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Inflation is not only a result of war-induced supply disruptions but also those from the lockdown period, and is largely a monetary phenomenon
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It is unclear whether we have stepped into the climax or if the worst is yet to come
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A debt crisis is possible as inflation raises interest rates
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Most business owners from younger generations, who came of age after the mid-90s, have no experience with inflation. They know it only in theory. Moreover, until recently, analytical estimates indicated that it was merely a temporary and not overly concerning phenomenon. As soon as the supply chains (which were disrupted in the second phase due to the war) are repaired and the blocked energy routes are compensated (even though the EU is importing more oil from Russia than ever before, so it is possible) everything will return to the old normal. Except it won’t.
It has turned out that inflation is not only stubborn but that the war has little to do with it – this time inflation is not just a result of war-induced supply disruptions but, above all, those from the lockdown period (and the currently ongoing Chinese one) as well as the printing of vast amounts of various banknotes during the pandemic. Thus, it is largely a monetary phenomenon. This makes it even more surprising that some countries, like Canada, have ‘brilliant’ ideas – to distribute financial aid to citizens/voters to help them cope with the inflationary shock. Is there anything more normal than extinguishing a fire with gasoline, at first glance, a hefty $9 billion? Welcome to the new normal!
However, what lies behind the long-unseen rates of inflation growth is of little interest to entrepreneurs. They are concerned about when it will end and how to manage the rise in almost all input costs in the meantime. Large companies have enough of their own reserves to endure for a while longer, although the rise in producer prices (almost 25 percent in March!) has already partially spilled over to consumer prices (official inflation was 10.8 percent in May). And the others? How, who. Most are not at all ready to talk about this topic, and those who are are quite stingy with words.
Nothing is certain yet
Josip Budimir, president of the HUP Association of Coffee Producers (and a member of the Franck Management Board), says that the problem is everything, from the fact that inflation is going through several iterations (first, commodity prices rose, then energy prices, and now all input prices are rising) to the biggest problem being that it is unclear whether we have stepped into the climax or if the worst is yet to come.
– In just one year, the price of the main raw material, coffee, has risen by 80 to 100 percent, depending on the market. Since coffee is the main item in the cost structure of producers, this has hit us the hardest. All processors have raised prices by about ten percent, but that is too little to amortize the overall impact of input prices. And now a new blow is coming, the rise in energy, packaging, and transport prices – Budimir says, emphasizing that he is still an optimist because only states can add fuel to inflation with helicopter money, and that is not happening for now. Quite the opposite, more or less all key central banks have started fighting inflation by raising reference rates.
Ivan Miloloža, the head of Munja, says that in such inflationary times, only pharmaceutical companies and food producers can plan.
– Everyone else is just pretending to plan. For us, electricity, water, and gas normally account for about twenty percent of material costs, while lead and lead alloys make up the rest. Now our energy costs are almost half of our expenses! The price of gas has jumped from 0.31 to 1.17 kuna per kilowatt-hour, that is, four times, electricity has increased five times! Why has the price of electricity risen so much? There is no logic to it, unless something particularly difficult has happened in thermal power plants, which is unlikely. Electricity is not rising globally as much as it is here. The late Bandić and the team that led Plinara Zagreb in 2019 are to blame for the jump in gas prices because they did not contract a gas lot – Miloloža openly and categorically accuses, adding that only a few companies can survive this without serious ‘damage’ to their balance sheets.
At Tim Kabel, they can no longer assess when the rise in inflation will end.
– When prices first jumped, by five percent, then ten percent, we thought that was the ceiling. But prices continued to rise. We are particularly concerned about the enormous transport prices, especially for containers, energy prices, raw materials, and copper, which is of strategic importance to us. We would be satisfied if prices stopped at the current, albeit very high, levels, because everything has its limit of sustainability – they convey to the employees of one of the most beloved companies, adding that they are convinced that there are indeed speculative reasons behind the rise in transport, raw material, and energy prices, which would mean that no one can assess where the end of the price rise is.
Perhaps they could, not exactly know, but at least assess economic analysts. The same ones who claimed last year that it was temporary and would not pose an unbearable problem. However, Budimir also believes that inflation will gradually calm down because, regardless of how long the war lasts, Russia has found a new major buyer, China, and Europe is slowly turning to oil and gas sources in the Middle East, Africa, and America. Over time, he claims, prices will normalize, because, for example, the price of capital goods is already slowly sliding – investors are delaying investments due to high prices. As everyone knows that this leads to recession, prices are slowly falling so that a new investment cycle can begin.
Other producers, who did not want to publicly comment on the whole matter, rely on decades-long acquaintances they have made through business, so they have managed to negotiate somewhat more favorable contracts with HEP. Some, on the other hand, have secondary sources of income (many from rentals), so they hope to patch up inflationary gaps with that. And endure. For how long? Let’s see what the economists say.
Possible debt crisis
The chief economist of HGK, Goran Šaravanja, states that due to statistics alone, when calculating annual inflation, it will decrease. Namely, for inflation to reach this year’s rates next year, it would have to rise just as much, meaning there would need to be a new wave of price increases, say, gas prices rising by 400 percent. And that, he is convinced, has no chance of happening. Therefore, by the end of this year, and especially next year, he expects stabilization. However, at high levels, a decrease is not anticipated, but in a sea of bad news…
Šaravanja, like all our analysts, expects that the rise in interest rates will stop inflation, if necessary, even with a recession. However, the problem that is very much visible on the horizon is a possible debt crisis, as inflation raises interest rates, and the rise in interest rates brings all indebted states to their knees.
In the EU, all PIIGS countries (Portugal, Italy, Ireland, Greece, Spain) are at risk, where the rise in interest rates (for Italy, the price is already around 4 percent) is not as concerning as the rapid rise in spreads (between Italy and Germany, there is already a two percentage point difference). Velimir Šonje therefore relies on the ECB and the announcement of a new instrument.
– To prevent a crisis in the government bond market, the ECB will soon announce details of a new financial instrument that should limit differences. From what we know now, the principal and interest of bonds in the portfolio held by the Eurosystem that mature will be reinvested according to a flexible key. For example, if a German bond matures, the funds will not have to be used to buy German bonds, but could also be used to buy Italian bonds. The markets welcomed the announcement. Yields fell, even the Italian yield dropped below four percent – explains Šonje, adding that the official projection for U.S. economic growth has been lowered from 2.7 percent to 1.8 for this year, which practically means an acknowledgment of the danger of recession in the second half of the year.
The market consensus is that the FED rate could reach 3.4 percent by the end of the year, but the door is open for different interpretations, with lower rates. It will just take some time for both the market and the FED, he says, to turn the tanker. And when it turns in the U.S., it will turn in the EU as well.
Green transition as an additional problem
However, there is another danger regarding inflation that few want to talk about – the green transition. Aside from the inexplicably foolish German move to shut down nuclear power plants, the CO2 most neutral, which could have significantly mitigated the current price shock, the question is not only the time it takes to build green facilities but, above all, their cost and financing. Both raise the overall price level. Besides the insufficient EU state money, there is a lack of institutional investors. Until they get involved with ‘healthy’ capital, everything else (whether through money printing or membership/tax collection) will only be additional fuel for inflation. And that for a very long time.
But for all younger owners and managers who think that the current inflation is a catastrophe, here is a little reminder of how it used to be – in Yugoslavia.
Statistics show that the average inflation rate in Yugoslavia from 1965 to 1980 was 15.3 percent annually, and from 1980 to 1987 even 57.2 percent. After 1986, inflation completely spiraled out of control and exceeded 100 percent annually, and by 1990, it reached 1000 percent – by the late 80s, prices were first doubling every year, and eventually even decoupling tenfold. Who still remembers the appearance of Ante Marković, who in 1989 erased several zeros from banknotes and achieved a ratio of 1:7 against the DEM (and practically brought inflation down to zero in just two years)?
