World War: Against Inflation

The words “world war” evoke images of two groups of countries fighting each other. That was how world wars I and II happened. However, the world wars that we are witnessing in this millennium are of a different kind – all countries of the world fighting a common enemy.

Such a scenario has been the subject of sci-fi books and movies – the earth trying to save itself from aliens, meteors, etc. The world wars that we are actually witnessing are not as fanciful but can impact the world as much.

Actually, in this millennium what we are witnessing might be called world war III. The first world war (not as prominent but still going in the background) is against climate change; the second world war against the pandemic is just drawing to a close (hopefully). The third world war, which is against inflation, can be considered the result of the second world war against Covid-19. Some might consider the 2008 financial crisis is another of these.

When Covid struck, all the governments and their central banks girded up to save the economy and people. The governments used fiscal policy via tax cuts and positive actions (furloughs, unemployment protection, benefit payments, etc.) while the central banks used monetary policy to effect rate cuts and bond buying (QE) to keep the economy active. All these were the appropriate actions, considering the magnitude of the pandemic and the suffering it inflicted on the people.

The turning point came with the arrival of the vaccines. Fears of death subsided, lockdowns were eased, and, to borrow a popular phrase, “livelihood” regained its place at the top of the priority table, pushing “life” behind. However, the money pumped into the economies remained – in the hands of corporates and individuals. The more disposable income in the hands of the people, the more the demand for goods and services.

An increase in demand is good for the economy because it means brisk business. Goods fly off the shelves; more vehicles come on the road; more apartments are sold and so on. This directly results in more employment. And the government gains in the process too – a spurt in economic activity means more taxes. Thus, there is all-around prosperity.

Thus, it should have been a happy scenario, but was marred by supply-side issues. Lockdowns resulted in factory closures. Ships got stuck in ports. Labor mobility was impacted as the workers returned home during lockdowns. The shortage of semiconductors hurt many industries. In short, production got impacted and the outputs were lesser.

In effect, the situation was one in which the people wanted to buy more but things were not available in sufficient quantities. This is precisely what economists call “too much money chasing too few goods”.

As is well-known, inflation is primarily the product of demand and supply (and inflationary expectations). Demand and supply work in opposite directions – an increase in demand elevates prices while an increase in supply depresses the prices.??The post-pandemic scenario was a recipe for high inflation as the supply went down just as the demand was booming. This meant, that instead of restraining each other, supply and demand both worked to push up the prices.

The war between Russia and Ukraine proved to be the last straw on the camel’s back. It effectively cut off Russian supplies of fuel, thereby setting the oil and gas prices on fire. This naturally stoked inflation further.

Thus, prices started shooting through the roof in almost all countries. However, the governments and central banks persisted with the so-called loose money policy as they were not sure whether the pandemic is really behind. Looking back, one can say that they were behind the curve in recognizing the dangers of looming inflation and should have tightened earlier. However, this is the advantage of hindsight – it is always correct.?

So now the firefighting is on to contain the inflation. US FED has trained its hoses of rate increases on the fire of inflation. This tight money policy is usually supposed to halt the economy on its tracks and cool it down. However, that is not yet happening. The economy is blazing with record lows of unemployment, increased job openings, and wage increases. Thus, it looks like the FED has to continue with the rate hikes for some more time. And, eventually, the economy has to and will slow down.

The US being the polestar in the economic world, other countries have to respond to the rate increases whether they like it or not. The problem is that while the US economy continues to be hot despite rate cuts, the other countries are not so lucky. They have started raising the rates, and the constrictive impact on the economy is being felt already. They also need to buck up for the ripple efforts of the eventual slowing down of the US economy.?

So the situation does not look great. The trillion-dollar question is when inflation will abate.??It is like predicting the winner of FIFA 2022 or the T20 world cup – one can guess but nobody is sure. It is hoped that the kitty built up during the pandemic will get exhausted soon by the spending that has happened since then. After all, once you have bought the latest I phone and taken an extended vacation, your wallet is bound to come back to its normal size.

So what should individuals do? Pretty much what you do when a hurricane rages. Sit tight, preserve the essential things, and wait for it to pass. In the meanwhile, the brave ones with extremely deep pockets may want to avail of the discount sale of shares and other assets.