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A history of UK inflation

Government’s deliberate blow up prices through inflation to reduce the real value of debt

I’m pleased to introduce another post by Pete Comley, author of Monkey With A Pin and a much-debated Monevator article last year extolling the virtues of cash. This time it’s inflation that Pete has in his sights…

Most people think inflation is just one of those things that happens. That like the rain, it is a fact of life and almost appears like a random act of God. We have always had inflation and ever will. It is meant to be around 2%, but sometimes it goes higher and (much less often) a bit lower.

End of discussion.

But if you look back into history, it was not always like that.

The following graph shows the UK inflation index – including the best attempts to historically replicate it where applicable – since 1750.

UK inflation over the centuries (Source: ONS and House of Commons Research Paper 02/44, July 11, 2002)

History of UK inflation (ONS & House of Commons Research Paper 02/44, July 11, 2002)

What this graph of inflation shows us is that for nearly 200 years, prices in the UK went up and down in a zigzag, largely influenced by good and bad harvests.

The graph also shows the impact of war. During conflicts, resource shortages and massive increases in money supply led to sharp price rises. However the graph shows that after the Napoleonic Wars and World War I, there followed a period during which prices to a certain extent came back down again.

But inflation did not come down after World War II. Since that time, UK prices have taken a very different direction. They have moved continually upwards.

To understand why – and what it means for us today – we need to understand the economic situation back then.

Britain’s Financial Dunkirk

After the war in 1945, Britain’s finances were in a mess.

We had won the war, but in the process government debt had soared to 237% of GDP. The Americans had given us billions and then, after VJ day, demanded we pay it back. To make matters worse from this perspective, the UK had just elected a new Labour government that had promised to spend even more cash to nationalize everything.

The famous John Maynard Keynes, then working for the Treasury, said Britain faced a ‘Financial Dunkirk’.

But roll on just 25 years and Britain’s debt to GDP ratio had reduced to around 50%. A remarkable achievement!

How was this economic miracle pulled off by a country that was often described in the 1960s and 1970s as the sick man of Europe?

According to some detailed analysis of deleveraging by Ray Dalio of Bridgewater Associates, virtually all of the debt was just inflated away.

The UK’s ever increasing tab behind the bar

If you look at the government debt statistics, you’ll find that over that period, the UK did not net pay off any of that debt. Instead it actually increased debt, from £2.6bn in 1947 to £3.3bn in 1970.

Moreover, if you start pouring over the debt numbers – as I did for my latest book – you’ll notice that no UK government has had a written plan to pay down its debts since Sir Robert Warpole in the 1720s! The government debt tab behind the Treasury bar has been rising for hundreds of years. You are still paying for the Battle of Waterloo today.

There are basically three ways governments can deal with their debts, if they don’t plan to pay off the capital.

  • Firstly they can make the payments easier to afford. For example, following the Napoleonic Wars, productivity increased massively in Victorian times, as did the population, and so UK debts became a much smaller proportion of our tax take.
  • The second option is default. The UK likes to pride itself that it has not formally defaulted on government debt – although it has rewritten its debt contracts like War Loans, which some might class as a default.
  • The third option is to just inflate the value of the debts away.

Given the lack of much real productivity growth, the third route was the one that the UK (and other countries) decided to follow after 1945.

An inflation whodunnit

So how did this change in UK government attitude towards inflation come about? Who or what was responsible?

Culprit #1: Hugh Dalton

hugh-daltonClement Attlee’s post-war Chancellor must bear some of the blame for instilling an inflation policy into UK governments and the Treasury.

Hugh Dalton was one of the few Chancellors that the UK has ever had who really understood economics and public finance . He wrote some the first textbooks on the subject in 1923.

‘Comrade Hugh’ as he was known passionately strived against passive rentiers. Ideally he would have got the rich to directly pay off the debts after the war.

Instead he decided on way of making cash and bond holders pay by ensuring he kept interest rates low whilst fostering inflation – a policy that today we call financial repression.

Culprit #2: John Maynard Keynes

imaynard-keynesSome of the responsibility also lies with John Maynard Keynes, although it was probably not intentional on his part.

Many aspects of Keynes’ economic thinking as expressed in his General Theory came to be adopted by postwar governments, both here and in the US. In particular, politicians somewhat simplistically interpreted Keynes’ writings as saying that if you wanted full employment you had to have a certain level of positive inflation.

Therefore policy makers started adopting a positive inflation attitude.

A good example of this was in 1952 when the Federal Reserve in the US was granted greater independence, and specifically tasked to maintain “low inflation”.

Culprit #3: Bretton Woods

BrettonWoodsWhat the US decided about inflation had a positive impact on the UK because of the Bretton Woods monetary system.

This in effect pegged the pound to the dollar, so inflation being created in the US was then exported to the UK. Both countries then benefited from the reduced burden of their debts in real terms.

Inflation today

We have inherited that system where having positive inflation is built into the very structure of our economy. And the Bank of England is tasked with ensuring we always have it, targeting a rate of around 2%.

The government has allowed contracts to be created that also stoke inflation – think rail fares that go up every year by above RPI, and the recent rises in tuition fees. They are but two examples. Indeed recently Merryn King was bemoaning the fact that nearly half of our inflation was caused by these government regulated prices.

As a result of the UK government’s bias to inflation, prices in the UK have gone up over a half since 2000.

Inflation since 2000 (Source: ONS)

Inflation since 2000 (Source: ONS)

The need for inflation in the economy is arguably more important now than ever, due to the escalating nature of UK government debts. Our budget deficit of £120bn a year is adding very quickly to our total public debt.

Indeed if you look at our projected debts for the next few years in inflation-adjusted terms (as opposed to a ratio of GDP) you can see the reason why inflation must continue in the UK, and why it will almost certainly will be helped higher by Mark Carney in some way.

[Many will see the Bank of England’s new linking of the inflation target with a 7% unemployment threshold as a move in this direction – The Investor].


UK inflation adjusted public debt1

Why inflation is a real danger to you now

The impact of inflation – and how you might avoid the consequences of inflation – has been well-covered on Monevator in the last few years.

What I think few people have fully appreciated though is that inflation now – even at 2-3% a year – has suddenly become a problem for us in a way it was not, even just five years ago.

As I discussed on Monevator last year, cash deposits for decades kept up with inflation. Even after subtracting basic rate tax, savings accounts were usually able to preserve wealth.

That all changed with quantitative easing, and more recently with the government’s Funding for Lending scheme. Interest rates are now a long way below inflation and I think they are likely to remain there for many years to come, ensuring anyone with cash will see its real value eroded.

An even larger concern in my mind is what is happening to wage inflation. Because of the recession, many workers have effectively struck an unwritten deal with their employers that they’ll take little or no inflationary rises in return for keeping their jobs. Average wage inflation is 0.9% vs RPI at 3.3%.

Moreover if you look at the latest four years of data for average gross income for all UK households, it has not grown a penny. Against that RPI is up 12.5%. We are all becoming poorer because of inflation.

Why income matters is that it also affects how effective inflation can be in helping reduce the burden of household debts, such as mortgages. It is all very well inflation being above 3%, but if you’ve not had a pay increase, inflation is not going to erode the real value of your debt.

In my view before we all rush to load up on ultra-cheap mortgages, we need to check we’re in a job that is certain to be awarded inflation-linked pay rises.

What history teaches us

inflation-tax-hugh-comleyInflation is not a random act of god, like the rain. It is also not a mere by-product of a set of economic variables.

Inflation serves a specific purpose and has been effectively government policy since World War II.

Pete Comley’s book, Inflation Tax: The Plan to Deal with the Debts, is now available from Amazon and other retailers.

  1. Data source: http://www.ukpublicspending.co.uk for 1750–2011; Public Sector Finances Databank for 2012 onwards; data for 2013–2018 are government estimates; data adjusted by RPI. RPI is assumed to be 3% pa for 2013–2018 []
{ 29 comments… add one }
  • 1 RetirementInvestingToday August 7, 2013, 12:43 pm

    The Bank Charter Act of 1844 required that BofE notes were fully backed by gold. Ie a full gold standard. We enter a period of price stability. Gold convertibility was then suspended during WW1 before being officially dropped in 1931. Ties up quite nicely with your first chart.

    Inflation redistributes wealth from savers to borrowers. Given governments like to spend more than they should to win the next election it suits them fine. It’s also a great stealth tax as it allows governments to play with fiscal drag. Again making them look better than they are. The general population sees their getting poorer but can’t figure out why.

  • 2 The Investor August 7, 2013, 12:51 pm

    @RIT — I don’t think it can all be blamed on politicians. The ability of the wider public to delude themselves is shocking. We get the politicians we vote for.

    Got in early with ‘gold!’ there, I see. Appreciate it wasn’t from a goldbug point of view, but do hope we’ll see a few comments that avoid citing the 3% inflation-resisting asset that’s down 30% year-to-date.

  • 3 ermine August 7, 2013, 1:14 pm

    Blimey, you guys didn’t live through the 1970s. That was serious inflation 😉

    The rule of thumb I’ve always used is that half your cash dies every ten years. I’m not sure why everybody’s discovered inflation right now. I’ve never considered cash a store of value, ever since those 1970s years, and I was only a teenager then 😉

    > we need to check we’re in a job that is certain to be awarded inflation-linked pay rises.

    Good luck with that… Career progression would be nice too, perhaps 😉

  • 4 Dave August 7, 2013, 2:09 pm

    I think the squeeze on real incomes is interesting, although I suspect inflation is just a way of making it easier to adjust real wages downwards. My calculations show real wages have gone no-where in a decade. Which is more surprising when you considering government borrowing has exploded(and this ought to have increased incomes).

    I guess from an investment point of view there is lots of labour sat around unused, a fair bit of land and capital. At some point there will be something that ignites growth.

  • 5 The Investor August 7, 2013, 2:42 pm

    @ermine — You might not have, but that doesn’t mean it wasn’t, as we’ve discussed before. Cash has delivered a positive real return for most of the past 30 years… but not the last two or three. So this is a real change. 🙂

  • 6 BeatTheSeasons August 7, 2013, 3:11 pm

    Your rate of inflation depends on what you buy.

    The latest ONS figures show the Top 10 risers over the 12 months to June were: Education (+19.7%), Flights (+9.8%), Newspapers/magazines (+8.4%), Domestic gas (+8.3%), Health Insurance (+7.8%), Electricity (+7.7%), Fruit (+7.5%), Tobacco (+7.5%), Spirits (+6.7%) and Postal Services (+6.3%).

    The Bottom 10 all got cheaper: Photographic instruments (-12.8%), Data Processing Equipment (-9.3%), House Contents Insurance (-5.6%), more audiovisual equipment (-4.3%), Transport Insurance (-3.7%), Repairs to Household Appliances (-3.5%), Garden Plants & Flowers (-3.1%), Sea & River Transport (-2.0%), Medical & Therapeutic Equipment (-1.7%) and Second-Hand Cars (-1.6%).

    The official CPI rate is an average of these Top 10, Bottom 10 and another hundred or so categories in between. It’s also a weighted average where food is only around 10% of the total, whereas discretionaries like hotels, culture and restaurants make up nearly half.

    Conspiracy theories sometimes complain about the accuracy of the data, shrinking pack sizes and the omission of categories like owner-occupier housing costs (and investment platform fees!). Statistics nerds will tell you the way they calculate the average is a bit dodgy as well.

    If your spending was more closely aligned to the Top 10 than the Bottom 10 then your personal inflation rate could easily be 7.2%, the threshold at which the value of your cash really does follow the Ermine’s rule of thumb and halve in value every 10 years.

  • 7 emanon August 7, 2013, 3:14 pm

    Few questions…

    1. The biggest cause of inflation is QE, correct?

    2. If the cost of things are going up how can we secure ourselves against it? Gold?

    3. Can we really trust the governments inflation figures? The US have fudged their unemployment and inflation figures (Boskin Commission). What they do affects us and we are also prone to the same cover ups. Assuming that is the case, then the situation is far worse than the mess we think we’re in. When the interest rates rise will our salaries have caught up with inflation so we can prepare ourselves for the higher cost of living? If not, what is the logical outcome of that situation? Also, how can we protect ourselves from the stone cold truth of inflation? Will gold sky rocket like some people think?

    From Keynes himself:

    “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some”

    Is that whats really happening??

  • 8 Pete Comley August 7, 2013, 3:42 pm

    1. I’m not sure that QE is in fact the biggest cause of inflation. It is a factor sure. QE has not massively increased the money supply – it largely just replaced money destroyed by loans being repaid/defaulted on. What is driving inflation currently is mainly government regulated prices and the prices of imports/commodities.
    2. Gold is not an inflation hedge. As I show in my book, the best you can say about it is that it is unrelated with inflation at low levels. What gold is is a safe haven asset. In times of great uncertainty it rules. Some of those times happen to correlate with very high inflation, hence the fallacy that it protects you from inflation.
    3. I however do have more sympathy for your third comment. In my book I look in detail at the abuses of not only inflation stats but also GDP. The deflator currently being assumed for government spending is near zero because they use hedonic adjustments. Had they not done that the UK would have been in recession for the last 3 years.
    4. I also agree with the quote. (Keynes was actually quoting Lenin.)


  • 9 Neverland August 7, 2013, 4:17 pm

    There is an animal farm like quality about our current government telling us “we’ve never had it so good” as the shopping basket costs more every visit and the pounds shops proliferate on the high street

    On a positive note is it is very different overseas; US/Eurozone inflation is about 1.0-1.5% with a 10 year bond yield more than our own

    When the UK government last instituted financial repression you had to hide any more than £50 in your underwear if you wanted to go abroad with it

    Nowadays you invest abroad easily with a few keystrokes

  • 10 mucgoo August 7, 2013, 4:18 pm

    Equities tend to be inflation tolerant over the long term as the goods and service they produce and price are the very thing which inflation is based upon. Otherwise inflation linked bonds. Although currently a ten year UK inflation linked GILT is yielding -0.3%.

  • 11 RetirementInvestingToday August 7, 2013, 4:36 pm

    Hi TI

    “I don’t think it can all be blamed on politicians. The ability of the wider public to delude themselves is shocking. We get the politicians we vote for.” It’s unfortunate but I’m afraid I have to agree with you 100% on that one.

    “Got in early with ‘gold!’ there, I see. Appreciate it wasn’t from a goldbug point of view, but do hope we’ll see a few comments that avoid citing the 3% inflation-resisting asset that’s down 30% year-to-date.” You’ve just scared me with that comment. I’m off to find a mirror to see if I have a tin foil hat on 🙂

    On a serious note I think you’ve seen the extensive work I conducted back in January looking at whether gold protects UK Investors from inflation. For my dataset this showed that when the annual change in inflation (RPI) is compared with the annual change in Gold prices the resulting Coefficient of Determination was only 0.06. This means that only around 6% of the change in gold price can be explained by the change in inflation. Over a 2 year period that 6% turns into 0% and over 5 years it becomes 2%. Therefore I agree it’s not an inflation-resisting asset.

    Hoping I’ve redeemed myself now 🙂


  • 12 Neverland August 7, 2013, 4:59 pm


    I wouldn’t count on equities beating inflation

    75% of the UK economy is services, a big chunk of that goes directly to consumers

    Consumers pay for it with wages which are not automatically inflation linked and have lagged inflation for most of the last 5 years

    Actual research (which I can’t be bothered to find the link to) shows equities keep up with moderate inflation up to the mid-single digits and then start to lose purchasing power pretty rapidly as inflation gets higher

    The only thing which guaranteed to beat inflation is an index linked bond bought on issuance and held to maturity…even that only works if the index matches the inflation you actually experience

    The last UK index linked bonds I saw issued paid a princely RPI +3/8% for something like a 10 year…

  • 13 Niklas Smith August 7, 2013, 5:12 pm

    Thank you to Pete Comley for a very interesting and well-written article.

    Also some good points raised in the comments. In reply to Emanon, I agree with Mr Comley that gold is not a good inflation hedge. As can be seen from this chart, gold has had long periods of falling real (inflation-adjusted) value: http://goldprice.org/inflation-adjusted-gold-price.html

    And if you don’t trust inflation indices, it has also had long periods of stagnant nominal value. The gold price tends to peak in panics and fall away when people forget their fear and become greedy again. Gold might have a place in a portfolio, but primarily as a haven asset or hedge against hyperinflation (the problem is that single-figure rates of inflation can still seriously damage savers’ wealth).

    The only hedge against inflation in my opinion is to invest in real assets, such as property or equities. These are not necessarily a perfect hedge, as some companies (usually capital-intensive ones) suffer negative effects from inflation. See the excellent discussion in Warren Buffett’s 2011 letter to shareholders (pdf, go to page 16-17 to find the section on different kinds of investments): http://www.berkshirehathaway.com/letters/2011ltr.pdf

    Of course, equities and property can underperform inflation over periods (especially if you buy at the wrong moment). There is no such thing as a free lunch. But at least you can expect a positive real return over the long term, unlike gold where the expected real return is 0 % before cost of storage and taxes (in Sweden capital gains tax is levied on nominal gains and the is no exception for investment gold…).

    As an aside, it is also interesting how different the inflation rates are in Western developed countries: 2.9 % CPI inflation is still stubbornly above target in the UK but in Sweden (where I live) the equivalent inflation rate is only 0.5 %. Inflation is also lower in many other major economies, as Neverland points out.

  • 14 Pete Comley August 7, 2013, 5:14 pm

    Just being doing some calculations on the effect of Carney’s new inflation policy. I reckon he now has effectively given the government license to create up to 5% inflation – see http://www.inflationtaxbook.com/bank-of-england-5-inflation-targe/

  • 15 Niklas Smith August 7, 2013, 5:21 pm

    @mcgoo and Neverland:

    Yes indeed, under periods of high and rising inflation shares have often performed poorly. But at least they perform less poorly than nominally denominated investments.

    The current situation is odd; previous bouts of inflation have usually been accompanied by rapidly rising nominal wages (e.g. 1970s and wartime), increasing the nominal purchasing power for both goods and services. If we experience a long period of wage stagnation companies could be affected in novel ways.

    Back in the last serious epidemic of inflation in the Western world Warren Buffett wrote a penetrating article for Fortune arguing that inflation also “swindled” shareholders: http://features.blogs.fortune.cnn.com/2011/06/12/warren-buffett-how-inflation-swindles-the-equity-investor-fortune-1977/

  • 16 The Investor August 7, 2013, 6:50 pm

    As others have said, inflation and stocks have a relationship, but it can take a few years to play out. Tesco can raise its prices, and Tesco’s *nominal* revenues and profits go up, but over any short period of time (3-10 years, say) an awful lot is going to depend on the valuation of the shares to begin with. It’s only over the long term that earnings and stock prices strongly correlate.

    The main reason equities have bested inflation is mathematical. Equities have delivered the strongest returns of the major asset classes over the long term, and over the long-term average 9% returns p.a. (depending on your market) have been much higher than long-term average inflation of say 2-4%. If your equity class only delivers a small real return over the long-term (cash, government bonds, gold, say) then it doesn’t have much capacity to keep up with inflation.

    I fully expect the global stock market to continue to deliver over the long term, certainly in our lifetimes (barring nuclear war or environmental collapse or similar!)

    In an ideal world you could buy inflation-linked bonds to protect against inflation, but the real returns even of these that you’d see on buying would work out to be pretty near-zero if bought at various points in the last 3-4 years.

    If you must play the short-term game (and I do at times, so I can’t complain!:) ) I think commercial property (and also residential property) has a better bet at keeping up with inflation over shorter periods (<5 years) because rents will go up, they're linked to dividend payouts, and property is priced off yield to a great extent. Again it's also prone to valuation shifts with sentiment, but sentiment is low currently so you're probably safe on that score.

    All this is assuming long-term inflation will be any higher than normal. I'm on-board with Pete's interesting research that shows inflation will always be with us now. I'm unconvinced we face hyper-inflation, or even >5% inflation, at least not predictably so. QE has been widely misunderstood — including by me at the start — and I don’t see it causing inflation unless they really overdo it. The market is selling off on Fed talk of tapering, so I don’t see that happening.

    People have a tendency to look for simple solutions to financial conundrums, but there really are none. There are simple processes (e.g. invest in equities for the long term, spend less than you earn, usually avoid debt) but there’s no “if X do Y” if only because everyone else will already know about it, and it will be factored into the market.

    @Niklas — Hi! I do *love* it when one of the earliest readers drops in. 🙂 Hope you’re well.

  • 17 dearieme August 7, 2013, 7:14 pm

    It’s a pity that you adopted that old error about War Loan. It wasn’t even a quasi-default: read the terms.

  • 18 Pete Comley August 7, 2013, 9:02 pm


    I stand corrected. Looks like I am in the good company of Reinhart & Rogoff – that will teach me to believe everything I read in their book. It wasn’t just their spreadsheets that had errors.
    Having said that, anyone holding such war bonds in 1932 I’m sure thought it was semi-default. It was in the small print effectively and probably not fully understood by purchasers. As a holder of certain PIBs, I have a great deal of sympathy with them!

    Thanks for pointing it out though.


  • 19 Tortoise1000 August 7, 2013, 9:06 pm

    Pete Comley’s new book is excellent. He has an interestingly straightforward, readable style and explains things so clearly. I bought it as soon as I got an email telling me it was out, and I was not disappointed. Well recommended, along with ‘Monkey with a Pin’. What are you going to write about next, Pete? I am looking forward to it.

  • 20 SG August 7, 2013, 9:24 pm

    >Even after subtracting basic rate tax, savings accounts were usually able to preserve wealth

    And the likelihood is they still will. Returns on cash were above inflation to an abnormal degree for much of period 1985-2008. The current subinflationary phase corrects for this and the long term trend for cash to be roughly on par will reassert itself during the next 5-10 years.

  • 21 mucgoo August 7, 2013, 10:41 pm

    Us consumers can tend to outperform the cash returns benchmark if we spend a little time pursuing the highest rate accounts while taking on a tiny bit more risk although the FSA makes that minimal.
    Currently you can open an easy access account paying 1.7% but the number which goes in the historical records will be the 1 month government bond at 0.3%. That gaps tends to be wider during better times.

  • 22 neverland August 7, 2013, 11:34 pm


    so 1.7% after BASIC rate tax is only 1.35% a year, after higher rate tax its barely over 1%

    CPI is 3%…RPI is about 0.5% higher

    Compound the difference over 5 years and see how much that losses you

    *begins foaming at mouth at the inequity of it all*

  • 23 Moneywise August 8, 2013, 10:32 am

    Really good article thank you.
    I also believe that liberal party is increasing the UK’s deficit, thus increasing the inflation, when they are in power. I don’t remember where, but I have seen statistics where the economy is compared to liberal and conservative parties reign, and usually it’s the liberals who give away money everywhere and conservatives who are trying to gather it back.

  • 24 Neverland August 8, 2013, 12:32 pm


    Have you actually looked at the charts in the article?!?!

    The current conservative led government is actually breaking all records in giving money away with a 120bn a year spending deficit :/

  • 25 Moneywise August 8, 2013, 3:04 pm


    Yes, I have looked at the charts and I have seen when spending deficit went up. My opinion is definitely biased =) I have looked at some other stats, I don’t usually read Guardian, but this charts show UK budget deficit and party in power. Here is the link: http://www.theguardian.com/news/datablog/2010/oct/18/deficit-debt-government-borrowing-data

  • 26 smiling vulture August 8, 2013, 4:06 pm

    can I ask monkey if you are still in cash?


  • 27 Pete Comley August 12, 2013, 12:01 pm

    Smiling vulture – to answer your question, the answer is largely yes. It has optionality which I like. Until I know whether we are going to break out of the 13 year trading range upwards (or go back down to the bottom again), I’d rather wait on the sidelines and not chew up trading costs.
    I’m guessing we’ll know the answer to that conundrum very soon, so I may not remain hold that much cash much longer.

  • 28 smiling vulture August 13, 2013, 2:08 am

    thx for the reply Peter

    Much appreciated

  • 29 The Accumulator August 25, 2013, 8:08 pm

    Very enjoyable and interesting article and great comments thread. If we get poorer then doesn’t that make us more competitive and more likely to be able to sell things to the rest of the world? Thus helping us to dig our way out of the hole?

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