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 blog 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.
Inflationary Effect
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.
Summary.
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.
If you would like to talk to me
about the potential effects of inflation on your
finances and how to protect
them, or any other financial matter in general you
can contact me on
gareth.horsfall@spectrum-ifa.com or call me on +39 333 649 2356
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