Inflation: Don't Worry Yet

The Lehmann Letter (SM)

Rapidly rising commodity prices have generated concern that economic recovery will bring escalating inflation.

Last week the Bureau of Labor Statistics announced that consumer prices rose at a 6% annual rate in December, although they increased by only 1.2% when food and energy are excluded:

http://stats.bls.gov/news.release/pdf/cpi.pdf

That highlights commodities' role. Primary products such as raw materials, foodstuffs and fuels have accounted for most of the gains.

The developing worlds' rapid economic recovery is responsible for the surge in primary-product prices. As the Chinese economy expands it gobbles up minerals (iron ore, bauxite), fuels (oil, coal) and food (wheat, corn). Consequently world primary-product prices have risen swiftly despite slower recovery in the developed economies of Europe and the United States.

That raises the question: Will these price increases kindle inflation here at home? After all, rapidly rising food, energy and raw-material prices accompanied swiftly rising inflation in the 1970s.

But the 1970s do not serve as a precedent. Rapidly rising demand, stoked by runaway private borrowing, bid prices upward in that decade. Today's economy is beset by weak, not strong, demand. It's hard to see how prices can shoot upward while demand remains stagnant. The depressed residential construction and automobile industries, for instance, provide weak markets for building materials, steel, glass and a host of other inputs. That will restrain those prices.

Also keep in mind that consumer prices include services, such as rent, as well as commodities. Prices of these services respond to changes in demand here at home, and that demand remains flat.

It's difficult to contemplate severe domestic inflation without stronger growth in domestic demand.

© 2011 Michael B. Lehmann