The Times They Are A-Changin’: Everything Comes as a Price 

 

 

“Unemployment’s rising in the Chigley end of town
And it’s spreading like pneumonia! 

 

We start with a wonderful quote on the “special relationship”! Some 40 years ago the former West German chancellor Helmut Schmidt said: “The special relationship is so special only one side knows it.” 

There is a new word that can be added to the library of economic terms; Trumpflation. This is caused by one persons ego, arrogance and stupidity. 

The US/Israeli war with Iran has already impacted other Gulf states, and, although, other world governments have refused US requests to join-in, the majority will all be effected, due to the regions role in oil and gas supply. 

Last week saw a further escalation when Israel bombed the South Pars gasfield, which Iran shares with Qatar. President Trump denied that the US knew about the plan, however, his own officials and Israeli sources say that the US helped to coordinate the attack, in the hope that it would put pressure Iran into reopen the strait of Hormuz. 

Instead, and predictably, it has further intensified the conflict, with Iran retaliating with more strikes across the region, causing significant damage to a Qatari facility that normally supplies 20% of the world’s liquified natural gas (“LNG”).  

QatarEnergy told Reuters that they might have to excuse themself from long-term contract obligations to Italy and Belgium, as well as South Korea and China – warning that it could take up to five years to fully restore production.  

American allies in the region, who are the most exposed, are becoming increasingly critical of the situation Majed bin Mohammed al-Ansari, an adviser to Qatar’s prime minister, described the Israeli targeting of facilities as “dangerous and irresponsible”. Regional powers were already angry at Iranian attacks on energy assets, but the Israeli strike and Iranian response are of a different magnitude. Oman’s foreign minister, Badr Albusaidi, has called the conflict a “catastrophe” and warned that the Trump administration has “lost control of its own foreign policy”. 

Further evidence of the belligerents loss of control can be found in reports that the US is considering plans to occupy or blockade Iran’s Kharg Island to pressure Tehran to reopen the strait of Hormuz despite earlier suggestions by Trump that he was not leaning towards putting “boots on the ground”. 

 

“The special relationship is so special only one side knows it.” 

 

Kharg is only 20 sq km in size and, being only 25km (16km) from the Iranian city of Bushehr. Iran is heavily dependent on revenue from fossil fuels, and any attempt to seize such a key strategic asset would almost certainly be resisted. The Kharg terminal exports C.90% of Iran’s oil and is supplied by pipes from nearby offshore fields.  

This is only a part of the contradictory briefings from the US and Israeli governments, with descriptions of plans appearing to change on an almost daily basis, reflected in statements by officials grappling with a war whose consequences have spiralled beyond their control. 

What is becoming increasingly clear is that energy prices will remain high, and lead to similar supply-side inflationary shocks to those seen after Russia’s invasion of Ukraine in 2022. 

Gas prices jumped to four-year highs and Brent crude, the global oil benchmark, have soared by 60% since the US-Israeli war on Iran started. 

UK gas prices have also more than doubled since late February and are likely to drive up household bills.  

Also, a prolonged conflict would lead to energy supply constraints hitting fossil fuel byproducts such as fertiliser. The Gulf is home to some of the world’s biggest plants and is a linchpin region for farming worldwide. About half of all global exports of urea, a commonly used fertiliser, and sulphur, a critical fertiliser ingredient, are sourced from the Middle East. 

Before the critical spring planting season in the northern hemisphere, analysts warn rising fertiliser costs will hit crop yields and drive up food prices,  hurting low-income countries and poor households globally. 

Plastics, chemicals and pharmaceuticals are also being hit. Supplies of helium – critical to microchip production and MRI machines – have been hit by Qatar shutting down production. The Gulf state accounts for a third of global supply, as an important byproduct of LNG. Analysts say global manufacturing supply chains from the production of cars to electronics could all be impacted. 

 

‘rising fertiliser costs will hit crop yields and drive up food prices,  hurting low-income countries and poor households globally’

 

There are, of course winners as well as losers in this situation. 

Xi Jinping, the Chinese leader, has been preparing for a crisis like this for years. China must secure its energy supply “in its own hands”, its president was reported to have said during a visit to one of its vast oilfields in 2021. 

As a result, China’s energy system has significant buffers, including huge reserves of oil and LNG to a robust domestic supply, including alternative energy sources, such as wind and solar. 

China, which usually imports around half its crude supplies from the Middle East, is far less exposed than other Asian economies. For example, Japan sources about 95% of its oil imports from the region. 

Iran is continuing to ship to China, who are the prime buyer of its oil, with imports slipping only marginally; Kepler estimates, from 1.57m barrels per day in February to 1.47m barrels per day in March. 

Chinese vessels operated by state-owned firms are meanwhile working to navigate the broader region.  

 

‘The amount of wind and solar under construction was double the rest of the world combined’

 

Whilst Beijing does not disclose the size of its oil reserves, it is widely agreed to be sitting on a massive stockpile of C.1.4bn barrels, according to Columbia University’s Center on Global Energy Policy. 

China has also sought to reduce its economic reliance on fossil fuels. More electric and hybrid vehicles are sold inside China each year than across the rest of the world, according to the International Energy Agency. 

Its renewable sources of power have meanwhile expanded rapidly in recent years, curbing its dependence on fossil fuels. Energy thinktank Ember estimates that wind, solar and hydropower generated about 31% of China’s electricity in 2024. The amount of wind and solar under construction was double the rest of the world combined, helping China to reach an installed capacity of 1,200GW six years ahead of the government’s schedule. 

We now turn to inflation. 

Supply-side, or cost-push inflation, occurs when rising production costs, such as raw materials, wages, or taxes, reduce the overall supply of goods and services, forcing prices up. The key drivers of supply-side inflation today are:  

• Supply Chain Disruptions: Bottlenecks, shipping delays, or natural disasters restricting the availability of goods. supply chain disruptions. 

• Increased Raw Material Costs: Energy price shocks for oil, gas, and the knock-on effects to foodstuffs increasing production costs.  

Unlike demand-pull inflation, supply-side inflation often occurs during economic stagnation (stagflation), where rising prices reduce peoples purchase power, this can lead to lower GDP and higher unemployment. 

As we saw in 2022-23 this can be short-term, but it can cause lasting economic adjustments. 

The issue we face, is that the current monetary policy framework, in the UK, US and eurozone, is based on the last time a major inflation crisis emerged from a war in the Middle East. This was in the early 1970s, when a rise in energy prices set off “wage-price spirals”, as firms raised prices to maintain profits and powerful trade unions responded by pushing up wages. This was finally, overcome in the early-80s, when central banks ramped up interest rates to very high levels.   

Under Fed chair Paul Volcker, US interests rates hit a peak 19.1% in June 1981, causing a sharp, deep recession with unemployment hitting 10.8%, but successfully slashed inflation from over 14% to under 4% by 1983. Unfortunately, unemployment stayed high for much longer. 

As a result, of this, central banks believe that inflation is driven by the expectations of future price rises by both firms and households. Their key job was to “anchor” such expectations via snuffing out any sign of wage-price spirals with interest rate hikes. 

This led to monetary policy based on an inflation target by the government; in the UK, the target is 2%+/-1, with the BoE’s MPC using interest rates to meet this target. 

If inflation is forecast to increase above the target, the MPC is likely to increase interest rates. 

Increased interest rates will help reduce the growth of aggregate demand in the economy. The slower growth will then lead to lower inflation. Higher interest rates reduce consumer spending  

The 2022 Russo/Ukraine induced inflation highlighted the fact that aggressive rate hikes did not directly solve supply issues and instead risked weakening growth. The most effective relief came from the natural cooling of energy and food prices later in the year.  

 

‘aggressive rate hikes did not directly solve supply issues and instead risked weakening growth’

 

Central banks across the world scrambled to respond, but their results were surprisingly similar irrespective of whether they officially targeted inflation or not. The episode reignited a fundamental question: are inflation-targeting regimes inherently better at preserving price stability, or can other frameworks deliver equally credible results when policy is coherent and communication is clear? 

Inflation targeting was designed to anchor expectations and enhance central bank credibility. For over three decades, the framework proved effective in a world where inflation was largely demand-driven. 

The 2022 inflation surge showed that monetary policy frameworks need to be more flexible when facing supply shocks, potentially allowing for temporary, targeted support and longer-term, structural, supply-side improvements. 

The 1970’s supply-side inflation was exacerbated by strong unions ability to seek increases for workers, creating wage spirals which kept the inflationary pressure going. Today, the situation is very different; union power has declined considerably, and there is the addition of a global labour force. Meanwhile, firms in the energy and food sectors in particular have huge market power to set prices as they wish.  

Another difference is in demand, as, today the world economy is less reliant on fossil fuels. Some estimates suggest energy intensity – consumption of energy per unit of economic output – has fallen by C.70% since the mid-1970s. 

 

‘there was “profit-price” inflation, as firms ramped-up prices to maintain profits, which caused the initial supply side shocks to energy and food to osmose into general inflation’

 

Whilst there was little evidence of “wage-price spirals” during the 2021-23 inflation period, there was “profit-price” inflation, as firms ramped-up prices to maintain profits, which caused the initial supply side shocks to energy and food to osmose into general inflation. 

Also, in 2021, there was the added inflationary effects of the post-Covid economic restart. Pent-up consumers had a voracious appetite for goods and services. Governments and central banks were pushing to stimulate activity, and labour markets were tight. 

“The result today in the case of a protracted war would be an intense supply shock that runs up against much weaker demand growth,” said Kallum Pickering, the chief economist at Peel Hunt. 

If there aren’t contributing factors, such as wage spirals and profit-price chasing, supply-side pressures, that are often caused by external factors that may subside on their own. 

Furthermore, surveys show that household inflation expectations are largely driven by short-term changes in actual prices of the goods they most often purchase, such as groceries and gas prices, rather than their beliefs in the central banks’ ability to control long-term prices. 

 

Sadly, she appears to be in a minority on the Bank’s rate-setting committee, and, it is reported, that markets have priced-in a rate hike! 

 

The BoE should, after the last crisis, realise that its main policy tool is largely irrelevant in dealing with geopolitical supply shocks and their impacts. Instead, it should support and coordinate with the government to implement price caps or controls on essential services to ensure firms don’t pass on price shocks to consumers. Alternatively, it could support a changed approach to problematic sectors such as energy through public ownership As we have seen in Spain, these types of measures were more effective in controlling inflation than was raising interest rates. 

By lowering interest rates, the Bank can reduce the cost to the government of these interventions and also encourage investment in the clean energy sectors the UK needs to expand in order to wean itself off imported fossil fuels. 

Some on the MPC appear to realise this. The LSE economist Swati Dhingra noted in a talk last year that “monetary policy action alone, however, is not well-suited to address systemic price shocks in key sectors such as energy and food. It may even be counterproductive, as it could constrain investment that would enhance supply resilience and exacerbate future vulnerabilities”. 

Sadly, she appears to be in a minority on the Bank’s rate-setting committee, and, it is reported, that markets have priced-in a rate hike! 

 

“A dollar bill can’t buy you a meal
‘Cause a dollar bill just ain’t no deal” 

 

I decided it was high time we looked at inflation, especially supply-side inflation, which seems to be the bete noire of central banks mired in monetarism.

As we saw in 2021-23, central banks increased rates to squeeze out demand that was largely illusory. As a result, more people were pushed into poverty and forced to choose between “heat and eat.”

At the time, this didn’t seem logical to me, and this time around its no different. Sometimes the best course of action is to do nothing and let the situation right itself. I believe this is what happened previously, and all central banks achieved was slowing already mundane growth and making people suffer unnecessarily.

Of course, I write all this because it seems Trump might call a halt to the war, if his post on Truth Social is to be believed. As usual he is predictably unpredictable.

Having repeatedly stated that there is nobody to negotiate with, now Trump reveals that negotiations have taken place.

As a result, financial markets are considering more moderate interest rate rises and will have to wait for Trump’s next social post to change their minds yet again.

The point is that the sudden and constant change in market expectations of interest rates, almost entirely driven by Trump’s geopolitical actions and social media posts, demonstrates that the BoE’s policymakers should sit on their hands rather than rushing into anything

Lyrically, we start with “The Trumpton Riots” by Half Man Half Biscuit and play out with “Inflation” by Cameo.

Perhaps spring will let me enjoy myself?

Philip.

 

@coldwarsteve

 

 

 

Philip Gilbert is a city-based corporate financier, and former investment banker.

Philip is a great believer in meritocracy, and in the belief that if you want something enough you can make it happen. These beliefs were formed in his formative years, of the late 1970s and 80s

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