Page 22 - DIY Investor Magazine | Issue 31

This is the classic emerging market, export-led growth model where you bring low cost labour into the workforce and slowly move up the value chain driving growth by exporting goods into the Western countries; you do it at a lower cost than anyone else can do it, which works for a long time. The effect is quite deflationary, and that’s what we’ve seen happen: the price of tradable goods has been deflationary for a long time, and that’s why we see low rates of inflation in Western countries, because you have tradable goods prices which are flat or declining and then domestic service prices – the price of your haircut, the price of your train ticket – going up, and it’s the average of the two which is the inflation number that we see. Going forward, we won’t have that same deflationary force because the labour costs arbitrage doesn’t exist in the way that it existed before; labour costs have gone up so much in China that the economics don’t stack up in the way they used to. That’s why we’re seeing companies re-shore their supply chains back to the US and Europe, because it makes sense; I don’t think that’s going to lead to a surge in inflation, but I certainly think it’s less deflationary than we have become accustomed to over the last 10 or 20 years. JL: Let’s talk about the surge in energy prices. In the UK we’ve seen queuing for petrol and diesel, which may be more closely related to Brexit and the lorry drivers who’ve gone back to Europe following the full exit of Britain from the EU, but energy prices have risen all over the world, which could have an impact, especially on inflation. MT: You’re right, they have risen a lot; there are two things going on - short-term issues, which may resolve themselves, but also longer-term factors. In the short term we’re seeing recovering demand all around the world as economies reopen, but also peculiarities such as gas storage where levels are unusually low; we’ve also had a poorer period for renewables, particularly here in the UK where the wind just hasn’t been blowing. That may sound flippant but it illustrates one of the problems; the PM has put a lot of weight on wind power being how we’re going to decarbonise and I’m supportive of that, but it is an intermittent source of energy and when it’s not available, until we have reliable scale storage solution, we will be vulnerable to these situations. It doesn’t take much; demand is very inelastic for energy, so even a small shortage and suddenly prices go up enormously to ration demand. Longer term, there has been a real lack of investment in this industry; starting around 2014, we had a crash in oil and gas prices driven by the growth of US shale and then the decision by OPEC to effectively try and out- compete shale. That was really a regime change for the fossil fuel industry, because it changed its whole pricing dynamic and it had to change the way it behaved. The previous 10 years had been an investment boom, where they’d spent loads of money on new projects, many of which proved uneconomic, or made very low returns; since then the industry’s been much more focused on financial metrics like return on capital. Shareholders have held companies to account as well, and so there hasn’t really been the same level of investment. It takes a long time because projects can take 5-10 years to fully come online, so it’s only really now that we’re coming to the end of some of those big projects that were sanctioned in 2012/14. Looking forward we don’t really have much new supply coming on and demand is still very resilient and recovering; to me, that point is more of a concern. The shorter- term issues will probably work themselves out, but the longer- term questions are harder to correct without new investment. On top of that we have the ESG dimension as well – listed fossil fuel companies in Europe are basically no longer investing in new fossil fuels because they need to transition their businesses away. It’s a bit of a wake-up call for everyone because it shows that we are still reliant on these sources of energy and if we pretend we’re not, the danger is we end up in these situations. DIY Investor Magazine · Nov 2021 22