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Costs of oil, raw materials renewing fears of inflation
Knight Ridder News
April 10, 2005
SHADY SIDE, Md. - Soaring fuel costs, rising interest rates and creeping retail prices are hitting American pocketbooks in a combination unseen since the early '80s.
Inflation isn't surging anywhere near the 13.5 percent peak of 1980, but it's rising worrisomely as the economy suffers many strains, with a common root in global competition.
Oil prices grab the headlines, but prices for raw materials such as steel and even meat are rising too. Growing global demand is to blame. China, India and Brazil - emerging economies expanding fast - are competing with U.S. business for raw materials, driving up their prices.
Oysterman Don Sheckells feels the inflationary pinch of high fuel prices, which are driving many Maryland watermen to other jobs. He's one of the few still in Shady Side, working the Chesapeake Bay as he has since 1972. Disease has ravaged the oysters and cut their harvests, and the jump in marine fuel costs hit Sheckells hard.
"It used to be 80 or 90 cents a gallon'' less than 10 years ago - adjusted for inflation, 85 cents in 1997 would be a bit over $1 today - "but now it's double that,'' said Sheckells, bracing for $2 or more per gallon at his next fill-up. "It's going to hurt.''
When prices of goods and services rise, that's inflation.
Oil prices are now inflation's biggest driver: They reached $57 a barrel earlier this month before tapering off to around $54 last week.
Higher oil prices raise operating costs and eat into the profits of fuel-dependent businesses such as airlines, cruise ships and package-delivery firms, not to mention anyone who drives. The costs of other raw materials are soaring too.
Fastest pace in 20 years
This month, prices of core intermediate goods - semifinished goods, such as the nylon used to make a tent - are rising at an annual pace above 8 percent, the Labor Department reported. That's the fastest in 20 years. Prices on finished goods rose at a much slower pace: 2.8 percent, still the fastest since 1992.
To quell inflation, the Federal Reserve is raising interest rates. Higher interest rates tend to reduce purchases of homes, cars and other big-ticket items. That eventually takes the steam out of inflation - and sometimes out of the economy.
If the Fed slows things too much, that can tip the economy into recession, as it has several times in the past 50 years. Sometimes that's the only way to stop inflation.
When commodity prices began rising last year, many businesses ate the costs and tried to offset them by working more efficiently or cutting back elsewhere. Now they're starting to pass them on to clients in the form of higher prices. That means prices are rising throughout the manufacturing chain, and the results eventually show up on store shelves.
"This suggests some further pass-through into higher consumer prices will occur in the months ahead,'' warns investment bank Goldman Sachs in New York.
Miami-based Carnival Corp., the giant cruise-ship line, anticipates a 23 percent increase in fuel costs this year.
Fuel surcharge imposed
United Parcel Service operates more than 500 planes and 88,000 delivery vehicles. It tries to control costs by purchasing fuel in bulk. Last year those costs exceeded $1.4 billion. With oil prices spiraling, UPS imposed a fuel surcharge March 7 to pass along some of the higher cost to consumers.
Higher oil prices hit manufacturing, too. PPG Industries of Pittsburgh makes brand-name retail paints such as Olympic, Lucite and Pittsburgh. On March 15 it announced price increases to defray "the rapid escalation of raw-material costs.''
Petrochemicals are used to make paint. When oil prices go up, paint gets more expensive. PPG spokesman Jeff Worden said that in the first three months of this year, the company's raw-material costs rose by $50 million.
The Polymer Group of North Charleston, S.C., makes textiles that are used in doctors' scrubs and disposable diapers for consumer-product giants such as Johnson & Johnson and Procter & Gamble. Its products contain polyester and polypropylene, both of which come from petroleum.
"We haven't passed on 100 percent'' of the cost increases, said Dennis Norman, the company's vice president of strategic planning. "We're doing everything we can to mitigate the cost increases to customers.''
Higher steel prices are making Whirlpool washing machines and Caterpillar tractors more costly. Higher global meat prices forced Bruce Rohde, the chairman of Con-Agra Foods Inc. in Omaha, Neb., to announce aggressive price increases for lunch meats. Con-Agra owns brands such as Armour hot dogs, Butterball turkeys and Hebrew National lunch meats.
Fed boosts interest rates
To clamp a lid on this incipient inflation, the Fed has increased short-term interest rates seven times since last June. At its most recent move, on March 22, it noted that "pressures on inflation have picked up in recent months'' and signaled that more aggressive rate increases may be necessary.
A day later, the Labor Department reported that the consumer price index had shot up by an unexpectedly robust 0.4 percent in February.
The Fed is trying to ease off the gas instead of stepping on the brakes, but getting the balance right is tricky. If it raises interest rates too far, that could threaten the hot housing market.
Home prices have risen more than 40 percent over the past four years in many metropolitan areas. Many economists think they're going up largely on expectations of even higher prices rather than economic fundamentals, making home prices a speculative financial bubble that could burst.
Mortgage interest rates tend to rise with Fed rate increases. If they go high enough, buyers may dwindle and home prices could fall. That could lead to defaults on mortgages and bankruptcies.
The benchmark 30-year fixed-rate mortgage climbed to 6.01 percent this week, compared with 5.40 in the same week of March 2004. Today's rates remain historically low, but some analysts think there's a psychological barrier at 7 percent, since the 30-year rate has been under that since March 2002, and under 8 percent since August 2000. Exceed those numbers and buyers may disappear.
Waitress Sandra Howes has had her home near Annapolis on the market since December. She greets rising mortgage rates with a brave face.
"Maybe they'll help sell my house more quickly,'' she reasoned between customers at the Double T, an old-fashioned diner. She hopes someone will snap it up soon to stay ahead of rising borrowing costs.
So far, consumers appear only a little worried about rising prices and interest rates. The Consumer Confidence Index dipped only slightly for March. It's published monthly by The Conference Board, a private business-research center.
"We haven't seen much of a drawback on spending. It would really depend on how high and how long; I think duration is important here,'' said Lynn Franco, a Conference Board economist. "So far, we've seen consumers at least weathering the hikes well.''
The test is how far rates have to rise. Fed Chairman Alan Greenspan, who's balanced these risks since 1987, knows the danger. As economist Ed Yardeni noted this week: "The Fed chairman retires on February 1, 2006. He certainly doesn't want to burst the housing bubble now and push the economy into a consumer-led recession.''
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