December 20, 2021
The U.S. economy is about to get the “Indiana Jones treatment.”
He’s the iconic archaeologist/adventurer from the four Steven Spielberg films of the same name. Indiana Jones, played by Harrison Ford, evades Nazis, saves the world, gets the girl… and wields a mean bullwhip.
That’s a single-tailed whip made of braided strips of leather (or – if you’re not the epitome of Indiana Jones cool – nylon) usually used to control livestock… or, in Indiana’s case, to ward off a ferocious lion and then swing across a chasm in the earth.
And as I’ll explain… the American economy is about to experience the economic equivalent of the crack of Indiana Jones’ favored weapon, in what’s called the “bullwhip effect.”
What this means is that we’re going to soon see post-Christmas sales that will make Black Friday and Cyber Monday look like high-priced sidewalk sales by comparison… and, secondly, all this talk about inflation – just now the highest since 1982 – will fade like snow on a 70-degree day.
First, though… let’s talk about demand, supply, and where they do – and don’t – meet.
Demand on Steroids
After COVID-19 lockdowns, and with pandemic-related stimulus cash magically deposited into bank accounts, millions of Americans moved into “treat yourself” mode. And the surge in working remotely – the percentage of Americans working from home nearly doubled due to the pandemic – drove up demand for computers and other home-related creature comforts.
That meant that demand for consumer goods – the kind of things made (mostly) in Asia and shipped across the globe – boomed. Overall consumer spending in the U.S. rose 12% in the second quarter of the year (though it cooled off in the third quarter).
All that buying of PlayStations, lumber, Honda CR-Vs, LG InstaView fridges, five-piece bamboo garden sets, etc., has helped drive a sharp economic recovery. In the second quarter of the year, U.S. GDP rose at an annualized rate of 6.7%. And it’s on track to post the strongest full-year growth since 1984.
But as you know – if you’ve tried to buy any of that stuff in recent months – there’s been a shortage of pretty much everything. That’s partly a function of demand on steroids… But it’s also been a supply problem.
The Weak Link
Too many people wanting stuff results in a shortage of stuff… There just isn’t enough to go around. And that shortage is worse if less of the object-of-desire stuff is being produced… or if it’s stuck in transit… and isn’t where it needs to be.
That’s where the global supply chain – the network of production and distribution that’s the backbone of the world economy – comes into the picture.
Once upon a time, companies gathered all the inputs to a product (whether they were making tanks, toasters, or toys) and stored the parts in big warehouses that were usually located physically close to the place where the product was put together.
For example, if automaker General Motors (GM) had a warehouse full of bumpers waiting to be installed on sparkling new 1972 Chevy Vega… it paid for the land, the storage space, and the personnel to track the inventory.
But upon the development of just-in-time manufacturing by Japanese automaker Toyota Motor (TM) in the early 1970s, companies became more aware of the cost of holding massive inventory. And they figured they could improve their profit margins if they offloaded onto other companies – that is, suppliers – the task and expense of making and delivering inputs (pistons, tires, rearview mirrors, hood ornament doodads, cup holders, whatever) to the production facility, when they were needed.
Just-in-time manufacturing evolved and spread far and wide. Advances in tracking and information technology and systems also allowed for the increasing globalization of supply chains.
Today, as the Economist explains, supply chains are “some of the most sophisticated forms of human endeavor.” The iPhone, for example, sources inputs from a network that spans 49 countries. Pharmaceutical giant and vaccine maker Pfizer (PFE) has more than 5,000 suppliers.
But when something goes wrong in that global supply chain, all bets are off. If a supplier in Malaysia closes because of COVID-19 restrictions… ports don’t have enough workers to unload ships due to pandemic lockdowns… there aren’t enough shipping containers to go around… and the “butterfly effect” spreads its wings. (The butterfly effect is when a small alteration to one part of a system creates large-scale changes to another part.)
The Result: Inflation
Once upon a time, stimulus cash met up with post-lockdown pent-up demand for a drink… and not long thereafter, their screaming toddler kicked the knees out of the global supply chain.
Like other basic infrastructures of modern civilization – the Internet, the electric grid, and cellular networks, for example – the global supply chain is something that we take for granted… until it stops working.
But if I really want something – beef tenderloin, an iPhone 13, a Samsung 65-inch 4K TV – I might be willing to pay more. After all, a shortage of something doesn’t (usually) mean that it’s not available at all. Rather, it means that there’s more demand for it than supply… and that it’s available for a higher price.
And if I’m Best Buy or Walmart or that creepy guy on Facebook Marketplace who always seems to have another treadmill to sell, the calculus is clear… Economics 101 says that supply and demand will meet (at what’s called the market-clearing price) – and that price will be higher than it would be if the global supply chain was operating like the trains in Germany.
Extrapolate that situation to an entire economy of goods – gas, crayons, Sichuan food at the local Hunan Delight, townhouses in Maryland, Cuisinart Digital Air Fryer Toaster Ovens in Stainless Steel – and the result is inflation… which, stripped of economist doublespeak, is too much money chasing too little stuff.
And it’s not a surprise that year-over-year inflation as of November clocked in at 6.8%, the highest reading since 1982.
The Most Powerful Force in the World
Inflation is right up there, along with gravity, the wrath of a person scorned, and a hungry baby, as a force that will not be denied…
But for my money, what’s more powerful than that force is mean reversion. It means that for every strong reaction, things eventually swing back the other way… and find their way to the middle again.
Mean reversion is when something goes back (reverts) to the average (that is, the mean). A string of good luck – say, six three-pointers in a row in a basketball game – will eventually end. So, too, will a run of bad luck. Periods of great joy – or extreme grief – eventually even out to the dull beige that’s normal life… It’s the pendulum swinging back to the middle.
When applied to investing, mean reversion refers to extreme price movements eventually correcting – reverting to the mean, like a rubber band. If the share price of your boring and old power-utility stock moves up 30% in a month, chances are (all else equal) that hot sentiment is going to cool off. And after that, you’ll be in for a period of subsequent underperformance.
And when applied to many months of global supply-chain constrictions… sooner or later, things will spring back.
Mean Reversion in Action
What we’re about to see (or already seeing, in some cases) is the pendulum swinging back.
Efforts to repair those weak links in the global supply chain and unlock those bottlenecks – to unload 1,000-foot-long container ships in limbo at the Port of Los Angeles, to ramp up microchip production in Taiwan, to get people back to work making sneakers in Vietnam – are bearing fruit.
This is clear, for example, in the sharp decline in the cost of transporting goods. The Baltic Dry Index, which measures demand for capacity to ship dry goods, hit 15-year highs in early October – and since then, has fallen by more than half. Shipping rates are falling, and available ship-storage capacity is rising – which is the opposite of what happens when global supply chains are under strain.
Meanwhile, in recent weeks, a number of global automakers have indicated that they expect semiconductor supplies to increase… the shortage of which has been a big bottleneck for cars, along with everything else that uses microchips – from cellphones to cars to football helmets.
And since September, monthly manufacturing data from IHS Markit’s Purchasing Managers’ Index has shown strong improvement throughout much of Asia, led by Vietnam and Malaysia… That means output throughout that region – home to four of the world’s six biggest manufacturing countries – is rebounding.
A new system shows which stocks could soon rise 100% thanks to a Connecticut couple’s catastrophic 401(k) loss.
Here Comes the Bullwhip
What happens next? Shortages will turn into surpluses, and “out of stock” will become “inventory reduction sales.”
Retailers that have spent months offering warmed-over apologies to consumers – “global supply-chain problems” is the “my dog ate my homework” excuse of 2021 – are about to find themselves swamped with goods. All the Costco couches, Instant Pots, packages of dried mango, Teslas, and everything else that has been on order will arrive… along with a lot more that wasn’t on order.
The “bullwhip effect” is what happens when demand distortion misinforms the supply chain. It’s when your local Best Buy (the next-to-last stop of the supply chain) orders too many PlayStation 5s out of the fear of not being able to meet demand… and the factory in China (the beginning of the supply chain) ramps up too much, and doesn’t cut production until it’s too late. Before long, the local Best Buy is slashing prices to move the PlayStations off the shelves.
In other words, it’s the supply-chain-management equivalent of your brain not getting the message from your stomach that you’ve had enough to eat… so you keep chowing down, until finally your head gets it: OK, stomach is sated.
And by then, it’s too late, and you have a bellyache – or worse.
Big-Time Post-Christmas Sales… And Lower Inflation
If you can convince the family to postpone Christmas for a while – and you’re not sentimental about the anniversary of the birth of Jesus (after all, he could just as easily have been a few days earlier, or later… so why not, say, a month later?) – you’ll get a lot more return on your Christmas dollar next year. That’s because everything is going to be on the mother of all sales, as the global supply chain finally chokes up all the goods that haven’t been on their way.
And there’s another positive side effect… lower inflation. It’s not complicated… As the upward price pressure on goods across the economy dissipates, inflation will fall.
What’s more, there’s another reason for inflation to decline… Federal Reserve Chair Jerome Powell finally waved the white flag and admitted that inflation isn’t “transitory.” That’s been the Fed’s preferred term for inflation, which has been steadily rising all year, from an annual rate of 1.4% in January to 6.8% in November.
“Transitory” suggested that as the economy moved past pandemic-induced supply shortages, and as demand fueled by COVID-19 stimulus cash dissipated, recent price increases would gradually disappear.
And ironically, just as the Fed acknowledged the obvious – that inflation would be around for longer than a few months – it’s finally going to go away.
It’s like finally calling the guy who’s been sleeping on your living room couch all year your roommate rather than your houseguest. He’s become part of the furniture, and is most definitely not just passing through. And just when you label him your roomie, he picks up and leaves.
The Fed is becoming the ultimate contrarian indicator… the proverbial bell ringing at the top of the market. The Fed says “no más” – and inflation vanishes like an unwanted house visitor.
And in the meantime… the real bullwhip is coming back soon.
The fifth Indiana Jones movie is due out in June 2023. It’s the first Indiana Jones flick not directed by Steven Spielberg… And it’s the last one with Harrison Ford, who, at 79, is a stretch as an action-flick hero. (The movie’s filming schedule had to be adjusted after Ford injured his shoulder while rehearsing a fight scene in June. Jerome Powell should be so lucky.)
Love us? Hate us? Let us know how we’re doing at [email protected].
Executive Editor, American Consequences
With Editorial Staff
December 20, 2021