https://www.wsj.com/articles/new-age-of-scarce-supply-risks-…
**Russian Gas Cutoff Symbolizes New Era of Supply Shocks and Inflation**
**War, sanctions, export controls and natural disasters all threaten commodity supply chains, challenging central banks’ inflation goals**
**By Greg Ip, The Wall Street Journal, April 27, 2022**
**Inflation is the result of demand growing faster than supply. Central banks can deal with the demand part. The problem is that the world they confront in coming years might be one of recurrent supply shocks....**
**Demand is robust, especially in the U.S., where fiscal and monetary support have been especially generous. Advanced economies report shortages of labor, and Covid-19 continues to snarl supply chains, most recently in China. Meanwhile, Russia’s invasion of Ukraine has triggered widespread shortages of commodities, in particular for food and energy....**
**Inflation surged in the 1970s because central banks failed to curb excess demand and allowed prices and wages to feed on themselves. But their job was made harder by repeated supply shocks that pushed up costs....** [end quote]
“Curb excess demand” is jargon meaning “consumers have less money to spend.” The Fed can do that by raising interest rates in order to slow the economy – hopefully without causing a recession that would cause people to be fired from their jobs.
Central banks can create fiat money out of thin air to suppress interest rates whenever they want to. But nobody has the power to snap their fingers and create oil, natgas or wheat in the amounts and places and for the price they are needed.
Reality bites. Eventually, the economy will work out substitutes for some of the supply shock commodities. As long as prices stay high, entrepreneurs will find ways to increase production or make processes more efficient.
Governments are stuck between a rock and a hard place. Consumers become upset when prices are high. (Revolutions have been caused by high bread prices.) But when governments suppress commodity prices with subsidies, entrepreneurs don’t have the incentive to increase supply. And many governments have been burdened by subsidies – when they try to stop them, angry crowds can demonstrate in the streets.
The article mentions that solving supply shortages by increasing production takes time, maybe years. But causing supply shortages with boycotts, sanctions and tariffs can happen quickly. Russia cutting off oil to Poland happened overnight.
Supply shortages cause inflation as demand outstrips supply. The Fed will try to quell inflation by raising interest rates. That will hit the price of all assets – stocks, bonds and real estate.
A new era of supply shocks would mean a new era of high interest rates and stock market volatility.
Commodity prices rise in supply shocks so the producers benefit. Commodity pricing is historically very volatile. (That’s why the Fed looks at inflation without energy and food pricing.) Investing in commodity producing companies is riskier than consumer staples but an era of supply shocks may be a good time to do this.
Wendy