Could U.s. Monetary Policy Ignite World War Iii?

We know the Bernanke Fed is doing odd and dangerous things these days. But could U.S. monetary policy actually touch off a third World War?

It seems far-fetched, no doubt. And the odds of actual world war breaking out are ridiculously low. (They have to be by definition, since world war is in itself such a low-probability event.)

But still, the potential connection is worth exploring, if only as a thought exercise. Highlighting the connections that make the scenario possible, if not plausible, provides useful food for thought.

To start we'll draw on some concepts already featured in these pages, via pieces like "The Pyramid and the Pie" and "Let Them Eat Paper." Namely, it's important to note that:

There is great inequality in both the Western and developing worlds.

The middle class is being squeezed by rising global competition, and all below a certain class threshold are being squeezed by rising food and energy prices.

In its effort to stimulate the U.S. economy with a paper asset boom, the Federal Reserve is indifferent to the pain it is creating via rising food and energy prices -- particularly outside the United States.

In short, the Federal Reserve can look at "non-core" inflation and shrug, because the official statistics do not pay attention to it -- and because U.S. consumers spend a relatively small percentage of their incomes on food and energy (compared to the rest of the world).

Elsewhere it is not so easy to look away, as the following Economist excerpt shows:

Outside America, food has a bigger share than energy in consumers' shopping baskets -- and thus in inflation too (see chart). In developing countries, rising food prices can be a human as well as an economic disaster. In Asia in early 2008 a spike in the price of rice led to widespread unrest and desperate attempts by governments to secure more supplies. In December in India, for example, food prices rose at an annual rate of 14%, and there has been a run on onions, a dietary staple...

The equation here is fairly simple. Countries that trade with the United States, or otherwise do a lot of trade in dollars, are subject to an increased flow of dollars thanks to loose Fed policy. In order to keep their own currencies competitive, these same countries take the dollars from their exporters and print up new home currency in exchange for those dollars. (If they did not do this, the value of the home currency would rise, hurting competitiveness.)

(This isn't the first time I've talked about U.S. monetary policy. Sign up for Taipan Daily to receive all my investment commentary.)

The end result is more home currency sloshing around the local economy, which drives food and energy prices up. When developing world families spend 40% of their income or more on basic food staples, this can get to be a problem fast.

In fact, in the previously stable Arab world, food and energy price hikes have led to blood in the streets...

In Tunisia, where the spirit of revolution broke out most plainly, violent town riots centered around "a desperate shortage of food and heating oil" (as reported to the BBC).

Meanwhile, earlier this month, riots in Algeria broke out as the cost of staple goods such as flour, salad oil and sugar more than doubled.

And now, in the latest twist, Egypt and Yemen are erupting. Thousands are rallying... hundreds are being arrested... and an unfortunate few are being killed.

The Middle East power structure has long been dominated by "strong men" -- totalitarian leaders who have held an iron grip on power for decades, reacting to dissent with brutal crackdowns of force. Sad to say, the United States government has also cultivated official ties with many of these strong men in the name of combating terrorism and maintaining links to the region.

Now, many unsavory characters are at risk of being toppled by a rising swell of anger, sweeping through regimes like a chain of dominoes. And the core of it comes back to out-of-control food price escalations, which, in turn, are in no small part a consequence of the money-pumping Federal Reserve.

So where is the World War III connection? That goes back to Middle East leaders and the dawning horror that is engulfing them. As the "Jasmine Revolution" of Tunisia causes protests and revolts to leap from country to country, no strong man can feel truly safe. Those who have not been forced to flee are drawing up alternative plans.

As Samuel Johnson reputedly said, "Patriotism is the last refuge of the scoundrel." Extreme forms of patriotism involve beating the drums of war. And for authoritarian regimes facing existential crisis, one of the oldest plays in the book is stirring up fervor for an outside enemy.

Nothing like a rise of nationalist anger and outward directed aggression to cool the simmering discontentment at home...

So now let's connect all the dots:

U.S. monetary policy exports inflation to the rest of the world (exacerbating a sharp rise in food prices).

The Federal Reserve continues on this path assuming "no inflationary impact," as it is only focused on U.S. domestic markets (and artificially massaged "core" inflation stats).

Cost-of-living increases in Tunisia, Algeria, Egypt, Yemen and elsewhere touch off a domino chain of protests and riots, with large reserves of pent-up aggression finally bursting forth.

Other Arab "strong men" observe with horror the plight of their fleeing brethren and set their minds to avoiding the same scenario.

A desperate lack of choices ultimately leads to one of the oldest tricks in the book: A diversion disguised as patriotism (or nationalism), the more belligerent the better, to draw civilian attention away from crumbling conditions at home.

With the potential for military escalation unclear, and much of the Middle East power structure in jeopardy all at once, the wrong combination of destructive feedback loops -- and there are many combos to choose from -- ultimately leads to war...

Regardless of ultimate outcome, we can see via this exercise how bad policies can have unintended impacts. Like the "butterfly effect" in chaos theory, one never knows how far an unwise decision can reverberate, or what unexpected further chain reactions will be touched off. With a little imagination and scenario-building, we can further see how the Western world powers that be -- who project their smug confidence and assurance daily -- are fooling no one but themselves.

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By: J. Litle

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