2

Fed's Hoenig Finds Bitter Inflation in Colorado Chocolate Plant

By Vivien Lou Chen

July 18 (Bloomberg) -- For Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, chocolate isn't as sweet as it used to be: The cost of almost every ingredient has gone up.

``Commodities across the board have pressured us,'' said Bryan Merryman, the chief financial officer of Rocky Mountain Chocolate Factory Inc., as he led Hoenig on a two-hour tour of the company's Durango, Colorado, factory this week. ``There are a lot of pressures in our system that we haven't seen before.''

Nestled on the western slope of the Rocky Mountains about 400 miles (643.6 kilometers) southwest of Denver, the 53,000- square-foot (4,770-square-meter) factory offers a glimpse of how Fed policy makers gather anecdotes that shape their views on the economy. Hoenig, one of 12 regional Fed presidents, said he takes road trips two or three times a year. The factory visit supports his worries about inflation, he said.

``When you see a business like this one, where everything it uses has been accelerating in price, you see what it does to a business person,'' Hoenig, 61, said. The July 15 visit ``reinforced the way I think, because I'm on record as being concerned about inflation,'' he said.

A day after the trip, the Labor Department reported a 5 percent increase in consumer prices for the 12 months ended in June, the most in 17 years. Fed policy makers are trying to fight inflation and economic weakening. Growth for the six months ended in March was the slowest in five years.

Rocky Mountain's sales began to slow in September, Merryman said. Now, ``our business is certainly in a recession. I don't know what the catalyst is going to be for a turnaround.''

Rising Costs

Cocoa prices have risen 10 percent annually for five or six years, and fuel and corn syrup are climbing at annual rates of 30 percent or more, Merryman said.

The central bank is facing the biggest U.S. financial crisis since the Great Depression, according to the International Monetary Fund, amid collapsing home values and lack of credit for many borrowers. Fed Chairman Ben S. Bernanke told the Senate Banking Committee in Washington on July 15 that risks have increased for U.S. growth and inflation.

Durango, best known for whitewater rafting, kayaking, and access to five major ski areas, has largely been shielded from the ``peaks and valleys'' of the real-estate market because of economic diversity, said Gary Derck, chief executive and president of the company that manages the Durango Mountain Resort.

The Old West city of about 15,000 people has a college and a medical center and acts as a center for the oil and gas industry in the U.S. Southwest.

Donning Hair Nets

Hoenig and the Kansas City Fed's Denver branch directors donned hair nets and peppered Merryman with questions on the tour as they watched workers make Rocky Pop caramel corn and raisin clusters.

Rocky Mountain's revenue for the fiscal first quarter ended May 31 dropped to $7.1 million from $7.3 million a year earlier as fewer customers visited its more than 300 stores. Rocky Mountain shares have dropped 45 percent this year to $8.72 yesterday on the Nasdaq Stock Market.

With chocolates priced at $19 a pound, Rocky Mountain positions itself between Godiva Chocolatier Inc., owned by Yildiz Holding AS of Turkey, and See's Candies Inc., owned by Berkshire Hathaway Inc.

While states such as California, Florida and Nevada were hit by falling real-estate values during the past year, the Kansas City Fed's district has been insulated by surging farm incomes and farmland values. The district includes Colorado, Kansas, Nebraska, Oklahoma, Wyoming and parts of New Mexico and Missouri.

`Modest' Growth

Economic growth in the seven-state area has been ``modest,'' with higher gasoline and food prices limiting spending at malls in April and May, according to the Fed's most recent summary of current economic conditions in the region.

Anecdotes like the ones gathered at the Rocky Mountain factory make their way into the Fed's so-called Beige Book report and are a part of a give-and-take process of gathering and sharing information, Hoenig said.

``The Fed is not just a Washington-centric institution,'' he said. ``It's an institution that has 12 regional banks reaching out for information and sharing information with citizens.''

Hoenig, who makes 50 to 60 mostly private speeches a year, said he plans to make trips to Oklahoma City and Scottsbluff, Nebraska, later this year.

``What the reserve banks hear from their contacts can provide the Fed with an early warning of changes that may not show up in the published statistics for several weeks or even months,'' said Al Broaddus, former president of the Richmond Fed.

`Emotional Recession'

While Durango Mountain Resort is expecting a 20 percent year-over-year rise in lodging rates and volume from June to September, some families aren't staying extra nights or buying vacation homes, Derck said.

``We think we have an emotional recession that's preventing even folks whose personal situations are better off than a year ago from investing, spending and enjoying life,'' he said before meeting with Hoenig at the French restaurant Chez Grand-Mere. ``People who are affluent and well-off have a brain, too, and have the same psychology: They don't know what the next shoe is to drop.''

To contact the reporter on this story: Vivien Lou Chen in San Francisco at vchen1@bloomberg.net

Last Updated: July 18, 2008 01:01 EDT