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Bank of England Quarterly Inflation report – not happy reading (except…)

Posted by markharrison on November 16, 2007

It was the best of times, it was the worst of times, as the saying goes. When a Bank of England report’s opening remarks contain phrases like the following, you know that most people in the UK are not going to have a good year (financially) in 2008.

“There will be some difficult decisions in the months ahead”- Mervyn King, Governor of the Bank of England

It’s getting harder and harder to have a serious conversation about the UK economy without using the word “stagflation”. Mervyn King managed to avoid using the word, but in the report there were an awful lot of phrases that spelled a “tricky period” ahead.

OK, I’d better explain what on earth “stagflation” is. Surprisingly for a made-up word, it’s not American – it was Iain MacLeod, who was chancellor in 1965, who seems to have coined the word – which is a hybrid between “stagnation” and “inflation”. It means you have both!

Stagnation is a sluggish economy, with little or no growth in output. So, basically, there isn’t going to be any more “stuff” to share around than there has been. By comparison, the last ten years have had wild booms – the growth in manufacturing productivity in Asia, coupled with the US’s willingness to borrow billions of dollars for everything from tanks to TVs has meant that there have been more “consumer goods” to go around.

Certainly, compare the size of TV you have now to the one you had 10 years ago…. or the number of DVD players in your house – locally to me, a DVD player now costs £17 ish from Asda or Tesco, so I now have four – one in the bedroom, one in the living room, one in my daughter’s bedroom, and one in a plastic crate that I use for one of my technology training courses.

Those DVD players illustrate another point – we haven’t had much inflation in the last 10 years. While some things (houses!) cost a lot more, others (DVD players, or for that matter cars, cost less. Don’t expect this situation to continue.

The trouble is, the way that most of us buy DVD players is different to the way they buy houses. (At least, very few people have spare houses sitting around for use a few days of the year, like the DVD player in the crate does.)

No more stuff to go round, but higher prices – not a good combination.

One key reason it’s such a bad thing is that most things that governments (or central banks) can do to affect the economy will help one of inflation / stagnation, but harm the other. When growth is racing ahead, you can pull a lever (interest rates go up) and slow down demand (because higher interest rates mean people can afford to borrow less), which slows growth (at a time when that’s good), but also slows down inflation. (The more people clamouring to buy things, the more they cost.) In a period of stagflation, pulling the lever either way has a bad consequence… either growth slows down (when it’s ALREADY too slow), or inflation goes up (when it’s already too high.)

So, not happy times.

Of course, as we have been told many times (and who knows, may even be true), the Great Depression of the 1920s-1930s created more millionaires than any other period in history. I suspect, in fact, that this is a false claim, however the general principle that it IS possible to thrive in a collapsing market is one that intelligent traders have followed in many places at many times.

The key word is “intelligent”. Going on and replicating the property investment strategies that worked in the late 1990s, and early 2000s is likely to be a recipe for disaster. What would be the impact on your wealth if house prices decline 20% in the next 3 years? I’m not saying they will, but if the answer is “I would go bankrupt”, then realise how HUGE a risk you’re taking.

From where I’m sitting, I’d love prices to start tumbling – I’ve updated my strategies to cope with that, and it would give me a much bigger buying opportunity than the last few years has shown.


2 Responses to “Bank of England Quarterly Inflation report – not happy reading (except…)”

  1. […] – stagflation seems to be with us. Prices are going up, but consumption’s going down. Whichver way the MPC […]

  2. […] OK, readers of a certain age will have been expecting the letter S, rather than the whole word, but Stagflation is one of those things that seems to have hit us […]

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