Monday, April 4, 2011

Inflation: Better than a good curry

The Big Picture

The Big Picture © fintag

News comments:

We all love inflation. As asset prices rise, we feel good. That car you bought for 100 is worth 100 three years later. Depreciation has been beaten by inflation. That house you bought for 100 is now worth 300 and you didn't do anything except just live in it. Yesterday you earned 100 and now you earn 150 despite being less productive. That 100 debt you have is in real terms now only worth 50 and so have reduced your debt without paying it off.

However, inflation only benefits those who can ensure their income increases at the same or faster pace than the basket of goods and services inflation is based off. Or those who are "rich" and just have lots of capital. The net effect is inflation is a very good thing. Or is it?

Governments don't like inflation because it impacts their currency. High inflation deflates a currency. As it deflates, import prices increase and add to the inflation. And so it goes on. Argentina. Zimbabwe. UK.

Go back to the 1970's in the UK and inflation was so bad compared to other countries the government had to constrain wage inflation which was running at a higher rate than inflation with the consequences of falling company revenues and taxes. The unions went on strike and the people lived by candle light amongst piles of uncollected trash.

Of course the idea came first from Richard Nixon, who implemented one of the first peace time incomes policy to curb inflation. This blatant attempt to control the markets ended up with massive hikes in inflation when these temporary policies were stopped.

Short term inflation is good (hence Ben Bernankes attempts to reflate) but in the medium to long term it is devastating.

So what is going on with the equities markets? Is it in a parallel universe? I am afraid so. If you want to see what impact the ECB's rate rise is going to do to Europe, in its belated attempts to combat inflation, then check out the bond markets for they really do tell you what the future holds.

You see those who work in equities have inflated egos whilst those in fixed income have more chance of making money.

Today's shorts:
Poland rates (bloomberg)

Graduates now earn less than the minimum wage thanks to inflation (scotsman)

Australians inflate (wsj)

Indians suffer scurvy from inflation (the hindu)

Smoke, mirrors and the Taylor Rule (wikipedia)

Today's longs:
iPad eaters (bloomberg)

Google to charge for searches.