Should we see red on the Red Sea?

There are many reasons to be horrified by recent events in the Middle East and the prospect of attacks Maritime transport that could undermine progress against inflation is very, very low on the list.

However, if you want to predict inflation, the disruption of a major choke point for global trade: the Red Sea It’s the route ships take to enter and exit the Suez Canal – it’s not what you want to see. But,

How much is important?

Well, it’s not trivial.

But while overall supply issues have been a major factor in inflation’s rebound in 2021-22, and the resolution of those issues is the main story behind the recent disinflation, it’s important not to get too physical.

Effects

The buildup of ships waiting outside Los Angeles ports in early 2022 was a conspicuous and highly visible cause of inflation, but it was less important than more widespread and relatively intangible factors, such as how the pandemic and its consequences disrupted labor markets.

Since there is no reason to expect these more widespread problems to return, the inflationary impact of the conflict with the Houthis and its effect on navigation in the Red Sea will be limited.

But before we get to that, a few words about the current inflation situation.

After last week’s consumer price index report, I’ve had several conversations with friends who believe, probably based on what they’ve heard from cable TV pundits, that inflation is stuck at a relatively high level.

In fact, the consumer price index, which excludes food and energy, has increased 3.9% over the past year.

But anyone who cites this as evidence of persistent inflation is profoundly misinformed.

In fact, if you’re in the financial consulting business, insisting on 3.9% is bad professional practice.

To understand why, let me give you a few more numbers:

– Core CPI, last 12 months: 3.9%

– Core CPI, last six months (annualized): 3.2%

– Core IPCA (harmonized index of consumer prices), last 12 months: 1.9%

– Market expectations for inflation in 2024: 2.2%.

Therefore, when we talk about an inflation of 3.9% in the last year, we are on average with an inflation of 4.6% in the first half of the year and 3.2% in the second; I mean, it’s way behind the curve.

Furthermore, much of that inflation reflects official estimates of housing costs, particularly an estimate of what homeowners would pay if they were renters, which lag far behind market rents.

The Harmonized Index of Consumer Prices, which does not include this imputed figure – and is how Europe measures inflation – has already fallen to the Federal Reserve’s 2% target, showing that faulty cost estimates of homes are at the root of any perception of persistent inflation. And the markets know it:

Recent market behavior involves believing what the data really shows us, which is that inflation is now under control.

Which ultimately brings me back to the original question:

It may seem like we’ve won the war on inflation right now, but will shipping disruptions in the Red Sea bring it back?

This brings us back to the question of how inflation came to be so high for a time and why it came down so easily.

When inflation took off in 2021, it was initially concentrated in sectors facing supply bottlenecks due to the lagged effects of the pandemic, and many economists, including myself, thought inflation would soon ease to clear those necks of bottle.

Those of us who believed this were nicknamed the Transition Team – and they were wrong.

Inflation spread to much of the economy.

There are several ways to show this magnification.

One is to compare the inflation rate as measured by the personal consumption expenditure deflator – which the Federal Reserve prefers to the CPI – with the “trimmed mean” estimate produced by the Federal Reserve Bank of Dallas, which excludes extreme price movements.

As of September 2021, despite the sharp increase in headline inflation, the trimmed mean had not seen a significant acceleration, suggesting that bottlenecks in some sectors were the main cause.

But then the trimmed average skyrocketed too, so it wasn’t just bottlenecks.

But in that case, what was driving the inflation?

Many economists, the most famous Larry Summershe insisted that the problem was excessive spending and that controlling inflation would mean both sharp reductions in spending and a sharp increase in unemployment.

But that’s not what happened. By almost every indicator (except that very misleading 3.9% that people keep quoting around), inflation fell rapidly in 2023, with no increase in unemployment.

What’s the point of this story?

The better story is that the transition team was basically right, but thinking too narrowly.

The pandemic caused major disruptions, which were a big part of the inflation story, but those disruptions extended far beyond physical bottlenecks, such as clogged ports, and took much longer to resolve.

Let’s put it this way:

Faced with the pandemic, Americans have reorganized their lives, the way they work and spend their money; Subsequently, when the fear of contagion subsided, we reorganized our lives, resuming old habits in some ways but not in others.

We stopped going out to eat and did it again; We started working from home, and in many cases continued to do so, which resulted in big changes in the geography of the economy, i.e. where things happen.

All this created what we might call ““churn out”because companies and people they changed the game.

One readily available measure of turnover is the rate at which workers voluntarily leave their jobs.

Typically, the dropout rate is negatively related to the unemployment rate:

Workers are more willing to quit when they are sure of finding a new job.

For a time, however, resignations deviated from that trend and were really high (as well as unfilled vacancies), before declining as the economy adapted to post-pandemic changes.

This agitation caused a temporary shortage of workers and what they produced, which caused inflation to rise, which then collapsed as the economy stabilized.

After all, inflation was temporary, but the “transitional” period was bigger and longer than we thought.

Which brings me back to the Red Sea (no, I haven’t forgotten).

One way to think about the effects of Houthi attacks on shipping is that they could recreate a situation comparable to the supply bottlenecks of the first half of 2021, albeit on a more limited scale.

But as I just argued, these bottlenecks ended up representing only a relatively small part of the overall inflation story.

And nothing that happens in the Middle East will cause the kind of broader upheaval that has led to inflation being so high and widespread.

So the economic aspects of the events in the Red Sea, while not a big deal, are not of great concern.

Now ask me what if China attacks Taiwan.

c.2024 The New York Times Company