Three Inflationary Case Studies: Coke, Pasta And Rent

Tyler Durden's picture

Following what appears to be just the beginning of a major market flush which could well bring the S&P to triple digits in order to serve as a catalyst for QE3, the word inflation has become taboo: after all, it is expected that Bernanke will have snapped his fingers, and the 15 minute count down to deflation will start. Alas, no. There are at least three products in which inflation has proven to be particularly stubborn, all due to a unique set of factors. The first one is Coke (the drink, although probably not isolated thereto), which just announced plans to hike prices 3 yo 4% due to still surging commodity costs. The second is pasta, whose prices are also set to soar, this time due to adverse climatic conditions. Per Bloomberg, "Unrelenting rainfall may have slashed U.S. planting of durum wheat to the lowest level in more than 50 years, fueling a surge in the price of pasta and noodles as mills scramble for supply of the grain." And the last, and possibly most perverse price spike, is the one which will actually hike the CPI, due to an increase in the shelter, or rents, component, as more and more Americans forgo owning a home in exchange for renting, in the process pushing up the one component that accounts for 41% of core CPI. In this way we see three completely unrelated channels in which inflation will continue to push through even as stocks plunge: an event which most MMT theorists always perceive as inherently deflationary.

First, on the Coke price hike:

Coca-Cola Co. (KO) plans to raise prices 3% to 4% on drinks beginning July 31 to combat rising commodity costs.

The price increase, reported by trade publication Beverage Digest and confirmed by a Coke spokesman Friday, will vary across different sizes and drink brands, and will result in prices being 5% to 6% higher than they were a year ago. The magnitude of the announce price increases is in line with Coke's announced pricing plans.

The report cited a letter from Coca-Cola Refreshments, Coke's company-owned bottling business in North America, to retailers.

Another independent Coke bottler, Coke Consolidated, plans to raise prices 3% to 5% in early July, according to the report, which also noted that most other Coke bottlers will likely raise prices by similar amounts.

Next, the reason to start warehousing pasta:

Unrelenting rainfall may have slashed U.S. planting of durum wheat to the lowest level in more than 50 years, fueling a surge in the price of pasta and noodles as mills scramble for supply of the grain.

Farmers who normally are finished planting by now had completed just 44 percent as of June 19 in North Dakota, which produces more than two-thirds of U.S. durum, government data show. It’s too late to sow more without delaying the harvest to the winter-frost period, said Frayne Olson, an agricultural economist at North Dakota State University in Fargo.

Planting may drop 47 percent this year to 1.365 million acres, the lowest since 1959, Olson said. In the past month, parts of North Dakota and Montana, the second-biggest grower, had triple the normal rainfall, National Weather Service data show. North Dakota durum prices are up 52 percent in the past month, and U.S. pasta in May was the most-expensive on record.

“Basically, the selling has shut off in the U.S., because if you’re a holder of durum, there’s no point in selling it,” said Jim Kulp, a general manager at Philadelphia Macaroni, which makes pasta including the Alphabet Soup noodles for Campbell Soup Co. “If you’re holding durum wheat, it’s like gold. So why would you sell it?”

Durum futures:

Grain elevators in North Dakota are paying farmers about $14.40 a bushel for durum on average, up from $9.50 a month ago, North Dakota State’s Olson said. The price may top the record of $23 reached in February 2008 if additional weather problems hurt crops this growing season, he said.

The price of durum is rising faster than wheat futures on the Chicago Board of Trade, which primarily track the soft-red winter variety grown in the Midwest. Wheat futures are up 41 percent in the past year to $6.6925 a bushel yesterday.

“Higher durum prices are going to work their way through the system to higher pasta prices,” Olson said. “The cost of durum in the total cost of manufacturing pasta is fairly significant. There’s a limited amount the pasta manufacturer can do to absorb that cost differential. This will eventually have to be passed on to consumers.”

And the third iteration of inflation comes in the form of product substitution, in this case one which will actually hike the very metric used to measure inflation. Greed and Fear's Chris Wood explains:

One technical problem for the Fed is that core CPI inflation is rising because the so-called “shelter” component, which measures rents, is rising. Thus, core CPI inflation rose from 0.6%YoY in October 2010 to 1.5%YoY in May. While the shelter CPI, which accounts for 41% of the core CPI basket, rose by 1.1%YoY in May, up sharply from a 0.7%YoY decline in August 2010 (see Figure 1). GREED & fear is not surprised to see shelter rising. For the one segment of the American housing market GREED & fear is long-term bullish on is rental housing. This is because Americans will now want to rent not buy, as they are fast learning to appreciate the flexibility that comes with not being trapped in negative equity. Remember that 22.7% of American mortgage holders are now in negative equity, with another 5% of borrowers having less than 5% equity, according to real-estate research firm CoreLogic. It is also the case that there are good deals for tenants in rentals because of the continuing excess supply of housing.

Ironically as the Obama administration has realized this urgency to move from home purchases to rents, his latest action will be one of further stimulus, this time one which will however blow the Core CPI inflation out of the water due to the heavy weighing of rents in the Core CPI basket. From Reuters:

The Obama administration is exploring ways to support rental housing as the troubled U.S. real estate sector has kept potential buyers on the sidelines, a top U.S. Treasury official said on Friday.

"We support a housing finance market that provides liquidity and capital to support affordable rental options and help alleviate the burdens that many low-income households face," Treasury Under Secretary Jeffrey Goldstein told a housing conference.

"We are also exploring how private channels can finance affordable multi-family housing, perhaps with limited, targeted governmental support," he said.

Goldstein said the administration's range of options to expand support for lending for multifamily rental properties include reforms such as risk-sharing with private institutions.

It would be very paradoxical if the Fed will soon be willing and able to commence QE3 due to "deflationary" concerns, better known as plunging stocks, only to see artificially stimulated Core CPI prohibit this overture courtesy of increasing Obama efforts to pander to voters as the presidential race picks up in earnest.