The monetary economist Tim Congdon was correct when in 2021 he predicted increases in inflation across much of the developed world. The central banks of the world were not quite so prescient. In particular, the strength of consumer demand and the resulting increase in prices in the US seems to have supported Congdon’s analysis.
One physical expression of this is the congestion at the port of Los Angeles. The queues of ships and stacks of containers are the principle of demand over supply made material. These sorts of problems are seen elsewhere in logistics markets with, for example, road freight suffering from labour shortages, although airfreight is crippled by extraordinary conditions.
However, there are some notable observations that should be made about the inflationary environment in the logistics sector.
For much of the sector, returns on capital employed have traditionally been very low, frequently at just the cost of capital. Container shipping has been a good example of this with capital returns occasionally being negative over the past decade or more. Unsurprisingly this has led to consolidation in the market, with furious merger and acquisition activity in the decade prior to 2020. This, in turn, triggered an increasing focus on asset utilisation. Therefore, when demand increased at an unanticipated speed and direction in 2021, additional shipping capacity did not exist to respond to customers’ requirements. The exponential effect on prices was predictable.
Yet through 2021, it was not a gross increase in container shipping demand that was the problem. Overall, at a global level demand was growing at low-single-digit percentages. Rather it was the increase in demand in the US in particular that drove the market. This geographical shift also had the effect of unbalancing container shipping networks, with containers building up in demand locations and unable to return to supply locations. This amplified the shortage of capacity.
All of these factors have fed through to freight rates.
Airfreight is different. Much more than sea freight, it has suffered from extraordinary quarantine measures that have suppressed passenger demand with the effect that belly-freight has been hugely reduced in supply. This has occurred at the same time as an increase in demand for e-retail services that are intense users of airfreight. The near future will see a return of airline services and thus belly-freight, yet the shortages of pilots and the weak state of airlines are likely to result in price volatility.
Road freight is less unbalanced than either, yet the problem of a history of low returns applies equally. Here the wider market has become used to road freight being a cheap resource that can be flexed to reduce costs elsewhere. The limits of this approach have probably been reached in many markets and thus behaviour will change. As it does prices will become upwardly volatile.
It should also be noted that there are also longer-term, secular changes in markets, notably in retailing, where the violent growth in e-retail has created additional demand not just for transport but for new types of logistics property. This trend will underpin prices in the long-term.
Overall, Tim Congdon’s observation on the monetary origins of inflation has proven to be correct and the extraordinary monetary and fiscal policies pursued in the US, in particular, have resulted in a burst of inflation. However, specific conditions in logistics markets have resulted in an amplification of inflationary forces.
Source: Transport Intelligence, January 27th 2022
Author: Thomas Cullen