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Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.”

Ronald Reagan

If you don’t remember the inflation of the 1970s, you’ll certainly have heard about it. Prices surged out of control. There were shortages. And it took interest rates of 17% to bring inflation back under control.

But today, the setup for a return of inflation is even worse. And I’d like to show you the five reasons why we expect inflation to surge out of control once again.

1. The inflation genie is already out of the bottle

Inflation rates have already spiked to high levels. And once the inflation genie is let out of the bottle, it’s notoriously hard to get it back in.

Let’s look at some recent figures…

The UK’s June consumer price inflation rose to 2.5%, much higher than the 2.2% expected. The Retail Price Index (RPI), which is used by the UK’s inflation-linked bonds, came in at 3.9%.

And we’re not finished yet, according to the former Bank of England chief economist.

Bloomberg summed up his speech, which made a prediction for inflation:

Bank of England Chief Economist Andy Haldane said inflation is likely to finish the year close to 4%, posing the biggest challenge to policy makers since the pound plunged in 1992.

Read that again. Our economist from the Bank of England, reckons that this challenge is bigger than Brexit. It must be a real problem then, mustn’t it…?

British business is also worried according to Bloomberg’s coverage of a Chambers of Commerce survey:

The share of businesses worried about inflation is at its highest level in almost a decade.

That’s according to the British Chambers of Commerce’s quarterly economic survey of more than 5,800 companies, which also found that the balance of manufacturers expecting to raise prices was the highest since records began in 1989.

But the UK isn’t the centre of the inflation maelstrom.

That centre would be the world’s largest economy, its key financial market and the global reserve currency. In short, the United States’ inflation problem is very much our problem too, as it was in the 1970s.

The US Consumer Price Index (CPI) rose 0.9% month over month and 5.4% year over year in June. The monthly increase was almost double the expected amount of 0.5%.

Core CPI, which strips out highly volatile prices like food and energy, was also up 0.9% month over month and 4.5% year over year. That’s the largest increase in 30 years.

Goods prices, which people notice disproportionately, are soaring much faster than services, up 8.7% year over year, the fastest rate since 1981.

Bank of America’s inflation indicator hit its highest possible level of 100 on the June data dump.

If the 0.9% monthly jump in inflation doesn’t worry you, I need to explain what it really means. If inflation continues at the June pace, the US would have 11% annual inflation! We’re talking about a double-digit inflation rate. Suddenly that 0.9% isn’t so small, is it?

My colleague Rob Marstrand of UK Independent Wealth, who lives in Argentina and therefore knows a lot – from personal experience as well as from economic history – about inflation, sent me this in an email exchange shortly after the US CPI results came out. The exchange highlights what’s most worrying about the data:

From: Rob Marstrand 
Sent: Tuesday, 13 July 2021 11:13 PM
To: Nick Hubble
Subject: Re: US June CPI release….

0.9% month over month inflation would work out at 11.4% annualised (1.009 ^ 12 = 1.1135).

Also I worked out YTD (H1) all items is 3.7%, which is 7.4% annualised.

Excluding food and energy YTD is 2.9%, or 5.9% annualised.

The key thing to watch are the monthly figures… because there’s no “base effect” from last year in those… and the trend is acceleration:

Jan 0.3

Feb 0.4

Mar 0.6

Apr 0.8

May 0.6

Jun 0.9

In other words, for the first half of 2021, prices rose 3.7%, which, if it continued for the year, would mean inflation at 7.4% for the year. Excluding the volatile food and energy components, we’d still have 5.9%.

In a similar line of argument, Bloomberg pointed out that, “In the three months through June, the core CPI increased at a more than 8% annualiszed rate, the fastest since the early 1980s.” In other words, if inflation continues at the same pace as between April and June, we’d get 8% inflation in the global reserve currency.

But the most concerning part is the acceleration of inflation. It has been rising surprisingly consistently, almost every month. And if that continues, the United States will get inflation in the teens!

To put it simply, devastating rates of inflation are already here. The question now is whether they’ll continue.

A part of the answer lies in producer prices, often called factory gate prices. Inflation for producers can lead to inflation in consumer prices as companies pass on the burden. That’s how our frequent contributor to Fortune & Freedom John Butler anticipated the current consumer inflation spike back in May, before it kicked off.

Well, the data revealed that US producer prices soared 1% month over month and 7.3% year over year in June. That’s even faster than CPI!

In the last ten years, the Producer Price Index has only managed a year over year high of just over 3%, so we’re more than double the last decade’s highs.

Inflation is already here. And surging producer prices suggest it looks set to continue.

Do you agree that inflation is already out of control?

My real worry is that we won’t be able to get inflation back under control.

2. There’s too much debt to raise interest rates

Surely, if inflation spikes, central banks will just raise interest rates to rein it in?

That is what happened in the United States and elsewhere in the early 1980s.

This time round, though, I very much doubt that the central banks will raise rates – and for a simple reason.

There is so much debt in the economy that interest rates cannot be raised fast enough to rein in inflation.

Not without crushing the economy and its many, many, many borrowers who rely on low interest rates and have become accustomed to them.

It’s tough to pull together the figures, but 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 the debt.

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. This is both because of low rates and the amount of debt.

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.

Given the choice between a debt crisis and inflation, I think central bankers will prefer inflation.

As will their employers…

3. Central bankers are too busy saving the government to save you from inflation

German school children are all taught a rhyme about the source of inflation. It’s probably a legacy of the Weimar hyperinflation experience, when the cause of inflation wasn’t really understood.

The rhyme is “Geldvermehrung ist Geldentwertung”, which translates to “money creation is money devaluation”.

Just as with all other goods and services, the more you have of something, the lower the value. Money is the same. And inflation is the devaluation of money by creating more of it.

When central banks create new money, they largely do so by buying government bonds. This helps finance the government.

The thing is, governments are in desperate need of financial help thanks to huge deficits. And central banks are beginning to put the cart before the horse by worrying more about financing governments than the inflationary consequences of doing so.

The Bank of England governor Andrew Bailey admitted to the Guardian that the Bank of England rescued the government:

“Britain came close to effective insolvency at the onset of the coronavirus crisis as financial markets plunged into turmoil, the governor of the Bank of England has said.

Laying bare the scale of the national emergency at the early stages of the pandemic, Andrew Bailey said the government would have struggled to finance the running of the country without support from the central bank.”

Over in Europe, Eric Oynoyan, a strategist at BNP Paribas SA, estimated that “ECB purchases of euro-area bonds next year could exceed net issuance by almost 60%.” That means the European Central Bank is providing more than enough money to finance governments in the eurozone. 

The question is whether governments would be able to finance themselves without central bank help. And, if we don’t want to risk finding out the hard way, then central bankers will continue to help finance governments with freshly created money – the underlying source of inflation.

Crucially, they could do so despite high rates of inflation.

Given a choice between letting the government go bust and reining in inflation, which do you think central bankers will choose?

4. Inflation is a tax and the government needs the money

You might think that central bankers learned their lesson in the 1970s. Inflation is hard to get back in the box once you’ve let it out.

But, according to their own pronouncements, central bankers now believe we need a serious dose of inflation.

The economist Roger Bootle explained how in the Telegraph:

In the US, the Fed has made it clear that it would not react to higher inflation by raising interest rates immediately. For a while, it would tolerate inflation running above the 2pc target. The Bank of England would probably behave similarly.

But why? Bootle explained that nicely:

This would have the benefit of reducing the real cost of financing the Government’s deficit even more and reducing the ratio of government debt to GDP. Of course, this would be far from a victimless policy. Savers would suffer and the costs of inflation would gradually seep through the system.

Have you heard the phrase “inflation is a tax”? Some call it a “hidden tax”. Others a “tax on capital” or on savers or on money itself. That’s because it transfers wealth from savers to borrowers by making debts cheaper to repay in the future with devalued money. But that also devalues savings because your money is worth less in the future.

Of course, the biggest debtors in the world are governments. And so here’s what we believe is really going on: central banks are trying to bail out their employers in government from too much debt. They’re letting the inflation tax run hot for a few years to try and reduce the burden of government debts by making that burden worth less.

Fortune & Freedom reader M.C. explained it well in an email to me:

“Central Bankers are appointed by Governments so they will seek to rescue Governments or get fired and replaced by more complicit Central Bankers. Inflation not taxes will reduce Governments’ debts.”

It would take many years of inflation to reduce the value of government debt. And, given governments are struggling with their debts, that’s what I expect to happen.

5. Inflation is easier to disguise when it’s global

Price inflation is an insidious thing. You don’t always notice it because it happens slowly, or it’s disguised as shrinkflation – where the contents of your chip packet gets a little lighter every year, but the price stays the same.

Historically, periods of inflation were truly exposed by the plunging value of the national currency in foreign exchange markets.

But, because the inflationary policies of low interest rates and quantitative easing are so global this time, inflation won’t be as obvious.

Foreign exchange markets won’t expose the inflation in the same way because so many currencies are being devalued at the same time. This will allow central banks to get away with more inflation than usual before people begin to react badly.

Austrians and Germans in their hyperinflationary 1920s watched their currencies sink against the Swiss, British and Germany currencies. That’s how they measured and tracked inflation.

Germany’s lack of inflation in the decades before the euro is what gave the deutschmark its legendary status as a strong currency that helped Germans steal English deckchairs in holiday resorts across southern Europe.

Conversely, southern Europe’s high inflation rates were exposed by their weak currencies.

The point is, inflation and foreign exchange markets are intrinsically linked. But today, we have remarkably low interest rates and remarkable amounts of central bank money creation in so much of the world that foreign exchange markets won’t be the canary in the coal mine. This will make it easier than ever to keep inflation under wraps.

It also makes it harder to escape inflation by simply buying foreign currency to escape the devaluation of your own.

You’ve been warned.

We began looking into why inflation is back by mentioning the 1970s – our last real bout of inflation in the UK. Perhaps the biggest risk of all is that too many of us don’t remember that period – or not vividly enough to understand what it really meant. We have forgotten how to invest and behave in an inflationary society – and what makes inflation so bad.

An entire generation of financial professionals are unfamiliar with the inflation risk. We are complacent. And we’re in for a real surprise. Unless, of course, you’re prepared for what’s coming.

That’s why we’ve put together a report on inflation for you. Fortune & Freedom subscribers can access it here.

Nickolai Hubble
Editor, Fortune & Freedom

PS. Nigel and Rob agree with me – inflation is a big challenge for investors in Britain right now. The opportunities Rob has been sharing with readers include some very savvy ways to keep your financial ambitions on track during periods of high inflation.

To get more details on where Rob thinks your money should be right now – click here.