The Lies (And The Truth) About
Governments say they hate
inflation. That's a big, big lie. Governments love inflation - especially at the
moment - because it is the one way to get rid of debt. If the value of a
currency goes down then the amount of money a country owes will also fall.
Politicians also love inflation because it helps rescue greedy house buyers who
have bought homes they can't afford. When inflation goes up there is a much
smaller risk of a house price collapse. The fall in the value of the currency
means that house prices can collapse without appearing to collapse. Of course,
inflation destroys the value of money people have saved. But neither politicians
nor the Bank of England give a stuff about the prudent. They just want to avoid
a house price crash because that will make them unpopular.
tell two other lies 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 then pushes up prices. So governments cause
inflation. The second lie is the size of the problem. Inflation is much higher
than they say it is.
Current inflation is much, much worse than the
Government says it is. The official figures exclude luxuries such as housing,
energy and food. Education, pensions and healthcare are also routinely omitted -
even 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. And people whose incomes rise according to the official inflation
figures also suffer. In order to retain your spending power (and your quality of
life) you need to make much more than inflation levels from your investments -
otherwise your capital is shrinking. So if you don't take risks you are going to
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. With a lower
official level of 2.5%, and an unofficial level of 5%, any increase in your
capital of less than 5% means that 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. Savers are being forced to
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 figure in the UK is
now around 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 after tax 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.
Unfortunately, most peopleís investments actually fell in value during the first
years of the 21st century. And successive governments have kept interest rates
low to protect the greedy millions who bought houses they could not afford and
to try to delay a house price crash.
Many investment funds are now at
more or less the same level that they had been in the mid 1990's. It is hardly
surprising that many people feel that there is really little point in saving.
Inflation has a powerful effect on investments. Risking 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 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 then 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:
1. 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 want higher wages. They want motor cars and they want
television sets of their own. They want more money. So our inflation rates are
going to soar.
2. 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 itís 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 which drove the powerful bull markets of the 1980's and 1990's.
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.
3. 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 my wife yesterday. 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 have been out of date and useless even if they
hadn't been eaten by mice.)
4. 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.)
5. 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). I also believe that countries such as Canada and
Australia (which produce huge quantities of essential commodities) are likely to
have a relatively strong future.
6. 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
7. 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. When inflation soars it enables workers to have pay rises
without the pay rises actually costing anything. But people aren't really better
8. Real inflation is around 10% (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.
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.
10. 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 you are doing a good job - if you
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 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
Hedonic adjustments enable politicians to
take advantage of progress to keep inflation low. If you bought a computer a
year ago for £1000 and you replace it with a computer which cost £1500 but is 10
times as fast then the computer is registered by the Government as costing
And rental-equivalent home pricing?
That's a trick they use to minimise the effect of rising house prices. 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
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.) And they have worked very well on both sides of
the Atlantic. Politicians and civil servants are concerned only with what they
can get away with. If they can make something legal they will do so - and ignore
the moral or ethical dimensions.
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
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.
11. 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.
12. In August 2008,
Zimbabwe issued a Z$100 billion note to keep up with inflation (then running at
2.2 million per cent). That was not, however, the highest denomination banknote
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 old term and
when it came due 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 am. 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 the 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.
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 because of their unspoken fear of
inflation that ordinary people throughout Europe and America have unwisely (but
understandably) relied on housing as a defence.
13. If you want your
investments to match inflation then you probably need to make a minimum of 8 or
9% after tax. Any less will probably not be enough to cover
14. 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% 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 Government is printing new money at around 13% a year. The European Bank
is printing money at 9% a year. And so on. The British Pound, the Euro and even
the once powerful Swiss Franc have all lost value in recent years. Today there
is $40 trillion worth of paper money in the world and $50 trillion worth of
bonds. A trillion is a million million or a thousand billion.
Printing more money reduces the value of the
money in existence. And that inevitably causes inflation, a liquidity bubble and
absurd overvaluations in almost every market - from paintings to shares to
Copyright Vernon Coleman 2011
Moneypower by Vernon Coleman.
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