Today, the government reported that May producer prices rose by a higher
than “expected”.8%,
the biggest increase in more than a year. Cumulatively the gain over the
past 12 months has been 5%, the most in 14 years. Year to date producer prices
are already up by 2.7%, annualizing to a rate of 6.5%, with May’s.8% rise
annualizing
to a rate of 10%. Yet the Fed and Wall Street continue insisting that inflation
is well contained because the “core” PPI only rose by.3%

As there is generally a lag between producer and consumer prices, such pronounced
and persistent increases in producer prices will ultimately exert substantial
upward pressure on consumer prices in the coming months. This relationship
is true for several reasons. First, producers do not want to react to what
might be temporary price increases that may ultimately be reversed. Second,
producers do not want to risk alienating customers or losing market share.
Third, constantly changing prices are themselves costly and bad for business.
Fourth, some producers hedge, which keeps their costs down and exerts competitive
pressures on those that do not. However, once it is clear that prices increases
are permanent and likely to continue, and once hedges have expired, not only
will producers pass on current price increases, they will try to recoup prior
price increases which had previously been absorbed.

Despite this, the perception that U.S. inflation is well contained continues.
Yesterday, CNBC reported that the Bank of England had recently raised interest
rates to fight inflation because “they have a bigger inflation problem
over there than we have here.” Oh really? Year-on-year British consumer
prices are up 1.5% compared to a 3.1% increase in the U.S. Even the year-over-year
rise in U.S. “core” CPI is 1.7%, higher than U.K. inflation including
food and energy. It’s not that the U.K. has a bigger inflation problem
that the U.S., it’s just that the Bank of England has acknowledged
the problem and is taking necessary action to combat it.

As further proof that denial is not just a river in Egypt, the current consensus
forecast among the “experts??? is that 2004 U.S. CPI will rise by
2.7%. However, during the first five months of 2004, consumer prices are
already up by 2.1%, which annualizes to over 5%! For the consensus forecast
to hold
up, monthly CPI gains will have to average less than.1% for the remainder
of the year, more than 75% below the pace achieved during the first five
months. Yeah, right.