Watering the Garden While the House Burns Down

As mentioned previously, the US central bank, or Federal Reserve as it's known, has the power to expand the money supply through the monetization of US government debt. This is a complex way of saying the Fed prints money against the amount of government debt it assumes on behalf of the US Treasury, and subsequently injects the printed dollars into the money supply. (Read "Creature from Jekyll Island" for an excellent description of how this literally occurs.) The result is that, with the increased amount of dollars circulating through the system, prices respond accordingly and move upward in reaction to the increased amount of capital in the economic system.

By now you've likely heard about the rice rationing at Costco and Sam's Clubs in the US, and the soaring commodities prices around the world that are causing food riots. These events are directly related to the Fed increasing the money supply and expanding credit through the artificial lowering of interest rates. But how, you might ask?

To answer this, we must go back at least as far as 1944. (1910 might be more appropriate, as that was the year the Federal Reserve Act was formally conceived of by several bankers and one US Senator; or even to the late 18th century when Thomas Jefferson and Alexander Hamilton stood on opposite sides of the fence regarding central banking; but to do so would be to digress too far from the topic at hand.) In 1944, with WWII nearing its conclusion, the world powers who were the presumptive winners of the war convened at Bretton Woods, New Hampshire to discuss the economic world order post-WWII. One of the major decisions made at this conference was that the US dollar would be the world's reserve currency. Other foreign currencies would be pegged to it, and commodities would be denominated in it. Thus, today you see oil, as well as commodities such as wheat, corn, sugar, coffee, rice and so on, priced in dollars. It should be relatively clear then that any significant fluctuation in the supply of the US dollar would cause noticeable price movement in commodities. As the Fed prints dollars, these dollars eventually make their way into global circulation, affecting markets all over the world. The more dollars in the system, the greater the share oil and other commodities producers will claim through the act of raising their prices.

Lately, there have been a few events that will precipitate the printing of more dollars: the $150B economic stimulus package (many taxpayers will be receiving their checks this week), the $200B Bear Stearns bailout, and various bailouts aimed at homeowners facing foreclosure due to the credit crisis. Of course, one must also take into account other massive federal expenditures, such as the $3 trillion Iraq war, to even begin gauging the total debt that must be monetized by the Fed.

Therefore, it should be no surprise that oil and commodity prices are spiraling upward, leading to cost pressures in third world countries and subsequent shortages and riots. For more well-off countries such as ours, it means potential rationing, longer lines at grocery stores, and a larger percentage of our personal budgets being allocated to the basic necessities such as food and gas.

Amusingly enough, none of the so-called experts on television, or in the print media, are applying the appropriate degree of focus to this aspect of the problem, if they are even mentioning it at all. (Exception to this rule: Peter Schiff of EuroPacific Capital. Catch him every time he is on CNBC, Fox and the like and you'll get an accurate dose of reality.) In fact, the Wall Street Journal has taken to describing the problem as "inflationary psychology," as if the rising prices were a result of some form of mental perturbation amongst consumers. CNBC panelists speak of the soaring prices as if they were caused by voodoo magic, outside the realm of basic economic principles. Any and every other plausible explanation is posited -- unusually high demand, bio fuel consumption, production shortfalls -- besides the one that is right before us: the expansion of the money supply by the Fed.

And so as the title of this post suggests, the focus is being placed on the wrong, or certainly less important, areas when attempting to answer the question of where the rising costs at our gas pumps and grocery stores are coming from. Until we can recalibrate this focus, the situation will remain a mystery to our populace and the wrong remedies will be prescribed by those with the power to alter the status quo.