The Real Problem With Inflation Isn't on Wall Street

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Food aisle in grocery storeLast summer, many on Wall Street feared that the budget woes of the tiny Greek economy would threaten the very existence of the European Union and throw the world back into a brutal recession.

Then, what in hindsight proved to be a run-of-the-mill mid-recovery consolidation and slowdown phase was heralded as setting the stage for a double-dip recession. Soon, many high-profile investors were saying a brutal deflationary spiral awaited the U.S. economy.

Of course, none of these dire forecasts played out that way. But a new bogeyman is already being created as the prior fears drift away. As commodity prices post sharp gains, rampant inflation is supposed to torch corporate profit margins, destroy stock values and throw the economy into another tailspin, judging by the slew of recent news reports.

Most Pain at the Lower Rungs

But as with the prior bouts of alarmism, investors will be better served by taking a levelheaded approach. Pundit prognostications aside, inflation remain at benign levels. Companies and most consumers should be able to deal with rising commodity prices far better than the current howls over inflationary prospects would imply.

And the real concern about inflation tends to get overlooked in the overall hysteria: the harsh toll that rising prices could take on those at the lowest end of the country's socioeconomic spectrum.

It's true that inflationary pressures are rising. Wholesale prices excluding food and energy lifted at the fastest pace in two years last month, according to government data released Wednesday.

But that should hardly be surprising. The economy is witnessing a fairly sharp rebound, after all. Economists at Goldman Sachs (GS) see U.S. GDP expanding as much as 5% this year, while Deutsche Bank (DB)sees it possibly rising closer to 6% under the right circumstances.

Don't Overlook the Slack in the Economy

It would be odd not to see some inflationary pressures under these conditions, and investors should keep things in perspective.

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"Although the recent pickup in some commodity prices is showing up in the core PPI, inflationary pressures remain quite low for now," analysts at Ned Davis Research wrote in a note to clients Wednesday. "We continue to expect low consumer inflation in the intermediate term, mostly due to the large amount of slack in the economy."

For one thing, the role commodity prices play in the actual costs of products may be far less than many think. Some back-of-the-envelope calculations, for example, imply that the price of wheat accounts for only 12% of a loaf of bread's cost.

That's in line with analyst estimates that wheat and corn combined account for only 14% of the cost of goods sold by General Mills (GIS), and that company seems to be coping with rising commodity prices just fine through modest pass-through price increases.

Any eventual toll on most consumers is likely to be modest as well. Necessities like food, gas, clothing, personal care products and cleaning and laundry supplies account for less than a quarter of U.S. household spending.

Wrong Time to Cut Heating Oil Assistance

Rather, the real worry about rising commodity prices should be about how households at the lowest end of the income distribution will cope. Analysts at JP Morgan (JPM)estimate that households in the bottom fifth of income distribution spend 9% of after-tax income on gasoline, compared to less than 2% for those in the top fifth.

President Obama's approach of talking tough but making only cosmetic budget cuts may make sense broadly. But cutting back on assistance with heating oil to the poor is particularly misguided at this juncture.

Wall Street's current preoccupation with inflation may prove as ephemeral as many other jitters have recently. But far worse, the fallout for the most vulnerable corners of Main Street, meanwhile, continues to get overlooked.

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