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The Tedium of Inflation

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The Tedium of Inflation

By - Tuesday 14 December 2010

Whilst being reasonably well versed on a wide array of subjects in the investment world, the one I can probably least stand is inflation. If you need to ask why, you are in the right place.

Inflation, for all intents and purposes is an inordinately boring way for economists to tell us how right or wrong they are with their predictions, and the press to hype up how expensive everything is now compared to X days/weeks/years ago. It is also something that gives the older generation something to talk about apart from the weather, often starting with "when I was a boy/girl, that cost..."

Nevertheless, tedious as it is, we all need to know about it. Inflation is calculated generally by assessing how much cash is about and how many goods that cash is trying to buy (using the Consumer Price Index or CPI). The more cash to goods there is the higher inflation will rise, and of course, if there are more goods than cash, deflation occurs.

As inflation rises, so do interest rates, both on loans and savings - most importantly on loans, because the inflation is devaluing the currency of the loan (your pound buys less basically) and the interest rates on loans have to be raised to account for this devaluation.

Sadly, inflation is a fact of life for everyone, much like the wind. It doesn't matter what you think about it, how much you earn, or what investments you might hold, in just the same way you can have a calm day with a mild breeze, or a gale force wind where you take a right old battering. It's one of those things that just "is", whether you like it or not, and nothing you do, say or think will change it (unless of course you happen to have your own country somewhere where you can set your own interest rates and the like).

Things to consider when inflation figures are published.

If inflation is on its way down, there is a good chance interest rates may well be on the way down shortly afterwards. This being the case, money held in a typical savings account will accrue a lower rate of interest - time to look at alternative ways of having spare cash work for you.

Similarly, if rates are coming down, you might want to consider a remortgage, or consolidating loans at the lower rate. (Obviously in most cases there will be costs to do this, but you have to asses the viability over the life of the loan)

If inflation is on the rise, this is good news for savers (provided only that the rise is passed on in the form of increased interest rates by the banks).

For mortgages and loans, increasing inflation invariably means rising interest rates. A half or one percent rise over a year is not the end of the world for most, but when inflation gets out of control (resulting in hyperinflation), this is where mass panic can set in. Once excessive inflation kicks in, there really is not a lot you can do about it.

The key to all things inflation-related is pretty simple. If rates are low, consider fixing your mortgage or loans. If rates are high, try to avoid borrowing and concentrate on investments that will stand the test of time over the longer term.

So what is the point of inflation?

In general, inflation can be seen as how well or not a country is managing its finances. Excessively-increasing inflation would suggest they have it wrong (possibly caused by something like quantitative easing). Very low inflation would suggest the country has an economy that lacks stimulus - if nothing rises in value at all, no further investment will happen and the country will stagnate.

For those that can, there are some limited ways to take advantage of inflation around the world if you dare. Save in higher inflation countries (bear in mind such countries at the extreme end of the scale can tend to have incredibly unstable banking systems), and consider loans or mortgages from lower inflation regions (this is not easy due to the difficulties the lender will encounter in trying to gain a lien on a property outside its jurisdiction).

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