The FT noted yesterday that Europe might be heading for its strongest economic growth for 15 years right now. I confess I was not surprised, thinking ‘so it should be'. We did, after all, see large parts of that economy shut down last year. If there wasn't a strong rebound when attempts at easing restrictions were made then it would be very odd indeed.
More interesting were three other things. The first is that the article noted considerable supply chain blockages. The second was it noted inflation as a result. Third, the European Central Bank still thinks this will be a temporary phenomenon.
As regular readers of this blog will know, I have long felt the most difficult part of this downturn will be the reopening. I always suggested this will be down to. a shortage of what is called ‘working capital'. That is the net total of the short term money locked up in a businesses' production process. So it's the amount it is owed, the stock it owns less the people it owes money to, all related to available cash, of course. And when supply chains are disrupted for any reason - as I always thought that they would be during the reopening - then that working capital gets very strained.
Why is that? Well some things have to be paid, come what may. That includes the rent and the staff. But customers pay you late and, as is now becoming apparent, actually getting things done is hard, which means that the stock of half finished goods grows and have to be paid for to the current state of completion without much chance arising of turning that work into an invoiced sale because some crucial bits are missing. In the motor industry it is semiconductors that are missing. In building it is timber and tiles, and maybe more. It makes little difference what it is. For the sake of a missing washer it is entirely possible that a whole supply chain can collapse, and that is what is happening.
Most economists don't get this. That's in part because they have never been near, let alone run, a real business. But it's also because they do not want to get it because it makes the maths of their economic models hard. So, most pure neoclassical economists assume there is no lag in the economy between a change in possible circumstances (call it an economic reopening) and its consequences being seen. Things ‘clear', as they would put it, perfectly. New-Keynesians think there is a delay in the clearing process, but that it happens. And the reality is that there is no guarantee of that clearing happening at all.
The simple fact is that working capital failures kill more businesses than almost anything else. The very best idea can be brought to its knees by a failure of working capital. And right now the government is moving to end its financial support for business, just to exacerbate matters.
Almost no economic forecasts I have seen appear to take this risk into account. But it is real. And it has three consequences.
The first is short term inflation as there is more competition for scarce resources. If the economists are right, however, and the market ‘clears' and the blockages are released then this resolves itself. Supply chains reopening will end this cause of inflation. To some extent I am sure that will happen.
The second is that businesses could fail before that is possible. They won't fail because they are not viable in the long term. They will simply fail because they can no longer pay their staff in the short term. And that is fatal.
Third, if too many businesses fail before supply chains properly reopen we end up in a wholly different economic environment. There may still be money chasing consumption in the short term but things will change pretty rapidly. Businesses will fail; unemployment will grow; debt failures will mount; banking crises will grow; government income will fall and Covid bad debts will have to be accounted for; and recession is possible.
And all that as a result of the disruption on reopening from Covid that it seems no economist thought about because they don't actually have real world experience. The sequencing of reopening is now key to whether it happens successfully, or not, in other words. If ‘clearing' takes too long we are in deep trouble.
We could pay a very heavy price for that lack of real world experience in that case. This crisis may not happen. But it might, and the signs are already there.
It's not inflation we need to worry about. It's the causes of the short term inflation we might suffer that are of real concern, and too few get that as yet.
I just hope the government is willing to step in again, because no one else can stop this.
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I’m with you – a contingent approach is needed – there is no doubt about that.
You are of course completely right to say that working capital is absolutely essential to cover cash flow (paying suppliers including landlords and staff before you can turn work in progress into sales, and then sales into cash). And that cash flow crunches kill businesses. Being unable to pay debts as they fall due is one of the two definitions of insolvency (the other being more liabilities than assets).
This is above my pay grade, but isn’t there also inflation risk in so much free or cheap money being added to the economy over the last year? Plenty of wealthy people have become even more wealthy and will be looking to hover up assets. The surge of SPACs shows there are pools of money looking desperately for a return. Private equity funds have lots of “dry powder”. The generous government support was required to get us through the coronavirus crisis (which is still not over quite yet) but how do we transition to whatever the “new normal” might be?
I think there is a real fire of asset price inflation – hence my suggestion that we withdraw as many tax reliefs as possible on speculation and tackle wealth more
But I posted the sectoral balances from 2008 on very recently – people kept saving after 2008 and I think they will for quite a while this time
A little splash maybe, but deep down they are worried about jobs
As you may remember, I work in affordable housing development and we also have an acquisition programme to complement the new build.
We are currently priced out of the local market – it’s up 50% – prices are frankly bonkers – and from what we can tell in the Town and the Shire is that we are getting a lot of Southerners coming in who have loads of cash.
Houses are both a good and an asset, but the asset angle is one that has to be watched. When houses prices go up, so it seems does everything else. There is a huge private housebuilding programme in the North West of the town as well that isn’t even complete. No matter how much of a good housing is it still gets treated as an asset and defies the conventional logic about the the more you produce of it as a good (to be consumed/used) you reduce the price. Asset prices tend to rise no matter how good the supply (because the credit is there to make it happen and also the behaviour of seller and buyers).
I’m also already sick of the those idiots like Larry Summers crowing about raising interest rates because of the neo-lib bullshit about Governments causing inflation – that from a man who likes ‘tax efficiency’ (when taxes can contribute to inflation control) and whom resists efforts to regulate derivatives – a major destabilising force in markets. What a jerk.
The economy (as you say) needs to be nurtured back to health – not hobbled.
Anecdotally, I wanted to upgrade my desktop’s graphics card, but they are like gold dust now, and even secondhand cards are selling for inflated prices on eBay. This is mostly to do with their use in cryptocurrency mining. But large retailers like Currys PC World don’t have them. That’s not something I’ve experienced before.
I’ve also noticed that fruit and vegetables in supermarkets are scarcer than before.
I know this is not proper evidence, but it is unusual – I’ve never seen it in the West previously, although I did travel in Eastern Europe before the Wall came down and saw empty shelves on supermarkets there.
I asked my son who is a gamer and chip shortages have happened before
I asked because I could remember him not being able to get them
The current shortage is affecting a lot more sectors than just gaming, though I know it’s almost impossible to get a PS5 anywhere for love nor money. The boom in demand for electric vehicles and for PCs and laptops to facilitate WFH and EFH during the pandemic are two reasons for the unprecedented demand and the temporary closure of chip fabs in Texas to conserve energy during last winter’s snowstorms has affected supply. US restrictions on China’s biggest semiconductor maker, SMIC, haven’t helped either. Ford thinks its production will fall by half this year because of the shortage and Apple is staggering the launch of new iPhones. It’s a big deal not just for gamers.
I agree
I was using an example
The shortagenisbexamplenof the problems I foresee in much of the economy
nVidia are now producing cards with some functionality disabled – no use for mining bitcoin.
Semiconductor production is boom & bust.
Supermarkets always have shortages – just-in-time supply chains.
This seems obvious to me, but what is less obvious is what governments can do about it beyond continued financial support – would that be your recommendation, keep business afloat until supply chains clear?
Yes, in a word
Remember that old saying ‘for a ha’porth of tax the ship was lost’?
It will apply this time to the economy
“ha’porth of tax”? I can see it sinking the economy, but not a ship 🙂
Oops…..
This article seems as good a place as any to ask whether you have tried to publish in Tribune. It’s probably the only semi articulate publication representing the very loosely organised left in the Labour Party and seems as economically illiterate as one would expect. One of your articles on ‘the deficit myth’ would be progressive. Please give it some thought.
I think I did a long time ago
But not for a long time
And I suspect this is better read
As a mining engineer I was involved in the start up of a mine in Ireland and argued with my boss for 3 months costs for working capital. I pointed out we would have to finance the build up to near full capacity before profit would be achieved. We would also need to finance the ore stockpiles and ore concentrate until payment from the smelters in Europe.
He told me that the 90 day credit for supplies would cover the operating costs so only one month would be required. This left me a bit concerned but I became fully involved in the mine construction and production start up problems.
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