Daniel Lacalle

Energy-Induced Inflation

t the end of f ebruary, the prices of oil (West Texas Intermediate and Brent), Henry Hub and ICE natural gas, aluminum, copper, steel, corn, and wheat, and the Baltic Dry Index were below their year-earlier levels.

The supply chain index and the global supply and demand balance, published by Morgan Stanley, had declined to September 2022 levels.

However, the latest inflation readings are hugely concerning. Considering the previously mentioned prices of commodities and freights, if inflation was a “cost-push” phenomenon, it would have collapsed to 2 percent levels already. However, both headline and core inflation measures, from the consumer price index (CPI) to personal consumer expenditure (PCE) prices, show extremely elevated levels and rising core inflationary pressures.

I’ve mentioned numerous times that there’s no such thing as “costpush” inflation. It’s only more units of currency going to relatively scarce goods and services.

The monetary aspect of inflation has been proven on the way up and in the commodity correction. The Federal Reserve rate increases have deflated the price of commodities despite rising geopolitical tensions, supply challenges, and robust demand growth. Rate hikes make it more expensive to store, take long positions, and finance margin calls. Fed Chairman Jerome Powell offset the entire supply-demand tightness impact on prices.

Governments can’t blame inflation on Putin’s war or “supply chain disruptions” anymore. Printing money above demand is the only thing that makes prices rise in unison. If a price rises due to an exogenous reason but the quantity of currency remains equal, all other prices don’t rise. A PCE index of 5.4 percent in January 2023 with all the main commodities below the January 2022 level shows how high inflationary pressures are.

Inflation is accumulated, and the narrative is trying to convince us that bringing down inflation to 5 percent from 8 percent in 2024 will be a success. No. It will be a massive destruction of more than 20 percent of the purchasing power of citizens from inflation in the period.

Broad money growth was too aggressive in 2022, and it may take some time to ease the inflationary pressures to a level that doesn’t make citizens even poorer.

Two recent papers published by the Bank for International Settlements remind us that money growth was the main culprit for the inflation surge. Claudio Borio, Boris Hoffmann, and Egon Zakrajzek conclude that “a link can also be seen in the recent possible transition from a low- to a high-inflation regime. An upsurge in money growth preceded the inflation flare-up, and countries with stronger money growth saw markedly higher inflation. Looking at money growth would have helped to improve post-pandemic inflation forecasts, suggesting that its information value may have been neglected.”

Ricardo Reis wrote: “Inflation rose because central banks allowed it to rise. Rather than highlighting isolated mistakes in judgment, [here I point] instead to underlying forces that created a tolerance for inflation that persisted even after the deviation from target became large.”

The supply chain and Ukraine war excuse has vanished, but inflation remains too high. Many market participants want rate cuts and money supply growth to see higher markets, with multiple and valuation expansion. However, rate cuts are very unlikely in this scenario, and central banks know they’ve caused a problem that will take more time than expected to correct.

Governments can’t expect inflation to correct when public spending is rising, which means higher consumption of new monetary units via deficit and debt.

Citizens are suffering these inflationary pressures via a weakening real wage growth added to a much higher cost of living as the prices of nonreplaceable goods and services— education, health care, rents, and essential purchases—are rising much faster than the headline CPI suggests.

We’re all poorer, and a slightly lower headline CPI doesn’t mean lower prices, just a slower pace of destruction of the purchasing power of currencies.

Someone will invent another excuse to blame inflation on anything except the only thing that causes prices to rise at the same time: printing currency well above demand.