Busts, and Food Prices
by Gary North: World's
Longest-Using WordPerfect Author Abandons WordPerfect After 30 Years
have heard about rising food prices. It is happening all over the
world. We hear of Third World rural populations that are trapped
by rising food prices.
Why are food
prices rising? Simple: because urban people in formerly Third World
nations are getting richer. India and China are the obvious examples.
As these economies are freed from the regulations that once burdened
them, the growing urban middle class bids up the price of food.
People with money in their pockets like to eat more and better food.
In the bidding war between rural people with little capital and
therefore low incomes vs. urban residents with more capital and
higher incomes, rural people lose.
The price of
food is rising not just in U.S. dollar terms, but in terms of all
currencies. This is not a U.S. phenomenon only. This is international.
When we compare
the rise in the price of oil since 1999, the rise in the prices
of commodities in general (including gold and silver), and the price
of food, food remains a bargain. Two
charts are here.
in 2008 drove down the oil price from $147 to $33 in the final five
months. This was a collapse. The price of food fell, too, though
not to this extent. Silver and gold fell silver far more
sharply than gold. This indicates the degree to which commodities
are tied to the worldwide business cycle. Commodity prices fell
because the international economy fell.
are not the initiating force in price inflation; monetary policy
is. The prices of raw materials rose in the first decade of the
21st century because central bank policies around the world were
expansionary. When the recession hit in 2008, the prices of commodities
fell, but not until several months into the recession. (Gold and
silver fell in March, before the others fell.)
There is an
ancient error, stretching back to Adam Smith, which says that retail
prices rise because of cost-plus inflation. Prices for raw materials
rise, forcing up retail prices. This was refuted by Carl Menger,
the original Austrian School economist, in 1871. He showed that
production costs rise in response to bids by entrepreneurs, who
in turn expect rising demand for the output of their enterprises.
The prices of economic inputs rise in response to expectations.
When, in the
second half of 2008, entrepreneurs and speculators finally recognized
the extent of the recession, they stopped bidding for as many raw
materials. So, the prices of these production goods fell.
It is true
that monetary policy affects the business cycle. It is true that
QE2 is inflationary. But let us not mistake cause and effect. The
increase in commodity prices all over the world ever since early
2009 is the result of simultaneous central bank policies. The Federal
Reserve System and other large central banks began inflating in
late 2008 to reverse the banking panic by large depositors, not
small depositors, who were covered by FDIC rules.
of late 2008 have not produced mass inflation, because commercial
bankers have increased their banks' excess reserves at the FED and
other central banks. They are not lending all of the money that
they are legally entitled to lend.
QE2 has nothing
to do with much of anything. Yet.
did not get rolling until early in 2011. For most of 2010, the Federal
Reserve System was deflating. This
is seen in the chart of the adjusted monetary base.
prices rose in 2009 and 2010.
cause of this increase was the prior monetary policies of central
banks, late 2008 to early 2010.
increase in the adjusted monetary base in 2011 indicates that the
"exit strategy" of 2010 has ended. Bernanke keeps talking about
being ready to adopt an exit strategy when the time is ripe. This
is a smoke screen. The FED actually began to adopt a policy that
can best be described as an exit strategy in March 2010. It has
made a fast exit from the exit strategy in 2011.
prices could continue to rise in expectation of a QE2-generated
recovery later this year is quite possible. It depends on what entrepreneurs
expect commercial bankers to do. Will bankers lend? If so, the M1
supply will rise, and so will the M1 multiplier. That will force
up prices. But QE2 may fail to persuade commercial bankers to lend.
Then the FED will be pushing on a string.
My point is
this: you should pay no attention to anyone who tells you that the
rise in food prices has been the result of recent Federal Reserve
policies. Commodity prices rose in 2010 despite a policy of monetary
deflation by the FED. This is rarely discussed by financial commentators.
I think the
upward move of commodities will continue until China goes into recession.
China's central bank is raising interest rates. As far as we are
told, monetary policy remains expansionist. But rising rates for
commercial banks will have the effect of making commercial loans
unprofitable for some entrepreneurs. They will cease hiring workers.
They will cease buying commodities. This is what the Austrian theory
of the business cycle teaches. In order to avoid price inflation,
the central bank changes course and lets interest rates rise. This
ends the boom.
At the margin,
Western consumers are not the source of the rise in food prices.
The West is rich. It allocates relatively little of its monthly
expenditures to food. When Western incomes increase, the bulk of
the money does not go to increased consumption of rice, wheat, and
corn. This is not the case in the Third World. When people move
from the country to work in urban settings, they increase their
purchases of food. Their mark of wealth is their ability to buy
more food. They bid against each other. They bid against rural residents.
price of oil and food indicates a growing economy worldwide, just
as falling prices in the second half of 2008 indicated a contracting
Oil is extremely
volatile because of the inability of buyers to store large quantities
in reserve. This is not true of foodstuffs. The food is kept in
grain elevators. The price of food is less volatile than energy
prices, because entrepreneurs who hold grain in reserve can sell
into this increased demand. This increases the supply of food available
to retail food producers.
AND FOREIGN CURRENCIES
One of the
marks of an ill-informed analyst is the absence of any discussion
of foreign central bank policies in relation to Federal Reserve
policies. Let me explain.
Food in foreign
countries is priced in the domestic currency units of those countries.
What the Federal Reserve does is not directly relevant to the economies
of those countries.
When the FED
increases the monetary base by purchasing Treasury debt, this reduces
the interest rate of short-term bills, but it can and did
increase the mid-term rates. This was not what Federal Reserve
economists would have imagined. You
can see what happened in February.
of limited magnitude have little effect on foreign central banks.
They buy U.S. Treasury debt for other considerations than a few
hundredths of a percentage point in interest. They buy for reasons
of mercantilism: subsidizing their export sectors.
resident in a foreign nation bids for food, as for all other scarce
resources. But he bids in terms of his nation's currency unit. This
has nothing directly to do with the Federal Reserve and QE2. The
bidding process raises the price of food. Americans must bid more
dollars to buy food. But this demand is in terms of consumers' output,
not dollars. Japanese residents bid with yen. Americans bid with
U.S. dollars. Chinese residents bid with yuan. But to buy yen, dollars,
or yuan, residents must sell their output. They are buying food
with their output. This is the fundamental fact of all pricing.
The FED inflates
the monetary base. This may or may not lead to increased M1 and
a higher M1 money multiplier. At some point, Americans will get
their hands on some of this new money. They will bid for goods and
services. But they will not bid very much extra for increased food.
If Richard Simmons had his way, Americans would bid more for a new
Richard Simmons DVD on how to lose weight by this or that technique.
They would bid more for fresh fruits and veggies and less for snack
foods that most people enjoy eating. Snack foods are more about
packaging and taste than about the cost of grains to produce them.
So, what matters
most for the price of food in a foreign country is the domestic
monetary policy and economic output in that country.
If the central
bank of some Asian country tries to keep its currency from rising
in relation to the U.S. dollar by inflating the domestic currency,
this will affect the price of food there. The increased monetary
expansion will fuel the boom phase of the boom-bust cycle. This
will goose the economy by lowering nominal interest rates. But this
effect would not take place if the central bank did not tamper with
the money supply or the interest rate on short-term government bonds.
To blame Bernanke
and the FED for the rising cost of food is based on a misunderstanding
of the currency markets. It blames a cause which is not in fact
the primary cause. The primary cause is rising output increased
bids in Third World countries that are experiencing economic
growth. To the extent that this rising output is based on long-term
innovation and capital investment, this is positive. To the extent
that it is based on fractional reserve banking and central bank
purchases of debt, it is not positive. Rather, it is creating a
boom that will turn into a bust, just as it did in the second half
inflate to keep government debt markets solvent. That is their official
task. It has been ever since the Bank of England was created in
inflate also to keep large commercial banks solvent in a financial
panic. That has been their unofficial task for at least a century.
doing this as a depression hedge in the early 1930s. John Maynard
Keynes announced his last career flip-flop in 1936, with the publication
General Theory of Employment, Interest, and Money. Here,
he set forth his recommended cure for the Great Depression: government
spending. This could be done through taxes, borrowing, and monetary
inflation. He preferred the second, but he was not limited to it,
nor have his disciples been limited. Keynes baptized policies that
Western governments had already adopted. He invented a new terminology
to cover his tracks. He was merely promoting the crackpot monetary
theories of Major Douglas and Silvio Gesell, as he admitted (pp.
policies up to date, the unprecedented increases in the monetary
base of the Federal Reserve, the Bank of England, and the European
Central Bank, beginning in late 2008, were the cause of the reversal
of the collapse of the financial markets. This reversed the recession.
This led to a recovery of commodity prices after 2008. These effects
had impact on the eating habits of Chinese and Indian consumers.
China and India are part of the international economy. But the effect
on food prices was indirect. They rose because demand for Asian
exports recovered. The people involved in the export trade were
able to bid up the price of food.
There is talk
about food being a bubble sector. Given what happened in the second
half of 2008, this is a legitimate conclusion: the bubble popped.
If the central banks continue to inflate, and the West's economy
avoids another major recession, then food prices will continue to
increase. Poor people are becoming less poor, and as they become
richer, they will eat more. They will also move from bicycles to
motor bikes. Motor bikes consume gasoline.
rise in price when there is increased demand for them as factors
of production. There will be increases in technology in these sectors,
but the rate of speed at which Indians and the Chinese are getting
richer is greater than increases in production of raw materials.
This is a bubble in the sense of central bank policies promoting
a boom economy through inflated currencies. But the general upward
move of commodity prices, as distinguished from consumer goods prices,
will likely continue over the next two decades.
be a bust at some point, perhaps in the next few years, and maybe
before. Central bankers in China and India will separately decide
to put on the monetary brakes in order to avoid mass price inflation.
There will be recessions in both nations. This will once again force
down the price of food. But this will be a buying opportunity. The
long-run trend is up, because the long-run trend of Asian productivity
responsible for persuading all of the FOMC members except Hoenig
to vote for the expansion of the monetary base. To the extent that
this delays the day of reckoning, when capital is finally priced
apart from monetary inflation, the FED is responsible for the bubble
in food prices. But this increase has been going on for a decade.
This is not recent. It has nothing to do with QE2. Yet.
The rise in
food prices is a mark of deliverance out of poverty for hundreds
of millions of Asians. The fact that they are saddled with imitations
of the Bank of England, just as residents of the West are, is unfortunate.
It will be even more unfortunate when the era of central banking
and the welfare state reaches its apogee and collapses.
bankruptcy of the national welfare states will provide a great opportunity
for free market economists to say, "We told you so," and perhaps
gain their followers a market for the reconstruction of the political
order from the bottom up.
will be a price to pay. The rising price of food in the boom phase
of the great transformation is likely. When poor people get richer,
they spend money more on food, but less time producing it. The bubble
in food prices is indeed a bubble, because Asian central banks are
inflating. But in the long run, food prices and oil prices will
rise because newly middle-class people prefer to buy food and fuel
with their increased output.
mark of a more productive economy is the increase in the price of
land, meaning the raw materials that land produces. Capitalism is
reducing poverty today on a scale never before seen. So, food and
fuel prices will rise until new technologies are implemented that
allow raw materials suppliers to keep pace with the move from the
Asian countryside to the cities. Such innovations will not keep
pace for the next 20 years.
that you are not some middle-aged peasant trapped in the pre-capitalist
economy of some Asian village. For him, this vast increase of urban
wealth will be no picnic.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2011 Gary North
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