4 big retailers fight the inflation economy

By Jim Jubak

Inflation is reshaping the economy. And since this is an odd kind of now-you-see-it, now-you-don't inflation, the changes in the economy are far-reaching but subtle.

You can see the shape of the new inflation economy in the tales of four retailers, all of which have released sales numbers recently.

If you're wealthy, you probably aren't feeling the current bout of inflation at all -- and you certainly aren't changing your buying habits.

Tiffany (TIF, news, msgs) is doing just fine, thank you.

If you belong to the lower half of the economic pyramid, higher inflation mostly takes the form of higher energy prices -- even though those aren't a part of the official inflation core. Stretching that paycheck to the end of the month is a challenge in the best of times and, since these aren't the best of times, you're hunting even harder for bargains. When you can't find them, you're cutting back on what you buy, period. Wal-Mart Stores (WMT, news, msgs) feels your pain at its cash registers.

And the middle-middle to upper-middle class? We're showing the most interesting and far-reaching changes in purchasing behavior of all. Although the overall rate of inflation is modest, inflation in the big-ticket service expenses, such as tuition and health care, that eat up a huge chunk of middle-class income is soaring at near double-digit rates.

But even though we may be strapped for cash, the middle class doesn't easily give up its aspirations to luxury. In our buying, we're looking to goods that combine low price with quality design to feed our appetite for luxury. And thanks to falling prices for goods, the middle class is finding it possible to buy luxury at bargain prices at stores such as Target (TGT, news, msgs) and Costco Wholesale (COST, news, msgs) that have cracked the code.

No inflation and double-digit inflation

It's all a result of the very peculiar nature of current inflation.

On the one hand, there is no inflation.

For example, I recently went shopping for a 5,000 BTU window air conditioner for my son's room to replace his very noisy and very energy inefficient seven-year-old unit. A year ago we paid $229 for a similar air conditioner for my daughter's room, so my wife and I were pleasantly surprised to find a new Panasonic 5,000 BTU, the updated version of the model we bought last year, selling for $179 at our local appliance store.

That's a huge 22% drop in the air-conditioner inflation index in a year.

On the other hand, there's double-digit inflation.

Private-school tuition for my two kids will pop 9% and 11%, respectively, for the 2006-07 academic year. That's above the national average of a 7.5% increase in college tuition for 2005, according to the U.S. Bureau of Labor Statistics. But it's near the 9.5% increase in the national average in 2004 and the 8.4% increase in 2003.

Painful hikes in service costs

And tuition bills aren't the only thing going up at close to double-digit rates. In the first quarter of 2006, for example, health-care costs rose at an annualized rate of 8% to 10% (depending on whether you get your health care through an HMO or a individual physician), according to the Arlen Group, an employee-benefits consulting company.

What explains this now-you-see-it, now-you-don't inflation pattern?

The breakdown is pretty simple. If you're looking at the cost of a manufactured product, the price is likely to be steady or even falling. If you're looking at the cost of a service, the price is likely to be climbing and maybe even climbing fast.

According to the Consumer Price Index (CPI) for the three months that ended in April 2006, the annual inflation rate for personal-care products was -2%, for footwear -1.6%, and for new cars -0.3%. Meanwhile, the annual inflation rate for personal-care services was 4.1%, for tuition 5.4%, for hospital services 10.6%.

Stunned by gas prices

In short, any product facing the intense pressure of the global economy -- and the vast new manufacturing supply added to that global economy by China, India and other developing countries -- is likely to be showing very small price increases, despite the rise in the cost of raw materials such as oil, iron and copper. Any service that is domestically produced and that can't easily be outsourced to cheaper service providers overseas, such as hospital care, is rising in price -- often at a rate substantially above the official rate of inflation.

Energy is the huge exception to this pattern. The surge in gasoline prices in the first part of 2006 took the annualized inflation rate for the three months ending in April to 55%. That's a stunning number. It will come down as the gasoline-price spike of early 2006 yields to a more gradual increase in the price of gasoline. But as distorted as the number is by short-term volatility, it is a good indicator of the kind of pain that everybody who drives is feeling right now.

These inflation trends play out differently, however, depending on where you stand on the income pyramid. For lower-income consumers, the pain of higher energy prices trumps all else. The top income levels aren't yet seeing any reason to rein in their luxury buying. And the middle income levels, squeezed disproportionately by the huge inflation in services, are busy shifting costs.

Evidence at Wal-Mart

Higher energy prices have so much impact on lower-income consumers because these aren't exactly boom times for these folks to begin with. Real hourly wages for blue-collar manufacturing workers and non-managerial service workers were up, as of April 2006, 0.1% from April 2005. And, thanks to longer hours worked, weekly wages were up 0.4%, according to the Bureau of Labor Statistics. The cost of gasoline is up about 20% in that same period, according to the bureau.

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