The last U.S. inflation reading of 3.6% was the basis for numerous headlines warning about runaway price escalation that will hinder economic growth. The core reading – less food and energy – came in at a paltry 1.5%. I understand the popular frustration with the fact that all of us do in fact eat and drive, day in and day out, rendering that core reading a bit useless from a practical perspective. But that is not the point.
Considering the magnitude of energy inflation as reported by the Bureau of Labor Statistics, the surprise is that inflation hasn't filtered into every aspect of our lives in a more meaningful way. While "Food at home" prices increased 3.5% over the last 12 months, "Energy" increased 21.5% and "Energy commodities" experienced a 36.2% price increase, according to the report. In addition, we know and can verify, that oil rose about 36% over the same period.
But taking into account that energy, unlike other commodities, is a component of every product and service the economy provides, we can deduce that general business pricing power is quite weak. Lately we've been hearing about upcoming price increases from some well known companies, while citing cost pressures as the catalyst. But I submit that the claim is nothing but a red herring and "inflation" is a far superior excuse that they hope the consumer will understand, as compared to the outright need to grow revenue.
Corporations cannot squeeze labor costs to infinity to extract productivity and cost savings and an alternative is to increase prices for those consumers that still buy their products and most likely can afford a little extra. Many will not stop buying frozen pizza because the price goes up 5% or 10%, the thinking goes. And that is a risk worth taking that can be countered quickly with special offers and coupons.
But despite the disconnect that can be established between real living costs and the core CPI number, there's a reason for its existence. As imperfect as it may be, the volatile nature of food and energy is the core argument and in truth monetary policy has very little impact, or none whatsoever, on controlling food and energy prices.
But within the report one item is especially important when the depreciation of the dollar is taken into account: Apparel. Why? Because it's hard to find any clothing manufactured in the U.S. and import prices must have gone through the roof, or so we think. Higher cotton prices, transportation costs and loftier wages in emerging markets should have been reflected on clothing prices, but a meager 1% increase for the category over the last 12 months is hardly a scary number.
Furthermore, commodities have taken a beating since May 2011, the drop hasn't abated yet and the lower prices still have to find their way into everyday's products.
Then there's the argument that the U.S. is exporting inflation, especially as far as food is concerned. The Food and Agriculture Organization of the United Nations provides data and analysis on the World Food Situation and we hear some alarmists predicting runaway prices, starvation and war. But that is not what the data shows, taking into consideration normal cyclical variations heavily influenced by weather conditions and well beyond the reach of monetary policy.
As a matter of fact, the chart shows that over the last 10 years cereal stocks have fluctuated within a predictable range. In addition, utilization has steadily increased and while production has fallen short at times, it also has outpaced consumption during some periods.
Lastly I must refer to the "Arab Spring," the end result of enraged populations affected by higher food prices, or so the news media tells us. Since Libya is still in focus, I use their currency – the Libyan dinar – for this exercise to put the issue in perspective (source: exchange-rates.org).
The Libyan dinar increased about 4.3% against the U.S. dollar between the beginning of January 2011 and the end of April 2011 – and the dollar decline started in May of 2010. During the same four month period, wheat futures declined around 15% in dollar terms and Libya enjoyed a 19% decrease for the same commodity.
Corn increased 24% to the U.S. consumer, while Libyans saw an increase of 16%. Rice was virtually unchanged in dollars, yet it dropped 6% in Libyan dinars. Live cattle increased close to 8% in dollars and was virtually unchanged in dinars.
And all of this took place while oil increased 21%, keeping Libya's oil revenue constant, if not higher. Since May 2011 just about every commodity has declined – oil included -- and in some cases the decrease is significant. The dollar has risen 3%, the Libyan dinar decreased close to 1% and the resulting change in commodity prices is shown in the table below.
| Commodities | Change U.S. Dollars | Change Libyan Dinars |
| Wheat | -16% | -14% |
| Corn | -3% | -1% |
| Rice | -1% | 0% |
| Cattle | 0% | 1% |
I know that the Libyan diet centers around wheat and lamb and that global lamb prices are high as reported by Voxy out of the New Zealand, although it's a cyclical phenomenon that will resolve itself in due time.
Lamb prices for April averaged $116 per head and were up 53 per cent on last year's $76 per head for the same month. Similarly mutton prices are up 63 per cent on 12 months ago and for April averaged $97 per head. These price increases follow from a period of low lamb prices for 3 years from 2005-06 to 2007-08 and depressed farm profitability that helped underwrite the swing to convert prime sheep and beef farmland to dairy production.
Are we certain that food prices were the root cause of the "Arab Spring?" And is inflation really uncontrollable, even with the Fed's money printing exercise? Not everything is as simple as it looks.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
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