Article

Fools Gold - Justin Urquhart Stewart comment

March 29, 2010

Depending on your age, the mention of the word inflation will have a different meaning for you.
For anyone in their 30’s, inflation has been more or less irrelevant. It has been quite low and
frankly not much to get too excited about, but then again you will not have known anything
different and perhaps wonder why some of the older ‘fogies’ seem to get quite concerned about
it.

For any of us in our 50’s, we can recall the double digit inflation of the 1970’s with probably a
somewhat mixed view. We will remember that the British economy was in a disastrous state,
often with the tag of the ‘sick man of Europe’ being applied. From the three day week in the
miners’ strike, to several Winters of Discontent and a peak of union militancy – the place was a
mess. However more positively, for those of us who were reckless students with irresponsible
and profligate borrowings, actually it was a marvellous boon as, without any effort on our part,
these debts seemed to dissolve in value even if the interest rates were somewhat punitive.
For those who were in paid employment, you looked forward to a somewhat variable payslip
that seemed to change by the month, with inflation adjustments clipping in on a regular basis.
You seemed to have extra Pounds even though costs were also rising but, so long as you could
keep up, then all seemed to be fine.

However for those in their 70’s, inflation will be remembered with a real and tangible fear. This
generation were often the ones who had either finished or were close to ending their working
lives and thus the prospect of living on a fixed income and with fixed capital in the teeth of an
inflation storm was very worrying. For those fortunate enough to have inflation linked pensions,
then they were weather proofed by their financial tarpaulin, but for those less fortunate then
they were faced with the prospect of serious financial erosion.
So what is the real, corrosive effect of inflation?

Inflation even at low levels is an insidious acid eating away at the value of your money. For
example, even at an apparently somewhat benign 2%, long term savings can be significantly
reduced. From 2010 to say 2050 £1,000 would be reduced to £445.70 if no investment had
taken place. Try the same calculation at 4% and your money would have been reduced to a
mere £195.37 – and most would regard 4% as hardly a high level of inflation. Oh yes and just to
frighten us all about the real damage of inflation – try 8%. At this level your £1,000 disintegrates
to a pile of dust, valued at just £35.61.

The reason I wanted to bring this to the fore is that after that somewhat tedious political
Budget, and as we enter the last run up to the General Election, we will hear much comment
from the politicos about managing inflation. Here now we must beware those with forked
tongues, as it will be an easy temptation for politicians to engineer some more inflation to try
and magically get rid of our national debt. Inflation erodes value, erodes the economy and our
wealth. It may be tempting to inflate our debt away but at what price? Beware Fool’s Gold.

Banks - I think most would agree that we need more banking competition and slowly, through
certain new initiatives like Metro bank, Tesco and no doubt Virgin, more will finally be
happening. Even the initiatives announced by the Chancellor will encourage further
entrepreneurial activity – but at what pace?
If banking supplies the life blood to our economy, then we need some more transfusions. The
bleating that lending has increased is only partially true; in fact it seems to me that it has been
the offers of lending that have actually increased and not necessarily the lending itself. Speak to
many smaller companies and they tell the tales that it has been the increase in lending margins
that has been the real killer. It may be an offer of lending but not one that people want to
accept at that cost.

We need more banking now and there is one area where we could see smart action taken quite
quickly. Gary Hoffman’s very effective surgery at Northern Rock has now provided an excellent
base structure to provide some real competition in quite short order. With the bank now
separated from the bad ‘stuff’, recapitalised and restructured, here is a far more logical
structure to try and add certain RBS and Lloyd’s branches to. Quite quickly you could create
quite a significant competition for the other banks, both on cost and service, and hopefully also
have the effect of spurring the two government dependent banks into action to carry out their
own surgery rather than their painfully slow sticking plaster and paracetamol cures.

And a tale from the train – the ‘Transpennine Express’ from Manchester to Preston – from the
trolley lady, “You look like a banker so you can’t have any fruit cake. In fact you are all bl***y
fruit cakes.” “No,” says the conductress, “he’s the bloke in red braces off the telly – he can have
a free slice”. Now I know the price of some media coverage – a slice of fruit cake!

And finally a story which can only damage your local Neighbourhood Watch scheme.......

This article represents a personal and lighthearted view from Director, Justin Urquhart Stewart of Seven Investment Management Limited, and is based
on current financial news and events around the world. Its content should not be used for investment purposes and you should contact an
independent financial adviser before making any investment or financial decision. Seven Investment Management Limited is authorised and regulated
by the Financial Services Authority. Member of the London Stock Exchange. Head office: 23 Austin Friars, London EC2N 2QP. Telephone 020 7760 8777.
Registered in England and Wales number 4092911. Registered office: 3 More London Riverside, London SE1 2AQ.