‘Paul Donovan clearly demonstrates a critical issue for economic policy makers and investors Even if inflation remains contained, specific groups in society will have a very different inflation experience from that portrayed by aggregate consumer price data Understanding why and how inflation experiences differ from group to group will be increasingly important in creating a fairer society.’ Right Honourable Danny Alexander MP, Chief Secretary to the United Kingdom Treasury ‘Inflation is a topic that can become deeply embedded in a political culture, as Paul Donovan makes clear Properly understanding the politics as well as the economics of inflation is critical to investment success.’ Gerd W Hintz, CIO Aequitas, Allianz Equity Advisors (Allianz Global Investors) ‘Unveils the ins and outs of inflation – always with the investor and practitioner in mind The author’s sense of humour makes reading the book a real pleasure.’ Bo Bejstrup Christensen, Head of Asset Allocation, Danske Capital The Truth About Inflation Inflation is a simple topic, in that the basic concepts are something that everyone can understand However, inflation is not a simplistic topic The composition of inflation and what the different inflation measures try to represent cannot be summarised with a single line on a chart or a casual reference to a solitary data point Investors very often fail to understand the detail behind inflation, and end up making bad investment decisions as a result The Truth About Inflation does not set out to forecast inflation, but to help improve its understanding, so that investors can make better decisions to achieve the real returns that they need Starting with a summary of the long history of inflation, the drivers of price change are considered Many of the ‘urban myths’ that have built up about inflation are shown to be a consequence of irrational judgement or political scaremongering Some behaviour, like the unhealthy veneration of gold as a means of inflation protection, is shown to be the result of historical accident In the modern era of lower nominal investment returns, inflation inequality (whereby some groups experience persistently higher inflation than others) is a very important consideration This book sets out the realities of price changes in the modern investing environment, without using economic equations or jargon It gives investors the framework they need to think about inflation and how to protect themselves against it, whether the aggregate inflation of the future rises or falls from current levels Paul Donovan joined UBS in 1992 and is a managing director and global economist Paul is responsible for formulating and presenting the UBS Investment Research global economic view The Truth About Inflation Paul Donovan First published 2015 by Routledge Park Square, Milton Park, Abingdon, Oxon OX14 4RN by Routledge 711 Third Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2015 Paul Donovan The right of Paul Donovan to be identified as author of this work has been asserted by him in accordance with the Copyright, Designs and Patent Act 1988 All rights reserved No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers Disclaimer: The opinions and statements expressed in this book are those of the author and are not necessarily the opinions of any other person, including UBS AG UBS AG and its affiliates accept no liability whatsoever for any statements or opinions contained in this book, or for the consequences which may result from any person relying on such opinions or statements Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Donovan, Paul, 1972– The truth about inflation / Paul Donovan   pages cm  1 Inflation (Finance) I Title  HG229.D636 2015  332.4´1–dc23 ISBN: 978-1-138-02361-1 (hbk) ISBN: 978-1-315-77629-3 (ebk) Typeset in Times New Roman by HWA Text and Data Management, London 2014041863 To my father, Roy Donovan, who gave me my first economics book and who bore the spiralling cost inflation of supporting a son who wanted to be the economist, with remarkably little complaint Consider this the real return on your investment, Dad Contents List of illustrations Acknowledgements What is inflation? A brief history of inflation All that is gold does not glitter What makes up inflation? Printing money never, ever, ever creates inflation Inflation numbers ‘aren’t true’ Inflation numbers really aren’t true It is all the fault of the foreigner The debt–inflation myth 10 Inflation and the modern investor Bibliography Index Illustrations Figures 3.1 3.2 6.1 6.2 6.3 6.4 7.1 7.2 7.3 7.4 7.5 8.1 8.2 A broad price index in the UK from 1830 until 1913 The price of a gallon of milk in the US, in paper dollars and gold dollars UK high inflation perceptions versus ‘core’ inflation UK high inflation perceptions versus food and energy prices US consumer price inflation for durable goods and non-durable goods Consumer price indices in recent times according to modern weightings, and approximating the weightings of the 1917 index The cumulative change in prices for the poorest 20 per cent and richest 20 per cent in society, for selected economies, 1997 to 2014 The level of income inequality compared to the difference between rich and poor peoples’ inflation, 1997 to 2013 The IMF commodity price level compared with the US consumer price level Overall US consumer price inflation and consumer price inflation reweighted for spending by the elderly Australian inflation rates – average, lower-income elderly and higher-income elderly British exporters raise sterling prices and hold foreign prices unchanged when the pound weakens Japanese export price inflation rates in invoice currency terms, and converted into yen Tables 4.1 Inflation weights in different advanced economies today 6.1 Selected economies’ hedonic adjustments Boxes 1.1 5.1 8.1 9.1 Let them buy bread Money demand in hyperinflation Price and floating exchange rate theory The debt–inflation myth: the British example Acknowledgements I have long wanted to write a book on inflation; economists tend to have the strangest desires Several things provoked my interest in the topic Perhaps being a child of the 1970s, and British to boot, has meant that inflation is something always lurking in the background of my subconscious Even as a child I was aware that prices changed I can remember the creeping cost of the mid-morning milkand-biscuit at school, and the point at which the two pence coin that had previously bought me a chocolate biscuit on a Friday was no longer sufficient, creating an early and powerful form of the ‘loss aversion’ theory that pervades this book (Believe me, the loss of that chocolate biscuit was very, very keenly felt Do not let anyone tell you that a small piece of shortbread is an adequate substitute.) More recently, sitting on the investment committee of St Anne’s College, Oxford, has made me very aware of the problems of relying on headline inflation as a generic statistic The inflation in costs faced by the college bears little relation to the headline UK consumer price index for much of the time, and the investment committee spends a great deal of effort trying to overcome the differences The discussions of my colleagues on the committee, who have a truly frightening depth of experience and wisdom, have always proved a source of stimulation for my work I always feel my membership of the committee is fraudulent, for I take away infinitely more than I contribute to the committee meetings Though it will not compensate for everything St Anne’s has given me over the years, the royalties from this book are being donated to the college Working at UBS Investment Bank has also been a huge source of intellectual stimulus Over two decades of discussions with colleagues have led to countless instances where my views have been corrected, adjusted and polished Larry Hatheway, chief economist of UBS, deserves special mention as heading a department that not only allows economists to pursue their own projects, but provides an environment in which proper discussion and constructive criticism can take place George Magnus, Larry’s immediate predecessor, set that environment in place and it has been a privilege to be able to argue repeatedly with George on a wide range of economic (and other) issues over the years The views of other current and former colleagues have been very helpful: whether wittingly or unwittingly provided, I must acknowledge a real debt to Maury Harris, Reinhard Cluse, Tao Wang, Duncan Wooldridge, Scott Haslem, Andy Cates, Jeff Palma, Erika Karp and Justin Knight Other colleagues very kindly gave up their time to read and check various chapters Edel Tully, one of the most experienced minds on the topic of precious metals, very kindly looked over the chapter on gold Ramin Nakisa, an accomplished author on financial assets, took time from his more cerebral reading to look over the chapter on inflation history I should also give a word of thanks to Julie Hudson, UBS’s head of Socially Responsible Investment, who co-authored two books with me (what books, you ask? Why, From Red to Green: How the Financial Credit Crunch Could Bankrupt the Environment and Food Policy and the Environmental Credit Crunch Both still available from all good booksellers and suitable purveyors of e-books.) Julie’s hard work as an author, her patience as a colleague and her superior command of the English language made the last two books far easier to write than this Ruth Ridout, with considerable bravery, agreed to edit the text of this book, and with considerable tact pointed out the many glaring errors that cropped up (she has the nicest way of indicating when something is complete gibberish) Philip French of UBS also reviewed the text in its entirety with his customary good humour and great eye for detail I also have the great fortune to have had the support of friends and family, who have sat listening to my rambling pontification with tolerance, or at least without throwing things at me (most of the time) My nieces Louise, Emma and Sammy are always willing providers of honest criticism – a sample being, ‘That’s just my uncle: he’s on TV and writes books and stuff, but he’s really boring’, which seems a pretty succinct description of who I am David Wareham, Alison Wareham, Ciara Wells, Peter Wells, Bhauna Patel, Mark Shepherd and Trish Shepherd have consistently exhibited the enormous depths of tolerance that is a necessary condition of being a friend of mine, and have made valiant efforts not to shut me up when I hold forth on loss aversion and similar fascinating subjects Chris and Judith Trimming have, as ever, provided a refuge from the pain of writing and editing Despite all the support and help, the responsibility for any errors or omissions must be my own, I suppose Believe me, if I could find a way of blaming someone else, I would But it seems if the reader has reason to disagree with anything that follows, it must be my fault set (for example, unemployment), the normal response of a monetary policymaker is to say ‘the best way we can meet the other target is by meeting our consumer price inflation target and creating suitably stable economic conditions’ This means that as generic consumer price inflation is going to be a factor in determining the monetary policy interest rate, consumer price inflation will have some bearing in determining the performance of short-dated government bonds (bonds which will mature in a relatively short period of time, and whose interest rates tend to be quite closely linked to the official monetary policy interest rate) Generic consumer price inflation is also going to be an important factor in determining the budget deficit, through the impact of consumer price inflation on government spending The precise importance of this is going to vary from economy to economy Not all government spending is tied to inflation and parts of a government’s spending will be tied to different forms of inflation, like wage inflation Nevertheless, the indexation of government spending, explicitly tying certain forms of expenditure to the level of the generic consumer price index, means that the size of the government’s borrowing requirement and therefore the performance of the government bond market must in some way be tied to consumer prices This does mean that a rise in inflation has the potential to be a triple negative for a government bond investor To the extent that the rise in the generic consumer price index encompasses a rise in the bond investor’s own consumer price index, their real return is diminished To the extent that a rise in the generic consumer price index prompts monetary policy tightening, their bond portfolio is at risk from rising short-term interest rates To the extent that a rise in the generic consumer price index produces a weaker fiscal position, the credit quality of the government bond portfolio may be diminished Perhaps the two most salient points to remember as a bond investor, however, are that the changes in the generic consumer price index are very unlikely to match the bond investor’s own inflation rate This means that an investor may have a very different real rate of return from the simplistic real yield that is calculated by subtracting consumer prices from bond yields This could be either good or bad – if an investor is confident that their inflation rate will run below the generic consumer price inflation, the real returns on bonds could be flattered With inflation inequality, for instance, higherincome investors have enjoyed an enhanced real rate of return on government bonds relative to their less well-off peers However, it also means that instruments like the US TIPS or the UK index-linked gilt offer far from perfect protection from the inflation that an individual investor is facing The second point to keep bearing in mind is that governments will find it very difficult to inflate their way out of debt without rushing to the extreme of hyperinflation (which has, other, adverse consequences) The instinctive reaction of investors to the fiscal consequences of the recent global financial crisis has been ‘there must be inflation because debt is high, and that is how governments get rid of debt’ This is not true There may be inflation, but unless it is very mild and very short-lived, it is unlikely to reduce debt To base an overall investment strategy on the unreliable foundations of the debt–inflation myth would be foolish Inflation and foreign exchange The final issue for investors to consider is how foreign exchange markets respond to inflation A reliable foreign exchange model has evaded economists over the course of the profession’s entire history – perhaps the movement of foreign exchange markets will remain one of the eternal mysteries of humanity Any investor who thinks that the foreign exchange markets determine the price of currencies in an environment of perfect rationality is strongly urged to spend a few minutes observing a foreign exchange dealing room in operation; they will soon be disabused of the rational markets hypothesis Inflation is supposed to have a bearing on foreign exchange movements through the law of one price – at least, so monetarists would have us believe A product sold in the US, converted into sterling at the prevailing foreign exchange rate, should in theory have the same price as the equivalent product sold in the United Kingdom The problem is that so much of local prices are driven by local labour costs that the law of one price is not necessarily going to hold Moreover, global companies seem to have less faith in foreign exchange markets than economic theorists, and tend to ignore fluctuations in foreign exchange rates – as we saw with the example of IKEA This means that the relationship between price, inflation and foreign exchange markets is tenuous at best There is a less direct series of impacts that inflation can have on foreign exchange pricing If generic consumer price inflation influences monetary policy, then that may have an impact on foreign exchange markets Similarly, if other asset prices like equities and bonds are influenced by consumer price inflation changes, then the foreign exchange markets may well respond to the investment opportunities created by the relative shifts of asset prices Thus, capital flows, which help to determine the relative prices of foreign exchange markets, can be driven by expectations about what inflation will to relative asset returns in different economies It is all a little second-hand, but there is a foreign exchange–inflation relationship Perhaps rather than expecting inflation to influence foreign exchange as an asset class, investors should turn the relationship on its head and focus on how foreign exchange influences inflation (and through that, other investment decisions) The tendency to assume ‘weak currency = generic inflation’ is well embedded into at least the political psychology The weakness of the relationship does not seem to influence the tenacity with which some policymakers and indeed some investors cling to the concept Investors need to consider exactly how foreign exchange movements will influence local inflation This then loops back to the equity market A weaker currency may not boost real economic activity (as measured by GDP) However, a weaker currency could boost profits for exporters, by allowing them to translate foreign earnings into the local currency at a favourable rate That could be an important aspect in judging a company’s profitability At the same time, if the price of imported commodities (especially energy) starts to rise as a result of higher inflation that will impact other companies, and may impact the consumer’s willingness to spend Foreign exchange market shifts are likely to encourage relative price shifts that impact different companies in different ways – good for exporters, bad for those that import commodities So what is the true story of inflation? In the aftermath of the global financial crisis, inflation has been subdued in most of the major industrialised economies Indeed, the fear of deflation has emerged in some economies This does not mean that inflation can now be pushed to one side by an investor as some kind of quaint anachronism of times past In a world where overall investment returns are likely to be lower than they have been in the past, small differences in the inflation rate can play a far more important role in determining relative standards of living than in the past In a world where investment returns of per cent are easy, a per cent difference in inflation is not necessarily a major concern In a world where investment returns of per cent are more normal, a per cent difference in inflation suddenly assumes more importance in the mind of the investor In all likelihood, phenomena such as inflation inequality are going to continue in the future This makes per cent variations in inflation – at least in the true inflation faced by a discriminating investor – just as probable in the future as in the past The difference from the past is that in the modern world those relatively small inflation variations matter more to investment strategies The modern investor should not be afraid of inflation, but it does pay to try and understand as much as possible about the concept Everyone likes simplicity, but blindly applying the consumer price measure as an inflation metric is almost certain to be the wrong approach Investors will be rewarded for thinking about inflation in a more sophisticated way, recognising the complexity of the concept and rejecting the single-line charts that oversimplify the issue When it comes to inflation, perhaps the most useful weapon the modern investor has in their arsenal is the ability to fire off questions ‘Why?’ or ‘How we know that?’ can be a very strong attack to the baseless assertions that litter the fringes of the world of economics Central banks and government statistical agencies put out a wealth of information on inflation It can be somewhat tedious to wade through, but reliable answers can normally be found with a little perseverance The message of this book is that for inflation, the truth is out there The modern investor should rigorously question every anecdote, assertion and statement on inflation to test the robustness of the analysis The wise investor will not accept any assertions on inflation without question Except, of course, the assertions of this book Those, you can believe Notes The blogosphere is relatively easy to attack because it has, as economists would say, ‘low barriers to entry’, which encourages the dissemination of views that are rarely fact checked before they are published It would be remiss not to acknowledge that even more traditional forms of media are on occasion inclined to put forward misinformation Even errors as basic and as glaring as ‘the chocolate bar is getting smaller, and inflation does not capture 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(2012), The Oxford Handbook of the History of Consumption, Oxford University Press, Oxford Trevithick, J A (1988), Inflation – A Guide to the Crisis in Economics, 2nd Edition, Penguin Books, London Tullock, Gordon (1957), Paper Money – A Cycle in Cathay, The Economic History Review, Second Series, Volume IX, Issue 3, pp 393–407 Wells, James & Restieaux, Ainslie (2014), Review of Hedonic Quality Adjustment in UK Consumer Price Statistic and Internationally, Office for National Statistics, London, 13 March Wheelock, David C (1991), The Strategy and Consistency of Federal Reserve Monetary Policy, 1924-1933, Cambridge University Press, Cambridge White, Michael V & Schuler, Kurt (2009), Who Said ‘Debauch the Currency’: Keynes or Lenin?, Journal of Economic Perspectives, Volume 23, Issue 2, Spring, pp 213–222 Woodward, Donald B & Rose, Marc A (1933), Inflation, McGraw-Hill Book Company Inc., New York World Gold Council (2013), The Direct Economic Impact of Gold, World Gold Council & Pricewaterhouse Coopers, October Index Bold page numbers indicate figures; italics indicate tables age: Australian inflation rates – average, lower-income elderly and higher-income elderly 132; and inflation inequality 130–2 Age of Enlightenment 31–2 animal spirits 141–2 Apple iPad 144–5 asset allocation strategies 181 asset prices 61–2, 120–1 assignats 32 Australian inflation rates – average, lower-income elderly and higher-income elderly 132 Austro-Hungarian Empire 34 average, inflation as 119 average inflation rate, irrelevance 132–3 Babylon 22–3 bad deflation 15–16 balance sheets, central banks 82 bank regulation 94–5 banks, credit creation 91 Baxter, Marianne 153 benchmarks 134 bills of exchange 51 blogs, influence and unreliability 2, 7, 19, 44, 79, 97, 105, 117, 179 Blunkett, Basil 54 bond holders, behaviour 170–1 bonds 82–4, 169; cancellation 86; and investors 184; maturity 93; selling 93–4; yields 94 bonuses, payment and clawback 17 book: aims of 2; structure and overview 18 Boskin Commission 111 Brazil 140–1 Bretton Woods exchange rate system 46, 55–6, 149–50 Britain 39–40, 154–5; see also United Kingdom Brittan, Samuel broad money 80, 83 Burns, Arthur 38 Canute/Cnut 72 cash holdings 92 cash, use of 13 central banks: balance sheets 82; independence 95–6; management of money supply and demand 92–5; and money supply 81–5; regulatory powers 94–5 certainty 14 chain weighting 105–6, 115 China: global role 142–8; inflation 27–9, 86–7 climate change 31 clothing, quality adjustment 110–11 coins: debasement 24–5, 26, 29, 30; industrial production 31; from silver plate 31 commodity-intensive economic growth 147–8 commodity-intensive products 129 commodity prices 141; and consumer price inflation 125; and economic growth 147–8; factors affecting 152–3; and foreign exchange 157 complexity 181, 186 conditions, for inflation 20 consumer behaviour 98 consumer debt 162–3, 165 consumer durables/non-durables 101, 125 consumer price indices 7, 22, 59–61, 184; core inflation 65–6; credibility 66–7; food and energy costs 65; headline index 62, 65, 66; hedonic adjustment 105–12, 108; housing 62–5; and income inequality 119–23; reliability 115–17; scope 98, 105; welfare costs 166–7 consumer price inflation: anecdotal evidence 109; and commodity prices 125; consumption basket 124; consumption patterns 112–15; context and overview 97; data changes over time 112–15, 113; different rates 126; durables/non durables 127–8; effects of 184; effects of fashion 113–14; IMF commodity price level compared with the US consumer price level 126; introduction of euro 101–3; measurement aims 97; perceptions of 98–103; and poverty levels 166–7; summary and conclusions 115–17; UK high inflation perceptions versus ‘core’ inflation 100; UK high inflation perceptions versus food and energy prices 101; US consumer price inflation for durable goods and non-durable goods 102, 125; weighting 114–15 consumer prices 8–9; international comparisons 60–1 consumer spending patterns: chain weighting 105, 115; durables/non durables 124–5, 128; and income inequality 119–23; low-income households 129 consumer spending power 183 consumers, debt–inflation myth 161–3 consumption basket 124 consumption patterns: China 147, 148; consumer price inflation 112–15; and money demand 88; and perceptions of inflation 99–103 core inflation 65–6 corporate debt 163–4, 165; and investors 183 correcting imbalances 56–7 correlation is not causation 144 cost of living 5, 61; core inflation 65–6; food and energy 65; housing costs 62–5 costs of labour 69–72 credibility: of central banks 66–7, 76–7; policy making 81 credit: availability 89; growth of 91; as medium of exchange 49, 51 credit cards 13, 79–80, 81, 88, 89 currency: gold as 44–6; intrinsic value 46–7; media of 47–9; movement 156; multiple forms 48, 51; nature of 141; paper 27–30; wampum 47; see also coins currency debasement 24–5, 26, 29, 30 currency pegging 142 currency reform, Germany 37 de Gaulle, Charles 56 debasement, of currency 24–5, 26 debit cards 13, 79–80, 88 debt: defining 159–60; as investment 183–5; rollover 170–1 debt cancellation 85–6 debt financing 24–5 debt–inflation myth: British example 173; consumers 161–3; context and overview 159–60; corporate debt 163–4; financial repression 172–6; government debt 164–72; summary and conclusions 176–7 debt monetisation 84 debt service costs 169 debt-to-GDP ratio 166–7, 171–2 deflation 15–17, 54–7, 186 demand deficient deflation 15–16 Dionysius the Elder 24–5 disinflation 15 disposable income 123–4 divergent inflation 122, 123 division of labour 21 dollar-gold standard, collapse 38 dollarisation 142 domestic labour costs 68–9 domestic production 21 drivers of inflation 10–11, 40–1 dual market for gold 46 Dulles, Eleanor 11 economic analysis, anarchic economic growth: and commodity prices 147–8; and money supply 88 economic ignorance 41 economic reality, disregard of 41 Edward II 72–3 efficiency: consumer 148; of economy 128 electronic transactions 13 employment costs 69 energy costs 65 energy price shock 39 equities 182–3 Erzberger, Matthias 35 euro, introduction 101–3 euroisation 142 Europe 28–9; hyperinflation 33–7 European harmonised inflation data, housing costs 63 exchange rate, Bretton Woods system 46, 55–6 exchange rate moves: after global financial crisis 153–6; Britain 154; and commodity prices 157; Japan 155 exchange rate policy, foreigner-blaming 149–56 extreme poverty 128 fashion effects 113–14 Federal Reserve 38 financial credit crunch 90 financial market distortion, quantitative policy/easing 84 financial regulation 172–5 financial repression 172–6 financial risk management 172–4 First World War, effects of 33–7 Fisher equation of exchange 10–11, 59, 78 fixed rate debt 165–6 floating exchange rates 149–52, 157 floating rate debt 165 fluctuation 41 food costs 65 food price riots food prices 70–2; United Kingdom 169; United States 39 food production, as industry 70–2 foreign exchange: investors 185–6; manipulation 82 foreign exchange intervention, sterilised/unsterilised 82 foreign exchange rates: control of 74–5; defining 149; dollar-pegged 37 foreign influences, discerning 147 foreigner-blaming: context and overview 139–40; exchange rate policy 149–56; floating exchange rates 151; global monetary policy 140–2; summary and conclusions 156–7; supply and demand 142–9 French revolution 32 Friedman, Milton 10–11, 38–9, 78 Germany, hyperinflation 35–7, 41 Gini coefficient 123 global financial crisis, liquidity demand 88–90 global inflation rates 145–6 global monetary policy 140–2 globalisation 32, 128–9 gold: context and overview 44–6; correcting imbalances 56–7; as currency 44–6, 47–9; dual market 46; effects of use as currency 52–4; and inflation 49–51; intrinsic value 46–7; myths 46–9; relative prices 53–4; stock increase 55; summary and conclusions 57–8; trade volume and deflation 54–7; unpredictable supply 50 gold bugs 44 gold coin 44–5 gold-derived standard 46 gold standard 45, 179; cheating on 50–1; deflationary bias 88; price stability 52; rules of the game 50–1 good deflation 15 Goodhart’s law 80–1 goods, labour/commodity intensive 119, 125, 127–8 government debt 164–72; debt service costs 169; financial repression 172–6; and investors 183–4; modelling 171–2; post-war reduction 175; rollover 170–1 government income 166–7 government intervention: central banks 95–6; in prices 72–6; in wages 74–6 government spending, indexation 111, 184 Greece 23–5 gross domestic product deflator gross domestic product (GDP) 7, 166–7 guns and butter policy 38 ‘harmonised’ consumer prices 60 harvests, effects on prices 31 Havenstein, Rudolf 36, 41 headline inflation 65, 66, 126–7 healthcare costs 130–2 hedonic adjustment 105–12; international comparisons 108 historical records 21–2 history of inflation: ancient 22–7; Babylon 22–3; Britain 39–40; China 27–9; common threads 40–2; context and overview 20–2; Europe 28–9; Greece 23–5; later twentieth century 37–40; learning from 178–9; medieval 27–30; Renaissance to industrialisation 30–3; Rome 25; twentieth century 33–40; United States 38–9 hoarding 56–7 hokey cokey 62 Hong Kong, currency pegging 142 household disposable income 161 housing costs 62–5, 105, 110–11, 113, 120, 122 Hungary, hyperinflation 34–5 hyperinflation 13, 14, 33–7, 78–9, 81, 86, 160, 185; Germany 41; and monetisation 85; money demand 89; Zimbabwe 41 IKEA 153 imbalances, correcting 56–7 IMF commodity price level compared with the US consumer price level 126 imputed rent 122 income distribution 127 income equality 128 income inequality 119–24, 129 income inflation income-specific inflation rates 130 income, variable bonuses 17 index-linked gilts 133, 134, 169–70 index-linking 111 indexation 166–7, 184 industrialisation of coin production 31 inflation: as average 119; defining 3–6; different types 160; disaggregation 132; drivers of 10–11, 40–1; fear of 11–15; levels of concern 1–2; measures of 7–9, 59; not always damaging 12–13; real/nominal 6–7; true story 186–7 inflation illusion 16, 17, 137 inflation inequality 122; and age 130–2; Australian inflation rates – average, lower-income elderly and higher-income elderly 132; awareness 136–7; breaking down 130–3; context and overview 119; healthcare costs 130–2; implications for investors 133–5; income inequality compared to the difference between rich and poor peoples’ inflation 124; origins 123–7; prevalence 127–9; radical economics 136–7; social importance 122–3; summary and conclusions 137–8; US consumer price inflation and consumer price inflation reweighted for spending by the elderly 131 inflation-linked securities 133–4, 170 inflation risk, managing 135 inflation stability 18 inflation uncertainty risk premium 14, 53, 171 inflation volatility 66 inflation weights: international comparisons 61; skewed 122 instincts, not trusting 116 inter-company credit 91–2 interest rates, real 161–2 intra-company trade 152 intrinsic value 46–7 investment decisions 53; and consumer debt 162–3; and corporate debt 163–4; implications of inflation inequality 133–5; and misperceptions 104; using data 180 investors 186–7; asset strategies 181; bonds 184; and complexity 181; context and overview 178–9; debt and inflation 183–5; equities and inflation 182–3; foreign exchange and inflation 185–6; reasons for investing 179–81 irrational behaviour 98 Japan: exchange rate moves 155–6; money supply 90 Johnson, Lyndon B 38 Keynes, John Maynard 17, 34, 56 labour costs 68–9, 182; food production 70–1; relative values 75–6; wages 74–6 labour specialisation 21 labour supply 128 Landry, Anthony 153 Latin America, credit growth 40 law of one price 150–4, 185 legislation 72–6 lending, rational 160 Levi, Leone 143 liquefaction 83–4 liquidity demand 94–5 liquidity, of money 80 liquidity preference 88–9, 90–1, 94–5 living standards 148; international comparisons 128–9 living wage 33, 136 loss aversion 12, 17, 49, 103, 106, 130, 135 low-income households, consumer spending patterns 129 luxury goods indices 120 make up of inflation: big picture approach 68; context and overview 59; domestic labour costs 68–9; interconnections 67–8 Mantega, Guido 140 Marcet, Jane 32, 69 Massachusetts Bay dilemma 46–7 measurement, real/nominal 6–7 measures of inflation 7–9, 59 menu cost pricing 183 middle class 129 milk production 71 misperceptions 98–103, 104 misunderstanding, of inflation mobilia 29 monetarism 10–11, 32 monetary policy 83; global 140–2 monetisation 84–5 money: broad money 80, 83; circulation 90; defining 79–81; liquidity 80; narrow money 80, 81–5, 88, 95–6, 164–5; price change money demand: control of 94; determining factors 91–2; in hyperinflation 89 money printing 81–5, 95–6, 164–5 money supply 29–31, 77; behaviour 91; and central banks 81; context and overview 78–9; control of money demand 94; debt cancellation 85–6; and economic growth 88; future management of 92–5; narrow money demand 86–91; price of 76–7; printing 81–5; printing money 81–5, 95–6; raising liquidity demand 94–5 mortgage payments 62–5 narrow money 80; printing 81–5, 95–6, 164–5; use of 88 narrow money demand 86–91 negative inflation see deflation Nixon, Richard 38, 72, 166–7 nominal pay cuts 17 nominal values 6–7 official inflation rate, as wrong 125 offshoring 146–7 oil price shocks, October 1973 37, 39 Organization of Petroleum Exporting Countries (OPEC) 37 outsourcing 146 overstatement, of inflation 116–17 paper currency, Chinese use of 27–30, 86–7 pay cuts 17 pegging of currencies 142 Pennsylvania 87 pensions, indexation 167 ‘Phase Three’ controls 38–9 policy makers: limits of influence 65; pragmatism 66 policy making: credibility 81; vs legislation 76 politicisation 84–5 portfolio diversification 172–4, 181 poverty 128 poverty levels, and consumer price inflation 166–7 prediction, futility of 178 price of a gallon of milk in the US, in paper dollars and gold dollars 53 price stability, and gold standard 52 prices: broad-based change 5–6; change in 3–4; consumer 8–9; cumulative change for the poorest 20 per cent and richest 20 per cent 121; defining 3; floating exchange rate theory 151; food 39, 70–2; globalisation 128–9; government intervention 72–6; and labour costs 69–71; of money 76–7; producer and wholesale 8; relative 53–4; relative change 4–5, 6, 21, 120, 124–5, 136, 148, 182–3; and types of goods 119–21 pricing behaviour, analysis of 179 pricing power 182 pricing to market 152–6 printing money 81–5, 95–6, 164–5 private sector, quality adjustment 111–12 producer price data 163–4, 182 producer prices production, domestic 21 productivity 69 profit margins, food production 71–2 promissory notes 51 protectionism 139–40; United States 140 prudential regulation 94 quality adjustment 105–12 quantitative policy 2, 85–6 quantitative policy/easing 83–4, 140–1 radical economics 136–7 rate of return 135 rational economic theory 98 rational investors, behaviour regarding inflation 116 rational lending 160 rational markets hypothesis 185 real interest rates 16 real price real values 6–7 real wages 2, 35, 40, 173 records, historical 21–2, 32 Rees-Mogg, William regulation 172–5 reliability, consumer price indices 115–17 rent 63–5, 105 reserve requirement ratio 94 risk: appetite for 141–2; deflation 16; management 172–4; protection against 134 Rogers, Sarah Rome 25–6 Ruhr, occupation of 35–6 Rumpelstiltskin principle 51 Russia, hyperinflation 34 saving, purpose of 134–5 scapegoating 139 self-sufficiency 21, 68–9 ‘senior loan officer’ surveys 91 shelter see housing costs shoe leather costs 13 shop price index 163 silver, as currency 48; see also Spanish silver silver plate, melting for coins 31 small businesses, credit sources 91 small economies, pricing to market 152–3 Smith, Adam 21, 51 sound-bite economics 2, 69–70, 87, 97, 126–7 Spanish silver 30–1 specie 44–5 stability 18 standards of living 64 statistics: mistrust of 137; use and interpretation 119 sterilisation 56–7, 82 sterilised intervention 82 substitution effect 115 supply and demand 3; foreigner-blaming 142–9 supply chains 146 surveys, money demand 91–2 target rates 18 taxation 166–7; United States 168–9 technology: effects of 13–14, 88; and global trade 128 technology products, quality adjustment 110–11 Thatcher, Margaret Trade in Value Added (TiVA) 145 trade payables/receivables 91–2 trade volume, gold and deflation 54–7 transnational companies (TNCs) 152 transport costs 25 Treasury Inflation Protected Securities (TIPS) 133, 134, 169–70 Triffin Dilemma 56 true story 186–7 trust 88 truth is out there 186 uncertainty: about deflation 16; about inflation 12, 14–15, 53 unit labour costs 69 United Kingdom: gold standard 52; high inflation perceptions versus ‘core’ inflation 100; high inflation perceptions versus food and energy prices 101; price index 1830 to 1913 52; see also Britain United States 38–9; consumer price inflation and consumer price inflation reweighted for spending by the elderly 131; consumer price inflation for durable goods and non-durable goods 102; income inequality 129; index-linking 111; protectionism 140; taxation 168–9 unsterilised intervention 82 urbanisation 20–1, 33 US Civil War 32–3 variable bonuses 17 variable rate debt 165 velocity of circulation 10, 30 Viner, Jacob 54 wage bargaining 40; and inflation misperceptions 104; living wage 136 wage control 74–6 wage hierarchy 75–6 wage inflation wages, real 2, 35, 40, 173 wampum 47 war, financing 35 weather, and food prices 65 weighting: age cohorts 131; consumer price inflation 114–15 wholesale prices zero interest rate bound 16 Zimbabwe, hyperinflation 41 ... investors the framework they need to think about inflation and how to protect themselves against it, whether the aggregate inflation of the future rises or falls from current levels Paul Donovan. .. than they about gaining the same thing Give someone $100 and they feel happy Take the $100 away from them, and they will feel worse than they did before the whole monetary give and take began The. .. noticed inflation s corrosive power in the past, perhaps one is still overlooking aspects of the damage wrought by inflation even now? And then there is the uncertainty about the future If inflation