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Russia''s Norilsk buys Anglo American''s 20 percent of Gold Fields
Prices rising despite low inflation rate;
key indicators questioned
By Greg Burns
Chicago Tribune
Sunday, March 28, 2004
http://www.chicagotribune.com
At the same time the federal government is reporting inflation
at rock-bottom levels, the cost of medical care, tuition and
housing have shot up. From gasoline to coffee to gold,
commodity prices are soaring to heights not seen in years.
"We're rewriting history," said Chicago Board of Trade veteran
Jacob Morowitz, who has watched soybean prices double
since last March. "You have a market in never-never land."
Yet the Fed, along with many mainstream economists, says
inflation is no worry at all. Last week, Chicago Fed President
Michael Moskow assured a hometown audience that inflation
would remain low again this year.
"Concerns are premature," he told a business group. "Inflation
rates are unlikely to increase significantly."
The difference between inflation as measured by the Fed and
the inflation everyday consumers experience is prompting a
re-evaluation of how the nation assesses this critical
phenomenon. Some claim the federal government for years
has systematically understated inflation, thus missing a
gradual but far-reaching shift in the global economy.
"We're looking for inflation in all the wrong places," said
technical analyst Louise Yamada, a managing director at
Smith Barney. It is "subtly shifting seats."
Inflation may well be tamed in the manufacturing sector,
where the cheap labor of China and other developing nations
has pushed down the costs of finished products like
computers, apparel, furniture, and electronics. But it is
pronounced in what Yamada describes as "the essentials
people need on a daily basis," such as food and fuel.
By failing to account for the rising cost of so-called
consumer essentials, the official inflation rate of 1.7
percent over the past 12 months has lost touch with the
reality of everyday spending habits, some say.
"Inflation's down except for what you actually buy," said
portfolio manager Chad Hudson of the Prudent Bear Fund.
"People are feeling it more than the government is
calculating. They have to be."
The debate over the accuracy of inflation measurements is
long-standing, though surging commodity and housing prices
have given it renewed urgency. Last week's Commerce
Department report confirming robust economic growth of 4.1
percent in the final quarter of 2003 included an upward
revision in a closely watched inflation barometer.
For decades, the Bureau of Labor Statistics has gotten an
earful about the accuracy of its benchmark Consumer Price
Index, arguably the government's most important single
indicator.
In the mid-1990s, a commission headed by prominent
economist Michael Boskin concluded that the index
exaggerated inflation by understating the rising quality of
goods and services, as well as the tendency of consumers
to buy less of a given item when its price rises.
Periodic tweaking of the index has followed, to the disgust
of those who believe the government has a vested interest in
making reported inflation as low as possible.
After all, they say, the index is used to calculate
cost-of-living adjustments to Social Security and other
federal outlays, as well as interest payments on some
government borrowings. "The Fed has what in the private
sector is called a conflict of interest," sniffed analyst
James Grant, of Grant's Interest Rate Observer.
The single biggest distortion in the government's main
inflation index involves housing, Grant said. Instead of
capturing the sizzling prices being paid in the latest
home sales, the CPI uses an estimate of how much those
homeowners could collect in rent.
With home ownership soaring, rental rates are depressed,
and the index is a full percentage point lower than it
should be, said David Lane, a researcher at Grant's.
"The estimates have gotten farther and farther afield of
where the truth lies," he said.
The same goes for the food and fuel components of the index
-- often excluded from statements of the overall inflation
rate due to their volatility.
As living standards rise in the developing world, demand for
food, fuel and other basics is bound to grow, said Smith
Barney's Yamada. The bull market in commodity prices
"may be trying to signal a new, gradual 21st Century global
inflationary trend."
The less-gradual price uptick in some sectors today could be
laying the foundation for more pronounced inflation in 2005,
according to Paul Kasriel, chief economist at Northern Trust
in Chicago. "Inflation has a nasty habit of flaring up," he
said.
Kasriel compares today's conditions to the mid-1960s, when
a long period of debilitating inflation originated, and he is
unswayed by the Fed's reassuring message. "When central
bankers tell me not to worry about inflation, that's when I
start to worry," Kasriel said.
In his remarks last week, the Fed's Moskow dismissed some
of the inflationary pressures that Kasriel, Yamada and others
view as troubling. Raw materials account for only a small part
of final goods and services, Moskow pointed out, and many
producers are taking smaller profit margins rather than raise
prices.
Despite robust economic growth, unemployment remains
elevated and plenty of industrial capacity is going unused.
"Slack resources could persist for some time," Moskow said.
"With inflation low, the Fed can be patient."
Translation: Don't expect the central bank to raise interest
rates any time soon -- maybe not even this year, some economists
predict.
To a degree, the expectations can be self-fulfilling, noted
Sung Won Sohn, Wells Fargo's chief economist. Higher gasoline
prices, for instance, have a broader economic effect only to the
degree that they encourage an upward spiral of wages and prices.
So far, he said, "It's not spreading to the rest of the economy.
The inflation expectation is low."
Even Morowitz, from his perch in the soybean pit at the Board
of Trade, has his doubts. The rise in commodity prices is more
of an anomaly than a systemic problem, he said. "We just have
short crops. It's as simple as that."
Like always in the fast-moving commodity markets, though, not
everyone is willing to make the same bet.
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