Why the Latest Inflation Figures Are a Paper Tiger
News was bad on the inflation front Friday morning. The Labor Department said wholesale prices of raw materials--wheat for bread, oil for gasoline, lumber for houses, newsprint for the newspaper you hold in your hand--posted a sharp rise in August. Stock and bond markets trembled at the prospect of higher inflation and the Federal Reserve raising interest rates once again to slow the economy.
Nothing will happen immediately. The Fed will watch such wholesale figures--Friday’s numbers indicated a 5% to 6% annual inflation rate--to see if they lead to a broad rise in consumer prices and wages, explains economist Daniel Sichel of Washington’s Brookings Institution.
But what else is new? Markets are always trembling, and Fed officials continually ponder inflation barometers. The problem with such news is that it really gives you no information at all.
For understanding, we need to go behind the news--to note, for example, that it was short-term considerations that caused some prices to rise. A big wheat sale to Russia pushed up grain prices, but wheat prices are already falling back; lumber prices rose on threats of a strike in Canada, then fell on news of labor peace.
And for a deeper understanding, we might look through the prism of the paper business, a vast industry of more than $100 billion in revenues spread among more than 30 major companies in the United States, which leads the world in paper production and technology.
Paper prices, whether linerboard for corrugated boxes or market pulp for facial tissues or newsprint, are going up faster than at any time in 50 years. Why? Recovery from a four-year depression in which prices fell and paper mills closed, for one thing.
The big reason prices are going up right now is added demand from the rapidly developing countries of Asia, where millions are reading newspapers and using computer printout and fax paper for the first time. Their demand, added to traditional business in the strong U.S. economy and recovering Europe and Japan, explains why U.S. and Canadian paper plants are operating at 95% of capacity.
But does that warrant a hike in interest rates that could stall expansion, cost jobs and further hike mortgage rates. No, not necessarily. Supplying new customers is not inflationary, especially if new plants are built to increase production. And new plants are always going up in the paper industry, which right now is building recycling plants in response to other pressures.
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Sawmills, for example, have gotten more efficient at converting timber to lumber for housing. “More efficient” means they leave fewer wood chips, the raw material for pulp from which paper is made. Also, one company found a way to use wood chips for building materials. “Wood fiber has become more expensive and harder to get,” says analyst Richard Keletas of McLean McCarthy, a Canadian investment firm. All this adds up to higher prices for newsprint and other paper grades.
Thus the shift to recycling of old newspaper and office waste paper, which is the way all new plants are going to make paper. That’s why the old newspapers collected at your church or community center have risen in value lately, from $10 a ton to $70 a ton.
Recycling plants are not cheap--a de-inking machine costs $100 million, and a recovery boiler another $100 million. But this is an industry that has always spent big, throwing up a dozen $1-billion mills every year even in bad times.
It is because paper plants are expensive that paper prices go through cycles, falling when there is overcapacity and rising when supply and demand come into balance.
What lies ahead now? Repeat of the normal cycle, say analysts. New plants will increase supply; economies will slow, reducing demand; prices will fall.
But a couple of longer term perspectives should be noted.
One is that paper continues to be in demand, despite the spread of electronic media and talk of information highways. Analyst Mark Rogers of Prudential Securities reports production of printing paper and many other grades is at near-record levels right now.
Another perspective is that a more permanent increase in demand for paper and other raw materials will occur in the late 1990s, says David Shulman, chief investment strategist for Salomon Brothers. As Asian and Latin American countries reach full development, “that will take demand and production and possibly prices onto a higher plane altogether,” he says.
But even if predictions were undeniable facts, that would not be an argument for imposing higher interest rates on U.S. business now, as it invests in new plant and equipment to be ready for the expanded world economy. The Commerce Department last week reported that all U.S. industry is increasing capital investment 9.4% this year.
And one should always keep in mind that economies run on human ingenuity, not on numbers. The paper industry has seen the likes of Owen Cheatham, who saw that Southern pine could be used for paper and lumber as well as Pacific Northwest timber. Cheatham, who died in 1970 at age 67, borrowed money, bought trees in his native South and built Georgia-Pacific--and the Southern forest products industry.
Vision sometimes needs timing. Roger Stone, chairman of Stone Container, foresaw today’s rising use of paper and packaging by developing countries. He borrowed billions to make acquisitions of linerboard manufacturers. But he plunged in too soon. Chicago-based Stone Container has lost money four years running, eaten up by interest on its debts. Still, Roger Stone, 59, may yet see his vision fulfilled as packaging grows worldwide.
In fact, a hot company in the industry right now is Riverwood International, an Atlanta-based supplier of printed cardboard cases for soft drinks and beer and of the machinery that makes the packages. Riverwood is following Coke and Pepsi around the world, supplying the packages as more countries come into the supermarket age and customers carry home 12-packs of soft drinks.
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Paper is an industry based on brains, not on trees; Brazil has trees, but burns them to clear land. Years ago, Harry Merlo, chairman of Louisiana-Pacific Corp., developed a way to use wood chips for a particle board that was cheaper than plywood. His company has thrived on that development.
But that use of wood chips and other factors make wood fiber expensive. So the paper industry is responding by recycling old newspapers for its raw materials.
Such adaptability is why predictions or fears about prices and markets tend to be folly--and why one should always look for the story behind the numbers.
