Slower Growth and Higher Inflation Suggest 'a Hint of Stagflation-Lite'

Commerce Report Raises Eyebrows

By Nell Henderson and Howard Schneider
Washington Post Staff Writers
Saturday, April 28, 2007; D01

The U.S. economy slowed sharply while inflation quickened in the first three months of the year, the government reported yesterday, rekindling concerns that the nation might be sliding into a more serious downturn.

Strong consumer spending was largely offset by plunging home construction, falling exports and tepid business investment from January through March, the Commerce Department reported.

Add it up, and the nation's gross domestic product, a broad measure of economic output, rose at a sluggish 1.3 percent annual rate -- a significant loss of momentum from the moderate 2.5 percent annual rate of expansion in the previous quarter, and the brisk 3.3 percent growth recorded for all of 2006.

Many analysts, including those at the Federal Reserve, forecast the economy to perk up enough to grow at a modest pace through the rest of the year without tipping into a recession. But at the same time, they see rising risks that the economy will deteriorate further, perhaps into a prolonged period of high inflation and weak growth.

"It was a quarter that was beset by the worst of both worlds, more inflation and less economic growth," said Stuart G. Hoffman, chief economist at PNC Financial Services, who called the combination "a hint of stagflation-lite."

Janet L. Yellen, president of the Federal Reserve Bank of San Francisco, said in a speech Thursday night that "economic growth has unexpectedly slowed from 'middling' to a crawl," developments that have "significantly increased the risks to the outlook, both for growth and inflation."

Her comments and the economic data strengthened investors' expectations that the Fed will hold short-term interest rates steady at its next policymaking meeting May 9. Many investors are betting the economy will weaken enough that the Fed will cut rates later this year.

The stock market, which rallied earlier in the week on a series of strong corporate profit reports, showed little reaction yesterday to the economic figures. The Dow Jones industrial average has added more than 800 points in the past month, rebounding from a steep sell-off in February to close yesterday at a record 13,120.94, an increase of 15.44 points over Thursday. But the market's enthusiasm could ebb if economic growth remains modest and earnings weaken.

Analysts worry most about the strength of consumer spending, which accounts for 70 percent of the economy and which kept the economy afloat by rising at a robust 3.8 percent annual rate in the first quarter.

Forecasters expect unemployment to edge higher this year from its very low 4.4 percent rate in March. Analysts also note that American households are coping with heavy debt service, softening home values and rising gasoline prices. If consumer spending falters, the economy could stall or even contract, some observers said.

"If energy and food prices continue on their recent upward path, then it is very likely that the economy will be facing a recession before the end of the year," said Dean Baker, co-director of the Center for Economic and Policy Research in Washington.

Others countered that consumer spending was fueled by a strong 4.5 percent annualized increase in after-tax personal income in the first quarter. Recent job losses related to housing and manufacturing have been more than offset by rising employment in health care, education, finance, tourism and other services.

"The consumer has not been spooked by either the meltdown in housing or the recent rise in gasoline prices," said Nariman Behravesh, chief economist at Global Insight. He said consumer spending would probably slow, but not enough to tip the economy into recession.

Housing, however, remains a drag on the economy. Spending on residential construction fell at a 17 percent annualized rate in the January through March period, the sixth consecutive quarterly decline.

Data show the housing slump is continuing, exacerbated by rising foreclosures that have added to the supply of unsold homes and caused lenders to tighten credit for some buyers. Sales of previously owned homes, which account for about 85 percent of the market, plunged in March by the largest amount in nearly two decades.

The Commerce Department also estimated that U.S. exports, which rose strongly and boosted economic growth last year, fell at a 1.2 percent annual rate in the first three months of this year.

Another soft spot was business spending on buildings, equipment and software, which rose at a 2 percent annual rate in the first quarter -- a modest gain, but an improvement after a worrisome 3.1 percent decline in the fourth quarter of 2006.

Meanwhile, consumer prices jumped at a rapid 3.4 percent annual rate in the first quarter, after falling in the last quarter of 2006, following the path of energy costs. After excluding volatile food and energy prices, consumer prices rose by 2.2 percent, compared with a 1.8 percent rise in the previous three-month period.

Crude oil prices surged yesterday to $66.46 a barrel on the New York Mercantile Exchange, the highest level in almost eight months.

The Commerce Department's report provides a first estimate of GDP growth. The figures will be revised in coming months as more data become available.

Slower Growth and Higher Inflation Suggest 'a Hint of Stagflation-Lite'

Commerce Report Raises Eyebrows

By Nell Henderson and Howard Schneider
Washington Post Staff Writers
Saturday, April 28, 2007; D01

The U.S. economy slowed sharply while inflation quickened in the first three months of the year, the government reported yesterday, rekindling concerns that the nation might be sliding into a more serious downturn.

Strong consumer spending was largely offset by plunging home construction, falling exports and tepid business investment from January through March, the Commerce Department reported.

Add it up, and the nation's gross domestic product, a broad measure of economic output, rose at a sluggish 1.3 percent annual rate -- a significant loss of momentum from the moderate 2.5 percent annual rate of expansion in the previous quarter, and the brisk 3.3 percent growth recorded for all of 2006.

Many analysts, including those at the Federal Reserve, forecast the economy to perk up enough to grow at a modest pace through the rest of the year without tipping into a recession. But at the same time, they see rising risks that the economy will deteriorate further, perhaps into a prolonged period of high inflation and weak growth.

"It was a quarter that was beset by the worst of both worlds, more inflation and less economic growth," said Stuart G. Hoffman, chief economist at PNC Financial Services, who called the combination "a hint of stagflation-lite."

Janet L. Yellen, president of the Federal Reserve Bank of San Francisco, said in a speech Thursday night that "economic growth has unexpectedly slowed from 'middling' to a crawl," developments that have "significantly increased the risks to the outlook, both for growth and inflation."

Her comments and the economic data strengthened investors' expectations that the Fed will hold short-term interest rates steady at its next policymaking meeting May 9. Many investors are betting the economy will weaken enough that the Fed will cut rates later this year.

The stock market, which rallied earlier in the week on a series of strong corporate profit reports, showed little reaction yesterday to the economic figures. The Dow Jones industrial average has added more than 800 points in the past month, rebounding from a steep sell-off in February to close yesterday at a record 13,120.94, an increase of 15.44 points over Thursday. But the market's enthusiasm could ebb if economic growth remains modest and earnings weaken.

Analysts worry most about the strength of consumer spending, which accounts for 70 percent of the economy and which kept the economy afloat by rising at a robust 3.8 percent annual rate in the first quarter.

Forecasters expect unemployment to edge higher this year from its very low 4.4 percent rate in March. Analysts also note that American households are coping with heavy debt service, softening home values and rising gasoline prices. If consumer spending falters, the economy could stall or even contract, some observers said.

"If energy and food prices continue on their recent upward path, then it is very likely that the economy will be facing a recession before the end of the year," said Dean Baker, co-director of the Center for Economic and Policy Research in Washington.

Others countered that consumer spending was fueled by a strong 4.5 percent annualized increase in after-tax personal income in the first quarter. Recent job losses related to housing and manufacturing have been more than offset by rising employment in health care, education, finance, tourism and other services.

"The consumer has not been spooked by either the meltdown in housing or the recent rise in gasoline prices," said Nariman Behravesh, chief economist at Global Insight. He said consumer spending would probably slow, but not enough to tip the economy into recession.

Housing, however, remains a drag on the economy. Spending on residential construction fell at a 17 percent annualized rate in the January through March period, the sixth consecutive quarterly decline.

Data show the housing slump is continuing, exacerbated by rising foreclosures that have added to the supply of unsold homes and caused lenders to tighten credit for some buyers. Sales of previously owned homes, which account for about 85 percent of the market, plunged in March by the largest amount in nearly two decades.

The Commerce Department also estimated that U.S. exports, which rose strongly and boosted economic growth last year, fell at a 1.2 percent annual rate in the first three months of this year.

Another soft spot was business spending on buildings, equipment and software, which rose at a 2 percent annual rate in the first quarter -- a modest gain, but an improvement after a worrisome 3.1 percent decline in the fourth quarter of 2006.

Meanwhile, consumer prices jumped at a rapid 3.4 percent annual rate in the first quarter, after falling in the last quarter of 2006, following the path of energy costs. After excluding volatile food and energy prices, consumer prices rose by 2.2 percent, compared with a 1.8 percent rise in the previous three-month period.

Crude oil prices surged yesterday to $66.46 a barrel on the New York Mercantile Exchange, the highest level in almost eight months.

The Commerce Department's report provides a first estimate of GDP growth. The figures will be revised in coming months as more data become available.

Interest rates 'could reach 7.5pc'

Interest rates 'could reach 7.5pc'
Evans-Pritchard, The Telegraph
A group of Britain's leading monetarists have launched a harsh attack on the Bank of England's Monetary Policy Committee, warning that inflation risks surging out of control in repeat of earlier boom-bust cycles.

Gas Prices Are Going to be Painful .... AGAIN

April 10, 2007

By Bonddad
bonddad@prodigey.net

From CBS:

The average cost of self-serve regular gasoline rose about 18 cents per gallon nationwide over the past two weeks, according to a survey released Sunday.

That translated to an average price of $2.78 a gallon, according to the latest Lundberg Survey of 7,000 gas stations across the country.

On April 6, a gallon of midgrade gasoline averaged about $2.89, and premium was nearly $3.

I've been closely following gas prices for the last 5-6 weeks for several reasons.

1.) They are a big component of inflationary pressures. As it appears a bit more likely that we may have a recession, it's a good idea to know what the possibilities of a Federal Reserve rate cut are. In his latest Congressional testimony, Bernanke stated declining oil prices were the primary reason for a decreasing inflationary pressures:

Core inflation, which is a better measure of the underlying inflation trend than overall inflation, seems likely to moderate gradually over time. Despite recent increases in the price of crude oil, energy prices are below last year’s peak. If energy prices remain near current levels, greater stability in the costs of producing non-energy goods and services will reduce pressure on core inflation over time. Of course, the prices of oil and other commodities are very difficult to predict, and they remain a source of considerable uncertainty in the inflation outlook.

....

To date, the incoming data have supported the view that the current stance of policy is likely to foster sustainable economic growth and a gradual ebbing in core inflation. Because core inflation is above the levels most conducive to the achievement of sustainable growth and price stability, the Committee indicated in the statement following its recent meeting that its predominant policy concern remains the risk that inflation will fail to moderate as expected.

The problem here is gas prices were about 15 cents/gallon lower than present prices when Bernanke made that speech. That means from Bernanke's perspective, inflationary pressures are increasing and barring a complete move into recession a rate cut is not going to happen.

2.) Consumer spending is the only thing holding the economy above recession -- at least according to the Dallas Fed. In a recent analysis of the US economy, they noted that although residential and business investment is down, consumer spending remains high. The Dallas Fed was essentially summarizing the latest GDP report from the BEA. So what the economy needs right now is for the consumer to keep spending to keep us out of a recession. The problem is increasing gas prices make the likelihood of a consumer pullback a bit higher.

So, where are gas prices right now?

According to the Department of Energy:

Gasoline prices saw another significant increase for the week of April 2, 2007, jumping 9.7 cents to 270.7 cents per gallon. This is the ninth consecutive week of increases; prices are now 11.9 cents per gallon higher than at this time last year. All regions reported higher prices. East Coast prices were up 9.6 cents to 267.1 cents per gallon, while Midwest prices rose 9.6 cents to 261.4 cents per gallon. The Gulf Coast saw the largest regional increase, with prices up 12.3 cents to 256.5 cents per gallon. In the Rocky Mountains, prices increased 8.1 cents to 261.9 cents per gallon. West Coast prices were up 8.0 cents to 309.6 cents per gallon, with the average price for regular grade in California up 7.6 cents to 322.8 cents per gallon, 48.5 cents per gallon above last year's price.

Here's a chart from the same report. The red line -- which is higher -- represents this years prices.

One of the primary reasons for the decease is a declining inventory of gasoline. Here is a chart of gasoline stockpiles represented by the orange line.

So, what does all this mean?

We're probably going to have higher gas prices as the summer progresses. And the higher those prices go, the more likely consumers will pull back on their spending. Considering they are the only economic sector increasing their economic input, their cut backs would not be welcome.

For economic commentary and analysis, go to the Bonddad Blog.

Inflation Is Legalized Robbery, Part

by Gregory Bresiger, Posted March 26, 2007

Whether one believes in the “price stability” policies of our nation’s central bank, or believes such policies have caused countless economic problems, the onus is on the Federal Reserve. It is a strange, quasi-secret public/private agency with little or no accountability.

It is the Fed, which since 1913 has had an exclusive monopoly over the money-making power, that must be held accountable. Its overall record is a sorry one despite all the ballyhoo, whoop-it-up stories, and books about how Alan Greenspan supposedly performed miracles in the 1990s.

Acclaimed as the greatest central banker of our time by Bob Woodward, Greenspan actually practiced legerdemain. He began as a young economist defending the ideas of Ayn Rand and the gold standard, but one of his early political benefactors, President Richard Nixon, broke the federal government’s last link to gold in 1971. Thus, Greenspan ended up running a central bank divorced from the gold standard, which is a key reason that today’s economy may be heading for the double-digit inflation rates of the 1970s, or the recession of the early 1980s, or the bear market crash of 2000–2002.

In 1971, Nixon’s “closing of the gold window” effectively devalued the dollar, causing untold financial losses to foreign investors who had trusted the U.S. government by holding dollars in their reserves.

Even worse, breaking the link with gold was combined with other disastrous economic policies. These included wage and price controls and surcharges. The results brought shorter-term political gain: Nixon was reelected in 1972. But they also caused long-term economic damage, not to mention anger and resentment among foreign central banks that had lost untold amounts of money as a result of the dollar devaluation.

Until 1971, the quasi gold standard — one in which foreign central banks could still redeem dollars for gold — had been one of the few remaining brakes on the Fed’s almost unlimited ability to create more and more new money. Post–1971, nothing could stop the Fed. It could, and did, flood the markets with dollars, which meant less and less buying power for those holding this diluted currency. In the short term, cheap money tricked Americans into thinking that the economy was strong when it wasn’t.

Thirty-five years of failure

The Fed’s record since 1971 has been one of numerous recessions preceded by booms. We have had a stop-and-go economy, one that inevitably misleads investors and damages retirees. An example of the former were those investors during the stock market run-up in the 1990s who were led to believe that business cycles were history and that bull markets were now permanent. An example of the latter is the elderly person who, 10 years ago after the beginning of retirement with a seemingly adequate amount of fixed savings, now finds himself struggling to maintain a lifestyle that it took a lifetime to achieve.

“All such savings are prejudiced by inflation. Thus saving is discouraged and extravagance seems to be indicated,” wrote economist Ludwig von Mises more than half a century ago. Mises had personally witnessed the horrible damage wrought by inflation during the Weimar Republic.

Thus, the average American who saved for retirement now finds his well-earned lifestyle threatened by the unanticipated pace of price increases that come as a result of inflation. For example, suppose a person retired in 1996 with $1 million. Ten years later, figuring the damage of relatively “comfortable” inflation, that $1 million is worth just $803,748. And imagine how much worse it will be if we return to the high inflation numbers of the 1970s.

Inflation has also brought about adverse structural changes in our lives and in the economy. I speak of the permanent acceptance of inflation at “comfortable” rates by many economists, politicians, and even ordinary people who have lived with inflation all their lives and thus know nothing else. This inflation-can-be-good philosophy appeared at the same time as the post–Great Depression Keynesian encouragement of excessive consumption, especially among lower income groups, as a way of preventing depressions. This is a culture, backed by tax policy, that virtually destroyed thrift in our country and encouraged private debt at the same time that government red ink was hitting record levels.

In recent times, savings rates in America sometimes have been recorded at less than zero. Why save today when tomorrow your money will be worth much less, owing to the inexorable power of inflation? Worse than that is the psychology of never-ending inflation. Few in the financial or consumer markets expect that inflation will ever be stopped. So, again, why save? Saving is difficult. It is denying oneself a higher standard of living in the expectation of a future reward. The Austrian economists call this time preference.

And why save when you can borrow at artificially low interest rates? And why pay off debts when there is plenty of credit around and refinancing is always available? Why not consume now, since everyone “knows” that prices will always rise?

Here is the triumph of an inflationary policy pushed for generations. It is a policy that has become a virtual article of faith. It can no more be seriously questioned than the supposed benefits of fiat money, or mandatory social insurance programs, or an interventionist foreign policy.

The Fed’s easy-money policies also explain why both public and private debt levels have been rising for generations, with fewer and fewer protests. Indeed, spendthrift ways are embraced along with inflationary values. So the average American household today carries a credit card balance of $8,000.

Inflationary addiction

One of the biggest problems with inflation is its seductive power. In its beginning phases, or when one is in its “comfort” zone, it seems harmless. Like strong drink or other drugs, it produces a temporary euphoria. In fact, in some cases, as Austrian economist F.A. Hayek pointed out, inflation actually seems beneficial to business at the outset. That’s because sales in certain sectors rise at a faster rate than they would have if free-market forces were operating. Inflation, Hayek wrote, distorts how the businessman views the economy and his business.

“It is this which creates the general state of euphoria,” he warned, “a false sense of well-being, in which everyone seems to prosper. Those who without inflation would have made high profits make still higher ones. Those who have made normal profits make unusually high ones. And not only businesses which were near failure but even some which ought to fail are kept above water by the unexpected boom.”

Hayek, who was describing the stop-and-go monetary policies of Britain’s central bank of the 1970s, could be explaining any of the boom-bust policies employed by our own central bank. Inflation has a long lamentable history nearly everywhere.

For example, by 1973, after a period of money expansion that helped reelect Richard Nixon and most of a Democratic Congress, the United States went into a brutal period of stagflation. This lasted for about a decade and produced double-digit inflation along with slow growth rates. This included a period in which the Fed battled inflation by raising interest rates.

The Fed, which had ignored inflationary signs in 1971 and 1972, had overexpanded the money supply. By the mid 1970s and early 1980s, it paid for that policy with skyrocketing interest rates that topped 20 percent. These unprecedented rates threw parts of the nation into a virtual depression. Tens of millions of jobs were lost. Certain interest- rate-sensitive industries, such as the housing and automobile industry, went through terrible times. Mom-and-pop businesses felt the ripples. Hardship reached into millions of homes.

This vicious and destructive downward economic spiral ended in the early 1980s. Then, the Fed’s stop-and-go economy started all over again. The Fed began to inflate again in the early 1980s.

The Fed’s boom-bust cycle has continued over the last 20 years or so. But the cycle of boom and bust seems to be worse every time. The recessions are deeper. The inflation required to continue the boom requires more and more money creation accompanied by higher and higher levels of private and public debt.

Austrian economists describe how inflation pumps up markets, creating a bubble. “One of its consequences,” warned Mises, “is that it falsifies economic calculation and accounting.” Examples of the latter were the artificial, Fed-induced, bull markets of the late 1990s. While they lasted, they seemed great. But when the bubble burst, millions of dreams went with them.

When I was a student in college in the 1970s, I was told by a Keynesian economics professor not to worry about the U.S. government’s Treasury borrowings. “It’s only money that we owe to ourselves,” he assured me. My professor was ignoring a hard fact. He forgot that one group — the taxpayers — would be in debt to another group — the bondholders — for generations to come. Moreover, today large amounts of Treasury instruments are owned by foreigners, who might be inclined to be less willing to hold dollars than Americans are if the dollar starts rapidly losing value.

But they’re not the only ones worried about currency manipulation as well as huge federal and trade deficits that induce the Fed to print money at a faster and faster pace. The illusions created by inflation are not fooling the smart money. For example, in 2002, noted value investor Warren Buffett announced that, in order to hedge his bets, a significant amount of his assets would no longer be in dollars. “If we have the same policies, the value of the dollar will go down,” Buffett announced. Nothing has changed since then.

Another successful investor, money manager John Templeton, is also concerned. He has warned that the U.S dollar is overvalued by 40 percent. Templeton will no longer invest in U.S stocks. One of the great problems that will face investors in the future will be persistent inflation, Templeton predicted in 1980 in a book called The Money Masters.

Templeton, Hayek, Mises, and others who have documented the damage done by inflation and warned against its dangers are unrecognized sages in an inflationary age. Those who ignore such warnings do so at their financial and economic peril.

Part 1 | Part 2

Gregory Bresiger is a business writer living in Kew Gardens, New York. Send him email.

Why Are Food Prices Spiking? Pt. II : Bonddad

Mar 20, 2007

By Bonddad
bonddad@prodigey.net

On Saturday I wrote an article titled Why Are Food Prices Spiking? In that article, I noted that agricultural prices are spiking and noted a basic drop in supply and increase in demand. This article follows up on that, especially in regards to how the development of the ethanol market is playing agricultural prices spikes.

I would also like to point out that I am not the only person who has written on this. Many other writers have pointed this out. Simply do a search under ethanol and you will find many well-written and informed articles.

From the blog, Financial Sense

Thanks to Federal mandates and subsidies, corn used for the production of corn ethanol is expected to increase from ~ 700 M Bushels in 2000/2001, to 3.2 B bushels in 2007/2008 – an increase of 357 percent. On December 11, 2006, the USDA estimated 2006-2007 U.S. ending stocks would be 935 million bushels, down from 1.97 billion bushels in 2005-2006. That decreases the ending stocks by more than 50 percent and puts the ending stocks to use ratio at 8%, - the lowest in 11 years. It should be obvious to all, we are going to need a lot more acreage and big yield improvements if corn production is going to keep up to demand. Prices could exceed $4.50 per Bu by the end of 2008. That’s a price increase of 125% over 2005/2006 season prices.

Let's take this one point at a time.

corn used for the production of corn ethanol is expected to increase from ~ 700 M Bushels in 2000/2001, to 3.2 B bushels in 2007/2008 – an increase of 357 percent.

In other words, demand hasn't just increased; it has spiked off the map. Econ 101: increased demand equals increased price.

On December 11, 2006, the USDA estimated 2006-2007 U.S. ending stocks would be 935 million bushels, down from 1.97 billion bushels in 2005-2006. That decreases the ending stocks by more than 50 percent

Supply is contracting as well, and not by a little. By a lot. Econ 101: decreased supply = increased price.

It should be obvious to all, we are going to need a lot more acreage and big yield improvements if corn production is going to keep up to demand. Prices could exceed $4.50 per Bu by the end of 2008. That’s a price increase of 125% over 2005/2006 season prices.

Yes we are. The problem is the total amount a acreage devoted to corn farming is decreased. Accordiing to the Department of Agriculture the US produced 299.91 million metric tons n 2004 and is projected to produce 267.60 million metric tons as of March 2007. That's a drop of 11%. Also remember that demand has increased by 357%. That explains why corn futures have soared.

And it's not just corn that's increasing in price. Remember corn is a basic ingredient in a ton of food.

If corn prices increase by ~ 55 percent, year over year, then will the corn used for hog, cattle, chicken, turkey and fish feed go up 55 %? Doesn’t that increase the price of meat, poultry, fish, milk and eggs? If corn is used in corn meal, corn flakes, corn oil, and hundreds of other food items goes up 55%, doesn’t that increase the price of all these foods? Maybe. Since 2000, the price of beef is up 31%, eggs up 50%, corn sweeteners up 33%, wet corn milling up 39%, and corn flakes are up 10%. Chicken prices haven’t changed very much. Yet. Food producers are predicting higher prices.

There's a ripple effect through the entire food production change because of increased corn demand.

The author goes on to discuss the political situation with the corn industry and offers better solutions. I'm not scientifically qualified to say yeah or nay on any of these ideas (Damn it, Jim! I'm an economist, not a scientist).

However, I can say with certainty that if the current situation holds we have some really big possible problems coming up. These are the observations I made before and they still hold true:

1.) Inflationary pressures. Last year oil was the big inflation boogie-man. Now food prices may take their place. The charts above show the food prices are spiking. With overall production down over the last three years and a projected lower production level this year supply won't pick-up until next year. That means food based inflationary pressures may be with us for at least another year.

Also remember that agricultural prices in CPI and PPI have increased over the past three months at very high rates. I am sure the Fed will be discussing these increases at their meeting today.

2.) Higher inflationary pressures means the Fed will be less inclined to lower interest rates. If the economy continues to slow, the Fed won't be able to provide monetary stimulus. That could exacerbate an economic slowdown.

3.) The economy has been growing for the 2004-2007 time period, yet food production is down. There may be a bigger problem lurking here.

The short version is out dependence on corn may wind up creating a really big problem in the future.

One final note. I am not endorsing nor condoning the ethanol program. I'm not qualified to make a recommendation one its veracity on way or the other.

For economic commentary and analysis, go to the Bonddad Blog

Inflation is eating US wage gains

from the March 19, 2007 edition

Food, housing, and healthcare costs rose at a 6 percent yearly rate in the past three months.

The Christian Science Monitor

Brian Fortinberry, who runs Front Range Barbecue in Colorado Springs, Colo., is feeling the brunt of a spike in prices.

Beef costs about 10 percent more than it did in January, he says. Fruit and lettuce are also pricier. Gasoline has gone up, adding to costs when his restaurant does a catering job. And Colorado voters just raised the minimum wage – pushing up his payroll tab.

"We haven't increased our prices, but we're looking to do that," Mr. Fortinberry says. "Eventually you have to pass it along."

The economy may be a bit cooler than it was a year ago, but inflation is still running hot. It's not like the runaway price train of the '70s, but it's enough so that people notice at the grocery checkout, when they pay for day care, or when they buy college textbooks.

Some prices – namely for housing, food, and medical care – have been more noticeable than others of late, jumping at a 6 percent annual rate during the three-month period from December through February, the government reported Friday. Retail gasoline prices rose 7 percent in just two weeks, according to a March 12 report by the US Energy Information Administration.

Of course, not everything is getting more expensive. The core rate of inflation – prices of all goods and services minus volatile food and energy – has been edging up, not soaring, for the past three months. Still, at a 2.6 percent annual rate, inflation is hotter than Federal Reserve officials would like.

Economists are divided over what happens next. Some say inflation is bound to taper off – though maybe not for some months – as the ripple effects of a housing-market downturn cool the economy. Others say that rising prices will persist and that the economy, instead of cooling off, will run close to its speed limit.

"You're going to see continued [inflationary] pressure," predicts Michael Darda, chief economist at MKM Partners, an investment firm in Greenwich, Conn. "Firms will find the pricing power [to pass along increased costs]. I think it is a broad-based issue."

Doug Stoddard, who works at a computer job in Boston, doesn't need government reports to tell him about rising prices. He's seen them in numerous bills over the past year.

"Rent went up. Cable went up. My gym membership went up," he says.

His subway pass rose from $44 to $59 a month. And he's noticed higher prices for gasoline and groceries.

Mr. Stoddard figures that all this has outstripped the change in his income. Higher health-insurance costs alone ate up most of his last raise, he says.

Wage gains of Fall 2006 dissipate

Millions Americans face a similar touch-and-go battle to keep up with rising prices.

In the past two months, average weekly earnings have fallen in real terms (adjusted for inflation). That marks a reversal from last fall when, thanks to a dip in energy prices, real incomes were enjoying sturdy gains.

Consumers are being buffeted from several directions. The resurgence of inflation comes even as homeowners face a dip in property values and as the stock market has sagged from a recent peak. All this dragged consumer confidence down a notch in an index released Friday by the University of Michigan.

Hopes dim for an interest-rate cut

These economic crosswinds also pose a challenge for Federal Reserve policymakers. At a meeting Tuesday and Wednesday, they will weigh the risks to the economy – whether the threat of inflation is greater than the opposing forces that could cause an economic slowdown.

Many investors have been anticipating that the Fed will cut its short-term interest rate later this spring. That would help ensure that the housing downturn doesn't push the nation into a recession.

To pave the way for such a move, the Fed could first announce a "neutral" policy stance, rather than its current inflation-fighting bias toward raising interest rates.

But the latest news on consumer prices is dimming hopes for both the tonal shift and a subsequent interest-rate cut.

Not everyone has given up on the possibility of some easing by the Fed. But it now looks less imminent.

"The Fed will be on hold for the balance of this year," predicts Carl Tannenbaum, chief economist at LaSalle Bank in Chicago. He says surveys of wholesale and retail prices "are suggesting that inflation is not entirely under control."

In fact, the Labor Department's consumer price index on Friday showed price momentum in a wide range of goods. Food, clothing, shelter, medical care, energy, and airline tickets all posted sizable gains in February.

Some of the recent price changes may represent one-time shocks. Beef prices are reacting, in part, to a devastating storm that buried cattle country in snow. The higher costs for fresh vegetables and fruits such as oranges can be attributed in part to bad weather. Oil and gasoline prices have gone up and down based on forecasts for demand, production quotas set by OPEC nations, and glitches at refineries.

But if the Fed doesn't need to worry about any one price, it does have the task of watching the overall price level. A loose monetary policy can allow a broader cycle of price hikes in the economy, damaging consumer and investor confidence. Such a spiral, once started, can be hard to stop.

The Fed wants "to maintain a healthy investment environment where investors are not seeing their ... returns eaten by rising prices," says Mr. Tannenbaum. That stability helps businesses create jobs and boost productivity, allowing workers' real income to rise.

Some economists say a cooling economy will help to tame inflation. Prices have been falling, in fact, for cars, computer equipment, and other categories that respond to cyclical swings by consumers.

Other analysts are skeptical that the economy is slowing down. Mr. Darda expects both output and inflation to show surprising strength.

"I think we're going to end the year with core inflation much closer to 3 than to 2.5" percent, compared with 12 months before, Darda says. The Fed may not act soon, but "the next move is probably a tightening."

By Mark Trumbull | Staff writer

Why Are Food Prices Spiking?

Mar 17, 2007

By Bonddad
bonddad@prodigy.net

Last week the government released two inflation reports: the Producer Price Index and the Consumer Price Index. The PPI was released first. For the last three months, food prices at the producer level have increased 1.5%, 1.1% and 1.3% respectively. In the CPI report we learn that for the last three months food prices have increased .0%, .7% and .8%. These numbers are way above the trend so I looked at the CRB Agricultural Prices Chart. Here it is:

Here are the individual price charts for various grain commodities:

Wheat:

Feed Wheat:

Corn:

Barley:

All of these charts are at least 1 year in duration or longer. This indicates we aren't seeing seasonal fluctuations (which futures are suppose to prevent in the first place). So, what's happening with these prices?

The information below is from the the Department of Agriculture's World Agricultural Production Report

Total US wheat production has dropped from 58.74 million metric tons in 2004 to a projected 49.32 in March of 2007. That's a drop of 16%. Over the same period (2004 to Match 2007's yearly projection) all European countries have decreased wheat production as well. Australia -- which has been hit by a drought -- has seen production drop from 22.60 to 10.5 million metric tons. Overall world production has dropped from 628.59 million metric tons in 2004 to 593.11 million metric tons -- a decrease of 5.62%.

US and world production of course grains is also down. US production has dropped from 319 million metric tons in 2004 to a projected 280 million metric tons in 2007. That's a decrease of 12.2%. Overall world production has dropped from 1,014 million metric tons in 2004 to a projected 966 million metric tons in March 2007. That's a decrease of 4.73%.

And corn production is also down in the US and the world. Over the 2004 to the projection 2007 yield, US production has dropped from 300 million metric tons to a projected 2007 yield of 267 million metric tons (or 11%) while world production has dropped from 712 million metric tons in 2004 to a 2007 projected yield of 693 million metric tons (or 2.66%).

Simple economics states that declining supply = increasing price.

In addition, we have demand increasing from two areas. The first is simple population growth. As more people are born they will naturally want to eat. This obviously increases demand. In addition, there is a new element to demand: synthetic fuels. As the US adopts policies that promote ethanol and other food based fuels, demand increases which pulls prices higher.

Simple economics states that increasing demand = increasing prices.

In other words, we have two basic economic events (decreasing supply and increasing demand) pulling prices higher.

So what does all of this mean? Economically we have several issues:

1.) Inflationary pressures. Last year oil was the big inflation boogie-man. Now food prices may take their place. The charts above show the food prices are spiking. With overall production down over the last three years and a projected lower production level this year supply won't pick-up until next year. That means food based inflationary pressures may be with us for at least another year.

2.) Higher inflationary pressures means the Fed will be less inclined to lower interest rates. If the economy continues to slow, the Fed won't be able to provide monetary stimulus. That could exacerbate an economic slowdown.

3.) The economy has been growing for the 2004-2007 time period, yet food production is down. There may be a bigger problem lurking here.

Anyone who has any insight, please provide it.

Soft Landing So Far; Housing Recession Still Looms: Bonddad

Dec 18,2006

By Bonddad, bonddad@prodigy.net

Right now, the US economy appears to be moving into a soft landing. GDP growth is slowing but not turning negative. The unemployment rate is still technically good. The official BLS measure of inflation has declined the last several months -- although the alternate Cleveland Fed median CPI is still showing higher levels. Basically, Fed Chairman Bernanke has a lot to be pleased about. However, there are three economic wild cards that threaten the soft landing. These are oil, the dollar and housing.

Of these three wild cards, housing still causes the most concern.

Let’s review the general economic background. According to the Bureau of Economic Analysis, US GDP increased 5.6% in the first quarter, 2.6% in the second quarter and 2.2% in the third quarter. The BEA revised third quarter GDP up from 1.8% to 2.2%. However, the three quarter trend is clear: growth is slowing.

Housing is in a slump. The Federal Reserve made the following comment in its FOMC statement on December 12:

Economic growth has slowed over the course of the year, partly reflecting a substantial cooling of the housing market. Although recent indicators have been mixed, the economy seems likely to expand at a moderate pace on balance over coming quarters.

Housing will most likely continue to be a drag on GDP growth going forward. The chart below is from the blog Calculated Risk and shows the percentage of housing to GDP. The graph shows that housing has a long way to go before it returns to historically normal levels:

The employment picture is statistically solid:

Nonfarm payroll employment rose by 132,000 in November, and the unemployment rate was essentially unchanged at 4.5 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Job gains continued in several service-providing industries, including professional and business services, food services, and health care. Employment declined in construction and manufacturing.

The US continues to lose manufacturing jobs. More importantly, construction sector employment topped out at the beginning of this year and is starting to turn downward.

Hourly wages have actually increased through November of this year. So far, hourly wages increased from $16.40 in January to $16.91 in November for an increase of 3.1%. Over the same period, the BLS’ inflation index increased from 198.3 to 201.5 for an increase of 1.61% making wage gains 1.49%. This is the first year of this expansion when wages have increased faster than inflation. So this is good news, but it will take a bit of time for 80% of the population to start making money beyond inflation. However that may prove difficult in a 2.2% GDP growth rate environment. I should add that using the Cleveland Federal Reserve’s median CPI calculation, inflation would still be rising faster than wages.

Finally there is inflation. The overall level of inflation isn’t as relevant as what the Fed thinks about the overall level of inflation. The Fed stated its position on inflation in the last FOMC statement:

Readings on core inflation have been elevated, and the high level of resource utilization has the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.

Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

Short version – the Fed is still concerned about inflation. They still think a slowing economy will do the Fed’s job, but their statement gives them enough wiggle-room to raise rates if they need to. The Fed has been saying this for the last few months.

So using the above metrics we see the US is in a low-unemployment situation. Wages are either increasing slightly or are still stagnant depending on which inflation measure is used. Inflation is still too high according to the Fed, but they are willing to sit on the sidelines to let the economy slow inflation’s growth. But growth is slowing and the housing market is slumping. So the US economy is technically in OK to good shape, but certainly not something to write home about.

There are three wild cards going forward which place the "soft-landing" scenario in doubt.

The dollar

Below is a weekly chart for the dollar, going back a few years:

The dollar had been trading in an upward slanting range for most of the year. However, it broke through support in late November/early December. This indicates a downward change in the trend.

There are several reasons for this drop. The first is the interest rate differential between Europe and the US. The European Central Bank has increased rates while the US has maintained interest rates. This process has closed the interest rate gap between the US and the EU, taking away the carry-trade (borrowing in the US and lending in Europe) between the continents. In addition, European growth is picking up while the US is slowing down. This makes the euro a more attractive investment relative to the US.

In addition, the US trade deficit is again getting press time. Below is a chart of the overall US trade deficit from the St. Louis Federal Reserve.

Although the deficit has narrowed over the last few months it is still on track to set another record this year. Paulsen’s visit to China may have opened the door going forward, but the US does not have any solid actions from China regarding the deficit as of yet. In addition, a large portion of the trade deficit’s recent increase is based on oil. As long as the US remains an oil dependent country we will have a trade deficit. So, while the deficit may narrow in the coming years, don’t expect any miracles.

The chart below from the St. Louis Reserve indicates that foreign holdings of debt have greatly increased the last four years.

As more foreigner central banks take on more US dollar obligations, the possibility of a shift away from the dollar to other currencies (most notably the euro) increases. The quiet shift away from the dollar to the euro has already started. The South Korean, Japanese and Chinese governments have slowed their purchase of US debt, Russia has announced they will diversify their currency holdings into the euro, and OPEC has shifted 2% of their assets in the euro over the dollar.

The downtrend is in place. It will probably take a fundamental shift in world sentiment towards the dollar, the US trade deficit or the US economy to change the dollar’s direction.

What does a weakening dollar mean going forward? It creates two inter-related problems. First, a cheaper currency means imported goods increase in price. This increases the possibility of importing inflation. This leads to the second problem – hemming-in interest rate policy. Several economists have predicted the Fed will lower interest rates sometime in 2007. However if import prices increase to a high enough level the Fed won’t be able to lower interest rates to stimulate the economy if it slows down.

Oil

Below is a weekly chart for oil, going back a few years.

Oil has come down from it’s yearly high in about September. One of the quiet market forces leading to this decline was Goldman Sachs re-weighting a major commodity index. They changed gas’ weighting from 7.3% to 2.5%. Whenever a market index changes a component’s weighting mutual funds, index funds and other investment managers who track the index must also re-weight their respective portfolios. This resulted in a net selling of oil futures.

However, there are other fundamental reasons for oil’s drop which primarily center around the US’ slowing economic growth. The US is the world’s largest oil consumer. When the US economy slows, overall oil demand slows (This may have been a reason for Goldman lowering oil’s importance in its index). A drop in US demand will have a negative impact on oil’s price. However, India’s and China’s growing economies provide a floor for oil prices, which the market currently pegs right around $60/bbl.

In addition, OPEC has announced two production cuts. The first went into effect about a month ago and the second is scheduled to go into effect in February. This provides additional support for oil’s price. OPEC’s members have a habit of breaking production cuts because there is no formal enforcement mechanism within the OPEC cartel. So we will have to wait and see how effective this cut in production actually is.

Finally with regard to oil, the world economy is only one geopolitical event away from an oil price spike. With the US Iraq policy in a state of flux this risk increases.

Housing

Housing has been slowing for the last six months or so. There are three inter-related problems with housing that do not bode well for the future. A slowing rate of purchases is the first problem. According to the latest Census data on new home sales, the year-over-year (YOY) sales rate has declined 25% from an annual pace of 1.3 million homes to 1 million homes. According to the National Association of Realtors, the YOY sales rate of existing homes has decreased 11.5%. The second problem is an increasing inventory level. The total inventory of new homes available for sales has increased 13.8% from October October 2005 levels, from 490,000 units to 558,000 units in October 2006. The slowing rate of purchases has increased the number of months of available inventory from 4.5 months to 7 months from October 2005 to October 2006. Existing home inventory has increased from 2.868 million units in October 2005 to 3.854 million units in October 2006 – an increase of 34%. Meanwhile, the slowing rate of existing home purchases has increased the months available for sale to 7.4. Finally, there is the issue of total household debt outstanding, which has greatly accelerated during this expansion. The chart below shows the rapid escalation in household debt for the duration of this expansion.

No soft-landing housing person has been able to answer the following question: "How much more debt can the US consumer put on his respective balance sheet?" The US consumer is already massively in debt and most people already have houses, leading to the question of "who will actually buy this inventory?"

To sum up we have the following. The current economic environment plays out the soft landing scenario. However, there are three economic wildcards that will take time to play out: the dollar’s overall value, oil and the domestic housing market. Housing is still the number one concern. There's a ton of inventory on the market and buyers are already massively in debt.

A downturn in either one of these three could tip the US into a recession. So while the soft-landing camp has plenty to cheer about right now, raising a toast is very premature.

For an update on the market and current economic events, go to the bonddad blog

US Inflation Statistics: 'Nonsense'

HOW YOU MAY HAVE KINDA SAVED $392.10

November 16, 2006 -- YOU will be happy to know that your household costs actually went down in October because of that light truck you didn't buy.

I don't mean to mess with your head this early in the day. But the declining costs of light trucks was a major reason the government earlier this week was able to announce a surprise 1.6 percent drop in producer prices for October.

If you believe the U.S. Department of Labor - whose statistics rarely make much sense - we are on the verge of another deflationary episode like the last one that never happened.

I'll explain about deflation scares in a minute.

But first, let me talk about light trucks.

I didn't buy a light truck last month, and I'm guessing that you didn't either.

Yet as insignificant as the price of these vehicles is to the average American's budget, a $392.10 drop in light-truck prices did help the government conclude that the producer price index (PPI) declined.

Wow! It almost makes me wish I needed a truck.

And I'm almost tempted to buy one - except that the price didn't really drop $392.10. (Remember that lies are always best when told with precision - hence the 10 cents.)

In fact, the new light trucks that reached showrooms this fall didn't really go down 9.7 percent in price as the government implies.

Washington simply concluded that the new models are so much better than last year's class that buyers got more for their money - and a price break.

How did the Labor Department come up with the $392.10 figure?

It said that you got an extra $160.09 (notice again the precise number) in extra value from new federally mandated and non-mandated safety improvements "such as tire pressure monitor systems, stability control and airbag system improvements."

And you got another $58.01 in powertrain improvements, plus another $174.00 in value for "other quality changes." These include "changes in levels of standard and optional equipment."

Voila, the price went down even if it really went up.

Hedonics (a word that I've been barred from using ever again) and an assortment of other such razzmatazz allows Washington to report lower inflation, which automatically makes economic growth look stronger than it is, which in turn allow politicians to proclaim that an economy is great when it isn't, which ultimately gets them thrown out of office.

But on a more pernicious note, these inflation tricks can also fool economic planners like the folks at the Federal Reserve.

Recently the head of the Dallas Fed, Richard Fisher, complained that Alan Greenspan's Central Bank kept interest rates too low because it had been tricked into thinking the nation was on the verge of deflation.

He said the Fed was incorrectly worrying about deflation.

"In this case, poor data led to a policy action that amplified speculative activity in the housing and other markets," Fisher added.

In other words, if you bought a house at a price that turns out to be too high, you can blame bad data caused by hedonic adjustments to light trucks that makes the PPI looked tamer than it really is.

Today, the government will announce its October Consumer Price Index.

It too will be nonsense.

john.crudele@nypost.com

http://www.nypost.com/seven/11162006/business/how_you_may_have_kinda_saved_392_10_business_john_crudele.htm

US Inflation Statistics: 'Nonsense'

HOW YOU MAY HAVE KINDA SAVED $392.10

November 16, 2006 -- YOU will be happy to know that your household costs actually went down in October because of that light truck you didn't buy.

I don't mean to mess with your head this early in the day. But the declining costs of light trucks was a major reason the government earlier this week was able to announce a surprise 1.6 percent drop in producer prices for October.

If you believe the U.S. Department of Labor - whose statistics rarely make much sense - we are on the verge of another deflationary episode like the last one that never happened.

I'll explain about deflation scares in a minute.

But first, let me talk about light trucks.

I didn't buy a light truck last month, and I'm guessing that you didn't either.

Yet as insignificant as the price of these vehicles is to the average American's budget, a $392.10 drop in light-truck prices did help the government conclude that the producer price index (PPI) declined.

Wow! It almost makes me wish I needed a truck.

And I'm almost tempted to buy one - except that the price didn't really drop $392.10. (Remember that lies are always best when told with precision - hence the 10 cents.)

In fact, the new light trucks that reached showrooms this fall didn't really go down 9.7 percent in price as the government implies.

Washington simply concluded that the new models are so much better than last year's class that buyers got more for their money - and a price break.

How did the Labor Department come up with the $392.10 figure?

It said that you got an extra $160.09 (notice again the precise number) in extra value from new federally mandated and non-mandated safety improvements "such as tire pressure monitor systems, stability control and airbag system improvements."

And you got another $58.01 in powertrain improvements, plus another $174.00 in value for "other quality changes." These include "changes in levels of standard and optional equipment."

Voila, the price went down even if it really went up.

Hedonics (a word that I've been barred from using ever again) and an assortment of other such razzmatazz allows Washington to report lower inflation, which automatically makes economic growth look stronger than it is, which in turn allow politicians to proclaim that an economy is great when it isn't, which ultimately gets them thrown out of office.

But on a more pernicious note, these inflation tricks can also fool economic planners like the folks at the Federal Reserve.

Recently the head of the Dallas Fed, Richard Fisher, complained that Alan Greenspan's Central Bank kept interest rates too low because it had been tricked into thinking the nation was on the verge of deflation.

He said the Fed was incorrectly worrying about deflation.

"In this case, poor data led to a policy action that amplified speculative activity in the housing and other markets," Fisher added.

In other words, if you bought a house at a price that turns out to be too high, you can blame bad data caused by hedonic adjustments to light trucks that makes the PPI looked tamer than it really is.

Today, the government will announce its October Consumer Price Index.

It too will be nonsense.

john.crudele@nypost.com

http://www.nypost.com/seven/11162006/business/how_you_may_have_kinda_saved_392_10_business_john_crudele.htm