Meal wheat again

Never underestimate the importance of the price of a loaf of bread. While political analysts from Brussels, Washington, London and elsewhere climb up each other's arses discussing the causes and implications of the Egyptian revolution for democracy in the Middle East, the man in the Cairo street (which appears to include most uniformed policemen now) seems most concerned about whether his wages will pay enough for his family to eat.

To generalize about the causes of unrest throughout the Middle East is to take a naive eurocentric attitude. These are all different countries and their people are rebelling against authority for a number of reasons, from the educated youth who want democratic freedoms to the people who would quite like enough to eat.

And I think that it is the cost of food that is what "makes it different" this time round. We have, after all, had protest from the educated youth before (not least Iran in 2009), but we didn't see governments overthrown. This time round, we have. The difference? The cost of wheat.

Aha, you might say, but the bread in Egypt was "tariffed", with the army running the bakeries and the price seriously controlled. However, with the price of wheat rising, the subsidy had to rise as well. It's also well known that no-one in the middle class buys this subsidised stuff, because the bakers take half the subsidy for themselves and cover that by "buying in" inferior flour.

I mention all this because it seems fairly plain to me that inflation has now gone past that "tipping point" in the UK (it went past it some time ago in countries far more dependent on basic staples), whereby wages are playing "catch-up". Mervyn King might disagree, but I sense that the psychology of the pay rise amongst people now is that 3% "doesn't count" -- that's just keeping at the same level. A "real" rise is 5% to 6%. In other words, 3% is the new 0%.

Mervyn King seems to think that it would be quite easy to go back to 0% being the new 0%, but I don't think so (and, anyway, King does not address the fact that there is no sign of "external pressures" on inflation going away).

Another common argument for price inflation (booked in this morning at 5% or 4.1%, depending on your preferred measure) not feeding on itself is that there is excess capacity in the wage market. This, claim the theorists, means that people won't demand higher wages because they will be scared of losing their jobs.

This may be true in some sectors, but in others there is a distinct shortage of labour capital. When that happens the worker doesn't need to fight for extra money. The employers do the work for him. Recalling the Black Death (always a favourite) and the aftermath, which saw for the first time the appearance of the salaried landworker rather than the feudal serf, this wasn't the result of the feudal serfs going "hmm, clearly the law of supply and demand means that I now have a stronger hand -- I'm going to ask for a wage". It was the result of one landowner going "FUCK! All my peasants are dead. I need someone to work the land and I need them NOW! I know, I'll offer the serfs on the farm next door a better deal than they are getting at the moment!"

You don't need an organised unionised working class for wage inflation to grow in circumstances such as this. And that wage inflation will inevitably feed on itself. We are, in other words, now at the point where if the BoE does nothing, inflation rates will increase of its own accord.

It's often forgotten that inflation is a derivative. The first level is that of prices. Inflation is the rate of change of prices (derivative level one). Increasing inflation is an increase in the rate of change. "Reducing inflation" doesn't reduce prices, it just slows down the speed at which they go up.

Are there still any deflationists out there who think we are in danger of entering a "lost decade" along the lines of Japan in the 1990s? I have to assume there are. because if there weren't, we would be hiking interest rates now.

Or perhaps there is a hidden agenda. Perhaps, secretly, the Bank of England knows that the "Japan scenario" is really so much bollocks. They no that inflation has taken hold, and their worry is that increasing interest rates will succeed in slowing down the economy, but won't succeed as well in slowing down the rate of inflation. That would be a recipe for stagflation, which, as far as the BoE is concerned, would be even worse than increasing rates of inflation in a growing economy. At least under the current system the rules of fiscal drag will help the UK government pay off its debt.

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And, speaking of debt, I hope you don't think that Portugal has gone away. Interest rates on Portuguese sovereign debt secondary market are now 6.825% for five-year debt - that's 447.2 bps above the rate on German bonds. The Portuguese economy grew by 1.4% in 2010, but contracted by 0.3% in the third quarter. Exports are actually declining (not good news for a country that, like us, is going to need to export its way out of trouble). Consumer spending is falling (this isn't a surprise, because some austerity measures have actually been introduced). The markets, I think, know that a restructuring is coming.

Back in January Portugal appeared to have seen "strong demand" for its 10-year bond issue -- it was more than three times oversubscribed. But this was at a time when the hot talk was of a Chinese bailout. In addition, both Greece and Ireland had strong auctions prior to their bailouts. This was because marketmakers were short of the bonds going into the auctions and then short-covered the shorts during the auction.

Not sure when the next Portugal auction is, but that magic 7% number will reappear fairly soon.

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