Where's the beef?

Bulls, bears and the volatile price of gasoline aside, evidence to support the Fed's fears about inflation is hard to find.


Merrill Goozner
October 20, 1999 3:00PM (UTC)

Tuesday night, after the government had released its latest inflation report, I tooled over to a local gas station. Yep, Uncle Sam was right: Gas prices are up -- a good 25 cents a gallon since last spring.

But let's take the long view, here. This puts the price of gas back where it was during the Gulf War. Or, if you want to take the really long view, back where it was in 1967, before the Vietnam War sent prices surging.

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And that's exactly what the folks over at the Federal Reserve Board should be thinking about when they contemplate the potential evils of inflation in this economy. If they do, they will no doubt conclude that inflation is still well within a tolerable range.

This week's inflation report showed prices rising at a 2.6 percent annual clip, up nearly a full percentage point from a year ago. But what was happening a year ago?

Many of the East Asian countries had just watched their currencies collapse in global financial markets, sending their local economies over a cliff.

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The result was a sharp plunge in the price of oil, copper, imported parts and other industrial commodities, since what were once called the "Tiger economies" suddenly had to severely curtail their demand.

U.S. business had a field day scarfing up these critical resource inputs at unrealistically low levels. That, in turn, provided low prices for consumers around the world, and higher profits for business -- the best of all possible worlds, unless, of course, you happened to be an Indonesian laborer in a shoe factory.

Which reminds us of the other big benefit for consumers in the rich world from last year's already forgotten global financial crisis. When currencies plunged, so did the price of local labor, as measured by the global market. To the extent that consumers in the developing world purchased foreign-made goods, they suddenly became poorer in real as well as in relative terms.

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But the suffering of local peasants turned day laborers in the global economy has been good news for Circuit City shoppers here, because the prices of VCRs, television sets, stereos and cellular phones -- many of which are assembled in China, Malaysia, Indonesia or Mexico -- have gone down.

More than one economist has likened the series of currency collapses that occurred among some of our larger trading partners to a massive tax cut for U.S. consumers.

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But now East Asia is on the mend, and these one-time effects from the crisis of '98 are gone. So does a return to slightly higher annual price increases mean the dreaded beast of inflation is back?

For Fed officials and aging Baby Boomers who remember the 1970s as more than the age of disco, inflation raging out of control is truly something to be feared, of course.

Fortunately, there's very little evidence from the latest inflation report that rising prices are about to become a serious problem for this economy. "Inflation is not coming back in any significant way," flatly states Stephen Roach, chief economist at Morgan Stanley & Co.

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Indeed, if you remove the volatile energy and food prices, which are now returning to pre-crisis levels, the overall inflation rate over the past 12 months has been just 1.9 percent.

Even the much-dreaded cost of medical care, which has been the most consistently inflationary item in most household budgets for a while now, rose at just a 3.4 percent clip over the past year. While that is higher than most other items in the index, it is still far below the double digit health care increases we experienced in the late 1980s.

Major contributors to last month's jump in prices were the rising costs of transportation (at 0.6 percent) and apparel (at 1.2 percent). But the long view is again in order here.

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Over the last decade, the cost of transportation, which includes oil, has gone up just 29 percent, an annual inflation rate comfortably within the 2-3 percent range.

Clothing prices have risen less than 10 percent in the decade, and if one uses 1991 rather than 1989 as the comparison point, apparel costs have not risen a dime.

Now let's turn to the high-growth areas of the economy. Here it is the same new story. The cost of communication fell another 0.3 percent last month, continuing the decade-long trend. Leading the way was a 2.4 percent drop in the price of computers and peripheral equipment. Notice what's been happening to long distance telephone rates lately, despite the massive merger recently announced between MCI and Sprint?

The Bureau of Labor Statistics, which compiles the inflation data, confirms that telephone services fell 0.2 percent last month.

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Economists are having a hard time explaining this benign inflation picture despite eight years of economic growth and near full employment. Traditional economic theory suggests that full employment inevitably leads to higher wages as employers vie for the limited pool of workers. This. in turn, leads them to raise prices to recoup costs, which eventually forces the Fed to raise rates. Only then does the economy cool and slow inflation. It's the economics profession's version of the domino theory.

Yet "the inflation picture is surprisingly good, particularly in the area of service prices," said Pierre Ellis, a senior economist at Primark Decision Economics Inc. "It was assumed that this would be the first place where tight labor markets would drive prices higher."

Indeed, despite the tame inflation picture, the majority of the economics profession is still convinced the Fed will raise interest rates when it meets on Nov. 16. The bond market, where investors bid down prices (which move inversely to rates) at the hint of inflation, continues to signal a major market move into bear territory.

Bond traders have already priced in another quarter point increase and are now signaling they expect the Fed to eventually move rates up toward 6 percent (the target rate for the rate the Fed sets for banks that borrow from each other is now at 5.25 percent).

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If the Fed does push rates higher, it will be a clear signal that Greenspan and company do not buy into the countervailing argument propounded by New Era economists. The New Era argument says, in short, that the higher productivity allowed by new technologies actually lowers prices, which makes the traditional domino theory as relevant to modern day economics as the geopolitical domino theory was to Vietnam.

"If you look at costs for sales and distribution over the internet compared to the cost of sales in a bricks and mortar environment, it's one-third the cost," said Brian Wesbury, a prominent New Era economist at Chicago-based Griffin, Kubik, Stephens & Thompson Inc., an investment advisory firm. "And we're only at the beginning of that process."

The test for New Era economists will come as this economic expansion continues to soar. (Next February, it becomes the longest in U.S. history, including those in wartime). If rising productivity allows the economy to maintain full employment and rising wages without generating inflation, then the computer and all its attendant technologies will have truly ushered in a new era.

But if the Fed raises rates and chokes off interest-sensitive sectors like home-buying on the fear of inflation (as opposed to its real presence), then it won't have been a fair test.

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Merrill Goozner

Merrill Goozner is chief economics correspondent in the Chicago Tribune's Washington bureau.

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Alan Greenspan Inflation U.s. Economy

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