Perhaps the Fed should include food and energy prices in inflation?

Since the late 90’s, oil prices have rocketed over 1000%. Riots are occurring around the world because of shortages of such staples as rice and wheat. Even Costco and Sam’s Club are rationing rice consumption here in the U.S.!

If the cost of such fundamental necessities as food and energy are going up so much, why do economists and the Fed believe that inflation is stable and at acceptable levels?

Quite simply, they don’t include food and energy prices in their calculation of “core” inflation (that sounds like the same game as reporting “operating” and “pro forma” earnings that companies were criticized for 8 years ago).

You see, food and energy prices are very volatile, and most of the time their movements make inflation look uncomfortably unstable.

But, what happens if food and energy prices are rising because of real, no kidding inflation? The Fed and most economists have no way to adjust for this. Don’t be surprised, though, if they finally get around to adjusting long after we’ve all been beaten down by “non-core” inflation.

I’m no economist, but I think I understand what makes for a stable currency.

The central banks of the world run the printing presses, and they can print dollars (euros, yen, bahts, pesos, reals, etc.) at almost no cost. This doesn’t create value, mind you. What it creates, when dollars are printed faster than underlying growth, is inflation.

In my humble opinion, that’s what we’ve been experiencing at a faster and faster pace over the last 10 years.

The central banks of the world reacted to the Asian contagion by printing more money. Then, they reacted to the fall of Long Term Capital Management with more money printing. Y2k (remember that “crisis”?), more money printing. Telecom, technology and dot-bomb crash, print more money. Housing crash and credit crisis…you get the idea.

I don’t think energy and food prices are running up temporarily, I think this is the slow bubbling up of inflation created by the world’s central banks over the last 10 years. You can see it bubbling up through the economy from energy to metals to transportation to food.

The easiest place to see this is in the price of gold, which bottomed at around $250 and ounce in the late 90’s and is now 360% higher (after peaking 400% higher). Or, look at shipping rates. Or, look at base metals prices. Or, look at iron ore and coke used in making steel. Or, look at wheat, rice, etc. Do you suppose chicken, beef and pork could be next?

Think what you’d like about government bailouts and stable currency, I believe we’re getting more and more inflation.

Could this all be the result of higher demand, especially from China and India? In the short term, yes. In the long term, no. That’s where the rubber meets the road from a forecasting standpoint. If demand is the cause, then profits and innovation will eventually drag prices back down, as most economists are betting will happen. But, if part or all of the price rise is due to inflation, then expect prices in general to stay higher.

How long before central banks and economists start adjusting inflation for food and energy costs? Don’t hold your breath.

I’m expecting prices to go up long term, even if they take a breather as the U.S. and global economies slow down. In time, though, we’ll all have to recognize that prices are probably permanently higher, and the it’s the result of inflation caused by our central banks. When people start to more generally recognize this, higher interest rates will be another thing to deal with.

Investing in such an environment can be difficult, but also very profitable. I’m glad I prepared myself and my clients for just such a possibility years ago.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Who has oil and natural gas?

A fascinating editorial in Forbes magazine recently (April 16, 2007, Steve Forbes) pointed out an amazing fact: 95% of oil and natural gas reserves are controlled by government owned oil companies versus only 5% for international oil companies.

I find this interesting for a couple of reasons.

First, I think it points out how ridiculous it is to blame big oil companies for oil and gas prices. If international oil companies like ExxonMobil, BP and Chevron only control 5% of oil and gas reserves, it’s simply not possible for them to control energy prices. All they can really control is their costs of production, and they should be judged by that criteria.

Second, I think it brings up an interesting question about where oil and gas prices will go over the long term.

If you believe that government owned oil companies will do an efficient job of finding, producing and bringing to market oil and natural gas, then such energy prices should be headed down.

If you believe the government controlled oil companies of Saudi Arabia, Iran, Qatar, the United Arab Emirates (UAE), Iraq, Russia, Kuwait, Venezuela, Nigeria, Libya, Algeria, Malaysia, Mexico, China, Brazil, and India will do an inefficient job of keeping supplies up with demand, then you should expect oil and natural gas prices to head up over time.

Please keep in mind that not every country has an equal vote. Saudi Arabia and Iran have close to twice the reserves as #3, Qatar. And, Quatar, UAE, Iraq, Russia, Kuwait and Venezuela have about twice as much as #9, Nigeria. (ExxonMobil, #14, has only about 1/3 as much as Nigeria)

I’m over-simplifying things a bit, but in general, the performance of investments in oil and gas companies will hinge on the market price of the commodities they produce. If exploration and production can stay ahead of demand, prices will go down. If it can’t, then prices will go up. And, judging by the low price to earnings multiples of many oil and natural gas companies, I’d say the market is guessing the government oil companies will keep up. I’m not so sure.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.