The truth about inflation

If you have a preference for do-it-yourself investing and timing the markets then you need to have an understanding of economics. I have long been an admirer of Dr Ron Woods of Econoclast for the fact that his economic insights are actually understandable as well as often challenging the conventional wisdom. This is the same approach I take to money management and wealth creation.

Inflation is being talked about a lot in Australia at the moment with various scapegoats offered as causes. To get a real understanding of what causes inflation read this article by Dr Ron about “Dodgy Chicken” (reproduced with permission):

and if pain persists…

In the USA Chicken breast meat prices are falling as the demand for “boneless chicken breast” is falling. US consumers are switching to less expensive kinds of chicken meat “with bone”, “skin on” and falling demand for premium boneless breast has led to price falls for this type of meat. Reports that chicken breast meat prices are falling in the US is another example of the difference between relative price changes and inflation. This shows the US and Australia do not have inflation just some prices have become a lot higher relatively.

Many think high food and fuel prices causes inflation but it doesn’t work like that. Rising fuel and food are relative price changes, not inflation. Widespread reports of ‘strained family budgets’ is another sign we don’t have inflation. We’re paying out more from our purses for food and petrol or cutting back on them or other goods. When food prices rise if you want to keep eating the same quantity you have to pay out more of the contents of your purse which leaves less to spend on other items which puts downward price pressure -not upward price pressure- on all other things in the economy. Inflation could only occur if you are given more money to put in your purse so that you don’t have to cut back on anything and that’s how higher prices stick. We wouldn’t have to cut back on anything but the economy would have inflation. In other words only with an increase in the money supply can you get inflation. Inflation is caused by an oversupply of money such that its value falls. It loses purchasing power because more dollars are required to buy the same quantity of goods.

The main reason you have to get a prescription for many medicines is that if you try a cure for a non existent disease you can get into trouble; it can be hazardous to your health. That is an appropriate metaphor for our economy. The RBA has given the economy high doses of interest rates to cure a disease “inflation” which we don’t have; and that is hazardous to investors’ wealth. Not only lost wealth but it is causing other complications like an unnecessary economic slowdown, a collapse in housing construction, soaring rents and lost jobs. In our March 2008 Update Food glorious food I wrote “the RBA don’t see it this way and they have pushed interest rates too high. I really don’t know what will stop this cycle other than some shockingly bad economic or market news or both. It is this prospect of more bad news before we get a rate cut which continues to make me believe the investment outlook remains extremely problematic.” I had turned negative on Australian equities back in August 2007 when the ASX200 was about 700 points higher than now. We reiterated in May that the bounce in the equities was unlikely to be sustained and that seems to have been the right prescription. Remember if pain persists please see your doctor (at econoclast.com.au).

Here is the link to the US report:

Chicken investors squawk: Feed prices soar and demand for boneless breast meat drops unexpectedly.

DIY investors: I recommend you visit Dr Ron Wood’s website and subscribe to his newsletter. Cut through the noise of the popular media and get some real insights.

Author: Matt Hern

Certified Financial Planner professional, Matt Hern has three times been awarded as one of Australia's Top 50 Financial Planners by The Australian Financial Review Smart Investor. He is passionate about guiding you on the right financial choices to achieve what you really want. Matt Hern is an Authorised Representative of Charter Financial Planning Limited AFSL 234665. All information is general advice only.