Wednesday, April 01, 2009

Victims Of The Great Inflation

In the 164 years from 1750 to 1914, prices in Britain roughly doubled: an average inflation rate of under 0.5% pa. In the 95 years since then, prices have increased 86-fold, an average inflation rate of nearly 5% pa (all data from Office for National Statistics).

That's what happens when governments are given unfettered access to the printing press.

We can see that only too vividly by comparing inflation rates before and after we came off the Gold Standard (in 1931). Up until then - with the exception of the Napoleonic Wars and WW1 - we had routinely experienced periods of inflation and deflation. But since then, it's been one-way traffic, with 10-year inflation never falling below 2.6% pa:

Why the change? Because for governments, inflation is very convenient. It erodes the value of their debt, and means they can borrow without worrying too much about ever actually repaying it. It means they can default on their obligations without going through the awkward business of actually admitting bankruptcy.

But for savers, inflation is a disaster. It destroys the value of their nesteggs and their pensions, and it makes a nonsense of saving for retirement. If Henry Allingham had patriotically invested in one hundred pound's worth of the government's irredeemable War Loan when it was issued in 1917, he'd find its real value today had fallen to just 93 pence.

The government may have promised the War Loan would deliver sovereign value, but they subsequently abolished the sovereign (the gold one), unilaterally slashed the Loan's supposedly fixed interest rate from 5% to 3.5% (Chancellor Neville Chamberlain's forced debt conversion in 1934), and inflated away the vast bulk of its value. All in a day's work for our bad faith politicos.

So here we stand on the brink of a new Great Inflation. Forget all that self-serving stuff about deflation: the only way the government can ever hope to deal with the vast mountains of debt it is now accumulating will be to stoke up inflation. And the printing presses are already in overdrive.

So who will be its victims?

Small savers for sure. Their bank and building society accounts - already paying virtually zero interest - will be dealt a savage blow. Indeed, anyone who holds money in any form - cash or bank accounts - will suffer an inflation tax on their holdings.

Pensioners face a grim future. Those on fixed annuities will see their purchasing power plummet, especially since food and energy prices will continue to soar on the back of sterling depreciation. Even those on final salary pensions will find the going tough, because employers will not raise pensions enough to compensate for higher inflation... unless they're in the public sector, of course.

In fact, anyone who has lent money is likely to suffer, because inflation redistributes wealth away from lenders to borrowers. True, lenders can in theory protect themselves by demanding higher interest rates. But that's very difficult when the government/central bank is systematically pushing rates down.

Taxpayers will also suffer. Higher inflation means that the real value of their tax allowances falls - they are only increased annually with a lag, and governments do not have to increase them at all (eg Geoffrey Howe famously failed to index tax allowances in his 1981 Budget).

So what's the advice?

According to the Major's brainy friend Herr Doktor Professor Kuntz, you could buy some index-linked gilts/National Savings Certificates. But on the other hand, you do need to remember Chamberlain's forced debt conversion in 1934, and the risk that somewhere down the rocky road some Treasury gremlin will dream up some other wheeze to dispossess you.

Kuntz prefers stuff that's well out of the government's clutches and has some chance of keeping pace with inflation over the long-term - gold and commodities, bombed-out equities, bombed-out property (fancy an empty office block on Canary Wharf?). His Liechtenstein-based hedge-fund stands ready to serve.

Alternatively, we suggest the following investment portfolio:

  • baked beans
  • Fray Bentos meat pies
  • longlife milk
  • flour
  • dried yeast
  • sugar
  • tea
  • paracetamol
  • gin

You might also want to consider the nuclear bunker under Cheltenham. It was put up for £400 grand in 2002, and as far as we know never sold. Given how strapped the government is right now, they'd probably take an offer.

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