Not since Americans came home from World War II has inflation run through the economy like it is now

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Residential single family homes construction by KB Home are shown under construction in the community of Valley Center, California, U.S. June 3, 2021.
Mike Blake | Reuters

Not since Americans came home from World War II has inflation percolated through the U.S. economy like it is now, and it could continue to do so for months to come.

That's because the pandemic hit the economy like a sledge hammer, shattering the normal way business is conducted and consumers live their lives. The disruptions for many businesses have been difficult to repair, and the return to normal has been challenging due to supply chain disruptions and labor shortages.

“You had a very quick and abrupt shift in the economy,” said Michael Gapen, chief U.S. economist at Barclays. “And it takes time to retool. It's a super tanker. It takes time to turn.”

Companies and consumers across the country are feeling the hit from rising prices and goods shortages, and many businesses are adjusting the way they operate.

Frank Barbera, president of Barbera Homes in the Albany, N.Y. area, said this period of rising prices is unique in the 30-year history of his family business.

“The costs definitely went up faster than the price. Our average home is up over $60,000 and that's just hard costs passed along. The average two-by-four for example over the course of the past year from July, 2020 to roughly the same period in 2021, went from $4.30 to $11.36,” he said. The two-by-four is now about 50% lower but lumber is still volatile.

Barbera said other building materials have also gone higher, including a 20% increase in insulation this year.

Homebuilder Chris Carr said his construction company has changed the way it buys some materials for the homes he builds in New Jersey beach towns, like Avalon and Stone Harbor. 

“We've acquired more storage space so we can store all the things we are buying. We're buying truckloads of roofing materials” plumbing supplies and other materials, said Carr, owner of McLaughlin Construction.

“Before we were just-in-time purchasers, and so for certain aspects of a home we can't do that anymore.”

Pressures on prices

Pent up demand, changing lifestyles and a load of stimulus money created a surge in demand for all kinds of goods. But that demand has met a supply network that was also damaged by the pandemic and is struggling to return to a more normal level of activity. Labor shortages and logistics problems are compounding the situation.

Gapen said the consumption of core goods is now about 17% to 20% above pre-pandemic levels and core services demand has not yet recovered. Core goods exclude food and energy.

“It's like any economy in any situation would be in trouble if its citizens were requiring it to produce 20% more goods in one year's time,” he said. Post-pandemic consumers changed their lifestyles. Many fled to suburbs and beyond, moved into houses, and furnished home offices. They also needed cars.

“It's the greatest historical anomaly in the relationship between core goods and services prices that we've seen since the end of World War II,” said Gapen. “I think the World War II experience is the closest parallel to what we're seeing.”

Soldiers returned home in the late 1940s, and the demand for everything from housing to clothing soared. “You had to rejigger the economy and re-employ all those people. What happened is you had an inflation boost for two or three years,” Gapen said. “By the end of the '40s, you were flirting with deflation.”

The debate among economists is how much of this pandemic era inflation will linger and how much of it will be temporary. In October, the consumer price index was up 6.2% year-over-year, the highest in 31 years. Core CPI, excluding food and energy, was up 4.6%.

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Goods prices across the board have been rising. The price of gasoline in October was up about 50% over last year. Used cars were up 26%, and new cars were up nearly 10% year-over-year.

The index for meats, poultry, fish and eggs jumped 11.9% while beef prices were up 20% from a year ago in October.

“It's a relative demand story. Three [core] goods categories are responsible for most of that inflation – autos, used autos and household furnishings. Bigger durable items,” he said.

For decades, core goods prices have fallen relative to services. “It's just really unusual to see this surge in goods prices and trend because of things like technology innovations and globalization had meant that you may pay more for that computer, but the computer you have today is far more powerful than the one you had 20 years ago,” Gapen said.

Apparel and appliances are two areas where globalization has resulted in lower price trends. According to Moody's Analytics, relative to the overall consumer price index, the price of appliances is down 46% since the year 2000, meaning appliance prices are higher but they are 46% lower than consumer prices. Apparel prices are also higher but they are 43% lower than consumer prices in that period.

An area where prices have risen very rapidly was hospital services, where prices are 92% higher than overall consumer prices since 2000.

Gapen notes that normally consumers tend to halt purchases of durables in more traditional downturns, leading to price declines of core goods. But as the economy recovers from its downturn, household demand for durables tends to increase, bringing prices back up.

But the pandemic was unusual and instead it boosted goods prices relative to services, raising concerns about how long prices will rise.

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Mark Zandi, chief economist at Moody's Analytics, does expect to see a decline in prices in some categories next year.

Meanwhile, the inflation could feed on itself as consumers and businesses acquire hard-to-get items, making prices go even higher. But that cycle should break once producers catch up, inventories build and overproduction could cause prices to drop.

He therefore expects inflation to ultimately fall back to about 2.5% for core CPI, excluding food and energy.

“It may take until early 2023, but I think we'll settle into 2.5% core CPI. I actually think there's a possibility that prices are actually lower again. I think energy prices will come in, vehicle prices will come in and various building materials will come in,” he said.

But still, there is a risk they won't.

“If these spikes in prices do affect inflation expectations and get embedded in wage price dynamics then we have a problem,” Zandi said. “I don't think we're there. I think this is garden variety supply shocks which result in big price spikes but that sows the seeds of future declines.”

“At that point you have prices coming back down to earth, and that's the dynamic I think we're going to see,” he said.

Paying the rent

Shelter costs are an area where many renters would expect to see a sharp increase, but they rose just 3.5% year over year in October in the CPI. The category includes rents and owners equivalent rent, and makes up about a third of CPI.

Rent is one area where economists expect to see continued price increases, even as other categories fall. According to Apartment List, rents between the beginning of the year and October were up 16% nationally, and CPI data should start to catch up.

“That's being affected by the pandemic but regardless of whether there's a pandemic or not, rent prices would have accelerated because of an affordable housing shortage,” said Zandi. “The pandemic made it worse because you have all these millennials that went back to live with their parents or doubled up when the pandemic hit. They're all starting out on their own, forming households and renting.”

Zandi said rent is adding a half percentage point to his 2.5% CPI forecast, and that is the factor that could keep inflation above the Fed's 2% target.

Builders, like Barbera, are still seeing strong demand for single family houses even with much higher prices. In order to meet demand, Barbera is carefully managing what he builds.

“We limited our lot releases so in some neighborhoods we stopped selling temporarily or we limited the amount of lots we put on the market at one time so that we could have better control over not only costs but labor, making sure we could produce what we're selling,” he said. “We have been fortunate. We have a very stable trade base, but everyone is working 24/7 just to keep up.”

He's hoping prices will start to stabilize.

“Other than lumber, I cannot foresee any of the products we're currently using coming down in price, and I don't see labor coming down. It will find its peak, but materials have not leveled off yet,” Barbera said.

But for small businesses, the challenge is to operate effectively.

“With the price increases we've seen, we had a lot of homeowners who have said 'holy smoke, this is expensive!' Then it's our job to make them understand what the trigger points were that made it expensive,” said Carr. “Other than lumber, every other material we're seeing is going up in price. On a weekly basis, we're getting price increase notices. It's a very volatile market.”

Carr emphasizes that the volatility, except with lumber, has been one way. “I'm not getting 2% to 3% price notices from these suppliers. I'm getting 10% to 15% increases multiple times a year,” he said. Carr said depending on the home, the cost is 25% to 50% higher in the past two years. “Land values have increased. The whole package has increased.”

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