"Every action has an equal and opposite reaction."
- Sir Isaac Newton's Third Law
Two people were shot to death by police in Mogadishu when starving Somalians rioted over rising food prices. Starving Haitians are eating "mud biscuits" because they can no longer afford to eat real food. The United Nations Food Agency sees civil war breaking out in "sub-Saharan, African and also in Asia and Latin America" because of the rising price of food, fuel, and basic commodities.
So what does starving people in the third world, and bailouts in Washington and on Wall Street have to do with each other?
Everything. In fact it is fair to say that the ongoing, and ultimately futile effort, to re-inflate the housing bubble is causing thousands of poor people to starve all over the world and will eventually result in the end of the dollar's place as the world's reserve currency.
During the final days of WWII the leaders of the free world gathered at Bretton Woods, New Hampshire and agreed to a new world monetary order. The main feature of Bretton Woods was a "pegged currency" system, where other nations fixed their currency rate to the U.S. Dollar while the dollar was fixed to a price of gold.
America defaulted on its gold peg in 1971, but the system of fixed exchange rates has largely remained. Thus when the dollar gets devalued it gets filtered to the rest of the world through both fixed and "dirty" currency pegs.
Some smart guy might ask "If the world still pegs its currencies to the dollar, then can what can the dollar devalue against?" The answer to that question is "commodities."
I want you to meet my friend - inflation.
Inflation: A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services.
In other words, more currency chasing fewer goods produces price inflation. Price inflation is a symptom of monetary inflation, in the same way that a high temperature in a person is caused by a virus infection. Inflation is not caused by union wage demands, or greedy oil companies, or extraterrestrials.
The current rising price of all commodities is blamed on speculators, "global tensions", and one-off events like terrorist attacks.
Nothing could be further from the truth.
The value of commodities aren't going up. The dollar is going down.
Food prices aren't going up because of "geopolitical tensions". Your dollar is worth less.
Oil prices aren't going up because of terrorist attacks. Your dollar is worth less.
Gold isn't going up because of speculators. Your dollar is worth less.
And why is the dollar worth less? Because there are more dollars out there.
As the housing bust has deepened the Bush Administration and Federal Reserve have responded by flooding the system with cheap money in order to try and re-inflate the housing bubble. This has had the predictable effect of lowering the value of all the dollars in existence, thus punishing savers. All those dollars have to go somewhere, so they wind up in the price of "things" like commodities.
While Bush's Treasury Department and the Federal Reserve are pushing monetary inflation as quickly as they can roll the printing presses, it is having secondary effects all over the world. Remember me mentioning all those currency pegs?
For example, Saudi Arabia has fixed their currency to the dollar since the 1970's. So when the Federal Reserve lowers our interest rates, making dollars cheaper, Saudi Arabia also has to lower their interest rates, thus making their own currency cheaper. Plus, the Saudis huge trade surpluses with America means they must print riyals in order to recycle all those dollars. So what effect has this had on the Saudi economy? Record price inflation.
Saudi Arabia isn't alone. China has a "dirty" peg to the dollar and a huge trade surplus, and thus has inflation of 6.5% and the possibility of domestic unrest. India is looking at inflation of over 7% and the possibility of domestic unrest. In fact the IMF is warning the global inflation rate is too high.
The story gets repeated in every nation that pegs their currency to the dollar. Because so many of the commodity and goods producing nations of the world peg their currencies to the dollar, the monetary inflation that America is producing gets replicated all over the world and eventually becomes ubiquitous.
Thus you can see how a huge Washington bailout of subprime homeowners in suburban America can cause poor people in Haiti and Nigeria to go hungry.
Newton's Third Law was meant for physics, but it applies to economics as well. You can't simply print money like it is going out of style and not have undesired effects in some way. There is a moral cost of trying to get something for nothing.
There is also another undesired effect to these enormous bailouts that we are rapidly approaching.
as this food crisis grows and civil unrest intensifies worldwide, all nations impacted by it will finally be forced to stand up and walk off this particular field of dreams.
For if it is one thing and one thing alone that all politicians understand it is power, and remaining in power. And in most places that means votes.
The question for the longest time has been ‘when,’ as in when will countries begin to un-peg from the dollar. That’s already happened in some places, but I believe is about to pick up pace as prices of not only food but also all basic necessities spiral out of control.
Foreign governments are coming under enormous pressure to do something about these outrageous food prices. Eventually they will be forced into taking drastic action, or face a revolution.
That drastic action is un-pegging their currencies from the dollar.
Un-pegging their currencies should immediately drop inflation rates in many of these nations. However, it will also cause the dollar to fall against those currencies, thus increasing domestic inflation here in the states (as opposed to exporting inflation overseas). Everything we buy from overseas will jump in price almost overnight.
More importantly, once the process of nations un-pegging from the dollar begins it will become untenable to the countries who try to remain pegged. Thus the Bretton Woods system will finally end and the dollar will lose its reserve currency status. That means less demand for dollar assets in the world.
And with fewer foreigners wanting our dollar assets, America will finally be forced to live within its means foreigners will not be so eager to loan us their savings. Credit will permanently become tighter and Americans will be forced to save, like the generations of Americans before the Baby Boomers did.