Why Gasoline and Food Matter When Measuring Inflation

Is there or is there not an inflation problem in the U.S. economy? Anyone who buys gasoline knows inflation is rampant. Filling up the average sized gas tank costs about $50 these days. Just a few years ago you would have needed only about $30. Food prices are also way up. Even Starbucks (SBUX) is complaining that high dairy prices are pinching profit margins.

Yet Fed officials and most economists say inflation is not so bad because they prefer to focus on core inflation. In other words, they want to know how much prices are rising if we exclude gasoline and food. They believe gasoline and food prices are just too volatile to provide a meaningful measure of inflation, so they simply ignore them.

But investors are waking up to the fact that gasoline and food really matter. Consumers know these items are taking a bigger and bigger bite out of their paychecks. The effects are starting to show as consumer spending becomes strained. For example, Wal-Mart (WMT) has been complaining for some time about higher gasoline prices weakening their customers' purchasing power. It turns out some of those customers are making up for this by resorting to the 5-finger discount. Wal-Mart is getting fed up with the increased levels of shoplifting activity it is seeing, so it announced plans to be more aggressive about prosecuting violators.

In the meantime the housing market continues to implode and foreclosures keep rising. Even S&P and Moody's (MCO) have finally figured out that sub-prime mortgages are indeed risky. Housing prices are falling nationwide. Of course, the high-end of the market will probably fare well. But average prices are likely to fall enough to put some homeowners in a negative equity position.

As for jobs, so far so good. The economy is still creating jobs and the unemployment rate remains low. Nonetheless, incomes are not doing so hot. According to the Commerce Department, inflation-adjusted incomes actually fell in May. Of course, that's using overall inflation, which includes those volatile gasoline and food prices. Those of you who are lucky enough not to have to drive or eat, well it turns out you're doing pretty well!

Comments

[phdinsuntan...:]

finally someone says "the king is naked"

2007 Jul 12 06:15 AM

[cmorris01:]

Your premise is that rising prices define inflation. I must disagree. An increase in the price of a good or service resulting from a direct or indirect increase in the scarcity of that good or service is not inflation. Inflation is a monetary phenomenon, occuring when growth in money supply exceeds growth in production of goods and services. What is missing from most discussions regarding inflation these days is the use of inflation measurements that are capable of separating real scarcity-induced price increases from artificial price increases that result from excess money supply. The Fed seems to prefer the core Personal Consumption Expenditures (CPE) as such a measure; I can't say how good a job it does. As you point out, this "core" indicator excludes the most volatile portions of consumption. But that is a separate issue from scarcity. I'm no expert on such measures. Perhaps other readers could respond to this thread?

2007 Jul 12 10:02 AM

[mlp investor:]

I agree with your premise that Gasoline and Food price matters. I would go on to argue they have an disproportionately large impact on consumer behavior. As thees are very tangible measures of inflation that everyone understands and is reminded of every day.

As for the cmorris01's point of they are not really inflation as they are a scarcity induced price increase. While that may true. Lets call it commodity-inflation. Commodity-inflation has the same buying power erosion effect on the consumer. In an environment where wage increase cannot keep up with commodity-inflation, the erosion in the buying power is most definitely occurring. Especially among the bottom 50% of the population.

The numbers do not reflect the grim ground realities well.

2007 Jul 12 08:38 PM

[Oldtimer:]

Food and energy only matter to those who don't count anyway so why include it. Jaga has hit the nail on the head for those who cannot hedge their (nearly fixed) wages against commodity price increases (caused in part by excessive money supply). In an earlier world, labor would have gone on strike to increase their wages to compensate for what to them is a real increase in their living expenses - that reaction is no longer available as organized labor has been essentially crushed by the same people who are responsibe for the excessive money supply.

Who would have thought that by simply importing cheap labor, exporting skilled jobs, and printing money, a vast and permenant lower class could be created so quickly. Oh yes, buying both political parties also helped a lot!

2007 Jul 12 10:33 PM

[scadaman66:]

Excellent article that Larry Kudlow wouldn't approve of I am sure. The feds like to play the game of curve fitting inflation numbers so they don't have to pay out big increases every year to Social Security recipients, etc. If people would hear the truth about inflation, which is probably more like 8 - 10%, there would be widespread panic. I know of nothing except obsolete computers, digital cameras, and other electronic items that fall in price every year. Even if someone does not drive, he or she is feeling the effects of higher oil prices in their electric bill (wait until the price caps come off in a lot of states in a few years...hold on to your wallets folks!), dairy products, household products, and on and on and on. Couple higher inflation with little or no wage increases for many people and it is just a matter of time until we see another nasty recession. The only thing the average investor / saver can do is buy oil and commodity stocks and ride the wave. While other dimwits on TV are moaning about "big oil" you can laugh out loud and make money too.

2007 Jul 13 09:08 PM