Month: June 2022

Consumption settles

Posted on by Philip J Palin

This morning’s report on May Personal Consumption Expenditures finds an increase in nominal spending that flattens considerably when adjusted for inflation. See chart below, blue is nominal, red is real. The absence of much real growth since about October should not obscure the almost six percent growth since May 2019. That pre-pandemic moment was widely considered a healthy economy. Even with fuel, food, and other inflation, the current pattern still suggests a robust US economy. Deacceleration and gradual de-escalation of demand should also constrain inflation. From a narrow supply chain perspective we are getting closer and closer to equilibrium.

Last Saturday I hypothesized, “that between May and September we will see food-at-home real consumption gradually decline by another seven to ten percent and then flatten or incrementally increase. I hypothesize that durable goods and services will begin to show slopes similar to 2022 food consumption. I also hypothesize a more rapid rate-of-change than that for food between last November and April.” According to the May PCE, real personal consumption expenditures for food fell 0.99 percent between April and May. It has fallen five percent since January. See chart below. Real expenditures on durable goods also fell between April and May. Services expenditures slightly increased. It is too early to say anything about rate-of-change.

My hypothesis for near-term supply chain resilience

Posted on by Philip J Palin

At the close of his recent newsletter discussing the crucial role played by rate of change, Paul Krugman insists, “you do need a theory” regarding “what kind of inflation process you think is currently operating.”

I don’t yet have a theory regarding what kind of supply chain resilience process is currently operating. But I do have a hypothesis that I am now ready to test on my way to a working theory.

Supply disruptions are undeniably complicit in price increases. But at least until February 24, when Russia invaded Ukraine, I perceive that in the United States these disruptions have mostly been demand-driven (if the excavation of causal factors goes deep enough); even more than the substantial demand-driven contribution found by Adam Hale Shapiro.

In 2021 personal consumption expenditures (not adjusted for inflation) soared well above preexisting capacity to fulfill demand. This is shown below in the red top line. This seriously stressed supply chains and caused higher price levels. In March 2021 persistently high demand beyond production and/or transportation capacity was accelerated by pandemic-relief payments. This resulted in a yet higher rate of change for increased prices, as demonstrated in the comparatively flatter slope for real PCE shown here and below in the bottom blue line. Since February 24 we have seen what Krugman calls “a high rate of change in the rate of change,” especially in regard to retail fuel prices.

I have already spent most of nine months expecting to see more conservative consumption. This has begun to feel like waiting for Godot. But since at least this January — arguably, even November 2021 — we have seen serious softening in food-at-home purchases, once adjusted for inflation as shown here and in the chart below. This is not (yet) possible to confidently claim with any similar data for durable goods or services. But the data for all the charts above and below close on April 30. I will not be surprised to see demand behaving more conservatively in May (we should see the May PCE print on Thursday) and even more conservatively for June. Part of this is collateral damage caused by the high-rate-of-change-in-the-rate-of-change for fuel prices.

So, despite nine months of unfulfilled anticipation (or because of it), I hypothesize that between May and September we will see food-at-home real consumption gradually decline by another seven to ten percent and then flatten or incrementally increase. I hypothesize that durable goods and services will begin to show slopes similar to 2022 food consumption. I also hypothesize a more rapid rate-of-change than that for food between last November and April. These are deniable hypotheses. I am not sure. It does seem plausible. If this happens, demand and supply will be closer to equilibrium. Accordingly supply will be much less a factor in price increases than over the last 12 to 14 months.

Will this rate of change be sufficient to exorcise behaviors related to wider fears of stubborn inflation? That’s not a question this supply chain resilience guy is competent to answer. What’s above is already on the bleeding edge of my competence.

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If you are a new reader, it may be helpful to scan the two immediately prior blog posts. You can find them under Conversation in the red top task bar or at these links: Supply Chains and Inflation and The Output Gap.

Supply chains and inflation

Posted on by Philip J Palin

For the last year plus I have emphasized the role of extraordinary demand in disrupting supply. For example, here and here and here. This angle emerges from a perception that contemporary supply capacity is organized around — essentially emerges from — demand. A sudden shift in demand misaligned with capacity will inevitably disrupt flows. So, I look at the slope of US Personal Consumption Expenditures (including sub-components) since Spring 2021 and see a recurring cause of stock-outs, freight congestion, production gyrations, more hires, price increases, and related.

It is worth emphasizing, this blog focuses on Supply Chain Resilience. I am mostly concerned with how demand influences physical flows.

I confess to often treating even stubbornly constrained supplies as (usually, eventually, really) demand dependent. For example, I trace reduced supply of new vehicles to reduced supply of legacy semiconductors that, I argue, emerged from sharp declines in demand for new vehicles in spring 2020. Vehicle manufacturers slashed orders of semiconductors. Production capacity for semiconductors was shifted to other higher margin categories (suddenly in much higher demand). When demand for new vehicles surged several weeks later there was no longer sufficient production capacity to make and deliver the semiconductors needed.

Is this outcome supply-driven or demand-driven? Both for sure. But for what it’s worth, for me these specific swings in demand seem causal, while the resulting shortages are symptomatic. (To acknowledge supply driven possibilities: reduced wheat supplies resulting from Russia’s invasion of Ukraine are not demand-driven.)

Symptoms cannot be ignored. But I mostly want to understand and focus on causes.

Adam Hale Shapiro at the Federal Reserve Bank of San Francisco is as concerned with causes of inflation as I am concerned with how shifts in demand can cause supply complications. These are distinct, but related angles on our shared reality.

Yesterday Dr. Shapiro authored an Economic Letter which, “highlights that both supply and demand factors are responsible for current elevated inflation levels. Supply factors explain about half of the difference between current 12-month PCE inflation and pre-pandemic inflation levels, and the effects appear to be rising more recently. Demand factors are responsible for about a third of the difference, and those effects appear to be diminishing more recently. The remainder is due to factors that cannot be definitively labeled as supply or demand. The large impact of supply factors implies that inflationary pressures will not completely subside until labor shortages, production constraints, and shipping delays are resolved.”

Below is a visual break-down of how this analysis compares and contrasts the interplay of demand and supply factors on inflation.

Dr. Shapiro’s method is as fine-grained as my approach is superficial. I am not quite sure — yet — if his careful method offers insight on how demand influences physical supply. I need to read and think some more — when not as distracted as right now. If readers see promising connections, please let me know. It is, in any case, a constructive and provocative presentation worth your reading — before I swing in with my supply chain resilience bias

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June 25 Update: Too many meetings and urgent requests for “professional (disguised personal) judgments” on emergent reality have left little time for actual thinking by me. But for your consideration, I will pass along recent thinking on related issues from two thoughtful observers.

On Thursday at the Financial Times, Robert Armstrong (or his headline writer) concludes: Supply Won’t Save Us. He agrees with Dr. Shapiro that, “The data on supply tells a mixed story.” Armstrong then reviews various data and indices that to him (and me) detail significantly improved equilibrium of demand and supply compared to late last year. But his concerns go beyond supply chain resilience. The rate of change from bad to better for supply chains (my problem) is not accelerating fast enough for his problem: “Nice, growth-friendly disinflation from the supply side, it seems, isn’t coming to save us.” In other words, the current rate of supply chain improvement will not save us from an inflation-fighting recession (with follow-on implications for supply chains too).

Helpfully, yesterday this rate-of-change issue was the principal topic in Paul Krugman’s newsletter. Here is a chunk of how he starts:

A hot economy leads to higher wages and prices. When demand for labor is strong, workers can and do demand wage hikes; when demand for goods and services is strong, businesses have “pricing power,” or the ability to raise prices without losing customers. But does a hot economy lead to a higher level of prices? Or does it lead to a higher rate of change in prices, i.e., ongoing inflation? Or maybe even to accelerating inflation, a higher rate of change in the rate of change? These may sound like abstruse questions, but they aren’t.

Krugman is also not focused on supply chain resilience per se. But it seems to me — admittedly, a bit vaguely right now — that the rate of change in production capacity, demand velocity, and related flows will also be crucial to how the feedback loops between supply, demand, wages, employment, price increases, inflationary pressures, and potential recession play together over the next several months. Will they be “nice, growth friendly” or not?

Obviously I am thinking out loud with you — even more uncertainly than usual. Perhaps I am just babbling at you. I am on a long plane ride today (if a fueled plane with flight crew shows up). Maybe that will finally provide time for real thinking. As the whole rate-of-change angle suggests, duration can be a crucial factor.

Shapiro’s assessment of causal contributions to inflation: Supply versus Demand

Contributions to annualized monthly changes in inflation

The output gap

Posted on by Philip J Palin

From a June 15 commentary by Greg Ip in the Wall Street Journal:

… the evidence suggests high demand and restricted supply are interacting in ways that economists struggle to calibrate. That is a problem, because it suggests inflation may remain unpredictable as the Fed rapidly withdraws stimulus but supply disruptions from Covid and war persist.

Two paragraphs tee-up a crucial difference between an economist’s angle on what has been happening and a supply chain professional’s view of the same behavior.

Economists have treated the supply side—autos, housing, restaurants, energy, healthcare, finance—as homogenous and elastic: When demand for nursing home beds or cars rise, so does their supply, and prices rise only a little, if at all.

But in the last two years, supply hasn’t been homogenous. Some industries like e-commerce have hired easily, while others like nursing homes have lost workers in droves. Food sold to restaurants didn’t substitute easily for food sold in supermarkets. Supply hasn’t been elastic…

The supply side is never homogenous, says this supply chain guy. Supply is never elastic.

It may seem that way to consumers, even B2B consumers (and, apparently economists). Supply chain professionals work hard to make it possible for consumers to get whatever is wanted, when and where it is wanted. (For the last decade this was very often the case in much of the United States.) But inside the network: sources, products, flow, categories, topographies, pull, targets, margins, modalities, and more are profoundly heterogenous. Supply is calibrated to demand. Production capacity and transportation capacity are calibrated to persistent consumption patterns. Push is calibrated to pull.

Over the last two years — even the last two months — demand has swerved, surged, and swayed dramatically. The aggregate Personal Consumption Expenditure (PCE) graph — and its slope — is worth a long stare and longer thought (see chart below). Contemplation of volatile PCE sub-components can cultivate humility.

In April 2018 total PCE was $13,809 billion. In April 2019 total PCE was $14,309 billion, reflecting healthy, historically happy year-over-year economic growth with low inflation. April 2020 PCE crashed ($12,021 billion), but by April 2021, total PCE was $15,601 billion. This April total PCE was $17,059 billion!

There are laws of physics, wads of regulations, financial management principles, and quite reasonable uncertainties that conspire to frustrate quick recalibration of push capacity to this extraordinary acceleration in pull.

Yet, since 2020 in the United States, unfulfilled demand has usually not been because of reduced supply. It has been because much more supply has still not been enough to satisfy demand. There has been a reduced supply of new automobiles. But grocery manufacturing, for example, is producing more than ever before. Durable goods manufacturing (other than cars) has grown by over ten percent since Spring 2019. US manufacturing of clothing and footwear is up 18 percent over 2019. US imports from China increased across all of 2021 and remain above pre-pandemic seasonal levels. Supply can be said to be “restricted” by various factors. It is not easy or automatic to grow this much so quickly, but growth in capacity and flow has been robust.

From March 2020 until March 2021, Personal Consumption Expenditures were restrained. Many Americans — especially high-earners — did not spend nearly as much as usual (saving more). Since April 2021 spending has, however, made up for lost time. For US personal consumption expenditures to increase over 8 percent inside twelve months is just about unprecedented.

It is not surprising that a much faster rate of increase for the Consumer Price Index began about the same time as this sustained demand surge. The CPI has also experienced a proportional increase that closely mirrors growth in personal consumption expenditures.

From when this buying surge began until at least January 2022 — even until now, depending on where and how you look — many supply chains have been challenged to keep up and grow with the increased demand. But both global and domestic flows have mostly kept up (here and here). Given the swift, significant surge in demand: any supposed elasticity was not nearly enough. Flows needed to be supplemented with substantive capacity expansion. This has happened in terms of new investments in technology, space, and labor. For example, in April 2021 there were 1.64 million US warehouse and storage employees. In April 2022 there were 1.78 million employees serving this sector.

Now, since January there is (finally) evidence of some reduced demand across several categories (for example, food). I suspect this slowdown will become more pronounced — especially under pressure from increased fuel costs. Given increased capacity (US and worldwide) built out over the last two years and some softening demand, we will soon be back to where elastic and homogeneous supply will feel real (even when it is not). In any case, barring some extreme event (not implausible), disequilibrium between demand and supply in the United States will be much less than 2021 — and contribute less to inflationary tendencies.

Unfortunately, since February 24 the disequilibrium between demand and supply outside the United States — especially in regard to fuel and food has widened, deepened, and become very complicated. One source of inflation has been mostly absolved, another potentially worse has emerged.

United States Personal Consumption Expenditures: April 2018 to April 2022

Flows push and pull

Posted on by Philip J Palin

[June 16 update far below]

According to the International Energy Administration, in May Russia’s oil export volume was down 3 percent. The total dollar value returned was, however, up 11 percent (despite considerable price discounting per going global rates) (more). Outbound flows to China, Turkey, and India have picked up as other flows have declined (despite China’s much lower crude oil demand). Total inbound cash-flow matches pre-March (pre-sanctions) on reduced product outflow. So far, pull is effectively overcoming earnest efforts to impede push.

Given inescapable impediments caused by counter-pandemic policies, many have been surprised that China’s customs data for May exports were up almost 17 percent in value year-over-year (and 2021 was also up YOY) (more and more ). Volumes were also up. According to the South China Morning Post, “container throughput for foreign trade at eight major ports in China increased by 13 per cent year on year in May.” Inbound flows have been much more constrained. There have been earnest efforts to maximize outbound push, despite near grid-lock conditions for domestic flows.

Ukraine’s grain flows through Black Sea ports are blocked by defensive mines, military attacks, Russia’s blockade, and the full friction of war (more and more). Before the war up to 90 percent of Ukraine’s grain exports moved through Black Sea ports. In 2021 just four ports, Odesa, Chernomorsk, Pivdennyi, and Mykolayiv handled 6 million tons per month.  Since the war began on February 24, a rough average of one million tons of grain per month have been exported using every available means (see chart below). Most years Ukraine is among the top five grain exporters. Pull is persistent, even intensifying. Grain and related prices are mostly increasing. Push is cutting new channels (more and more and more and more). But, so far, push has not found a way to compensate for suddenly losing 90 percent of preexisting capacity.

While only three examples, to compare and contrast suggests that pull can be very persuasive as long as push capacity persists. Strong pull can motivate overcoming considerable friction in flows and even loss of usual demand. But if a significant proportion of upstream capacity is blocked or destroyed, no amount of pull will restart push in the short-term. Large scale capacity is the result of large-scale and typically long-time investments.

Some readers may wonder: why give so much space to explaining what is obvious. It is increasingly my experience that capacity issues — and especially capacity-crashing issues — are not obvious to many otherwise wise and experienced folks.

Ukraine’s grain exports per month 2021 and 2022 through May

Source: State Customs Service of Ukraine, accessed June 7, 2022.

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June 16 Updates: Good detail on Russia oil flows from S&P, including: “Russia’s oil export resilience to Western boycotts and sanctions so far has surprised most market watchers. After plunging 930,000 b/d in April, Russian total oil production in May actually rose by 130,000 b/d to 10.55 million b/d…” Report includes break-down by old and new pull. New shipping spot market index (more)shows price for China to US containers well below highs (if still double pre-pandemic averages). Interesting angle on reshaping Ukrainian grain channels by constructing new — supposedly temporary — distribution nodes where stocks could be concentrated to size, scope, scale and optimize non-traditional flows. See Reuters report on temporary silos (more and more).

Less comforting food

Posted on by Philip J Palin

[June 15 update far below]

Americans are big eaters.

According to IRI (see chart below) grocery demand has recently been up five to almost ten percent, depending on product category, compared to 2021… which was higher than than 2020 which was about one-fifth higher than 2019.

Comfort food has — understandably — been in high demand.

According to the Federal Reserve in April 2022 compared to April 2017 the US produced 12 percent more “sugar and confectionary product,” and about 16 percent more meat (seasonally adjusted). The overall food production increase was just about five percent. (The US population increased by about 2.2 percent over this period).

We are now eating out about as much — or much more — than pre-pandemic (see chart below). According to the Fed in April 2019 Americans spent $63,137 million at Food Services and Drinking Places. This April we spent $83,741 million. That’s about one-tenth above a generous extension of pre-pandemic growth trends.

Many expected (I expected) grocery demand to gradually soften as eating-out returned. Instead for most of the last year-plus, dollars spent have increased for both Food-At-Home and Food-Away-From-Home. In April 2022, according to the Bureau of Economic Analysis, Americans spent about one-quarter more on food than in April 2019 (see chart below). American consumers also continue to spend well above pre-pandemic trends on durable goods… and much more.

Given these aggressive new spending habits, I am less skeptical regarding the reality of “retail therapy.”

As expected with a demand surge, food prices have increased. This reflects pull exceeding existing push capacity. When adjusted for inflation, the growth in “real” demand has moderated, especially this year (see final chart below). But this real demand remains at least 8 percent above April 2019. (Please mind the gap: while overall food production has increased about five percent, overall food demand has increased yet three points more over the same period.)

In its May Consumer Price Index released Friday (more), the Bureau of Labor Statistics reported:

The food at home index rose 11.9 percent over the last 12 months, the largest 12-month increase since the period ending April 1979. All six major grocery store food group indexes increased over the span, with five of the six rising more than 10 percent. The index for meats, poultry, fish, and eggs increased the most, rising 14.2 percent, with the index for eggs increasing 32.2 percent. The remaining groups saw increases ranging from 8.2 percent (fruits and vegetables) to 12.6 percent (other food at home).  The index for food away from home rose 7.4 percent over the last year, the largest 12-month change since the period ending November 1981. The index for full service meals rose 9.0 percent over the last 12 months, and the index for limited service meals rose 7.3 percent over the last year.

Even on an inflation-adjusted basis, Americans are spending more on every category tracked. We are spending savings accumulated early in the pandemic. We are spending more (saving less) of current wages.

Disequilibrium of demand and supply prompts price increases. Disequilibrium results from less supply or more demand. Because of avian flu there has recently been a reduced supply of eggs — even while there has been increased demand. Hence, the nearly one-third price increase. In other food products we have mostly had more supply, but we have had even more demand.

There is evidence that real US demand for food peaked around Thanksgiving 2021… and consumer willingness (ability?) to pay increasing food costs is subsiding. As fuel and other household costs continue to increase, I expect to see a decline in inflation-adjusted spending on food until supply and demand are better balanced. Given increased energy costs and global disequilibrium in food-related demand and supply, what the United States may then experience is incremental demand-destruction for food as discretionary expenditures narrow. We will not see a June PCE for another six weeks; that will provide retrospective evidence for what is happening right now.

IRI Demand Index through May 29, 2022

Federal Reserve Sales at Food Services and Drinking Places, April 2019 to April 2022

Federal Reserve Personal Consumption Expenditures (Food-At-Home)

Federal Reserve Real Consumption Expenditures on Food (inflation adjusted 2012 chained dollars)

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June 15 Update: While not as meaningful as the June report on Personal Consumption Expenditures (or even the May PCE scheduled for June 30), the retail sales report for May (released June 15) does reinforce the sense of an incremental softening in consumer demand for food. The chart below shows grocery sales not adjusted for inflation. Overall retail sales were at least as flat and arguably lower. The overall retail inventory to sales ratio is still below par, but continuing to improve. Some retailers, though, are having painful encounters with inventory bullwhips.

Apologies

Posted on by Philip J Palin

Real-world Supply Chain Resilience issues have claimed most waking hours. I look forward to soon being back and digging deeper into PCE behavior patterns and much more.