But what on earth is inflation anyway?

The textbook definition of the word is a general increase in the prices of goods and services. This doesn’t tell anyone why prices would increase. After all, the prices are set by individuals. They don’t go up without someone taking the initiative to increase them. So the real question is, why would businesses inflate their prices in this way?

Two main theories avail.

Excess Money

Too much money can cause inflation. Here’s how.

The first thing to understand is that the economy is constantly expanding. Businesses are at the centre of this expansion. They’re continually finding ways to produce more value in the form of products and services. They achieve this by innovating and investing. But all this new value has to be paid for somehow. Thankfully, the economy has an innovative way of increasing how much money is available to pay for stuff.

The money supply to the economy is also constantly expanding with it. This mainly happens through the banking system. In simple terms, banks create money by lending it out to individuals and businesses. To put it differently, when you finance a car purchase with a vehicle loan, the bank is not giving you money it has laying around. It’s giving you money it just created for you to buy that car. That’s new money in the economy, and the banks are constantly handing it out to individuals and businesses through loans. 

In a perfect world, the banking system will create a bit more money than necessary. This is a good thing. It means the money supply to the economy is growing slightly faster than the economy itself, hence there’s always enough money to pay for everything on offer. But it also means that there’s more money than there is stuff to buy with it. Consequently, people are willing to pay more for stuff because they have the money for it. It feels simplistic, but by bidding up the price of existing goods and services, consumers create pricing pressures that eventually cause inflation.

This phenomenon is called demand-pull inflation, and it’s most often attributed to an excess money supply. It happens whenever people want more than businesses can offer. Businesses can’t just ramp up production to meet demand when they’re operating at capacity, so they inflate prices instead.

It should be noted that demand-pull inflation generally happens in good times when the economy is booming and people have a lot of disposable income. 

That’s all good and fine. But I imagine you’re clearly experiencing inflation and you haven’t been in a bidding contest lately. Demand-pull inflation is only half the story.

Rising Costs

Quite often, businesses inflate their prices to stay profitable amidst rising costs. 

The graph below shows how crude oil – the main input for producing various types of fuel – has fared in price this year. There’s a clear upward trajectory.

source tradingeconomics.com

Naturally, businesses will pass these costs unto the final consumers. Hence we see increases in vehicle fuel prices.

Since fuel is a significant input for the transport sector, we can reasonably expect all the other industries that rely on transportation to experience rising costs. They will also pass on these increased costs to the final consumer. Say hello to $12 iceberg lettuce.

Cost-push inflation is caused by shocks to the supply chain that make input resources like labour and materials harder to source than usual. In the case of fuel, the war in Ukraine has caused major disruptions in the global supply chain. The resulting scarcity drives up prices as business buyers scramble to get their hands on limited resources. And those higher prices are eventually passed on to consumers of goods and services.

There’s no formula for working out the exact effect of rising fuel costs on grocery prices. Each product has a unique supply chain and cost structure. It’s impossible to predict what a ripple on one end might look like for prices on the other end. Trying to do so would be missing the point. 

Looking Ahead

It’s worth noting that economies move in cycles. Sometimes it’s great. Other times, meh. Inflation is a general litmus test we use to gauge things. For those who have never experienced an economic downturn, things may feel like they’re spinning out of control. While I can’t say what the future holds with any certainty – tragically a crystal ball was not issued with my finance degree – I can share what I’ve learnt in life and firmly believe:

This too shall pass.

In the meantime, a visit to fortitude valley (pun intended) could help us brace for the times ahead. I recommend researching strategies to accommodate both the financial and mental strains of inflationary pressures. My personal favourite is noodle soup. It ticks all the boxes: nutrition, price, taste, versatility and more. You’re welcome.

In the 2nd part of this series, we’ll take a top-down look at the economy and unpack the options available to the reserve banks, as they look to tame inflation and reassure citizens.

Since the pandemic began, I’ve heard of strained supply chains but never had to deal with it. Not anymore. With this purchase came a reckoning that piqued my interest, causing me to probe into the supply chain, and to unpack why chips are all the rage lately.

Here’s what I learned. 

What is a Microchip?

You’ll know that the microchip (also known as the chip or semiconductor) is what gives computers and modern devices their “smarts.” But what’s not as obvious is the bleeding edge technology that enables this to happen. Although the modern microchip is barely the size of a fingernail, its integrated circuitry can span several kilometres in length – a feat of precision engineering. In essence, the details of the circuits on modern chips are so small that they’re invisible to the naked eye. It’s called atomic-level manufacturing. 

Cramming these complex circuits into such a small area requires high-end capabilities and large capital outlays. Surprisingly, some of the most recognisable tech brands (like Microsoft) generally don’t have these production capabilities. Thankfully, not everyone needs to have them.

The Industry

The i5 processor chip that would power my new laptop is both designed and produced by Intel, a feat that places the US semiconductor titan in a special class. That’s because, in this complex and fragmented industry, it’s extremely rare for one company to boast of having both design and production capabilities. But even with this much control over its value chain, Intel is only able to cater to a fraction of the market. Here’s why.

There are different types of chips, each suited to a unique need. Intel specialises in microprocessors that PCs, laptops and servers run on. Other categories include memory chips for storing data, graphic processing units for rendering images, and standard chips that perform simple utilities to name a few. 

You may be wondering, why not just switch from producing one chip to producing another type when the need arises? That’s a valid question but there’s more to consider. Given the sheer level of specificity in product design, the switching costs involved are simply prohibitive. This is why chip manufacturing (aka fabrication) is a game of very few elite players. Even the most dominant PC brands outsource chip production. The leading player here is by far Taiwan Semiconductor Manufacturing Company (TSMC). As a dedicated chipmaker, TSMC produces chips for smartphones, PCs, automotive, IoT devices and consumer electronics.

This delicately balanced supply industry had been running more or less in sync with global demand until recently.

Why The Shortage?

The reason why there’s a global shortage of chips today has to do with human judgment and some misfortune.

When the pandemic hit, stock markets experienced an epic nosedive, plunging economies around the world into a period of brief recession. This led businesses to tighten their spending, anticipating a prolonged recession. Things turned out differently. People needed more of the products that run on chips to adapt to their evolved work and home lives. 

Other factors that have exacerbated the shortage include early stockpiling of chips by some consumers, chip production outages due to weather and (of all things) fire, and increasing costs.

All these inconveniences layer on top of extremely intricate supply chains that span multiple regions. Last month, in an article titled “Why is there a chip shortage?,” the BBC concluded that the pandemic accelerated an already precarious situation for chipmakers. The effect of a strained chip supply has been amplified through supply chains in the industries that rely on it.

Broader Concerns

Evidently, nobody wants to be in a precarious situation. The shortages have highlighted the role of chips in our world today and exposed how reliant we are on them. Perhaps most spectacularly, carmakers have lost out on sales, with consulting firm Alix Partners estimating that loss to be in the region of $110 billion globally. 

This dependency on chips has created some eagerness in the US to build up its chipmaking capacity. Earlier this year, US president Joe Biden is reported by the New York Times to have issued an executive order requiring his administration to review critical supply chains with the aim of bolstering American manufacturing of semiconductors. 

But it’s not only the US that’s interested in chip manufacturing resiliency. According to abc news, Chinese President Xi says the country will spend more than $1.3 trillion on high-tech industries with a particular focus on semiconductors. Indeed semiconductors have been a recent focus in the ongoing trade tensions between US and China. 

Efforts on either side to build chipmaking capacity will not yield any significant results in the near term. According to Time magazine, bringing leading-edge semiconductor manufacturing to the U.S. will take years. This is an indication of the lead times needed to realise investment gains in this complex sector. 

Final Thought

For the miniature marvels they are, microchips are far mightier than their humble size may suggest. They’ve brought governments and consumers to a place of reckoning. 

The chip shortages have forced me to reflect on other things we rely on, like food, clean air and electricity. So many things need to work properly for us to have the normalcy our lives run on. The biggest lesson I’m learning here is gratitude. 

I’m still waiting on my laptop purchase. Estimated delivery is at least a month away. Thankfully, it’s not an urgent need for me, and I can afford to wait. 

What are digital assets?

..any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.

Whether inspired by economic need or opportunity, the reality is that this bill brings cryptocurrency into the regulatory fold. And that’s a significant milestone. At the least, it’s an official acknowledgement of cryptocurrency. But what happens in the world’s largest economy tends to reverberate profoundly outside it. This acknowledgement could be a precursor to more.

So Far

It would be presumptuous to speak with any certainty on what crypto normalcy would look and feel like. These are uncharted waters. But if we assume that the cryptoverse will not entirely displace the current financial system but rather plug into it, we can reasonably anticipate where frictions might present. 

One such friction has been around the coin stability – or the lack thereof. Because stability is a key to why people trust the current financial system, extreme volatility (a feature of cryptocurrencies) sends the opposite message. As a result, anyone who is not keen on speculating has stayed away from it. That’s most people. 

And the proponents of crypto have taken note, responding with stablecoins. These are coins with their values pegged to other assets like fiat currency or a commodity. If stablecoins become widespread, the cryptocurrency proposition changes entirely. People who want to transact, not speculate, will see themselves represented in this new ecosystem. The idea of stablecoins has garnered interest from key players in the fintech space. 

Mastercard, for example, is clearly welcoming of stablecoins. In an article posted on their site earlier this year, the digital payments giant stated:

We are preparing right now for the future of crypto and payments, announcing that this year Mastercard will start supporting select cryptocurrencies directly on our network. 

Another leading digital payments provider, VISA, has also shown much interest in stablecoins. The eagerness is evident in their digital currency white paper.

But all the interest, intent and innovation from fintech services providers fail to move the needle on coin adoption for one key reason: these solutions layer on top of the current financial system, the banking system. And the banks are not ready yet. This has a lot to do with the regulatory environment banks operate in, another source of friction that cryptocurrency has to navigate to gain mass adoption. 

Banks provide safekeeping for deposits. They also extend loans up to a maximum fraction of deposits held, creating money in the process. For cryptocurrencies to gain widespread adoption, the regulatory framework needs to evolve to a point where coins are recognised as deposits. This would mean that banks can extend loans based on their combined holdings of cryptocurrencies and fiat currency. A massive leap indeed. 

It will take some time, but the momentum is at its highest yet. Last year, the Office of the Controller of Currency, an independent bureau of the US Department of the Treasury that provides regulatory oversight in the banking sector, issued a statement allowing banks to hold cryptocurrencies for their customers, much like deposits. At the moment, US banks can only hold coins for their customers, nothing more. But they have no reason to do so just yet. Since these coins are not legal tender, banks cannot issue out loans backed (wholly or partly) by cryptocurrency. 

So what would it take to make coins legal tender? For one, central banks would need to be on board with it. Unlike commercial banks, central banks have a public interest mandate. If they run with this idea, they would be interested in stable coins that allow the economy to run smoothly. They would also want to regulate the supply of these coins. In essence, these would be stablecoins backed by fiat currencies and controlled by the central banks. The idea is not without precedent. October 2020 saw the Bahamas launch the world’s first central-bank digital currency (CBDC). The conversation about sovereign digital currency has since taken on renewed fervour. 

CBDCs will likely be the gateway into a new era in how we move value digitally. 

Lingering Issues

The cryptoverse itself still needs to evolve before it can fully cater to real-world needs. There are issues around a fixed supply of coins. This is like having a situation where the central bank does not print new money and all the physical currency in circulation remained unchanged.

Another bottleneck is the transaction volume the system can handle, a small fraction compared to the current digital payments system. 

Both of these limitations result from the computationally intensive process of validating/mining cryptocurrency transactions, a concern that has sparked debate on the climate implications of adopting coins. 

Improvements are needed here as supply would have to scale with real-world needs sustainably. 

A final, more elemental question mark has to do with the need for cryptocurrencies. The arguments for it centre on privacy and enabling peer-to-peer transactions without institutional interference. On privacy, the finance realm is one of several exposure sites. Solving it here would only partially reduce the individual’s overall risk. And on limiting institutional involvement, it’s interesting to note that institutions (central banks specifically) are proving to be the most significant players in making coin adoption the norm. 

Summary

The cryptocurrency movement has come a long way since its debut. It introduced several ideas around how we engage with finance themes. Coins may indeed become the norm in a few years. Remarkably, if this happens, it won’t be for reasons that have made the highlight reel – outsized profits from speculative trading – but rather because institutions, the very establishment which the intervention was meant to exclude, have given it their approval. And that’s quite a turnaround.