Provisional
Truth | Essays | June 23, 2007
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Inflation's Early Warning System
Red lights are blinking on inflation's early warning system
control panel – fasten your seat belts. “Crude Foodstuffs
and Feedstuffs,” commodities such as grains, raw milk, sugar
and slaughter animals making up the raw materials that
eventually become the finished products we call “food,”
registered an unadjusted 35 percent year-over-year increase
in the May Producer Price Index reported June 14th. Its
five-month annualized increase is nearly 22%.
Extremely sensitive, and thus extremely volatile, the
commodities component of PPI nonetheless is a credible
harbinger of future inflation, and by extension, long
opportunities in a bullish commodities market, as previous
periods of rapid raw materials inflation since the 1970s has
shown.
For reference, a table of Crude Foodstuffs & Feedstuffs is
linked
here. Note the lengthy month-to-month periods of
price inflation over the last 35 years, including 1971-1974
(Nixon/Burns “Wage and Price Controls”), 1975-1976
(Ford/Greenspan “Whip Inflation Now”), 1978-1981
(Carter/Volker “Malaise”), 1987-1989 (Bush/Greenspan “No New
Taxes”) and 1995-1996 (Clinton/Greenspan “Last Great Bull
Market in Grains Until Now”).
While the Federal Reserve monitors “core” inflation rates
(inflation less food and energy), from which it divines the
direction of interest rates, its exclusion of food and
energy gives, at best, an incomplete picture of monetary
inflation, and, at worst, a grossly distorted view of what
most Americans intuitively sense at grocery stores and gas
stations.
So
last week, when the Bureau of Labor Statistics reported May
PPI up 0.9 percent, but up only 0.2 percent
ex-food-and-energy, and the May Consumer Price Index up 0.7
percent/up 0.1 percent ex-food-and-energy, financial markets
focused on the all-is-well “core” rates. American consumers,
however, who cannot eat or drive with “core” goods, already
know the real inflation story and are beginning to make
personal economic adjustments to compensate, which, if that
translates to lower consumption, is not good for an
expanding economy.
Chief among the causes of edible raw material inflation is
rising energy costs. Farmers and ranchers are paying much
higher prices not only for fuel to plant and harvest crops
and to raise slaughter animals, but also for feed,
fertilizer and pesticide.
Other factors always influence short-term movement of
commodity prices, including weather, water, crop mixes and
global grain supplies on hand, but longer-term price
movements now are being impacted most by a surge in
worldwide demand.
Like energy, the world's demand for food is increasing
exponentially as a function of both population growth and
intensified slaughter-animal production to support a trend
toward North-American-style meat-based diets, which convert
roughly 3-7 pounds of grain into each pound of meat.
Furthering grain demand is America's new desire for corn
ethanol, which myopically is diverting food supplies to
biofuel in in hope it will become some sort of scalable
alternative to petroleum-based auto fuel. A near-record US
planting of more than 90 million acres of corn this spring
evidences the renewed profitability of this crop, while
Mexican farmers are burning blue agave fields, which yield
the key ingredient in tequila, to replant their fields with
corn. (Bueno para tortillas, pero muy mal para
margaritas. Ole.)
As
it is, global grain production has fallen short of demand
seven of the last eight years, more than halving grain
days-on-hand to the 2007/2008 estimate of 53 days from 115
in 1999/2000, the lowest level since the US Department of
Agriculture began tracking these data nearly 50 years ago.
The picture is no less bleak, no less inflationary, in the
world's oceans, where a third of fishing grounds are thought
to be “in collapse,” and possibly two-thirds in less than
two decades, at which time global population may exceed
eight billion, up from 6.7 billion today.
It's said on Wall Street the most dangerous words are “but
this time it's different,” which invariably holds true until
it doesn't. This time it is different.
Energy prices will remain at new lofty plateaus from a
combination of worldwide demand growth, Middle East
instability, static refinery capacity, growing extraction
costs, the possibility of peaking production from the
world's major oil fields and, at least at present, a seeming
unwillingness on the part of US drivers, who consume 25
percent of the world's energy, to modify their consumption.
Food prices, incorporating rising energy prices and other
environmental and demand factors, also are likely to remain
in an uptrend which could last, based on historical trends,
several years or more. Like energy, we may have seen the
last of foodstuffs inflation/deflation cycles which has
brought this volatile sector back to 1982 levels (1982=100)
a number of times in the last several decades, including as
recently as November 2002 in the aftermath of 9/11.
At
an index level of 146.4 in May 2007, foodstuffs now are
inflating at about 10 percent a year since late 2002.
Not to worry – too much. Prices of flat panel HD
televisions, gas-guzzling cars, roofing nails, computers,
incandescent light bulbs and, likely, housing prices will
continue to deflate or at least stabilize.
But - and there's always a “but” - foodstuffs and feedstuffs
inflation is the bearer of bad tidings of rising producer
and consumer inflation and, perhaps, a faltering economy. If
so, welcome to the new millennium's version of that 70s
show: “stagflation,” with attendant opportunities for
commodity profits.
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