Even with today’s larger than expected .7% decline in December producer prices, the index still posted a 4.1% gain on the year, the steepest rise since the 5.7% jump in 1990. In fact, even during the 1980’s there were only three years in which the gain in producer prices exceeded the rise in 2004. Yet despite this year’s substantial increase, Washington and Wall Street not only continue to embrace the fantasy that there is no inflation, but despite the proven lag between higher wholesale prices and rising consumer prices, see no significant threat of higher future inflation either. Before the corks start popping, a quick look at the numbers reveals little to celebrate.
Clearly, this December’s .7 decline in the PPI was all about energy, which saw a 4% monthly decline. This is a sword which will cut both ways as crude oil prices have already increased by over 10% in the first two weeks of January. As a result, the index is likely to ring in the New Year with a bang. The core PPI rose by .1% during December, and gained 2.2% on the year, the most since 1998. Also, data released yesterday reveled a .5% increase in non-petroleum import prices, bringing the annual rise to 3.8%, the largest gain in 10 years. Including energy, import prices rose 6.9% for the year. Given continued weakness in the dollar, look for import price gains to accelerate in 2005.
The 5.7% rise in producer prices in 1990 mainly resulted from surging oil prices in the aftermath of Iraq’s invasion of Kuwait and the run-up to the First Gulf War. These sharp increases were quickly reversed after America’s lightening victory in Dessert Storm in 1991. With a Vietnam-style quagmire now developing in Iraq, threatening even greater regional destabilization, and with energy demand continuing to grow in Asia, Bush Jr. will have no such luck in 2005.
Further, sharp rises in producer prices during 1990 occurred in a year in which the Fed funds rate ended at 7%, down form a high of 9.75% in 1989. Given today’s ridiculously low rate of 2.25%, imagine how far behind the inflation curve current Fed policy is, and how much higher future interest rates will have to rise to contain it. In fact, the inflation Genie is now so far out of its bottle that even Major Nelson couldn’t sweet talk her back in.
Also consider the differences between the US economy in 1990 and the one that exists today. Fifteen years ago the U.S. had a healthy supply of domestic savings, and most of its public and private debt was locked into comparatively long-term instruments. In 1990 we were not in the process of unwinding a stock market bubble, or blowing an even bigger one in the housing market. We were not then, as we are now, dependant on the unlimited generosity of foreign lenders. In other words, a variety of factors that helped contain interest rates in 1990 are absent today. How high will interest rates and inflation go this time around? In the words of Ralph Cramden.. “To the moon Alice, to the moon!???