Will the bullwhip effect bring inflation under control?
At the beginning of 2020 empty supermarket shelves were a common sight as consumers rushed to stock up on goods they thought might run out. Suppliers struggled to keep up with soaring COVID-induced demand.
Governments reacted by pouring billions (or trillions) of dollars into their economies to avoid an economic meltdown. Locked-down consumers who could not spend as much on services, and buoyed by the wealth effect of high asset prices spent more money on physical goods. At the same time production in China was shut down or limited. Retailers, responding to the demand and shortages, ordered even more stock and upstream wholesalers and manufacturers did the same. Supply chains became congested and freight charges skyrocketed.
The Bullwhip Effect
By the second half of 2021, the combination of these factors triggered inflation and set the scene for the so-called “bullwhip effect”. The bullwhip effect has been described as “a cowboy lassoing the ground: each rope swing corresponds to an event in the supply chain. A small jolt from the cowboy can result in a violent whip at the end of the chain. More concretely, the various stakeholders cannot anticipate sufficiently: a slight variation can create increasingly significant stock increases as you move up the chain. So, the further away the perception of demand is from the final consumer, the less accurate it is.
Increasingly, international commentators now argue that inflation may be about to ease as the bullwhip effect takes its next twist. According to Paul Krugman supply-chain issues “may well be about to fade away”. In the US this will lead to a significant reduction in inflation in the next few months. He warns the US economy is still overheated, but there is little chance that inflation will become entrenched as it did in the 1980s. At that time the US was experiencing a particularly painful combination of rising prices and high unemployment.
With inventories now high at a time when consumer demand appears to be falling, the world faces a growing risk of recession.
New Zealanders have not yet registered the change in economic outlook despite the faltering levels of consumer confidence. Consumer spending is still “concerningly high” according to the ASB and debit and credit card spending rose in April across all categories.
A Looming “Trucking Recession”
Craig Fuller, CEO and Founder of FreightWaves which monitors millions of trucking transactions in the US argues that the bullwhip effect will do the Fed’s job in reining in inflation. “Prices for freight will come down. Supply chain bottlenecks will ease. What were recently inventory shortages are now gluts, and will likely result in price discounts, not increases. This is a late-stage supply chain correction.”
While the trucking industry globally found itself with a labour shortage throughout 2021 there is now evidence of “plummeting demand”, suggesting consumers globally are tightening their belts for everything from food to furniture. This is consistent with the shipping data with shipping logistics company Xeneta reporting lower costs for shipping across major routes, including from East Asia to Europe and the American Northeast.
The recessionary factors which have been building up over the last two years may, unfortunately, be triggered by the invasion of Ukraine according to George Kokoris in Supply Chain 247. For businesses, this means they should prepare as much as they can by conserving cash, reducing inventory levels and prioritising their key customers. For consumers, it will mean curtailing spending and drastically reducing debt-fuelled spending.
The Bullwhip’s Sting
Forecasting in an ever-changing pandemic environment — and now with the added unpredictability caused by the war in Ukraine — is fraught. However, after two years of massive demand, it seems we are heading into the final phase of the bullwhip effect where an oversupply in certain industries starts to bring down prices for transport and goods.
What’s next, according to Yossi Sheffi in the MIT Sloan Management Review is the “bullwhip’s sting” where an amplified demand surge is “followed by an amplified plummeting of demand”. The signs are now pointing to a global recession in the next painful, but inevitable twist of the bullwhip effect.