Inflation

Have you noticed anything about the inflation statistics of late?

I ask that for a reason. The cost of everything seems to be rocketing and yet inflation, well, it just keeps bobbing along at around 2 percent.

At the end of 2003, both the UK and US governments altered the way in which they calculated inflation. To take the UK example, we first had RPI (Retail Price Index) and then RPIX (Retail Price Index excluding mortgage interest costs). Now we have CPI (Consumer Price Index) as well. However, this new index also excludes housing and council tax. Apparently the new figure is the 'core' number.

Great!

But, to most people, the 'core' number is the one that involves a roof over their heads each night. In July, a study of UK prices was released. It had tracked the prices of goods between 1989 and 2004. Here are some of the findings:

Smoking costs increased by 204%

Beer up by 94%

Holidays up by 61%

Dentists bills up by 164%

Cinema and sports events up by 157%

Housing up by 94%

(Not on the list were other things: oil is rocketing - that will have a knock on effect to every area of the world economy; gold is up; virtually all commodity prices have risen dramatically; interest rates are now rising; council taxes are up again steeply (but don't panic - inflation is just a touch above 2%.)

There were a few items that actually went down in price over the 15 years, but not many, electrical goods mostly. In a rather strange way, this has helped crime figures. I am reliably informed that burglary is down quite dramatically across the UK. Why break into a house to steal a DVD player when a new one costs just Ł40? Conversely, it also explains why thefts in mobile phones have risen so fast. Why bother lugging around a stolen TV set that you might sell for Ł20 when a mobile phome might get you Ł50?

Did you notice that housing is up by 94%? As a consumer, the largest purchase we are ever likely to make is that of a property. Personally, I would think that property costs would be given a very heavy weighting in any inflation index because of the amount we all spend on it. But no, RPI was up by just 62% in that 15 year period.

Before this turns into a diatribe about inflation statistics (because that isn't my point), have you thought about just what this does to an investment? Those numbers above are largely taken from a time of 'historically low' inflation! For money you have saved or invested has to be working very hard indeed to be just maintaining its purchasing power.

It also tells us that any children you have that are unsure about a future career path should consider dentistry! Their bills are rising by almost 1% each month. If you need a filling, I'd go and get it done now - it will cost more very soon.

The one thing it must highlight above almost all others is the effect inflation will have on your wealth if you keep most of your money in the bank. You will be earning perhaps four percent (in sterling) on your savings - before any tax. And yet, I would guess that right now UK inflation is more like 6-7% in real terms.

So how to invest? Real estate doesn't look to have the potential upside it once did, even though traditionally values rise in times of inflation. Most fixed interest securites won't do too well in inflationary times. The world stock markets don't exactly seem 'strong' right now. Yet it seems to be something of a stockpickers market. Though the markets themselves do not seem to be too strong, some companies and a few sectors are doing well. At some points in the business cycle, it is easy to invest and almost anything will turn a profit. This is not that time! Caution is the word I would use right now.

One last point. What will happen when the 'CPI' figures look bad and need to be 'seasonally adjusted' or whatever? Will we have CPIX - the core number minus other non essentials that have a negative effect on inflation figures? Perhaps food and energy costs could be removed as they are in America. It would be RPI minus mortgage interest, housing, council tax, food and energy. Sounds like the core of the core to me.

* This was published in September 2004 *