Clem Chambers: Inflated opinion of deflation

Published on Friday 18 June 2010 20:44

APPARENTLY we are not going to get inflation – deflation is the real threat.

This leaves me scratching my head. Why would we need to suffer deflation? Even Zimbabwe knows how to create inflation. It is not making inflation that is hard, it is stopping it.

You cannot have deflation and inflation at the same time. There is only one reason that inflation is hard to make and that is because it is heresy to do so, not because it is difficult.

I look at the UK's current predicament in a very broad way. When a situation looks complicated, summarise it with fag packet calculations.

Here are mine on UK PLC: By the time this is all over, the UK will have created an extra debt of at least 500 billion more than before the credit crunch kicked off.

Let's be grossly approximate and call it 40,000 a family. We can be as rough and ready as we like but the amount represents a giant financial hole for those who have to fill it: us.

It looks like a ten-year dig-out. If you were suddenly personally landed with that debt that's how long you'd think you'd take to pay it off on top of the debt you already have.

So how do you pull down this debt mountain or even for that matter go from digging a bigger debt hole than the current rate of 140bn a year?

The answer is obvious: cut costs, tax more, try to grow and dilute the debt lump with inflation. That doesn't sound unreasonable and it isn't, yet it's hard to cut and tax and tricky to grow but very easy to inflate.

Inflating also cuts costs (if you nail down wages), boosts tax (percentage of more money is more money) and, within reason, it also helps growth.

Cutting costs hurts growth and tax revenue and lowers inflation. Raising tax hurts growth, can increase costs and can even hurt tax revenue.

So what is likely to happen? At the very least, a surge of inflation is the line of least resistance.

If you don't believe inflation is coming then cash is king. With deflation cash only gets more valuable. If you believe in deflation you don't have to do much other than make sure your wealth is in a solid bank and safely hoarded.

It's a valid position to take – and I think it's wrong.

It seems governments and central banks are happy to poo-poo the likelihood of inflation and maybe they are right this time. But they are the same people who didn't see the credit crunch coming, so I'm not backing their judgment.

The good news is you will see inflation happen in front of you. If and when you see it and believe there is more to come you should look to buy equities and gold. Gold in an ETF (exchange traded fund) is a convenient way to do it.

We are in for two or three years of choppiness, but financial prudence is a long game and worth winning. And whatever happens – buy during panics.

&#149 Clem Chambers is chief executive of stocks and shares website ADVFN.