Soaring Import Prices Paints a Troubling Picture

Friday's update on import prices once again paints a troubling picture on pricing pressures.

The U.S. Labor Department reported that import prices jumped 2.8% last month. That's the highest since last December's unnerving 3.2% spike. More troubling is the fact that the 2.8% rise in March is in the upper range for monthly changes going back to the 1980s. Adding insult to injury, import prices soared 14.8% measured over the 12 months through last month, as our chart below shows. That's the highest 12-month rate in the Labor Department's archives, which goes back to 1982 as per the web site.

The "good news," if we can call it that, is that much of the rise in import prices was due to higher energy costs. And energy prices can't rise forever - we hope. In any case, the 14.8% surge in import prices over the past year falls to 5.4% after stripping out energy. But the lesser rise in non-petroleum import prices is hollow comfort once you recognize that the 5.4% annual pace is the highest since the 1980s. The basic trend, in short, is not in doubt, no matter how you slice the import-price pie.

How troubling is a 5.4% rise in non-petroleum imports? In search of an answer, consider that inflation generally in the U.S. is climbing by 4.0%, based on the annual rise in consumer prices through February. And the nominal (pre-inflation adjusted) annualized pace of economic expansion in 2007's fourth quarter was 3.0%. In other words:

Non-petroleum import prices are advancing at a roughly 33% faster rate than general inflation.

Non-petroleum import prices are rising 80% faster than the nominal growth of GDP.

And if we add energy back to the mix, import prices are, well, let's just say they're skyrocketing.

It should be obvious to everyone that the current scenario can't last. Something, as they say, has to give. Among the possible scenarios are:

The Federal Reserve will say enough's enough and pull a Volcker and hike rates. Of course, at this point in the cycle that decision would exacerbate the already weakened economy, although it probably would take the edge off import prices by more than a little.

The economy will weaken of its own accord, doing the Fed's dirty work without the political blowback that would arise if the central bank took the lead. In that case, tempering import prices seems inevitable if energy costs merely stay flat, although a drop of oil prices to, say, $80 a barrel would have a huge soothing effect on import price calculations in the near term.

Given that this is a presidential election year, the odds for the first one look dim. As for the medium and longer terms, there's reason to wonder if a new era of global inflation has begun, as the new IMF outlook for the world economy suggests. No, a return of the 1970s isn't likely, short of a colossal failure of policy makers. We've learned a thing or two over the decades, and one of them is that central banks do, in fact, have a large influence over inflation rates. Of course, that assumes central bankers will act decisively, but that's another matter.

The central lesson of the 1970s was that the Fed stumbled in keeping inflation in check. Presumably, that mistake won't be repeated, at least not intentionally. Still, considering monetary policy over the past year or so, one wouldn't be out of line in expecting inflation of a somewhat higher level to prevail.

Yes, an interruption in the new era of inflation may be coming, depending on what happens in the global economy. It wouldn't take much on the marginal-demand front to deflate the oil bubble a bit from current levels, which would go a long way in pushing pricing benchmarks down.

The underlying forces that are pushing commodity prices higher are fundamentally driven, which is to say a combination of rising demand and supply that hasn't been able to keep up, at least so far. Some of the pricing pressure is related to central banking missteps. To the extent that monetary policy can be improved in the months and years ahead, inflationary pressures will fall, or at least stop rising. But the fundamental catalysts behind higher prices are immune to central banks, and there's reason to think that these fundamental forces will be harassing the global economy for some time.

Comments

[flow5]

As any monetarist knows, it is impossible to control properly the money supply through the manipultaion of interess rates.

The crux of the cause of our monetary mismanagement, esp. since 1965, is the assumption that the money supply can be managed through interest rates, specifically the federal funds rate (or the federal funds "bracket racket", or a series of temporary "pegs").
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We should have learned the falsity of that assumption in the Dec. 1941-Mar. 1951 period. That was what the Treas. - Fed. Res. Accord of Mar. 1951 was all about.

The effect of tying open market policy to a fed. funds bracket or rate is to supply additional (and excessive legal reserves ) to the banking system when loan demand increases. Since the member banks have no excess reserves of significance the banks have to acquire additional reserves to support the expansion of deposits resulting from their loan expansion.

If they use the federal funds market, which is typical, the rate is bid up and the Fed responds by putting through buy orders, reserves are increased and soon a multiple volume of money is created on the basis of any given increase in legal reserves.

The Fed's technical staff either never learned, or forgot, how Roosevelt got his "2 percent war". This was achieved by having the Fed stand ready to buy (or sell) all Treasury obligations at a price which would keep the interest rate on "T" bills below one percent, and long-term bonds around 2-2 1/2%, and all other obligations in between. This was achieved through totalitarian means, involving the control of total bank credit and the specific rationing of that credit. Plus there were controls on prices and wages that kept the reported rate of inflation down.

There are only 2 interest rates that the Fed can directly control; the discount rate charged to bank borrowers & the PCDF rate. The effect of Fed operationson all other interest rates is INDIRECT, and varies WIDELY over time, and in MAGNITUDE.

The money supply can never be controlled by any attempt to control the cost of credit. An "easy money policy" will bring lower short-term rates in the short run; but, if continued long enough, will bring about higher interest rates, both long & short-term. Higher interest rates consequently are not evidence of “tight money”; rather they are the consequence, over time, of an excessively easy (irresponsible) money policy – money expansion so great that monetary flows (MVt) substantially exceed the rate of expansion in real output.

The only tool at the disposal of the monetary authorites in a free capitalistic system through which the volume of money can be controlled is legal reserves (and now reserves are no longer binding). We are on a ship without a rudder or an anchor.

An even greater impediment to achieving the monetarist goal involves personnel acquiring a technical staff for Congress as well as the Fed which does not confuse the supply of money wi9th the supply of loan-funds; people who can make the proper distinctions between means-of-payment money and liquid assets; know the difference between money creating institutions and financial intermediaries; recognize aggregate monetary demand is measure by the flow of money – not nominal GDP; recognize that interest rates are the price of loan-funds, not the price of money; that the price of money is represented by the price level, that inflation is the most important factor determining interest rate3s operating as it does through both the demand for and the supply of loan funds, and above all else recognize that even a temporary pegging of a series of federal funds rates over time forces the Fed to abdicate its power to regulate properly the money supply.