Tuesday, March 22, 2005

Inflation matters: the Greenspan lag

With today’s 25 basis point interest rate increase, the Fed included some language about inflation, noting “pressures on inflation have picked up in recent months and pricing power is more evident.” It’s about time!

I have been ringing (an unheard) bell on inflation for two years. In February 2003 I sent an e-mail “Are you better off today than you were four years ago?” which highlighted the dramatically higher inflation rate between January 2003 (2.6%) and January 1999 (1.7%). In January 2004, I wrote another e-mail “Is inflation roaring back?” which noted, “The price outlook for 2004 suggests that many big components of the typical family budget will continue to increase. For example,

  • Housing prices to continue climbing. David A. Lereah, chief economist of the National Association of Realtors, predicts that despite an expected rise in mortgage rates, the median existing-home price will rise 4.7% -- nearly half 2003’s 9.1% gain -- while the median new-home price will rise 5.1%, up from 3.6% in 2003. This national median masks wide regional variations. For example, the median price of a single-family California home is forecast to increase 13% from $369,500 in 2003 to $417,500 in 2004;
  • College tuitions up. 2004 college tuition increases are expected to range between 6% and 14%. Over the last 10 years tuitions have increased on average from 42% to 47%;
  • Oil prices expected to remain high. In 2004 Raymond James predicts an average of 1,155 drilling rigs will be at work this year, up from 1,030 in 2003. This increase will help out the Houston economy (useful in this election year). Energy represents 45.7% of the jobs in the area's economic base, according to the University of Houston's Institute for Regional Forecasting. That base represents industries that export goods and services outside of the region; and
  • Food price increases to exceed inflation rate. According to the USDA’s Consumer Price Index forecast, food prices are expected to increase 2% to 3% percent in 2004, twice the expected rate of inflation. Households could see annual food bills jump more than $270. This is higher than 2003’s food price inflation rate. Higher prices for beef products and eggs were the main factors behind a 1% increase in food prices during 2003, according to the year-end Market Basket survey released by the Wisconsin Farm Bureau Federation.

But thanks to demand from China, the prices of many industrial commodities and services are expected to increase dramatically in 2004:

  • Nickel prices up 40% due to an acute shortage of new nickel production capacity in the pipeline to offset the expected strength of demand from stainless steel mills, particularly in China;
  • Copper prices up 25% due to ever-tightening raw material supply and accelerating demand growth -- China is absorbing the vast bulk of supply;
  • Coal prices up 13% to 20% The tight coal supply situation that currently exists in the face of strong demand from traditional US coal customers and from new customers in China;
  • Steel prices up 19% due to hikes in prices of raw materials coupled with increased demands from China;
  • Aluminum up a “mere” 12% due to some excess supply; and
  • Shipping costs to continue spiking due to China's voracious demand for raw materials, particularly for iron ore and coal as the world's most populous country wrestles with power shortages. This has fueled the demand for Capesize ships, vessels in excess of 80,000 deadweight tons in size. The Baltic Dry Index, a measure of shipping rates, increased 174% in 2003 – hitting an all time high."

I concluded mistakenly, as follows “Given the way these commodities eventually find their way to consumers as automobiles, plastics, utilities, and others there is only so long that price increases of these magnitudes can be kept out of the official inflation statistics.”

Last October, Business Week Online published an article which highlighted this mysterious absence of inflation in the official government inflation statistics in an article entitled,
“A Federal Inflation Conspiracy?”

As Alan Greenspan’s two decade plus term in office comes to a close, his skills and ambitions as a politician are far greater than his commitment to communicating and acting on economic reality.


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1:07 AM  

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