The Insistent Fugue

The nation adjusted to its resource problems grudgingly in 1974, as it did to other aspects of a generally traumatic year. Prices were the key point of irritation. Inflation, which had already been a consumer fact of life for several years, hit home with renewed impact. Almost all price and wage controls came off, and even where they theoretically remained, it made little difference. Energy costs, both at the gasoline pump and at the household meter, zoomed from inconvenience to grievance. If one kind of food wavered for a hue in its price rise, there were others to take up the insistent fugue. Costs of apparel, rents, services, and whatever else seemed important were all upward bound. Despite numerous wage adjustments, average real (price-adjusted) income declined—and for the unemployed, the unorganized, the pensioners, the situation was especially alarming. There was no longer an evident shortage of goods. What hurt, as prices kept rising, was the shortage of dollars.

Some observers insisted that this was a real resource problem, that concrete forewarnings of the ultimate limits to growth were being visited upon us. Others viewed the difficulties of the year as the results of trying to do too much at once—especially of trying too quickly to clean up the environment while at the same time endeavoring to expand our domestic resource base. Many focused on the unnovel phenomenon of lagging industrial capacity, hampered in its return to the over-investment phase of the familiar cycle by the skyrocketing cost of money. Still others emphasized the "administered" character of the price system. And at the extreme there were those who maintained it was all a well-organized plot by the powerful against the powerless.

Omitting the "wholesale conspiracy" and "beginning of the end" theories, all of these views seemed to possess some merit. But none by itself can explain the double-digit inflation, which has been a dynamic process, feeding upon itself. Of the prime movers in this process, two commodities have been of salient importance: grains and oil. Each of these bulks large in both consumer and producer purchases, each has widespread multiplier effects, each has been pushed up in price by an unusual set of circumstances, but neither reflects a basic resource shortage.

Food accounts for roughly 20 percent of the average urban household budget. Meat and poultry account for about one-third the cost of food consumed at home, dairy products for about one-sixth, and cereal products (including baked goods) for around one-eighth—in combination, over one-half the food-at-home total. Meat, poultry, and dairy prices, in turn, largely reflect the prices of animal feedstuffs. For example, every dollar's worth of meat and poultry, as sold by the producer, embodies some 80-90 cents of feed. Feed, in turn, is 80 or 90 percent grain. As of November, the retail price of beef had increased about 60 percent over 1967 average levels; the price of poultry and dairy products each about 50 percent; the wholesale price of grains about 180 percent; livestock on the hoof about 60 per-cent; and live poultry about 80 percent.

Most of the increase in the price of grains took place prior to 1974; the December 1973 level was nearly 150 percent over that of 1967. The explanation for the initial rise lies primarily in soaring foreign demand, especially the large sales of grain to the U.S.S.R., and the depletion of surplus stocks (see "Depleted Granary," below). The failure of prices to stay down in 1974 after a springtime drop may be attributed mostly to the vagaries of the weather.

A small, but noticeable, part of the continuing upward pressure on food goes back to the price of oil. Roughly half the total value of crop output in the United States is attributable to supplies and materials produced off the farm. In turn, directly and indirectly, at least 10 percent of the cost of such supplies is petroleum. Petroleum fuels farm machinery; petroleum (along with natural gas) is the source of much of the raw material for fertilizer. In addition, it is largely petroleum that brings the food from farm to market. In this manner, petroleum has been one of the insistent contributors to the continuing inflation—not only down the road at the gasoline pump, but closer to home, in the meat freezer and the bread basket.

Direct household purchases of fuel and power now account for about 8 cents out of the average dollar spent on personal consumption. Of this 8 cents, utility bills (gas, electricity, and fuel oil) comprise about half and gasoline the other half. The energy input into all other consumer goods and services, such as food, clothing, and recreation, adds roughly another 5 cents, bringing the role of energy in the consumer budget to about 13 cents per dollar in total.

The diversity in regional experience and among individual fuels makes generalization hazardous. Nonetheless, it appears that during the decade of the 1960s, all consumer fuel and energy prices, and particularly that of electricity, which was steadily increasing its share of the household market, were falling in real (relative) terms. Around 1970 this downward trend in real prices was arrested, and, since 1973, consumer fuel and energy prices have been outrunning the rest of the consumer price index. By November 1974, household fuels and utilities combined were 19 percent higher than in November 1973. Of the main sources of household energy, heating oil showed the sharpest rise: 46 percent. Electricity rose by 21 percent and natural gas by 16 percent. During the same period, the consumer price index as a whole rose "only" about 12 percent.

As with food, the impact of higher utility prices has fallen with particular severity on poorer families, who spend about 15 percent of their total income on direct purchases of energy (compared with 4 to 5 percent for more affluent households) and whose energy consumption may already be at such minimal levels that further savings are difficult to achieve.
The other major item of direct energy expenditure is gasoline. Gasoline prices began to rise rapidly in the fall of 1973, and by mid-1974 they were more than 40 percent above pre-embargo levels. As of November, there had been a small decline, but this still left a much sharper net increase than that in the general price level.

The reasons behind these developments are complex, and some predate the 1973 embargo. Well before that episode there had been signals that the easy supply conditions of the 1960s were a thing of the past and that increases were to be expected in the prices of all types of energy. The 1970 National Power Survey, for example, forecast a rise in the real cost of electricity in marked contrast to the previous long-term decline. Coal prices had already started rising in the late 1960s, and increases began to be permitted in the regulated price of natural gas. Though crude oil prices had not yet risen sharply, a declining ratio of proved reserves to annual production presaged increasing price pressures.

These market conditions were also setting the scene for precipitate price action by the Organization of Petroleum Exporting Countries (OPEC). Since the mid-1960s, the gap between U.S. energy consumption and domestic production had been widening, leading to a sharp increase in U.S. oil imports, particularly from the Persian Gulf. These increased imports contributed in turn to the tightening of the world oil market, already under strain from the rapid increase in world demand. Thus the OPEC found it possible to accelerate crude-oil price increases, which during the 1960s had been quite modest. By early 1974, typical delivered costs of Saudi Arabian crude, for example, were more than triple those of a year earlier. This reversed the relationship of imported crude to what had traditionally been regarded as the "high-cost" American product.

Pre-embargo developments had already led, in the spring of 1973, to the reimposition of special price controls on oil. A two-tier system was set up, with the intention of encouraging increased production of "new" domestic crude while avoiding sharp increases in the price oil whose development costs had already been incurred. Successive OPEC price increases inevitably tended to draw the freed domestic price similarly upward. By mid-August 1974 the price of "new" oil, by then so broadened in definition as to apply to some 37 percent of domestic supplies, had risen to $10 per barrel, comparable with the price of imports.

Controls over the refining and retaining parts of the industry were designed to limit end-product price increases, yet permit the pass-through of increases in raw material cost. However, the differing costs of crude resulted in some very erratic price patterns, even within limited geographic areas. In the fall of 1974, for example, the average cost of domestic crude petroleum to refineries was just over $7 per barrel, while imported crude was costing them about $12.50. These prices compare with $4 and $3, respectively, at the beginning of 1973. The cost effect on any individual refinery or power station depends on the relative proportions of "old," "new," and imported supplies used, but at a minimum, fuel costs have risen by 30 percent and more typically by over 50 percent. Sharp as this may be, without price controls the rise would have been much greater.
Rising prices of crude oil and fears of shortage have naturally increased interest in other fuels, even though it is difficult ordinarily to change quickly from one source of fuel to another. Under such pressure, coal prices resumed an upward climb and even the regulated prices of interstate natural gas started rising sharply.

What are the likely effects of such price rises on industrial costs and thus on the general rate of inflation? Though energy is used ubiquitously, it accounts for only a small proportion of costs in most industries. In 1972, the total value of basic fuel supplies—that is, the mine or wellhead value of domestic coal, natural gas, and crude oil plus net imports of these items—totaled about $23 billion, or about 2 percent of GNP. A year later the same amount of fuel supplies would have cost about $43 billion, thereby directly contributing almost 2 percentage points to the 8 percent inflation rate of this period.

The effect of rising basic fuel prices is spread quite unevenly. Some industries are energy-intensive and therefore experience above-average increases in costs. For manufacturing generally, the recent average cost of purchased fuels and electricity has been between 1 and 2 percent of the value of goods sold. But for primary metals and for stone, clay, and glass products (including many building materials), the percentages have been about 3.5 and 4.5 respectively. Lumber and paper industries are also much more energy-intensive than the average. In transportation, rising energy costs have led to steep increases in total operating costs, particularly for the most energy-intensive modes, such as ships and airplanes. The higher costs of the energy converting sector (e.g., refineries, utilities), where the basic fuels are both raw material and a source of operating energy, were quickly reflected in sharply higher consumer utility and gasoline bills.

These higher prices, among other factors, have already had depressing effects on consumer purchases, notably of cars, large, detached houses, resort vacations, campers, and second homes. Even should the recession and inflation dissipate to-morrow, much of the heightened energy consciousness will probably remain, with permanent imprint on both private habits and public policy.