Consider what happens when a central banker prints money and causes prices to increase. A popular misconception is that all prices in the economy will rise simultaneously. But money doesn't appear everywhere at once. It ripples through the economy, causing increases in prices to happen in specific places before being fully absorbed by the global economy.

 

If the global reserve currency is being printed, higher prices could show up outside the nation that is home to that currency. Like, say, hypothetically speaking, in wheat prices in Egypt or chilli prices in Indonesia.

 

New money begins its life with privileged bankers, who deal with the central banks, where it is created. The money will either flow into financial assets or loans. Loans usually finance capital spending, so capital intensive industries find favourable lending standards because there is more money to go around. This encourages them to invest in projects that seem profitable. Usually these projects involve producing the goods that have gone up in price as a result of the new money rippling through the economy. They think the increase in price is a signal of profitability.

 

But, as the money stops rippling through the economy, prices adjust and many of the investments made by companies turn out to be unprofitable. Sticking with our example, farmers who borrowed money on favourable terms to invest in food production will learn the price of food only went up because of inflation. Now that all other prices have risen as well, farmers won't profit the way they expected. What's more, there are now many other competitors who also spotted the high prices and went into farming.

 

Soon, the farming sector and wider economy fall into a recession. Crucially, the economy experiences a credit crunch, as it is the industries that borrowed heavily that are struck hardest.

 

This is how a change in the money supply causes a misallocation of capital and subsequent recession. If you look at the US money supply before the Great Depression and the recent recession, you will notice that it first increases, inciting a boom, and is then followed by a bust.

 

This is why Austrian Economists are so good at predicting recessions. They see any boom triggered by monetary policy as an unsustainable boom based on malinvestments, which will be exposed when prices adjust for the inflation.

 

As you will have figured out, the increase in food prices mentioned in the link above is due to the flooding in Australia. At least part of the increase, that is. The price will incite investment into food and the issue will solve itself. As it would on a global scale ... absent government interference.

But not everyone agrees. Columnist Ambrose Evans-Pritchard thinks it will take strong leadership to solve the global food crisis.

"Can the world head off mass famine? Yes, with leadership. The regions of the former Soviet Union farm 30 million hectares less today than in the Khrushchev era, and yields are half Western levels.

Wait, wasn't it "strong" leadership that gave you the Soviet Union and its famines. And wasn't it grains in particular that were in severe shortages due to attempted management of the economy?

It gets better:

"There are untapped hinterlands in Brazil, and in Africa where land titles and access to credit could unleash a great leap forward."

If those last three words didn't make you cough up whatever you were drinking, then you might have missed some remarkable irony. Whether it was intentional or not, Pritchard referenced Chairman Mao's economic policy, known as The Great Leap Forward. It resulted in – you guessed it – grain shortages. Yes, that's what strong leadership gets you. The very thing you are trying to prevent. 

And there are currently few stronger leaders than central bankers. Considering themselves to be tasked with generating an economic recovery, they have taken remarkable steps attempting to do so. But with Bernanke creating dollars at unimaginable rates, you do have to wonder where they are going. The dollars that is. We mentioned above where central bankers go.

 

The remarkable correlation between Bernanke's QE activities and stock markets is a symptom of the effects new money has on financial markets. To be honest, it has turned the American stock market into a complete farce. But the ASX seems impervious to the US's lead lately. Perhaps because the AUD/USD exchange rate is absorbing the move instead of passing it on to the ASX.

 

But not all the money is going into financial assets. As you may know, banks aren't lending much recently, except to the government. By directing hoards of new money into Treasuries and financial markets, but not the real economy, the banks are still creating bubbles. Not unlike the one in housing.

 

The misallocation of capital, then, can be found in stock markets, bond markets and especially government debt. This has allowed the massive government deficits of the world to be financed. Not only is government spending inherently wasteful (or the private sector would be taking its place), but the amount of spending that is supported by newly created money is unsustainable.

 

At some point, the public sectors of the world will have a rude awakening, just like the building sector had in 2007 and 2008. Many will go insolvent. (Rumour has it that the EU, IMF and ECB have reached agreement on Greece's restructuring.) Some governments will attempt to print their way out of insolvency. Either way, bond markets will be routed.

 

So you can be sure to see government spending go down. Unless some authoritarian form of government emerges. One where choices are limited to the bad and the really bad. And you only get to choose every couple of years. Oh wait, we already have that.

 

Justin Jefferson at economics.org.au illustrates the absurdity of our governmental system with an excellent metaphor. In the world of Fast Food Democracy you can only choose one fast food chain every three years. During the three, you have to stick to that one only.  Of course, you could always choose to eat something else, right? Sadly, the Fast Food Democracy forbids it. Anyone caught growing vegetables gets fined. If you can't pay your fine, you go to gaol.

 

Sound fun? If you don't like the idea, what does that make you? Anti-democratic of course. Tut tut, you rebel.

 

Of course, the fast food chains that never get started, because they aren't allowed to compete, don't get a mention. So not only is your choice of fast food limited during the election cycle, you don't get much of a choice when election time comes up.

 

Most people realise that a democratic system of fast food wouldn't be very satisfactory. Yet we apply the same system to our government.

Politicians only let you choose every few years. And you don't choose policies, you choose people. Once you have chosen them, who knows what they will "serve" up.

 

The solution to both problems is of course to introduce competition. Let the people choose every day. No, every meal. And, all importantly, let them choose for themselves only. That's what they do with food, so why not do it with everything else?