Crude is at record highs (though not quite as high as it was in 1980-1981 when you adjust for inflation.) But crude only needs to rise as high as $101 a barrel to reach the all-time inflation adjusted high. During the last peak price, Jimmy Carter was president and inflation was running so high the Fed had to raise interest rates to 18% to crush it.

That can’t happen this time, right? Look at gasoline prices. Gasoline actually seems cheap right now (under $3.00 a gallon in most parts of the country.) It’s been falling in recent weeks. No inflation there.

Larry Kudlow, an economist and talk show host on CNBC, actually said on his show this week that crude was not an inflationary indicator. He thought that higher oil prices merely reflected a strong global economy.

And so they do. Demand is outstripping supply.

But it would be foolish to say that simply because gas prices haven’t been rising in recent weeks (give it time) that $90 crude isn’t “affecting” the economy.

Do you have any idea how many products use crude and crude byproducts? Thousands. All of them are about to get a lot more expensive.

These products use crude

Ink
Make-up/Cosmetics
Crayons
Bubble gum
Telephones
Tires
Sunglasses
Tape
Ammonia
Purses
Deodorant
Pantyhose
Basketballs
Floor Wax
Petroleum Jelly (such as Vaseline)

This is just a short list. It goes on and on and on.

How can it be that the maker of, say, crayons is not feeling the squeeze from the higher prices? Of course they are. They all can’t be eating the difference. Their margins are going to shrink. Eventually, they’ll have to raise prices on their products.

Chemicals, those that are byproducts of crude and those that aren’t, are seeing severe spikes in prices. So severe that manufacturers that use these products are in disbelief at the price movements. The following is just one of the recent price increases:

Sun Chemical announced price increases in Europe of 6 to 12%, depending on the specific products, due to continued and rapid increases in raw material prices as well as shortages of many key ingredients, mainly for pigments’ manufacturing.

The increases, effective from November 1, 2007, will cover Sun Chemical’s complete portfolio, in all the markets in which it operates.

Felipe Mellado, corporate vice president marketing, Sun Chemical Europe, said: “Sun Chemical is proactively working with its supplier base, monitoring industry conditions and continuing internal efficiency programmes to mitigate the impact of rising costs, material scarcities and transportation availability.”

Sun Chemical is a big manufacturer of ink. Not inflationary, huh Larry?

The average consumer just thinks that because gasoline is “affordable” that the record crude prices aren’t affecting them. How wrong they are.

Watch crude prices. It is much more of an inflation indicator than watching the CPI number or going to your local gas pump.

Is it any wonder why gold usually moves in tandem with rising crude prices?

Both can sniff out inflation when needed. Both are on code red right now.

The Fed says that inflation is “contained.” The pundits on tv claim that inflation is within the “comfort zone.” Yet companies around the world are raising prices to combat increases in natural resources and agricultural commodities. Some recent examples:

Starbucks recently raised its prices as coffee beans continue to go up in price.

According to the Wall Street Journal, three of China’s largest instant noodle makers (and China is the world’s largest producer and consumer of instant noodles) colluded on illegal price increases. They were raising prices in response to rising prices for wheat and flour. Additionally, palm oil, a main ingredient, is up nearly 70% in the past 12 months through June.

Rising prices are putting the squeeze on the companies gross profit margins, even as sales increase.

The Chinese government has ordered them to roll back prices even as wheat continues to move higher. Said Julie Chu, an analyst at Sinopac Securities in Taipei:

The costs of raw materials have to be passed on to end prices. There has to be some transition.”

You would think so, right?

Caterpillar just announced that it will be raising prices on its machinery in January as aluminium, nickel and steel prices continue to increase. From the Chicago Tribune:

The company will boost machinery prices by as much as 5 percent and engine prices by as much as 6 percent, according to a filing Tuesday with the Securities and Exchange Commission. The increases will affect most models, said spokeswoman Rachel Potts.

With wheat reaching records, companies like General Mills and Kellogg are shrinking their cereal boxes (to keep prices down). The consumer, therefore, is getting less product for the same amount of money. Kellogg also said it would take a hit in earnings this year because of the increase in agricultural prices. Sounds inflationary to me, but what do I know?

Watch gold. It’s moved over $700.

This morning the most recent consumer price index number was released (otherwise known as the CPI.) It tracks the rise and fall of consumer prices on items such as energy, food, housing, autos, clothing and furniture.

The “core” rate was only 0.1% which is very low. That is essentially telling us there is no inflation in the economy among consumer prices.

But the overall rate was 0.7% which is pretty high. That number includes both food and energy, which have been soaring.

Wall Street and economists have resoundly refused to include food and energy in inflation calculations arguing that they are but a small percentage of overall consumer spending. For instance, consumers spend only 6% of their income a month on energy. So if you have only that 6% of a consumer’s budget up by 10% month over month, it’s not going to have that big of an impact (is their thinking.)

Energy, by the way, WAS up 10%. That isn’t surprising given the prices we’ve seen in the past few weeks at the pump.

Auto prices actually declined last month (were in the negative) as well as other items like airline tickets.

But I ask this: how many of us buy a new car on a monthly basis or even fly on a monthly or weekly basis (where it is coming out of our own pockets?)

I don’t know of many. Recently, one of the newspapers (might have been the Wall Street Journal) reported on the price on hotel rooms in Manhattan. The demand is so great that you aren’t getting room, even in the Motel 6 (yes, there IS one in Manhattan) for under $400 a night. And that’s a standard room, with a standard bed and no other frills.

You can see the cost of doing business in Manhattan now (let alone vacationing there- unless you’re a European with the good exchange rate.)

Hotel rooms are another item that just keep going up. My grandmother lives in small town Michigan with a population of 8,000. The local motel there charges $100 a night. I’ve looked in nearby larger towns (Holland, Kalamazoo) and the prices are even higher ($130 and up.)

While it’s true that some other items, like clothing and furniture, are seeing a decline in prices, I still don’t believe you can just brush off or discount what is happening in two key sectors: food and energy. If you combine the two, they are at least 10% of the average consumer’s budget. Add on rising health care costs and rising home costs (not in rents but in mortgages) and there are lots of inflationary indicators.

Maybe the core CPI number just isn’t relevant anymore?

Thank goodness the rest of the core is not yet rising as food and energy are or we would be in real trouble. Maybe that is what the Wall Street crowd is celebrating: the inflation news isn’t great but it’s not horrible either. I’ll keep my eye on the supermarket and the pump though.

There’s something in the air with the bond markets. The recent sell off in the 10 year treasury- now 39 basis points in less than two weeks- smells of something more sinister.

Yes, the dreaded “bond market vigilantes” are back.

I use the word “dreaded” only because Wall Street partygoers hate them because they bring sanity back to the financial markets. In the 1980s and 1990s, the bond market vigilantes were known for pushing treasury yields up when they though the Fed was misbehaving with the money supply and/or if inflation seemed to be ticking up.

But lately, they seemed to be more like the 17 year cicadeas, sitting underground for years and not seen.

Is this an emergence? Or is it a fake-out?

There is clearly enough evidence to give bond market vigilantes pause regarding the economy. Heck, don’t they go grocery shopping? Have they checked out the $7.00 a gallon orange juice lately?

I knew eventually the bond market vigilantes would return. They are, once again, causing havoc on the stock market with the sudden sell-off in bonds. All stock investors should have a strong stomach in the coming weeks because it could get rough.

There seems to be a bit of a panic over the bond market and that leads to interesting behaviors. The “herd” doesn’t like panic. It usually overreacts when there is a panic.

Ultimately, as I said, it is usually a good thing when the bond market vigilantes DO appear. For me, it seems like it is too little too late. They should have been pushing up rates years ago (at least in 2005- as housing went into orbit.)

Why now then? Maybe the inflationary signals were just too hard to ignore.

Stay tuned. Investing is about to get really, really interesting.