Chapter Seventeen

INFLATION

I have included a few snippets on inflation because more uninformed opinions are given on this subject than on almost any other.

WHAT IS INFLATION?

When many prices rise over a short period, people complain about inflation. It is as vague as that.

WHAT CAUSES INFLATION?

Each economist and every politician conjures up their own explanation for inflation like a rabbit from a top hat. Some blame too much money, ready for the asking, with credit cards and the like. If everyone wants and can afford a fixed number of goodies, the price goes up. Everyone outbids everyone else, just as at an auction sale. The fancy name for this is 'demand-pull inflation'.

Others blame increases in the cost of raw materials which manufacturers have to hand on to customers.   Suppose all the deposits of tin which are easy to mine have been used up. Miners then tunnel deeper or further under the sea. So the cost of producing tin will rise. Any goods with tin in them (your stannous fluoride toothpaste, for instance) will increase in price. This is called 'cost-push inflation'.

When the raw materials are imported from abroad and the foreign producers increase their price, people talk about 'imported inflation'.

These different forces can tug the price in various directions at the same time. Increased wages in Sri Lanka may yank up the cost of your morning cuppa. Improved packing machinery in Britain may reduce it - and so will the fact that more and more people prefer coffee.

HOW DO YOU MEASURE INFLATION?

Governments produce the retail price index, which is sometimes called the cost of living index or the consumer price index. How? They make detailed surveys every month of how much things cost. Governments have been collecting similar figures for years. Then they choose a 'base year' say 1990. All the prices in 1990 are taken as 100.

Suppose that sugar cost 50p a bag in 1990 and 55p a bag in 1991. This is an increase of 1/10 or 10 percent (55p the new price minus 50p the old price, all divided by 50p the old price: 5 divided by 50 = 1/10). The  1991 index will then be 110  (the old 100 plus 1/10 of 100, which is 10).

If sugar costs 59p in 1992, this is an increase of 18 per cent over the 1990 base price, so the 1992 index will be 118. and so on.

The figures are collected and processed by the government. The lower that inflation appears, the happier we voters will be. There are dozens of ways in which these accurate figures can still mislead. They don't reflect how you  live or what you pay.

For a start, every price is an average over the year. Yet you know that the price demanded for, say, your Sunday roast beef, varies from one shop to another, from town to town, from week to week. So does its quality which is impossible to measure.

What base year do you choose? Some calamity like an oil crisis or a war may have erupted in 1990, making it untypical.

Which items do you look at? A non-smoker does not give a hoot for any changes in the prices of cigarettes, cigarette lighters, pipe tobacco or cigars, let alone ashtrays, pipe-cleaners or cigarette paper.

No one bought a mobile phone in 1990; they did not exist then. So you cannot compare their prices. Many things that were popular are no longer so widely used - like manual calculators, paraffin heaters, hair-nets and carbon paper. Who cares what they cost now?

The government picks what it thinks the average household spends its money on. Then it decides how much of its income the family spends on each item. If most goes on food and only a pittance on entertainment, an increase in the price of potatoes will hit the family far harder than a rise in the cost of cinema tickets.

But the government can fix certain prices, like bread and milk. So it may include both as though they are overwhelmingly important. This way, it can keep the overall increase looking as low as possible.

I think I have said enough for you to take inflation figures with some suspicion.   If British ones are suspect, even when accurately and honestly calculated, foreign ones are far more so.

INFLATION FALLACIES

Here are two great fallacies about inflation:

1 It was caused by introducing decimal currency. Rubbish. There is nothing new about inflation. People complained about it in the 1500s when all the galleons sailed back to Spain laden with gold from the New World. The Spaniards spent so freely, they forced up prices all over Europe.

2  If the rate of inflation falls, so will prices. Rubbish. Inflation is a measurement just like that given by the speedometer in your car. If you are cruising at fifty miles an hour and you ease back to forty, you don't expect to drive backwards. You expect to go forwards more slowly. In the same way, if the rate of inflation falls, prices continue to increase, but more slowly.

When you drive backwards, when prices really fall, it is called deflation. This does happen. It happened in the 1930s when the prices of houses and the cost of living fell, and every civil servant was forced to accept less pay. Deflation is associated with depression, unemployment and poverty. So, if you like worrying, you can worry just as much over deflation as over inflation. Now you see why economics is called 'the dismal science'.

SHOULD I WORRY ABOUT INFLATION?

If inflation becomes hyperinflation, you should worry. That is when people carry a suitcase full of banknotes to the bakery for a loaf of bread. It has never happened in Britain.

CAN I PROTECT MYSELF AGAINST INFLATION?

You can protect yourself a little against inflation. Everything I have recommended in Chapter 8 to help you keep your money also helps you to fight inflation at the same time. Then remember the hints in Chapter 9 on how not to squander it.

An inflation-linked pension helps. Some private pension schemes offer a form of inflation-linking too. But it costs a lot more, and there is no guarantee it will be enough.

What you spend your money on and your choice of investments can help. Some assets increase in value as inflation increases - like houses, antiques, art. Guard against buying things that depreciate wildly - anything with a short life and no chance of reselling it; inflation makes them lose value even more quickly. Remember, anything 'fashionable' has a short life by definition.

Remember, even inflation has advantages. During inflation is a good time to borrow. The £1,000 you borrow today will buy you a lot more than the £1,000 you repay in a year's time. So, in buying terms, you are not repaying as much. You are repaying even less if the inflation rate if higher than the interest rate you pay.

figure 2 Supply

SUPPLY AND DEMAND

Finally, because I have referred to it several times, just a bit of economics. 'Economics is easy, ' somebody once jibed. 'A parrot could learn it. Just keep mouthing "supply and demand".'

The basic ideas are quite simple.

When we talk about the 'supply' of a service, we mean the number of people willing to provide it at a given price. Clearly, the higher the price, the greater the supply there will be. If typists earned £100 an hour, we would all rush to join them. If they only scraped up 10p an hour, who would want to be a typist?

The same goes for the supply of goods. This is the amount of the goods that people would produce in factories or farms at a given price.

Economists draw a graph to show this. The supply line curves upward left to right. It simply links up the dots which show the size of the supply at each price - see Figure 2.

As far as demand is concerned, when Champagne costs £50 a bottle, most of us leave it on the supermarket shelves. If it fell to £1 a bottle, we would be queuing up outside the shop.

Demand - the number of us who want to and can afford to buy - increases as the price falls.

Economists show this on the same sort of graph. The demand line curves downwards from left to right. As the price rises, fewer and fewer of us want or can afford to buy - see Figure 3.

Where the supply line and the demand line meet is the price that buyer and seller agree on: the market price - see Figure 4

So far so good. Of course, the real world is far more complicated. You may prefer Spanish fizz at half the price of Champagne - or cider, lemonade or even Perrier water. After a health scare, the government may ban its sale, or the French government its export. Then, there are items, like cigarettes, where smokers know they must have them and would buy their thirty a day even if the price tripled.

While you know broadly what price you would or would not pay, or what wage you would or would not accept, you don't sit down and draw a graph. Economic theory explains broadly how money makes the world go round, but for help with day-to-day living, forget it. Business people do.

It may console you to remember the old joke about economists. If every one in the world were laid end to end, they still would not reach a conclusion.

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