The just-released monthly inflation report showed that prices for most goods eased a bit. The exception of course is oil, and even though oil prices globally have declined in recent weeks, most Americans are paying ever more for gasoline even as inflation overall remains statistically tame.
The way we calculate inflation is fraught with problems. There is the awkward distinction between the headline rate (which is now 3.2% and includes volatile food and fuel prices) and the core rate (which strips out volatile food and fuel prices and now stands at 1.3%). Statistically we have the luxury to differentiate, but in our individual lives, we can’t separate expenses into “core” and “headline.” The official inflation rate as defined by the “consumer price index” (CPI) also includes a component meant to capture home price moves using the rental market, which may or may not track actual home prices.
But the real issue today is that inflation is almost entirely a product of rising raw material costs and for now, these are being born not by individuals but by companies. Many economists assume that eventually, these rising input costs will be passed on to consumers in the form of higher price tags. What is striking, however, is how rare that currently is. Yes, Starbucks, McDonald’s and luxury goods makers have recently announced modest price increases, but the vast majority of companies have no pricing power. If anything they continue to cut the price of goods because in a world of stagnant wages in the United States, Japan and Europe, raising prices isn’t feasible, and in an expanding world of China, Brazil and India, the price point starts much, much lower.
That emerging world is hungry for goods, for food, cars, appliances, gadgets, homes, and clothing. And governments in Sao Paulo, Beijing, and New Delhi are authorizing vast spending on modern infrastructure. China’s is well known, but Brazil and India both have significant needs that are only now beginning to be met.
I just returned from a conference with some of the world’s leading money managers, and one theme was clear: there has been massive underinvestment in the global supply chain of industrial metals and raw materials. This is less about oil and gas than about things like copper, iron ore, palladium, titanium, zinc, rhodium, and a host of other “iums” that are the essential, irreplaceable inputs for the industrial world that we all inhabit and that billions are on their way to inhabiting. Simply put there is yawning gulf between demand and supply, and it cannot be narrowed in the coming decade be bridged by technology or spending.
That means we are in for a period of rising commodity inflation, including oil and of course food as more people consume more calories and crop yields strain to increase. That may not show up in normal ways that we calculate inflation, and it may not affect the decreasing cost of consumer goods in the western world for some time. But it is a challenge for companies, and the only way they can maintain profitability is through a combination of technology, more efficient business models and keeping labor costs in check. In short, low consumer inflation in the United States may be good, but its less appealing twin is the relentless pressure on wages and companies being loath to add costs by adding jobs.
So unless China truly implodes or Brazil stops growing, or hundreds of millions in India and Indonesia stop believing that they have a right to the same middle class lifestyle that has characterized the West for the past century, we are at the early stages of a spike in commodity prices the likes of which we have never seen. And judging from debates in Washington over how much to spend on Planned Parenthood and how much to reduce pension of state workers, we are nowhere near prepared for this world that we are entering.