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Bagel Index Is Showing Inflation's Bite
The Street ^ | November 22, 2006 | Jim Jubak

Posted on 11/22/2006 10:24:55 AM PST by GodGunsGuts

Bagel Index Is Showing Inflation's Bite

By Jim Jubak MSN Money Markets Editor 11/22/2006

Inflation isn't dead, despite the recent official government numbers. In fact, it's a bigger problem than the Federal Reserve admits publicly. Stagflation -- high inflation and low growth -- is still very much a possibility for 2007.

How do I know? My bagel inflation index tells me so.

Here's what happened to me one recent morning. As usual, I stopped off for a bagel and schmear after I dropped off my daughter at school. As usual, I handed over $2 and waited for my change. But I didn't get my usual 15 cents back, just a nickel. Before I squawked -- yeah, I'm not a native New Yorker -- I looked up at the price list overhead. Sure enough, the bagel and schmear that had cost me $1.85 two days earlier was now $1.95.

The Thai man behind the counter -- the consensus is that Thai bakers make the best bagels in New York right now; don't ask me why -- noticed my look.

"Everything's up," he said. "Wheat," I said. "Especially wheat," he agreed. With wheat prices up 50% in 2006 and projected by some commodity experts to go up 30% in 2007, I certainly understood where the squeeze was coming from. I've seen earnings reports recently for big baking companies that blamed lower-than-expected third-quarter earnings on a 35% increase in the cost of flour. No reason my local bagel shop should be able to escape the pain.

Food and Energy Thanks to the way inflation is reported in this country, that 10-cent increase, a 5.4% bagel inflation rate, isn't figured into the most-watched measure of consumer price increases. The core consumer price index, which came in with an increase of just 0.1% for October and raised so much speculation about an end to worryingly high inflation, doesn't include changes in the price of food or energy, you see.

The official numbers took the annual increase in the core CPI down to 2.7% from the 2.9% rate in September. That's still higher than the 2%-to-2.5% range that the Federal Reserve feels comfortable with, but you could argue -- and the bond market did by rallying after the number came out -- that inflation is headed in the right direction, down.

But it's too soon to organize a parade or break out the confetti. My bagel-inflation index, at 5.4%, is telling us something important about future inflation, and the message isn't comforting.

Inflationary pressures, my bagel index says, are still working their way through the economy. Wheat prices, for example, have been climbing all year, but the increase has just now shown up in the price of my bagel. That tells me that past increases in the price of things like wheat, corn and oil are driving prices higher now and into 2007 -- even if the prices of the commodities themselves have actually slumped in recent months, as is the case with oil.

Too Much Money? It makes sense to me that inflationary pressures are still at work in the economy, despite 17 interest rate increases by the Federal Reserve that have taken short-term interest rates from 1% in June 2004 to 5.25% in June 2006.

One cause of inflation, economists say, is growth in the money supply, as too much money chases too few goods. On that front, the inflation news isn't good. Growth in the U.S. money supply as measured by M2, the broadest measure of money in the economy available now that the Fed no longer calculates M3, has started to climb again. M2 grew by 5.9% in the three months that ended in October, after growing by just 4.6% in the six-month period ending in October and by 4.8% in the 12-month period ending in October.

The recent resurgence in money-supply growth isn't just a U.S. phenomenon. Inflation in the prices of goods and assets such as real estate is a global phenomenon. China's money-supply growth, as measured by M2, picked up speed in October, accelerating to 17.1% from September's 16.8% growth. That's a big surprise, since the People's Bank of China had success earlier in 2006 in its battle to cut money-supply growth, which had peaked at 18.4% in July.

The bagel-inflation index also captures another feature that makes recent inflationary pressures so hard to stamp out. Global growth in demand for energy and for food has created a novel linkage between prices in these two sectors. With higher oil prices driving the development and production of alternative fuels based on agricultural commodities such as corn and wheat (for ethanol production in the U.S. and Europe), energy consumers and grain consumers have become competitors bidding for limited stockpiles of these commodities.

That competition has had the effect of keeping total inflationary pressures higher than you'd expect in a period of falling oil prices. For example, on Nov. 16, crude oil prices hit a low for 2006, but corn prices were still near a 10-year high. Consumers may be paying less at the gasoline pump, but they are, or soon will be, paying more for chicken, beef -- and bagels.

My bagel index says that as we go into 2007, not much has changed on the inflation front. The Federal Reserve is still fervently hoping that either 1) its policy of increasing interest rates has failed and both the economy and inflation are growing too rapidly, or 2) its policy of increasing interest rates has slowed both the economy and inflation.

And frankly, I think there are even a few Fed members who privately would be willing to take No. 2 further and send the economy into a recession if it brought inflation down to within their comfort zone, near 2%.

It may sound odd -- perhaps the correct word is "wrong" -- to say that the Fed might be hoping for such unpalatable alternatives, but I think it's true. And not just because the Federal Reserve's bankers aren't likely to lose their jobs in a recession, even if it is one they cause.

A Dreadful Specter No, the reason for being willing to accept even an outright policy failure or a recession is that a third alternative, stagflation, is just too dismal to contemplate. The Federal Reserve knows that stagflation, the mixture of high inflation and low growth that made the 1970s such a dismal period economically, isn't easily cured with the tools the Federal Reserve has at its disposal.

With growth too slow, as it would be in a period of stagflation, the standard remedy is to cut interest rates to stimulate the economy. But that would send a high rate of inflation even higher.

With inflation too high, as it would be in a period of stagflation, the standard remedy is to raise interest rates to curb inflation. But that would slow an already slow economy even more.

Once stagflation takes hold, the lesson of the 1970s argues, it takes drastic action, double-digit interest rates and a full-blown recession, to stomp it out. To reduce inflation from its high of 13.3% in 1979 to a more "normal" rate of 3.9% in 1982, it took a recession that saw the economy shrink in real terms by 1.4% in 1980 and 2.9% in 1982. The economy didn't recover to its 1979 size until 1983.

Now, I'm not predicting stagflation in 2007, and I certainly hope that we don't see it in that year or any other. But my bagel index says that we're not out of the woods yet. Inflation, as measured by core CPI, remains at a high annualized 2.7%, and it's too soon to say from just the latest numbers which way the trend is headed.

Economic growth in the third quarter came in at an annualized 1.6%. That's troublingly low, but again, it's impossible to project a trend from just that quarter's number, especially when that number is apt to get revised strongly up or strongly down in the coming two months.

I think we'll have a better read on the trend -- just right (not too much growth and not too much inflation), too hot (too much growth and too much inflation), too cold (too little growth but not too much inflation) or stagflation (too little growth and too much inflation) -- when we see the numbers in January on the economy in the fourth quarter and on inflation in December. At least we'll have two data points to help draw a trend line.

Until then, enjoy this very unusual but still profitable end-of-the-year rally and try not to get too excited or too depressed about next year.

And send me your favorite inflation indicators modeled on my bagel index. Let's collect more real-world data on the direction of inflation. Why should the Federal Reserve and the Commerce Department have all the fun? New Developments on Past Columns Turn Short-Term Fear Into Long-Term Profit: The dust had hardly settled on Goldcorp's (GG) acquisition of Glamis Gold, finalized on Nov. 4, before the ex-CEO of Goldcorp, Robert McEwan, who lost an effort to block the deal, was out on the acquisition trail himself.

His new company, U.S. Gold (USGL) has bid for four Nevada gold-mining companies with the most recent offer coming on Nov. 13. The goal of buying Coral Gold Resources, Tone Resources, Nevada Pacific Gold and White Knight Resources is to combine the four companies' holdings with U.S. Gold's Tonkin Springs property.

All are in the Cortez Trend in Nevada, which runs parallel to the Carlin Trend, which has so far yielded more than 60 million ounces of gold. The potential for the Cortez Trend to produce something like that amount of gold is exciting over the long run, of course, and it could well turn U.S. Gold itself into an attractive acquisition target.

Meanwhile back at Goldcorp, over the next year the challenge facing the company is integrating operations at the former Glamis Gold with those of Goldcorp. That could take a year if the company's third-quarter results are any indication. In the third quarter, earnings of 22 cents a share were way below expectation of 29 cents a share, as gold and copper sales lagged Wall Street projections.

But the company also reported that production has improved at the Porcupine and Musselwhite mines that the company acquired from Placer Dome in May 2006, as they were increasingly integrated into Goldcorp's overall operations. That gives investors a rough sense of how long it might take to integrate the much bigger Glamis Gold acquisition. As of Nov. 21, I'm keeping my target price at $40 a share but extending it out to December 2007 from December 2006.

At the time of publication, Jim Jubak owned or controlled shares in Goldcorp. He does not own short positions in any stock mentioned in this column.

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Jim Jubak is senior markets editor for MSN Money. He is a former senior financial editor at Worth magazine and editor of Venture magazine. Jubak was a Bagehot Business Journalism Fellow at Columbia University and has written two books: "The Worth Guide to Electronic Investing" and "In the Image of the Brain: Breaking the Barrier Between the Human Mind and Intelligent Machines." As an investor, he says he believes the conventional wisdom is always wrong -- but that he will nonetheless go with the herd if he believes there's a profit to be made. He lives in New York. While Jubak cannot provide personalized investment advice or recommendations, he appreciates your feedback; click here to send him an email.


TOPICS: Business/Economy; Culture/Society; Government; News/Current Events
KEYWORDS: bagelbs; inflation; muffinstumps; muffintops
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1 posted on 11/22/2006 10:24:58 AM PST by GodGunsGuts
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To: GodGunsGuts

There's always muffins.


2 posted on 11/22/2006 10:27:46 AM PST by jdm
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To: ex-Texan; djf; Pelham; TonyRo76; finnman69; winodog; durasell; remember; expat_panama; GSlob; ...

ping


3 posted on 11/22/2006 10:29:37 AM PST by GodGunsGuts
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To: jdm

LOL!


4 posted on 11/22/2006 10:30:13 AM PST by GodGunsGuts
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To: GodGunsGuts

I knew it when the lemon cookies went from 30 cents to 65 cents at Starbucks.


5 posted on 11/22/2006 10:32:38 AM PST by MarkeyD (The tree of liberty must from time to time be watered with the blood of tyrants and patriots.)
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To: GodGunsGuts

Everyone knows that the world economy is important in forecasting future conflicts, and if it tanks, the eurasian powers that are hostile to us will move against our allies in the region and us.


6 posted on 11/22/2006 10:33:29 AM PST by Thunder90
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To: GodGunsGuts
If we get stagflation back, I'll be glad I've locked in my next home purchase long before every one around me is paying 18% for their mortgage.

"Show me just what Mohammed brought that was new, and there you will find things only evil and inhuman, such as his command to spread by the sword the faith he preached." -Manuel II Paleologus

7 posted on 11/22/2006 10:34:56 AM PST by goldstategop (In Memory Of A Dearly Beloved Friend Who Lives On In My Heart Forever)
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To: GodGunsGuts

Trying to turn bagels into gold, again.


8 posted on 11/22/2006 10:35:04 AM PST by Old Professer (The critic writes with rapier pen, dips it twice, and writes again.)
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To: MarkeyD

I knew it when my #3 McDonalds value meal went from $4.95 to $5.05. I was expecting change, but instead I owed them 5 cents! And don't get me started on what gold has been telling us for the last five years!!!


9 posted on 11/22/2006 10:40:33 AM PST by GodGunsGuts
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To: Old Professer

If you ever manage to figure out how to do that, let me know. I'll be the first in line.


10 posted on 11/22/2006 10:41:43 AM PST by GodGunsGuts
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To: GodGunsGuts

My gold stopped talking to me a while ago, so I'm at a loss on that score.


11 posted on 11/22/2006 10:46:56 AM PST by CharlesWayneCT
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To: GodGunsGuts
We had bagels for breakfast at work.

Bagel Story: I attended Rutgers in the early 60s and was a member of the Newman Club, (Roman Catholic). We were invited to a mixer at an EXCLUSIVE girls college in Lakewood NJ. Georgin Court College was founded by the Catholic Church and situated on the Jay Gould estate, (1800s Robber Baron), which he had bequeathed to the Catholic Church. The Nuns ran the school and when they said None they meant NUN!

We went to the second mixer and decided to have some fun. We stopped at a bagel bakery in Lakewood, (Lakewood was and is a noted Jewish community) and bought bagels and creme cheese. When we arrived at the mixer we acted kinda dumb and asked if this was the Hillell mixer, (Hillell was the Jewish version of the Newman Club). The Nuns were scandalized until they realized our joke, then they laughed The Nuns were sumthin else. Curfew was at Midnight and at 5 minutes till they would enter the hall and bang cymbals and gongs to chase us off!! When dancing they enforced the two fist rule!

12 posted on 11/22/2006 10:51:34 AM PST by Young Werther
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To: GodGunsGuts
Another measure of inflation is auto repair costs. In 2001, I was forced to pay for some mechanical repair work. The hourly fee at that time was about $ 49/hr. Today the hourly rate averages $ 72.50 per hour in Portland. That is an increase of over $ 23 per hour. Do the math. Shocking! And the Fed is still playing games with CPI figures claiming inflation is under control. U.S. Wholesale Inflation Jumps CPI does not reflect the true price of energy or the price of energy on retail prices. Home sales prices have been ignored because the Fed uses a complicated fair rent index substitute. Greenspan and Bernanke are cut from the same mold. [More?]
13 posted on 11/22/2006 10:53:31 AM PST by ex-Texan (Matthew 7: 1 - 6)
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To: Thunder90
They are already doing it. But you are right, it will accelerate the process immensely. I'm surprised how many people want the dollar to fall. Don't they realize how much power we will lose if the dollar, as the reserve currency of choice, begins to give way to the Euro? Not only will it have massive international economic implications, but it we reduce our geopolitical clout as well. We need to save the dollar by bringing it back on the gold standard. Here's a good article to get us thinking in the right direction (read the whole thing...it's worth it):

The Case for a Genuine Gold Dollar

http://www.freerepublic.com/focus/f-bloggers/1696147/posts?page=15
14 posted on 11/22/2006 11:00:01 AM PST by GodGunsGuts
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To: ex-Texan
You are absolutely right. Many economists and financial writers have been decrying the skewed CPI for some time now. When the true magnitude of inflation completely filters through the economy you can bet these people will finally get the attention they deserve.
15 posted on 11/22/2006 11:03:47 AM PST by GodGunsGuts
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To: GodGunsGuts

That's not inflation, that's supply and demand.

Just because the price of bagels are up, doesn't mean we have inflation.


16 posted on 11/22/2006 11:05:12 AM PST by Perdogg (I'm Perdogg and I approved this message)
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To: MarkeyD
He's not even a business/economics major, he's a journalism major.
17 posted on 11/22/2006 11:06:37 AM PST by Perdogg (I'm Perdogg and I approved this message)
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To: GodGunsGuts

Explain to me how you adjust inflation to consider changes in technology. For example the TV you bought 20 years ago vs. the TV you bought today - How do you measure the changes in cost??


18 posted on 11/22/2006 11:09:00 AM PST by Perdogg (I'm Perdogg and I approved this message)
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To: Perdogg

"Just because the price of bagels are up, doesn't mean we have inflation."

Agreed. For example, what does the price of Bagals have to do with what we pay for gas, which has been down over the past few months, and is also factored in the over-all inflation index.


19 posted on 11/22/2006 11:24:36 AM PST by ScottfromNJ
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To: Perdogg

Have you taken the time to investigate whether it's just supply and demand or too many dollars chasing the same goods???


20 posted on 11/22/2006 11:28:50 AM PST by GodGunsGuts
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