The Peter Zeihan Podcast Series - Peter Zeihan - Inflation: The Gift that Keeps on...Taking

Episode Date: February 28, 2023

Over the past few years, every aspect of life has been trapped in a constant state of flux...thanks COVID. Unfortunately, the economy's lack of stability forced inflation to skyrocket to 9%. The effect was devastating.Full Newsletter: https://mailchi.mp/zeihan/inflation-the-gift-that-keeps-on-taking

Hey everybody, Peter Zine here coming to you from Colorado, and today we're going to talk about inflation. Now, as I'm sure everyone is aware, last year was a little rough for inflation. In midsummer, we hit 9% year on year, which really ate into people's incomes and caused a lot of pain. Since then, especially in the fourth quarter of last year, though, inflation has been coming down. We're now down to about half that level, and it seems to be still dropping, and for the next couple of months, I would expect it to continue to be dropping. but we shouldn't get used to that. We're dealing with some mid and long-term factors that are at significant cross-currents. So let's start with the mid, because that's the good news. The inflation pulse that we experienced in 2020 and 2021 and into 2022 was largely COVID-related.

Now, from the point that you change how you live, it takes about a year and a half for the industrial supply chains that service your needs in terms of manufacturing. goods to kind of catch up to where you are. And for a couple of years, we had something new every few months. We had our initial lockdown, then we had an initial opening, then we had the Delta strain, then we had the Omicron strain, then we had the vaccines, then we had anti-vaxxers, then we had the decision that we needed second shots and blah, blah, blah, blah. Every single time there was a shift, our demand profile changed. And the manufacturers had to retool everything to match whatever it happened to be. So are we staying home? We want to do a more home repairs, we need a new computer, or are we excited to get out? We're going to vacation

and we buy in a car, or going back. And it was over and over and over. Well, in roughly June of 2021, Arizona, Texas, and Florida threw off their restrictions for the last time. And by the time we got to December, everyone in the United States, except for California had thrown off the restrictions. And California followed suit a couple months after that. Well, you know, you fast forward from that general opening until now, it's been about 18 months. months. So our demand profile changed that one last time, and now we've largely caught up. In addition, there were some short-term factors that have also pushed inflation down. We had some spooling up of capacity in terms of gasoline refining because prices have been so high,

so the refiners were able to build more. That took a few weeks. The European system has been remarkably warm. Temperatures in Europe this winter have been 20 to 30 degrees above average for six weeks now, that took some of the heat out of energy prices. And globally last year, agricultural has had some of the best weather they've ever had in almost every single growing season. Put all that together and inflation has come down, probably has a couple more months to go, and I would expect for things that were particularly out of whack like, say, car prices to really get better over the course of the next three months. That's the midterm. Unfortunately, there's some long-term trends going absolutely the opposite direction.

The Biden administration has this thing called the Inflation Reduction Act that is seeking to electrify a lot of the system on environmental grounds. That is going to require a massive industrial buildout and everything that involves electricity. So copper wiring, lithium batteries, electric vehicles, and all the rest. A lot of this capacity for the manufacturing, the actual industrial base has to be built from scratch. And any time you do that, that's inflationary. And anytime you've got demand for a product that doesn't really exist in terms of mass manufacturing, that is also important. inflationary. In addition, we're seeing disruptions out of the Russian space. Fertilizer exports from the Russians and the Belarusians are already down by 20 to 40 percent based on which nutrient you're

looking at. Now, that's been true for a year, but last year, most agriculturalists worldwide had a degree of reserve that they could draw upon. You can't draw down your reserve twice in a lot of places, especially in Africa. That has not been replenished. That would suggest we're going to have significant food inflation on a global basis later this year, and that is assumes nothing else goes online. We also can't count on weather in Europe staying cold forever, and that means higher natural gas prices and higher electricity prices, which means a lot of industrial activity in Europe, whether it's steel forging, aluminum smelting, fabrication of ferbitalizer and petrochemicals, all that good stuff goes away. With the economy likely to get

hit the hardest being Germany, because Germany uses Russian natural gas not just for power, but as a feedstock for its entire petrochemical and therefore its entire manufacturing system. So we should see significantly lower industrial output out of the Germans, not just for a year, but over the long term, until they can figure out a new economic model or other places can build out industrial plant to replace what we used to get from the Germans. There's also going to be some problems with the Chinese. We already have the Russians cutting their energy output by about a half a million to three quarters a million barrels per day. That's only about 10 to 12% of their total output, but that's enough to

make a pinch because the Chinese have been importing more and more crude from the Russians because it's been at a lower cost. Well, if it's not produced, it can't be imported. And any problems that we see with shipping or insurance or the technical aspects of fields that the Russians can't maintain themselves, the Chinese are the very last country in the kick line, and they're the ones who are going to feel all the pain. That means energy inflation for the Chinese, which means product inflation for everyone else. In addition, the demographic situation in China has gone from atrocious to something truly horrible, and so labor costs in the Chinese system are now at a point that they're generating labor inflation, which means manufacturing inflation for everybody else. And there's no fix here

unless we can figure out how to clone fully skilled people in their 20s. I'm unaware of any imminent breakthroughs on that front. And all of this assumes no miscalculations on the part of Moscow or Washington or Brussels or especially Beijing and we see a lot of those on deck. The decision-making capacity within the Chinese system is breaking down. The balloon incident is a great example of that. The Chinese are still trying to save face and just blatantly lying about it even though the United States actually has all the spy apparatus from the balloon in hand now. So it's just, you know, it just makes them look stupid. And they're carrying out this desire to save face into economic policy and military policy.

it looks like they're about to do some things in security policy with the Russians and trade policy with the Americans that would almost be designed to trigger a retaliation. Either way, we should expect to see fewer goods coming out of the Chinese space, or even if they continue, more expensive goods. Now, all of these trends are not things you fix with an executive order. They require a sharp change in policy, or more likely, the private sector adapting to the new circumstances. The bottom line is that North America as a unit needs to roughly double the size of an industrial plant as the Chinese and to a lesser degree the Germans fall out of the system. You don't do that in six months. That's a five-year program, which means that we should think of the inflation environment of 2022 as arguably the lowest inflation we are going to see for several years. Good luck.