The Bank of England Governor cannot say it. Politicians dare not admit to it. But the truth is, high inflation and low interest rates is a most effective way to reduce the debt burden. It has been used before in the 1970’s and will no doubt be used again in the future.
It is basically a way of defrauding the public. Rewarding borrowers and penalising savers. In the 1970’s vast numbers of people saw the value of their life savings wiped out in just a few years by inflation rates of up to 25%. We’re not there yet.
But the difficulty, which we are now beginning to have to struggle with is that once you have released the Genie from the bottle it does tend to have a mind of its own. What we can see happening now is things may be beginning to unravel.
It looks worrying. Not helped by the turmoil in surrounding the Euro.
When “QE” was first announced in 2009 we highlighted (“So the nuclear button has been pressed then!”, 6th March 2009) that:
“Well it will take at least 18 months to feed through but come the middle of 2010 prices will be rising strongly whilst interest rates will still be being held artificially low at close to zero percent.”
We also went on to say:
“The risk this raises, though, is that the government will wrongly see any "lack of progress" in its official statistics as evidence that the medicine isn’t working and so administer more of as we get towards the second half of the year.
The result would be that by 2012 we could be in an "unwise boom" with already relatively high inflation being fuelled by previous decisions taken to stimulate the economy which cannot quickly be reversed.”
Well the new Tory government has not yet lost its nerve and taken steps to over-stimulate te economy which is good. But at the same time they are actively considering a further round of QE (and may quietly be implementing it even as we speak – they are under no obligation to reveal these things unless it suits them.
The greater danger at the moment however is that RPI inflation – which is used as the basis for wage negotiations, benefits payments and many other contracts, is running at well over 5% a year and this will begin to bite over the coming 12 months adding another twist to the inflationary spiral. Coupled with yet further depreciations of Sterling against the dollar – caused in this instance by our exposure to the turmoil in the Euro-zone – and we have the makings of a perfect storm: rising domestic inflationary pressures, pressures from import prices and a government who may react by pumping more cash into the economy. To many of us who were there at the time this sounds so familiar to the 1970’s that it is hard to avoid extrapolating the consequences and see a rather unsavoury outcome.
So what should you expect?
Well, we don’t like to have to say this but it does look as though it is about to get rougher. Rising inflation and rising unemployment – the return of “stagflation”.
So our advice is to borrow money on fixed interest rate deals wherever you can. Investing in assets is also good – although the price of gold looks a little over-egged.
Holding cash (whether directly or in financial plans) plans looks a little dodgy for now.
Investing in “staples” (companies like supermarkets, utilities and so forth) would be a safer bet.
Then keep an eye on how the authorities are reacting to the situation. If they do act to reign-in the inflationary pressures then we may stave-off some downside risk. But if they “go for growth” (a phrase borrowed from the “unwise Barber boom” period of the 1970’s – named after the chancellor at the time, Antony Barber) expect things to get a little sticky through 2012 and into 2013.
In sum, don’t panic yet, but take some precautions and batton down the hatches just in case.