Inflation can be a Good Thing
Posted on August 30, 2006 by Angela
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I was a very young person in the 1970s, but I can still remember inflation. One year I took a nine month sabbatical from my job to attend University and do a one year higher qualification. When I returned to work my colleagues greeted me with the stunning news that whilst I was away our pay claim had at last been settled and my salary had doubled - and I had back pay to boot. Glorious times for a kid with no responsibilities and a good job. We bought our first house together in 1977 for £7,500. and inflation over the next ten years meant that by the time we had two kids we had traded our way up to a £500,000 home, and hardly felt any financial pain, as inflation eroded the value of our mortgage payments as fast as we paid them.
Of course, I paid lip service to how awful inflation was for those on fixed incomes and the elderly, but really - all the older people I knew were on occupational and state pensions that increased yearly with inflation. Older people talked of Weimar Republic inflation and how it destroyed a nation, but inflation was a result of Germany’s economic collapse - not the cause of it.
Inflation in the 70s was the result of a fairly healthy economy trying to rebalance itself when oil (a basic cost of production) went through the roof. It hurt the wealthy, who derive the lions-share of their income from interest on capital, it also harmed the affluent, who had retired on fixed annuities purchased from savings (or a defined contribution pension). It also harmed the financial institutions, who saw the real value of their long term business and domestic loans reducing.
Inflation looks to me like a very effective way of redistributing wealth from the old to the young, and from the wealthy to the hard up. Of course the establishment loathe it - they are mostly old and rich.
My Boomer generation got their headstart from a long period of high inflation, and then, as usual, pulled the ladder up behind them, as the world moved into a period of prolonged stable inflation that coincided with our middle years. This generation of youngsters are in debt up to their ears. University loans, sky high mortgages, car loans, credit card loans. Well paid, secure, pensioned jobs are not easily come by any more, and they have been tought to expect their parents lifestyle - but that pulled-up ladder means that they can’t escape the debt they are drowning in.
I read that a large proportion of us investors believe that inflation is under control. We are not alone in this belief. The Chancellor certainly thinks he is on top of it, and the MPC think they can control the whole shebang - inflation, house prices, unemployment et al, with their single magic wand - interest rates.
We are all wrong - we need inflation to save us from the consequences of our reckless borrowing and spending, on a macro as well as a micro scale. No doubt we are going to get it.
So, as investors, the time has come to re-examine the traditional hedges against inflation, and to think carefully about those areas of the economy likely to thrive in a high inflation environment.
I would suggest energy of all descriptions. The overall economy is pretty sound, so I would not be rushing into gold bars yet, but gold miners may prosper. I would say property, but I think its overvalued, (wait for the repossessions to start). Any suggestions?
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7 Responses to “Inflation can be a Good Thing”
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That’s such a cogent argument you’ve almost got me to forget about immigration (cheap labour), globalisation (cheap imports) and business models predicated on giving stuff away free that push prices down… It wasn’t so long ago that economists were banging on about deflation. What happened?
We have had deflation in certain sectors of the marketplace, primarily in manufactured goods (e.g. electronic goods made in China, Taiwan, Korea etc, and clothing and household goods made in the Far East and Eastern Europe); in utilities in the immediate aftermath of privatisation; and most recently in customer support with largescale offshoring of call centres to India.
Everywhere else in the economy, where prices are directly linked to dometic wages, there has been steady inflation, driven by skills shortages (in IT, healthcare and construction in particular), the Minimum Wage, and generous settlements with public sector workers.
The net result across the marketplace has been very low inflation for most of the past two decades. But now deflation in manufactured goods is bottoming out, with increased energy and raw material costs (both currently being finite resources), and increasing wages in China and India. So the trend will now be higher inflation, as Angela suggests.
The only way that deflationary pressures can kick in again are if we discover a cheap and abundant new source of energy or if sub-Saharan Africa starts challenging China as the world’s manufacturing centre. Neither is likely.
There is an interesting parallel: it is likely that global warming has been attenuated for the past few decades by the cooling effect of air pollution. Now that developed countries have cleaner air, the true impact of unprecendented levels of CO2 in the atmosphere is rapidly emerging.
No doubt about it.
What we all need is a good old fashioned dose of raging inflation.
We’ll all feel so much better for it and the morons in government will get their just rewards!
It seems strange that significant inflation is accepted for Gas and Electricity bills, Council Tax and the like, but of course, when it comes to salary negotiation, all these things magically disappear under the heading of government statistics!!
I think most of us understand that we actually have significantly higher inflation than the headlines show.
While goods have been stable or falling in price (imported goods) services have been rising at well above the headline rate (home grown) I have seen figures suggesting that inflation for middle class people, who use more services and fuel etc, is around 10% already.
A few years ago, after the millenium slump (or crash) growth slowed a lot, people began to worry about deflation, and the US governments and the Bank of England dropped interest rates to encourage continued economic activity.
It worked well, economic activity picked up, and so did house prices. Now we are again facing slowing economic activity, but this time, instead of deflation being a threat, we have inflation beginning to pick up.
The hawks solution is the opposite of last time. Raise interest rates. This will slow down inflation. On the other hand it may well seriously damage economic growth.
So which result will be the bigger disaster from the point of view of the average voter? a) Raise interest rates. Slow the economy. Increase housing costs (mortgages). Controlled inflation. Raise unemployment total to its highest since late Thatcher.
Or b) Do not raise interest rates. Growing economy. High employment. Rising house prices. Inflation rising to its highest level since early Thatcher.
So we have a choice. Which solution do we think a rational government that wants to be re-elected will go for? Er…
Low inflation keeps the lid on costs in this country compared to the rest of the world. So while the amount of money in the pocket of mr USA, Japan, etc.. goes up we get poorer in relation.
To me its all about our wealth compared to other countries and because we seem to depend so much on foreign imports our costs go up and we get poorer.
Glad to hear it
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