Rising costs as inflation dragon awakens

Article Category: Demographics

By David and Libby Koch, News Limited newspapers, 26 October 2009

In its latest board minutes, the Reserve Bank has warned about the prospect of rising prices, and we should be heeding that advice.

The warning has surprised many experts, who have been more concerned with deflation rather than inflation.

This is based on the theory that the global financial crisis has forced manufacturers to cut production and prices to boost sales and survive the downturn.

But with the strong rebound in Asian economies pushing up oil prices and forcing our official interest rates higher, inflation is likely to start rebounding. Lower import costs (because of the strong Aussie dollar) will likely be offset by rising housing costs.

It's not a time to panic there's little chance of it getting back to those horrible double-digit days. But it's better to be prepared for any solid jump than be caught unawares.

We've become so used to low inflation that we've forgotten how it erodes purchasing power, impacts debt repayments and affects asset values. Australia's economy is vulnerable to an inflationary onslaught simply because we are in much better shape than the rest of the world.

While central bank bosses around the globe are warning their politicians against winding back their stimulus measures too quickly, we are in a different position. It would be dangerous for us to follow them because we're at a different stage of the economic cycle.

Economies and markets move through boom and bust cycles. Booms always end, as do busts. Markets and economies do end up turning, it's just a matter of when.

The next turning point has worried us for a while now because we fear some of the consequences. Stimulus packages introduced around the world have been massive, so big that they will have to be inflationary when economies turn because of the sheer weight of money involved.

I know economies are in bad shape and they need stimulus, but when they start to improve, stimulus will still be washing through the system and will accentuate the turnaround.

That's fine if it's controlled properly, but central banks and governments are notoriously slow at recognising turning points and the delay generally means actions end up being more severe.

Think back to March last year when we were still putting up official interest rates when global economies were showing signs of collapse.

Over the past year, central banks have replaced their inflation-fighting agenda with one of economic stimulus, but they will return to the inflation battle after the turnaround and it could be bloody.

That's why the Bank of England's "print more money" strategy has been foolish. While they don't have any further room to move on interest rates, it is an incredibly tricky and risky strategy to manage over the long term.

The rationale is that the catastrophic British economy is faced with potentially destructive deflation, so the inflationary consequences of printing more money are negated. But get the timing wrong and that high inflation comes roaring back.

That's why it's terrific our Reserve Bank is putting the issue on the table so early. It means they're thinking ahead and being proactive. It's better to be ahead of the cycle than to play catch-up.

Over the past year, the key to investment has been capital preservation. But that will change. You'll need to start thinking about how you position yourself for the potential of high inflation.

This is not just about rising prices of everyday goods such as groceries. It's about preserving the purchasing power of your capital against the ravages of inflation and making sure you can service the much higher cost of debt.