Governments Want Inflation so Invest With An Inflation Hedge

Published / Last Updated on 17/09/2020

On 16th September 2020, the Federal Reserve (US equivalent of the Bank of England) issued “strong, powerful guidance” that it would keep interest rates at or around 0%pa at least until the end of 2023.  It also suggested that it would: not tighten policy until inflation had been “moderately above” 2%pa “for sometime”.

Why do governments want a sustained period of inflation?

Government debt.  Sovereign debt across the globe is at record levels.  The US and EU in its trillions of $ and €, the UK hitting a record £2 trillion in July 2020.  We are nowhere near through coronavirus or redundancies or Brexit (deal or no deal) with huge additional debt to follow.

Do the numbers:  £2 trillion divided by a UK adult population of around 53 million. This means government debt amounts to just short of £40,000 per adult.  If two adults are in a household that’s £80,000 per household.  Imagine, if HMRC approached every household in the UK and asked you to pay £80,000, it will never happen.

The same can be said across most of the globe.

The only way governments can ‘repay’ debt is to allow inflation to devalue it.  This is exactly what Ronald Reagan and Margaret Thatcher did in the 1980s.

If we look at compounded inflation for a sustained period of 5 years and 10 years at 3% and 5%pa, the compounded inflation effect is as follows:

  • 3%pa inflation compounded over 5 years =  15.9% and over 10 years = 34.4%
  • 5%pa inflation compounded over 5 years =  27.6% and over 10 years = 62.8%

If inflation was at 5% for 10 years then the UK’s public sector debt would be devalued by 63%, that’s nearly 2/3rds .  

This is why governments want inflation, as well as the obvious that if we have negative inflation then the whole economy would collapse as people would put off buying their new car or television this year if they knew it would be cheaper next year or the year after.

The Federal Reserve’s statement of policy is a clear signpost as to what they are planning.  Think 1980s, think recession then boom, think stock markets regularly hitting record highs, think price increases, wage increases and property price increases.  In the words of Mark Twain: “Buy land, they are not making anymore”. 

For some time, we have been predicting a sustained period of inflation.  We have been gradually moving clients to index linked gilts and other inflation hedged assets.  Inflation, equities and property may fall in 2021 but long term, consider positioning yourself for a long term swing upwards:  index linked assets, property and equities.

We are investing with an inflation hedge in 2020.

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