Here’s why inflation numbers are about to get worse

This week the government announced that the inflation rate – as per its Consumer Price Index – has reached 7 percent, the highest it’s been since 1982.  But ask any business owner and they’ll tell you that the consumer price index only tells us about the past. It isn’t the true indicator of future inflation. The future is all about the Producer Price Index (PPI), which measures the costs to make things. That index rose a whopping 9.7 percent. And – bad news, everyone – inflation is going to go a lot higher in the months to come because of this.

Why? Because there are many different materials that go into the PPI. Some are used more frequently than others. So we have to dig further. And when we unpeel the PPI and look closely at the costs of the core materials and labor used in manufacturing, farming and construction, we find that prices have risen much, much more than the reported 9.7 percent. And those prices are ultimately going to find their way to customers in the coming months. Maybe you don’t believe me. So, let’s go to the data.

For starters, the costs of most of the core raw chemicals that make up just about everything we use are skyrocketing and show no sign of future relief. Aluminum is used in just about all sectors of the economy, and the costs of this core material have risen 37 percent in the past year and show no sign of letting up. Tin, which is used as a protective coating and alloy for steel, has gone up 116 percent. Speaking of steel, the cost of iron and steel has shot up 87 percent.

The index gets pulled down because a few materials dropped in price. But those materials – graphite being one (a drop of 16 percent) – are used less often than the core materials I’ve mentioned above. Graphite, for example, is used primarily for lubricants, batteries and fuel cells. Meanwhile, the costs of all industrial chemicals have gone up 42 percent.

Yes, many of these materials are commodities, and the price of commodities can fluctuate. But there’s no indication that our worldwide supply chain and labor shortage problems are going to be resolved any time soon. Plus, with countries such as China shutting down entire regions as I write this due to omicron, it looks like these materials – and the labor to produce them – will continue to be in short supply, with higher prices as a result.

All in all, the total costs of manufacturing have increased more than 15 percent over the past year. But it’s not just the manufacturers that are suffering.

Farmers are paying almost 16 percent more to feed their animals and 92 percent more for potash, which is one of the main ingredients in fertilizer. Construction businesses are seeing enormous increases in the costs of lumber (after ups and downs, lumber costs are now up almost 19 percent this year) and concrete (almost 9 percent). In fact, the costs of all construction materials have increased 35 percent this year. Corrugated container costs, which make up packaging, have gone up 20 percent. And shipping costs are up overall a whopping 25 percent.

Let’s not forget labor. Payroll company Paychex reports this week that its hundreds of thousands of customers are now paying an average wage of $30 per hour, an increase of 4.27 percent, which is the highest level since Paychex began reporting these numbers more than 10 years ago. Total compensation of all salaried and hourly employees rose more than 11 percent this year.

Doesn’t this seem like a lot more than the 9.7 percent rate the government reports? It does because it is.

And I’m ignoring the enormous amount of cash washing around in the system thanks to the various stimulus and spending actions taken by Congress, let alone the added $4 trillion of liquidity provided by the Federal Reserve to prop up the economy during the pandemic. The Fed already plans to have anywhere from three to four interest rate hikes this year to taper down this liquidity. Will their strategy work to curtail inflation in 2022? Given its performance over the past couple of years, many business owners I know are skeptical. They have a right to be.

So they’re preparing. They’re trying to lock in longer term supply, lease and employment agreements where they can. They’re refinancing. They’re buying up inventory and property if they can afford it. They’re investing in technologies to cut overhead. Some are practicing “shrinkflation,” where they’re selling fewer products and services at the same price. Others are simply raising prices and hoping their customers will understand. They’re also huddling with their financial advisers and re-positioning their assets into more interest-friendly vehicles.

They’re doing this because they know that more inflation is coming this year. Why? Because it’s simple economics: Demand remains strong, and supplies remain short. The underlying costs that make up the Producer Price Index are already giving us that warning.

But don’t fret, folks. This is just business. And there is a little bit of good news here: The price of alcohol has gone up by less than 1 percent so far. My advice to clients? Drink up. It’s going to be one of those years!

Gene Marks is founder of The Marks Group, a small-business consulting firm. He frequently appears on CNBC, Fox Business and MSNBC.