Is Britain heading for hyperinflation or deflation?
The burning question in financial markets is pretty much the same around the world: will the fallout from the economic crisis precipitated by COVID 19 lead to hyperinflation or to deflation?
In the UK, many fear that the country is going back to the 1970s – or to a strange world of which no living Briton has any recollection. A more pronounced fear is that it will be savers and investors who get ripped off by the taxman to pay the bills of the crisis, while borrowers get further buried into debt.
All the economic textbooks tell us to expect inflation to rise when you mix together an expansion in the money supply combined with a contraction in output. It is safe to say that we have those two ingredients at the moment and yet in August 2020, inflation fell sharply from 1% to 0.2%.
So what is going on?
Since the beginning of the crisis, the Bank of England has whisked another £300 billion out of the air – bringing total quantitative easing since the financial crisis of 2008 to nearly £750 billion.
Meanwhile, shops, restaurants, leisure parks have been closed, reducing the things we can spend money on, and causing savings to rise and personal bank balances to swell.
By the time the crisis is over, many businesses will have gone bust, yet extra money – effectively printed money — will be swilling through the system.
It seems so obvious that we will end up with inflation – and yet that was what many people were expecting last time around, after the 2008 crisis. Yet it never happened. Not only that; in 2015 inflation even turned negative for a time, although very briefly.
Credit, then, to the Bank of England’s Monetary Policy Committee, which steered the economy through the unknown territory of quantitative easing by doing, er, virtually nothing – and leaving interest rates unchanged for seven years.
If there’s no inflation, what is likely to happen?
The alternative scenario is deflation. People also feared that after the financial crisis and that didn’t happen either – except briefly in 2005 when the CPI fell to 0.1 percent for two months.
That wasn’t a huge problem, but serious and prolonged deflation certainly would be. Older readers will remember well the hazards of inflation when the real value of savings is eroded and workers start demanding three or four pay rises a year.
Deflation, though, brings arguably worse horrors. Imagine if, in spite of you keeping up your repayments, the real value of your mortgage started growing month on month? Eventually, you would be overwhelmed – as would anyone with debts they had been unable to pay off.
Given that the biggest borrower of all – HM Government – is up to its eyeballs in debt, deflation would soon bury public finances, too.
There is a good reason why economies can suffer chronic deflation but don’t tend to mirror the inflationary spirals that have taken down economies such as Mugabe’s Zimbabwe and Germany’s Weimar Republic. The dynamics are very different. It is one thing to jack up your prices or demand higher wages to keep up with perceived inflation; but who is going to demand a pay cut to keep pace with deflation?
Public borrowing to guard against deflation
There is another guard against deflation. With vast national debts, it is hard to imagine Britain, the US or any other developed country allowing deflation to occur. They simply can’t afford to allow it to happen. They will do everything they can to avoid it. If QE doesn’t do the trick, they will surely try something even more blatant: helicoptering money directly into our bank accounts would be nice. In the end, they will be far more relaxed about risking inflation than they will deflation.
After the 2008 financial crisis, we did experience inflation – asset price inflation. The excess liquidity was sucked into stock markets and property markets. As rising stock markets suggest – the US market is actually higher than it was in February, before the crisis – that is quite capable of happening again.
The common view among analysts is that we’ll end up with markets – like property – that are much stronger than the economy. It just goes to show that when all else fails, investors are more likely to gain capital protection from tangible assets, regardless of the length of term they remain invested.
Stocks are likely to remain attractive for investors with very deep pockets and a hearty risk appetite because although the FTSE is highly volatile, it offers the promise of big returns (and, of course, losses). For the majority of investors with an eye on the future, property will always be the best safe haven against volatility and uncertainty, mainly because of the market’s much slower pace and consistently strong fundamentals.