How to protect your wealth from the global currency collapse
By
Dominic Frisby Mar 25, 2009
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Currencies - in for a battering
The big and, to some, surprising news yesterday was the unexpected rise in the Consumer Prices Index (CPI), the Bank Of England's key measure of inflation. A fall had been expected.
Yet CPI now stands at 3.2%, more than 50% above the Bank of England's 2% target. As one commentator put it, rising CPI is "bad news for anyone who eats food."
As if Gordon Brown didn't have a bad enough day yesterday with MEP Daniel Hannan making a devastating attack on him in the European Parliament (watch the video here), now one of the many sleights of hand he performed as Chancellor has come back to haunt him.
Brown's change has led to more debt than the UK can afford
Back in 2003, Gordon Brown changed the Bank of England's target inflation measure to the Consumer Price Index (CPI). Before that, the Bank's target measure was based on the Retail Price Index (RPI), excluding mortgage interest costs (this measure was known as RPIX, for the curious among you).
Why the change? Ostensibly it was to use the same measure as mainland Europe, but cynics like myself felt it had more to do with the fact that CPI was markedly lower than RPIX.
Broadly speaking, if inflation rises the Bank of England will have to put up interest rates. Higher interest rates usually lead to a slowdown in credit expansion and, by extension, rising house prices. By making the Bank use CPI, Brown was able to keep interest rates that bit lower than they would have been under the RPIX measure.
The net result is that more debt was taken on and the boom went on for longer and got far bigger than it ever should have. Individuals, companies and the UK itself took on far more debt than they can now afford.
But the great irony of yesterday's revelations was that CPI - which Brown was effectively using to understate inflation - went above the Bank's 3% limit, while RPIX came in at 2.5% - still up, but well within target range. Why's that? Because RPIX is more sensitive to rising and falling house prices. While house prices were soaring, it suited Brown not to incorporate them in his inflation figures. Now they are falling, how long before Brown goes back to using the old measure?
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Are we going to see rising or falling prices?
So why all the fuss about deflation? Bear with me here. The measure that had everyone worried about falling prices was RPI, which fell to an annual rate of 0.0%. But RPI includes mortgage interest costs. So if you slash interest rates (which is what the Bank does when it wants to push inflation higher) then RPI is bound to fall.
That's the technical details. But what does it all mean? Are we going to see rising or falling prices? Well, that's easy. There's a clear trend in place and I can see no fundamental reason why it should change. We will continue to see falling prices in products associated with debt - houses, cars and financial services, for example. This is because credit is deflating - there is less and less of it - so there is less money available to spend on these products. We will also continue to see a falling pound - maybe not by next week, but by next year certainly - because it is a currency representing an economy built on debt.
However, the cost of products not associated with debt - such as food - will continue to rise, unless those industries, for whatever reason, suddenly encounter vastly lower production costs. A period of exceptional weather, for example, might help lower food prices. But recent reports suggest the opposite is coming our way.
And the cost of products we import, even luxury imported goods, will also rise. I was in my local off-licence the other day, baulking at the price of a certain sparkling French product. Why so expensive? I got a two-word answer - 'the euro'. But it's not the euro; it's the declining purchasing power of the pound that's the problem.
Inflation or deflation?
That's what prices are going to do. As for the true definitions of the words 'inflation' and 'deflation' - meaning 'an increase (or decrease) in the supply of money and credit' – well, that's easy too. We are seeing, with quantitative easing, bank bail-outs and goodness knows what else, unprecedented growth or inflation in the supply of money. However, this is more than offset by the unprecedented contraction or deflation in the supply of credit. We are about to find out what happens when a deflationary crash in credit meets an unlimited printing press (we talk more about this, and the big US bailout, in this week's edition of MoneyWeek, out on Friday - get your first three issues free here).
So what does it all mean for your investments? Well, as we've mentioned several times already this week, when the world's governments are competing to debase their currencies, there's one thing that everyone should have in their portfolio - gold. Gold is the one currency not associated with debt. It's nobody else's liability. As such, gold will continue to rise against all currencies throughout this depression that is now upon us. We will see deflation - falling prices - in virtually every asset class, whether debt-related or not - when measured in gold.
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