The world inflation: a sudden rise in prices with multiple causes and effects in most countries. This may sound complicated, but there are very simple reasons for it. Here are two examples:
– Inflation linked to demand
When there is a high demand for certain goods or services, it can lead to higher prices. It usually occurs when economies are recovering and people are confident and are spending more instead of saving.
Demand inflation begins with an increase in consumer demand. Sellers try to meet this demand by increasing supply, but when additional supply is not available, sellers raise their prices, which leads to demand inflation, also known as “price inflation”.
– Inflation due to rising costs
It is when the cost of producing goods or services increases and this increase is passed on to the customer.
And that’s what we’ve seen recently around the world. The Covid-19 pandemic and the war in Ukraine have disrupted supply chains and made it difficult for companies to produce and deliver their goods, but more on that later.
Global inflation: the winners… and the losers!
Like in every games, there will be a winner and looser…
Who’s the winner? There are not many of them…Nevertheless, they have the merit of existing:
They will, little by little, return to their equilibrium levels and emerge from the strange mysteries of so-called negative rates. This will therefore benefit savers. With the valuation of asset prices (with less risk premia), it is possible to perceive the opalescence of financial stability in the long term, with less systemic risk. It’s wordy, I agree, but the idea is pretty much that.
Indebted economic agents
If their income is indexed to inflation, the “stock debt/income” ratio falls mechanically. it’s painless deleveraging.
Investors who have property income indexed to inflation
The happiness of some is the misfortune of others, says the popular adage. Here, it is the tenant, in this case, who goes to the cash desk in “Fraiche”, under the lease contract that he will have signed with his landlord.
We had almost forgotten them. They are back like Arnold Shwarzenegger in Terminator 4, or swallows in the spring, which would have avoided the Southwest. Like the Phoenix rising from its ashes, banks and insurers are becoming profitable again. Magic of rising interest rates.
Your sagacity will have preceded me: The big winners are the people who have access to liquidity, namely:
- The banks
- Investment funds
- Hedge funds
- Large companies with a good rate of return
The losers of the game… in the world inflation
Mechanically, inflation penalizes creditors and favors borrowers because the real level of their debt decreases (for a loan not indexed to inflation, the sum returned is depreciated money).
Savers and investors
They who have fixed income such as bonds or money. It is not an increase in the savings account A this summer of 0.5% that will tip Europe headlong into the Metaverse and connected glasses.
Those who have a fixed income such as bonds, savings accounts or money. They don’t increase much but their interest is getting less and less.
Eeternal economic victims via their purchasing power and who will continue to take huge beatings, starting with the gas pump…Long live the bike, they tell us all the way through JT! (100 years of automobile research to return to the bicycle?
Isn’t it ironic?
Companies, without pricing power
(i.e. the ability to pass on the increase in their production costs in prices)
Economic sectors that depend on the purchasing power of others
Through recourse to debt: typically real estate in general.
(apart from perhaps defensives, the arms sector and a few commodity-indexed ETFs): if interest rates rise, like a weighted jersey on a slope of the Vercors in July, savings flows will return to less risky assets. This is already happening to Nasdaq tech stocks, which have been struggling for several weeks.
In summary the big losers from inflation are:
- Employees on fixed incomes (private and public)
- The unemployed,
- Temporary workers
- In short, at a glance, just about almost everyone
Why is inflation suddenly high?
Western countries are emerging from a very long period of very low inflation. We must indeed go back to the 1980s to find the current levels.
The phenomenon of inflation is very complex. It does not mechanically obey the classical quantitative theory according to which inflation is first and foremost a monetary phenomenon (an increase in the quantity of money in circulation sooner or later implies a rise in inflation). During the long phase of very low key rates, the central banks largely contributed to monetary creation without this sharp increase in the money supply having moved inflation (excluding securities and real estate).
However, the sudden rise in inflation has many reasons,(new window), both cyclical and structural. The main short-term, and therefore rather transitory, reasons are:
> a phenomenon called “base effect”. Inflation is usually measured over one year and, following two years of pandemic, the level of inflation that serves as a reference is particularly low;
> reopening after the pandemic. Since the resumption of activity after the Covid crisis, consumers have caught up with some of their deferred demand. During such a recovery in demand, it is quite easy for companies to raise prices a little bit without losing customers. Reopening also has supply-side effects: re-establishing supply and transportation chains is time-consuming and expensive. China’s zero-Covid policy (closing factories, even entire cities as soon as a few cases appear) makes this process even more complicated. Stronger demand meets reduced supply: prices rise;
> the war in Ukraine. Since February 2022, the Russian military intervention in Ukraine has driven up the prices of many raw materials (oil, gas, oil, wheat). The drop in Ukrainian exports is drying up supply on the markets and pushing prices up. Moreover, the sanctions against Russia force many countries to reorganize their supplies, a complex and costly process;
> massive fiscal stimulus. In order to avoid the collapse of economies and to maintain incomes, many countries have widened their deficits to set up aid programs. Thus, in France, public spending jumped by 4% in 2021 after +5.1% in 2020.(new window) In 2022, the government launched an aid program to support purchasing power. Some countries have implemented exceptional recovery programs, notably the United States (to renovate infrastructure and reduce the carbon footprint). This public spending stimulates demand and accentuates inflationary pressure;
> the weakness of the single currency in many Euro zones. The decline of the Euro started in 2021 and accelerated in 2022 and the euro reached parity with the dollar. The Euro also depreciated against other currencies such as the Swiss franc. This fall in the euro increases the price of imports, including the price of fossil fuels in particular, and thus reinforces the effect of imported inflation.
The main structural factors in favor of inflation are:
> the effect of “the law of supply and demand”. The pandemic has affected ways of life and work and has changed certain needs. Purchases of certain products (computer and electronic goods, home improvement equipment, etc.) surged during and after the pandemic and exceeded business inventories. Some components such as semiconductors are difficult to obtain, even out of stock: prices are rising;
> rising energy prices. After the lifting of Covid-related restrictions, energy prices rose massively. The consumer prices of gas, fuel and, to a lesser extent, electricity increased sharply in France between December 2020 and October 2021 (respectively by 41%, 21% and 3%(new window)). The trend will continue in 2022: energy is, for more than a third, the main component(new window) of the inflation rate. The depletion of fossil fuels, as well as the ecological transition will continue to put energy prices under pressure;
the monetary policy of central banks. To counter the various crises since 2008, the main central banks have practiced a monetary policy known as quantitative easing (new window), their traditional tools (in particular the fall in interest rates and reserve requirements) proving to be insufficient. This unconventional policy consists of massive purchases of financial assets, including public debt, to inject maximum liquidity into the economy, in order to revive the economy and inflation. For a long time, this policy has above all created inflation in financial assets (particularly equities) and real estate. Today, the colossal volumes of liquidity thus created face an economy whose production potential is more limited than before (effects of the pandemic and more fragmented global economy).
Inflation rates among members of the International Monetary Fund in April 2022. JJLiu112, CC0, via Wikimedia Commons
Who gets affected by World Inflation?
Inflation is a global economic phenomenon that affects various aspects of society. It refers to the sustained increase in the general price level of goods and services over time. While inflation can have complex causes and implications, it is important to understand its impact on different stakeholders. Here are some key groups that are affected by world inflation:
- Consumers: Inflation directly impacts consumers as it erodes the purchasing power of their money. When prices rise, consumers may find it more challenging to afford essential goods and services, leading to a decrease in their standard of living. They may need to allocate a higher portion of their income towards basic necessities, leaving less room for discretionary spending or savings.
- Businesses: Inflation can have both positive and negative effects on businesses. On one hand, businesses that can adjust their prices in response to inflation may benefit from increased revenues. However, rising input costs, such as raw materials or wages, can squeeze profit margins. Moreover, uncertainty caused by inflation can hinder long-term planning and investment decisions, making it challenging for businesses to forecast and manage costs effectively.
- Workers: Inflation can impact workers in several ways. If wages do not keep pace with inflation, workers may experience a decline in their real wages, reducing their purchasing power. Additionally, inflation can lead to higher living costs, affecting workers’ financial well-being. However, certain industries or professions that experience wage increases to match inflation may see improved income levels.
- Investors: Inflation can significantly affect investment portfolios. Certain assets, such as stocks, real estate, or commodities, may act as hedges against inflation, preserving or increasing their value over time. Conversely, fixed-income investments, such as bonds, may lose value in an inflationary environment, as the purchasing power of the fixed interest payments decreases. Investors need to consider inflation when making investment decisions to protect the real value of their assets.
- Governments and Central Banks: Governments and central banks play a crucial role in managing inflation. They implement monetary and fiscal policies to stabilize prices and promote economic growth. Central banks may adjust interest rates or money supply to influence inflation levels. High inflation can have adverse effects on the economy, including reduced consumer and investor confidence, lower foreign investment, and increased costs of borrowing for governments.
How to fight against inflation?
Fighting inflation is not easy. The main instrument is monetary policy: central banks have tools to make money more expensive and to reduce the mass of liquidities in circulation. However, monetary policy always acts with a certain lag, so it cannot cancel out one-off inflation spikes. Furthermore, to bring down inflation resulting from a mismatch between the money supply and the volume of goods and services, it is also possible to practice a policy that favors supply. Its downside is that it takes a long time to show results.
In order to contain, or even bring down inflation, the main central banks have made a change in monetary policy to make it more restrictive: reduction in the volume of purchases of financial assets and increase in interest rates. In the United States, the Federal Reserve (the Fed) quickly moved in this direction. As of May 2022, it began raising rates, first by 25 basis points (a rate hike of 0.25), then by 75 basis points. The US monetary authorities are particularly firm in their desire to contain inflation. The European Central Bank (ECB) reacted later: a first rate hike on July 27, 2022, then a new hike decided on September 8, 2022.
The current turn in monetary policy is unprecedented,(new window) because it concerns all the major economic blocs in the world. Its success, however, is not certain. In theory, monetary tightening slows down activity, investment and the speed of circulation of liquidities and should therefore lower the level of monetary depreciation. Its impact on economic growth and employment also needs to be monitored.
However, if the phase of high inflation persists, economic agents risk anticipating persistently high inflation. A race between wages and prices, as well as the rise in selling prices simply to anticipate higher supplier prices, could be the consequence. These expectations are notably influenced by confidence in the monetary authorities to be able to guarantee price stability. For a long time, the hypothesis of the authorities, including European ones, was that of simply transitory inflation, a kind of post-Covid inflation. But faced with the persistence of inflation, central banks have adjusted their analysis. This lag in appreciation can harm their confidence.
What developments for the next few months?
Inflation, like other economic quantities, evolves in rather long cycles. The long phase of low inflation could not last forever. Globalization is no longer as vigorous as before. The dynamics of world trade are weakening(new window) and a fragmentation of trade seems to be taking shape. This development can weigh regionally on the overall supply: a lower supply in the face of stable demand puts pressure on prices. The role and objectives (monetary stability, growth, etc.) of the monetary authorities are also questionable. Finally, a possible return of what economists call “second-round effects”, that is to say a spiral of prices and wages, can no longer be ruled out. It had largely contributed to the high inflation of the 1970s and 1980s.
In conclusion, world inflation impacts various stakeholders in different ways. It affects consumers’ purchasing power, businesses’ profitability, workers’ wages, investors’ portfolios, and governments’ ability to manage the economy. Understanding these dynamics can help individuals, businesses, and policymakers make informed decisions to navigate the challenges posed by inflation.