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

Frontline troops push for solar energy
The U.S. Marines are testing renewable energy technologies like solar to reduce costs and casualties associated with fossil fuels. Play
25 Best Places to find rich singles
Looking for Mr. or Ms. Moneybags? Hunt down the perfect mate in these wealthy cities, which are brimming with unattached professionals. More
Fun festivals: Twins to mustard to pirates!
You'll see double in Twinsburg, Ohio, and Ketchup lovers should beware in Middleton, WI. Here's some of the best and strangest town festivals. Play
Overnight Avg Rate Latest Change Last Week
30 yr fixed4.08%4.24%
15 yr fixed3.19%3.23%
5/1 ARM3.36%3.46%
30 yr refi4.06%4.15%
15 yr refi3.17%3.17%
Rate data provided
by Bankrate.com
View rates in your area
 
Find personalized rates:
Index Last Change % Change
Dow 17,098.45 18.88 0.11%
Nasdaq 4,580.27 22.58 0.50%
S&P 500 2,003.37 6.63 0.33%
Treasuries 2.34 0.01 0.39%
Data as of 5:23am ET
Company Price Change % Change
Bank of America Corp... 16.09 0.08 0.50%
Apple Inc 102.50 0.25 0.24%
Intel Corp 34.92 0.27 0.78%
General Electric Co 25.98 -0.03 -0.12%
Microsoft Corp 45.43 0.00 0.00%
Data as of Aug 29

Sections

Union organizers say that fast food workers will strike in more than 150 cities on Thursday. Workers want a $15 minimum wage and protection from retaliation by employers. More

Gas prices are falling to nearly $3 a gallon in some parts of South Carolina, and that will soon be common in much of the country. More

Xiaomi is beating Apple and Samsung in China and 'selling a dream' as it bids for world smartphone domination. More

The Coolest Cooler is the most successful Kickstarter campaign in the site's history, raising $13.3 million from over 62,000 backers. More

Five CNNMoney readers share stories about saving that you can learn from: What they would do differently if they had another chance. More

Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.