Wednesday, January 11, 2012

Fed Claims Inflation is Subdued -- Oh Sure, As Long As You Do Not Have To Buy Food or Gasoline

The claim by the Fed in a report released Wednesday that "inflation is subdued" seem ludicrous based on a trip to the gas station or grocery store. The increased cost of gas and food is hurting consumers and reducing their capacity for discretionary purchases.

Gasoline is up by $0.242 cents a gallon versus the record setting start of year prices of 2011, and is almost certain to go over $4.00 per gallon in the spring when refineries switch over to summer formulations.

The cost of food-at-home (grocery store) prices rose by 4.25 to 4.75 % in 2011 according to the FDA and is projected to rise by another 3-4% next year. Anecdotally, based on the cost of bread, milk and other staples, my perception is that food costs increased by even more than 5%.

There are three factors that are putting inflationary pressure on the cost of gasoline and food:

1) the end of cheap oil
2) extreme weather reducing crop yields and killing livestock
3) increased demand from Asia

The end of cheap oil is due to the annual decline of 3 million barrels per day from existing fields and increased automobile ownership in Asia. Tom Whipple explains, "Despite all the hype concerning new oil finds and technological breakthroughs in oil production, these developments still are not contributing enough new oil to offset the annual increase of 1 million barrels per day of new demand. The bottom line among those following this issue is that global oil production likely will start to decline in the next one to five years as depletion gets ahead of very-costly-to-produce new sources of "oil."

The droughts and flooding around the world caused by extreme weather in 2011 reduced food stocks going into 2012. Further, based on all the weather weirdness already experienced this winter, including the snow drought in the lower 48 states and the drought in South America, extreme weather may lead to even greater food price increases. Additionally, the high cost of oil increases food costs through more expensive fertilizer and transportation costs in getting food to market.

The Fed may claim that inflation is subdued, but rising prices for gasoline and food will hurt consumers. However, the Fed needs to maintain the perception that inflation is subdued in order to keep interest rates low. Based on the low interest rates for U.S. Treasury bonds, the Fed seems to have convinced the financial markets that inflation is subdued, at least for now.

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