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The upside-down world

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I am strictly not a 'baby boomer' as my father never went away to war and I must have been conceived around VE Day. My parents would never have told me such a thing but it is not too difficult to work it out. However, my view of the world is much the same as baby boomers and they had three great fears as they reach maturity (that is if baby boomers have or ever will mature). The question 'would you rather be red than dead?' has largely gone, admittedly to be replaced by questions that may ultimately prove to be more deadly; but then every generation has its bogeyman, or men.

As we came to buy our homes and raise our families we were faced with the twin problems of inflation and mortgage interest rates. These were serious issues for families as inflation was at levels that were on occasion well into double figures, peaking during the years 1974-1981 at various rates between 8.3% (the only year in single figures in that period) to a massive 24.2% in 1975. The younger ones amongst you might now understand our collective fear of inflation.

My parents' generation feared deflation. My parents married in 1934 and during the years 1921-1933 there was almost permanent deflation, with the exception of 1925 when there was rampant inflation of 0.3%. Assuming you equate deflation with people being out of work and there being social deprivation, in the five complete years since 2008 there has only been one negative year and that was at 0.5%. For those of you who might wonder, my figures are based on the old fashioned version of inflation known as the RPI.

The problem with deflation, as the people of Japan understand, is that it is better to put off buying something as you can be reasonably confident that the price will be cheaper next year. But of course, that means there is a lowering of expectation by sellers and perhaps desperation to sell that results in even lower prices. As a result of this, government revenues are lower and as we are seeing in Greece, Italy, Portugal and Spain, pressure is built up on the banks and that in turn affects the ability of governments to borrow at reasonable rates. This is particularly relevant to the members of the Eurozone as they do not have the opportunity to devalue their currency as effectively we did at the beginning of this crisis by slashing interest rates.

Up until the rate cuts that got us down to the current 0.5% in April 2009, rates for the previous 17 or so years had moved between 3%-7% but in the previous three years the rates had exceeded 10%, very briefly reaching 14%. These are Bank Base rates but the mortgage rates suffered by home owners broadly followed.

Certainly for the baby boomers, high interest rates and high inflation made us suffer. Although there was the offsetting effect that mortgages reduced in real value due to their fixed nature and property tended to increase in value. However, we still had the problem of finding the cash to actually pay our mortgages, put food on the table and live. So this was the 'normal' position but now the opposite is the experts' view of what is the ideal. They are seeing higher inflation and higher interest rates as being the objective.

In the Eurozone there is concern because there is a lack of inflation. The fear is deflation as we experienced in the 1920s and early 1930s. The austerity packages imposed on the 'sick' countries in the Eurozone threatens to create a long term contraction in their economies to the detriment of their respective populations. The problem was (and still is) that the economists who demanded those draconian cuts were a little like the Sorcerer's Apprentice and it has all gone too far, but unfortunately there is no sorcerer to return who can sort it out and those (and other countries) are in danger of being locked into a deflationary cycle.

We are seeing the value of Sterling improve against the US Dollar and the Euro as we appear (only appear, because there can be little certainty that our economic miracle can continue as we depend on the rest of the world scrambling out of the slough of despondency) to be in a better position than most.

Ironically we now expect, Mark Carney expects and David Cameron hopes that interest rates are going to move upwards. Our inflation rate increased last month and Sterling reacted by improving against both the US Dollar and the Euro. Why? All those foreign investors are looking for a safe haven for their funds and a strong pound, an improving economy and the prospects to beat the pitiful rates that are being offered elsewhere are appealing. Who wants to invest in Spanish or Greek bonds that might collapse in value? Although the rate of interest is higher, it does reflect the risk factor.

And so after 60 odd years, I see my world turned upside with increasing inflation and the prospect of increasing interest rates being seen as good news. As long as interest rates remain at historic lows (that is the base rate stays under 2%), then life will be tough for those with mortgages but that's got to be better than the double digit rates that we lived and coped with.

There have always got to be clouds on the horizon (after all I am an accountant), and these metaphorical clouds are the inevitable movement in Sterling if money pours in from abroad, attracted by our interest rates and the perception of a safe haven. The boost to Sterling can and will affect our exporters. The other danger are those politicians who never seem to learn that meddling in the economy based on political ideals always sells the electorate short. I can cope with living in an upside-down world but I dread that sooner or later the politicians will turn things upside-down yet again.

David Ingall
Past President, UK200Group

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