The Daily Telegraph - Saturday - Money
Diary of a private investor
It’s the question that will determine everything, says James Bartholomew: is inflation coming back?
In case not everyone is aware of this, there is an extraordinary, once- in30- years- type disagreement about what is going to happen. A lot will depend on who is right and who is wrong. The stock market will rise or fall. Mortgages will become unaffordable or not. The pound will weaken or not. House prices will be strongly affected.
The difference of opinion centres on inflation and interest rates.
On one hand, the majority of people in prestigious, powerful jobs believe that inflation is not going to be a problem. This large group includes Christine Lagarde, the head of the European Central Bank.
Martin Currie, the investment management company, has gone so far as to take out an advertisement in MoneyWeek rejecting worries about inflation. It argues that there are “deflationary undercurrents”. Technological advances are helpful, it argues. High and rising debt levels “tend to be associated with periods of lower growth” and “weakness in the labour market caused by the pandemic” will act against inflation. It concludes: “We suspect that these factors will combine to prevent a meaningful, sustained pick-up in inflation.”
The Economist Intelligence Unit chimes in with a forecast that in Britain consumer price inflation this year will be a modest 1.7pc and in America it will be only 1.9pc.
This is the majority view. But a minority of economists believe this is utterly wrong and, for what it is worth, I agree with them. Prominent among them is Prof Tim Congdon, a monetary economist. He looks at changes in the amount of money in an economy. The basic logic is: if you suddenly, say, double the amount of money in the economy, the value of that money, sooner or later, will more or less halve.
To people of my generation, this was emphatically proved by the experience of the 1970s when money supply soared and, with a lag, so did inflation. Suddenly everybody was forced to care about monetary policy. But economics teaching in universities
Many people who have invested in long-term bonds through pensions and Isas would lose money
did not change very much, so that lesson has gradually been forgotten.
The big problem is this: the money supply in the British economy has increased by 15pc in the past 12 months. This has not yet affected inflation. The theory of monetary economics is that it can take a year or two for inflation to come through. In America the rise in the money supply has been even more dramatic: it is up by 22.6pc. In view of this enormous jump, the idea that America can avoid a surge in inflation seems to me to be quite bizarre.
If Prof Congdon, other monetary economists and I, following in their wake, are correct, the implications are worrying. A rise in inflation later this year or in 2022 would lead to a rise in interest rates to try to bring it under control. That rise in interest rates would mean the dividend yield on shares would look less attractive and shares could fall even though many British shares are on good yields. Companies and individuals who have borrowed a lot would be under pressure. Some might go bust. The value of long-term bonds would continue the fall that has already started. Many people who have invested in long-term bonds through their pension funds and Isas would lose money. The challenge could be to hold on to the real value of one’s assets, never mind increasing that value. I wish I could think of a perfect way we could protect ourselves but every option I think of has some flaw or other.
I am still heavily in British shares but I really must not delay much longer in taking more defensive measures. I will increase my “shorting” of long- dated American government bonds by holding exchange-traded funds that go up if long-term government bonds go down. I aim to hold more cash. I should only hold on to shares that seem to me to be exceptionally good value.
I should weed out companies that rely heavily on overdrafts. I should make any major purchase I have in mind – such as antiques or a new car – now rather than in a year or two.