The Vicious Circle Of Producer Price Inflation

This morning, the producer price data was released for the month of January and those prices soared 1.4 percent for that month (Click to See Full Story: January Producer Prices Rise More Than Expected). Producer prices reflect the cost of finished products that are making their way through the retail market system. These finished goods can be gasoline, heating oil and things like picked, packaged, and processed food stuffs and dairy products being delivered to the markets for retail sale.

The reason that producer prices are such a closely watched metric is because it is producer prices that will ultimately force retail prices up and that, in turn, will eventually hit us all in our wallets in the form of inflation. At the heart of any past rampant inflationary period has been the rapid rise of producer prices. If you assume that normally acceptable inflation rates should be at about 3 to 4 percent in an entire year then, having a 1.4 percent increase in a single month (as in this report) is very worrisome.

Producer price increases are a double edged sword; especially in a time of recession.

Any retailer who is hit with a big jump in the prices they pay for the products that they intend to sell are typically faced with only one of two choices: Either raise prices or hold the line. In the majority of cases, they will raise prices.

However, if a retailer fears that they won't remain price competitive in their own market space, they will hold their pricing. In doing so, this action means that their profits will be reduced. When profits are reduced, the income taxes that they will pay will also be reduced. The vicious circle that results from this decision is the fact that State and Federal taxing agencies will now see lower revenues; and, as usual, they will be forced to raise taxes in order to compensate for that loss. Then, in turn, all retailers will be forced to make another pricing decision to compensate for the new higher tax rates.

As I said before, most retailers will make the decision to raise their prices. But, what that does is take disposable income away from the consumer. If the consumer's paychecks don't rise at the same rate as inflation, then we could see a variety of bad things happening in our economy. And, it is typical, in a recession, that workers have little or no leverage to demand salary increases in the face of rising prices. Therefore, the amount of people who are unable to pay their bills will rise. This could also result in higher number of bankruptcies, foreclosures, and defaults on other loans and credit cards. It also means that non-essential spending will be curtailed and the retail sales for things other than food and clothing could suffer a setback and cause a double-dip recession. Once again, tax revenues will be reduced; forcing taxing agencies to raise taxes. And, so, higher taxes will force higher prices and the vicious circle will just keep repeating.

Normally, the Federal Reserve would fight inflation by raising interest rates. However, with business loans and mortgages already hurting, raising interest rates will only continue to reduce bank lending. Therefore, the Federal Reserve is in no good position to do anything because their actions to fight inflation could be as bad for the economy as the unbridled inflation they are trying to fight.

Any way you shake it, the continued high spending rate by this Congress and this President is probably at the core of this month's high rate of producer price increase; and, it is an early sign of the double-digit inflation we could see in the next 2 to 3 years; as most non-Keynesian theory economists have predicted. This is why the theory of Keynesian Economics to use a high rate of government spending to pull us out of recession is so wrong. What should have been done is broad base of tax cuts to stimulate our economy -- as was so effective under Reagan's watch. But this President doesn't seem to get it. It appears now that we have another Carter-like economic fiasco on our hands as this President continues to pursue an economy-killing, liberal agenda with high taxes and outrageous government spending.

Lastly, I would like to point out that I, in this blog, and along with many many others in this world have been more accurate about the direction of this economy and the failure of Obama's economic policies than either Obama or his economic advisers. In most cases, economics is just common sense -- something that Obama and his academics don't seem to understand. But, then, how could they? None of them has ever run a business or managed anything other than their personal trips to the bathroom. And, based on the amount "crap" and B.S. that we keep getting from them, those trips are quite frequent.