The Central Economic Question of Our Time Is Monetary

Dinocrat points out that emerging market nations now export and import to and from each other as much as they do to and from the United States and Europe. Dinocrat suggests that multilateral trade will lead to increased commodity prices if the US and Europe are in recession because the third world will continue to demand commodities given that their economies are independent of the first world's.

The increase in commodity prices is due not just to real demand for commodities but, more importantly, to monetary expansion by the Federal Reserve Bank. Monetary expansion (the Federal Reserve Bank's and the banking system's printing of new dollars) escalated when Richard M. Nixon abolished the gold standard for international dollar holders in 1971. The Federal Reserve Bank has increased the number of dollars in circulation by something in the area of 8 percent per year since then.

Until recently, this generous dollar inflation has not translated into higher prices for three reasons. First, the Department of Labor began excluding increases in home prices from their price inflation statistic, the consumer price index, in the early 1980s, and a significant share of the price inflation went into home prices. Second, international investors have held the majority of dollars. Approximately ten dollars are held internationally for every dollar held in the United States. The expansion of international holdings of dollars has permitted low interest rates to be coupled with relatively low price inflation. Should the international dollar holders decide to sell, there could be hyper-inflation in the United States, resulting in much increased commodity and general price inflation.

The recent increase in commodity prices is not especially long in the tooth. We could see much greater inflation in the coming years if global dollar holders decide to sell.

Third, Howard S. Katz has argued, convincingly, that the low commodity prices of the 1990s were attributable to the Greenspan Fed's high rate of monetary inflation. The initial effect of the Greenspan Fed's monetary expansion since the Reagan era was to reduce interest rates. The low interest rates led to an expansion of commodity production because miners and other commodity producers could borrow and so expand their production. The expanded production led to price competition in the 1990s, which in turn led to low commodity prices and low inflation. However, the producers closed their doors because of the lower prices. Mines and farms became less profitable. However, the monetary expansion has led to continued increased demand. It will take time before the mines can reopen, and therefore commodity price inflation will continue for several years.

As well, the Fed lent money to real estate developers who developed farm land. When President Bush pushed through the ethanol policy that increased demand for corn, farm land that had been previously available for farming was no longer available because it had been developed into shopping malls, residential housing and related real estate investments. This has been true globally as nations like China have also inflated their money supplies, malinvesting artificial, central bank-created money into real estate and reducing the amount of farm land available. Thus, the recent food, metals, energy and other commodity shortages are interrelated, and they are the result of the Greenspan Fed's and third world central banks' policies.

In order for commodity prices to fall, new commodity production will need to reopen. However, there is a multi-year lag because it is expensive and difficult to re-open mines once closed. In the case of agriculture, it is prohibitively expensive to reclaim farm land that has been converted into homes that cost six figures apiece.

If the recent secular upward trend in commodity prices were merely due to demand for specific commodities in the third world, increases in one commodity's price would be offset by reduced demand for that commodity. This is true whether third world nations trade with themselves, with the US or with the man in the moon. When all commodities go up in tandem the reason is that central bankers have increased the money supply.

One of the key effects of monetary inflation has been increasing asset values. Thus, the increases in the stock market since 1981 have been attributable to the same Federal Reserve policies that caused the post-2000 real estate bubble, the hedge fund and private equity boom, increased starvation in the the third world, and flat real wages among US workers (due to price inflation).

These ideas are expressed in the writings of Ludwig von Mises and in Howard S. Katz's Paper Aristocracy. In order to end price inflation, the Federal Reserve's monetary expansion (reduction of interest rates below their market level) would need to be ended. Because the stock and real estate markets depend on the wealth transfer that the Federal Reserve effects, this is unlikely to happen unless the public demands a metallic standard, a gold standard. Inflation will exist as will food shortages and third world (if not first world) starvation as long as the Fed transfers wealth to wealthy borrowers from wage earners.