Inflation looms as oil prices soar



According to Stephen Hoch, most young people in America today don’t know what inflation is.

But Hoch, chair of Wharton’s Marketing Department, says they may soon become quite familiar with it. The reason is simple: Oil prices.

With oil prices still hovering around all-time highs and not expected to drop anytime soon, the next few months may prove to be a challenging time for American consumers, Hoch says. Gas prices remain sky-high, winter heating bills figure to be an enormous drain and retailers are already bracing for a disappointing holiday season. Costs are rising for suppliers and businesses, and it may not be long before those costs are passed on to consumers.

“If you look at core inflation [which doesn’t include gas costs] today, it’s still pretty low,” says Hoch, who also directs Wharton’s Jay H. Baker Retailing Initiative. “But if you look at inflation including gas and food prices, it’s quite a bit higher. Many young people haven’t ever experienced inflation, but the rest of us have. It’s a 25-year memory, but I think we’ll start remembering it better really quick.”

It’s fairly easy to see why, Hoch says. When a business at the top of the supply chain sees its fuel prices skyrocket, it may raise prices on its product from, say, $1 to $1.05. The next business on the chain, in order to absorb that cost, raises its prices in response. So does the next business. And suddenly, that 5-cent price increase has been multiplied many times over.

“The mentality right now is that businesses are still trying to hold the line and not pass on price increases,” Hoch says. “But once that resolve is broken, it just becomes part of life. Once other people have done it, it’s like a disease.”

So why haven’t they gone ahead and raised prices?

The answer, Hoch says, is Wal-Mart. The retailing giant has so far held off on price bumps, but the question is how long it can hold out.

And were Wal-Mart to finally give in, the shockwaves would be felt across the economy.

“Frankly, if they jumped on the bandwagon [of price increases], things would become clear that we’re in a more inflationary environment,” Hoch says. “We have an important player in the economy who, basically, has resolve. If we look back to the last big inflationary period, in the late ’70s and early ’80s, the king of retail was Sears. They were glad to pass on everything.”

Wharton finance professor Jeremy Siegel, like Hoch, sees inflation—and a rough few months for consumers—as a distinct possibility.

But Siegel says that may not be a bad thing entirely. Americans in recent years have “gotten lazy” about energy conservation, buying up gas-guzzling SUVs and putting efforts to find alternative energy sources on the back burner.

Once they’re faced with a rough winter of high gas, heating oil and natural gas prices, they’ll become much more conscious of conservation. And in the long run, that could pay dividends for all of us.

“I’ve always claimed that the best energy policy is higher prices, because that’s the only way we’re going to get conservation on the part of consumers and get new supplies of energy,” Siegel says. “The recent price surge has really woken us up. We got lazy. Gas dropped down to a buck a gallon, and nobody wanted to conserve. Nobody wanted a fuel efficient car, and now suddenly people care about them.”

Already, he says, consumers are clamoring for hybrid cars and seeking out ways to better insulate their homes. Sales of gasoline, meanwhile, are 5 percent below trend.

The situation will spur government spending on new energy sources and open doors to energy-saving entrepreneurs, Siegel says.

“It’s going to be across the board, and eventually this is what’s going to spark the development of new power sources,” he says. “I think we’re going to see more government support and research in this area, and we’re going to see private firms set up here, because there’s a profit to be made.”

Originally published on October 20, 2005