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Transcript: Inflation Tax, And How To Avoid It

Owain Bennallack is joined in the studio by Pete Comley, the author of Inflation Tax: The Plan To Deal With The Debts. Pete argues that both history and pragmatic common sense tell us that the government will turn to inflation to try to manage down Britain’s massive public debt burden, and that most people won’t even see it happening. Owain naturally asks him how we can duck the bullet! Unfortunately there’s no simple solutions on offer, but there’s certainly plenty to think about.

The following is an unedited transcript of this Fool podcast:

Owain:

Hello, and welcome to Money Talk, the investing podcast from The Motley Fool.  I’m Owain Bennallack, and my guest today is Pete Comley.  Pete is the author of “Inflation Tax”, and it’s not your first time in the studio, is it, Pete?

Pete:

No.  I was here just over a year ago, talking to David about my last book, which was called “Monkey With a Pin”, which was all about why investing in the stock market, your returns are maybe not as high as you might expect.  I know David and I had some interesting spurrings over my thoughts on what people should be doing for investing.

Owain:

Well, the great thing with that book was, it was very controversial.  All over the boards, we had people saying, Pete’s far too pessimistic; Pete’s far too optimistic, a few people said.  So I’m hoping, that with this hot button topic that you’ve picked for your new book, we’ll get a similar response, and the new book is called “Inflation Tax”, and is about the coming threat of inflation. 

Pete:

It’s not so much the coming threat of inflation, as we’ll discover later on in the podcast.  Inflation has been here and growing for a number of years, but its impact at the moment is greater than what it’s been in the past, and I think that’s the critical thing, and why I particularly wrote the book.

Owain:

OK, well let’s start off with very first principles, Pete.  Can you please explain to me, in simple terms, I’m a humble podcaster – can you explain to me what inflation is, and why it matters when it comes to our financial well-being?

Pete:

If you were to go down the street, and ask someone what’s inflation, they would probably say to you, it’s just an increase in prices.  If you were to ask an economist, they’d probably tell you, it’s all to do with increasing the money supply.  If you go into a dictionary, say 30 – 40 years ago, it would have just had the economist’s description in it.  If you go to it now, it would probably say, it’s an increase in prices, and also associated with a decrease in the value of money, and it’s the latter bit that people don’t often realise, the decrease in the purchasing value of their money. That’s why it’s a particular problem at the moment, because of various policies that governments have had to follow, namely keeping interest rates down, and also the economic position we’re in at the moment, which means that wages and benefits and things like that are not keeping up with inflation.  People have a real problem with it, so even though it may not be that much higher than it was before, it’s actually a big problem for people.

Owain:

Yeah, I think it’s interesting that you say it’s not much higher, because the average person, and I’ll put myself into that bracket, looks at inflation, and it’s, 2, 2½, 3% – it always seems to be a bit more than the Bank is targeting.  They don’t seem to be particularly good at ever hitting their target, but it doesn’t seem to be particularly high, so what do we mean, when we say inflation is high, or indeed low?

Pete:

I think you’re right – people’s perceptions of inflation is very much framed by the Bank of England. It set a target of 2% inflation on CPI, and therefore provided inflation’s around about that figure, people tend to think, yeah, it’s fine – I don’t need to worry about it.  Indeed, why would the Bank be setting a target of 2%, if that wasn’t an OK level?  But I think, if you look back in history, you can see that inflation has actually varied quite a lot in this country.  The records go back to about 1750.

Owain:

And you’ve dug them out?

Pete:

I’ve dug them out.  If you look at them for the first couple of hundred years, inflation went up and down a bit like a yo-yo.  Some years it would go up, when there was crop failures; some years it would go back down again.  If there were major wars, like the Napoleonic War, or First World War, prices would go up, mainly because of increasing the money supply.

Owain:

What sort of range are we talking about? – are we talking 1 – 10,  or 2 – 4?

Pete:

We did get odd periods in the past.  There’s only been two or three times in the last few hundred years when we’ve gone over about 20% inflation, I think back in about 1800, and during the First World War, and again in the Seventies, but those are about the only times when we’ve had a big spike.  The first couple of hundred years, the average inflation was about 1½%, but something strange happened in 1945.  If you look at a graph of inflation, and I’ve put it in the book, and I think it’s on the website as well, it suddenly starts rocketing up at 1945. The average rate since then’s been over 5%, and it’s been pretty continuous from that point.  The Second World War was unusual – we didn’t drop back like we did after the previous war.

Owain:

And the key would be, I would hazard, having both read your book and read the history books, that we came out of World War Two with a whopping great bill to pay?

Pete:

We had a whopping great bill, and in fact Keynes described it as a financial Dunkirk actually, to just make it slightly emotive.  We came out with debts of about 237% of GDP, which is absolutely massive.  That’s more than Greece has got, that’s more than Japan’s got at the moment.

Owain:

It’s far more than we have at the moment.

Pete:

And far more than we have at the moment, which is less than, it’s only about 70, 80%. It was a massive problem, and they had to do something about it, and the planners at the time knew that there probably only were a few solutions to that.  Clearly one option might be to pay it back, but historically UK governments tend not to do that with their debts. I think the last person to seriously do that was Sir Richard Walpole, back in about 1700, so we tend not to do that with our debts.  What we do do is, we create inflation, and we watch them gradually disappear away, and indeed that seemed to be particularly the policy after the war. 

Owain:

I think probably it’s worth remembering that, even though in the UK, we haven’t had that many episodes of high inflation, other countries, not Mars or the moon, countries quite close to us, have of course had bouts of inflation, so what has happened elsewhere could equally happen here again.

Pete:

It could indeed.  I mean, personally I don’t think it’s likely we’ll end up with massive inflation, like hyper-inflation or anything like that.  They’re pretty rare occurrences, and despite all the money that the Bank of England’s printing, I don’t think it’s going to create hyper-inflation.  I think those who are saying that are slightly scaremongering.

Owain:

But anyone who has spent some time with a compound interest calculator, working out if they can make their return 7% instead of 6%, will know that little differences make a big difference.

Pete:

They do indeed, and that is really the issue.  I think part of the concern at the moment is that we have a new governor at the Bank of England, Mark Carney, and he’s certainly been rumoured to want to increase inflation potentially by switching across to a nominal GDP target, which, to all intents and purposes, means that we’re probably going to have inflation towards 4% rather than 2%, so the risk of this going forward is much bigger.

Owain:

OK, so your book is called Inflation Tax – quite emotive, but as you’ve explained very nicely, inflation isn’t really an explicit tax, is it?  Rising prices, you don’t have to pay the difference to the government when you go and buy a burger, and it costs 50 pence more than it did a couple of years ago.  So what do you mean by inflation tax? – when you say inflation tax, how is your scaremongering working there?

Pete:

How is my scaremongering working?

Owain:

It’s basically that, democracy, it’s hard to tax people, but they don’t notice inflation.

Pete:

You’re right – inflation tax, it’s not an overt tax on people, but what it does do, is it erodes the value of anyone who holds government debt, and who holds government debt – it’s mainly pension funds, which, to all intents and purposes, is you and I.  The value of that debt is gradually being eroded by inflation, and also the annual income that’s being paid out is being eroded by inflation, as time goes by.  Similarly, if you’re a saver at the moment, you’re just not getting the rate of interest to balance inflation.  A few years ago, it was quite typical that inflation rates would be maybe a couple of percent below interest rates, so you were pretty guaranteed, by leaving the money in the bank, to make a level income, but that just doesn’t happen any more.

Owain:

And of course, the key is that if the government wants to come out and say, we’re going to increase income tax by 5% to pay off the debts, there would be uproar, whereas sneaky inflation …

Pete:

Just deals with the problem. It’s been long known – you even had the likes of Lenin about a hundred years ago, saying one of the best ways to deal with economic problems was to create inflation, and Keynes and others well knew that fact.  In fact, it’s part of his general theory he wrote in the Thirties that then started to get adopted as government policy by countries, that they realised that inflation was not only a way of dealing with debts, but it was a way of potentially creating higher employment, and that was part of the justification which people use for creating inflation after the war. 

Owain:

So we know it’s been done before, after the war.  We know it’s been done by Lenin, to some extent.  But what about today?  As we’ve briefly discussed, we know the Bank of England has consistently overshot its inflation target.  It was doing this even before the financial crisis.

Pete:

It was indeed.

Owain:

So I guess you could say it’s quite skilled at it.  Do you think you would have to tinker with the rules now? – as you say, it would have to say, well we’re going to target unemployment, maybe like Bernanke’s done in the US, or some other figure which would give it a bit more cover for letting inflation run a bit higher?

Pete:

I think it does.  One of the other reasons we probably overshoot the target is, it’s actually very difficult for central bank to actually control inflation.  They have one simple lever, which is interest rates largely, and with that they hope to control the amount of money that’s in the economy, and therefore what happens to inflation, but it’s actually incredibly difficult for them to do that.

Owain:

It’s very interesting that, at the moment, we seem to be giving central bankers almost God-like powers.

Pete:

We are. 

Owain:

But if you look at Japan, where people say, well yes, even their central bank has God-like powers – it just didn’t use them properly, because they’ve been unable to create inflation for twenty years.

Pete:

I know.  In fact, Japan, I think, is a really good casebook example of how difficult it is to actually control and create it when you want to.  I think the problems in Japan is that they just had so much of an overhang of asset prices that had got so high, and a debt mountain and a company dip, that it was, as you worked through that debt, and it gets written off, the money supply contracts, and even things like house prices are still almost coming down to this day, so that’s having a direct impact on the inflation index over there as well.

Owain:

And when we look at what happened last time, it’s a bit like looking at, previously on Lost, or whatnot; previously in this episode, known as governments using inflation, we saw World War Two, the high debts.  Eventually that ended up, you could argue, with inflation truly being out of the bottle by the Seventies, grandparents growing up knowing that your savings could be eroded away to an extent (obviously interest rates were also a lot higher in the Seventies).  But you’re not particularly one of these people who is saying, we have to be careful, because inflation’s going to be 10 or 12%, are you?  You think that, we have wised up to that extent?

Pete:

I think we’ve wised up.  This country has been pretty good at controlling its inflation rates over the time.  Actually I’m a market researcher by trade, so of course I ask people questions about inflation, and from that I know that, provided inflation stays below about 5%, most people are pretty happy to, they might get a bit concerned about it, but they’re not going to get too worried about it.  The minute it goes over 5%, they start getting quite concerned, and the powers-that-be know that, so therefore they do whatever they can to make sure that interest rates, expectations about inflation, are kept low, which is, as you were saying about the Bank of England, it’s been predicting that inflation will come down to 2%, every single prediction over about the last six or seven years, and every single time it’s been higher than 2%.  It’s quite incredible, but people still believe it, and the government still puts it into every one of their plans, that that’s what’s going to happen.

Owain:

It is truly incredible.  I mean, it’s hard enough to forecast economic variables if you’re in the City, but they actually have some control. There may only be one lever – they have their hand on the lever.

Pete:

They do, yeah.

Owain:

And yet even then they can’t get it right.

Pete:

I know, it’s quite incredible.  In a period of a few years ago, when I think they were predicting inflation would get down to about 0.6%, and we might even go into deflation, the actual outcome from it two years later was about 4.5% – miles out.  Mind you, they had printed a few hundred billion dollars, so maybe that might have something to do with it.

Owain:

And something we should briefly mention, I suppose, is that inflation can occur and be different in different places.  So I might be in my local supermarket, and I might notice that the price of bread has gone up.  If I’m filling up the car, petrol may have gone up.  If I don’t have a car, I won’t be affected by the latter form of inflation, and of course I have to buy things with my wages, and you say you have wage inflation, and perhaps the key is that, if inflation is running at 5%, but my wages are only going up by 1 or 2%, even 5% is going to effectively start to hurt.

Pete:

Yeah, and that, to be honest, is one of the biggest problems.  I look back at the published data on average household income, and if you look at it over the last four years of published data, I think the average weekly gross income is £713 a week, in the last bit of data.  Four years before, it was exactly £713 as well.  So during that four years, RPI went up 12½%, yet gross income did not change, and yet a whole set of areas, inflation in the 15 – 20% mark; we all had to spend more on fuel; we all had to spend more on food during that time.  Things like car insurance went up massively. So what happened? – people had to cut back, and had it not been for mortgage rates coming down, and therefore giving a benefit of extra cash in people’s pockets from that way, and also tax revenues going down a bit, because the thresholds went up, the whole country would have been in a much bigger mess.  My concern going forward is, I don’t see average household income going up much in the forthcoming years, and yet prices are still going up.  There’s a whole set of prices, things like train prices – they go up every year above inflation. 

Owain:

I haven’t looked into the data, so I’m going to rely on the fact that you have, and throw you this curveball.  Presumably, after the war, we see Britain’s golden age, and booming in the Sixties, and whatnot.  Presumably wages were rampant effectively, in those times?

Pete:

In the past, wages were much more closely aligned to increases in the retail prices index, and unions had a stronger ability to negotiate that. That’s the key difference now – people aren’t able to get inflation wage rises like they were before.  Most companies are giving their employees a trade-off – what do you want?  Do you want a job, or do you want an inflation pay rise?  Most of the country has opted for a job, thank you very much.

Owain:

I think if David Kuo was here, we would now go into an argument – that’s one of his favourite bugbears.  But we’re going to sidestep that, because we only have one podcast today, so let’s move on to say, to look at how we’re going to get out of this problem as individuals.  I’m all for the government dealing with its debts without taxing me, if I don’t have to pay the inflation tax – I’ll be honest, Pete.  I’m a rational, economic agent.  So, you say in your book though that you think we’ll all have to accept that we’ll pay some inflation tax.  In fact, you say it wouldn’t be fair, to do what I’m doing, to try and sidestep it.  I think the phrase, “we’re all in this together”, is one that has been used by some politicians.  Is it really correct, though, to say that we’re all in it together?  If I’m a pensioner, and I lived within my means, I amass some savings, and I’m now trying to supplement my living standards, Eccles cakes go up by a couple of pence. There’s nothing I can do about my income, because I’m a pensioner, I’ve got a fixed income.  So surely I should be trying to avoid inflation tax in that circumstance? – possibly not in the circumstance I personally find myself in, but without becoming too philosophical about this, is it not rational for people to say, I’m going to avoid trying to pay debts that were run up by more profligate people? – or do you think that’s just …

Pete:

I totally agree with it.  Funnily enough, when I started to write the book, the whole part of writing the book was I was just so incensed by the fact that it looked like this appeared to be an unofficial, unwritten government policy to deal with its debts, and it seemed so unfair to people who had saved, and also to pensioners, and indeed there are organisations out there sort of lobbying that very cause.  But I suppose, when I started to look at it more, I realised, we’ve got such big debts now.  It isn’t just the government debts – we’ve got private debts, which are slightly, I think they’re about 1.4 trillion, so they’re slightly bigger than the government debts.  Business has got debts of about 1.7 trillion as well, and banks have got debts of over 2 trillion.  So if you add them all together, the country’s got about 7 trillion’s worth of debt, which is about 3 or 4 times its GDP, actually 4 or 5 times its GDP.  Those are massive. How are we going to deal with those debts?  As a country, we’ve never had accumulative debt that size before.  Inflation is probably one of the only ways to deal with it.

But I think, my other point really is, to those people who are savers and pensioners, another way you could look at it is that you lived through the great period of the Seventies and Eighties and Nineties.  You bought your house for next to nothing, in today’s terms, and inflation has eroded away not only debt that you had on it, but you’ve had a massive capital gain on it over the last couple of decades.  So your wealth is higher because of inflation, so I think, having said all that, I can see that the comments on the board are going to go firing at me, and shoot me down.

Owain:

I think that is a very good point.  It’s a bit of a bugbear of mine, that people talk in absolute terms about a trillion here, and a trillion there, in terms of debt, and they very rarely reference assets.  Assets, the wealth of the country, has absolutely exploded over the last thirty years.  I take your point relative to GDP – there’s a relationship there, but I think the country’s a little richer than perhaps people sometimes fear, when they look at the big numbers, and go, how will we pay that?

Pete:

If you think about it, money is created, when you create debt – money is created at that point, so there is another penalty. So if you’ve got debt, someone else has gone an asset, so there should be the wealth here as well.

Owain:

Well, I have some of those assets, Pete.  I want to keep them, so I propose that, the rest of the podcast …

Pete:

Moving forward, and working out how to avoid you losing those assets.

Owain:

Yes – let’s save my financial well-being. So what are the main steps that investors like myself, I guess a pensioner on a fixed income, is kind of stuck, but if you’ve got some flexibility, what are the main steps, maybe to start with, just as the general principle?

Pete:

I think the first thing is to understand how inflation normally impacts upon different asset classes, and also there was a very good report put out by Credit Suisse in their yearbook, by Dimson and his colleagues, who I think you interviewed on The Motley Fool a few months ago. They’re very clear in their analysis in this year’s report that inflation is going to erode all assets.  So what you can do is to try and be eroded less.

Owain:

So pick your assets.

Pete:

Pick your assets.

Owain:

Let’s do a quick run through of the asset classes.  We did have Elroy, as I insisted on calling him – Professor Dimson in, and he was quite pessimistic, I would say, about the returns that we’re going to see.  So we won’t be specifically looking at those returns, from the point of view of inflation, so it’ll be interesting now to look at them purely for their ability to potentially protect me from this insidious inflation tax. So I’m going to start with one which, with interest rates at a couple of percent, I’m presuming is not the asset of choice, which is cash.

Pete:

At least with cash, you know you are going to suffer an inflation loss, and you can quantify almost exactly what it is. 

Owain:

That’s like, if you’re a hostage, or something, and you say, please, just tell me – put me out of my misery! That’s not a reason to hold cash, surely?

Pete:

Well, I think one of the main reasons to hold cash is optionality, and certainly with the stock market at its current levels, you could argue, who could say which direction it’s going to take from here, but I think it’s going to be fairly explosive in one direction or other. But if it’s going up, I want to make sure I’m in that, so that’s one reason you might want cash. But anyway, the returning to cash, what you can do is quantify exactly how much you’ve lost. In the book, I did some simple calculations over average interest rates that people had been receiving over the last four years, and also what inflation’s been, and if you subtract the two, you can work out what the loss is, and the loss of anyone holding cash in an average building society over the last four years has been about 11% of the value of their cash, which is a large amount to have lost.  In fact, if you put it in perspective, in Cyprus, only a few months ago they were talking about taking away 6.7% out of everyone’s account, and 9.9% out of anyone’s account over £100,000, and there were riots on the streets.   In this country, we’ve lost 11% in four years, and no-one’s said a word. 

Owain:

I would like to see the pensioners riot.  OK, I fully take that on board.

Pete:

So cash, we know, is a defined loss.

Owain:

It’s not our weapon of choice, but at least we know the pain.  So moving onto a different, but in some ways similar, asset class, and that’s bonds.  Bonds, again we have a fixed payout. We know what we’re going to get back for our bonds. They have no real ability to respond to inflation.

Pete:

Correct, and indeed if you look at the analysis done by Elroy Dimson and his colleagues, they show that bonds are the one asset class that is arguably most negatively affected by inflation.  I think their calculations were something along the lines, for each 10% increase in inflation, bonds go down 7%, or at least that’s over the last hundred or so years, so it’s not looking a good asset class.  Also you’ve got to factor in that, at the moment, we’re probably at the peak of a bond cycle, and there’s probably only one way that interest rates are going to go from this point. So it doesn’t look a very good asset class, to be holding in, in not only the current time, but also with inflation going on.

Owain:

OK, let’s walk further down the street – we get to the estate agent, and residential and commercial property.  Now, this would seem to me to have some potential to protect me.

Pete:

Let me just quickly do commercial property first.  Again, if you look at the analysis by Elroy Dimson, commercial property tends to be fairly negatively correlated with inflation, so if inflation goes up, commercial property tends to go down, and it’s partly related to the business cycle, that one. But residential property’s quite an interesting one.  I think, if you look at the official correlations, they’re slightly negative, but to me, I’d say residential property is not particularly affected by inflation at all.  It’s affected by other factors.  It’s affected by government policy, and it’s affected by the willingness of the banks to lend, and probably, to a lesser extent, your wage rises, which affects affordability. But it’s really those three factors that affect it, so what’s going on with inflation is a bit immaterial. So what’s going on with those factors at the moment? –  well, the government is doing everything it can at the moment to try and encourage house prices to go up before the next election, to create the so-called wealth effect that will come from that. So we’ve got the funding for the lending scheme, we’ve got loans of 20% – they’re throwing as much as they can at that one. What’s going to happen to interest rates? – they’re going to keep those interest rates as low as they can for as long as they can, certainly I’d say through to the next election. So, do I think we’ll see a housing boom in the next few years? – I think we probably would, really.  Is it sustainable long-term? – I very much doubt it, because all it will take is just the interest rates to go up, or we get through the next election, and there will have to be a big correction there.

Owain:

I’m inclined to agree with you. I think just to summarise, what we’d be saying, in the case of residential property then, is, and I say this because it’s going to be interesting with the next asset class, with residential property, we’d be saying, in your view, it’s not particularly linked to inflation, but seeing as it’s likely to deliver positive returns, then that will outpace inflation, so it’s a better place for your money.  The reason I say that is because we come on now to a subject close to our hearts here at The Motley Fool, which is shares equities.  As I understand it, shares have comfortably outpaced inflation over the years – I think about 5% has been the real return, but of course that is arguably just because shares do deliver a superior return, because of all the risks of holding shares.  It’s not necessarily because they have a particular relationship with inflation. Now, people do argue that Tesco can put up its prices and whatnot, and therefore there is some inherent ability within shares to respond to pricing, but mainly you’re getting your bang from your buck, because of the potential for higher returns, are you not?

Pete:

You are.  It’s interesting actually – the evidence is actually slightly against shares and inflation.  Certainly, if you go back and look, and I did it in the book really, just showed every period where inflation had been above 4% in the last hundred years, and plot it against the FTSE index, you’ll see that all of the periods when inflation is high, the FTSE is going down, in inflation-adjusted terms. 

Owain:

Sorry – when you say “high” there, are you talking about particularly high, not your 5%? – or would 5% count as high?

Pete:

The key tipping point for shares is around about 3 or 4% inflation, is a tipping point. The minute you get beyond that, historically they’ve not done so well, but I’m not saying that that will happen this time, because the reason there’s been that historical relationship is that central banks, whenever they’ve seen inflation taking off, they’ve immediately tried to put the brakes on, jacked up interest rates, and contracted the economy, and it’s that aspect which is being foreseen in the share prices, which is causing them to come down. That, I don’t think, is going to happen this time.  I don’t see any possibility of interest rates going up, or significantly in the coming years, so therefore I think shares are not going to necessarily perform as they’ve historically done, in such a negative way.  I think they’re going to do much better than that.

Owain:

Interesting – some potential cover there.  I’m going to turn now to one that has always been touted as a great protection against inflation, but possibly that was coming off a lower base, which is gold. Gold is the great guardian against inflation, but how is it going to perform now? We’ve seen gold come down by 30-odd percent in the last few months.

Pete:

I think gold is a fascinating one, because if you look, scour the web, or you read reports like the Dimson one, you’ll see that gold is the one asset that is described as having a positive relationship with inflation, but I started to look at the data, and I examined it in a lot more detail, and my view is that I think that’s a slight fallacy.  What gold is good at is, gold is a fantastic asset to have in a time of uncertainty.  Some of those times of uncertainty happen to include periods of high inflation, which is why you get the correlation, but the correlation doesn’t mean causality. So it’s not inflation, in my view, that was driving gold prices higher – it was a degree of financial uncertainty, and also the investment side of it, which is the other reason that was driving it.  Where do I think they’re going to go now? – I agree with you, you could look at the graph of gold prices over the last 10, 20 years, and it very much looks like a bubble to me.  Whether it is a bubble, I don’t know – I think it’s certainly going through a big correction at the moment.  It may well come back from that, and carry on up, particularly if some other financial uncertainty happens, but I think many investors are misleading themselves to think that it’s an inflation hedge, it’s not an inflation hedge.

Owain:

OK Pete, I’m going to rally around the one asset class we had there with any crumbs of comfort, which was shares.  I’m going to ask you if you think there are any particular sectors that could do well, if your general thesis about inflation comes true, if inflation isn’t crazily high, but it’s a couple of percent more than perhaps we thought it might be.  Are there particular sectors that you would look at, particular kinds of companies?

Pete:

I think what you need to do is, you need to examine two critical factors for any firm or sector that you’re looking at. You need to find out whether the costs for those companies are being impacted by inflation, so is it something like a commodity user like an airline, which would be greatly affected by prices? – or is it maybe like a service company that’s mainly got costs to do with wages, which as somebody said before, aren’t really going up, so where does it fit on that dichotomy?  And where does it fit on the dichotomy of being able to pass those prices on? – so is it in a sector which it can get away with putting inflation rises through, or even if it’s like a railway, it can put above-inflation prices through?  Or is the competition so cut-throat, that it can’t? So therefore, if you cross tab those two together, you ideally want to find companies that are not particularly affected by inflation, yet they can pass the prices on.

Owain:

I’m thinking luxury firms here, luxury suppliers.

Pete:

Yes, you might do that.  A simple one might be a water utility. The water still comes out the ground, it’s not impacted by inflation, and yet because of their contracts, they’re allowed to put through above-inflation rises.

Owain:

They are.  I fear the utilities, Pete, because I think that the government, with this whole inflation tax policy, is obviously trying to keep the flak away from itself, and higher and higher utility bills will eventually come back and bite the government.  So the government sets the rules for the utilities, so I would fear that, if the utilities were able to start significantly increasing prices, which I understand they can do under their contracts, somewhere that they would be hit in another way, they’d be forced to do some sort of windfall tax, or it probably would be called investment in something or other, somehow the government would take that tithe off.

Pete:

All I can say is, I totally agree with you. The other factor you’ve got to know about any sector is what also influences its prices, and the regulatory cycle is the key determinant of what happens to the price of water utilities, particularly when those contracts come back up for renewal, is the biggest.  So I would have thought, at the moment, they may well not be a good bet in that respect.  But one of the things you do need to do is to look out particularly for that sector that I’d call as almost having fatal inflation, so it’s where a company or a sector is impacted by rising prices, yet they can’t pass them on.  If you think back to what happened to the travel companies a few years ago, when oil prices went up, and yet there was so much competition, the market went down, because no-one could afford to travel abroad – you need to look for those.  I don’t have any solutions for these things, but if I give you the framework, this is the framework you need to be thinking about.

Owain:

I have another method which I’m going to propose to you.  I read the book, and I read about how the country has all these debts, and that the government was going to use inflation to get rid of those debts, and it occurred to me that what I need is a big debt, because if I was to have a debt, the government’s inflation tax can do the work for me, for paying it off.  Is there an argument for going out there and getting the largest mortgage you possibly can, and then Mark Carney and his friend at the Bank of England effectively erode the value of that mortgage over the years?

Pete:

There can be, is my simple answer to it, but I think the critical thing isn’t so much what level of inflation there is out there, it’s what level of your personal wage inflation you have, because you have got to be able to, that debt has got to be eroded in terms of your personal earning power.  At the moment, the average wage increases in this country are only around 1% or so, so unless you happen to be in a sector which has at least inflation or above inflation, and I can’t think of many of those, apart from possibly an MP …

Owain:

Certainly not podcast recording.

Pete:

MPs are about the only category who are getting above inflation at the moment, and certainly not anyone in the public sector, that logic, I just don’t think that logic totally works really.  Added to that is, even if you are lucky enough to go fix it for maybe five or ten years, you still have the issue of, can you still afford that debt after that time? – because undoubtedly, in 5 or 10 years, interest rates will be higher.

Owain:

Yeah, I think that’s the bigger argument against it.  It seems to me that, if I go out and take a mortgage for £200,000, and the government has a debt of £2 trillion, or whatever it is currently …

Pete:

It’s not that much – 1.3.

Owain:

No, it’s about a trillion, isn’t it? – 1.3, but let’s give them a bit of leeway.  If we both have big debts, and inflation works its magic, the real value of that debt has to get lower.  I take on board your point about wage inflation, but equally the government ultimately can only pay its debt off via the wages of the people and the companies, so I would say we’re sort of in the same boat.  On the other hand, I totally agree with you that, even if I was to fix for 10 years, if you come out of that period, and interest rates are 9%, which seems unfeasible at the moment, but if inflation was 10%, that would be just historically normal. You’d only have to go back to the Eighties, probably.

Pete:

Well, I’m not sure, totally normal, but I know what you mean.  I think the critical difference between the government and you is that you take on a debt, and you not only aim to pay the interest back on it, but you also aim to pay the capital back on it.  The government doesn’t ever pay the capital back.  We are still paying for the Battle of Waterloo and the Somme.  None of those debts, they’ve been rolled over, but none of those debts have been paid. The government just has a tab at the bar – it just puts more stuff on the tab.  Each time it runs a deficit, it just adds to the tab – it doesn’t pay them off.  There is no plan to pay them off, published plan anyway.

Owain:

It is incredible.  Hold on – this book says, the plan to deal with the debts?

Pete:

But there’s no published plan.

Owain:

I can’t remember which Greek philosopher wrote about it, now suddenly I’m thinking it was a Roman – there was one of the philosophers, or Romans, one of the old folks, who said that all democracies end like this, because governments effectively will just stop giving the public the bill, because the public will not vote for anyone who says, we’re going to pay off the debts.

Pete:

It happened in Roman times.  It was Emperor Trojan, or Trajan, sort of about, just over 100 AD and forward. They started debasing the currency, because they wanted to pay for things that no-one was prepared to pay for in terms of taxes, and we all know where that ended.  There’s probably a logic to that.

Owain:

Just to conclude, having got to the end of this book, which is a great read, is it available on Amazon?

Pete:

It’s on Amazon, either as a Kindle, or as a real paperback.

Owain:

And it’s called Inflation Tax – get the plug in.  Did you get to the end of this book, and put down your quill, and say, blimey – this is going to get ugly?  Or did you put down your mouse and say, well actually, all things considered, this is perhaps the best way forward? Do you feel optimistic, or genuinely pessimistic? Where do you stand, at the end of all this research?

Pete:

I don’t know.  I suppose I became more realistic at the end of it. Initially, I was just appalled at the fact that the government appears to use inflation as a way of dealing with its debts, but when I started to look at it, well what are the alternatives?  We could become financially responsible, and not run deficits, and raise more tax revenue, but I just don’t see anyone getting voted in doing that.  We could, what else could we do? In fact probably, discussing the book, one of the other interesting things we could do is that we could just get Mark Carney to write a cheque for about a trillion pounds, and just write off all of the UK debt.  We could just go do that tomorrow.  It would only be half of the money supply.  It would create a bit of inflation, the pound might go down a bit, but that might be the interesting solution for us.  It’s quite radical – why not?

Owain:

Well, I think the pound would go down a bit.

Pete:

But that might be good for the country. The decline might be sufficient to really kick-start the economy.  It would be effectively a reset button, so who knows?

Owain:

It’s an interesting idea.  It is interesting that, when you start to look at things on a relative basis, the pound has been devalued a lot over the last few years, so even where inflation has sat, understates things if you compare us to say an American who might be coming here, to buy things in the shops.  For an American, you’ve got the inflation aspect, plus they’ve got a much stronger currency, so all these different factors on a global stage work together. So I guess, at the end of the day, it’s what’s the best for us, relative to our peers, and perhaps taking the hit, and saying, let’s be Argentina for 10 years – perhaps it would work.

Pete:

It might work. 

Owain:

On the other hand, perhaps it’s a good thing that we’re not in power.

Pete:

Yeah, it’s probably not, really.  I’m not sure I should be writing cheques for a trillion pounds.

Owain:

OK Pete, well that’s been really fascinating.  I’m sure you’ll have some interesting comments.  Please do leave them on the site, listeners, if you have any views about whether Pete’s correct, that the government is right to inflate away all your savings.  That’s a cruel précis, but you can see that Pete’s got a far more considered view by reading his book, Inflation Tax.  OK Pete, thanks for coming in.

Pete:

Thank you very much – nice to meet you.

Owain:

And we’ll be here in a couple of weeks, listeners, so let us know what you think on the boards.  Bye.

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