In what seems to be a concerted action by the UK Treasury and the Bank of England, Bank Governor Mervyn King warned that pay demands for inflation-busting increases will be self-defeating if they trigger a rise in interest rates.

The Governor told the Treasury Select Committee of MPs that there is no magic bullet to protect workers from having their incomes squeezed by rising prices and interest rate increases. They could help themselves by avoiding excessive pay claims to cover the rising cost of living.

Cash-strapped families will find no shelter this year from rocketing oil and food prices.

“We are all in this together,” he said. “The most important thing is there’s no magic bullet that will protect the UK from higher oil and food prices imposed by the rest of the world. It is better than we face up to that now and recognize that fact, rather than pretend to ourselves that we can avoid it.”

MPC member, Tim Besley, said: “We have to adjust our living standards. One of the mistakes we can make collectively is to believe that by bidding up our wages we can somehow insulate ourselves from a global phenomenon - rising energy and food prices. If we do that that is a self-defeating process which will lead to higher inflation and wages will not end up being higher.”

Mervyn King said, “The cost of reducing inflation once it stays above the target for a period will be a very prolonged and deep slowdown in activity.”

With the housing market in meltdown, the next three years are set to be painful for everyone, with the possible exception of short sellers on the markets and the oil companies.

Ordinary folk need to batten down the hatches now, cut expenses to the minimum and protect their income sources as best they might. It’s not in the interests of the High Street, of course, but, for a few years at least, it’s everyone for himself.

One thing’s for sure, conditions will take the focus off rather abstract globalization matters, back to the real, local world that everyone lives in.

Around the world, government and central banks are thinking less about the possibility of deflation and increasing turning their attention to inflation.

But how much do we know about the causes of it, and why are some governments getting it all wrong?

Take the British Chancellor of the Exchequer (Finance Minister), for example. Alistair Darling recently said, “Pay awards in both the public and private sectors have got to be consistent with our inflation target of two per cent.”

It was like going backwards in time to the 1970s when a Labour government literally brought Britain to its knees by exercising almost total control over the economy.

Darling’s reasoning is that if pay rises were higher, prices would go up and consume the value of higher pay.

For a correct analysis of inflation, we have to turn to a former Conservative Health Minister, Enoch Powell, who knew a thing or two about economics. He said, “Of course when there is inflation, prices rise, including wages, which are the price of labour. That is what inflation means; the statement is a mere definition. But it is as absurd to say that inflation occurs because prices rise as to say that it rains because the ground gets wet. You cannot have rainfall without the ground becoming wet; the one is inseparable from the other; but we do not mistake the result for the cause.”

If that isn’t the most concise and accurate explanation, it must come very close.

His alternative to Labour’s prices and incomes policy approach would be to take money out of circulation by the government spending less or the Bank raising interest rates, or a combination of both.

In Britain, growth is at present around 2pc, and is likely to fall to about 1.3pc in the coming year. Inflation, according to government approved figures is about 3.5 per cent. That gives a total of 4.8pc.

Compare that to a rise in money supply (M4) of 12pc and there you have it.

Inflation is caused by having too much money chasing too few goods. And it’s the government that injects that money into circulation, partly by excessive borrowing.

The UK will now have to take money from the economy going into a possible recession — the worst of all possible worlds.

George Soros, the hedge fund operator who famously “broke the Bank of England” in 1992 after short selling sterling to force the pound out of the ERM, has given an interesting interview to a British newspaper.

“This is a period of wealth destruction. The people who make money will be few and far between. There will be a lot more money lost than made.

“I think this is probably more serious than anything in our lifetime. I think the dislocations will be greater because you also have the implications of the house price decline, which you didn’t have in the 1970s, so you had stagflation and transfer of purchasing power to the oil producing countries, but here you also have the housing crisis in addition to that.”

In other words he believes that the United States and Britain are facing a recession of a scale greater than both the early-1990s and the 1970s.

In the UK will be hard hit, he says. “House prices have risen over the years and are further away from sustainable than in practically any other country, in terms of household indebtedness and the relationship of house prices to incomes.

“This is going to be compounded by the fact that the financial industry weighs more heavily on the economy than in other countries, because London is the centre of the global financial system, and you have the unfortunate condition that the Bank of England is bound into inflation targeting, and is not in a position to lower interest rates until you have an economic slowdown.”

However, “It’s much better than the straitjacket sterling was in when I broke the Bank of England. The ERM would have been abandoned even if I had never been born.

“As a hedge fund manager, I do not claim to be serving the public interest. I am in the business to make money,” he says. “It’s a difficult point for people to understand and there’s a general attitude when they see people profiting to say that markets are immoral, or making money by speculating is immoral.

“It’s really the job of the authorities to set the rules, and there are times when some people break the rules or engage in improper activities, like the sub-prime mortgages. The impact fell particularly heavily on black and Hispanic minorities.

“It is a scandal, and I think you can blame Greenspan for not regulating the mortgage industry. But that’s very different from speculating in government bonds or financial instruments, and that’s a difficult point to get across, but I feel very strongly. Markets play a very useful role and they are amoral, not immoral.”

A version of this article appeared in Syntagma recently.

As we predicted here, this credit crunch cum downturn cum recession cum slump cum … was always going to happen in slow motion. That’s because of the normal lags involved in the transfer of economic conditions between countries and continents. Britain is said to be around nine months to a year behind America.

While the U.S. downturn started at the back end of last summer, it’s only now starting to decimate the British economy and parts of the eurozone. If we want to know how bad it’s going to get, we only need to peer across the Pond.

Gold rushes come and go in the world’s innovation capital, California. But when they go … they really go.

The City of Vallejo in California has filed for Chapter 9 bankruptcy, making history it seems. Half Moon Bay, home to some internet digerati, may well be next. According to John Moorlach, Orange County board chief, “This is the tip of the iceberg: everybody is going to line up for Chapter 9 in California.”

What can it mean to people on the ground when their city goes belly up? What of their assets, houses etcetera? It will be interesting to watch this pan out.

According to Goldman Sachs and Lehman Brothers American house prices are likely to fall 25pc from peak to trough. With between 10m and 12m households in negative equity already, there’s still a way to go.

Shares across the developed world are set for big falls too. Albert Edward Société Générale’s global strategist says, “Nowhere and nothing will be immune. We are on the cusp of an equity meltdown that will slash and shred portfolios. We see a global recession unfolding. Liquidity will drain away and crush the twin emerging market and commodity bubbles. The recent hope that ‘the worst might be over’ is truly staggering. Profits are disintegrating.”

Ambrose Evans Pritchard of the Telegraph (UK) — ever the Cassandra (rightly so, in my view) — says pointedly, “Britain, Europe, Japan, and China will go down before America comes back up. This is turning into a synchronised bust, after all. The Global Slump of 2008-09 is under way.”

The Bank of England and the European Central Bank are still stubbornly refusing to cut rates because of inflation fears, which will be the least of our miseries in the next two years and should abate soon as global demand falls off the much-imagined cliff.

It’s probably true that Ben Bernanke’s Federal Reserve has saved the U.S. and other countries from another Great Depression. But nothing can stop a slump now because it’s already happening.