3 January 2011

Inflation ... and What You Can Do

Inflation occupied headlines one way or another in 2010.

One issue was whether inflation or deflation was the more significant danger.. We know that inflation means the value of your money reduces, but it's worth summarising what deflation can mean... So consider what you would you do if you wanted to buy a new car / kitchen / house / TV / ... and you knew that prices were falling because of deflation? Well, you'd wait a bit longer, wouldn't you? The trouble is, so does everyone else, so prices come down some more, and then you are into the "deflationary spiral" which economists talk about, which many companies would not recover from.

With Government spending cuts reducing the nation's buying power (since unemployed people have less money to spend), we are not out of the deflation woods yet.

But in spite of fears of deflation, the actual inflation indices (the Consumer Price Index and the Retail Prices Index) remain stubbornly high, mostly due, it is said, to "temporary factors" like tax-related price hikes, rising oil prices, and soaring food prices. However, these temporary factors do not seem to be going away, and they certainly don't help when interest rates on savings remain stubbornly low. Basically the buying power of your savings gradually melts away.

Central banks in the UK, US and Europe have already shown that they will act to avoid the risk of sliding down the deflationary path. But the danger is that they will not get the balance right and inflation will get a foot in the door.

So what can an individual do within their own finances? Equities and property are seen as "real assets" and therefore a good way to hedge against inflation. While the other asset which has been a key beneficiary from this war between deflationary and inflationary forces is gold.

But real assets are not everyone's cup of tea, with, in some cases, extended timescales required to see a sensible return on an investment, and with liquidity issues making it difficult to sell an asset such as property when you want to. And gold tends to be rather difficult to store securely! (There are, of course, other ways to invest in gold.)

Nevertheless, subject to your circumstances, "real assets" look like being the place to be for long term inflation-protected growth.

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