Following the unsettled Covid years everyone was looking forward to 2022 being a more normal year. It has not panned out that way. Inflation has surged, particularly in the developed world, which is forcing central banks to reverse the policies of the last decade and to tighten monetary policy. Interest rates are going up, and stimulus policies are being reversed – the days of easy money are over.
Two of the factors fuelling inflation are rising commodity prices and supply chain disruptions. Let’s have a look at what is going on.
Commodity prices have surged over the last couple of months
The world still runs on oil, which is vital for nearly all modern activities. Over the last two decades environmental concerns have focussed on reducing the use of fossil fuels. This has meant that investment in new oil wells or coal mines has not been a priority. However, the global population has continued to grow and to become more prosperous, leading to the demand for energy to increase steadily. We are now in the position where demand for energy is outstripping supply, and the natural consequence is higher energy prices.
Food prices are going up worldwide. This is because large scale agriculture relies heavily on fossil fuels which are now so expensive. Much of the world’s arable land is given over to industrialised grain farming for both human requirements and animal feeds, and fertilisers, which are manufactured from natural gas, are vital to achieve high yields. Farming is also highly mechanised and therefore food prices rise when we have high oil prices.
Fertiliser and diesel are the biggest input costs for modern farmers
Metals and minerals such as iron ore, nickel and copper are vital to all economies, and demand is steadily increasing as emerging economies become more prosperous, and developed countries need to maintain and upgrade existing infrastructure. Many of us are not aware that the transition to a greener economy is also very metals intensive and this has created surging demand for minerals needed to feed new solar and wind power installations, lithium-ion batteries for electric vehicles and grid-scale utility storage.
The war in Ukraine has amplified already surging commodity prices because both Russia and Ukraine are key commodity exporters. Russia is a major producer of oil, coal and fertilisers and is the world’s largest exporter of natural gas, nickel, and wheat, while Ukraine is the largest exporter of sunflower seed oil. These commodities saw particularly steep increases following the start of the war in Ukraine.
The commodity boom is likely to be with us for some time because it takes years for the exploration and development of mines and oil and gas fields
Many industry experts point out that the easiest and highest grade deposits have already been exploited, so new mineral deposits and oil wells will be harder to reach and much more expensive to extract. If this plays out it would inevitably lead to higher commodity prices in the longer term.
South Africa benefits from higher commodity prices because we export large quantities of minerals and agricultural products. This is behind the record trade surpluses we have enjoyed recently. Higher company revenue has resulted in increased taxes for SARS and allowed the Treasury to reduce SA’s debt burden this year. A sustained commodity boom would be very beneficial for the SA economy.
Covid 19 shutdowns played havoc with global supply chains
Another factor driving inflation is that the supply of products from cars to computer chips has become less reliable and more expensive due to changes in the functioning of global supply chains.
Covid 19 shutdowns played havoc with global supply chains. It was hoped that this would be a short-lived phenomenon, however with the chaos at ports showing no signs of abating and prices for a vast array of goods still rising, the world is absorbing the troubling realization that time alone will not solve the great supply chain disruption.
The USA and European countries were shocked during Covid to discover how much of their manufacturing base had been outsourced to cheaper jurisdictions such as China. They are now scrambling to on-shore these essential industries, and the Ukraine/Russia conflict only adds urgency to the task. Since sophisticated products require components and processes from around the world, this is not something that can be done either quickly or smoothly.
It is likely to take many months, and perhaps years, before the chaos subsides. Cheap and reliable shipping may no longer be taken as a given, forcing manufacturers to move production closer to customers. After decades of reliance on lean warehouses and systems that monitor inventory and summon goods as needed, manufacturers may revert to a more prudent focus on holding extra capacity.
Global markets have enjoyed a long period of increasing globalisation, low inflation and very low interest rates (at least in developed countries). These trends are now rapidly reversing as countries seek to bring manufacturing back home. Inflation is way above central bank targets and raising interest rates to curb this inflation may soon tip the US and Europe into recession. 2022 looks set to be as volatile as the Covid years.