When too much new money is created too quickly, the result is typically a large amount of unprofitable investments because the newly created artificial money competes with real savings for a limited number of profitable real investment opportunities –like playing a variation on musical chairs with more and more people, but with the same number of chairs. Having too much money chase too few profitable investments means that much of the money invested will never be recouped once the music has stopped playing. Unprofitable investments result in business losses which in turn spur bank losses. Bank losses culminate in a decrease in the value of bank assets, a contraction of deposits, bank failures, and therefore credit implosion: money is destroyed and vanishes from thin air, just as it was created out of thin air.

We have witnessed these types of mass unprofitable investments and the resulting credit contraction most recently in the form of the housing market collapse, and prior to that in the form of the 2000 NASDAQ collapse, the 1990 real estate collapse, the 1997 Asian currency crises and Russian debt crisis, and the now 18-year implosion of credit in the Japanese economy, among others.  We have also recently seen U.S. and U.K banks going bust and the threat of quasi-governmental agencies Fannie Mae and Freddie Mac going bust. For fear of these events resulting in widespread credit contraction, the Federal Reserve is trying to paper over current credit losses with yet new money and new debt. When we witness negative growth rates for GDP, which is mostly a reflection of the amount of money in the economy and not a measure of economic growth, what is being registered is that money has been destroyed and that deflation of the money supply is in progress.  Usually, of course, the central bank comes along and prints enough money to raise GDP once more.  The question at hand is whether or not the Fed can print enough money to prop up prices in our economy, and whether or not new money being created will be outpaced by old money being destroyed. As was the case in 1929 and in Japan in 1990, so it could be the case now that the imbalances in the economy are large enough to cause such a destruction of real savings and capital that the amount of credit which is collapsing is simply too large to be outweighed by the new money being created. Should this indeed be the case, then we could imagine that in the intermediate future, not only would there be nothing to push all prices higher, but a falling quantity of money would take prices lower.

The possibility of a falling money supply presently occurring may be suggested by recent movements of world asset prices. Since, through time, credit is expanding and not contracting, ordinarily there are at least several asset classes on the rise and making new highs, even while other asset classes are falling. For example, while the world’s stock markets were imploding from 2000 through 2002, commodity and real estate prices were in bull markets. Now, by contrast, though developed-world equity and real estate markets have already rolled over into bear markets (with emerging markets teetering on the edge), other asset classes still in bull markets have recently all fallen from their highs; commodities, natural resources, oil, and gold have all declined substantially (though they did all have large previous gains which warranted a retracement). “Safe Haven” government bonds are still holding up, but not making new highs, and corporate bonds are looking rather weak. And, most interestingly, in the last few weeks, while stocks have fallen, gold and commodities have not moved in the opposite direction from stocks, as they have previously. So, one would have to wonder whether the fact that no asset classes are moving higher means that either not enough new money is being created to push them higher, or worse, that more money is being destroyed than is being created (money supply contracting), thus taking down all prices in the process (demand is declining).

The focus of the discussion thus far has been on asset prices because of the fact that credit is created within in the financial system.  Thus, new money created and new money destroyed is usually first reflected in asset price movements, which typically lead the movements in the economy at large by six to eight months. Falling money supply would not take only asset prices lower, but also consumer prices, business revenues, and GDP. Many pooh pooh the notion that this deflation could happen to us today and dismiss as doom -and -gloom crackpots those who claim that it could. But our “leaders” are taking the risk seriously: Ben Bernanke, the Federal Reserve Chairman, is certainly worried that we could see a debt implosion, which is why he and Treasury Secretary Hank Paulson are desperately trying to prop up the banking system. It is, of course, a contraction of the money supply which caused the stock market to continually decline between fall 1929 and spring 1932 (but the money supply and stock market fall were not responsible for turning an otherwise short recession into a 10-year depression! - our politicians were), as shown in the chart below.

Bernanke has said previously that a 1930’s style money supply collapse could not happen today because the Fed would print enough money to prevent it. This is questionable logic, however, because the same strategy failed in the 1930s. Contrary to popular opinion, the Federal Reserve did try to expand the money supply in the 1930s by pumping bank reserves into the system. As evidence of this attempt, the Fed’s holdings of bonds purchased from member banks for the purposes of expanding reserves increased by 300% between 1929 and 1931 . However, this maneuver did not stop the falling market and the collapsing economy because the money was not loaned out and did not enter the money supply. In order for the new money that the central bank creates to make it into the money supply, banks have to feel financially healthy enough to lend their excess reserves to the public, and the public has to feel financially healthy enough to borrow the new money. If either the banks or the public do not make use of the new funds, the money will not make it into the money supply to push prices up. Such has largely been the case in Japan for the last 18 years.

If the financial markets are indeed telling us that deflation might be at hand, we should expect the very nasty downward spiral we’ve all heard about from the 1930s, which involves the lack of access to credit that both businesses and individuals need to repay debts.  Without new credit to keep debtors afloat, and with falling incomes and revenues, debt repayment becomes harder, resulting in debt defaults.  The result is more bank losses causing more destruction of money, which sends prices even lower, which results in a new round of debt defaults, unemployment, lower prices, and diminished ability to repay debts.  Those who have gotten by in recent years by borrowing heavily (and lending) will likely have a tough road, and some will sadly be wiped out.

To the extent that government tried to spend its way out of the recession, the result would be monstrous government debt burdens, and more capital consumed.  The more capital taken from savers and from businesses to be spent by the government, the less production and greater impoverishment we would have. Japan has tried unsuccessfully to spend its way out of recession for 18 years. Its spending on bridges to nowhere resulted only in a debt to GDP ratio of over 195%, - the highest of any country in history, next to Zimbabwe. Just as the Keynesian spending multiplier did not work in Japan, it would not work here – it does not multiply incomes, it only raises aggregate profits .To the extent that government would try to keep wages (or any other prices) artificially high as they did during the great depression, instead of falling in line with prices and other business costs, the result will be unemployment, as it was during the great depression.  To the extent government tries to prop up bad debts in the banking system, as in Japan today, or forces creditors to forgive debts they are owed, the result will be a savings- and credit-gridlocked economy.

Paradoxically, the best strategy for the government would be to allow prices to fall in order to wipe out the excesses which have arisen from credit creation.  Misleading price signals from a central bank-distorted marketplace has altered the economy’s underlying structure of production from what it would otherwise be. Production which would take place in accordance with price signals given by consumers freely expressing their desires without government intervention would place labor, tools, and machinery in different locations producing different goods than they are currently.  Contrary to popular opinion, falling prices that re-set the economy and allow the market to clear would not constitute a never-ending spiral.

Though falling prices caused by deflation would be hurtful, it must be understood that falling prices in themselves are a positive and healthy occurrence.  Falling prices arising from an implosion of debt are in no way related to falling prices which occur from increased production in a free market.  In an economy with a stable quantity of money, or more realistically, in one which has gold as money, the increase in production of goods and services is greater than the increase in production of money (of gold, in the latter case); such was the case throughout most of the 1800s.  A given quantity of money supporting an increasing amount of goods results in lower prices for each good. With falling prices and constant wages, standards of living improve. Further, falling prices from increased production does not make debt repayment more difficult: though prices fall, aggregate business revenues and profits stay approximately the same since the decrease in selling prices of products is offset by the increase in number of units sold; more units are sold at lower prices. Debt repayment actually becomes easier because the prices of all consumer goods that debtors purchase go down as time passes, causing real after-debt incomes increase. It should be clear from this difference between deflation-induced and production-induced falling prices that recessions and depressions can arise only from a destruction of money created by the central bank, not from production which takes place with real, non-disappearing, money.  The “lack of demand,” “under-consumption,” and “overproduction” fallacies we hear bandied about as causes of recessions can be associated only with artificial credit creation. Contrary to popular accusations, the means by which we grow wealthier – production – is not what causes us to periodically suffer economic impoverishment .

In sum, though the pain of deflation could be tremendous, the best possible scenario would be for government to allow the market to work. In this case, the pain would probably last for a couple of years, after which the economy would again be very healthy. On the other hand, if the government prevents the market from working, the pain could last for decades.  During the many recessions of the 1800s, the government mostly left the market to work itself out, and recessions were usually short-lived.  But in the 1930s, in Japan currently, and in many Latin American countries in recent decades, governments intervened and prevented the economy from rebalancing itself, with disastrous results. Markets will clear. We should let them.

John McCain and Hillary Clinton propose a gas tax holiday

A gas tax holiday does little good beyond being a political gesture.  It would only reduce the price of gas by the amount of the tax for that day, week, month or year.  Nothing will change the oil supply or prevent actual oil/gas prices from continuing to rise.  What would prevent prices from rising is if the government quit printing money.  It is mathematically impossible for prices to rise, no matter how great the demand, unless the quantity of money in an economy increases.  What would then reduce prices after they quit rising would be an increase in the supply of oil.  We could increase oil production and supply three-fold in this country if only the environmentalists would allow us (government law supports them in preventing us).

Gregory Mankiw, a former chairman of President George W. Bush’s Council of Economic Advisers, and a famous economist in his own right, says that Obama is right to be against Clinton’s and McCain’s plan because “In light of the side effects associate with driving…gasoline prices should be higher than they are, not lower.”

Side effects of driving?  Higher taxes are good? This kind of logic can only be the result of government bureaucrat-hired economists whose job it is to tax us or give us tax reductions as incentives or disincentives to achieve the outcomes the government wants for us.  We citizens are equivalent to Pavlov’s dogs.

And what side effects is Mankiw referring to?  Congestion? If that’s the case, the problem is not too many drivers, it’s too few government roads.  The road monopoly organization (government) should have road production increase at least at the same rate as traffic volume. 

Additionally any tax cut helps the entire nation - the less you tax something the more you get of it, and taxing less means more capital is available to build more of the things we need and want (by private industry, since government produces nothing). 

It could be argued that if the government removes taxes from gas prices, there would not be money with which to take care of the roads.  Beyond the fact that government has not been taking good care of the roads till now, that argument should lead us to ask why it can’t be taken care of with other taxes - car sales tax, license tax, annual tag fee, property tax, state income tax, federal income tax, import tariffs, inheritance tax, licensing fees, capital gains tax, environmental-affecting taxes, consumption taxes, corporate taxes, excise taxes, tolls, other fees, retirement tax, payroll tax, transfer tax, value added tax, etc., or even by the money the government makes by printing money at our expense (the inflation tax).  The answer to the funding question is that, in reality, most taxes do not go to support our infrastructure; they go to the pockets of other voters in the form of wealth redistribution.

We should drive as much as we want so that we can meet the goals we want to achieve - to work, to produce more goods and services, to enjoy ourselves.  If the government is really there to provide for us, as so many believe, then it should let us drive all we want and provide for us the means with which to do it.  Otherwise, it should get out of our way, let the free market provide all that we need at lower prices, and let us enjoy our lives.

The article then states that “economists” say that reducing the gas tax will only increase demand for gas by the amount of the tax, pushing prices back up (which is true).  They then argue that since supply cannot currently be increased by the oil companies, the benefits of tax reductions will accrue to the oil companies’ bottom lines instead of helping consumers.

It seems that no one wants the oil companies to benefit because they are presumably making so much money and gouging us (gouging is economically impossible in a free market).  Oil companies are making their large profits because the government’s printing of money is raising ALL commodities prices, just as it previously raised real estate prices, and stock and bond prices.  The government handed them the profits.  But it will also take their profits away.  The oil and gas companies will be taxed a higher tax marginal rate on higher profits. But much of their costs, due to depreciation expense, are fixed.  When they go to replace their machinery and equipment, it will all cost these companies much more because of the inflation taking place in that industry.  With higher revenues being taxed more, and with costs rising, oil companies’ real purchasing power will not be that great.  They could be left in real terms with approximately the same amount of profits (or less) as they had before prices rose.

Additionally, and importantly, with such a high amount of profit, more capital will enter the industry resulting in increased supply, which will lower the price.  Also, the increased amount of competitors in the industry bidding for the same resources - people, equipment, materials, etc. - will raise costs and reduce profits.  Beyond that, it must be remembered that 10 years ago, with oil at $10 per barrel, these companies were suffering.  They might only now be coming out even in terms of actual return on invested capital - which accrues to the owners and debtors of the oil companies.

Too add to the previous point, the article then notes that Clinton wants to impose a windfall profits tax [to “go after” the greedy oil companies and help the consumers].

In doing this, Clinton will hurt consumers, not help them.    Taxing oil company profits will prevent these companies from reinvesting capital in increased exploration, refining, and production.  Instead, higher profits for oil companies mean more gasoline and lower prices for us citizens.  The more we take away from them, the more market share the Arab countries obtain and the less oil we produce domestically. 

(And what about these foreign oil companies?  Are they helping to raise world oil prices to help ExxonMobil earn high profits at our expense?  In reality, American oil firms are a small minority of global players and thus have a very small influence on the price of oil.  Additionally, even the “cartels” have only 60% world market share, and they all cheat by supplying more oil than they agreed to, and thus help lower oil prices.)

Further, generally speaking, profits are good, and losses are bad.  Profits mean that capital is being used wisely and consumers are being pleased.  Losses mean that real wealth is consumed and wasted and that consumers are not happy enough with a product to purchase it at a price which covers the costs of production; consumers are not being satisfied.  But this country punishes the successful ventures and props up the unsuccessful ones.  Unprofitable companies, instead of being subsidized by taxpayers, should go out of business so that their assets and people can be used in places where we are producing net wealth instead of destroying it.  Profitable companies should be celebrated and allowed to continue their success. Over time, no company in a competitive industry can make more than the economy-wide going rate of profit (which then, is only a nominal return to capitalists for providing the funds which allow the company to operate).

But in the end, our politicians care little to none about our companies’ success or failure.  They care just as little about the well being of the citizens.  What they do care about is selling votes to get elected, furthering their career, and living well off the taxpayer (i.e., primarily the rich).

Healthcare prices would rise at the same rate as do food, clothing, furniture, and other normal prices were it not for:

1) Our third-party payer system where someone else pays your bills. (Since it’s largely “free” you consume as much healthcare as you want since you do not pay for most of it. Employers pay most of your healthcare costs. They thus pay you a lower salary each year (in real terms) to cover the costs of your increased spending. Your insurance company charges them (or you, if you pay out of pocket) more each year for your insurance because you go to the doctor as much as you want. Your insatiable demand allows them to keep raising prices)

2) The reduction in supply caused by the American Medical Association’s government-granted monopoly. (The AMA intentionally restricts the supply of medical licenses, doctors, and medical schools in the name of “safety” in order to earn themselves higher salaries)

3) The massive amount of demand created by government spending. (Socialist redistribution programs such as Medicaid, Medicare, The Veterans Health Administration, Prescription Drug Programs, TRICARE, State Children’s Health Insurance Program, and many others constitute dramatic artificial demand for services way above and beyond the quantity demand that would otherwise be the case if people paid for healthcare out of pocket)

Were it not for these factors, which all originate from government intervention and law, healthcare would be just another good at comparable prices to other goods.

This is the result of what you voted for!

Supporting material/additional reading:

http://www.mises.org/article.aspx?Id=1547

http://www.mises.org/story/1588

http://www.mises.org/story/898

http://www.mises.org/story/1749

http://www.mises.org/econsense/ch20.asp

http://blog.mises.org/archives/005499.asp

Comments and corrections:

David Malpass: “..global income will hit $53 trillion in 2008, double the rate in 1995,…”

This statement is meant to show that world incomes are rising. But the fact is that this statistic is completely meaningless. Income, or GDP, is a worthless measure, unless comparing GDP from country to country. GDP growth is a worthless measure any way you look at it. GDP basically consists of the total number units of goods sold times the price of each good. If the amount of money in an economy doubles, prices will approximately double. If prices become twice what they were, and one multiplies this higher price times the same number of units sold, then voilà!, GDP just doubled. GDP is for the most part a measure of the amount of money in an economy, not the real standard of living of individuals.

David Malpass: “Others think the dollar can’t be strengthened, that it’s no longer credible enough to invite buyers.”

Any currency can be strengthened. If the government quit printing money, the dollar would quit falling. It’s as simple as that. Any country (such as Switzerland), which creates new money more slowly than other countries will see its currency rise relative to the other countries (but not against gold, unless no money is being printed). Buyers will buy a currency which they believe will hold its value. If they feel it will not, they will exchange it for other currencies. The only problem with the dollar is our government devaluing it intentionally.

David Malpass: “Washington’s actions should stop the financial crisis.”

The printing of more money to shape up bank balance sheets, the subsidizing of mortgages which many individuals cannot really afford, and the forcing of mortgage lenders to rewrite contracts, could possibly stop the financial crisis for now. But it would be at the expense of a larger crisis later. Distortions in the economic system caused by the Federal Reserve do not just go away. Their effects can be stalled only by the printing of more money, which causes inflation and causes more problems in the future, on top of the current problems.

David Malpass: “Funded by millions of U.S. taxpayers, the government will mail checks to millions of households hoping they’ll spend their rebates to lift the economy.”

This is shockingly incorrect. The rebates are not at all funded by taxpayers, but by the Federal Reserve. This means they will print money to give to us. The result is that prices will rise as we all go and spend our $300. Additionally, the whole idea that spending money can help an economy grow, much less get one out of a recession is fallacious. If we spent everything we had, we would waste all our capital and could no longer produce anything. Wealth comes from saving money which is then used to purchase machinery, technology, and other tools which help us to be able to produce more goods per person.

Lisa W. Hess: “The decline in interest rates didn’t just raise stock prices, to the benefit of all of us.”

It’s not so much that lower interest rates per-se raise stock prices. It’s the printing of new dollar bills that both lower interest rates (increased supply of funds reduces the price of funds) and raises stock prices. As more dollar bills are created, many of them find their way (partially because the cost of borrowing funds to invest becomes lower) into the stock market. If everyone had their money invested in the market, how could the market go higher? It couldn’t, unless new funds became available with which to bid prices higher.

It’s true that with a lower cost of capital they should theoretically be valued more highly. But this effect is much diluted. How do we explain the fact that P/E ratios now average about 20 whereas they used to average 10-15, with the same level of interest rates? The explanation is that stocks are now permanently more expensive because more money is chasing them than before. Previously, an interest rate reduction of 100 basis points might have meant that P/E ratios should rise from 10 to 12, based on fundamental analysis. Now, a 100 basis point reduction could mean that P/E ratios rise from 20 to 24.

Similarly, analysts value stock prices higher when profits rise. But profits can only rise because of new money being created. New money loaned out becomes new revenues for companies. Costs necessarily lag revenues for reasons such as 1) depreciation expense, and 2) the fact that they occurred in the past before prices/revenues rose, and widen the revenue-to-cost spread. This results in increased profits. You can start to get the picture of how much of the stock market “fundamentals” are driven by credit expansion.

Lisa W. Hess: “The U.S. market continues to be the best relative performer of the world’s bourses, with the S&P down 8% this year versus Germany’s Das, down 19%, and Japan’s Nikkei, down 17%.”

This is a terrible misrepresentation of the truth. The U.S. market is not down as much as the European markets because it did not have the spectacular bull run that those markets had. In other words, markets that increase higher and faster, fall further and more sharply. I would much rather have had the higher returns Europe had and the steeper correction they have had along with it. Their total return of the last 5 years far exceeds ours.

Additionally, she makes no mention (with respect to sock market performance) of the fact that our currency has declined against theirs by over 50% in the last 5 years. The REAL returns, from the perspective of other countries, means that our market has gone down in real terms. In fact, on average, one would have gained more money over the last five years by simply putting their money in a European bank account and had it sit there in cash, than having had it invested in the U.S. market. The Dow Jones has seen an increase of 52% over this time period, while the Euro has seen an increase of 71%. Now, consider that you had not only invested in European currencies, but in the rising stock markets of European countries. U.S. market returns pale in comparison.

And now, the REAL story:

In absence of sudden wars or famines and the like, there is never an economic bust which is not the result of government economic policies. The Icelandic government, which has in fact led a largely free market economy, has been printing a lot of money. A credit crunch, and the inability for banks themselves to obtain funds, is an expected and ever-recurring result of the previous printing of money, in the form of the expanding of credit by a country’s central banks to its member banks, and by the member banks to individual businesses.

The creation of credit which is not backed by real savings competes with real savings for the same limited assets and investments. The result is that businesses are fooled by artificially low interest rates and the seeming availability of savings at these low prices. They borrow this new fake money, which looks like the other money that is backed by savings. They then invest it in projects which seem profitable in the beginning only because of the false and distorted market signals caused by the credit expansion, but which really are not profitable. Many of these investments taken on should not have been, and once the credit expansion comes to an end or even simply slows, these improper investments representing the misallocation of scarce resources is revealed. The shoring up of these malinvestments by the abandoning of bad projects and the unloading of improper workforces is the necessary and healthy healing process we call a recession. The capital which is lost in these investments, and the subsequent failure to replay loads to banks, results in the credit crisis - credit was there, but it has been wasted and lost.

The balance sheet of the Icelandic Reserve Bank (central bank) shows a dramatic increase in the money supply in recent years, which is clearly the fuel for the recent economic boom, and is certainly the cause of current high prices and a devaluing currency. When more money is printed and added to an economy, there becomes more money chasing the same amount of goods. This results in higher prices for each good. If the amount of new money grows faster in one country than in another, that country’s currency falls against that of the other(s) country(s).

Annual credit expansion in Iceland was over 30% per year in 2005 and 2006, which is considerably higher than its 15-year average of 15%. It is true that hedge funds have poured a lot of money into this small country, which could even be the cause of much of the increase in the money supply (in which case we would have to blame the central banks of other countries such as ours for printing money).

But a deeper look shows us that the central bank itself is responsible for an overwhelming increase in the supply of money in Iceland. In order to create new money, the central bank has to purchase government debt securities. It pays for these debt securities by means of crediting the bank account of the entity which sold the central bank the bonds, with the value of the purchase price of the bonds. It does this by simply keying in that particular dollar figure on a computer keyboard. The bank credits the account with money which does not exist - until those keystrokes are complete.

The central banks’ balance sheet shows that the dollar amount of debt securities it held as of 2001 was just over 67 million krona. By the end of 2004 that number had reached over 200 million krona. Today it stands at almost 450 million. This 571% increase in government debt held by the central bank means that new checking accounts were created at a multiple of more than 10 times this growth rate. This is because banks are entitled to lend out approximately 90% of the new deposits they receive from the central bank. When the first bank lends out 90% it becomes a deposit in a new bank, which keeps only 10% and loans out the other 90%. The same goes for the third bank and so on. The end result is the creation of 10 times the amount of the original new money that was created by the central bank.  The value of checking deposits member banks held at the central bank also increase dramatically, as shown in Fig. 1. The subsequent decrease shows the amount of credit contraction which has taken place and caused the bust.

Whether the boom was created domestically or internationally, the cause is ultimately the expansion of money in the economy by one government or another. Adding new money to an economy does not help create real economic growth, which is the production of more goods and services. But printing this money does cause inflation, raise asset prices, cause a distortion of the production structure resulting in economic booms and busts, redistributes wealth from lenders to borrowers and from savers to spenders and from the poor to the rich, and destroys large amounts of real savings and capital. All of these events serve to reduce the real standard of living for most citizens in each country.

• New food demand by China
• The high price of oil
• Bad weather in important farming areas(particularly Australia)
• The reduction of farmland available to grow foodstuff (in favor of growingbiofuelcrops, for the purposes of alternative, (reputedly) environmentally safe energy sources such as ethanol)

Krugman’s proposed solution to these problems is for us to give more of our money to government, so that it can solve the problem the market is apparently incapable of solving.

And now, the REAL story:

Regardless of whether one thinks the above-listed factors play a role in world food shortages, there are in fact two issues of primary importance related to food shortages and food costs that Krugman does not mention, and may not know.

First, the underlying cause of any shortage is the lack of a free market, since genuine shortages cannot appear in a free market. Instead, while prices of goods would likely rise at the onset of reduced supplies, the goods in question would always be available at some price –and the higher the price, the more the supply would increase to meet demand, which would then of course reduce the price. If we had free world markets, food would be exported from some countries, such as the U.S. and Europe, where food is plentiful, to countries where it is needed. This is because it would be profitable to ship goods to needy areas like Africa, where shortages were making prices rise.

The fact that this is not currently happening can be a result only of government price controls (that prevent prices from rising in needy countries), trade restrictions, or some other government barrier which prevents people from getting what they need. The World Bank has cited a list of 21 countries which have price controls on basic staples. We all remember the stories of people in Ethiopia starving in the 1980s, when 3 million people went hungry. What was unreported was that there were 60 million people in Ethiopia at the same time who were unaffected by famine. The moving of food from one part of the country, where it was plentiful, to the other part, affected by drought, was prevented by fighting between the government and rebel groups near the area of the drought. Economic incentives were prohibited by the government’s forced withholding of food shipments (so that rebel soldiers would not have access to supplies), by price controls, by the declaring of grain wholesaling illegal in much of the country, and by the prohibition of the private selling of farm produce or machinery. A similar situation occurred in Zimbabwe in the early 2000s. Indian economist Amartya Sen won a Nobel Prize for demonstrating that most famines are caused not by lack of food but by governments’ ill-advised intrusions into the functioning of markets.

The second issue Krugman fails to mention is that high food prices are a manifestation of current world-wide price inflation. World governments have been printing money at very high rates this decade. While the U.S. has been expanding the money supply by “only” about 10% - 15% per year, many countries have printed money at rates exceeding 50% per year. This money, which had been previously contained mostly in world stock markets, has now also spread to commodity markets, whence the prices of food are derived. Since money is now being created faster than goods are being created, prices are rising.

As another example of this phenomenon of the increase of money exceeding the increase in supply of goods, we may cite the rise in oil prices. Although this has been attributed in the press and other public forums to speculation, greedy oil companies, and increased demands of oil from China, the real cause is the increasing disparity between available money and available oil. Along this same line, the steep rise in prices - of housing, stocks & bonds, oil, gold, commodities, food prices, etc. that we have seen this decade- would be mathematically impossible without the increased supply of money circulating in the world economy. In fact, if the supply of goods were increasing, as it has been, and if at the same time the quantity of money remained stable, prices would necessarily fall.

Make no mistake: for various fundamental reasons related to production, supply, and demand, there is a lack of supply of some commodities available relative to the growing real demand for them. Still, this lack of supply is not the root cause either of the occurrence of shortages or of the extreme increase in world food prices (by over 80% in three years). Additionally, though many commodities such as wheat have been stagnant or in reduced production over the last several years, other commodities have seen continued increases in production; other food groups such as cereals, fruits, livestock, and fish/seafood products have seen mostly increased supply. Data from The Food and Agriculture Organization of the United Nations show that both agriculture production and food production per capita has risen since 1990, and stayed steady since 2000[1]. In comparison, commodities prices have been rising since 1999.

Returning now to Krugman’s piece, we can see that the reasons he adduces for the food shortages and rising prices are illogical. For example, “new demand” for food from China would necessarily have resulted not only in the Chinese themselves producing more food to meet this demand, but in the rest of the world doing so as well. (In fact, China has increased agricultural production per capita by 22% since 2000.) Can we really imagine that world food producers would not have spotted this demand and tried to make profits by satisfying it? They have, and have therefore been producing more food. The Chinese population is increasing by just over one-half of one percent per year. How, then, could the Chinese suddenly have a desire and need for 30% or so more food per year in recent years? Further: how could they pay for it, even if they had the want of more food?

As a concept, “demand” is liable to misunderstanding because we use the term in several different ways. I might have a demand (desire) for a house in the south of France in order to have a place to park the yacht I also demand (desire). In this case “demand” is without consequence, because I do not have the means with which actually to pay for these items. Real demand can affect prices only if there is real purchasing power, in the form of money, to support the demand. Chinese consumers cannot demand, and thus pay for, increased consumption of food without more money, which can only arrive in their pockets after being printed by their central bank. They can have an increased real demand by way of producing more goods with which to pay for more food, but this would serve to reduce prices, not raise them.

To be clear: it is not the companies that people work for which are producing the money, as companies don’t produce money which they pay out as wages — they produce only goods. For companies to have more money (i.e., sell their goods at a higher price than last year) and then pay out more money in wages to workers, more money has to be created by their government in the form of credit expansion.

With regard to China, then: if there were as much of a new demand for food in China as Krugman claims-given a constant amount of money in the economy, there would necessarily be a corresponding reduction in the demand and prices of other goods. Therefore, the Chinese may well be consuming more food, but this increased consumption would not responsible for (absolute) higher prices or shortages.

What, then, about the bad weather? Bad weather could well play a role in the short run. But In the longer run, if Australia has bad weather, even for five years straight, other countries could and would step up their production and increase supply. As an example, more land in the U.S. would be turned to farming. Food shortages in one country would cause world prices to rise by some degree temporarily; but the result in a situation of free trade would be increased production in and increased supply from other countries, a result that would then push the price back down. It’s possible that the lack of free markets has prevented this from happening, but it’s certain that free supply and demand would preclude the possibility of global emergency.

If there were bad weather in most regions of the world at the very same time, the supply of food would in fact decline and prices would rise. But in a free market shortages would still not appear. And in a world of an unchanging supply of money, this effect would be temporary, as prices would fall when supply later increased. Again, as the price of food rose, the price of other goods would have to fall. Sustained price rises among all goods can result only from new money entering the (world) economy.[2]

As for Krugman’s last argument, that farmland usable for food is now being used for the growing of biofuel feedstock instead, this is a question mark. In a free market, if there were a shortage of food and if the (necessarily) associated high prices of food gave that market signal, land used for any other item - biofuel feedstock, car lots, movie theatres, houses, or whatever - would be converted to use for farming.

If we had sustained food shortages in the United States, for example, this is what would happen. Indeed, agriculture used to represent 50% of GDP at the beginning of last century, but is now less than 1%. Land use has changed to meet changing demands. But if we needed food, we could and would build agriculture back up towards that 50% level. On a world-wide scale, as food prices rose, land would be turned to the more profitable growing of food instead of the less profitable growing of biofuel feedstock.

Only if government subsidies were high enough to obscure these market signals, or if government required energy companies to purchase feedstock (which this author is told is the case in the U.S.), could the agriculture production structure be deformed so that this market response would not take place. Similarly, if agricultural lands became difficult to develop due to government regulations to, e.g., protect current farmers, increased production could become difficult.

In sum, the real cause of continually rising food prices is the printing of money by world governments. And the real cause of actual food shortages is the prevention of profitable global trade in food by the ill-advised policies of governments of the very people who are starving. To the extent that any other reasons proposed contribute to a reduced supply more than temporarily, it likely must be because governments prevent the market from working. To ignore these primary drivers of current world food shortages is either willfully to dismiss economic logic, or to be unaware of it.

[2] It could be argued that the observation of food prices rising faster than other goods reveals this very occurrence in our world of changing quantity of money, i.e., that this reflects relative price differences. This relative price difference effect is probably there, but this author would argue that it would explain only a small portion of the relative price difference. The effect of a credit boom being channeled into the commodities markets in general is likely the overwhelming effect of the relative price differences. To say that it explains most or all of the difference, it would require an explanation as to how stock prices, housing prices, and the like can rise so disproportionately more than other normal goods due to a reduced supply, when in fact they have risen while their supply has been in abundance. In other words, it happens all the time in other areas where supply is not limited.