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Inflation Nation: A Guide to Your Pocketbook Blues

A.K Gupta Apr 12, 2008

Unless you live in a bubble, like George Bush, who expressed total surprise in February when a reporter told him gas was nearing $4 a gallon, you’ve been socked hard in the pocketbook by rising prices.

It’s most evident at the supermarket — bread prices are up 30 percent over the last three years, milk is up 17 percent in the last year and eggs have shot up 62 percent in the last two years — and at the gas pump — the national average for regular gasoline just notched a record $3.34 a gallon and it could peak at $4 this summer.

As dramatic as the consumer price increases are, the frenzy on commodity exchanges, where traders negotiate “futures”
prices, is even more pronounced. Since early 2007, the price of crude oil has doubled, as have some varieties of wheat;
soybeans are up 75 percent; corn is up 49 percent; and Thai rice, a major export that ended 2007 at about $360 a metric ton, hit a stratospheric $760 barely three months later.

The soaring prices are an insult to injury with the weakening economy, falling home prices and fast-rising unemployment. Many low-income Americans, especially retirees, are being forced to choose between food or heat or prescription drugs.

Understanding the nature and causes of inflation — when prices rise quickly and purchasing power diminishes — is difficult
to grasp because there is a gap between people’s daily experience of rising prices and the official story. Basic economics says when the economy hits a rough patch demand falls and thus so do prices, which is clearly not happening. And for years government officials have been declaring soothingly that inflation is “under control.”

The government reports that consumer inflation has been 2-3 percent for the last ten years and is at 4 percent now. Some economists, including ones with the Shadow Government Statistics website, claim the real inflation rate has been above 8 percent for the last decade and is close to 12 percent currently.

With stories of higher prices in the news combined with reports that a recession is already at hand, the situation looks like
the tumultuous 1970s, when “stagflation,” a shrinking economy combined with galloping inflation, haunted the land. This is no mere coincidence. Like the seventies, soaring oil prices are once again hurting economic growth and feeding inflation.

THE ‘DOT-CORN’ BUBBLE

The food we eat is literally oil. Oil is used for fertilizer, for pesticides and herbicides, to plant, harvest and mill grains, to manufacture food products, to transport them, to drive them home from the supermarket. With diesel above $4 a gallon, businesses are passing the costs through the commodity chain to consumers (and truckers).

The rise in egg prices has been extreme, and therein lays an interesting story. The average egg-laying hen will produce 276
eggs and eat 83 pounds of feed annually, three-quarters of which is corn.

Rising oil prices has benefited biofuels like corn-based ethanol. Last December, Bush signed a law mandating the use of at
least 36 billion gallons of biofuels by 2020. In the summer of 2006, when corn was $2 a bushel and oil $70 a barrel, ethanol producers averaged $1.06 in profits per gallon sold.

But then, corn prices doubled to $4 a bushel last year and just breached $6 this April. Midwestern farmers giddily joke
about a “dot-corn” bubble as they (and their suppliers) mint money, but for everyone else, including ethanol producers, it’s
been a disaster.

Ethanol distilled from corn uses more energy to produce than it provides, it’s a worse greenhouse gas emitter than crude
oil, and it’s driving up feed costs for cattle ranchers, hog farmers and egg producers, which is a big reason why eggs have
gone up nearly a dollar a dozen across the nation.

The effects go further still. Corn or corn syrup is used in three-quarters of all processed foods, from bread, chips and soda
to peanut butter, oatmeal and salad dressing. It’s even found in diapers and dry cell batteries, meaning all these products are experiencing upward price pressure.

Corn is also distorting agricultural production as farmers shifted to produce more corn and less soybeans and wheat. In 2007, 20 percent of the corn crop, some 2.5 billion bushels, was made into ethanol.

The price of wheat has skyrocketed, boosted by the weak dollar, falling supplies and speculation. There is also a global shortage of soybean oil, pushing up its price. Having overplanted corn last year, many American farmers are switching
back to these other crops, partly because oil-thirsty corn, even at $6 a bushel, is seeing its margins squeezed by soaring input costs.

THE OIL FACTOR

There is still the issue of why oil prices have quadrupled since 2002. There are three standard explanations — supply and
demand, speculation and the U.S. government’s monetary policy.

The White House and many pundits point to supply and demand because it’s presented as a natural economic law beyond
anyone’s control. In this view, China, India and the rest of the developing world’s growing appetite for oil (and grains and
meat) is driving up prices.

Yes, China and India’s oil consumption is rising, as is that of Middle East and African countries awash in the black gold.
But from 2002 to 2006, even as oil prices tripled, global oil production kept up with demand by increasing 7.6 million barrels a day to 84.6 MBD.

There are some supply constraints, but these mainly stem from U.S. foreign policy. The Bush administration has destabilized three major oil producers that have suffered declining production in recent years — Iran, Iraq and Venezuela.

BUILDING BLOCKS

The building blocks of the modern economy, commodities include everything from coal, oil, wood, gold and copper to cotton,
milk, corn, cattle and sugar. Manufacturers need commodities to produce finished goods while consumers usually encounter
commodities at the grocery store.

Commodities trading, such as livestock, dates back to ancient times, but the modern “futures” market was established in
Chicago in the 1840s. There, at the board of trade, commodities are standardized according to “quantity, quality, delivery
month and terms” (traders bargain over price and amount). Ideally, through the buying and selling of futures contracts,
farmers can determine what to plant based on futures prices while an industrial-scale baker can lock in prices for flour, butter and sugar months in advance.

MONEY FOR NOTHING, INFLATION FOR FREE

In 2000, after the stock market meltdown, the Fed lowered interest rates to historic lows, which increased the amount of money being borrowed and thus the amount of money in circulation. This is known as monetary inflation. What happens is the money supply increases at a faster rate than the production of goods and services. When many more dollars are competing for a slowly growing pile of goods and services, the inevitable result is rising prices.

An example of how this works is the link between rising oil prices and the Fed’s interest rate cuts. Since the Fed started slashing rates last September, the dollar has plunged against the Euro, oil has risen by nearly $30 a barrel (and gold by some $300 an ounce).

With more dollars in circulation than before against the Euro, a leading currency, the dollar falls in value. As the dollar drops, oil-producing countries demand more dollars per barrel.

Another inflationary factor is the federal budget deficit, which has doubled under Bush’s watch, and the trade deficit.
To balance these deficits, the United States needs an inflow of nearly $1 trillion a year. Dollars flow out because of excessive consumer and government spending, while investments flow in to buy corporate, consumer and government debt. The torrential outflow of dollars, however, weakens the value of the dollar.

The trade deficit is running at about $58 billion a month. Two-thirds of that is for the 12.5 million barrels of imported oil we
use every day. Rising oil prices have become a vicious feedback loop. As oil prices zoom up and dollars flow out, the dollar
drops in value, spurring the next round of oil price increases, a greater outflow of dollars and a further drop in value.

Americans are feeling the pain in the gas tank. Gas has increased by about $2 a gallon. That is an almost $300 billion a year tax on consumers and businesses. With diesel above $4 a gallon, anything delivered by truck, which is pretty much everything, costs more.

A WORLD OF SPECULATION

There is one other factor that’s rarely talked about, except in the financial press — speculation, which “amplifies” price moves. After the Internet bubble popped in 2000, many investment banks and hedge funds began speculating in commodities. Speculators, when they buy a futures contract, create demand, but they are not interested in the actual pork
bellies or coal. They just want to make a fast buck.

If inflation is rising significantly, commodities become an attractive investment because they will increase in price rapidly.
But the speculation pushes the price up further still, which draws in more speculators and creates another feedback loop.

In 2004, The New York Times detailed one speculative episode in the oil markets: “When low inventories and news of violent attacks on oil executives and facilities in Saudi Arabia drove oil futures up, speculators piled on, according to market analysts. Their buying forced crude prices up even higher, attracting yet more investors betting on a continued rise, and so on in a classic spiral.”

Even the head of Exxon, in a March 5 press conference, admitted speculation was a big factor. According to the financial
news website Marketwatch, CEO Rex Tillerson called the price increases “pretty crazy,” and paraphrased him as saying, “A weak dollar accounts for about a third of the recent record run in oil prices, another third on geopolitical uncertainty and the rest on market speculation.”

Wild swings are now the norm in the oil market, with a barrel often fluctuating by five dollars or more a day. The same phenomenon is affecting grain markets, where price swings in a few days are greater than used to happen in a year. The chart of wheat prices, for instance, looks more like an Internet stock than the activity of a food that was essential to early human civilization.

Now, with the falling stock market and growing specter of inflation, even more institutional brokerages, hedge funds and
private investors are reportedly speculating in commodities.

THE GREAT RICE PANIC

There is no one reason why any particular commodity is rising in price. As the world’s workshop, China creates demand-
driven inflation for various industrial commodities. It needs mountains of coal, huge swaths of forests and great veins of copper ore to feed its industry. In contrast, since the end of 2007, the price of some types of Thai rice, a major export, have more than doubled to $760 a ton, with speculation that it could hit $1,000 a ton. The reason for the initial rise is attributed to supply and demand — a pest outbreak in Vietnam, low global stocks, the biofuel boom, rising demand from growing affluence. But speculation is driving these price leaps, too.

Essentially, all parties involved in the rice trade are reacting to a speculative panic. Rice-exporting countries like India,
Thailand and Vietnam are limiting exports to ensure domestic markets are satisfied, constraining supplies for rice importers. Some farmers are hoarding rice because, as one observer told The Guardian (U.K.), “Who’s going to sell rice at $750 a ton when they think it’s going to hit $1,000?” And according to anecdotal reports, consumers in Asia are buying large supplies of rice now because of fears they will pay more down the road.

All this fear feeds on itself. Absent a global famine, normal demand or supply issues cannot explain why rice prices would have doubled in Asia in just a few months.

WHIP INFLATION HOW?

Putting the inflation genie back into the bottle is no simple task. One immediate solution is to better regulate commodities
markets and tax futures contracts, such as the “Tobin Tax” proposal to curb currency speculation. A small tax would not hinder actual buyers and sellers, but it would take a bite out of speculative interest.

For the United States, the answers are much more difficult. The Fed is using inflationary policies to devalue U.S.-denominated debt, which helps the government and corporations, but which harms consumers. Cutting the federal deficit is a nobrainer but unlikely: repealing the tax cuts for the wealthy and ending the Iraq War. The trade deficit must be cut, but even in the best-case scenario, it would take decades to build a new energy infrastructure free of imported oil.

Some suggest inducing a severe recession, as the Fed did in the early 1980s by jacking interest rates, but the pain would
be severe. A better solution is a real green energy and infrastructure program combined with single-payer national healthcare and expanded unemployment and welfare benefits. This could cushion the impact of the recession, while shifting the United States to a healthier economic base. But in this neoliberal world, that’s about as likely to happen as George Bush ever admitting he’s wrong.

Illustrations by Jennifer Lew. 

For more information see:

Bailing Out the Billionaires

Tough Times in Queens