Is 2015 the turning point for a 100 years of rising prices? The investments that perform best during periods of low inflation and deflation
By Pete Comley For Thisismoney.co.uk 11:25 14 Apr 2015, updated 13:47 14 Apr 2015
- Global commodity pressures are bringing prices lower
- Government efforts to push inflation running out of steam
Is 2015 a turning point in global inflation and, if it is, what can you do to weather the storm? Pete Comely, author of a new book ' Inflation Matters: Inflationary Wave Theory, its impact on inflation past and present … and the deflation yet to come', explains.
The latest inflation data show that average prices in the UK remained static for a second month in a row.
History suggests that because of demographic changes we may now be about to enter a period of near-zero inflation for a lot of the next century. This is going to have major implications for many aspects of life, but especially managing wealth.
Workers Drilling for Oil
The Bank of England London, UK
workers at Karuturi's farm in Bako
Average prices were unchanged in the year to March, as measured by the Consumer Prices Index. This was due to a combination of a decline in the price of goods (-2.1 per cent) such as petrol, energy bills and food being balanced by increases in services (+2.4 per cent) including train and plane fares.
HOW THIS IS MONEY CAN HELP
However the declines are largely one-off changes and in a year when they fall out of the calculation, CPI will more than likely return to nearer 2 per cent again. But the current period of near-deflation is a symptom of a larger effect taking place across the globe that few have grasped the implications of yet.
The lower commodity prices we are seeing are as a result of supply exceeding demand. Moreover as we go forward in the 21st Century demand is going to fall still further and deflation is going to become a frequent theme.
Populations in most countries are ageing. The average number of children women are having is below the replacement level of 2.1 in every developed market. The UK is 1.9 and Japan just 1.4. It is also low in South America and most of Asia.
By 2050, some estimate that world population may even start to decline. In addition the ageing populations around the globe are consuming less too. The net effect of these demographic changes will be lower demand and prices.
This switch towards deflation also fits with longer term trends in inflation. We have seen significant price rises since 1900 but history shows that inflation exhibits a clear wave-like pattern and there are often periods of more stable prices.
A century of rising prices: Inflation has rocketed over the past century.
In my latest book, Inflation Matters. I show that what drives the underlying trend is population growth and competition for resources.
The wave-like form is created when man realises prices are starting to rise again and attempts to exploit the situation. Investors buy assets that will keep their value during the inflation i.e. property/land and shares. They borrow money to invest, knowing that inflation will erode the true value of their capital and repayments.
However that borrowed money increases the
money supply which then fuels more inflation in the economy. Governments also join in and encourage inflation, as it allows them to spend more and let inflation deal with their deficits.
But there comes a point when this inflation gets too far away from the underlying trend or there is a change in the population demand curve, as we starting to see now.
Historically we’ve then experienced some form of deflationary shock when prices have collapsed by about a half in a space of 5 years or so. Thereafter has followed a bounce back in prices but they never reach new highs. Over time prices then gradually decline as technology and productivity improvements reduce the costs of production.
Year of living dangerously: Is 2015 a turning point for inflation?
So how do you best invest for the long-term in this climate?
Short-term, governments have a strong incentive to keep inflation growing as long as they can against these demographic headwinds. It helps reduce the value of their escalating debts.
To this end, they have and will continue to encourage their central bankers to print money and will keep interest rates low. This will favour assets such as shares and property. On the flipside, all forms of cash savings and bonds will be gradually eroded by the combination of very low yields and the inflation rate that governments manage to create.
However all that will change when we enter the transition period and the inflation trend actually changes. It is impossible to predict exactly what will cause this to happen and when but a likely candidate could well be a bond market crisis.
Transition: Which assets are best as the inflation cycle turns?
At some point the ever increasing level of worldwide government debt will inevitably collapse and with it destroy a large portion of wealth not only in that area but in nearly all financial assets due to domino effects. The reduced the money supply will impact consumer prices, as will lower velocity of money as fear spreads.
During this brief turbulent period, the key asset to hold might be gold. Digital currencies may well come to the fore, if they have credibly established themselves by then. Holding cash might also be a good idea, but it is an easy target for governments.
The world will be different after the trauma of the transition. It would return to some form or normality. There may well be some growth in shares and housing, but it may probably be limited to genuine supply and demand effects.
The main return from holding shares will revert to be dividends of maybe 3 per cent. However in a world of average inflation of -1 per cent, that would still be a net return of 4 per cent, not far off historical levels.
Therefore investing for the long-term over the coming decades is going to be a challenge, but not an impossible one if you understand the bigger picture.
Pete Comley’s book Inflation Matters: Inflationary Wave Theory, its impact on inflation past and present … and the deflation yet to come is available in Kindle format and in hardback from Amazon.
Y ou can download a free Lite version of it featuring key chapters at: inflationmatters.com/thisismoney .Source: www.thisismoney.co.uk