How Lehman brought down the pro-western governments in North Africa

The world is always throwing up surprises. Did the leaders of Tunisia and Egypt think that their regimes could be threatened by the collapse of a highly leveraged bank like Lehman? Yet, that seems to be what is happening.

The casuality is straightforward. When Lehman crashed, central banks cut interest rates to prevent Wall Street banks and hedge funds from going under. As soon as the immediate risk of a financial meltdown subsided, these low rates unleashed a speculative bubble in commodities.

The consequences can be seen in the chart above that illustrates the FAO's world food price index. Since December 2008, world food prices have increased by 55 percent. Some items have increased much faster; sugar is up 148 percent, cooking oil is up 116 percent.

These increases can not be explained by falling supply or increasing demand. The price changes are too large and over a very short time period. No, it is the derivatives market. Speculators borrow cheaply and seeking higher yields, speculate on commodities futures. This speculative trade pushes commodity prices up, creating a massive surge in inflation.

The social and political implications of this speculation in developing countries is devastating. Regimes in places like Tunisia, Egypt and Yemen were always highly unstable. With double digit food inflation, they are crumbling. Moreover, this crisis is unlikely to stop in North Africa. Dare I mention the P word? - P---stan and their red hot nuclear arsenal.

There is now a conflict emerging between the strategic interests of Western governments and those of Wall Street and the City of London. The balance sheets of Western banks remain fragile. They need low interest rates to maintain cheap sources of financing. Global stability, on the other hand, requires higher interest rates to defuse the speculative bubbles in commodities.

Currently, this conflict is at its sharpest in Egypt. Should Mubarak fall, thirty years of carefully crafted US diplomacy in the Middle East will be destroyed. Anyone who thinks that Egypt will effortlessly transform into a thriving western democracy while food prices are crippling the urban poor is living out of fantasy.

Two years on from the Lehman collapse, what has the bailout achieved? Economies in western economies have crashed; their governments have become loaded up with debt, and inflation has ripped apart the tenuous living standards of the poor in the developing world. Yet, Goldman, JP Morgan and Merrill continue as if nothing has changed.

The world is too fragile to absorb another speculative bubble. However, that is what this extended period of low interest rates has unleashed. It has destabilised North Africa and other regions could follow. Who could have seen that when Lehman filed for bankruptcy?