Why Inflation Could Be Much Worse In 2023 From Supply Chain Deglobalization

The business world as we know it is experiencing a major shift right now. Interest rates are climbing at the fastest pace since the 1980's here in the United States, which has had a disastrous outcome on the stock and cryptocurrency markets.

Year-To-Date, as of November 23rd 2022, the following returns have been generated:

• S&P 500: -16%
• NASDAQ: -28.7%
• Bitcoin: -65.4%
• Ethereum: -68.3%

So what gives? As it turned out, the tech-heavy and innovative assets held within most of our investment portfolios were a terrible choice for this high inflationary economic environment.

Hindsight is 20/20, as they say.

While this inflation driven crash seems obvious now, keep in mind that Jerome Powell was still referring to this inflation as “transitory” as recently as December 2021. (This meant that it was “not permanent.”)

Simply put, the people in charge misled us and we lost money.

Another common saying is that you don't get to where you are going by looking in the rearview mirror.

So, aside from listening to the people in charge (who misled us in the past), how can we get an accurate idea of what will happen in 2023 in terms of inflation, cryptocurrency and the stock market?

In search for this answer myself, I ended up going down a long rabbit hole that led me to three specific topics for consideration:

1. Globalization – Operating your business on an international scale had huge benefits for the last 50 years. Now, the emerging trend is “deglobalization” – or bringing production back to your home country. (This could “snowball” our inflation problem.)
2. Supply Chains – How products (both physical and digital) are made is a very delicate operation based on either high efficiency or maximum responsiveness.
3. Inflation – Why is deglobalization going to potentially ramp up inflation in 2023 as we fix supply chains?

Let's dive in to each one now!

Globalization In The Early 2000's

Globalization is a term used to describe the increasing interconnectedness of our World in terms of production and even information flows.

This term gained popularity in the 1990's after the Cold War. Since this was a generally peaceful time geopolitically, Countries began to increase cooperations with each other for strategic and economic benefits.

This, in turn, led to more trade. Countries would ship materials, parts and components all over the globe for various phases of production.

A visual representation of this can be seen above looking at World Trade compared to World GDP (or total World economic output). While it may seem like complicated global supply chains have been the “norm” forever, it's really only been a trend over the last 50 to 70 years.

Our global supply chains should still be looked at as “one big economic experiment.”

Benefits Of Global Trade

Before we villainize this overall idea of Globalization, let's give credit where credit is due and finish off with the benefits of globalization on society:

1. Specialization within one country (ex: Brazil and Coffee Beans) has led to a comparative advantage. This leads to more of something at a lower price.
2. A global playing field has led to more competition, and this has driven both innovation and better overall quality of things.
3. Accessibility of goods and services is better than ever before based on cutting-edge global technologies and support tools.

So that's a recap on why we became one global economic machine. Now, let's get into why that machine broke and how it's going to be changed forever.

How Supply Chains Broke For Good

Before we get into the “how” behind the global economic machine breaking, let's first explain “what” this machine is.

Supply chains are networks of individual companies, technologies, ideas and resources used for the creation of something. This is normally a physical or digital product, however service-based businesses have a supply chain too.

On this Planet, we have gotten really good at doing two things with supply chains:

1. Doing Things Efficiently – Producing products with consistent demand at scale to maximize speed and minimize cost (ex: paper products).
2. Responding To Things Quickly – Launching new products within weeks to meet unpredictable demand for new things (ex: fast fashion).

If you happen to know a Supply Chain Manager, you could really get them going with the following question; “how do I build a supply chain that is both responsive and efficient?” 

That is because you are talking about two entirely different goals that are the polar opposite of each other. An efficient supply chain needs high utilization, which comes from a consistent product demand. A responsive supply chain changes gears quickly based on shifting consumer demand. 

The problems we are facing today mostly relate to our efficient supply chains, as these are the ones that are delivering our daily essentials such as gasoline and cereal.

Consistency vs Variation

So, we now understand that supply chains are designed with one of two specific goals in mind; speed or efficiency.

What exactly broke our current supply chain model, leading to this reversal of a 50-year trend of Globalization? The answer to that lies in the greatest flaw of the modern global supply chain; an inability to handle variation. 

What is Variation? A difference in the amount of something that is usually within certain limits. In this case, it is swings or changes in Demand. 

Efficient supply chains are designed to deliver a consistent number of products as cost effectively as possible on a routine basis.

The Toilet Paper Crisis

The best example of this is toilet paper. In the past, we would all buy “TP” on an “as needed” basis, generally speaking. While there were some who bought in bulk to use coupons or save money, most people would buy it at the grocery store every week or two.

Well, during the 2020 Global Pandemic, there was significant variation in the purchasing of specific goods, toilet paper included. As such, the demand went from being very consistent to highly variable.

You might think that toilet paper manufacturers could simply make more paper to cash in on this. However, that is not what these supply chains were designed to do, as they are not inherently responsive.

In a nutshell, the historically consistent demand for countless goods became variable based on the panic-buying of the pandemic. As a result, they were no longer reliably in stock for those buying them on a routine basis. As such, our consumer shopping behaviors changed.

Personally, I now keep an inventory of paper products and antibacterial wipes at home, whereas I did not do this before the 2020 pandemic. When you consider the millions of others doing the same, this significantly impacts the historical consistency of the purchasing of goods like this.

An inability to handle variation is just one of the problems associated with global supply chains. But why is variation Public Enemy No. 1 for supply chains?

Why Variation Is Bad

The efficient and complicated global supply chains we have built today are good at meeting consistent demand quickly and economically. So what happens when that demand goes from consistent to variable? This is where everything breaks.

Earlier on, we defined a supply chain as a network of resources working together to create or produce something. Let's dive deeper into this.

In order to understand how variation wreaks havoc on certain global supply chains, you have to be able to visualize the different components of a supply chain. While there are many tiers and groups, most supply chains consist of:

• Supplier(s) – Groups that provide you with necessary products or services.
• Manufacturer(s) – Organizations that turn raw materials and components into more complex goods.
• Distributor(s) – Facilities that handle the logistics of moving these complex goods to the individual locations that sell them.
• Retailer(s) – Storefront locations or e-commerce platforms, a place for people to come buy things.
• Customer(s) – The end user for your product who establishes demand.

In some instances, all of these different things are happening under one roof. This is referred to as Vertical Integration, where one company or entity owns multiple components of a given process. However, in most cases, each of these different components are being handled by multiple different companies.

Simply put, the impact that variation has on a supply chain is based on how well or poorly information is shared from one component of the supply chain to the next.

Small changes in consumer demand become amplified the further up the supply chain you go, as the delays in information sharing and reaction time grow. This is called “The Bullwhip Effect.” 

The Bullwhip Effect

This is a powerful economic phenomenon in which small changes in customer demand are amplified the further you go up the supply chain. As a result, upstream businesses can see huge swings in demand, even when the end consumer demand could be stable.

In order to understand “The Bullwhip Effect,” a term being used by economists like Michael Burry, we have to first understand how information travels within a company, as well as from one organization to the next.

Prior to learning about supply chains, I was under the false assumption that information sharing was near-instant in this day and age, thanks to technology. However, that is when I learned about the different types of relationships you can have with a supplier (which have varying levels of information-sharing going on.)

Transactional Relationships are very impersonal. There is a low amount of trust between parties, with minimal information sharing. Typically, the only information being shared is purchase orders. 

Collaborative Relationships are more intermingled. There is a high degree of trust between parties, and a lot of information being shared. This includes forecasts, orders, projections and more.

The Bullwhip Effect is most prominent in supply chains that rely on transactional relationships with low trust and low information sharing.

Causes & Effects

First of all, what causes The Bullwhip Effect?

1. Delays in the supply chain.
2. Uncertainty/Unreliability (or variation).
3. Decision separation between entities.

The common theme here is variation within a historically consistent operation. The initial cause of that variation could be a number of things. In the case of the United States right now in 2022, the causes are the Global Pandemic as well as the Russian War instigation in Ukraine. The pandemic led to major shifts in consumer shopping behaviors, and sanctions on Russia have wreaked havoc on certain industries.

What does The Bullwhip Effect ultimately lead to?

1. Sticky inflation that comes and goes in cycles for decades.
2. Supply chain overhauls as businesses aim to become more responsive.
3. Consolidation within industries as acquisitions and mergers lead to better information sharing.
4. Multiple sourcing of materials instead of single sourcing.
5. Greater collaborative forecasting as more information is shared faster.

Why Inflation Could Remain High (Or Climb Higher)

Now that you understand how delicate our global supply chains are, the question becomes about how to fix them. Keep in mind, the current supply chains we rely on for essential goods were designed to be as economically efficient as possible. Changing these supply chains means stripping away layers of economic efficiency, among other things.

Let me give you an example of this. One of the most common mistakes that was made was the single sourcing of materials. This means getting what you need for your operation from one singular entity. Ford, among other vehicle manufacturers, ran into this problem head on with the global chip shortage.

What becomes the solution then? Multiple sourcing of materials.

Instead of having one supplier for what you need, have multiple redundant suppliers. For example, Ford is pursuing a relationship with chip manufacturer GlobalFoundries to remedy this problem they are currently facing.

This redundancy being built back in to supply chains comes with many added costs. Consider the back office work associated with onboarding a new vendor and maintaining that relationship. What about the bulk order discounts that go away when you stop relying on a single source for materials?

Back To Toilet Paper

Lastly, in the same way that we as consumers have changed our buying habits, the same thing has happened with organizations.

Think back to the toilet paper example. When we all trusted the big economic machine and made purchases as needed, everything worked harmoniously. However, when items became unreliably in stock at the store, panic buying kicked in whenever inventory replenished. This, in turn, influenced the buying behaviors for even the “non-alarmists” who would not ordinarily panic buy.

When everyone is panic buying, you may have to as well. 

You might think these “TP” problems are completely in our rearview. However, this article from Bloomberg in September of 2022 discussed an impending toilet paper shortage based on production costs for toilet paper ballooning out of control.

So how does this relate back to organizations within our supply chains? In the same way we procure toilet paper for our household, there are millions of people sourcing materials and components to make the stuff our world runs on. A similar shift in buying behavior has occurred here, too.

From “JIT” To “JIC”

The shift in how we buy things, whether it be toilet paper or chips for an EV, can be attributed to the psychology behind the purchasing decision.

For the last few decades, we have all relied on “Just In Time” Manufacturing, also known as Lean Manufacturing. The goal of this is to get each step of the supply chain to be as close to the demand signal as possible in order to minimize overproduction. Instead, with this system, you get exactly what you need, when you need it.

Now, we are all knowingly or unknowingly doing “Just In Case” Purchasing. With this system, a surplus is intentional, as it is being stockpiled by the individual or organization since trust was lost in the overall system.

The problem arises when your “Just In Case” purchasing simply becomes demand for your supplier upstream who you order from. Next thing you know, they order a little bit extra of whatever materials they need, since they have lost trust in their supply chains.

Emerging “Friendshoring” Trend

So what exactly does deglobalization look like?

First of all, it's unlikely that all production of essential goods will be handled within one's own nationality. Simply put, many countries lack the essential resources needed.

For example, the Bahamas have almost no arable land for farming, so it would be impossible for them to source all the materials they need at home. Instead, the emerging trend is called friendshoring – or solely working with a network of allies in terms of sourcing materials for supply chains.

With the political unrest and protests going on in China, the United States (among other's) is looking to become far less reliant on this nationality. One of the main problems faced is the Zero-COVID Policy in China, which is causing major disruptions.

Instead, expect to see leading countries establishing more trade relationships with countries like Canada, Mexico and other European nations. 

Closing Thoughts

It's important to understand that our global supply chains are currently under multiple stressors:

1. Political Unrest 
2. War Sanctions 
3. Bullwhip Effect 

Whether it's a result of panic buying, sanctions, lockdowns, geopolitical tensions or plain old seasonality, variation is the enemy of our efficient supply chains. We now need to expect this variation to become the “new norm.”

As such, our global supply chains need a complete overhaul. The cost associated with fixing this problem is one that is just now being seen, and those costs will ultimately be passed on to the end customer.

What is inflation? A rise in prices. So, inflation is probably here to stay.

What does this mean for stocks and crypto? More pain ahead likely.

This costly process is going to compress corporate earnings, causing stock prices to come down. Non-yield bearing assets like Bitcoin and other crypto's will continue to have a slow bleed out until inflation cools off.

As an investor, now is the time to pursue yield-bearing, safe-haven assets at reasonable valuations. 

Check out my latest YouTube video above where we discuss 10 of these such assets!

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Now that you understand why inflation is here to stay, now is the time to do something about it.

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Thanks for tuning in.