Who’s Inflating Now?

The smugness must get annoying.

Before Ben Bernanke’s press conference Tuesday there were dozens of blog entries filled with hypothetical questions about Fed policy. Most of the questions had to do with inflation. Typically it challenged the notion of “core” inflation, and noted how oil and crop prices have recently increased, or asked why purchasing power has declined by 60% since 1980. (Here’s a hint: it has to do with math. 3% inflation compounded over 30 years will increase prices 145%.)

But most folks wanted to know what Bernanke is going to do about recent commodity price swings. The unspoken expectation is that higher interest rates might reign in price pressures.

But the best cure for higher prices is higher prices. We’re now seeing that with cotton. Six months ago the papers were a-twitter with concerns that soaring cotton prices could double the price of basic clothes like blue jeans. But a funny thing happened: farmers planted more acreage, consumers slowed their purchases, and inventories are now overstocked. Some observers are talking about a cotton glut, and prices have fallen (yes, fallen) by 20% in the last month.

One month doesn’t make a trend, but it certainly can be considered a correction. Fed policy didn’t make cotton prices rise, and it hasn’t made them fall. The Fed expects that the overall inflationary tendency is 1-2%. With falling housing prices, falling cotton prices, and stable labor costs, that seems reasonable.

The Fed is right to open itself up for questioning periodically. Let’s hope that the market’s myopia doesn’t annoy them into overreacting.

Douglas R. Tengdin, CFA
Chief Investment Officer
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