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Inflation – the savings killer
At a time of negative real interest rates, it is perhaps no wonder that we concentrate so much attention on the current predicament of savers. However, it is worth reminding ourselves that inflation – the kiss of death to savings – is constantly with us. Prices have tended to rise throughout history. A Parliamentary research paper on inflation found that, from 1750 to 2005, prices rose nearly 150-fold. As a result, one (decimal) penny in 1750 would have had the purchasing power of more than a pound in 2005.
The real acceleration in the decline in the purchasing power of the pound, however, came during the 20th century. If you feel ever poorer, the graph below amply demonstrates why.
This chart uses the RPI index based on January 1974 = 100 and uses a logarithmic scale, which gives equal proportional increases the same vertical value. For example, the doubling of prices between 1936 and 1949 (when RPI rose from 16 to 32) is given the same vertical impact as when they doubled in between between 1979 and 1989 (with RPI increasing from 224 to 455) or the doubling from 1989 to 2011 (RPI rising from 455 to 928).
Click on the graph for a better view
Inflation murders savings, chipping away relentlessly at their value. There is currently a commonly held belief in the financial community, particularly at the Bank of England, that a little inflation is no bad thing. Yet even an inflation rate of 3% reduces the purchasing power of £100 to just £73 after ten years, which is pretty much exactly what has happened over the past decade.
How the Bank of England “safeguards” our money
The same Parliamentary research paper pointed out that prices have risen every year since 1945. By 2005, prices were nearly 30 times higher. Shockingly, that figure has risen since to a multiple of 36; in other words you now need £36 to buy what would have cost just £1 in 1945. Go back to 1914 and the decline in the value of the pound is even more staggering, for in the ensuing years – less than a century – the pound has lost 99% of its purchasing power.
The graph below shows the declining value of the pound in your pocket. A pound you had as recently as 1974 is now worth just a paltry 11 pence.
Click on the graph for a better view
“In less than 100 years, the pound has lost 99% of its value.”
It makes a mockery of the Bank of England’s declaration that its principle role is to “safeguard the value of the currency in terms of what it will purchase.” Use our own inflation calculator to see inflation’s effect on your savings. And if you think this might somehow exaggerate things, try the Bank of England’s own calculator, which all too appropriately shows a piggy bank being smashed. This shows that to purchase what £100 bought in 2001 would cost £135.70 just 10 years later. Go back 25 years and £240.42 is now needed to buy what cost £100 in 1986.
“£240.42 is needed now to buy what cost £100 in 1986.”
Why don’t we object more?
How do they get away with it? Why don’t we take to the streets to demand that the value of our money is preserved? Surely it can only be because people do not notice incremental increases in the cost of living. Inflation is insidious and its effects only become really obvious when it gets as bad as it was in the 1970s. This is a perfect example of the “boiling frog syndrome”. But inflation is constantly with us, eating away at the money we have struggled to put by, ramping up the prices of food at the checkout and, of course, rather conveniently reducing the real value of Government debt.
Prices have gone up every single year since 1945 and, given the recent oil price surge, the CPI 2% inflation target looks as far away as ever. Most MPs don’t seem to care, but then they of course still have their platinum-plated pensions and show no sign of relinquishing them. Heaven forbid they should suffer the same problems as the poor electorate. We must endure Sir Mervyn King and the unelected apparatchiks of the MPC telling us repeatedly that the danger is deflation, not inflation. Yet, if they really believe this, why is the Bank of England’s own pension fund so keen on index-linked gilts, which protect against the effects of inflation?
Insider dealing at the Bank of England?
Although Deputy Governor Charlie Bean has admitted that the Bank’s MPC entirely failed to predict the financial crisis, the Bank’s pension fund presciently sold its entire 21.6% holding of UK shares at the end of 2007, avoiding the calamitous losses suffered by everybody else’s pension funds the following year when the stock market collapsed.
Not only that, but the fund switched massively to index-linked gilts. The proportion held in index-linked securities was increased from 25.6% of the portfolio to a massive 70.7% in the year to February 2008. By February 2009, they accounted for 88.2% and, by February 2010, 94.7%. This level has been maintained, with index-linked consisting of 94.8% of the portfoio in the last accounts to February 2011.
Throughout this period we were being told by the bigwigs at the Bank of England that the danger was not inflation but deflation. As blogger Guido Fawkes points out, given the programme of Quantitative Easing instituted by the Bank, this virtually amounts to insider trading. I’m not holding my breath waiting for the Financial Services Authority to mount an investigation.
So, next time we hear Sir Mervyn King expressing sympathy for savers or telling us that inflation will soon be a thing of the past, bear in mind that his own pension pot, so well protected from the effects of inflation, was arbitrarily increased from £3.95m to £5.36m. And whenever Charlie Bean opens his mouth to insult savers, telling us to stop moaning and that we’re better off than we think, don’t forget that his own pension pot, a measly £1.44m in the year to February 2009, was increased to £1.97m the following year and then injected with yet another half a million pounds to bring it up to £2.52m by February 2011. And it is almost entirely invested in index-linked gilts.
In future, instead of listening to what the Governor tells us, perhaps we should instead study the behaviour of the Bank of England Pension Fund. Whatever Sir Mervyn King says, the managers of the Bank of England’s pension fund clearly do not believe inflation is being eradicated.
Even at current levels, inflation is hideously corrosive. Albert Einstein said that compound interest is the most powerful force in the universe. Given that inflation is its opposite, it is surely equally true to say that inflation is the most destructive force in the universe.