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 [1] 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 [2] have seen the cost of food skyrocket in less time than it takes to recite Old MacDonald Had A Farm.
In Weimar Germany [2] 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 [3] in 2008.
They’re still at it. Here’s 77-year-old hedge fund manager Paul Singer writing in the Financial Times [4] 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:
[5]Source: Pew Research [6]
Now consider a key measure of UK inflation since the late 1980s:
[7]Source: ONS [8]
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 [9] 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:
[10]Source: ONS [11]
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 [12]
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 [13] 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:
[14]Source: ONS [15]
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 [16] recurrence. But as inflation didn’t surge back – and Central bankers further lowered rates – yields marched ever downwards:
[17]Source: Independent [18]
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:
[19]Source: ONS [20]
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 [21] at ports and factories, restarting commodity production [22], 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 [23] 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:
[24]Source: ThisIsMoney [25]
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 [26] 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.
- That’s assuming the ONS got its retrospective sums right. [↩ [31]]