The Era of High Costs Brought by the Ukraine War [Ukraine Shockwave ⑤]

Royal Staff in the UK Also Receive Pay Raises... US Coining New Term 'Lunchflation'
Base Interest Rate Raised Over 60 Times... Fear of Recession Like Oil Shock Looms

[Asia Economy Reporter Park Byung-hee] # Queen Elizabeth II of the United Kingdom agreed to a pay raise for royal staff on the 2nd (local time), ahead of her 70th anniversary of accession. The wages of royal staff had been frozen for the past two years, but with this increase, royal staff will receive a raise ranging from a minimum of 2.5% to a maximum of 5%. The royal household explained that this is not a bonus commemorating Queen Elizabeth II's 70th anniversary of accession, but a reward for the staff's hard work so far, taking into account the increased living costs due to inflation.

# Germany issued a transportation pass starting from the 1st of this month that allows unlimited use of public transportation such as buses and trains for only 9 euros per month. This measure aims to alleviate the soaring living costs for ordinary citizens. Considering that the original price of the cheapest monthly subway pass in central Berlin, the capital of Germany, is 63 euros, 9 euros feels almost free. Germany plans to issue the 9-euro unlimited pass until September. Ireland also reduced public transportation fares by 20% starting from the 16th of last month. This is the first time since 1947 that Ireland has lowered public transportation fares.

# In the United States, as concerns about COVID-19 have recently decreased, companies have instructed employees to return to the office, but cases of employee resistance are increasing. The reason employees refuse to come to work is not simply because they find commuting bothersome, but also because the economic burden has increased. Rising raw material prices have significantly increased commuting transportation costs and lunch expenses. A new term, "Lunchflation," combining "Lunch" and "Inflation," has become popular to describe this phenomenon.

The whole world is suffering from soaring prices. The long era of low inflation and low interest rates following the 2008 global financial crisis has ended, and a new era of high inflation and high interest rates has arrived. Ordinary citizens are complaining about the cost-of-living crisis, and companies are groaning under soaring cost burdens.

◆ The Era of Reverse Currency Wars = The U.S. consumer price inflation rate has remained in the 8% range since March. The current inflation rate is the highest since 1981, when the U.S. experienced the second oil shock. The Eurozone's consumer price inflation rate for May, released on the 31st of last month, also entered the 8% range. The cause of the rapid price increases is the disruption of existing supply chains due to the COVID-19 pandemic followed by the outbreak of war between Russia and Ukraine, compounding the problems. In particular, as Russia, one of the world's largest energy suppliers, became embroiled in the war, energy supply costs surged, becoming the root cause of all cost increases.

Before the war broke out, Europe imported 50% of its crude oil consumption from Russia. However, after Russia invaded Ukraine, Europe has been reducing imports of Russian crude oil to damage the Russian economy and prevent it from financing the war. Europe has increased imports of liquefied natural gas (LNG) from Qatar, the United States, and others, while Russia is redirecting the crude oil it used to send to Europe through the Suez Canal to China and India. The existing energy supply chain has been completely disrupted.

[Image source=Reuters Yonhap News]

Central banks around the world are responding to inflation with strong tightening policies. According to the Financial Times, in the approximately three months following Russia's invasion of Ukraine, central banks worldwide have raised benchmark interest rates more than 60 times. This is the highest number of rate hikes since at least 2000. In effect, a reverse currency war is underway. As global inflation emerges, central banks worldwide are competitively raising the value of their own currencies to reduce inflationary pressures.

◆ Supply Chain Disruptions That Central Banks Cannot Solve = The problem is that it is uncertain whether inflation can be controlled by strong tightening policies alone. The supply chain issues, which are the fundamental cause of soaring prices, are not problems that central banks can solve.

Larry Fink, chairman of BlackRock, the world's largest asset management company, pointed out in an interview with Bloomberg TV that "the U.S. central bank, the Federal Reserve (Fed), does not have the tools to solve supply problems across the economy," and predicted that inflation will persist for years to come. Fink also noted that the transition to a green economy?such as shifting from traditional fossil fuels like oil and gas to renewable energy sources like solar and wind, and the spread of electric vehicles?is also a factor stimulating price increases.

The market is already anticipating long-term high inflation. According to the Federal Reserve Bank of St. Louis, the expected inflation rate five years from now, calculated by the difference between the yields of 5-year U.S. Treasury bonds and 5-year Treasury Inflation-Protected Securities (TIPS), is 2.97%. This means that high inflation exceeding the Fed's monetary policy target of 2% is expected to continue even five years from now.

The 5-year expected inflation rate rose to the 3.7% range immediately after the invasion of Ukraine but has since declined somewhat. However, the Federal Reserve Bank of St. Louis has been publishing inflation expectations since January 2003, and this year is the first time the inflation expectation has exceeded 3%. This means that current inflation expectations are the highest in at least the past 20 years.

[Photo by Reuters Yonhap News]

◆ Inflation Leading to Earnings Shocks = High inflation is affecting not only individual consumers but also corporate earnings. The first-quarter (February to April) earnings of Walmart, the world's largest retailer, released on the 17th of last month, were shocking. Walmart's first-quarter sales were $141.57 billion (about 180 trillion won), up 2.4% year-on-year, but net income was only $2.05 billion, a sharp 25% drop compared to the same period last year.

It has been pointed out that Walmart's profitability deterioration is due to soaring prices. As prices soared, consumers mainly purchased low-margin products, worsening Walmart's profitability. There are also claims that Walmart could not pass the increased costs to consumers through price hikes and had to bear the burden itself, leading to profit declines.

Another major U.S. retailer, Target, also saw a significant decline in profitability in the first quarter. Target's first-quarter sales increased by 3.3% to $25.17 billion, but net income plummeted by 51.9% to $1.01 billion.

◆ Can a Recession Be Avoided? = There is considerable concern that aggressively pursuing tightening policies to control stubborn inflation could cause a severe economic shock. This is because, about 40 years ago during the second oil shock, the U.S. implemented strong tightening to control inflation but fell into a serious recession.

The U.S. consumer price inflation rate rose to 14.8% in March 1980, and then Fed Chairman Paul Volcker raised the benchmark interest rate to 20% to control inflation. Due to the strong rate hikes, the U.S. economy entered a recession in January 1980. Although it emerged from the recession in July of the same year, it fell into recession again exactly one year later in July 1981. This was a "double dip." The second recession lasted longer, continuing for 16 months until November 1982. The ongoing debates among Fed officials about the timing and magnitude of rate hikes stem from the caution to avoid recession during the tightening process.