Commodities go ka-ching; buyers go, 'Ouch'

"The average wage earner buys gas at the gas station and food at the supermarket; no one gives them a discount to get their inflation rate down to core," says G. Kenneth Heebner, manager of CGM Capital Development lomcx fund.

When consumers have to spend more on necessities, they have less available for niceties — such as new clothes, appliances or cars.

David Walker of Olathe, Kan., says higher oil prices have forced him to make big changes in his spending habits. Dining out is rare; so is casual shopping and going to see his beloved Kansas City Chiefs. "I got offered free tickets to the K.C./Green Bay game, and I had to decline," Walker says. "Tailgating costs alone precluded me from going."

The Fed in a bind

High commodity prices are one big reason for a seeming disconnect between financial markets, which expect additional Fed rate cuts to bolster the economy, and cautious language by some central bankers.

The Fed cut interest rates in September to ease fears of a worldwide credit-market meltdown. The Fed cut rates again in October as insurance against an economic downturn, Philadelphia Fed President Charles Plosser said last week.

But Plosser pointedly noted that such insurance itself creates new risks, especially when oil and commodity prices suggest "significant" inflation pressures. A rate cut stimulates the economy, which, in turn, increases demand for food, energy and raw materials.

A big fear: a wage-price spiral, similar to what happened in the 1970s. CGM's Heebner worries about that, too: "Rising food and fuel costs will generate more pressure from labor to raise wages."

But there's a moderating influence today, Heebner says. "It's a global economy, and we have to compete with labor forces in other countries." Management can threaten to move operations overseas, where labor is cheaper.

But rate cuts also threaten to further depress the value of the dollar against other currencies. The declining dollar has played a big role in commodity markets. For example, OPEC is mulling whether to stop pricing oil in dollars, considering using a basket of currencies instead. The falling value of the dollar has cut into OPEC earnings and made oil exporters reluctant to increase production to relax price pressures. A falling dollar also means that other nations, whose currencies are worth more, are better able to afford dollar-denominated commodities, helping support prices. A lower dollar also means U.S. producers pay even more for imported commodities, stoking inflation.

"I'm shocked that the Fed, which said all year long, 'We're going to keep an eye on inflation,' they've forgotten all about it," says Adam Hewison, president of INO.com, a purveyor of data and other information to futures markets, warning that additional Fed rate cuts would "put more pressure on the dollar, meaning more inflation, importing inflation."

The Fed also fears a resurgence of an inflation mentality, when people expect and accept price increases. "If inflationary expectations rise, it could prove very costly to put the genie back in the bottle," Plosser said. "Should that scenario come to pass, the insurance policy may turn out to be a very expensive one."

Economists debate the link between higher commodity prices and inflationary spirals.

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