The current surge in construction materials prices is similar in scale to the initial period of the steep price rises in 2004-05. This is ominous. That period of rapidly rising materials cost persisted for 22 months with an accumulated 18.3% rise in costs. Materials prices rose at a 16.5% annual pace in the first four months of 2008, close to the 18.4% rise in the same months in 2004.

However, the current period of rapidly rising materials costs differs in two significant ways from the previous price surge in 2004. First, metals, lumber, cement and gypsum drove the price increases in 2004. Now, lumber, cement and gypsum prices are approximately steady but energy and petrochemical prices are soaring. As a result, in contrast to 2004, single family construction is now experiencing relatively little materials cost increases when highway construction is now experiencing relatively high materials cost inflation.

Second, prices surged in 2004 when the economic recovery, overseas as well as in the US, was earlier and stronger than anticipated. This forced materials suppliers to ration supplies with price increases until they could expand production. The 2004 price surge began when extra capacity was available, with a brief lag, from most materials supply industries.

The current surge in materials prices is being driven by a physical shortage of raw commodities, especially for energy and metal ores. This is unlike four years ago when mothballed capacity could be brought back into production reasonably quickly. More ore and oil supply now requires additional and more expensive mines and oilfields.

The implications of this are frightening. We could be facing much longer than 22 months to boost supply up to the demand level. Realistically, some the potential price increases will be bled off in the form of a slower growth economy as materials buyers react to higher prices. That food prices are also rising quickly now for the same reasons is an additional complication that will also likely be absorbed, in part, by slower economic growth.

The term “stagflation” — slow growth and high inflation — has recently reappeared in the news after an absence of about two decades. Expect to see it more often in the next few years as we make the hard choice between growth and inflation.

Help is on the way. So far the US has borne far more than its share of the burden of adjusting to strained energy supplies. That is because of the combination of the declining US dollar and our practice of setting energy prices in competitive market. Outside of the US, prices for nearly half of the worlds’ oil have been restrained by rising currencies and prices controls on energy products. The energy subsidies used in much of the world, including china and India will be about $100 billion this year. This is double last year and again double several years ago.

Most foreign governments, excepting oil exporting countries, can not sustain these subsidies. Already some Asian and Latin American countries have cut subsidies and raised selling prices substantially. More countries will follow suit, eventually even China and India. As this happens through next year, some of the price adjustment burden will be lifted from US energy buyers and assumed abroad. Energy prices will begin to decline.

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