Thursday, February 21, 2008

Unexpected Consequences

I just wanted to take a second and pontificate expand on my crowing about stagflation.

Normally, markets respond to simple supply and demand. Thus, if there are wheat shortages prices rise. When wheat is in oversupply prices fall. But what happens when unexpected outside forces affect the market?

Let's take wheat. Bush, in his typical simplistic/stupid/naive policy thinking, announced the national "grow our way out of the energy problem" program a couple of years ago. Grow corn, make ethanol and we'll have abundant renewable energy! And not a single mid-western Senator objected. Consequently, growers by the gazillion have switched from wheat production to corn (follow the money baby). As a consequence, wheat stocks are at historic lows, farmers are getting rich while consumption worldwide continues to grow (afterall, those new Chinese consumers are going to want their Big Macs too!). Having recently been diagnosed as allergic to wheat and corn, I can personally tell you that there are few foods that do not have either corn or wheat in them.

Never mind the lousy economics of growing corn for ethanol, or the lousy energy payback, or the current glut in ethanol that has ethanol prices in the toilet, the unintended consequence of the "grow energy" policy is now putting enormous inflationary pressure on the economy ..... even as domestic demand slows. Because of the simplistic government policy, prices are inflated artificially even during a time when a slowing economy should result in lower prices. This is how stagflation occurs.

The same phenomena is at work in oil, corn and other commodities. And Bernanke, like pre-Paul Volker Fed chairmen think that the solution is to print more money and lower interest rates which will only pour gasoline on the fire. It will be interesting to see how bad it gets before someone who understands complicated policy consequences comes along and rights the ship. The last time it took Volker, who raised interest rates into the double digits areas instituting a severe recession, to tame the stagflation beast.

Oh, and it took ending the black hole expenditures of an endless war too.

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