to both discussants and economic managers alike. No thanks to this subject called 'Economics' that has never been straight forward (now you get why all economists always end with 'ceteris paribus').

This article is not to bug you with economic theories, but to show how difficult economic policies can be, and how each decision can affect you and your quality of life. I am confident you will learn one or more things from this.

The basic definition of inflation from my high/secondary school days says that inflation is the persistent rise in the price of goods and services. In other words, inflation is an observable economic phenomenon that shows its presence via rising prices in a clearly defined economy. The core impact of this rising prices is that your purchasing power reduces. Think for a moment that your monthly budget for 5KG of meat is $50 (meaning $10/KG). What happens when a price increases to $12? Yes, you got it, your $50 can no longer get you 5KG - you can only have 4KG. If everyone feels this shock, it impacts the economy in a negative way.

Inflation can be classified into as many types as you want. I personally think it boils down to a cause-driven classification, in which case I think it should just be limited to 2 or 3, namely, cost-push inflation, demand-pull inflation, and probably, imported inflation (a quasi-type which could be an offshoot of cost-push). There are many more types that could be derived from the 2 above (hyper, creeping, galloping, wage-push; just name it). In this particular episode, my focus is on cost-push inflation.

Cost-push inflation is rising prices driven primarily by increasing cost of input. Think of the factors of production - land, labour, capital, entrepreneur. Labour and capital are probably easy to understand - when wages go up, you expect it to reflect on prices of goods and services. The same is the case for capital as a factor of production (machines/equipment) - when the cost of machines increase, producers understand that to replace those machines will cost more. To ensure they remain in business, prices are increased such that they don't have to suspend operations if their machines break down. For the other 2, they are not as obvious. You may wonder - how can land as a factor of production add to inflation? Well, it does add. Think of land from the perspective of a factor of production (natural resources employed in the production process). A classic example is crude oil. If drilling or all of the relevant exploration cost increases, or when the global oil cartels decide to keep price up for whatever reason, cost of production for a gas supplier, a filling station, and even energy bills go up. Entrepreneur on the other hand is the aggregator of other factors, the risk taker. Entrepreneur could evaluate the risk of the business and decide to put additional premium on the stress he/she passes through. As a result, more profit/interest as the case may be demanded. To realize more profit, this is priced into the product thus driving inflation.

Now, let's get into the discussion proper. Have you wondered why virtually every country under the sun is grappling with inflation? In most parts of the world, central banks (which are the institution of government charged with price stability) have deployed virtually all tools in their arsenal. Instead of moderating inflation, we are having some sort of galloping/run-away inflation. (It is good to talk about some of these tools that the central banks can deploy to deal with inflation. Hopefully we have an extensive discussion about this in a subsequent part.) Again, why have the central banks and agencies of governments failed to control the global inflation? The answer is simple - the global institutions that can deal with the type of inflation we are experiencing are not ready to deal with them. It's like being diagnosed of by a doctor of Nasal Polyps (an inflammation or a non-cancerous growth in the nose) but your doctor chooses to give you paracetamol only while it waits to see if the paracetamol will do the magic.

Across the world, central banks have deployed monetary policy tools such as increasing interest rates (a typical effective tool to manage some types of inflation which unfortunately raises mortgage rates), buying back bonds (to deal with the impact of interest rate increases - funny, right?), selling bonds (to mop up cash in the system on the assumption that such inflation is driven by too much cash in the system). Some have even deployed certain fiscal policy measures such as cutting government spending (to slow down the economy), raising taxes (which effectively reduces your disposable income and sometimes worsens the situation - think where interest rate is raised and your mortgage rate increases, prices of goods and services have gone up, but government still feels that you are the cause of the inflation, hence decides to tax you more to reduce your spending powers). In any way you look at these combinations, they on their own can't solve the rising inflation. Why?

What happens when a doctor makes the right diagnosis but recommends the wrong medication? Simple - the ill-health lingers and sometimes gets even more complex. This is where we are at this time.

So first, every economic leader across the world agrees on one thing - the current global inflation is largely supply-side driven. What does that mean? It means that they agree that the cause of the current raging inflation is not because you are not paying enough taxes, not because your wage/salary increased, not because you are buying 7KGs of meat a month instead of 5KG, not because more people are buying/asking for more KGs of meat, not because money supply outpaced the 2021 levels (even though we can argue that there was free money in some countries during the pandemic), and not necessarily because more people are buying homes (on mortgage). They all agree that global output lags the pre-pandemic output. They agree that there are challenges with global supply chain first caused by the pandemic and while heading to recovery, was hit by an even raging problem. Indeed, they agree that the current global inflation is driven for the most part by the power play of the global superpowers who chose to test their might (without properly engaging) in Ukraine. They agree that this is the problem, yet, they turn blind eyes from doing everything necessary to de-escalate the issues.

Thus, as you read this, please understand that the current inflation will rage until the supply shocks are dealt with. In other words, don't expect any miracle, it will take some time for things to moderate. While countries keep raising interest rates, your pockets will gradually keep drying up as mortgage rates increase; borrowing costs will grow and this will reflect as increase in price of goods and services. While countries sell bonds, less cash will be left for banks to lend. While governments cut expenditure, less will be spent on social services and probably, wages may drop to accommodate the expenditure cut. While governments raise taxes amidst of all of the foregoing, you will fare worse, the pressure of all of these will surely place you worse than where you were before and immediately after the pandemic.

The challenge? You have so much so little you can do. Plan your monthly expenditure, cut down on non-necessities, keep some cash, and keep faith that soon, the power players will resolve this game they are playing with all of us.

Happy to get your views. Thanks for your time.