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What
happens when prices rise? Can government control prices? How will price
increases affect me? These are questions many people are asking, with good
reason. As anyone who drives a car or truck, heats their home with oil or
gas, purchases food at the local supermarket will tell you, “I’m
paying more and getting less.”
Well,
for most Americans, the cost of living is indeed rising. Prices for basic human
needs such as food, clothing, heat and transportation have increased
dramatically over the last two years. The average price for regular gasoline
in the US is $3.12 per gallon, the highest level since July 2008 and 62
cents/gal higher than the peak price during the 1974 oil embargo. General
prices, as measured by CPI growth, are ticking up worldwide. Food
prices are exploding here and around the world. Although drought conditions
of 2010 contributed to the spike in grain prices, the major cause is government
intervention.
Government
has attempted to control prices using monetary policy, government subsidies
for selected industries and emergency executive order. The Fed tries to
control inflation (and more recently, unemployment) by easing or tightening
interest rates. The Fed has cut rates to near zero, after lowering rates
continually since 2007. The easy money policy is designed to stimulate
economic activity and “manage” inflation to acceptable (low)
levels. Congress has enacted a series of farm bills since 1965 to subsidize
US agribusiness. The current farm bill, the Food and Conservation and Energy
Act of 2008, provided $288 Billon in direct subsidies, including increased
allocations for biofuels (ethanol). Presidents
Roosevelt, Truman, Nixon and Carter all implemented direct price or
price-wage controls to disastrous affect (I remember waiting in line for my
ration of 8 gallons of gas on odd calendar days in 1974).
History
has shown that price controls, however implemented, simply do not work.
Fixing prices below natural market levels has been tried since ancient Rome.
In the French Revolution, the "Law of the Maximum" sent offenders
to the guillotine. The Soviet Union’s central planners controlled all
prices and also created a vigorous black market. In the US, World War I
commissions and later during WWII, FDR’s Office of Price Administration
set prices in broad markets. The result was severe shortages in many staples,
including meat. Although controls were eventually lifted for most products
after the war, control of meat prices continued. In 1946, Truman nearly sent
federal troops to Chicago to free up meat supplies from packing-house
“hoarders”.
The
fundamental cause of general inflation is excessively expansive monetary policy, that is, printing money at a rate higher than the
growth in GDP. “Excess money” devalues the medium of
exchange, and drives prices up for needed products and services. The rise in
commodity prices over the last two years is a good example. Since the Fed
added $1.4 Trillion to the money supply two years ago, commodity prices have
skyrocketed 80% from 2009 levels. Commodity price increases flow to producer
prices and eventually into consumer prices. The Consumer Price Index (CPI) is
compiled and reported by the Bureau of Labor Statistics.
The
CPI, as published, is deceptive. It does not reflect the true inflation rate observed
by most individual consumers. This is because the published numbers are
composed of certain components, assumed to be representative of the average
consumer’s “basket of goods”. This can vary
significantly from, for example, fuel costs differ greatly for the person who
drives a super-duty truck for work every day compared to the urban office
worker who relies exclusively on public transportation. People tend to have
differing diets as well, as a result of tradition, religion or culture. So
the common basket of goods is a myth.
We
can point to real food price increases by a few common examples: at the
wholesale level, whole chickens cost 69c/lb in Dec 2006, and 85c/lb Dec 2010,
according to USDA data; Sugar cost 11.7c/lb in Dec 2006 and 31c/lb in Dec
2010. Where I live, a 3 1/4 lb whole chicken sells today for $8.
In
Dec 2006, coffee cost $1.29/lb wholesale and climbed to $2.37/lb wholesale by
Dec 2010. I paid $3.25/lb this week for coffee at my local grocery.
Since
I need to buy food, heat my house and drive my car, how can I protect myself
from inflation? For certain, I won’t rely on the Federal government. I
will rely on my own good judgment.
I
will invest some of my discretionary income in gold and silver as a hedge
against inflation, which I expect will accelerate in the near future and
further devalue the paper dollars I earn. With hard assets in my portfolio, I
spread my risk. Gold has never been worth zero. It has quadrupled in value
over the last ten years. I will also stay invested in gold and silver stocks.
Although these can be more volatile than the metals, the inflation premium is
discounted the market price, a distinct advantage over fixed income
securities, such US Treasury notes.
Thank
you for your interest.
Scott Silva
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