If you don’t remember the inflation of the 70s, you’ll have heard about it.
Shortages. Rationing. Strikes. Prices surging out of control.
And then interest rates raised ever higher to try and bring the inflation back under control. By the end of the decade, they peaked at 17%!
And that’s the Bank of England’s base rate – add in the bank’s profit margin and you’ll get a nosebleed.
Borrowing became a dangerous business, back then. The cost of your mortgage could spike fast. Businesses went bust under their own debts, destroying jobs. The price for bringing inflation under control was immense.
But, today, the setup for inflation is far worse. And, if we do get inflation, I believe it will run even more rampant than it did in the 70s.
The reason why is simple. There is so much debt in the economy this time, that interest rates cannot be raised fast enough to rein in inflation, if we get it. Not without crushing the economy and its many, many, many borrowers.
If we can’t rein in inflation with higher rates, that suggests inflation will be allowed to get out of hand when it does come. It’ll be the lesser of two evils, given higher rates to stop inflation would crash the economy.
That means history will take a different path to what happened in the 70s and 80s. For a while, at least.
Borrowers won’t be sacrificed with higher interest rates to combat inflation, as they were in the 70s.
Savers and consumers will be sacrificed to protect borrowers instead. Inflation will be allowed to run out of control, deliberately. Interest rates won’t be raised enough to compensate savers for the falling value of money in our bank accounts.
Sound alarmist? Surely the Bank of England, the US’s Federal Reserve and the European Central Bank are legally required to keep inflation low?
Well, lately, they’ve been taking a different line. They want to meet the inflation target of around 2% on an “average” basis instead of trying to hit it.
What does that mean? It means that, after years of undershooting inflation targets, they want to “overshoot” for a while. The average rate of inflation over a long period of time will thereby hit their legal mandate.
Now the legal mandate is clear – it doesn’t mention any averages. But that won’t stop the central banks from letting inflation run surprisingly high. And, once it does, it’ll be hard to stop.
The value of your money will tumble. And the interest on your savings won’t make up for it.
If you want to your wealth to be robust to the inflationary risks and trials of the future, you need it to be inflation proof. We explain the first step you can take in our report about investing in gold.
But, for today, let me explain what has me so convinced it’s worth preparing for a high inflation future…
Why inflation would spiral out of control
When debts in the economy are so high that nobody realistically expects us to pay them down, there are only two options left.
Default, meaning not paying your debt back.
Or inflation, meaning reducing the value of that debt by making money worth less. (Or worthless, if they overdo it.)
Governments and their cronies at central banks like the Bank of England prefer the inflation option. That’s how we paid down our government’s war debts – by printing money so that the burden of the debt was easy to repay.
That’s how I expect things to go again. But a bit of inflation is not what I’m worried about. It’s too much. Or, to put it better, it’s the inability to put the inflation genie back in the lamp once we let it out.
The way in which central banks are supposed to bring inflation under control is well known. They raise interest rates, making debt more expensive. This slows down the amount of money in the economy, which slows inflation.
Sounds simple. But that’s an inexact science to begin with. The fact that they’ve undershot inflation for so long proves they’re less capable of getting it right than you might think. And some economists are even beginning to doubt whether higher interest rates really do reduce inflation at all…
But here’s the thing. If central bankers do raise rates to stop inflation, we have so much debt in our economy that it’ll cause a crisis.
It was reported in June that the government’s debt is now larger than our economy. That means a small increase in interest rates can turn into a huge interest bill for the government.
But the real concern is for the private sector. Households and businesses are badly indebted too. It’s tough to pull together the figures, but economicshelp.org estimates that when you pool all of the UK’s debts, you get a mountain about five times the size of our economy.
At these levels of debt, even a small interest rate increase means a huge increase in borrowing costs. And, with interest rates starting out so low, at 0%, the rate of increase itself is dangerous. Let me explain that…
At 5% interest rates, a 1% change in the interest rate by the Bank of England means a 20% change in a borrower’s interest bill. (Because 1% is a fifth of 5%.)
At 1% interest rates, the same 1% increase in the interest rate is a 100% increase in the cost of borrowing – doubling the cost of borrowing.
At 0% interest, a 1% increase is an enormous change.
The point is, borrowers are more sensitive than ever before to any interest rate change. If the Bank of England does raise rates even slightly to rein in inflation, it’ll trigger economic chaos. Borrowers won’t be able to repay their debts. There will be mass mortgage foreclosures, house prices will crash and businesses will go bust.
For decades, interest rates have been falling. Borrowers are used to debt becoming cheaper. They’re not used to rising rates for any long period of time.
On an international level, each time rates did rise, it ended in a financial crisis. And then the rates had to resume their downward trend again, to protect borrowers.
The point is, there’s simply too much debt to raise rates. So the Bank of England won’t be able to. And that’s why inflation will run out of control, once it begins.
Of course, they might try. But raising rates was difficult enough in the 70s. When debts were a fraction of today’s levels. And rising rates still caused economic carnage back then. The Winter of Discontent, strikes and plenty more. That’s what it took to get inflation under control.
But, this time, raising interest rates would do even more damage to the economy because debt levels are far higher. Which means the economic price for reining in inflation will be higher.
And I’m not sure central bankers will be willing to pay it. I think they’d prefer to let inflation run out of control, rather than experience the stagflation of the 70s and the economic contraction it took to bring inflation under control.
As Nigel described it to me, it didn’t go so well north of Watford in the 70s and 80s…
If I’m right about this, then having an inflation proof set of investments will prove crucial for your financial future. That’s one of the many things we’ll cover here at Fortune & Freedom. But don’t forget to check out our gold report in the meantime. It’s the best place to start.
Editor, Fortune & Freedom