- The Washington Times - Thursday, March 13, 2008

Robert E. Frankfurt, an 82-year-old retiree who was born and raised in Washington, has experienced firsthand the scourge of inflation and the ravages of recession.

He remembers when a Saturday movie cost only 15 cents — about the amount he made collecting and selling newspapers each week. As a child during the Great Depression of the 1930s, everything was cheap, but “I did not get to enjoy the luxuries that today we look upon as necessities,” he said.

He considered himself lucky because both of his parents kept their jobs and he was able to stay “mostly warm in the winter.”

Mr. Frankfurt understands the quandary facing the Federal Reserve as it strives to save the economy from recession with deep interest-rate cuts that could have the unwelcome effect of worsening inflation.

Today, living on pension income when a gallon of gas costs a record $3.25 and a gallon of milk costs $4, Mr. Frankfurt avoids buying expensive cuts of meat and takes advantage of free meals offered through seniors programs. Yet he is amazed how little a new clothes dryer costs — $319, including delivery.

“On the basis of my living conditions now, I would selfishly opt for recession” to wring inflation out of the economy, he said, “knowing at the same time many would suffer” from joblessness and dislocation.

Mr. Frankfurt’s sentiments are echoed by many seniors and workers whose nest eggs, income and purchasing power are being eroded by the highest inflation in 16 years. The high prices are being fed mostly by soaring costs for oil, corn, wheat and other commodities whose prices are set in global markets where growth and demand for goods remain strong.

Consumers rate the inflation scourge as their top economic concern despite mounting job losses, a historic depression in the housing market, record foreclosures, a major credit crunch and the possibility of bank failures, among other problems economists say may have already tipped the economy into recession.

While inflation remains mainly an imported problem for the United States, the Fed’s move to forestall a recession has been greeted by an unexpected chorus of disapproval from many consumers who think the central bank is neglecting its central mission of guarding against inflation and defending the sagging dollar. Indeed, the dollar’s fall accelerated in the wake of the Fed’s actions, setting off an upward spiral in oil and other commodities that are priced in dollars.

Yesterday, the price of a barrel of premium crude rose to a record $109.92 in New York trading.

“When the Fed lowers the interest rate, the value of the dollar sinks lower, prompting speculators to drive up the price of a barrel of oil with cheaper dollars, which, in turn, drives up inflationary coststo consumers for gasoline, food, electricity and health costs,” said Robert Robinson, a Texas retiree who is unhappy with rising prices. “The cycle is being repeated time and time again by the Fed actions.”

Worries that the Fed’s aggressive rate cuts are triggering a broader inflation problem have prompted an acrimonious debate from Main Street to Wall Street, and even within the Fed itself.

Fed Chairman Ben S. Bernanke and most members of the Fed’s board of governors in Washington argue that the central bank can exert little control over the price of commodities in international markets, while it has been largely successful so far in preventing the imported commodity inflation from spreading into a generalized inflation problem.

Food and fuel prices are high because nearly 300 million Americans are now competing with several billion consumers in emerging countries from Brazil to China whose rising incomes are enabling them to eat more meat and buy more cars, among other things.

The result is that U.S. inflation rose to 4.1 percent last year, the highest since 1992, driven by higher energy and food prices. But as Mr. Bernanke pointed out in congressional testimony earlier this month, the rate of inflation excluding those expenses is running at half that pace — a tamer 2.1 percent. The so-called “core” rate of inflation reflects the modest and even falling prices for goods like clothing, appliances and computers.

Inflation rages outside U.S.

Inflation in many countries, by contrast, is running substantially higher, ranging from 7.1 percent in China and 12.4 percent in Russia to more than 25 percent in Venezuela and 150,000 percent in Zimbabwe.

Countries like Venezuela and China have amassed huge dollar holdings as a result of oil sales and trade surpluses with the United States, and they are using those dollars to send the price of oil and other raw materials higher.

Not surprisingly, faced with raging inflation at home, oil producers have been aggressively pushing for higher oil prices to fuel their booming economies. The United Arab Emirates, Qatar and other oil producers in the Persian Gulf, where inflation is running close to 10 percent, are in the middle of major building booms funded by oil dollars. They particularly want to maintain their purchasing power in euros because they have extensive trade ties with Europe.

The dollar has lost almost 90 percent of its value against the euro since 2002 and is down more than 25 percent against other major currencies. The euro topped a record $1.55 yesterday in New York trading.

The persistent slump in the dollar — which is driven more by burgeoning trade deficits than the Fed’s rate cuts — has become a perennial reason for global producers to raise prices.

Terry Francl, senior economist at the American Farm Bureau Federation, said high food prices reflect soaring international demand for crops, led by rapidly growing emerging economies, as well as the high cost of oil, which is needed not only to run farm machinery but is also used to make fertilizer.

Surging U.S. demand for ethanol, which is made from corn, as a substitute for international oil supplies also has driven up prices for corn and animal feeds, leading to higher prices for meat and processed foods.

Economists say there is little the Fed can do to control the external forces driving global commodities higher. Mr. Bernanke noted with some frustration in his testimony, for example, that oil producers have been engineering high oil prices, and he does not know where oil prices will go this year, even though the overall rate of inflation in the U.S. largely depends on it. He said the Fed’s only goal can be to prevent high energy prices from spreading to a larger inflation problem in the U.S.

While the drop in the dollar has increased inflation pressures, Mr. Bernanke noted it also has spurred a boom in exports as foreigners take advantage of cheap dollars to buy U.S. goods. Robust exports are now the strongest sector of the economy and may be the only thing keeping it out of recession right now, analysts say.

With the U.S. economy barely growing since the end of last year and job losses mounting, the Fed chief expressed confidence that inflation will have little chance of surviving in a weak economy while the greatest danger is falling into recession.

Even if the economy avoids recession, the Fed expects weak growth to drive up the unemployment rate to 5.2 percent by the end of the year — an increase that would mean more than a half-million people losing jobs. Unemployment could go still higher if the economic slump becomes severe.

What worries the Fed chairman is the downward spiral in the housing and credit markets since August. That has the potential to become self-reinforcing in a way not seen since the Great Depression, with falling house prices and rising joblessness leading to a cascade of foreclosures, financial losses and bank failures. Such a chain of events could hold down the economy for years.

Divide emerges within Fed

In an unusual break with Fed protocol, some regional Fed bank presidents have pointedly taken issue with Mr. Bernanke by voting against rate cuts and publicly airing their dissonant views.

Richard W. Fisher, the Dallas Fed’s president, said recent inflation readings have been “alarming” and recent talk about “cheap money” makes his “skin crawl.” He said that the global nature of the inflation problem makes it far from certain that inflation pressures will abate as the U.S. economy slows.

The drop in the dollar and rise in long-term interest rates after the Fed cut rates this year suggests that markets are unnerved that the Fed may be unleashing inflation, he said, adding that proving such market speculation wrong should be the Fed’s “overarching purpose.”

William Poole, president of the Fed’s St. Louis reserve bank, recently went so far as to say a mild recession that wrings out inflation is preferable to a Fed strategy that just delays the inevitable downturn and worsens inflation in the meantime.

Economists say the most serious inflation irritant in the economy is the high price of oil, because it not only directly raises consumer heating and motoring costs but it also adds to price pressures throughout the economy by raising the cost of manufacturing and transporting nearly everything people consume.

While many people blame the falling dollar for high oil prices, the dollar’s drop does not in itself explain the fivefold increase in oil prices from about $20 in 2002.

Oil producers have received a powerful assist from speculators riding the wave of rising oil prices as well as small investors who recently have been using oil and other commodities such as gold as hedges against inflation and the falling dollar.

In a sign of the speculative rage that has taken hold of oil prices, the relentless rise of crude has continued for weeks despite signs that the United States may be in a recession and fuel consumption here is dropping.

Alan Reynolds, a senior fellow at the Cato Institute, said the Fed most likely would induce a recession if it ignored such fundamental factors as falling demand at home and attempted to control global oil prices by keeping interest rates high. He said Fed efforts to stamp out oil-fueled inflation in the past were the main cause of U.S. recessions — a fact that Mr. Bernanke himself has documented in economic studies.

The Fed under Mr. Bernanke has “embarked on a fascinating new experiment,” Mr. Reynolds said, by trying to avoid repeating historic mistakes. The result should be a better chance for growth.

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