Washington, DC, February 22, 2011 --  

Consumer price inflation is spreading around the world. It is just arriving on American shores.

With inflation rapidly spreading around the world from China and India to Britain and Brazil, American policymakers remain motionless with their heads firmly in the sand. Confronted with evidence of creeping global inflation last week, Federal Reserve Chairman Ben Bernanke shrugged off culpability and worry, blaming economic growth on foreign market conditions.¹ He then quietly continued his November plan to print $600 billion by buying Treasury bonds -- recently becoming the largest holder of Treasury bonds in the world at $1.1 trillion, surpassing China at about $900 billion.^2,3

For the Federal Reserve and its defenders, the case for inaction on inflation is simple -- right now, it isn't a big problem in the United States. In December and January, the consumer price index went up 0.4 percent each month.⁴ This would be an uncomfortably high 4.8 percent annually, if it continued for a year, but core inflation excluding energy and food prices went up at an annualized rate of only 1.8 percent over the same period. Given that America's unemployment rate remains at a stubbornly high 9.0 percent⁵, it should be no surprise that the Fed chooses to print money to stimulate job growth, rather than fight high inflation that hasn't quite arrived.

Financial markets seem to be backing up the Fed's rosy prediction. 10-year interest rate derivatives are selling at a rate similar to before the financial crisis -- effectively predicting normal inflation for the next decade.⁶ Yet there is something unsettling about America's financial officials and traders unanimously agreeing that everything is okay in the light of disturbing trends, considering that this is exactly what happened right before the housing market collapse led to a global financial crisis.

In many places around the world, inflation is not just a future worry -- it is a reality that is rapidly spreading. In Brazil, it is 10 percent ⁸, in India, 8.2 percent⁹, and in China 4.9 percent.¹⁰ And these are all countries that had little or no inflation just a few months ago. In Britain, one of America's closest trading partners, and a country with a similar economic structure, annual inflation hit 4 percent in January.¹⁰

It's easy to dismiss inflation in these countries as based on local conditions. (After all, Brazil is no stranger to bad economic policies that destroy the value of its currency.) But given that the rise of inflation in these countries has been preceded by a staggering rise in commodity prices around the world (even in the United States), the situation today is different. The huge rise in gold and oil prices in recent years has been widely reported, but given the emotional baggage associated with the former, and the historic volatility of the latter, these are not good measures of coming inflation. Better measures may be more boring commodities like cotton (up 196 percent since January 2009), tin (up 137 percent) and wheat (up 36 percent). ¹¹

Despite what Bernanke says, the broad rise in commodity prices is not just higher demand due to economic growth in the developing world. (Economic growth was higher with many prices lower before the economic crisis.) The simplest explanation is that currencies around the world, disproportionately influenced by the U.S. Dollar, have lost value through a huge expansion in the money supply. And as these commodities reach countries heavily dependent upon manufacturing inputs, inflation is the obvious result.

So why has the United States been largely immune -- so far? Because the American economy is based not on manufacturing but on consumer spending. And it takes time for higher prices to rise from several levels of manufacturers, to wholesalers and retailers before it reaches consumers. Secondly, so long as American unemployment is high and household budgets stretched, consumer product companies and retailers are reluctant to raise consumer prices for fear of a loss of business by price-sensitive consumers.

Consumer Reports reported last month that many companies are addressing this problem by shrinking the volume of what appears to be the same package. Its study found that a wide range of products were now selling for the same shelf price, but a unit price that is up to 20 percent more. This clever gimmick fools most consumers, and might fool surveyors of the Bureau of Labor Statistics who calculate the Consumer Price Index. But it means that the leading edge of the inflationary wave is already here -- let us just hope that it does not rise too high.

Related Web Columns:

Living Like There's No Tomorrow, November 9, 2010

While the Gettin's Good
The Coming Inflationary Monster, November 17, 2009

From America to Zimbabwe, March 24, 2009

Notes:

1. Marketwatch, Bernanke Defends U.S. Policies, February 18, 2011

2. U.S. Treasury Department, Major Foreign Holders of Treasury Securities, February 15, 2011

3. Federal Reserve, Consolidated Statement of Condition of All Federal Reserve Banks, February 16, 2011

4. Bureau of Labor Statistics, CPI News Release, February 22, 2011

5. Ibid., Employment Situation Summary, February 4, 2011 (Seasonally adjusted unemployment for January)

6. Bloomberg Businessweek, Bond Market Backs Bernanke Mild Inflation in Swap Forwards, February 22, 2011

7. Wall Street Journal, Brazil Inflation Spurs Plan to Cut Spending, February 10, 2011

8. Ibid., India Releases New Consumer Price Index, February 18, 2011

9. Bloomberg Businessweek, China Raises Bank Reserve Ratios to Counter Inflation, February 18, 2011

10. New York Times, Inflation Hits 4 Percent, Double the Target, in Britain, February 15, 2011

11. Index Mundi, Commodity Price Indices, February 2011

Cotton: Jan 2009 57.70, Jan 2011 170.93 (up 196%) Tin: Jan 2009 11563, Jan 2011 Jan 2011 27439 (up 137%) Wheat: Jan 2009 239.36, Jan 2011 326.54 (up 36%)

12. Consumer Reports, CR Finds More Products Are Getting Smaller, January 4, 2011