Jill Kerby

Exactly one year ago, I was warning in this column about the dual dangers of inflation and taxation. The inflation risk was on two fronts – the inflated supply of money, which was running at about 11% for most of the year in the Eurozone, despite productive growth of only about 2%-3% -  and its consequence, price inflation, which was already taking off and much of it pumping up the price of oil. 

The taxation risk came in the form of indirect increases in government-controlled driven services like healthcare, education, transportation, energy; then in October, when the Budget was launched early, in the form of income levies, higher DIRT, capital gains and capital acquisition taxes, the  VAT increase and a raft of other cutbacks. 

But inflation was the big story in the first half of 2008. By late summer, as the price of a barrel of crude rose above $140, caused by the surge in the money supply and loss of confidence in the US dollar and the impact of diverting fields of corn from food to ethanol, our TV screens were full of people in countries from Italy to Indonesia protesting about the trebling and quadrupling of the price of bread, rice, pasta and meat. 

And then it was August.  And inflation began to recede.

Lehman Brothers, and its other over-indebted, investment siblings on Wall Street began to topple like a line of dominoes as the impact of 17 interest rate hikes since 2005 finally resulted in massive US sub-prime foreclosures.  

Soon all the other lines of interlinked dominoes – the global banks, hedge funds, private equity companies and pension funds that had bought into the seemingly risk free and endlessly profitable collateralised, sub-prime debt instruments began deleveraging their positions to pay margin calls and they too began to fail. Stock markets plummetted; credit disappeared.  People stopped borrowing and spending. 

If you thought 2008 was memorable for its jaw dropping financial events, 2009 could be the year that we get ring-side seats to a government-sponsored, spectacular, scary, pyrotechnic, anti-deflation show. 

INFLATE AWAY DEBT

The new US president will lead the way, say the US press.

In an effort to get credit back into the world’s biggest borrowing and spending economy, Mr Obama has already said that his government will spend at least $775 billion, in addition to the c$8-$10 trillion already created to recapitalise, underpin and save the banks, insurance and motor industries, on major infrastructure, education and health projects. About $310 billion of that new fund will go on tax cuts for businesses and individuals. If none of that works, the dollar printing presses will be turned up even higher. 

Given how determined politicians are to avoid the pain of economic correction and to put off the day of reckoning, it could happen in Europe too with further interest rate cuts and then the lighting of the infrastructure spending fuses as unemployment takes hold.  (Tax cuts will be the last resort on this side of the pond.)

If that happens – we could be back where we started in January 2008 with more monetary and price inflation…maybe even hyper-inflation. (Higher taxes and fewer social services will come for all of us when it dawns on the money printers and world improvers that there is a very large bill to pay.) 

POSITION YOURSELF

So what should we do?  How can you best position your own finances in the face of crippling deflation (that includes major wage and job cuts) and the potential dangers of hyper-inflation if the central bankers don’t turn off their printing presses in time?

Spend less.  Save more.  Work harder. Skill up. 

Deflation, for as long as it lasts, is a disaster for debtors and not much better for savers who will see their yields reduced.  Re-inflation will help debtors but only if they use all that lovely cheap or free money to immediately pay down their loans.  Unfortunately, savers won’t fare as well as they discover their hard earned money buys less and less.

If you have savings and have left it with one of the few safe deposit takers in Ireland, (like RaboDirect) you’ve done the right thing so far.  In 2008, the name of the game was the return of your money and less the return on your money. 

That probably won’t change for most of 2009, but you should be using the next few months to also research durable, sustainable assets and strong, debt-free, dividend earning shares/funds (like gold, oil, food commodities and giant consumer durables) to both hedge against inflation and to provide a steady stream of dividends.  Look to the long term.

Last year I started this column with a quotation from Vladimir Lenin*.  This year I’m going to end it with one from one of the world’s richest men, John Paul Getty: “I buy when other people are selling.” 

If you can overcome your fear, you should be doing so too.

* ”The surest way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation."