Rising Prices, Falling Dollar Stoke Memories of the '70s
Wednesday, June 4, 2008
Prices have been soaring long enough and fast enough, economists say, that the nation is at risk of a self-reinforcing cycle of inflation like that experienced in the 1970s.
It is a risk Federal Reserve Chairman Ben S. Bernanke highlighted in a speech yesterday, saying that the falling value of the dollar can feed into inflation expectations, and that rapid price escalation, if sustained, "might lead the public to expect higher long-term inflation rates, an expectation that ultimately could become self-confirming."
For some businesses that already is the reality. Many companies making long-term investments are assuming that prices will rise at a pace well above that of the past 20 years, as they pencil in larger price increases for the supplies they buy and the prices they charge. Consumers are coming to take rapidly escalating food and energy prices for granted. And labor unions are starting to push harder for across-the-board wage increases, though overall wages are still climbing slowly.
U.S. consumers expect prices to rise 7.7 percent in the coming year, according to the Conference Board, a research company. Investors expect inflation over the coming decade to average 3.4 percent based on bond market data analyzed by the Cleveland Fed. That is well above the Fed's unofficial target of about 2 percent.
When the price of food or gasoline goes up, economists generally think of it as a one-time bump. For the past four years, it hasn't been. The last time there were sharp and sustained increases in those prices, in the 1970s, a wage and price spiral developed that was so severe that the Fed had to engineer the deepest downturn since the Great Depression to end it.
"We're at the edge of the cliff right now," said Scott Anderson, senior economist at Wells Fargo. "It's still at an embryonic stage, like where we were in 1973 or 1974, not as bad as things were in 1979. But it could move in that direction if the Fed isn't aggressive."
Ordinary businesspeople, especially those in industries in which energy costs figure heavily, are responding as if that is the direction the economy is heading.
"We are assuming that prices will continue to go up, not that they're going to level off anytime soon," said John Benko, president of Manko Delivery Systems, a Tampa company that offers ground freight, logistics and other services. His company has been able to pass on about three-quarters of the higher fuel costs to customers in the form of higher prices, with the rest cutting into his firm's profit.
Ryder System has reduced the maximum speed on its fleet of trucks from 65 to 63 miles per hour, and many of its clients are making fewer shipments of goods with fuller trucks.
But these decisions are a logical response to higher fuel prices -- not necessarily signs that expectations for future inflation are coming unhinged. The best way to get a sense of those long-term expectations is through what executives assume as they make longer-term choices.
If a manufacturer expects energy prices to keep rising, it would be more inclined to pay extra for a more efficient machine, or choose to set up many small warehouses close to customers rather than one massive one that is far away.
That's what's happening, said Thomas L. Jones, a general manager for Ryder. "People are assuming prices have got nowhere to go but up," he said.
"Almost unilaterally our customers are expecting prices to continue rising," said Bob Strle, a vice president of Countermind, a Colorado firm that sells technology to help shipping firms plan their routes more efficiently -- an investment that offers a higher payoff when gasoline prices rise.
The big question is whether those expectations of higher fuel prices feed into a wage and price spiral like that of the 1970s, in which workers demanded -- and received -- double-digit wage increases to keep up with higher prices, which then fueled further inflation.
There are huge differences between now and the 1970s. In the past year, the average weekly wage for private sector non-managerial workers rose only 1.9 percent. A soft U.S. economy could continue to leave workers little leverage with which to demand pay hikes to match higher prices.
Moreover, fewer workers are unionized, fewer of those have automatic cost-of-living adjustments, and unions have less clout with which to negotiate wage increases. Finally, many of the most heavily unionized industries, such as the automakers, are in such dire financial straits that raises of any sort are unlikely.
"There is no evidence that wages have started to spiral up," Janet L. Yellen, president of the Federal Reserve Bank of San Francisco, said in a recent speech.
But there are signs that higher prices are changing the dynamic of labor negotiations, at least in certain sectors. For most of the past 20 years, wage negotiations have centered on various pay-for-performance schemes. With higher inflation, unions in a position to do so are now pushing for higher across-the-board raises, said David B. Lipsky, a professor at Cornell's School of Industrial and Labor Relations.
"The pendulum had swung away from across-the-board wage increases, now we're seeing it swing back the other way," said Lipsky, citing recent contracts among public-sector workers and some in the hotel and casino businesses.
In a four-year contract for 40,000 janitors agreed to at the end of last year, for example, the Service Employees International Union managed to get annual raises of 4 percent, not the 3 percent during the time when inflation was lower (the raises were even higher in more recently organized cities, including Washington).
"The high inflation has adjusted our thinking of what kind of dollars we would ask for at the bargaining table," said Mike Fishman, president of SEIU Local 32BJ, who said the union worked from the assumption that inflation in the years ahead will continue at a similar pace as it has recently.
Bernanke, in his speech yesterday delivered by satellite to a group of central bankers in Barcelona, also made clear that the dropping value of the dollar creates a risk of heightened inflation expectations.
Bernanke, Harvard Class of '75, will have a chance to address whether he sees any similarities between the current situation and those when he was a college senior in a speech today for the university's graduation exercises. Its title is "Economic Challenges: 1975 and Now."