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Prices for food in U.S. grocery stores jumped 6.6% last year - the biggest spike since 1980 - underscoring yet again that inflation is a much bigger problem than government officials, or most economists, say it will be.

Of all food categories, prices for cereal and baked goods hit U.S. consumers the hardest, zooming 11.7% in 2008 over 2007. Prices for meats, poultry, fish and eggs gained 5.1%. Fruits and vegetable rose 3.4%, while dairy products advanced 2.7%.

It was the second straight year U.S. consumers were forced to pay a lot more for their groceries. In 2007, food prices at supermarkets rose 5.6%. Prices rose only 1.4% in 2006.

Consumers had to pay the price last year because food makers battled the largest spike in commodities they’ve ever faced, walloped by duel increases in key food ingredients and fuel, which all marched to historic highs in July, a month in which crude oil peaked at an all-time record of more than $147 a barrel.

This major escalation in food prices calls to question contentions that inflation is not a problem, a stance that - on the surface - appears to be supported by government statistics that appear to be fairly benign.

Money Morning Investment Director Keith Fitz-Gerald said:

The notion that U.S. government inflation statistics are accurate has been the subject of intense debate for years. My own belief, based on nothing more than what I feel in my wallet, is that those statistics are more cooked than a Christmas goose. I hear the same thing from tens of thousands of investors that I talk to around the world each year.

The Lowdown on Inflation

For instance, inflation averaged 3.85% last year, according to InflationData.com, which offers investors statistics that are said to be more-specific versions of government figures. But just like stock prices, the inflation figures were whipsawed from one month to the next. The monthly U.S. inflation rate actually eclipsed the 5.0% mark in June, July and August, and was still above 4.9% in September. By December, however, the inflation rate for the month was a nearly imperceptible 0.09% - the lowest rate for any month in this decade.

The “official” consumer price index [CPI] - the measure of price changes that directly impact U.S. consumers - also seems to indicate that we’re right now in a fairly benign environment for prices.

On Friday, the Labor Department said that consumer prices dropped 0.7% in December, slightly smaller than the 0.9% drop economists expected, Yahoo! News and The Associated Press reported. For the year, consumer prices as measured by the consumer price index edged up by just 0.1%, down from the increase of 4.1% reported for all of 2007 and the smallest annual change since consumer prices actually fell by 0.7% in 1954.

The Labor Department said that the big yearly improvement occurred because of the sizable declines in energy prices that we’ve seen in recent months.

The so-called “core” CPI for December - which excludes volatile food and energy prices - was unchanged in December. For the year, the core CPI rose a moderate 1.8%, down from the modest 2.4% increase for all of 2007. Price pressures have eased as the recession intensified, the AP said.

Even back in July - the month in which crude oil prices reached their all-time peak - the overall CPI was only up a reported 2.1%.

The U.S. government actually has an incentive to understate inflation rates, since scores of payments - ranging from Social Security payments to retirees, to the interest payments on inflation-pegged Treasury bonds - are pegged to inflation calculations.

Money Morning’s Fitz-Gerald said:

The U.S. government is suffering from attention-to-deficits disorder. Scores of financial calculations are based on the inflation rate, and the additional increases could boost the deficit by trillions of dollars.

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The government contends that the decline in inflation is due to the economic slowdown. Further evidence of that slowdown came Friday in a separate report from the U.S. Federal Reserve that showed that production at the nation’s factories, mines and utilities plunged 2.0% percent in December, capping the worst year for manufacturers since 2001. Last month’s drop, double the amount analysts expected, came after a 1.3% in November, which was even sharper than initially reported.

For all of last year, industrial production declined 1.8%, a major reversal from the 1.7% increase reported last year. It marked the worst showing since a 3.4% decline in 2001, when the country last suffered through a recession.

The theory here is that a drop in industrial output means there’s an accompanying drop-off in demand for commodities used to make the products, meaning there’s no need for price increases.

But, as we’ll see, that’s not the case.

Food Prices Still Escalating

For December, gasoline prices fell by 17.2%, the biggest monthly decline on records that reach back 71 years. Overall energy prices also dropped by a record 8.3% as home heating oil and natural gas showed declines.

For 2008, energy prices fell 21.3%, with gas costs tumbling by 43.1%.

The story was different for food, however. While food costs were unchanged in December, they rose 5.8% for all of last year - including the 6.6% increase at the grocery store.

Some experts say these CPI figures drastically understate the real situation with regards to consumer prices. ShadowStats.com, for instance, has posted a chart on its Web site that shows an “alternate” CPI that peaked at better than 13% last year, and that ended 2008 at nearly 8% - far above the “official” government statistics.

The problems emanating from the big increase in food and commodities prices weren’t limited to the United States, either. In April, the leader of the United Nation’s World Food Programme warned that a “silent tsunami” of hunger was sweeping the globe because of soaring food prices, a situation that threatened the well-being of an estimated 20 million children in the world’s most poverty-stricken areas. At that time, food prices had risen 83% in the previous three years, and rice - a staple of daily diets throughout Asia - had actually doubled in price in the prior five weeks.

Here in the United States, however, the reported 6.6% jump in food prices - and the increase in the producer prices that necessitated the increase in the price of the products at retail - had widespread implications.

For instance, Pilgrim’s Pride Corp. (PGPDQ.PK), the No. 1 U.S. chicken producer, declared bankruptcy on Dec. 1, according to MarketWatch.com.

Analysts claim that relief is on the way - for producers and consumers alike. Commodity prices - particularly prices for corn, wheat and energy - have plummeted since peaking last summer. And inflation at the grocery store level has eased since prices reached their peak in September, the Labor Department says.

But real-world developments continue to contradict the predictions of research economists and the “official” government reports.

Price Hikes Play Out in the Marketplace

Just consider Kellogg Co. (NYSE:K), the No. 1 U.S. cereal maker, and the producer of the Frosted Flakes and Rice Krispies brand cereals, as well as the popular Pop-Tarts breakfast pastries. Kellogg was to increase prices on all three plans to lift prices in the “low-to-mid single digit” range this week to help offset the increase in commodity costs. It won’t increase prices for its All-Bran and Special K brands, however.

Kellogg said it was raising prices because it sets pricing behind increases or decreases in the value of the commodities it uses. A spokeswoman said a 2008 price hike didn’t help the company recover all its manufacturing costs.

And that may not be the end. UBS AG (NYSE:UBS) analyst David Palmer said in a research note that the price increases by Kellogg’s will likely be matched by rivaling companies - the ones that make branded products, as well as manufacturers that make so-called “private-brand” or “private label” cereals.

On Friday, Palmer upgraded Kellogg’s shares to a “Buy” from a “Hold,” noting the company’s price pricing actions and moderate input costs put the company in a good position to aggresively promote its products in 2009, The Wall Street Journal reported.

(Many analysts say that reasonably valued stocks can be sound buys during inflationary periods for this very reason - they can pass any increases in input costs along to consumers in the form of higher retail prices).

General Mills Inc. (NYSE:GIS), Kellogg’s top cereal rival, would not say whether it will follow Kellogg’s lead, telling MarketWatch that it doesn’t comment on pricing decisions it may or may not take.

Ralcorp Holdings Inc. (RAH), marketer of the Honey Bunches of Oats and Raisin Bran cereal brands, increased prices last year.

Grocery-store operators often try and push back on price increases, something that discount retailer Wal-Mart Stores Inc. (NYSE:WMT) is known for in the hardline goods world.

Supervalu Inc. (NYSE:SVU) and the A&P Supermarkets (The Great Atlantic & Pacific Tea Co. Inc.) (GAP) have said they plan to negotiate lower prices with food suppliers, while Weis Markets Inc. (NYSE:WMK) has instituted a price freeze through April 1 on 2,400 items it sells in 155 stores in Pennsylvania, Maryland, New Jersey, New York and West Virginia.

The mere fact that pricing is an issue with these supermarket chains underscores that price increases are a very real problem in the marketplace, meaning prices aren’t in the benign holding pattern many economists would have us believe.

Is the Financial Crisis Stoking Inflation?

Although the federal government says that the U.S. recession is reducing inflationary pressures, the opposite may actually be true - and the economic slowdown may actually stoke inflationary pressures, experts say. For one thing, even though stated interest rates are low, the fact is that there’s a credit crisis under way right now. That means banks aren’t lending. As a result, companies may be forced to look elsewhere for needed financing - financing that comes at a much higher cost.

And higher costs, as we’ve seen, are inflationary.

There’s also the massive bailout and stimulus packages the government is deploying to fight the financial crisis. To create the capital needed for these programs, the government is printing money. And that massive increase in the money supply can only be inflationary, says Money Morning Contributing Editor Martin Hutchinson, an expert on the global banking system. He believes inflation rates of 7% to 10% may well be in our future.

He said:

Once the bottom has been reached, the excess liquidity that has been created over the last few months through the various bailouts - such the Treasury Department’s $700 billion Troubled Assets Relief Program (TARP), which is fueling bank takeovers, and not expansionary lending, and the follow-on $800 billion credit-market stimulus unveiled late last month - will combine with the huge federal budget deficit to spur inflation.

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Source: As Food Costs Rise, Is Government Being Straight about Inflation?