UK's Inflation History Is Sobering Warning To Anyone Protecting Wealth

Tom Burroughes

25 February 2013

While they may not be much of a shock to anyone who watches these things closely, figures produced by Lloyds TSB Private Banking demonstrate the devastating impact of inflation over the long haul. And that is something the wealth management industry, never mind central bankers and their overlords, should note.

In the past 30 years, the value of money in the UK has crashed by 67 per cent, the private bank found, using a blend of data including official numbers issued by the Office for National Statistics.

Or, put it another way: a three-fold increase in retail prices means that someone today would need £299 ($456) to have the equivalent purchasing power of £100 in 1982. Conversely, £33.46 in 1982, back when Margaret Thatcher was prime minster and yours truly was at school, would provide the same spending power as £100 today. This means that someone would need £3 million today to enjoy the equivalent lifestyle of a person with £1 million in 1982.

The purchasing power of money has eroded at an average rate of 3.7 per cent a year over the past 30 years. The bank has worked out that the prices of essential household items have risen substantially since 1982 with, for example, the average price for a loaf of bread increasing from 37 pence in 1982 to £1.24 in 2012; a more than three-fold rise. The average price for a detached property has risen approximately six-fold over the same period from £45,211 to £273,7002, while a troy ounce of gold has risen by 439 per cent from £203 in 1982 to £1,096 today. Fuel costs have also risen substantially with diesel prices now 294 per cent higher than in 1982, while the price of coffee has risen by 176 per cent from an average price of 97p to £2.68.

“Looking to the future, even if inflation is kept firmly under control and rises only in line with the Government's target, it is likely that the value of money will continue to reduce significantly and decline by more than half its value by 2042," Nitesh Patel, economist at Lloyds TSB Private Banking, said of the bank’s data. She’s right.

Why this matters

The reason why such data is worth setting out is that, when official, headline inflation is “only” two or three per cent, as it is at the moment, it is easy to overlook the devastating cumulative impact of compounding. (Needless to say, some people experience price gains considerably higher than the official figures.) Over only a few years, inflation rates of these supposedly tame amounts can severely erode capital. And of course, at the present time, when governments are wrestling with heavy debts and budget deficits, it is easy to see the temptation for policymakers to use inflation to erode the real value of the debt that needs to be repaid.

There are many issues that seize the attention of wealth managers the world over, but if there is an over-arching issue, it is how do firms protect, at the very least, the wealth of their clients in real terms. When prices are generally rising, this is, typically, poor for bonds and better, to an extent anyway, for equities. And no wonder that in this environment, firms are touting the charms of gold, property, and even wine and paintings.

It is worth examining asset class returns with these thoughts in mind. Those diligent souls at Barclays, in the 2012 Equity Gilt Study, found over the past 50 years, equity returns in inflation-adjusted terms, were 5.3 per cent per annum, while gilts delivered 3.1 per cent and cash, 1.6 per cent. Since the figures were available in 1899, when the UK was still on the Gold Standard, total returns per annum have been 4.9 per cent for stocks, 1.3 per cent for gilts and a measly 0.9 per cent for cash. Of course, short-term returns can show a dramatic contrast. Equities sank 7.8 per cent in 2011, while gilts logged fat gains in real terms of 15.8 per cent in that year, while cash fell 4.1 per cent.

During the last half a century or so, the UK went through a painful build-up of inflation, culminating in double-digit figures during the 1970s and early 1980s before, with much pain and unrest, the inflation problem began to be squeezed out of the economy. At one stage, back in the era of the so-called “great moderation” in the 1990s, some economists, such as Roger Bootle, produced books with titles such as The Death of Inflation. How distant that all seems.

There are many reasons why the price of gold, for example, has surged to near-record highs (in inflation-adjusted terms) in recent years, pushing above $1,900 per ounce at one point, before settling back a bit. With governments injecting huge sums of money into economies via “quantitative easing”, there remains debate on if, or when, inflation pressures will build. The history of the past three decades, as recounted here by Lloyds, is a cautionary tale of how severe the effect of inflation can be.