Although inflation has inched higher in the past six months, U.S. investors and job-seekers should interpret that not as a danger sign, but as a harbinger of improving economic conditions. Here's why.
First, it's true, inflation at the retail level, which is measured by the consumer price index, has risen slightly in the past year. January's 0.4% increase in the CPI brought the 12-month inflation rate to 1.6%. That's higher than the 1.4% 12-month rate recorded in December.
However, CPI inflation at the core level, which excludes the often-volatile food and energy components -- rose just 0.2% in January and is up just 1% in the past 12 months.
That 12-month January core rate is considerably higher than the 0.6% December 12-month core rate, but investors need to keep in mind that even with January's rise, the core rate is still low.
Deflation Dangers Still Linger
In fact, the 1% 12-month core rate may still be too low. Slack demand due to the loss of more than 8 million jobs have reduced commercial activity so much that some sectors lapsed into deflation.
Deflation, a protracted, systematic decline in prices, robs companies of revenue and can lead to the dreaded "deflationary spiral," in which price cuts lead to lower corporate revenues, prompting layoffs, which lead to further consumer spending declines, which prompt more price cuts, layoffs and so on. Deflation can ruin an economy, and fear of that was one major reason the Federal Reserve implemented its unprecedented quantitative easing program, one of whose aims is to increase demand and maintain prices.
While recent improvement in the U.S. economy has removed the deflation risk from some sectors, the low core CPI means it remains possible in others. Therefore, the Fed would like to see core CPI inflation increase slightly more. From the Fed's standpoint -- and the modern economic history of deflation supports its argument -- a little inflation is a good thing.
Wages Lag Inflation -- for Now
The obvious question, then, if inflation is still low, why are so many Americans expressing concern about rising prices?
Part of it has to do with the large price increases in very visible items such as fuel. Gasoline prices have jumped 13.4% in the past year, to an average of $3.16 per gallon for unleaded regular. Heating oil has surged 17.3% to an average of $3.59 per gallon, and other energy products combined are up an average of 7.3%. Given the nation's high per-capita energy use, large spikes in oil prices have historically put Americans in a grumpy mood, and this has certainly has been the case during the latest surge.
Another inflation gripe is rooted in income. The 3.9% rise in personal income in 2010 masks the fact that while some job segments saw their incomes rise last year, most did not. And this wage stagnation probably accounts for much of the concern about increases in selected prices. Americans will tolerate an inflation rate of 3% -- if their incomes rise by 5% or more to cover it. Conversely, even a low inflation rate of 1% or 2% seems high when wages have been stagnant.
Nevertheless, a modest inflation rate means the Fed's effort to prevent the dreaded deflationary spiral is succeeding. Aided by a recovery in the Fed-assisted credit markets and by increasing international demand for U.S. manufactured goods, the nation's economic rebound is strengthening. And commercial demand is supporting prices.
Cranking Up the Job Machine
Lean, competitive corporations are well-positioned to capitalize on promising emerging-market opportunities, pushing corporate earnings even higher. Many of these companies will have to increase personnel to meet this rising demand -- and that bodes well for at least decent monthly job growth in 2011.
The great American job-creation machine appears set to start humming, and when it does, incomes should finally start rising at healthy rates. At that point, you probably won't hear too many Americans complaining about a little inflation.