Saturday, February 09, 2008

Inflation Getting Worse

Contrary to the repeated predictions of most economists, there is no sign that inflation is somehow slowing from their current high levels. Although oil is still, despite Friday's rally, below its January peak of $100 per barrel, most other commodities continue to soar in value. The CRB commodity price indexes reached yet new all time highs on Friday. The Economist's commodity price index is published only weekly, but the latest value showed a new all time high for that too, at 239.1, up 30.7% in the latest year. And do please note that this is not a base effect because the rate of increase is in fact accelerating. The increase for the latest 6 months is 17%, or 37% at an annual rate. The increase for the latest 3 months is 10.1%, or 47.1% at an annual rate. The increase for the latest month is 5.3%, or 85.8% at an annual rate.

Food commodities have increased particularly much, being up 8% (an annual rate if increase of 151.8%) in the latest month, 22.8% (an annualized rate of increase of 127.4%) in the latest 3 months and up 55.3% in the latest year. Investors who have followed the advice of me and Jim Rogers to invest in commodities in general and food commodities in particular have in other words earned very high returns.

So far, the price of finished food products has increased a lot less than that for three reasons: 1) Finished food products reflect the cost of other things than food commodities, and these costs have increased a lot less. This is especially true for food served at restaurants 2) Retailers and wholesalers have reduced their margins 3)There is an inevitable time between movements on the commodity prices and the prices of finished food products as the price of food sold now reflect market prices a few months or so earlier.

Factor 1 will continue to ensure that the price increase of finished food products will increase slower than the price of food commodities. However, factor number 2 will be difficult to sustain and will probably eventually disappear and factor number 3 will certainly disappear in a few months or so. This implies that food prices will increase a lot more in 2008 than in 2007, when it for example increased a mere 4.8% in America at the retail level.

That sharply higher food prices is on the way is also evident in the producer price indexes. Finished consumer food products at the wholesale level were up 7.4% in the 12 months to December 2007, a lot less than the 4.8% reported in the CPI. Intermediate food products were up 17.5% and crude food products were up 25.2%. And remember, in December the increase in commodity prices were a lot lower than now. Because of factor 1, not all of this will translate into higher retail food prices and in the short term factor 2 and 3 will probably also have a mitigating effect. But later in 2008, factor 3 and probably also factor 2 will gradually disappear as a factor, which implies a sharp acceleration of food price inflation.

And as "core" inflation have recently begun to rise again and as I expect the oil price to start rising again soon, it seems safe to say that consumer price inflation will remain at their current high level of above 4% in America and above 3% in the euro area (It might briefly fall below those levels during the spring due to base effects, but even if that happens, it will only be temporary). Not that this will stop the Fed from cutting interest rates as they will continue to claim that inflation will fall, like they did before the recent surge of inflation to more than 4%. Because of this and the underlying trends discussed in Jim Rogers book Hot Commodities, commodities remain an attractive investment object while bonds remain very unappealing considering how they provide low -in the euro area- or negative -in America- real yields. While brief corrections are likely to come, the underlying fundamentals for commodities remain strong so the upward trend will remain.


Anonymous Anonymous said...

What isn't clear, however, is whether the increases in the costs of these goods are the result of inflation (i.e. growth in the money supply), changes in supply/demand, so some combination of the two.

Price increases due to a decrease in supply or increase in demand are not inflation (by definition) and have different consequences than price increases caused by growth in the money supply.

6:43 AM  
Blogger stefankarlsson said...

Actually, it is clear that this is due to high money supply growth, if you look at the growth of MZM in America and M2 in the euro area. The main reason I didn't mention this fact in the post was because it was meant as a critique of the deflationists, like Frank Shostak and Mike Shedlock who use a different money supply definition.

10:13 AM  
Anonymous Anonymous said...

my email enquiry to the economist regarding the exclusion of oil in their commodity index has gone unanswered. a cursory net search has not shed any light on this either. i
can't believe others haven't asked the same question of them innumerable times!

3:47 PM  
Anonymous Anonymous said...

I don't disagree that an increase in money supply plays a roll in the current price increase we are experiencing. However, commodity prices have gone up in no small part due to higher demand, and as I am sure you know Jimmy Rogers also supports this theory.

And we have already had our debate re: Shostak and Shedlock :-) In any case, I enjoy reading your blog.

10:35 PM  

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