IS inflation really dead, or is it just taking a nice long snooze, waiting for the right set of circumstances to stir back into life?
Roger Bootle, chief economist of the Hong Kong Shanghai Bank (HKSB) and frequent contributor on economic developments in the British media and state of the world economy has recently published a book called The Death of Inflation: Surviving and thriving in the Zero Era which has caught the eye of analysts at Eagle Star. His findings, they say, make for an interesting backdrop to the performance of domestic and international markets, interest rates and currencies and should be taken into account by ordinary people seeking a suitable in vestment strategy.
Inflation, says Eagle Star, is something we take for granted, with the price of goods and services rising every year. But in fact inflation is a relatively recent phenomena, with most countries experiencing it only since the end of the Second World War. (The UK price index level in 1932 was about the same as it was in 1795.)
According to Mr Bootle, says the Eagle Star customer communique, this cycle of rising prices may be coming to an end. His argument begins with the view that over the past 60 years government focus on maintaining low levels of unemployment resulted in considerable power to companies and trade unions to provide jobs and to push up prices and wages. The erosion of the power of the unions to push through wage increases, the undermining of old monopolies by new technology and competition due to global competition limiting the ability of companies to raise prices, have all played a part in the success of the anti inflation drive by governments in the 1980s. Over the period, inflation here in Ireland has dropped from about 10.5 per cent in 1983 to just over 2 per cent in 1995, though at a cost of higher unemployment.
The implications for personal investors of long term low or zero inflation are significant and Eagle Star hi lights Mr Bootle's main suggestions:
. Focus on the real return by deducting the cost of inflation from the final return. A 10 per cent nominal return when inflation is 5 per cent over the same period is a real return of 5 per cent.
. Without the benefit of inflation, investments such as paintings, antiques, classic cars, fine wines, coins, stamps and gems, as a rule, will struggle. Enjoy them for their own sake and not as an easy source of profit.
. Avoid variable rate bank and building society deposit accounts because interest rates may fall to zero, as they have in Japan.
. Consider investing in long term, fixed interest, government bonds that carry good credit ratings. Equity investments may not do as well in cash terms as they have in the past but they will probably still give better returns than bonds. Be prepared for a bumpy ride - financial markets Bill continue to exhibit signs of short term panic. Be flexible about when you want to cash in these types of investments.
Life assurance companies like Eagle Star have good reason to promote the views that low inflation may be a near permanent feature. The growth performance of their main lump sum investment funds and bonds have been outperforming deposit based products for the last several years even after all charges and taxes are taken into account. For example, they say that a £10,000 lump sum invested in the 11th issue Savine Certificates on November 11, 1990 resulted in a guaranteed annual return of 6.96 per cent return (ie. £14,000) five years later while the same investment in the Eagle Star Rainbow Bond resulted in an 8.64 per cent annual return (£15,131).
Higher growth is only achieved with higher risk and the historical out performance of equities over deposits certainly proves the point. But Eagle Star is also arguing that while equity investment will always be a bit of a roller coaster ride, a near permanent climate of low inflation will flatten out some of the curves.
The question is whether investors, who have been spoiled up to recently by the high returns and no risk guarantees offered by the likes of An Post and others, are ready to take the plunge back into higher risk equity funds now that the deposit takers are slowly, but surely cutting their rates to better reflect the true cost of their guarantees? (The life companies have been arguing for years that An Post's rates have been kept artificially high at the Government's instigation.) If a higher return is the objective, there may be little choice but to consider managed and other higher growth funds.
The position for regular investors - those who contribute to a life assurance fund on a monthly basis rather than with a lump-sum - is still being clouded by the high costs and commissions associated with many of these products. Not every life company has introduced lower cost and better value regular savings policies and small savers are very reluctant to jump back into a market which has proved to be such poor value in recent years. Companies like Ark Life. Lifetime, and most recently Eagle Star itself, with its new low cost Personal Investment Plan, have gone some way to rehabilitate the regular saving equity based funds, but deposit interest rates - and inflation - may have to go even lower before the ultra safe deposit accounts are abandoned for good.
