Supply chain shocks increase the risk of more turbulent economic cycles


The author is the co-founder of Absolute Strategy Research

Since British logistics consultant Keith Oliver first coined the term in 1982, the world is witnessing the biggest impact on the supply chain.

If companies respond by increasing inventory levels to ensure they have sufficient material inventories, then we should begin to prepare for a more volatile business cycle.

Some argue that we are close to “peak” supply chain pressure. As spending gradually shifts from goods to services, American consumer demand for goods may soon begin to return to pre-Covid-19 trends.

In addition, global business survey indicators regarding supplier delivery times and component shortages have been in extreme conditions. At this level, these indicators usually return to their average values ??(usually very quickly). In Asia, inventories in countries such as Japan and South Korea have grown faster than shipments in the past three months.

The more the balance between supply and demand is restored, the more pressure on pricing will ease, and the inflation rate will fall. In this case, now is not the time for the central bank to raise interest rates prematurely.

Assuming that the post-Covid inventory chaos is only temporary, this optimistic view makes sense.

But the current level of supply chain stress is different from the normal cyclical experience of the past 20 years. For example, recent data from the European Commission in the Eurozone shows that the proportion of companies reporting shortages of equipment, raw materials, and labor is the highest in 40 years.

Interestingly, for the first time in nearly 40 years, the percentage of companies citing “shortage” exceeds that of companies with “insufficient demand”. This is both important and unusual: current supply constraints exceed demand constraints.

Most decision makers only know a world where demand is limited and supply is elastic. Regardless of the demand, China, as the world’s last supplier, is ready and willing to meet it.

The policy response to the pandemic broke this balance. The high level of savings and government transfer payments during the blockade supported a sharp rebound in global demand, but failed to prepare for supply, which created a bullwhip effect. Now, supply appears to be restricted and “inelastic.”

This is a very different policy environment—it has become more difficult to restore the global balance of the commodity market; where is the national output gap more important; ensuring adequate local commodity inventories is of greater importance to the country and the company.

The longer the supply chain crisis lasts, the more likely companies are to reconsider their business model. They may decide to invest more to re-support production; they may integrate vertically to regain control of their supply chain; as they shift from a just-in-time model to a just-in-case model, they may start over-ordering and Hold higher inventory.

Adapting to these challenges will place additional requirements on the company’s free cash flow and balance sheet. They may have macroeconomic consequences. Inventory accumulation and consumption are key drivers of the economic cycle. The longer inventory levels remain high, the more volatile they may become—the same is true for business cycles.

This supply pressure occurs when hyper-globalization is in a backward state, whether it is due to tensions between the United States and China, or due to countries’ pursuit of strategic autonomy from social distancing to economic estrangement. The climate transition policy is also facing the pressure of localization of supply, and the labor market is still extremely tight.

Optimists believe that the just-in-time supply chain model has survived the coronavirus crisis with excellent results. If nominal demand slows, if the economy rebalances from goods to services, and if new supplies emerge, then concerns about inflation may soon disappear.

However, the risk is that the scale and duration of the Covid stress test has begun to challenge the old model. The supply chain has proven to be fragile-even if it is caused by excessive demand and underinvestment. Supply chain disruptions and increased inventory volatility may not just be a temporary error. In this case, if nominal demand continues to grow faster than supply, inflation may remain high and spread to the labor market. The stakes for policymakers cannot be greater.



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