ARE politicians and central bankers right to be fretting about inflation? Inflation is, of course, growth in asset costs or service charges to an extent that can be potentially dislocating to a country's economic model.
It is certainly a scourge. Even at a modest compound annualised rate of about 2 per cent, £100 left under the bed will only buy around £90 worth of goods five years' hence. If this "modest" rate of currency depreciation starts to accelerate the impl
ications can be truly terrifying.
Of recent times, arguably the first experience of hyperinflation developed during the German Weimar Republic in the early 1920s. It was triggered not, as is sometimes thought, by the Treaty of Versailles, but by the allies under the London Ultimatum in May 1921, demanding full reparation for the cost of Germany's aggression, the price of defeat. Unable to have any prospect of meeting the demand of 132 billion gold marks, the government of the day began to print money.
By late 1923 the German government was issuing huge denominated notes, the largest one for 100 trillion marks, and the currency was effectively worthless.
Things were only brought under control by inventing a new currency, the Rentenmark, secured on the country's land; nine zeros were knocked off the currency, creating an illusion of stability that became, to an extent at least, self-fulfilling. Nevertheless, the long-term consequences were devastating. Savings were destroyed, with long-standing mortgages, for example, being paid off with six eggs. The middle classes were financially ruined.
Hyperinflation can be, if not always, a consequence of government. Witness today's tragic events in Zimbabwe.
Today's inflation is largely commodity-driven. Oil and gas prices have soared as a result of the ambitions of emerging economies and the actions of speculators, or so we are told. Food prices are also rocketing, partly as a result of genuine shortfalls as a consequence of poor weather, but also reflecting a growing commitment to so-called biofuels rather than crops for consumption.
Even so, commodity price spikes are just that and are usually self-adjusting, either because higher prices unlock alternative sources of supply or squeeze out demand.
It is only if governments start to interfere that real problems begin – subsidies, set-aside and the like. Allowing the market to take the strain is often the most sensible course of action.
When this cannot apply is when inflation is as a consequence of excessive wage settlements. That's what bedevilled the UK in the 1970s when powerful unions took advantage of weak governments and poor management. This triggered higher prices as increasing wages fed through to the demand chain, so wage demands became more aggressive in anticipation of higher prices, a dangerous spiral, which, once engaged, is almost impossible to arrest.
It was eventually capped only by the onset of an economic downturn that saw the tragedy of rising unemployment and, for a time, the real threat of price deflation, which is almost as dangerous as its inflationary counterpart.
The risk today is that central bankers, charged by their governments to control inflation but limited to the one-club policy of monetary constraint, will over-tighten policy orthodoxy. That said, some argue that US Federal Reserve chairman Ben Bernanke is in danger of repeating the mistakes of his predecessor Alan Greenspan by adopting an over-accommodating strategy, fearful of a looming slump and siring, instead, another rash of the irresponsible lending that got us into the current shambles.
Inflation must be controlled but would it not be better to establish a predetermined formula – which must include domestic housing costs, which the current Consumer Price Index largely ignores – and then gear interest rates automatically to a premium to this level?
Admittedly, this would involve human agency in the initial structure of the formula. But thereafter it would be a barometer of the ebbs and flows of pricing pressures not exposed to the political initiatives that have so often in the past proved nigh-on disastrous.
• Bryan Johnston is director of Bell Lawrie stockbrokers in Edinburgh.
The full article contains 684 words and appears in The Scotsman newspaper.
