Supply chain shocks increase risk of more volatile economic cycles

The writer is a co-founder of Absolute Strategy Research

The world is seeing perhaps the biggest shock to the supply chain since British logistics consultant Keith Oliver is believed to have first coined the term in 1982.

If companies respond by increasing inventory levels to ensure they have enough raw materials on hand, we should begin to prepare for more volatile business cycles.

Some say we’re nearing “peak” supply chain stress. U.S. consumer demand for goods could soon start to return to pre-Covid-19 trends as spending gradually rebalances from goods to services.

Furthermore, global business survey indicators of supplier delivery times and component shortages have been extreme. At such levels, these indicators usually return to the mean (usually quickly). In Asia, inventories in countries such as Japan and South Korea have grown faster than shipments over the past three months.

The more supply and demand return to equilibrium, the lower the price pressures will be and the lower the inflation rate will be. In that case, now is not the time for central banks to be drawn into raising interest rates anytime soon.

This optimistic view is justified, given that post-Covid inventory is temporary.

However, current levels of supply chain stress are on a different scale from the normal, cyclical levels of the past 20 years. For example, recent European Commission data on the euro area shows that the percentage of companies reporting equipment, raw material and labor shortages is the highest in forty years.

The line graph of the factors limiting production in the manufacturing industry (% firms cite each factor) shows that euro area companies are facing a sudden increase in supply

Fascinatingly – and for the first time in nearly forty years – the proportion of companies citing “shortage” has exceeded the number due to “insufficient supply and demand”. This is just as important as unusual: the supply constraint now exceeds the demand constraint.

Most policymakers only know of a world where demand is limited and supply elastic. Whatever the need, China is ready and willing to respond as the world’s last resort supplier.

The policy response to the pandemic has upset that balance. High levels of savings and government transfers during the lockdown created a strong recovery in global demand but unprepared supply, creating a bullish effect. Currently, the supply seems to be limited and “inelastic”.

It is a very different policy environment – one in which it is more difficult to restore global equilibrium in commodity markets; where the national output gap is more significant; and where ensuring adequate domestic inventory is of greater importance for both the country and the business.

The longer the supply chain crisis continues, the more companies will be inclined to rethink their business models. They may decide to invest more to reproduce; they can vertically integrate to regain control of their supply chain; they may begin to overorder and carry higher inventory as they switch from just-in-time to just-in-case models.

Adapting to these challenges will place additional demands on businesses’ free cash flow and balance sheets. And they can have macroeconomic consequences. Accumulation and depletion of inventories are the main drivers of the business cycle. The longer inventory levels stay high, the more volatile they can become – as does the business cycle.

This supply strain is occurring at a time when the super balance is in full swing, be it from US-China tensions or from the pursuit of strategic autonomy as countries move away from home. social to economic. There is also pressure from climate change policies to localize supply, and the labor market is especially tight.

Transaction Secrets

FT has revamped Trade Secrets, its must-read daily summary of the changing face of international trade and globalization.

Sign up here to understand which countries, companies and technologies are shaping the new global economy.

Optimists argue that the just-in-time supply chain model has weathered the coronavirus crisis with flying colors. If nominal demand moderates, if economies rebalance from goods to services, and if new supply emerges, worries about inflation could disappear as quickly as they appeared.

The risk, however, is that the size and duration of the Covid stress test has begun to challenge the old model. Supply chains have proven vulnerable – even if that is due to excess demand and underinvestment. Supply chain disruptions and increased inventory volatility may not be just a temporary fault. In that case, if nominal demand continues to grow faster than supply, inflation is likely to continue to soar and spill over into the labor market. The stakes for policymakers could not be greater.

Source link


News7h: Update the world's latest breaking news online of the day, breaking news, politics, society today, international mainstream news .Updated news 24/7: Entertainment, the World everyday world. Hot news, images, video clips that are updated quickly and reliably

Related Articles

Back to top button