Insidious Inflation

Although economic change can happen with dramatic ferocity – as it did in 1929 – it is far more likely to occur over a period of time. We can expect the inflationary impacts of higher natural gas prices, for example, to take several months to work their way through the chain of distribution from raw material to consumer product. At each step, business decisions are made about margins, material substitution, alternative resources, production volumes, and so on. And it's not unusual for a manufacturer to hedge forward commodity prices. Until these contracts expire, there is less pressure to increase end product prices.

But eventually, higher producer costs mean higher consumer prices. Increased oil and natural gas prices create a relentless upward pressure on inflation. And the forces of inflation are insidious – because they are often difficult to identify.

For example:

Chris Krug writes for the Oklahoman. In a recent article he shows how the farmers of Texas County, Oklahoma are being forced to dramatically reduce the size of their corn crops. Corn needs a lot of water. The water has to be pumped from the Ogallala aquifer from a depth of 300 to 350 feet and then pressurized for irrigation. The farmers use natural gas to power the pumps. Higher natural gas prices have almost tripled their pumping costs. So the farmers of Texas County are looking to plant other crops that need less water.

The price of natural gas has about doubled over the last two years. Higher natural gas prices force up the cost of irrigation. Planting corn becomes a higher risk business. That leads to less corn production. Less corn pushes up the price of corn. Higher corn prices push of the price of everything made from corn – including fuel amendments and cattle feed. Higher fuel amendment costs push up the price of gasoline. Higher cattle feed costs push up the price of that steak you plan to eat.

And the higher cost story doesn't end with pumping water. Higher oil and natural gas prices push up the cost of fertilizer, insecticides, and herbicides. It costs more to operate motorized farm machinery. It costs more to transport and process the crop. It costs more to convert corn, as a raw material, into consumer products. And it costs more to distribute these products through the chain of distribution.

It might take 2 or 3 years (or more) for these cost increases to work their way through the supply chain. But every link eventually gets more expensive.

Consumer prices go UP.

So the next time you hear someone say that increasing oil and natural gas prices have little impact on inflation, just remember the farmers of Texas County, and a supply chain that stretches all the way from Oklahoma dirt to your dinner table.

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