, September 27, 2021

Bitcoin demand partially explains semiconductor perfect storm; will chip shortage lead to inflation?


  •   5 min reads
Bitcoin demand partially explains semiconductor perfect storm; will chip shortage lead to inflation?

There is a global shortage of semiconductors, and there isn't single reason, but Bitcoin demand is one of them; will chip shortage be the spark that sets off inflation?

The perfect storm has more than one cause — that's what makes it a perfect storm. There is a global shortage of semiconductors, and it's serious. Some fear this could be the spark that sets off the inflation fire, the prospect of which has been unsettling markets. All the more ironic then that, Bitcoin, which is seen by many as a hedge against inflation, is one of the causes of the semiconductors shortage. But we have been here before. Those with long memories will be feeling a sense of deja vu. But to explain the causes of the chip shortage, we begin with toilet paper.

A year ago, there was panic buying of toilet paper. As Morris A. Cohen, the Panasonic Professor of Manufacturing & Logistics in the Wharton School, explains in this interview, this serves as a good model to explain what is going wrong with chip supply — at least part of the problem.

A lack of toilet rolls didn't cause the toilet roll shortage. It was partly caused by a surge in demand, due to panic buying, but the more subtle problem was that global capacity was partially geared to the wrong type of toilet paper. With lockdowns, demand for toilet paper from specific sectors, such as schools, fell. But these sectors demanded toilet paper of a particular shape — typically long rolls. The household wanted quite different toilet rolls, and so we had the problem of overcapacity in some areas and temporary under-capacity in others, exacerbated by panic buying, leading to temporary shortages, creating even more panic buying.

A significant market for semiconductors is car manufacturing. Last year, car companies cut back demand for semiconductors, and the semiconductor industry adjusted. The adjustment wasn't immediate — the oil tanker analogy is frequently used to describe the semiconductor industry — it takes time to turn it around. The industry adjusted to falling demand from the auto industry, but now the auto industry is planning for post-Covid recovery, and it wants more chips. Roughly 40 per cent of an automobile's value is tied up in electronics. But the semiconductor industry can't immediately respond to increased auto industry demand. Estimates suggest that it could take a year for the industry to fully adjust.

The complexities of oscillating demand caused in part by the Covid related fortunes of the car industry were a surprise, as was the massive increase in Bitcoin popularity.

Meanwhile, demand for chips in other areas increases. Although spending on IT devices fell last year — PCs, Tablets and Mobile Phones were worth $653bn in 2020, eight per cent less than in 2019 — demand is likely to surge in 2021 and over the next few years.

The PC Renaissance is approaching

Then there is Bitcoin — demand for Bitcoin leads to increased demand for processing power, meaning more chips.  The surge in Bitcoin demand is partly caused by a reaction to central bank policy designed to alleviate the Covid impact on the economy.  You can't just create more Bitcoins on a whim, suggest the cryptocurrency supporters, ergo the logical response to quantitative easing is to buy Bitcoin. It's been argued here that this is false logic. Still, whether the 'buy Bitcoin' narrative as a response to QE is based on poor understanding of economics or not, the narrative is there. It is driving demand for cryptocurrency mining and, thus, is driving demand for powerful chips.

That the demand for chips is increasing was widely expected — and the industry was prepared for it. Covid has accelerated a shift towards digital, and that was not a surprise. But the complexities of oscillating demand caused in part by the Covid related to the fortunes of the car industry were a surprise, as was the massive increase in Bitcoin popularity.

It is when the unexpected happens that supply chains struggle to adjust, and Covid was unexpected.
Then there is global politics.

Global supply chain

According to Accenture, "each segment of the semiconductor value chain has, on average, 25 countries involved in the direct supply chain and 23 countries involved in supporting market functions."

It is an industry dominated by just in time management, constantly attempting to innovate. In many ways, this makes the semiconductor industry massively dynamic, but it has led to poor resilience, and it can be slow to adjust.

Throw into the pot Trump and Biden's trade policy towards China, and things get more complex.

Joe Biden wants to bring chip manufacturing back to the US; China has responded by increasing local supply.

Covid adds to the problem again — vaccine distribution has clogged up shipping infrastructure such as containers. Roughly seven per cent "ocean freight is not making it out of China," states Harvard Business Review, reporting on studies from Clear Metal.

Bad luck, bad weather

Then there has been bad luck.

Last year saw fires at plants involved in the semiconductor supply chain in Japan.

And to cap it all, last month, cold weather has hit semiconductor manufacturing in Texas.

Put it all together, and you have a semiconductor perfect storm.

Inflation and semiconductor shortage

And it is quite easy to see how chip shortages will feed through to higher prices. Chips are everywhere, not just in PCs and smartphones and cars but also across the IoT. When chip costs go up, just about everything becomes more expensive.

There is a view that the rising cost of oil led to 1970s inflation. This view is probably wrong; instead, the underlying cause of 1970s inflation was more likely to have been growth in the money supply at a time of weak productivity growth. Higher oil prices didn't help though.

You can see an analogy with today — QE will lead to growth in money supply just as chips, which are surely as important to the global economy as oil was 40 or 50 years ago, increase in price; ergo, we will get inflation.

Ironically, Bitcoin mining, encouraged as Bitcoins are seen as a hedge against inflation, might be the catalyst that sets inflation off.

Except...

Those who have been around for a long time might be getting a nasty case of deja vu right now. Chip shortages is nothing new. In 2011 the earthquake in Japan hit chip supply. Throughout the 1980s, 1990, 2000s and last decade, there were periodic episodes of chip shortages.

Yes, there is a semiconductor shortage right now, and yes, this will lead to higher prices, not just of chips but many related products.
However, the price rises will be one-offs.

The inflation hawks will seize on hikes as evidence that inflation is back.

But post 2008, we also saw price hikes and temporary inflation. The inflation hawks warned then of impending runaway inflation.
As Paul Krugman pointed out on Twitter, the episode of temporary inflation at the beginning of the last decade has been largely forgotten.

And as we have suggested, new technologies and remote working will lead to rapid increases in productivity, which will lead to increased supply, cancelling out the inflationary effect of higher demand.

The chip shortage will lead to a one-off increase in prices; it will be short-lived, and in 2022 there will be no shortage, and later in 2022, the inflationary impact of higher chip costs will go into reverse.

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