Inflation has been in the news around the world in recent months - according to our politicians and media, 'We now have a cost of living crisis'. As if we hadn't noticed. No need to look further than the fuel pump or supermarket tickets to know that prices have risen sharply.

This week we look at inflation from different perspectives - what it is, what causes it, what is happening this time, and how we might respond.

We are not economists or financial experts, so the following comes from a position of observation, experience, and an exploration of logic, rather than needing to be right with respect to the the finer theoretical points. And we accept that there are those of us wrangling with inflation from the perspective of classical economics and finance, and there are those that are focused on 'real resources', 'real people' and the work of the 'real transition', and perhaps some in between. 

The definition (Wikipedia) - In economics, inflation refers to a general progressive increase in prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money. The common measure of inflation is the inflation rate, the annualised percentage change in a general price index.  (The yellow highlighted bits should concern us all!)

With this definition in mind, let’s look at the main contributing factors comprising the inflationary conditions and the consequences of them, as we currently experience it (this thing we call inflation).

Changes in demand (the average consumer)

With the advent of Covid and over the past 2 years, our behaviour and consumption patterns (generally) shifted from tourism and other service type sectors - to manufactured goods. We spent much more money on our homes, cars, furnishings and comfort items while confined through the pandemic. 

Additionally, this demand was turbocharged with significant additional money being added to the system by governments, to support the population and economy through the pandemic. New money was added to the whole system and into peoples pockets - especially those in low socio-economic groups, that usually have to spend what they get.

Changes in Supply - Cost structures and throughput

The pandemic triggered the start of supply chain disruptions and their ongoing reconfiguration. It also caused declines in production in some sectors, which directly impacted the availability of goods, usually by way of a reduction in supply or at least delays to supply.

While the availability of goods has been constrained, the costs of production and the final price of them has increased because of downtime, process inefficiencies and transport cost increases. For example, Global freight pricing per container is now approaching $10k per container, (if you can get one) while two years ago this was closer to $1400. Rates from China to the US are approaching $18k per container. Source: FreightOS via Exponential view.

Changes in energy and resource accessibility

There is a body of evidence suggesting that the general availability of both energy resources and some key minerals began to hit a wall in the early 2000's. Until the impact of the pandemic, global supplies were consistent due to the highly resilient production and distribution networks that enabled almost unlimited substitution capability. These are waning.

It now appears we are beginning to face real constraints and there is also the prospect that the Russia / Ukraine conflict exacerbates this condition. For example, Ukraine and Russia account for approximately twenty percent of global wheat production and with this supply curtailed there is likely to be chronic shortages in some countries, while at the same time global prices for wheat are expected to rise dramatically.

Live example. According to an article by Radio NZ today, coffee drinkers can expect 'Sky Rocketing' price increases due to a combination of the above factors in transport... and crop failures for coffee beans in Brazil.

Now some other considerations...

Fallout for developing nations - Within existing financial system

High levels of inflation make it harder for developing nations or those with weak economies or currencies to secure finance at acceptable rates and then to repay debt. Increasing levels of inflation in USA are likely to lead to higher interest rates there, which in turn attract those that want to maximise returns on investment. This in turn increases interest rates and a tendency for money to return to the strongest economies and away from developing economies. A vicious cycle.

An example here in New Zealand relates to the price regulated electricity network companies can charge. The Commerce Commission allows them an acceptable, increasing rate of return, which includes inflation and market discount rates rising. This attracts capital from elsewhere AND means our prices will go up through a reinforcing loop effect. (Inflation feeding inflation) while overall, attracting money to New Zealand and negatively impacting developing economies.

Stag-flation - a name for another type of possible risk

Stag-flation is the term that describes the condition where-by an economy is simultaneously experiencing inflation and recession or nil economic growth. This condition is particularly challenging and may be a paradigm shifting moment for an economy. Exploration of the kind of shift this situation might trigger is beyond this week’s edition, other than to say that we would be seriously re evaluating the sufficiency of the current economic and financial system at this point.

Energy is a key input, and we can't just make more of it

Let's not forget that humans don't create energy...we never have. All we do is use existing stored forms of energy (oil, coal, gas) or harness real time sources (hydro, wind, thermal) There is much debate about the role of energy as it might contribute to increased costs in future. If energy (at the rate at which we use it) is finite because of extraction costs and limits to the quantum of renewables and emissions that can be utilised, we may well be looking at steep price increases for energy in future. In the meantime, Oil and Gas producers are enjoying increasing prices and profits in the existing market, without investing in future production.

China may constrain future supply (for a period)

China may be yet to experience the full impact of Omnicron. It has avoided mass transmission through strict control regimes, but if there is a significant breach then it may be that economic throughput is reduced or halted for a period. This would see a slow-down in exports and perhaps we will see some empty spaces on our shop’s shelves. Would that matter?

Economists would say…

“The answer to high prices is higher prices” which in theory leads to behaviour change and creation of substitutes, alternatives, or altogether new options for consumers. This of course assumes we need to continue a consumption growth trajectory or that we need to consume as much as we do currently, which is very debatable (we advocate for absolute demand reduction)

The scene does seem to be set for what might be a dramatic shift in innovation that drives efficiencies, reduces product obsolescence, manages whole of product life cycle costs, including emissions and ecosystem impact, (which is likely to be increasingly costly or taxed in future) in response to generally rising prices and regulations.

Cost lowering and ecologically better solutions are likely to be treated increasingly well in future.

Government’s helping hand – A start in New Zealand, or part of the problem? 

Reducing tax on fuel and subsidising public transport to the tune of 50% is going to help those that have very tight budgets in the very short term, but isn't it just kicking the can down the road when it comes to getting off our addiction to fossil fuel? Why not keep the price of fuel high and subsidise public transport 100%? 

The flip side of Govt handouts, is the groundswell of new regulation coming through aimed at reducing emissions, waste, and negative environmental impacts, while increasing recycling and reuse. These are very likely going to increase inflationary pressures by adding new costs and redistributing the burden of transition in new and untested ways. Perhaps this is just the true cost of transition and the way we should be doing it? 

Ironically, this is on top of the inflationary pressures which were created by government in the first place, through the creation of new additional money. In addition to this it (the Govt) may also be looking to increase tax of the well off, while providing relief to those in poverty (Eg Goods and services tax off food has been suggested) 

And if things really get tough, we have in the past had regulated prices for basics such as milk and bread, this could happen again. Fuel and other scarce resources were rationed through WW2 years.

Ideas for reducing our own exposure to increasing costs through transition:

• Take on the fact that our decisions over the coming few years are critical to what happens in future – Spending, voting, community action - will all make some difference
• Re-think what we have always done – lifestyle, habits and priorities can be changed (Do we really need the latest iPhone when the existing one will do? Or maybe find a more economical brand?)
• Re-think values – Eg is ‘Keeping up with the Jones’s’ really that important?
• Share resources – Community hubs, carpooling, equipment sharing
• Repair, recycle, re-purpose existing assets and equipment
• Educate ourselves and those we influence on options for reducing cost and impact. Some young folks may not have experienced really tough conditions - lets look after them
• Buy local and support the retail system we need for the future
• Use public transport and support the transport system we need for the future

At the end of the day, reducing our exposure to increasing costs is going to be a positive step in the right direction, while making use of only the resources we need - in the best possible way forward.