“Real” inflation rising dramatically, despite official measures – Published in the Santa Barbara News Press in February of 2011

Although the Consumer Price Index (CPI) and Producer Price Index (PPI) both have shown tame inflation at most, “real” inflation – the cost of the things the average American ( you and me) – buys every day, continues to rise significantly.

The prices of food and energy, two things we all must have to get through each day, have risen steadily over the past few years, despite the recession and lack of demand.  Corn, for example, has risen from about $3.75 per bushel, to almost $7 per bushel, over just the past six months.  Corn is very important because it not only is a key ingredient in many food products such as cereals and as a sweetener – corn syrup, which goes into all kinds of foods, including candy – but it is also used to produce ethanol.  Ethanol is being added to gasoline more and more, since oil and gasoline prices are so high, and because we want to reduce our demand for foreign oil.
Food prices in general have risen steadily and dramatically around the world.  The United Nations Food and Agri­cultural Organization (FAO) food price index hit an all-time high in December of 2010. This sparked concern that high prices just prior to the global recession could reflect longer-term structural changes in supply and demand that will imperil the poor’s ability to eat.
Gallup surveys from 2009, (before this latest spike in food prices), indicated that about 1 billion people worldwide struggle to afford food.  We can expect the higher cost of food to dramatically add to the world’s hungry. But it’s clear that all around the world, where food is growing more expensive due to weather shocks, export bans, inflation, high oil prices and biofuels, speculation, and slowing growth in farm yields, many people are forced to get by with less food.  This situation is especially hard on the world’s children living below the poverty line.
In China, eggs have nearly doubled in price in just the past few months.  Overall, prices over the past three months or so have risen about 35%.  Prices for fresh foods, such as fruit and produce have increased much more.  Only 10 percent of China’s population went hungry in 2007, down from 18 percent in the early 1990s, according to the FAO.  However, many Chinese have seen incomes rise, offsetting higher food bills to some degree.
In 2008, a year with high food prices before the global economic crisis, the Gallup percentages of Chinese, Indians, Vietnamese, and Indonesians who said they had trouble affording food went down, not up, according to an economist with the International Food Policy Research Institute.  Now, however, these same countries are experiencing rapid food inflation.
Mexico’s National Policy and Social Development Evaluation Council (Coneval) estimates that the percentage of their population that cannot afford basic food rose by roughly 20 percent between 2008 and 2010. Experts say this has more to do with the global economic crisis than food prices, but it is a sobering reminder that this food cost increase comes on the heels of an economic downturn.
In Egypt last year, vegetables rose 45 percent, fruit by 26 percent, sugar by 23 percent, and dairy products by 8.5 percent.  Egypt spends billions of dollars annually on food subsidies, and in 2008, due to soaring food prices, it expanded its subsidy program by 15 million people, bringing the number of beneficiaries to fully 80 percent of the population.  About 5 million to 6 million Egyptians in 2008 were considered food insecure.  Now, with Mubarak cutting back on a lot of the basic services that the vast majority of Egyptians have come to depend on, and removing many of their civil liberties as well, citizens are rioting and demanding his resignation.  In addition to the political risks associated with its woes, Egypt controls the Suez Canal, a key transportation rout for oil coming out of the Middle East.  If the Suez Canal were to be shut down (they’ve done it before), oil prices will spike.
Supply and demand are also key factors that help determine the prices of commodities, including energy and food.  Corn, as an example, is in short supply, partly due to its use in ethanol, but also due to weather factors, demand, and so forth.  Lower supply drives prices higher, just like we learned in economics 101.  Demand for other commodities, such as copper, which is at a 30-year high price at the moment, is coming primarily from developing countries like India and especially China.
China will continue to increase its demand for just about everything, as their economy industrializes, and as their per capita income increases.  The Chinese have suffered for generations under communist rule, and are hungry for all things from the west, and especially from the U.S.  China’s need for energy is important for us, and is of great concern, because they, like us, do not produce nearly enough domestically to meet their needs.  As they industrialize, they will need more and more energy, and will continue to compete with us for external sources, such as the Middle East.  This increased demand will likely mean higher prices for you and me at the pump.
Keep in mind also that plastics, synthetic fibers, and thousands of other things that each of us have in our homes and buy on a regular basis, come from oil.  As the Chinese increase their earnings power, they will have more disposable income, and therefore will demand more consumer items, many of which will be produced from oil.  This means even higher demand for oil, and very likely, even higher prices for you and me on gasoline, and on all of the consumer items made from oil.
Gasoline futures prices are based on Brent crude oil prices, which have spiked dramatically due to the unrest in Europe and in Egypt and other Middle Eastern countries.  Gasoline futures are up 4% just in the past week, despite the fact that gasoline inventories are at their highest levels in more than 20 years.  Brent crude oil prices are significantly higher than West Texas Intermediate crude oil prices, although all oil prices are elevated at present.
The world population is expected to grow by 50 percent by 2050.  Food production will need to rise by 50 percent by 2030 to meet growing demand.  All of this growth in demand will mean food shortages and therefore higher prices for you and me.
One positive from a purely economic standpoint is that we grow a lot of food in California, and in our surrounding counties.  To the extent that price increases can be passed on from farmers to food buyers, and that higher prices drive higher profits for farming operations, we could see a boost in local economic activity over time.  Unfortunately, some of the same commodity pricing pressures that cause price inflation for you and me also affect farmers.
Energy, for example, is a key cost for farmers.  They need fuel for their tractors, fertilizer for their crops, (which in many cases comes from nitrogen, which in turn is typically made from natural gas), and they have to send their crops to market.  As energy prices rise, farmers’ costs also rise.  Farmers normally use hedging to reduce price risk, but if their hedges are unsuccessful, or if there are sustained price increases for the inputs into their farming process over a long period of time, farmers will not be able to offset cost increases fully.  If they can, they pass cost increases on to the buyer of their products.  Otherwise, their profits dwindle.
At the end of the day, despite the fact that CPI and PPI appear to show that inflation is under control, real inflation for the things we all have to buy to get through our daily lives continues to increase.  Sooner or later (and I expect it to be very soon), we will see real inflation showing up in the official calculations for CPI and PPI (and everything else).  When this happens, interest rates will rise, and the Fed will be forced to increase short-term rates to cool inflation, which can have a devastating impact on the economy.  On a personal level, we should all assume that the cost of living will continue to rise, and we should plan accordingly.

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