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Experts fear US price pressures could worsen
Updated: 2004-11-21 09:14

After years of relative calm on the inflation front, Americans are being battered by $2-a-gallon gasoline, rising food prices and higher medical bills. And there are fears that price pressures could worsen in 2005.

The problem came into sharp focus last week when the government reported that wholesale prices increased in October by the largest amount in more than 14 years, and prices at the retail level recorded the biggest gain since May.

At the same time, energy prices experienced another jump, climbing at an annual rate of 22.5 percent through October. This has contributed to inflation's rising at a 3.9 percent annual rate this year, compared with 1.9 percent in 2003.

Inflationary pressures have led some economists to worry about a possible nightmare scenario: The dollar weakens dramatically, which drives up import prices; as terrorists attack overseas oil production facilities, which drives up energy prices; and like that, America's productivity miracle, a main reason for moderate inflation in recent years, disappears.

Economists acknowledge this is a worst-case scenario. Still, they say some shock is likely.

"If my inflation projection for next year goes haywire, it will most likely be because of external factors such as geopolitical tensions or terrorism that we have no control over," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.

Some economists see inflationary pressures next year that will result directly from Bush administration policies on the dollar.

The administration insists it favors a strong dollar yet has done nothing to check the greenback's slide over the past three years. This decline could help combat the widening U.S. trade deficit by making American products cheaper abroad and imports pricier in this country.

Treasury Secretary John Snow and other U.S. officials have pressed China to sever its currency's direct link to the dollar. U.S. manufacturers contend that practice has undervalued the Chinese currency by as much as 40 percent and given China a substantial advantage against U.S. competitors.

If China should allow financial markets to set the value of its currency, that could mean steep price increases for the billions of dollars in imported Chinese products from sneakers to high-tech electronics that U.S. consumers have grown to love.

The threat of higher inflation will come not only from China but other Asian countries. They have managed their currencies to keep them from rising against the dollar.

"Once the Chinese revalue, almost three-fourths of consumer goods imported into the United States will see price increases," said Mark Zandi, chief economist at Economy.com. He said a change in China's currency policies could raise U.S. inflation rates by at least one-half a percentage point.

Other economists play down the impact of revaluation and see a potential offsetting positive development: global textile quotas will be lifted in January, which should increase supplies and lower clothing prices in the United States.

Analysts note the dollar already has fallen by about 26 percent since early 2002 against a market basket of major currencies while import prices have risen only slightly. Foreign producers, not wanting to lose U.S. market share, have been absorbing much of the difference from a falling dollar.

"Foreign producers want to keep a strong foothold in the United States," said Nariman Behravesh, chief economist at Global Insight in Lexington, Mass.

Another worry on the inflation front is whether the burst of productivity the country has enjoyed since the mid-1990s will continue.

The increase in the amount of output for each worker has meant higher corporate profits and raises for employees without making shoppers pay more for goods. Should productivity growth slow significantly, as some fear, companies might have to start raising prices.

Oil prices, which reached a record $55 per barrel last month, are troublesome. But many economists foresee a gradual retreat, barring supply disruptions from events such as a terror attack in the Middle East.

Lower energy costs would bring good news to air travelers and help energy-intensive industries such as building materials and chemicals. Even food costs, which have climbed this year, should moderate in 2005 as the cost of shipping eases, analysts believe.

David Wyss, chief economist at Standard & Poor's in New York, said that barring an inflationary jolt next year, he sees consumer prices rising by 2.2 percent, compared with 3.9 percent so far in 2004.

Given the expectation that inflation will ease, analysts see no reason for the Federal Reserve to deviate from its plan to raise interest rates by steady increments of one-quarter of a percentage point through most of the central bank's meetings in 2005.

Of course, if inflation does start rising at a faster pace, the Fed undoubtedly will respond with bigger rate increases.

"The Fed has to balance the risks between inflation and economic growth," Wyss said. "I think they are doing a good job, but one of the problems for the Fed is that you can never know the future."

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