"Inflation is Very, Very Low"...For Now

“We do not now have a problem…. Inflation made here in the US is very, very low”
– Federal Reserve Chairman Ben S. Bernanke, February 10, 2011

When inflation is rising, it is necessary to take matters into ones’ own hands, or, get crushed. Those who remain whole during inflationary periods act early.

What follows are summaries of recent quarterly earnings reports. Most of these companies have headquarters in the United States, although they buy and sell worldwide. The key take-away is that inflation is a major burden.

As such, the key question investors must ask themselves is, “How imminent and pervasive is the threat of resurgent inflation.” Bernanke says inflation is “very, very low.” Corporate America begs to differ.

Numerous quarterly reports from large multi-national companies indicate very clearly that inflationary pressures are building. Here’s a representative sample:

DuPont & Co. – Fourth quarter sales rose 15%; net profits fell 15%. “DuPont forecast raw-material and freight costs to be some 4% to 5% higher this year than last, moderating from the 6% rise seen in 2010. [Executives] were confident they would be able to pass these on to end users. Ethane, chlorine, solvents, and pigments were seen as the key areas of cost pressure.”

Procter & Gamble – Sales rose 2%; net profits fell 25.5%. “P&G, which sells everything from Tide detergent to Olay skin-care products, said its commodities bill will cost $1 billion for the fiscal year that ends in June, more than double what it had expected.”

Colgate-Palmolive – “Colgate’s profit fell [in the fourth quarter] 1%…squeezed by higher commodity costs and money paid to promote its products.”

3M Company – Fourth quarter sales rose 10%; net profit fell 0.7%. “Margins declined under rising material costs and weakening sales in the company’s health care and graphics businesses… 3M said it intends to recover higher material expenses through price increases, which include Scotch tape, Post-It notes, furnace filters, sand paper, automotive components, and thousands of other household and industrial items.”

Pepsico – [Pepsi-Cola, Frito-Lay, Quaker, Tropicana, Gatorade] – Full-year reported earnings per share increased 4%; fourth quarter earnings per share declined 6%. CEO Nooyi was pleased with the results, but acknowledged she is “mindful of three realities: (1) A weak consumer landscape given the poor macroeconomic picture, especially the high level of unemployment in key developed markets; (2) High levels of cost inflation for the coming year, driven by broad and pronounced commodity inflation; and, (3) A potentially difficult competitive pricing environment, particularly in beverages.” Hugh Johnson, Pepsi’s CFO, talked about cost inflation of 8% to 9.5%: “That type of inflation has a pretty strong impact.”

Goodyear – [tires, blimps] Net fourth quarter sales rose 14%; with a $177 million fourth quarter loss. “Raw material prices costs are likely to rise 25% to 30% in the first quarter of 2011 and rubber prices have risen 40% since October [2010].”

Whirlpool – [Maytag, Kitchen Aid] Fourth quarter sales fell 1%; profits fell 61%. It is “seeking to offset cost increases for such items as steel, copper and plastics…”

Electrolux – [refrigerators, washers] “Operating income in North America and Europe declined as the company was hit by higher costs for raw materials and lower sales prices.” “The costs for our most important raw materials continue to increase,” Electrolux CEO Mr. McLoughlin, said in a statement. “In addition to increased costs for steel, we also see considerable increases in resins (used in plastics) and base metals.”

In light of these firsthand accounts from the business world, Bernanke’s QE2 campaign is succeeding all too well. Inflation is on the upswing, just as he planned. But once this genie emerges from the bottle, there’s no telling what will happen next. Before long, the genie makes the rules; not the Federal Reserve Chairman. And often, the rules the genie makes are ones that punish the prudent and reward the reckless.

“Inflation is a means by which the strong can more effectively exploit the weak,” Federal Reserve Governor Henry C. Wallich, declared in a 1978 commencement address at Fordham University. “[Inflation] introduces an element of deceit into our economic dealings… [T]he increasing uncertainty in providing privately for the future pushes people who are seeking security toward the government.”

Wallich went on to tell the Fordham graduating class of 1978 that, during inflationary periods, contracts are no longer made to “be kept in terms of constant values.” By definition, one party to the contract understands this reality better than the other. The one who understands that tomorrow’s values will be much lower than today’s values is the one who benefits.

In other words, as inflationary pressures build, the forward-looking individual will want to prepare in advance. But that means the forward-looking individual will also want to ignore all the assurances from Washington and Wall Street that “everything is under control.” The latest testimony from the titans of global commerce demonstrates very clearly that Bernanke’s “very, very low” inflation has already become uncomfortably high.

Prepare accordingly…or you might get crushed.


Frederick J. Sheehan
for The Daily Reckoning

The Daily Reckoning