October Newsletter: ‘Welcome back? Is Inflation coming to a country near you?’

19 October 2016

‘Welcome back? Is Inflation coming to a country near you?’

MVAM Newsletter Image 2016/10

“When I was young, I thought money was important; now that I am old I know it is” – Oscar Wilde. Whether you agree with the above quote or not, whatever you want to do with your life it will
require some money to achieve it. So the figures on the screen whether in a bank account or seen on the MVAM app while perusing your portfolio are real, important and will impact your life.

Money however is never really yours in the same sense as you own your car or your house once the mortgage is paid off. Your money is more like a “marriage” – another party is involved. Your money is a partnership between you and your country’s banking system. And while the central banks these days tend to be “independent” it is clear that say the Bank of England (BoE) has a more important partner than you or I, i.e. the government.

Now the UK government is in a bit of a mess. It spends too much, doesn’t have the income to pay its debts off, and has just run away from its best mates. So the BoE has decided to help out. It is doing so by printing a little bit of money and buying some (more) government bonds and now also company bonds.

It does this because of the way the money system is set up. Modern monetary alchemy (aka the fractional reserve multiplier) means a small amount of Bank of England “high powered money” can have a big effect overall. The BoE’s money say buys £100m of bonds. This £100m is received by the seller and then deposited in the banking system. This enables the bank that received the deposit to provide a loan of up to £90 million to someone, the remaining £10m being kept by the bank as a reserve. The £90 million loan will in turn lead to another bank deposit, enabling that bank to provide another loan for £81m etc. as in the illustration above. This is how what started as £100m BoE “high powered money” theoretically creates £900m in “credit money” as it trickles down the system.

Doing this has a number of complicated side effects but is principally done to reduce interest rates and encourage people to borrow and spend so as to boost the economy. It seems to be working as companies issued 15x more bonds in August than last year.

The bottom line for your money though is that your partner is helping the government as much as you. The consequences are seen in the all-time high FTSE100 and the 30 year low sterling exchange rate. Understanding the money system is always vital when deciding how to store the value of the money you hold today. Money itself is not a good store of value as it tends to buy less tomorrow than it does today. For the UK bank account holder while the pixels on the screen suggest you have lost nothing what you can use those pixels for may tell a different story!!