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Where'd All This Inflation Come From?

Not that you need reminding, but in just the past year:

  • The price of corn is up around 65%.
  • The price of eggs is up around 28%.
  • The price of bananas is up around 21%.

I would cite the increase in the price of gasoline, but by the time you read this it'll probably be up another 10%, so we'll just settle for the fact that it's gone up a lot. And then some.

Make it stop!
Open any economics textbook and you'll learn that inflation is caused when demand increases relative to the supply of goods. 

While there are several forces bullying around the price of commodities right now, some of them don't fall into standard academic study. The typical inflation stimulant -- lower interest rates, which lead to more money in the banking system, which leads to more bank lending, which leads to more spending -- falls flat right now. Yes, interest rates have been slashed, but if anything, banks are curtailing their lending practices. Alas, we can't blame everything on Ben Bernanke, although it’s a pastime that rarely gets old.

So where on earth is all this inflation coming from? Here are a few inflation fuelers specific to today's economic climate.

The supply/demand balance for oil isn't encouraging. Billionaire oil tycoon T. Boone Pickens thinks production of 88 million barrels per day is about as good as it's going to get. When friendly, oil-rich countries can't increase production, reliance falls more on less-friendly countries.

If a political conflict arose in Iran, oil-rich neighbors like Saudi Arabia might not be able to make up the slack. If Venezuela president Hugo Chavez comes through on his threats to cut off oil sales to the U.S., there isn't much that friendlier oil-exporting countries like Canada and Mexico can do to alleviate the burden. Last year, Chevron (NYSE: CVX  ) , BP (NYSE: BP  ) , and Total (NYSE: TOT  ) had their stakes bought by Venezuela's national oil company after Chavez tightened his grip on foreign partners. Such events scare the dickens out of countries that rely on imported oil -- like the United States -- which in turn drives prices higher.

The weak dollar
People all around the world buy commodities from each other based in dollars. When the value of the dollar falls, the price of commodities has to go up to even things out. That's a big part of the reason multinational companies that do business in nondollar currencies, like Procter & Gamble (NYSE: PG  ) , Coca-Cola (NYSE: KO  ) , and Philip Morris International (NYSE: PM  ) , will likely fare better than many companies stuck within our borders.

Driving the problem further is America's foreign trade deficit -- fueled in part (ironically) by demand for foreign commodities. Not only does America's thirst for foreign commodities push demand higher, but it pushes the value of the dollar lower, causing a one-two punch than can do a number on your wallet.

Hedge fund hysteria
Hedge funds now control more than $2.8 trillion, and every single one of those dollars wants to be where the big returns are. With investors who'll force managers to answer to subpar performance at the end of a pitchfork, there's a tremendous amount of pressure to ensure that results keep up with the competition. What's been one of the hottest sectors over the past few years? Commodities. So that's where the money rushes to.

Many think hedge funds are pilling into commodity futures markets in an attempt to hedge against further inflation, causing a process that feeds on itself over and over again. More hedging pushes prices up, which calls for more hedging, which pushes prices up ... The problem is further exacerbated because those who really need to use the commodities futures market as a hedge -- farmers trying to minimize costs -- are at the mercy of financial titans with bigger bank accounts.

Don't give up
But enough doom and gloom. If you play your cards right, inflation doesn't have to be a death sentence for your finances. How can individual investors protect themselves from the perils of inflation? Check out:

Total SA is a Motley Fool Income Investor pick. Coca-Cola is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Morgan Housel owns shares in Procter & Gamble and Philip Morris International, but none of the other companies mentioned in this article. The Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (19)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 09, 2008, at 5:51 PM, stapelbroek wrote:

    Just a note. Oil is mostly fungable. (Not entirely because refineries need specific grades.) If Venezuela cuts off the US and still sells the oil on the international market, it will simply displace oil from other sources we can then buy. For his threat to be more than symbolic, he needs to withhold the oil--something I believe would put his government in a difficult position funding-wise.

  • Report this Comment On June 09, 2008, at 7:32 PM, slapshot10 wrote:

    You missed the real reason for inflation as all economic classes will teach... an increase in the money supply. As America should be aware, the printing pressess have been printing as fast as they can. Look at an M3 graph and you will see how much this increase has been over the last 10 years. This is why the dollar has to go down, why commodities priced in USD have to go up, and why prices to consumers will also go up. This is the real reason for inflation. This is also why the Fed are responsible for our inflation!

  • Report this Comment On June 09, 2008, at 7:51 PM, Candide08 wrote:

    The continual blaming of Bernanke for just about everything is getting very old.

    If anything Bernanke is cleaning up Greenspans mess.

    Greenspan took great glee in horribly popping the "tech bubble" - instead of "letting the air out slowly."

    Greenspans actions just about created the housing and mortgage bubble, that Bernanke has to deal with.

    Let's at least see some balance - and dump on Greenspan where appropriate.

  • Report this Comment On September 15, 2008, at 2:23 PM, JustNobody wrote:

    Our goods are transported via the trucking industry that is paying 5 times more for fuel than in 2002. That extra cost is passed on to the consumer and it appears as inflation to us. It is not supply and demand at work here, it is Captalism run amuck by greed. I am not in the trucking industry, just a retired consumer.

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