Inflation and deflation: the twin threats
Experts are battling to interpret data and use it to predict the next turn of events, but few, if any, foresee a swift return to stability and growth.
However, a rift is forming between those who fear a resurgence of inflation, sparked by rampant government spending, and those who fear the opposite - a long spell of deflation.
With inflation, the price of goods rises, reducing the buying power of your cash. This deters investment and punishes savers.
With deflation, the price of goods falls and the spending power of your cash increases. While this might appear attractive, a ‘deflationary spiral’ destroys jobs and depresses the value of shares and homes. The Great Depression sparked by the Wall Street crash of 1929 is cited as an example of the negative effects of deflation.
‘We have a battle between deflationary and inflationary forces,’ says John Chatfeild-Roberts, one of the UK’s most respected investment managers.
Chatfeild-Roberts of fund manager Jupiter in central London adds: ‘I suspect we will end up flirting with deflation during 2009, but my long term concern is inflation.
‘Given the extraordinary amount of government money that is being pumped into the system globally, I think that aggressive inflation will be the real threat eventually.’
>>[John Chatfield Roberts: Previous predictions]
Hugh Hendry, an outspoken financier with an uncanny record of accurately predicting the twists in this crisis - he warned of a banking ‘cataclysm’ long before it emerged - has a gloomier outlook.
Hendry, who runs Eclectica Asset Management in Notting Hill, west London, predicts a deflationary nightmare in which stock markets and house prices slump for decades.
He believes deflation is ‘the economic system’s healing process’ and that governments’ policy of vast expenditure is akin to waging an unwinnable ‘economic war’.
Hendry points to Japan as an example - house prices and the stock market there are at levels lower than 30 years ago. Fretting about inflation, he says, is like ‘buying flood insurance when the house is on fire’.
>>[Hugh Hendry: Previous predictions]
But veteran fund manager Bill Mott of PSigma Asset Management in central London believes there is a significant risk of ‘major inflation’, recently heightened by the Bank of England’s ‘quantitative easing’ (printing money). ‘We are increasingly worried quantitative easing will deliver inflationary impulses to the economy,’ he warns.
With such diverging views and uncertainty, what are the possible outcomes for our personal finances?
>>Why billionaire Warren Buffett is worried about inflation