Governments lie about inflation.
First, they claim that inflation is a rise in prices which is outside their control, and which they are struggling to hold back. This is the first lie. Inflation is caused by governments printing more money, and devaluing the stuff that is already in existence. If the government doubles the amount of currency in circulation then it halves the value of the money that’s already out there. And that pushes up prices. So governments cause inflation.
The second lie is the size of the problem. Inflation is usually much higher than they say it is. This is because the official figures exclude luxuries such as housing, energy and food. Education, pensions and healthcare are also routinely omitted – even though these are, for many people, the biggest costs in their budget. It is for this reason that people whose income is inflation-linked (people with inflation-linked pensions or private pensions depending on index linked gilts) find life difficult. In order to retain your spending power (and your quality of life) you need to make much more than official inflation levels from your investments -otherwise your capital is shrinking. So if you don’t take risks you are going to become poorer.
When the official level of inflation is 5% the real level of inflation will be at least double that. This means that if you are earning less than 10% a year on your investments you are losing money.
All this means that unless you are very rich, or are prepared to accept a deteriorating standard of living, you have to take some chances with your capital. Government policy means that you really don’t have much choice.
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It is vital to understand that inflation figures are now crooked and that the inflation figures governments talk about bear no relationship to the real inflation figures.
The official inflation figures in the UK and the USA in 2008 were both over 5% -- excluding non-essential fripperies such as food and energy. So, if you didn’t spend money on food or energy you only needed to grow your money by 5-6% a year to ensure that your capital remained the same. Of course if you did feel the need to spend money on food or energy then you would need to increase your capital by 10-15% a year or more in order to stand still. (Gas prices went up by 35-40% in the UK in the autumn of 2008 alone.) Unfortunately, most people’s investments actually fell in value during the first years of the 21st Century. Indeed, many investment funds were, in 2008, at more or less the same level that they had been in the mid 1990’s. It is hardly surprising that many people felt that there was really little point in saving.
Inflation has a powerful effect on investments. Rising inflation is toxic for shares and for bonds. When inflation goes up interest rates also rise and governments tighten up monetary policy. When inflation falls share prices and bond prices tend to go up, and sometimes soar. The huge bull markets of the 1980’s and 1990’s were a consequence of the fact that inflation was falling from the high levels of the 1970’s. Many investors who did well during the 1980’s and 1990’s still believe that their success was ‘normal’ and to be expected. Some actually believe that they are entitled to gain 15% returns from their portfolios for ever more.
Here are some things you should know about inflation:
- Inflation was kept down at the end of the 20th Century because we were importing cheap stuff from China. Cheap television sets, cheap bras and cheap shoes. This helped enormously in the 1980’s and 1990’s. It meant that we could buy more stuff with the money we had in our pockets and our bank accounts. But the Chinese workers now want higher wages. They want motor cars and they want television sets of their own. So our inflation rate will rise.
- The rate of inflation has a vital influence on the economy. Rising inflation means that interest rates have to go up (or must, at the very least, be kept at their current level). Rising inflation also means that monetary policy must be tightened. Falling inflation, on the other hand, results in lower interest rates and a booming economy. If inflation is not considered a threat central bankers can, if they think it is necessary, reduce interest rates in order to stimulate a stagnant economy. But if inflation is considered a threat central bankers will usually keep interest rates fairly high because they will be worried that if they lower interest rates too much they will over-stimulate the economy and produce more inflation. (Governments constantly claim to have found the way to conquer the ‘boom and bust’ economy. They are lying, of course.) The bull market of the late 1980’s and 1990’s followed the high inflation rates and big bear of the 1970’s. It was the falling inflation rates that drove the powerful bull markets of the 1980’s and 1990’s. I remember locking in loans at 11-12% for property investments in the 1980’s because the rate seemed absurdly low (to me and to everyone else). As inflation fell and productivity went up (as a result of new technology and as China and India started manufacturing things) so we did better and better. Cheapish oil made everything very easy. Those were the days when investors got, and learned to expect as normal, returns of 15% a year on their equity investments. If you wanted your money to grow there was no other game in town. Just buy shares and sit back and wait. And you didn’t have to wait long.
- In the middle of the 20th Century governments undermined the value of our money (and discouraged savings) by printing too many banknotes. The more money in circulation, the less the money is worth. (Because there is a finite number of things that can be bought with the money in existence). Today, the amount of money in circulation (in the form of real notes) is only a tiny amount of the money available. Banks are now creating money by lending it as a debt (with interest attached, of course) and it is that practice which has really pushed up inflation. The whole problem started when bankers and politicians got rid of gold as a basis for our currencies. When governments could only print as much currency as they had gold, the politicians were restrained. When the link with gold was abolished governments were free to print as much money as they wanted. Then they made things even worse by using computers to create seemingly endless supplies of ‘imaginary’ money. It’s hardly surprising that house prices have been rising (with occasional slumps) for decades. I bought a birthday card for a friend yesterday and in real terms it cost more than my first car. That’s inflation. Inflation really does eat away at savings. If you had put £1,000,000 in a box under your bed 40 years ago it would now have a purchasing power of £77,000. (Yes, I know the notes would be out of date and useless even if they hadn’t been eaten by mice.)
- Paradoxically, politicians and central bankers love some inflation. The reason is simple. When the value of money goes down a little bit (which is what happens in inflation – you can buy less for your unit of currency) debts get washed away. If you are a government with huge debts then inflation is a wonderful thing. It helps diminish the value of your debts as time goes by. (By the same principle, inflation helps reduce the value of debt for everyone else, too.)
- Rising commodity prices usually result in a rise in inflation in countries which have to import commodities. Countries which produce the commodities which are rising in value usually do well. I am very long-term bullish about the price of oil and other commodities (commodities of all sorts are running out and the demand for them is rising inexorably). I therefore believe that high inflation is likely to be a consistent problem in countries such as Britain (which rely on importing commodities such as oil).
- Inflation hit nearly 15% in the USA in 1980. (It was much higher in the UK.) This was a direct result of America’s 1971 decision to abandon the link between the dollar and gold. Freed from the need to back up their dollars with gold the American Government printed more and more dollars. And the dollar became increasingly worthless. Will inflation ever get back to those now seemingly absurd levels? Why not? Governments are still printing vast quantities of currency and backing up their banknotes with nothing but hot air. It seems inevitable that the value of currencies just about everywhere should continue to shrink. And that, after all, is all that inflation is.
- Inflation means that for most people their salaries and wages have failed to rise for many years. People think they are better off than they were twenty years ago. But when inflation soars it enables workers to have pay rises without the pay rises actually costing anything. People aren’t really better off because costs have risen faster than pay.
- Real inflation is around 10% to 20% (maybe more) so if money isn’t invested and growing then your purchasing power is diminishing and you will get poorer. If you are reliant on an allegedly inflation-proof pension you can rely on the fact that your pension will not keep up with inflation. Falsifying the inflation figures means that inflation-proofed salaries and pensions paid by the government can be increased by a much smaller figure than would be necessary if they were being increased by the real level of inflation.
- Officially, inflation in the UK for the last 30 years has averaged 5.3% a year. That means that if you had money invested for that period and your after tax income was less than 5.3%, you were losing money. If you are a 40% taxpayer it’s quite difficult to get an after tax income of 5.3% without taking considerable risks.
- Governments don’t just ignore rising costs in food and energy when they are assessing inflation figures. (They fiddle the figures in this grotesquely dishonest way because it is easier to keep the official inflation figures down – and to convince everyone that they are doing a good job – if they don’t count the things that are going up most.) They also use astonishing little tricks such as including hedonic adjustments and rental-equivalent home pricing and using geometric averaging when working out different varieties of inflation.
Geometric averaging means that if the basket of goodies measured to find the inflation figure contains one item which goes up 10% and another which goes down 10% the effect on the basket isn’t 0% (as you might imagine) but a 1% fall. Governments produce this miracle of accounting by multiplying 110 (the figure obtained because of the 10% rise) by 90 (the figure obtained because of the 10% fall). This gives a total of 99. And, lo, a fall in inflation (and the cost of living) of 1%. Only politicians and economists can do this.
Hedonic adjustments enable politicians to take advantage of progress to keep inflation low. If you bought a computer a year ago for £1,000 and you replace it with a computer which costs £1,500 but is 10 times as fast then the computer is registered by the government as costing less even though it really cost more.
And rental-equivalent home pricing? That’s a trick they use to minimise the effect of rising house prices (when they include them). If your home is now worth twice as much as it was a few years ago but the rent you would have to pay has only gone up by half then the inflation figure is deemed to be a half. The real rise in the cost of the home is ignored.
All these utterly, deplorably, dishonest inventions were designed to enable politicians to lie and cheat the voters. There are more tricks: for example, when they measure gross domestic product they tend to ignore the fact that the population has grown and that the per capita GDP – the figure that really matters – is probably going in the other direction but I’m getting weary and I suspect you are too. Unravelling the lies they tell can be tiresome work. The lies have worked very well on both sides of the Atlantic. Politicians and civil servants are concerned only with what they can get away with. They ignore the moral and ethical dimensions.
In the summer of 2008 the official US inflation figure was between 2% and 2.5% but, if the American Government hadn’t changed the way it measured inflation back in 1992, the official inflation figure would, during that summer, have been close to 9%. The real, practical inflation figure would have been even higher.
Businessmen and women who lie usually fail eventually (though they may get exceedingly rich before they fail). Investing in companies run by crooks can damage an investment portfolio. But politicians who lie (and lie well) usually do well. The electors consistently choose the politicians who lie most convincingly.
- Inflation is an invisible tax. Although it is a boon for borrowers (the £250,000 borrowed to buy a house shrinks as a result of inflation) it is a curse for savers (the £250,000 pension fund shrinks in value and purchasing power as a result of inflation). Pensioners and others on a fixed income lose out because their buying power is constantly being eroded. Earners whose income doesn’t match inflation (the real figure, rather than the false ‘official’ figure) also lose out. They may seem to be getting richer, as their income grows, but in reality they will be getting poorer. And everyone who pays tax will lose out. Tax thresholds do not usually rise with inflation. So stamp duty on house purchases affects an increasing number of people as house prices rise and the stamp duty thresholds remain the same. And since the point at which taxpayers find themselves liable for higher rates of tax tends to stay the same (or to rise nowhere near as much as inflation) the number of people paying higher tax rates is rising rapidly. You will probably not be surprised to learn that governments don’t usually take inflation into account when helping itself to a share of your income. So, if you have a 6% income on your investments and tax rates are 40% you will pay 40% of your 6% to the government. That leaves you with a 3.6% return. But if the official level of inflation is running at 5% then you are losing 1.4% a year. If real inflation is 10% you are losing 6.4% a year. You may think you are getting richer but in reality you are getting poorer.
- In August 2008 Zimbabwe issued a Z$100 billion note to keep up with inflation (then running at 2.2 million %). That was not, however, the highest denomination banknote produced in the last 100 years. In the 1920’s Germany had a 100 trillion Papiermark note. And in 1946 Hungary printed notes with a face value of 1,000,000,000,000,000,000 pengos (that’s one followed by 18 zeros and it is known to its friends, if it has any, as a quintillion). One German I know recently pointed out to me that his father had taken out an insurance policy in 1903. Every month he made payments. The policy was for a 20 year term and when it matured he cashed it and took out the proceeds. He used the entire proceeds to buy a single loaf of bread. A Berlin publisher reported that an American visitor tipped their cook one dollar. The family met and it was decided that a trust fund should be set up in a Berlin bank with the cook as beneficiary. They asked the bank to administer and invest the dollar. The price rises in inflation-crazy Germany became dizzy. A student at Freiberg University ordered a cup of coffee in a cafe. The price on the menu was 5,000 marks. He had two cups. When the bill came the price for the second cup of coffee had risen to 9,000 marks. He was told that if he had wanted to save money he should have ordered both cups of coffee at the same time. The printing presses at the Reichsbank could not keep up. Factory workers were paid daily at 11.00 a.m. A siren would sound and everybody gathered in the factory forecourt where a five ton lorry waited. The lorry was full of paper money. The chief cashier and his assistants would climb up onto the lorry, call out names and throw down bundles of notes. People rushed to the shops as soon as they had caught their bundle. Doctors and dentists stopped accepting currency and instead demanded butter and eggs. When the Germans introduced a note for one thousand billion marks hardly anyone bothered to collect their change. It wasn’t worth picking up. By November 1923 a single dollar was worth a trillion marks. People living on their pensions found that their monthly cheque would not buy a cup of coffee. People dependent on insurance payments were destitute.
When traced back it is clear that hyperinflation in Germany started when Germany abandoned the gold backing of its currency in 1914. The Government borrowed to finance the war.
Half a century later the Americans borrowed to finance the Vietnam War (their philosophy was identical: the war will be over quickly). And since America left the gold standard and started borrowing big time inflation has been a constant and serious problem. (Though the extent of it has been ignored and suppressed.)
- It is partly because of their unspoken fear of inflation that ordinary people throughout the world have unwisely (but understandably) relied on buying property as a defence and a way of preserving wealth.
- In spring 2007 the Japanese Government sold a two year bond which promised to pay interest of 1% a year. This was the highest bond the Japanese Government had issued in ten years. When Governments flood their countries with money that doesn’t cost much to borrow (because interest rates are kept low) they are deliberately creating inflation. When money is ‘cheap’ people buy more houses. Between 1985 and 1991 houses in Japan rose by 51% before the bubble burst. Similar things have happened in America and the UK. In America, where interest rates were kept low, house prices rose 90% between 2000 and 2006. And then the bubble burst. In the United Kingdom, where interest rates were also kept low, house prices rose 118% between 2001 and 2007. Many so-called experts dismissed thoughts that this was a bubble and claimed that house prices could, and would, continue to rise indefinitely.
Printing lots of new bonds (and ultimately lots of new currency notes) is an easy way to improve your exports. It was started in earnest by the Americans in the 1990’s. It works because when you print more currency you lower the value of the stuff already in existence. And when the value of your currency falls when compared with the currencies of other countries your exports become cheaper. All the world’s major powers are now increasing their money supply by over 10 per cent a year. The Americans are now increasing theirs by around 14% a year. It is hardly surprising that the American dollar has been on a downward slide for years. This is not an accident. It is the American Government’s deliberate policy. The dollar has lost more than seven eighths of its purchasing power over the last 60 years.
Of course, it isn’t only the American dollar which has been destroyed by Governments deliberately printing more money. The British Pound, the Euro and even the once powerful Swiss Franc have all lost value in recent years.
Taken from the book Moneypower by Vernon Coleman