Inflation is Back! Now Let's Tell The Fed

Everyone sees rising gas prices. According to AAA, the national average price of unleaded gasoline was $3.98 per gallon as of Friday 5/06/11. The last time the national average price of unleaded gasoline was $4.00 per gallon was 7/25/08, and the all-time high per gallon was $4.11 on 7/11/08. Beyond gas at the pump, we have naturally seen crude oil by the barrel increase by more than 55% from last summer's lowest levels. As such, we are not surprised that transportation prices are increasing due to rising fuel costs, as are utility costs, and that items that require transport to the end customer (us) like food, or delivery packages are also increasing in price.

All of us that purchase fruit, vegetables, bread, and orange juice have noticed the increase in prices and a reduction in the size of goods. (Remember when orange juice was sold by the gallon instead of 59.5 oz containers?)

Unfortunately, the Federal Reserve and the Federal government do not exactly see what many around the world see as obvious rising prices. After all, they say measured inflation is still very low, manufactured goods are still cheap, and wage pressures are contained because of high unemployment.

How do they see inflation? In February, the Consumer Price Index (CPI) advanced 0.5%. That followed increases of 0.4% in December and January. This doesn't exactly represent runaway inflation. To give you some perspective, the CPI rose by almost 1.1% per month during 1979 - but it may be cause for concern.1,2

Producer prices have also jumped. The government's Producer Price Index climbed 1.6% in February on the heels of a 0.8% increase in January and a 0.9% boost in December.3

We were told to not pay attention to the "headline" inflation figures and focus on the core numbers that exclude "volatile food and energy costs". Core CPI was just 0.2% in February, as was core PPI. 1,3 This is always amazing that the Fed and the Federal government honestly believe that we can simply ignore energy and food prices and their obvious impact on our wallets, because these costs are always changing (volatile).

They are nice low numbers, but other numbers within the indexes aren't very comforting. Prices for finished consumer foods went up 3.9% in February - the biggest monthly gain in that category since 1974. The CPI's index of fresh vegetable prices rose 6.7% in February. Natural gas prices rose 7.6% in February. Overall prices of crude energy materials have increased 17.8% from November to March. And those who drank Milk in March, you probably noticed that a gallon of milk costs nearly as much as a gallon of gas.3,4

I must share with you that during the late 80's and throughout the 90's the way that inflation (CPI index) is calculated by the Bureau of Labor Statistics (BLS) changed about seven times. And yes, it can be asserted that the net effect of these changes produced a lower inflation number than the prior calculations!

Lastly, I will say that I have read excerpts from some independent economists such as John Williams of shadowstat.com, who through reverse engineering how inflation is calculated vs. the measuring metrics of prices that we all can see, come up with a much higher inflation rate. Mr. Williams' inflation rate as of March was about 9.1% on annual basis.

Should the Fed take action? The Federal Reserve last raised the federal funds rate on June 29, 2006. It hasn't adjusted it at all since December 16, 2008.The Fed has downplayed the inflation threat, but it may not be able to continue doing so.5

The Fed has taken the position that it is not sure whether the recent spikes in energy and food prices are momentary and stemming from geopolitical events, or actually emblematic of a global rise in inflation.

Consumers have inflationary expectations, as measured by consumer sentiment surveys and other yardsticks. As rising food and energy prices lead businesses and consumers to expect a rising standard of living, the Fed may be forced to adjust borrowing costs.

Successive consumer sentiment surveys out of the University of Michigan show a rise in both one-year and five-year inflation expectations. In the final February survey, the one-year inflation expectation was 3.4%; in the initial March survey, it went up to 4.6%. The five-year inflation expectation was 2.9% at the end of February, but 3.2% in the preliminary March poll.6

There is a real sense that consumers are eyeing food, energy, and finished goods with a perception that prices are rising. Yes, core inflation across the 12 months of data thru March was just 1.1% - well within the Fed's target. Yet there are now clear signals that the Fed will have to address measurable inflation while it tries to promote economic growth.1

The latest Beige Book report of economic conditions, produced by Fed researchers, stated that nonwage input costs are increasing and that "manufacturers in a number of districts reported having greater ability to pass through higher input costs to customers. Retailers in some districts mentioned that they had implemented price increases or were anticipating such action in the next few months."

Translated into plain English, this means that retail prices have risen and expect more price increases in the coming months. With the "real life" data, their own statistics, and little tidbits like the March report from the UN Food Price Index, which says global food prices have risen by 22% from August 2010-March 2011.

Oh and there is also the substantial price rise of copper, gold, and silver in recent months too.

The question is not... Is there inflation, but rather when will the Fed see it, care about it, and take action?

Citations

1 - bls.gov/news.release/cpi.nr0.htm [3/18/11]

2 - data.bls.gov/pdq/SurveyOutputServlet [3/18/11]

3 - bls.gov/news.release/ppi.nr0.htm [3/16/11]

4 - bloomberg.com/news/2011-03-17/u-s-february-consumer-price-index-report-text-.html [3/17/11]

5 - federalreserve.gov/monetarypolicy/openmarket.htm [3/18/11]

6 - blogs.wsj.com/marketbeat/2011/03/11/great-inflation-debate-expectations-jump-crowd-gets-surly-with-ny-fed-chief/ [3/11/11]