The Inflation Story

The producer price index (PPI) is up 8.8% year over year, partly due to higher energy and higher commodity prices. But consumer prices are up only 4% on all items and 2.2%, excluding energy and food. This means that producers have been eating about 5% in gross margins to keep prices low. Discount retailers have been holding the line on prices as well, reluctant to give ground to any competitor. But if the PPI continues at this level or higher, eventually manufacturers and retailers will have to cave, accelerating the growth of inflation even more.

Producer Price Index is up 8.8% this year (8-19-08)

Core Inflation and Consumer Price Index through August 2008

At the same time, union membership has been falling steadily for the past two decades and outsourcing of white-collar information worker jobs gives workers less room to negotiate higher wages and salaries.

Partially offsetting the rise in prices, the dollar has been rising against foreign currencies, mostly due to their weakness, rather than the strength of the US economy. This makes imports cheaper and helps hold the line on inflation.

The Dollar Exchange Rate vs the Yen and Euro

All told, at the end of four years a 4% inflation rate, where the overall consumer price index is today, results in a $100,000 salary being worth only $80,000.

The Fed will have to turn its attention to this issue sooner rather than later if it wants to avoid a repeat of the stagflations of the late '70s and early '80s.