≡ Menu

Inflation is right up your street

Photo of up and down Lombard Street in San Francisco as a metaphor for inflation.

Few of the universals of personal finance and investing are – paradoxically – as individually experienced and feared as inflation.

That’s true both in terms of the headline inflation rates you happen to live through, and also your personal inflation rate that varies with what you choose to spend money on.

You may not even have thought much about inflation before 2021, depending on when you were born.

If you’re under 30, the most striking inflation you’ve seen is how many pints of milk it now costs to buy a Bitcoin, compared to a few years ago.

At its £48,000 high, the Bitcoin price was up about 70-fold since the start of 2017 – in pint of milk terms.

No wonder a generation of DIY-traders aim to get rich quick from Bitcoin.

Most of the YOLO crowd will never have thought much about the price of a pint of milk, though. Why would they? It’s been steady in the UK for ages.

But other people in history have seen the cost of food skyrocket in less time than it takes to recite Old MacDonald Had A Farm.

In Weimar Germany in the early 1920s:

Prices ran out of control. A loaf of bread, which cost 250 marks in January 1923, had risen to 200,000 million marks in November 1923.

The Weimar Republic 1918-1929, BBC

Such hyper-inflation is rare. But more routinely high inflation isn’t merely a ghost story from the economic textbooks.

Right now, annual inflation is running at 10% in Brazil, for example. It’s more than 20% in Turkey.

If you’re Turkish you’d be happier if some of your life savings had been in US Dollars. Let alone in Bitcoin.

How much was a Mars bar?

Closer to home, cautious 70-something fund managers have warned us about inflation ever since Central Banks began quantitative easing in 2008.

They’re still at it. Here’s 77-year-old hedge fund manager Paul Singer writing in the Financial Times in December 2021:

The global $30tn pile of stocks and bonds that have been purchased by central banks in order to drive up their prices has created a gigantic overhang.

With inflation rising, policymakers are reaching the limits of their ability to support asset prices in a future downturn without further exacerbating inflationary pressures.

– Financial Times, 6 December 2021

Younger investors too who’d read economic textbooks – for the little good it has done in the past decade – may have also have felt uneasy.

But the rest have happily bid up the multiples on equities, taken out huge mortgages, and saved into near-zero interest cash accounts in a low inflation world.

Today’s 20- to 30-somethings don’t know any different. At least not from lived experience.

In-between you have the likes of me – Generation X – who remembers inflation in my childhood and getting 7% on cash in my early working years, but who mostly invested this century. I’m caught somewhere in the middle.

Let’s recall how the generations are popularly sliced:

Source: Pew Research

Now consider a key measure of UK inflation since the late 1980s:

Source: ONS

Today’s Gen X senior banker, trader, or fund manager graduated in the late-1980s to mid-1990s with vague memories of crisps and sweets getting dearer as kids, but the cost of their lunch at work has changed little in 20 years.

It wasn’t a smooth ride. There were the Dotcom and banking crashes, the Eurozone crisis, a pandemic. Inflation fears have arisen now and then.

But as things turned out – and whether by luck or design – UK and US price rises have mostly been modest since the 1990s, when Central Banks began directly targeting a specific inflation rate.

As a result – and with hindsight – you could have done a lot worse than to buy long-term bonds in the early ’90s, and then gone to lunch for 30 years.

A truth universally acknowledged

Alas for bond managers (but fortunately for City tailors) the big win of buying a huge pile of bonds, reinvesting the coupons, and getting another hobby was only certain retrospectively.

Nobody could risk dismissing an inflation resurgence just because the Bank of England targeted a 2% rate forever. Inflation pops up all the time in the history books, so they kept an eye out for. Many suspected reports of inflation’s death might be exaggerated.

The oldest measure of inflation, RPI, (since superseded by CPI) was only introduced in 1947. However the Office of National Statistics has done some backward gazing to 1800:

Source: ONS

When I first saw this graph, I felt bad for Jane Austen’s rich men boasting about their fixed incomes.

Inflation often spiked towards 20% in the 1800s! Fixed income riches looks less attractive in this inflationary light than the Darcy-fanciers imagined.

However we can see that deflation was also incredibly common back then.1

Sure, Mr Darcy’s £10,000 income would have been inflated away for a while. But it would have surged again in real terms a few years later.

Economic life was just more volatile. As academics who’ve studied the backdrop to Austen’s novels note:

During Jane Austen’s own lifetime, the British economy experienced a series of economic crises. 

An oversized national debt, four waves of recession, two banking crises, the debasement of coins, a major economic crash, and a depression led, in combination, to a doubling of consumer prices, i.e., extreme inflation.

In 1795 […] the first financial crisis of Jane Austen’s lifetime occurred in the form of a massive crop failure brought on by a long drought and a harsh winter. 

The price of bread, meat, milk, and cheese doubled, leading to food riots across England.

The Economics of Jane Austen’s World, JASNA, Winter 2015

The 19th Century economy ran without Central Banks or government backstops as guardrails. This – along with war, disease, weather, and the industrial revolution – made for a cycle of feast or famine.

Twitter economists who rail against today’s crisis-dampening central bankers might want to ponder that graph above.

Down, down, deeper and down

A surprising number of people with arts degrees end up in money management. The English Literature graduates at least might have read plenty about financial instability.

But it was still more the 1970s than Jane Austen’s time that a Gen X bond manager would have had at the back of their head as inflation’s ‘great moderation’ got underway.

This chart shows how RPI surged in the 1970s:

Source: ONS

As you can see, a 21% inflation rate in the UK is very much within living memory.

Even more so when the benign conditions of the 1990s first took hold.

Memories of 1970s inflation was surely the main reason why UK yields took 25 years to fall to their nadir. Purchasers feared inflation’s bond-slaughtering recurrence. But as inflation didn’t surge back – and Central bankers further lowered rates – yields marched ever downwards:

Source: Independent

Near-zero interest rates are almost taken for granted today.

But for much of the past 100 years an economist would assume we were living in Bizarro world – or at least in a depression – if they saw this graph.

Even better than the real thing

Today few people who’ve worked through bouts of high inflation remain at the coal face of big financial institutions in London or New York.

They’d have to have been working in the 1970s, really. That would put them in their 60s or older.

A few (such as the aforementioned Singer) soldier on. But most by that age have headed upstairs and away from the trading terminals, or else out the door.

Which is interesting, given that in late 2021 inflation is on a tear:

Source: ONS

Some pundits argue the lack of hands-on investors with inflation experience is a blind spot. They say there are few people around who’ve seen inflation before who can spot the inflation that’s now (allegedly) taking hold, leaving us vulnerable.

But does their logic stand up?

Everyone and their FT-reading dog is worried about inflation, so it’s no secret. Along with speculation about rate rises, it’s 90% of what the financial media talks about.

Besides, perhaps someone who’d invested through an inflationary spiral could just as well spot a fake one? Maybe they’d tell us this recent uptick is a blip?

Where is the union bargaining power, they might ask? Why can’t firms continue to look overseas to cut prices in the long-term? Are the goods and services that make up the inflation basket inherently more expensive?

We may indeed be experiencing a small energy price shock. But did we also just come off the gold standard – that other hallmark of the 1970s episode?

Alternatively, is inflation just down to temporary SNAFUs at ports and factories, restarting commodity production, and perhaps even over-ordering by panicky companies trying to avoid problems in future?

A short-term supply/demand mismatch? (I suspect this, for what it’s worth.)

The reason the market wants answers to these questions isn’t just because higher inflation would probably require higher-than-expected interest rates eventually, and that could weigh on the bond market.

It’s also because our financial system has been broadly rewired for a low rate and low inflation reality.

For a very relatable example, look at how the price-to-earnings ratio for first-time buyers has soared to an all-time high as inflation has steadied and rates declined:

Source: ThisIsMoney

In 2000 a first-time buyer paid about three times their salary for the average starter home. Now they pay nearer six times.

That would not be possible without low interest rates keeping mortgages affordable.

The same relationship rolls out across the investment universe. For instance I’ve previously explained how low long-term yields and expectations for subdued inflation underwrite high multiples on equities that have boosted the indices for years.

Deflated expectations

Experienced antique dealers aren’t only good at spotting the real thing.

Much of their skill is avoiding old tat that looks like an antique, but isn’t.

We haven’t seen inflation shoot up like it has recently for a long time. No wonder it’s unnerving.

But maybe what we need is an old pro in a fedora to sniff the air, and then to turn up his nose at the scary headlines and walk on by, unruffled.

  1. That’s assuming the ONS got its retrospective sums right. []
{ 21 comments… add one }
  • 1 JimJim December 13, 2021, 3:23 pm

    As a generation X (just – Very thankful I am not a Boomer – OK 🙂 ) I remember my parents suffering the inflation of the 70’s and myself suffering the interest rates of the early nineties while servicing my first mortgage – 16%pa anyone? While I can’t see this happening again with the way central banks control things, they do not hold all the reins.
    Energy could still be our downfall. It is perhaps not too far fetched to envisage a future where our supply of natural gas from Russia might suffer disruption.
    Turn off the power and see where that takes us.
    Then again the rattling sabres might be quietened and business continues as usual. I am not betting either way.
    JimJim

  • 2 Jonathan B December 13, 2021, 4:02 pm

    The way I see it, Quantitative Easing injected money into the assets market (buy-back of government bonds) and if you look at property and share prices there is no question there has been significant inflation. But despite over 10 years of QE, there hasn’t been a rise in general retail inflation – until recently.

    So what has changed? Quite a lot of current inflation has resulted from shortage of supplies pushing wholesale markets higher: petrol and energy. And some of the rest also results from supply difficulties due to Covid in 2020, like those computer chips in cars. It isn’t clear that this element of inflation will be long-lasting, or be affected by an increase in interest rates.

    In any case the Bank of England is more concerned with barking than biting. Talking about rate rises sends enough of a message. In reality for most people the interest rate that affects their day-to-day spending decisions is that on credit cards, currently around the 20% mark. If the BoE raised the underlying interest rate to 0.5%, and that is more than most observers expect as a first step, despite that looking like a five-fold change it would only marginally affect credit card rates.

    (I am though of the generation that has seen proper inflation, and know it is always a risk. When I was a student the price of a pint of beer went from around 25p to over £1 – shock horror! And it was worrying to have bought a flat in the late nineties and find mortgage costs increasing beyond what I had planned on when taking the loan).

  • 3 Learner December 13, 2021, 5:29 pm

    6.8% inflation in the US this month with no sign of slowing. Will it reach double digits?

    It seems better to buy a home at low value and high rate knowing you can refinance to a better rate in the future, than the reverse. A small expensive loan can be made small and cheap when rates allow, a large cheap loan cannot be improved. This side of the pendulum swing sucks.

  • 4 ermine December 13, 2021, 5:36 pm

    > taken out huge mortgages

    Those first time buyers on income multiples of 5.5 had better get down on their knees and pray that 1970s inflation is coming down the pike, because not much else is going to save them for their overpayment – a low inflation low interest rate world is not their friend. A working life is 30-40 years, spaffing an eighth to a sixth of that gross on housing if going to be a tough gig to repay. Inflation rocks for people with mortgages because it reduces the real value of capital to spit over the term. My Dad on a single blue collar wage with ankle-biter bought his house outright in his early 40s, where I reached that stage in my late 40s. He had the benefit of that 1970s inflation, but kept his job.

  • 5 Al Cam December 13, 2021, 6:18 pm

    This ‘explanation’ of 1970’s [US] inflation makes interesting reading – especially if you are old enough to remember the period and what was being blamed at the time:
    https://www.investopedia.com/articles/economics/09/1970s-great-inflation.asp

  • 6 Learner December 13, 2021, 6:19 pm

    Hoping that corresponding wage gains will make it manageable? That seems like the material factor that actually offsets the debt.

  • 7 Jonathan B December 13, 2021, 9:47 pm

    @Al Cam, your link is obviously written by someone with a very particular political opinion. A lot of things around that time must have contributed, with a money-sucking war and the timing of a decision to allow the dollar free on exchange markets looking particularly significant to me. But it is possible with the benefit of hindsight to think that politicans got seduced by Keynes’s “multiplier” without realising it would have a limit (I am not enough of an eonomist to know whether Keynes addressed its limits).

    But my memory of the period is that a critical issue was human behaviour. Even if the triggering event was the OPEC price rise out of politicians’ control, the fact that inflation didn’t drop back meant that expectation of further inflation was built in to the system to create a vicious circle where the level of price rises meant workers knew they couldn’t survive without wage rises that would cover its continuation. That was only broken with the “sledgehammer to crack a nut” solution of sky-high interest rates in the UK and US which in both cases undermined a lot of the industrial base (and provided the opportunity for China to start building its economic and political power).

    I am not sure, even with the benefit of fifty years of distance, we know enough about the causes of inflation to confidently prevent a repeat.

  • 8 Peter December 13, 2021, 9:47 pm

    Vanguard inflation linked gilt fund as an asset to protect portfolio from inflation anyone? Their over 20 years duration might put some off but I did not found anything better then this which I could keep within ISA.

  • 9 Barney December 13, 2021, 10:07 pm

    @Learner..Hoping that corresponding wage gains will make it manageable?
    Unlikely, the days of “Union Power” are long gone, along with the Beer and Sandwiches at No:10.

    In September 81, the banks were forced to increase their base rates by 4 % points and the following month building societies increased their basic rates from 13 to 15%, but a loan of £25k would cost you 16.5%.
    But on the brighter side, a Canterbury Life Guaranteed Bond paid 17.1%

    And as Max Boyce would say,…..I know, cos I was there, see, boy’o

  • 10 Kraggash December 13, 2021, 11:05 pm

    Surely, the move of manufacturing to low cost places, such as China, was the main reason inflation has not taken off in the last few decades, even during ‘boom’ times? Instead of a wage-prices spiral, where increasing prices in the UK caused workers to demand higher wages, which caused higher prices, overseas manufacturing meant neither this, nor demand-led, price increases were experienced.

    As China seems to be falling out of favour, pulling manufacturing back may well change this.

  • 11 Barney December 14, 2021, 8:09 am

    @ Peter, It’s a long read, but here’s your answer:

    https://occaminvesting.co.uk/the-best-vanguard-bond-funds-for-uk-investors/

  • 12 Al Cam December 14, 2021, 12:03 pm

    @Jonathan B (#7):
    Indeed!
    Your mention of inflation expectations reminded me of this recent FED paper:
    https://www.federalreserve.gov/econres/feds/why-do-we-think-that-inflation-expectations-matter-for-Inflation-and-should-we.htm

    From time to time, I find it useful to remember that economics is, at best, empirical and is not an attempt to encode laws of nature!

    As already mentioned in the comments above inflation can create winners and losers.
    Currently, I tend to think (or probably I should say hope) it will pass.

  • 13 paul armstrong December 14, 2021, 4:49 pm

    As a boomer I have lived through most of that. From what I recall there was no consumer rush to buy before prices went up in the 70’s. Credit was less available and there wasn’t much money around.
    Wage rises were correspondingly large but there was a big lag. For salaried employees annual reviews were the norm. Ditto savings rates always lagged.
    There wasn’t a mass share holding culture then so share ownership was a minority sport.
    House prices were a problem then as they are now. They have been an issue for 60 years and no government has had the gonads to address the problem properly. They have caused so much anxiety and distress. Pity.

  • 14 DavidV December 14, 2021, 5:37 pm

    @Peter (8) I have a small holding of the iShares Index-Linked Gilts ETF (INXG) in my ISA. I seem to recall it has a very slightly shorter duration than the Vanguard fund, but may be wrong on this.

  • 15 Jonathan B December 14, 2021, 6:11 pm

    @Al Cam, thanks for the reference which firmly reminds me I am right out of my depth when it comes to theoretical economics. You can file my comment under “anecdote” not theory! My remembered impression – based on the papers, I wasn’t personally involved in pay negotiations – may not be a sufficient explanation.

    It might be as good a hypothesis to suggest that as long as inflation is less than profit margins, businesses can make choices about how much to increase prices to cover inflationary pay increases; once inflation exceeds that they have no choice and will inevitably perpetuate the inflationary spiral.

  • 16 The Rhino December 14, 2021, 10:11 pm

    Well my gas and electric bill has doubled since last month. Unnervingly, I’m not that far off the UK definition of fuel poverty now.
    I think inflation is particularly problematic for older frugal types as the anchoring is so much stronger. It gets to the point where you can’t bear the price of pretty much anything!
    I’ve not done extensive studies but I’m thinking a student doesn’t have the same visceral reaction to a pint costing over £5 as I do?

  • 17 The Investor December 14, 2021, 11:46 pm

    I’ve not done extensive studies but I’m thinking a student doesn’t have the same visceral reaction to a pint costing over £5 as I do?

    Definitely not. I’ve rarely felt so old as when in a pub at the bar with younger people in the past couple of years. Even mid-30-somethings with (in my mind) an awful lot of saving to do to get properly started don’t flinch at a £5 pint. And of course for 20-somethings it’s normal.

    My grandmother used to (to my young ears, wish I could go back now!) ‘prattle’ on about a 1p bag of chips and generally found everything outrageously dear.

    How right she was, for her (in nominal terms, of course).

    Comes to us all!

    Thanks for the comments everyone. 🙂

  • 18 Barney December 15, 2021, 8:41 am

    That’s why a lot of older folk complain about prices etc, because they can’t help but compare today with yesterday for the same goods, which as far as food is concerned costs much more for less.

    The “Plough” Upper Boddington, 1973, a pint cost £0.12p. Sunday morning x 5 £0.60p and thanks to Ted Heath, by candlight followed by a good home roast.
    https://www.flickr.com/photos/1st_grenadier/5041290115/in/dateposted-public/

  • 19 The Rhino December 15, 2021, 1:26 pm

    Another thing inflation related is the unwelcome development of broadband/mobile companies baking inflation + 3-4% price increases into their contracts. This seems to have become standard practice over past 12 months or so. They will be making out like bandits!

  • 20 Hariseldon December 16, 2021, 8:12 am

    It’s hard (impossible?) to predict what comes next.

    In the short term very strange things have happened since March last year, which inclines me to believe that inflation now is akin to a war scenario, significant disruption and government action distorting normal market activities.

    This to will end but afterwards….

    A globally diverse portfolio of different assets is the investment answer. What actually happens afterwards is anyones guess, doesn’t stop us speculating!

  • 21 Al Cam December 16, 2021, 9:31 am

    @Rhino (#19)
    +1 from me – especially galling given that:
    a) economists repeatedly claim that technology is a deflator; and
    b) these are said to be a regulated businesses

    P.S. this practice has been going on for some time now, but they have a long way to go to catch up with credit cards/overdrafts!

Leave a Comment