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Weekend reading: How governments have previously inflated away debt

Weekend reading

Good reads from around the web.

I have feared inflation ever since the credit crisis began. Interest rates at multi-century lows, quantitative easing, and the UK government taking on the liabilities of RBS and Lloyds only added to my desire to guard against the erosion of my wealth.

Unlike most inflation paranoiacs, however, who cover their windows in the silver foil and bury gold bars in their basement, I’m pretty optimistic about the global economy and stock market, at least in nominal terms.

This means I’ve been able to meet my fears by being extremely long equities and very light on bonds, together with buying NS&I index-linked certs when available. I am usually a fan of private investors holding a big slug of cash, but outside of the cash-equivalent linkers, my cash allocation is near its all-time low of March 2009.

This stance has been a reasonable one overall – who a decade ago would have thought we’d see inflation breach 5%, yet the Bank of England keep rates at 0.5%? – yet there have definitely been hiccups along the way.

Last year, for instance, was a terrible year to not hold any government bonds. They were the best performing asset class, yet I have long considered over-valued in light of my inflation concerns.


Those of you with pure passively managed portfolios that include a good slug of gilts probably beat the majority of active traders in 2011. Not unusual, and why passive approaches are our central recommendation here at Monevator, not my off-piste active shenanigans!

As The Accumulator has reported, gilts saved most of our Slow & Steady Portfolio’s bacon in 2011.

Currency debasement is a long-term game, however – it happens over decades, not quarters. The UK government has every reason to be happy seeing the real value of its debt watered down, provided creditors don’t get the willies. So I’m not running up the white flag just yet!

If you’re not familiar with why massive government debt and inflation so often goes hand in hand, you might want to read How Sneaky Governments Steal Your Money, on The Psy-Fi blog this week.

As author Timmar states, eroding debt through stealthy inflation:

“…relies on the sleight of hand that lies behind money illusion – the idea that people focus on nominal interest rates rather than real ones. Unfortunately, this seems to be hardwired into people.

Of course, if financial repression was on the cards then we might expect to see abnormally low interest rates, stubbornly high inflation rates and governments imposing all sorts of new capital holding requirements on banks and pension funds.

We’d better keep an eye open for those, then…”

For more evidence that inflation is the likely endgame, see this PDF from the Bank of International Settlements on The Liquidation of Government Debt.

I don’t expect we’ll see hyperinflation, or small boys pushing SIM cards around in wheelbarrows in lieu of pocket money.

But I do suspect real interest rates will continue to be low for years.

Note: Don’t take my suspicion for anything other than what it is – a best guess! Nobody knows what interest rates will do next, and the vast bond markets represent huge amounts of money being put where traders’ mouths are.

Still, with the FTSE yielding near 4% and 10-year gilts near 2% – especially against the backdrop discussed above – I know what I think is better value.

Of course, I said something similar last year. Roll on 1% gilt yields, then!

From the money blogs

Book of the week: Having worked with a few in my time, I’d suggest Jon Ronson’s hilarious yet insightful The Psychopath Test could be important due diligence on your next boss!

Mainstream money matters

  • Who exactly are the 1%? – The Economist
  • Why Spain’s bond market ignored the downgrade – Swedroe/MoneyWatch
  • Generation Y: Lots of time, little risk appetite – Vanguard
  • Developing world’s oil consumption about to surpass OECD’s – CityWire
  • The risks of linking employment with investment – FT
  • Rental yields are key to buy-to-let equation – FT
  • Mimic a trendy commodity hedge fund via an ETF – FT
  • Mortgages at their most affordable for 14 years – Telegraph
  • Six million UK householders have less than £250 in savings – Telegraph
  • Average shareholding is held for just 22 seconds – Telegraph
  • Can stamp collecting deliver profits? – Telegraph
  • How you can finance an enjoyable retirement – Independent

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{ 5 comments… add one }
  • 1 ermine January 22, 2012, 3:43 pm

    I’m surprised at the dearth of comment. Government shenanigans subtly altering the yardsticks that are meant ot measure wealth are a concern of mine. Strategies to deal with it are hard to find, however. Equities seem to scale with an infated money supply to some extend, National Savings ILSCs scale with it by definition but are 100% government controlled so the fox is in charge of the hen-house. Though I haven’t personally acted upon it, I do like the concept of gold as an independent arbiter and has value because of what it is, ie not depending on a financial infrastructure. However, it has its own investment risk by being a commodity as well as a pseudo currency.

    There aren’t any tremendously good insurances against government action. That’s partially because if there were one, it would be closed down. There are also disturbing drumbeats in some areas. I would like to stick a foot out and trip Vince Cable up, for starters, with his mansion tax. Not because I am ever going to own a house worth a million pounds, but because it starts us on the slippery slope to a US-style property tax, which will come down the scale in time. We have had window taxes and taxes on staple foods in the past.

  • 2 Rob January 22, 2012, 6:12 pm

    “I’m surprised at the dearth of comment.”

    It’s a difficult area to comment on.. I mean what’s the debt: £1tn… what’s government revenue £600m… it doesn’t look good. Thanks to the Euro crisis that debt is still very cheap, but if it all goes wrong we all collectively owe a lot of money. Considering that the debt grew in the boom times either that’s a lot less services or a lot more tax.

    Assuming they manage to control it I imagine it will peak at about £1.3tn so who knows what might happen. It might work out well with just a few decades of paying off the debt or they might never get a hold of it. Until I can be sure the latter won’t happen I’d stay away.

    The obvious solution for the government is inflation and devaluation of the pound. They’ve still time to try and get it under control, but after that who knows what might happen…

    As all these blogs say, you shouldn’t get into debt, but we’ve had no choice in the matter and must owe collectively £30k each? Add future pension liabilities etc and its not pretty reading.

  • 3 gadgetmind January 22, 2012, 7:17 pm

    2011 was kind to me, mainly because I sailed into those choppy waters with a hold full of cash and loads of capital gains in tech shares. During April, I used our shiny new CGT and ISA allowances to diversify into ITs such as Personal Assets, RIT, and Ruffer, and then dipped further into the sacks of doubloons to build my wife a high-yield portfolio of blue-chip defensives during the autumn sales.

    New themes in my portfolio are now infrastructure, corporate bonds, global strategic bonds, and a smattering of commercial property. Oh, and also a shed load of Vanguard trackers.

    If at least some of this rings bells, well thanks to Monevator for some of the core ideas, but I have of course done my own research.

    April will bring new opportunites, but for complex reasons I need to keep our CGT allowances in abeyance until winter 2012. I may use cash to fund this year’s S&S ISA allowances before then, but only if I see things to buy that are more attractive than cash.

    So, if the markets could crash about then, only to recover just as quickly, that would be great.


  • 4 The Investor January 22, 2012, 7:56 pm

    @Rob and @ermine — Inflation to deal with debt is basically a bezzle, as defined the great economist J.K Gailbraith in the context of how various financial intermediaries ‘steal’ money out of the system without anyone knowing. Only this time it’s governments! (Normally it’s fund managers and fashion retailers)

    @Gadgetmind — I know, if only crashes came on demand. Sooner or later these depressed markets will come to an end and the FTSE will be on a bloody P/E of 20 and we’ll look back on these times wistfully. (See my 2020 vision! 😉 )

  • 5 101 Centavos January 23, 2012, 12:54 pm

    I remember reading a while ago a lengthy article on the monetary devaluation by the various Roman administrations in the latter days of their empire. They Romans did it of course by steadily decreasing the silver and gold content of their coinage, over a good long period. Governments can keep this game going for a loooong time, outlasting hyperinflation bears along the way.
    Good link, I had psy-fi blog in the back of the mind, but hadn’t been there in a while.

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