Covid and the shutdowns it caused created the perfect squeeze on the supply chain for the global economy. When the pandemic hit last year for instance, companies cut employees, cut production, and sold off inventory in fear of an economic crash. However, instead of a crash, demand exploded much sooner than anyone expected. 

Historic government stimulus through expanded unemployment benefits, stimulus checks and a very accommodating Federal Reserve gave consumers and businesses enough confidence to spend again after the initial panic. 

For example home construction boomed in the second half of 2020 due to stimulus and record low interest rates as well as millennials hitting their peak years for home buying. At the same time, consumer demand for lumber increased when do-it-yourselfers suddenly found the time to do home renovation projects.

A similar story applied to car manufacturers and chip manufacturers – affecting nearly everything electronic. Factories shut down, sold off inventory and reduced capacity only to find several months later that demand rebounded much quicker than anticipated.

The global delivery system was also hit by lockdowns and a lack of personnel. Container ships are still sitting for weeks to be unloaded in many ports around the world, contributing to the inequity between supply and demand. 

This squeeze on the supply chain forced prices to go up.

For Example, in late May this year, the price of lumber peaked at $1,700 per thousand board feet. At the beginning of last year lumber was only around $400 per thousand board feet.

But since the May high, prices have tumbled. By June 18th it hit $900. We can be grateful that it’s come down, but it’s still dramatically more expensive than the beginning of last year.

There has been concern that the kind of pricing pressure the country has seen with lumber may translate into a new period of runaway inflation. But inflation is psychological a process. If the public is more afraid of continual price increases, they rush to buy now at whatever price they can get something, rather than risk having to pay more for it later.

Instead, the lumber market’s behavior is a sign of consumer sanity, said Kristina Hooper, chief global market strategist at the investment management firm Invesco.

“We don’t have that kind of buying frenzy that creates sustained inflation,” she said. “To me, this is very, very different than the 1970s.” *

The kind of runaway inflation the US saw in the 70s has often been blamed on an over zealous Fed. Today, the Fed has taken a very different approach. 

The Fed has signaled that it anticipated temporary inflation in sectors of the economy as the country started to reopen. The squeeze on the supply chain was bound to cause temporary spikes in prices, but officials still believe the recent surge of inflation is temporary.

In the most recent Fed meeting they projected that they could raise interest rates from basically zero by 2023. That move would likely be a half of a percentage point. 

The Fed of the 70s ended up adding fuel to the inflation fire by being overly aggressive with interest rates. Clearly this Fed has learned lessons from the Fed of the 70s and will allow the process of supply and demand to even out without reacting to temporary surges in prices.

It appears that the supply chain and production lag problems will continue to be a problem. But as the economy continues to open up, factory and industry production will ramp up and inventories will be replenished. Over time we’re likely to the spikes in prices to gradually reduce. 

Lumber prices provide some hope that prices are heading back to normal, but the fact that lumber prices are still much higher than normal indicates a need for caution.

* https://www.nytimes.com/

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