Let’s face it Inflation is not the most interesting of topics and not when we can have more interesting heated and political debates about Syria, Brexit, Trump and Russia, but from a Government point of view that is just what they want. The almost invisible creeping force of inflation to go almost unnoticed.
For investments, retirement and people who have fixed incomes it is by far and away the most important consideration when making plans for the future.
My bet is that it is likely to be the most significant financial issue that will affect us all in the not so distant future.
This article is about being prepared!
What is inflation?
By definition Inflation is the rise in the cost of living or an increase in the money supply in an economy. They are both intricately linked.
Since 2008 central banks around the world have created $6 trillion worth of new money.
Imagine $1 trillion
If you spent $1 million a day since Jesus was born, you would have not spent $1 trillion by now, but $700 billion. This is the same amount the banks got during their bailout.
We now know what it is but why is it so important right now? The policies the Governments around the world have taken to prevent financial depression and deflation were always likely to cause inflation and erode our standards of living. Governments have an incentive to distort real inflation rates because it allows them to keep their inflation-linked benefits and pension payments low. It also, magically, erodes the underlying debt of a country in the same way as a mortgage. For example the debt becomes proportionately less as the value of the house increases and wages grow as well.
A simple example would be someone who bought a house in central London in the 1980s for approx £40,000. A mortgage of £30,000 taken out at the time might have been a heavy burden, (75% – Loan to Value (LTV)) but in 2017 this would be considered very small and if the house is now worth £1 million, then proportionately the debt has been eroded to 3% Loan to Value.
The heavily indebted governments around the world have a huge incentive to allow inflation to run out of control for some time to come.
History repeats itself
I always find that there is some value to the phrase ‘History repeats itself’ and not forgetting it. In researching this article I found figures which show the inflation rates of countries around the world and in most developed economies inflation has been falling (with intermittent blips) since about 1980 and has fallen from its highs in approx 1974. I was born in 1974 and am 43 years old this year. I have never lived through a period of significant inflation.
Well, that might all be about to change!
Brexit and the fall in the value of GBP has certainly caused a marked effect on prices in the UK. Inflation is on the rise there and that is unlikely to stop soon. The true effects of Brexit were never going to be apparent straight away and real economic effects always emerge approximately 18 months after decisions have been taken. The UK can realistically expect more price rises. However, Europe is also seeing signs of recovery and inflationary markers are also turning up for the USA, Germany, Spain, Ireland and even Italy.
So the real question is…is this the start of a 40 year reversal in trend? or is it just another blip?
Wages must grow
I think it might be the start of a trend but which will not take off just yet. The biggest problem holding back inflation is wage growth. It makes sense that wages have to grow for inflation to take effect. The more money is in people’s pockets, the more they will spend. However wage growth has been stubbornly slow to take off.
Corporate greed and minimum wage
The EU have now started to look at ways in which people can receive a living wage. One way is by stopping state sponsored corporate tax evasion and fairly taxing the profits of large corporations. However, this might be more of a long term objective, Another option is to introduce a fair minimum wage and this is something the EU is pressuring all members states into imposing. So whilst it may be hard to see how wages could grow naturally they may be forced up through new regulation which in itself would in turn create an inflationary effect.
Inflation, investments and interest rates
So, you might be thinking that if inflation starts to rise then interest rates will rise as well. This is very likely to be true and then why the need to invest capital instead of leaving it in the bank account.
The answer to this is very simple
For as long as money measures have been recorded, and central banks have existed, they have never, ever been able to control inflation or deflation. Once the inflationary gun has been fired the central banks are always behind the trend. They are constantly playing catch up and trying to raise interest rates whilst real inflation rises. To make matters worse, this time round, they have a real incentive to be well behind the curve and allow inflation to spiral out of control. It will assist in deflating their debts away. So what incentive do they have to apply interest rates increases which will dampen the very effect which can erode the public debt.
And what about the personal saver and investor? Let’s look at the 2 things separately:
Savers: If you earn a fixed rate of interest at 1% (bank account of fixed rate Bonds) and inflation is at 2.3% (as is currently the case in the UK) then your net return on your money is -1.3%. On a deposit of £100,000 your net annual return is NEGATIVE £1300.
Investors: Whilst the price of your asset will fluctuate, you could be earning interest and in the right assets this could be as high at 3-4%. In addition the value of your asset might also rise. History tells us that the stock market generally rises in an early inflationary environment. Inflation in developed countries has been at historically low levels,
but the outlook is picking up and this could bode well for projected investment returns.
My feeling about inflation, for what it is worth, is that we are going to see a reversal in trend and over the coming years it will start to move swiftly upwards with intermittent slow periods. It has to! There are no more monetary manipulation tools left for central governments to play with and therefore inflation must rise.
Equally governments have no incentive to slow it down, quite the opposite, and we could see the cost of living start to rise quickly once it starts.
It is hard to see when it will all start and how, but that is the joy of economics and finance. It just is and just does. (I sound like Forrest Gump).
The key for individuals like ourselves is to be ahead of the trend and start planning forward…NOW. There is no value in waiting for things to start to happen and then playing catch up.