Materials Prices Are Flashing An Inflation Warning...

Just as many observers are proclaiming an end to inflation, others are warning that inflationary pressures are starting to build. "If you look closely," says economist Lawrence A. Kudlow of Bear, Stearns & Co., "you can spot evidence that inflation is on the uptrend."

Such evidence isn't apparent in the overall inflation indexes. Economist Bruce Steinberg of Merrill Lynch & Co. notes that the producer price index rose only 0.2% last year, while the consumer price index, up 2.7%, chalked up its best two-year performance since the mid-1960s. Even excluding food and energy prices, both indexes last year registered their smallest increases in two decades.

Nonenergy commodity prices, on the other hand, have been springing to life in recent months. The Commodity Research Bureau's spot price index of industrial raw materials, which excludes oil, has jumped 6.4% since late September (chart). The core producer price index for crude materials jumped 2.4% in December and ended 1993 some 11.4% above its year-earlier level.

Some of the sharpest gains have been posted by commodities that are mainly reliant on U.S. demand, such as scrap steel, lumber, and cement. But copper, lead, and zinc have also strengthened.

To Kudlow, such developments--along with the runup in gold prices and a Federal Reserve policy that he believes has been unduly stimulative--suggest that inflationary pressures are stronger than generally appreciated. Even Merrill's Steinberg concedes that commodity prices are trending higher.

The key question, though, is whether this pickup will affect final goods prices much. Continuing small wage gains and strong productivity growth, believes Steinberg, should enable manufacturers to absorb higher materials costs--particularly since economic growth is likely to slow to a more sustainable pace.

Economist Paul D. Mastroddi of Morgan Guaranty Trust Co. argues, however, that the economy is closer to an inflationary threshold than many observers realize. With capacity utilization at 83.5% and the jobless rate outside California close to 6%, stronger-than-anticipated growth could accelerate price pressures and prompt significant tightening by the Federal Reserve.

Right now, most economists doubt that will happen. The real inflation threat, they say, will come in 1995, when the entire industrial world will be expanding. The problem is that commodity prices are highly volatile. If they continue to surge upward, they are likely to reinforce inflation fears and prompt inflationary behavior by business and monetary restraint by the Fed.

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