Is this hyperinflation, deflation or just plain old inflation?

16th July 2010

There's a lot of talk about inflation at the moment.

Normally economists only differ in their forecasts by a fraction of a percent, but the Quantitative Easing (QE) has really upped the ante. Opinion is now divided over whether the main threat is hyperinflation or deflation.

Both of these scenarios would be extremely damaging so we have to hope that the authorities will get it right and keep inflation to a manageable level.

Nassim Taleb, the controversial author of Black Swans, is rather dubious about whether they are up to the task. Speaking to New Model Adviser on Citywire, he says:

"Policymakers have no control over the outcome of their actions.

"The plane they are flying will either hit the mountain, which is hyperinflation, or crash in the ocean, which is deflation. There is a chance of the pilot hitting the runway. But if he's not skilled, it's less than he thinks." 

Hyperinflation

The reason people are seriously worried about the prospect of hyperinflation is the policy of Quantitative Easing (QE) pursued in the UK, America and elsewhere.

The idea was to print new money to help get the global economy moving again, but too much money chasing the same value of goods and services is bound to lead to higher prices.

This video from World News provides a nice explanation.

Worrying parallels are being drawn with the Weimar Republic in Germany after the First World War when annual inflation was in the thousands of percent!

Dylan Grice from Societe General thinks this is a lesson that we should take to heart.

"Despite what economists everywhere say about being in `uncharted territory' with QE, we know that if you keep monetizing deficits eventually you get inflation, and we know that once you're on that path it can be extremely difficult to get off it", he is quoted as saying on FT Alphaville.

Some people were worrying about all this back in 2008.

As Wombat42 explained on the Money Saving Expert forum, hyperinflation is a very scary prospect. "What this means to you is that your money will be essentially worthless because the price of goods and services will be so outrageous."

He then sets out a plan for how to survive it, but be warned, it's a tad extreme. 

Deflation

If hyperinflation is such a bad thing then you might think deflation would be pretty good, but you only have to look at Japan to see how damaging it can be.

The country has been dogged by deflation ever since the boom of the 1980's came to a crashing end.

This led to the 1990's being dubbed ‘the lost decade' with property prices and share valuations failing to make up the lost ground.

Hiromichi Shirakawa, of Credit Suisse, explains the problem in The Guardian : "If consumers expect prices to fall further, they will stop spending and try to save.

"That's the biggest worry. That would have a knock-on effect on companies, on the government and everywhere."

It took Japan 20 years to emerge from the damaging deflationary spiral with the final impetus being 5 years of quantitative easing, but three years on and there is a real risk that prices might start falling again.

MPC member Adam Posen recently warned that the same thing could happen over here, except he thinks the UK's 'remake' of the Japanese deflation film could be on a bigger scale.

"Unfortunately, the ironic twist for this upcoming film is that in some ways the remake might be scarier than the original", he tells Citywire.

Sounds like we may need to tempt Paul the psychic octopus, as seen here on the BBC, out of retirement to help sort this one out. 

In the meantime for some sensible advice on how to inflation proof your portfolio see what the IFA's are saying on the professional advice website, unbiased.co.uk .

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