Soapbox: “A very, very difficult place”

When Andrew Bailey, governor of the Bank of England (BoE) told the British Parliament that he felt “helpless” in the face of soaring inflation he scored full marks for honesty, although nothing for usefulness. Consumer price inflation in the UK hit 9% in April (up from 7% in March), the highest for more than 40 years, and almost double the rate the Bank of England expected only six months ago. Bailey said it’s “a very, very difficult place for us to be in”. He’s dead right about that.

But it’s an even more difficult place for those on the average salary of about £24,600 a year than it is for someone on the £500,000-plus salary of the BoE governor. The cost-of-living crisis hits lowest income households hardest, simply because they spend a greater proportion of their income on fuel and food – and the price of those items is going up fast.

In the UK there is growing pressure on the government to ‘do something’, i.e. to provide money to cushion the blow for poorer households, for families and people on fixed incomes (such as students or pensioners), and for the unemployed who are living on welfare payments. These people certainly are in a ‘very, very difficult place’.

It isn’t all the war’s fault

Much of the inflation can be laid at the door of the Ukraine war but prices of essential commodities were on the rise months before the first missiles flew.

The international benchmark for wheat went up by almost 50% from the end of May 2020 and the same date in 2021. Arabica coffee – the kind that goes into premium blends – rose on futures’ markets by more than 85% between May 2021 and the start of February this year, before the Ukraine war erupted. Weather factors account for both of these price rises. A severe drought in Canada cut its wheat harvest by more than 38% in 2021, while a rare but severe frost has slashed the Arabica crop in Brazil, the world’s biggest producer.

Crude palm oil prices, as measured by the international benchmark on the Bursa Malaysia exchange, doubled between the end of May 2020 and the same date in 2021. A desperate (Covid-induced) shortage of migrant workers in Malaysia in 2020 meant the country (the second-biggest palm oil producer after Indonesia) turned in its lowest palm oil crop since 2016. That inevitably increased demand from Indonesia, and pushed up prices to record levels. In the past two years, crude palm oil prices have risen by 197%, from Ringgit 2,240 ($508) to Ringgit 6,653 ($1,510) per tonne. Palm oil, which represents a third of the world’s vegetable oil market, is used in everything from biodiesel to catering to lipstick; substituting with alternatives is either difficult or expensive. Indonesia banned palm oil exports on 28 April as a protectionist measure although, under enormous domestic pressure, it now says it will lift that ban today.

The war has certainly not helped. Ukraine is the biggest exporter of sunflower-seed oil (a partial substitute for palm oil); since the start of the war millions of tonnes have been stuck in warehouses, blocked from export. Ukraine has been unable to export 10 million tonnes of sunflower seed – which, when crushed, turns into some four million tonnes of sunflower oil – since the start of the war. Estimates for this year’s Ukraine harvest of grains and oilseeds are falling fast, the longer the war continues – around 60 million tonnes against 100 million last season. The boss of Ukraine’s leading sunflower oil exporter says: “We’ll have huge stock inside Ukraine, and no stock and no goods for the market outside Ukraine… It’s big damage for the food security of the global world, and a big problem with liquidity for the company and the farmers inside Ukraine”. Andrew Bailey told the English Parliament this is “not just a major worry for this country, but a worry for the developing world. I’m sorry for being apocalyptic, but it is a worry”. The global food crisis, which has pushed food prices some 30% higher than they were a year ago, could last for “years” according to the UN secretary-general. This rapid inflation will shortly push poor nations into debt distress – Sri Lanka has already defaulted on its sovereign debt. The World Bank president, David Malpass has warned that as many as “60% of the poorest countries right now are either in debt distress or at high risk of being in debt distress”. It brings to mind the German writer Bertolt Brecht’s dictum Erst kommt das Fressen, dann kommt die Moral (food first, then morality). If food becomes impossibly expensive, governments have few choices: they can flood the populace with newly created money; they can try to enforce ‘demand rationing’ (a euphemism for simply saying things have become unaffordable) or risk social disruption.

Nor does it stop with cereal and oilseed prices. Ukraine produces something between 70% and 90% of the world’s neon gas, an essential component of the microchips used to manufacture smartphone and computer screens. Production and export of this gas will be affected by the war.

We all know the shocking price rollercoaster in crude oil – from almost $150 a barrel in July 2008 it collapsed to below $20/barrel in April 2020, only to rocket back to $127/barrel on 8 March this year.

Black cygnet events

The last few years have seen not so much a single ‘black swan’ event – a single massively disruptive episode – as a series of ‘black cygnet’ events, occurrences that in isolation might be tolerable but which, coinciding with and overlapping one another, have severely disrupted trade and finance. Such ‘cygnets’ are the US-China trade war, the Covid-19 pandemic, supply chain disruptions, Russia’s war with Ukraine, sanctions and export controls. All have created a fragmented, febrile global marketplace for many basic goods. According to the chief economist of the World Trade Organization, Bob Koopman, “fragmentation” is here to stay.

It’s not so much fragmentation as a re-jigging of what we had become accustomed to thinking of as the stable international order.

As the European Union struggles to achieve a united front in its planned embargo of Russian crude oil , China appears ready to re-stock its energy reserves with Russian oil. At the same time the US is contemplating dining with a former devil, Venezuela. The South American country has massive crude oil reserves that will perhaps come in useful.

Little fires

In this context of radical uncertainty, it’s no surprise that people are searching for ways to protect their wealth, no matter how large or small. This has induced a rush to the US Dollar, widely regarded as a safe haven. The Dollar has appreciated by about 10% since the start of 2022. There are widespread expectations that the US central bank, the Federal Reserve, will raise interest rates more aggressively than other central banks, and that will be a further enticement to head for the Dollar.

But a stronger Dollar brings its own risks. Credit availability declines, which reduces real investment and therefore growth. And the Bank for International Settlements (BiS) has published a paper arguing that a decline in the value of a country’s currency against the US dollar triggers a decline in real investment in that country – and when emerging economy countries are already struggling with high debts and serious inflation the last thing they need is a slowdown in real investment. The economist Mohamed El-Erian has asserted that we may be facing a worldwide pattern of ‘little fires everywhere’. We may feel that annual official inflation rates of around 10% are beyond toleration; but our cost-of-living crisis pales into insignificance by comparison with the real and growing fear of famine in some African countries. Little fires if unattended can easily become conflagrations.