Last week the inflation numbers gave a good many people a bit of a shock. The Consumer Price Index was up 5.2% on last year, and the Retail Price Index up 5.6%. MoneyWeek readers probably weren’t that surprised – we’ve been warning about inflation for a long time now. But when people congratulate us for being right on inflation, I do feel the need to point out that we haven’t been right on this just yet.
Inflation at this level is horrible. It means the value of real assets is falling by much more than you think (house prices adjusted for inflation are down 25%-30% since 2007). It means that your savings are losing 4%-6% of their purchasing power every year. And it means that ordinary salaried borrowers, as their real wages fall, have even more trouble meeting their obligations than before. Pretty much the only people this kind of inflation helps is the government – assuming, as City AM’s Allister Heath points out, that George Osborne pays out less extra in benefits and the like than he makes from cutting real-term spending on public-sector services and wages.
However, the inflation we have seen so far is not actually the inflation we worry about most. That will be far worse. This round is partly to do with the falling pound, partly to do with energy prices and the rising costs of services, and of course, to do with tax. So it is perfectly possible that it will – as Mervyn King keeps promising – fall back fast next year. That’s particularly the case given the deleveraging environment we live in. Note that fast-rising energy bills leave you with less to spend in the shops, given that you are no longer able or willing to borrow to boost your consumption. That’s why almost all shops now permanently run some kind of sale. Note too that Australia has just announced its lowest core inflation for 14 years.
So what kind of inflation do we worry about most? It’s the one where the population suddenly loses faith in the currency and starts to spend it instead of saving it – where the velocity of money (the speed at which it changes hands) starts to rise, all the new money pumped in by quantitative easing (QE) gets to work, and prices soar.
Deflationists believe this won’t happen – that spending and confidence are so depressed that the velocity of money won’t rise. But they might miss the point – it doesn’t have to be confidence that gets people spending again. It can be lack of confidence. And under those circumstances it can happen very suddenly. Ruffer’s Jonathan Ruffer points to the speed at which the population of the UK lost faith in their banks – we went from financial inertia to queuing outside Northern Rock in just 24 hours. We can lose our faith in money just as fast: it will just take one round of QE too many or one too many patronising letters from King to Osborne on why 6% will soon be 2% for us to suddenly think an empty bank account might trump a full one. We haven’t been right on inflation just yet and it might be a while before we are (if you aren’t yet hardened to gold price volatility get used to it…). But I think we will be in the end.