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Long-time fans of DC Comics’ Superman will inevitably remember the oft-spoken words uttered by Clark Kent moments before flying off: “up, up, and away!” As a kid, I was actually a bigger fan of the short-lived U.S. sitcom TV show, “The Greatest American Hero,” which aired in the early 1980s. In the show, substitute teacher Ralph Hinkley is given a suit with superhuman abilities by a group of aliens. But Ralph doesn’t know how to use the suit properly, and while he can fly the suit, he can’t land it which results in a never-ending series of crash landings. (Hard to believe this show was cancelled after just a few seasons, right?)
These juxtaposed superheroes sum up my current view on inflation. Prices are “up, up, and away.” And the big question we face now centers on the kind of landing we should expect.
More accurately I should say, prices are up, up, and… up! Copper, for example, is at an all-time high—up 94% over the last year and up 69% compared to two years ago. But copper isn’t alone. We are seeing higher prices across the board. The IMF’s Non-Fuel Price Index, which includes precious metal, food, and industrial inputs, is up 43.6% over the last year and 44.7% over the last two years. Include fuel prices, and prices are up 70% over the last year. And that’s if you can even get the product you want in the first place, as shortages and longer lead-times abound.
Prices are up for three core reasons:
- Base-year effects
- Misaligned supply chains
- Pent-up demand
Let’s take a quick look at each of these.
Base Year Effects
In the early months of the pandemic, the level of average prices fell. Fast forward a year and higher prices feel even higher when comparing them to the low base of April 2020. In other words, year-over-year growth rates can misrepresent how quickly prices are accelerating. This effect will fix itself in the coming months as year-over-year comparisons normalize. It’s also why I like to look at two-year-over-two-year figures.
Misaligned Supply Chains
As I illustrated above, year-over-year price increases (and therefore base year effects) are only part of the story. Supply chains in disequilibrium are another reason prices are up. This is especially true for transportation and logistics costs. Roughly half of airfreight capacity is in the belly holds of commercial airlines. When passengers stopped flying, and especially when international flights all but disappeared, airfreight capacity declined right along with it. Seat capacity is still down 40% globally. While domestic travel is picking up, it will be years before international travel returns to pre-pandemic levels.
Waterborne transportation costs are also up. The Shanghai Containerized Freight Index is up 291% over the last year and up 357% compared to two years ago. Container rates were never higher than $3,000 prior to 2020, but the Drewey composite index exceeded $5,000 for the first time in 2021. On some routes, like China-Rotterdam, the average rate has moved above $10,000. I expect logistics and transportation costs will remain elevated well into next year.
Normally during a recession consumers cut back spending on durable goods—things like cars, appliances, and electronics. Rather than replace these items, consumers often try to extend the useful life of these products when economic growth is slow. Think about getting an extra six months out of your clothes dryer or another year from your car. When money is tight, consumers typically have focused on services over goods. But this recession has been unique on many fronts. Services closed due to COVID mandates and while quarantining at homes, consumers opted to spend on goods. Moreover, massive fiscal stimulus ensured that money was not tight in aggregate. Real disposable income is up 9% from pre-pandemic levels but is flat when government transfers are excluded. These forces combined to create tremendous demand for electronics. In the U.S., spending on durable goods has been above pre-pandemic levels since June 2020, only months after the pandemic hit. Spending on durable goods is 25% higher than it was pre-pandemic. Spending on services remain down 4%.
And remember, all this demand came at a time when supply chains were misaligned, and transportation networks were in disarray. This created shortages and pushed out lead-times. Excess demand combined with shortages and longer lead-times to push prices higher.
As the economy reopens, spending on services is coming back. Restaurants are filling up. Traffic is returning. Stadium attendance is growing to capacity. Broadway (NYC) is opening. The return of services could potentially slow the sale of consumer durables. The proverbial two-edged sword will cut both ways. Price pressure will ease but so will demand.
Already we’ve seen demand slow as supply constraints have curtailed production and led to higher prices. Some consumers are taking a wait-and-see approach. This is just one of the fallouts of higher prices. Higher prices can hurt demand temporarily if buyers decide to hold off until prices come down. The opposite is the case if consumers and businesses believe these price increases are more permanent in nature. When inflation is rising, and it looks like price increases are likely to be more permanent, buyers want to pull demand forward so they can lock in the lower price. It doesn’t seem like this is currently the case, but it is something to watch for.
Another fallout of higher prices is weaker margins. While it’s nice to suggest we can pass prices on, that isn’t always the case. More realistically, manufacturers will at best be able to pass on some cost increases.
Prices are set to remain high through the remainder of the year and will likely remain elevated through the first half of next year. And that’s when the landing comes in. Will we have an elegant Superman landing, or a Greatest American Hero sand-in-your-teeth landing? Right now, price increases look generally transient, and a graceful landing looks possible. But there is a real risk that higher prices will be sticky, and the Fed is already behind in the battle to contain prices. If that’s the case, interest rates will need to move higher more quickly which could, in turn, slow the economy and drive unemployment higher.
Shawn DuBravac is the chief economist for IPC.
This article appeared in the July 2021 issue of PCB007 Magazine.