What's really driving inflation

By Ali Velshi, CNN chief business correspondent

(MONEY Magazine) -- When Federal Reserve policymakers get together to talk about inflation, they focus on the "core" number, which takes out food and energy.

The thinking is that gas and grub prices bounce around so much they aren't much help in assessing how prices, overall, will behave.

Ali Velshi
Ali Velshi

Fair enough, but there's a shortcoming in that line of reasoning.

What happens if food and energy costs keep going up -- and up? The answer, as Fed chairman Ben Bernanke put it in March: "Sustained rises ... would represent a threat both to economic growth and to overall price stability." ("How the Fed has -- and hasn't -- fixed the economy")

Last month I made the case for continued high oil prices, focusing on the expense of tapping new reserves and the growing demand from emerging markets.

You know what $100-plus-per-barrel oil does to gas prices. But rising crude costs can seep through to other places in the economy too.

From cows to computers

Food costs are up in part because oil prices are making it more expensive to produce and transport beef, lettuce, and everything else you eat.

"Last year we paid $3 a gallon for fuel," Bill Donald, president of the National Cattlemen's Beef Association, recently told CNNMoney. "Now we're paying $4."

Airlines are raising fares. Potato chips are packaged in smaller weights without prices coming down. And because petroleum is used to make plastic, the cost of everything from computer monitors to plastic kitchen utensils will rise.

It's no wonder that more than two-thirds of the 23 economists recently surveyed by CNNMoney identified high oil prices as the most serious risk facing the economy.

"Costs are going up on things that we tend to buy frequently," said Sal Guatieri, senior economist with BMO Capital Markets. "The key issue now is whether we'll see a more generalized increase."

This time is different

That's a likely outcome. Deutsche Bank's chief U.S. economist Joseph LaVorgna noted in a recent report that the big difference between today's spike in oil (and other commodities) and past ones is "that underlying demand is significantly more robust. This means that price gains are more likely to stick."

He was referring to the fact that while the U.S. and European economies recover slowly, developing countries are booming and need raw materials that can be turned into goods for export as well as for consumption by their own rising middle classes.

There is, in short, a fundamental mismatch between the money Americans aren't yet earning and the global demand for the things we need to buy.

How can you respond, besides asking for a big raise? (Good luck.)

You can change your consumption habits. Less beef and more walking wouldn't hurt any of us.

Second, you can hedge against inflation through your investments. Last month, I recommended oil stocks.

Also look at businesses such as pharmaceuticals and luxury goods that will have an easier time than most passing along rising costs (see "Time for the Inflatables: 4 stocks with pricing power.")

Employ both strategies, and you could end up healthier and wealthier. Inflation needn't be all bad.  To top of page

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