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Why Shortages Aren’t (Entirely) Due to Covid

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One of the more noticed shortages currently riling up the markets is the lack of chips to manufacture cars. Most manufacturers have had to pause production of vehicles, which weighs on their stock price, naturally.

Shortages also have impacts beyond the company, as the lack of lumber has seen the price rise, and with it the price of housing and furniture.

After extended lockdowns, some degree of disruption is expected. But there are reasons beyond that for why shortages are more extreme, are taking longer to resolve, and have made the lockdowns less effective. All of that could have important trading implications going forward.

It’s all about the Benjamins

If we think back to February of last year, back when most people thought that what was known then as “the novel coronavirus” would be limited to China like its predecessor SARS.

Due to the impact on supply chains, there was already consensus that the world’s economy would be impacted by at least a couple of percentage points. Even before a single covid case was reported in their countries, some companies were already close to shutting down.

What was going on?

Just-in-time delivery (JIT), which has been further accelerated with online sales. Among other factors, of course.

But considering JIT for a moment, the objective is to try to time production to meet demand and reduce the amount of inventory on the factory floor. This has distinct financial advantages and reduces “ordinary” risk.

Where things can go wrong

Ordinary risk for a producer includes the possibility that market trends could change, and people stop buying your product. That leaves a large inventory expense.

If inventory is minimized, that “ordinary” risk is minimized. But it increases the “extraordinary” risk, such as for example a once-in-a-century pandemic, or a once-in-a-century weather event.

Earlier this year in the middle of a severe cold snap, many Texas energy producers were forced to shut down. Not because there was anything wrong with their facility, but because they couldn’t take delivery of natural gas. They had little inventory on-site because it’s cheaper and safer.

What it means for the markets in the future

The global economy is increasingly functioning on a similar logic as those Texas power plants. Naturally, there are some products and services that by their nature ought to be just-in-time, such as fresh fruit and vegetables.

On the other hand, low inventory and a sudden surge in demand from panic buying can leave shelves empty, further exaggerating panic buying.

As logistics chains get longer, they are also more vulnerable to interruption. The universally recognized way to stop the spread of disease is through containment. But exceptions have to be made if the area that needs to be contained has vital supplies. This would allow for the spread of the disease.

Are we really better prepared?

Most authorities have pledged to address vulnerabilities in the supply chain system and risks given the latest pandemic scenario. Part of this might reduce some systemic risk. But the trend towards digitalization puts pressure in the opposite direction.

Given the current economic situation, many organizations just don’t have the funds to build inventory. With corporate taxes on the rise, they also might not have the competitive edge to do so, either.

This is especially after many companies were able to avoid the financial implications of systemic risk thanks to generous government support.

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