Don't let inflation scare you

May 10, 2011

Gas prices are topping $4/gallon. Oil is over $100 a barrel. Gold and silver are at record highs. Food is more expensive. Does all this mean inflation is about to pounce on us? On this week's Money Matters, KPLU financial commentator Greg Heberlein says things may look discouraging, but there's no need to worry about runaway inflation.

What causes inflation? Too much money in circulation is the prime cause. During a recession, the Federal Reserve Board authorizes more cash to help businesses and individuals stay afloat. Some believe that surging commodity prices – prices for sugar, coffee, oil, even precious metals – fan the flames of inflation. But recent evidence suggests otherwise. 

The government pays closer attention to what is called core inflation, that is, inflation minus food and energy. Why? Because food and energy prices can soar and then sink in relatively short periods of time.  For example, oil was $60 a barrel five years ago, vaulted to $150, tumbled to $75, and is now possibly headed for $150 again.

A study of the past 25 jumps in commodity prices showed no significant inflation thereafter. Many believe the prime cause of inflation are wage increases.  Higher wages mean more spending, which means greater pressure on companies to keep the shelves full. Forced to produce more, companies raise prices.

Today’s picture:  In the past year ending a month ago, core inflation was 1.7 percent; total inflation was 2.7 percent. But average hourly wages fell 1 percent. With high unemployment, companies may be years away from significant pay raises. High inflation, which lags wage increases, if at all, almost certainly is well down the road.

Additionally, gross domestic product slumped in the latest quarter, suggesting the economy may be a long way from more jobs and higher prices.

The bottom line:  investors can rest easy regarding inflation. Low inflation and stagnant wages are good for stocks because companies can run their businesses more cheaply and expand profitability.  Inflation over the past 30 years has averaged 3.2 percent.  But even inflation of 5-7 percent has been considered a prime area for stock-price increases.