Supply chains, interest rates and inflation, by Alasdair Macleod

Intact supply chains have been an intrinsic feature of the low inflation global economy for several decades and the U.S. and Europe have been big beneficiaries. Unfortunately, supply chains get broken when amity and trade are replaced by hostility and sanctions. From Alasdair Macleod at

The disruption of global supply chains is seen to be a temporary problem yet to be resolved, but there are good reasons to believe it is now permanent.

Following the end of the cold war against China and the foundation of a new peaceful era, American and other manufacturers began to expand their production facilities into China and South-East Asia. It was the beginning of what became a trade system based on global supply chains, increasingly sophisticated logistics, and just-in-time inventory management.

Global supply chains deliver enormous benefits between peaceful nations, but they cease to work when they are at war.

Souring trade relations between America and China, covid, and the disruption to international logistics pits them into an undeclared conflict. The trade environment is now against a background of an increasingly belligerent geopolitical struggle, involving both China and Russia on one side, and America and its allies on another. In the absence of détente, which now seems a distant prospect, the system of global supply chains can operate no longer. They must become re-established within national borders.

The consequences are long-term product supply disruption, higher consumer prices, and soaring energy prices already evidenced in Europe. Coming on top of a new trend of rising interest rates and contracting bank credit, it has the makings of an economic crisis for the West, to which governments are bound to respond by creating an inflationary storm.

This article analyses these new war-time trade conditions in the geopolitical context and examines the likely consequences.

The background to global trade has deteriorated

There is a general assumption that eventually, perhaps next year, supply chain difficulties will be overcome. It is the main plank behind central bank expectations, that after the current hiatus restricting product supply, consumer price inflation will return to the 2% target. The mistake is to conflate two issues: the supply chain problem, for which conditions have changed fundamentally, and the declining purchasing power of fiat currencies. However, the inflation outlook is tied up with the trade outlook.

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