“What has that got to do with the price of wheat in Russia?” This was my father’s way of saying that an argument had nothing to do with his.
So too says the Federal Reserve and the financial community, except they ask the question in reverse: What does the price of wheat in Russia have to do with inflation? According to them, nothing. Nor do the prices for all food, gasoline, natural gas, and heating oil count. None of their price rises or falls, they believe, are relevant to measuring real inflation. They are excluded from “the core rate” of inflation, the index of price rises that is the gold standard central bankers use to raise or lower the interest rates on money. They set the prime interest rate that is the benchmark for all other interest rates, from passbook and money fund savings rates, to house mortgages, car loans, credit card debt, and anything else you owe on.
In contrast, “headline inflation” measures the rise in the prices of all that we consume. It is about the wheat in Russia, and how their wheat, our wheat, and the rest of the world’s wheat is worth over twice what it was worth 10 years ago, and 50% again over the course of the last year. That’s headline inflation. Its rise worries some economists, but it is not currently the stuff of policy.
Unfortunately, it turns out that as Russian wheat goes and the world’s wheat goes for that matter, so go the rest of our food costs. World corn prices are a third higher than 10 years ago, and have jumped and another 60% in the last year. The world price of soybeans has increased 30% over the last ten years, but is expected to jump another 30% within the space of this year. “Food prices,” said The Financial Times on May 27, “are heading for their biggest annual increase in as much as thirty years.“
The costs of feeding a family, driving a car, and heating a house in the US are also going up. Like food, they are running well above the core inflation rate of 2% between August 2006 and August 2007. Crude oil at last week’s $80 quote is running 18% higher than last year, and a gallon of gas last week cost $2.78. Natural gas is up 5%, and heating oil 5.8% over last year, according to the September 11 report of the federal government’s Energy Information Administration. Perhaps this Sunday’s Boston Globe’s business lead story banner says it best: “Cold Comfort: Winter is coming, oil prices are at a record high, and you haven’t locked in a price.” The cost of home heating oil this winter at $2.67 a gallon is 60% higher than a decade ago.
Is anything cheaper for Main Street Americans? Not medical care, crossing over once more to double-digits this year. Houses are, and ex-Fed guru Alan Greenspan forecasts further price declines. Though usually good news for buyers, this time it is not clear whether banks and mortgage brokers will lend people money at a rate they can afford or lend at all. And if fewer people buy first homes, rents may go up.
We’ve got it bad, and that ain’t good. But as usual, poor people here and abroad have it worse. Poor people in the US spend more of their income on food. Though the majority receives food stamps, large increases in food costs hit them harder and can run ahead of new food stamp funding increases. Though the average American spends just 3.6% of after tax income on gas, people in the lowest income bracket in 2005 spent 9% of their after-tax income on gas. The more one spends on life’s basic necessities – those items not included in the core inflation index – the more vulnerable one is to inflation as a whole.
Abroad the poor are even more vulnerable. The average Mexican, for instance, spends 26% of disposable income on food. Ten days ago, after the cost of tortillas had shot up almost 30% almost overnight, the Mexican government imposed a price freeze. Given the record world demand for corn, the action may only marginally affect the tortilla price while lowering the supply of corn available to Mexican consumers. People in poor countries spend up to 65% of their income on food. Though poor farmers can in theory protect themselves from food deprivation by planting crops for household consumption, the prices for seed and fertilizer rising with food inflation. And this year marks the first time in human history that the majority of the world’s population lives in cities. No maize plots for them.
People around the globe are served by the same markets for food and fuel and also have begun to experience the worst of both worlds: rising prices and diminishing supplies. Worldwide, wholesale food prices have increased 21% thus far this year. The Forbes September 20 issue reports that even as world wheat prices are at historical levels, wheat stocks are the lowest in 33 years. Though a predictable effect of supply and demand, its consequences are both worrying and dangerous. Food price inflation in India is running in the double digits and nearly so in China. The new middle classes of these two industrializing giants, a fraction of their combined 2 plus billion population, can doubtless afford to pay more for food, but the poor masses behind them are much more vulnerable to food insecurity.
Economists discount headline inflation precisely because food and fuel are volatile commodities. Bad weather, wars, and pestilence, among other things, create too much uncertainty for standard economic equations. The Fed, bankers, and most economists prefer the core inflation index because its curve is more gentle, its movements more predictable – all the better for figuring out how to make money from one quarter to the next, and from one year to another.
All well and good for them. But what happens to the rest of us when faced by an inflationary tide surging beyond their sacral standard? The US headline inflation rate has outpaced the core inflation rate every year since 2002. An economist for the Deutsche Bank reported to The Financial Times on May 24 that “there is growing concern within the food industry that the present upswing in soft commodity prices is structural rather than cyclical.” What about fuel prices declining significantly? I wouldn’t bet on it. Whether caused on the one hand by trends such as population growth, increasing affluence in formerly poor countries, or the current corn into ethanol craze, or on the other hand by accidents and acts of god, inflation itself is becoming a trend that is being built into the basic cost of living.
This is not good news for anyone. The Mister Moneybags of the world, as Marx caricatured capitalists, will see their real capital shrink, and their loans repaid by debtors proffering devalued dollars, Euros, renminbi, or yen. But debtors beware: if incomes continue to stagnate, or if they decline relative to inflation, your temporary advantage is lost. Interest rates will tick up, outrunning by Federal Reserve intent the inflation rate. Any debt you hold, if you haven’t locked in the interest rate via a contract, will become more expensive still.
And then, you might agree that the core inflation rate, while good for bankers, is a mighty thin and risky reed upon which to support the economic well being of the billions of people on the world’s Main Streets, whose cost of living and economic vulnerability, though overlooked by the Wall Streets of the world, is growing day by day.