Inflation myths…

Inflation is a measure of the value of any unit of money. When the price of anything increases, that unit of money is worth less. That is the best definition of inflation, and deflation is the opposite. Deflation is when the price of anything goes down, which means that the unit of money is worth more.

When the price of “most things” go up you need more units of money to buy the same amount of “most things”. That normally means ordinary working people need pay increases. 

Economists have many different definitions of inflation, each one measuring different groups of things. They talk about consumer inflation, producer inflation, wage inflation, retail inflation, or consumer inflation less energy related prices. 

Consumer inflation is the most commonly used and is an attempt to give a reasonable average price inflation of a basket of goods and services that people buy on average. The problem with this consumer price index is that Mr. and Mrs. Average are difficult to find… Young people consume quite different things than middle-aged people and pensioners, and thus inflation can be experienced quite differently. Inflation is particularly hard on people who have low levels of income. Those people who have high incomes are more insulated from inflationary movements and in many cases can actually benefit from inflationary price movements.

Economists have been telling us for years that a little inflation, around 2% is useful because it means that an open economy is usually working efficiently with the optimal amount of resources. The employment rate is relatively high meaning that most people who can work are working and that resources like factories, offices, farms, forests, harbours, airports, etc., are fully utilised without an over-heating economy. However, low income groups are clearly exposed in a distressing way to such small increases in prices….

Let’s take some examples from today’s consumer price index. The present consumer price index is showing a small 1% increase, but house prices are not included in consumer price indexes, nor are interest rates on housing loans. This last year there have been massive price increases in basic foods like soya and wheat. Fish and meat have also increased in cost – salmon now costs €20 a kilo and shows little sign of getting cheaper. meat will also increase because soya prices have increased by some 60%…

A single unemployed mother with children and a single female pensioner of 75 years will be buying food and paying rent with most of their income which will be either in the form of unemployment benefits and public grants (€1200 a month) and a small pension (€1000 a month). During the last year both food prices and house prices have increased but car fuel, computers, TVs and other electronic equipment have all fallen in price. These two consumer groups will have seen their biggest costs, food and rent, going up by some 5% to 7%. Can you imagine what it feels like when you find that money is gradually buying less and less of essentials. As the children grow they will need much more for a mobile phone, a laptop and a faster internet connection. 

A family of four – parents (both 59 years) old no debt, and €15 000 joint salary, both children (25 and 27 years) married and in their first jobs earning around €5 000 each every month with a loan of €200 000 for 25 years at a rate on interest of 1% p.a. that costs them €930 each month. Since interest rates are low and house prices are positive none of these four feel or are hard up! Even if food prices rise 10% it will not impact their purchasing power very much. They still feel secure with plenty of nice restaurant meals tucked into their tummies…

In order to stimulate economic activity, the central banks and politicians have sought to maintain low interest rates and this policy has remained in place for almost a decade. Success has been limited in the Europe. There has not been any big advances in economic growth in any of the big economies.

With interest rates at near zero you would expect Finnish banks and companies to be booming. Banks would be lending huge amounts of low cost money to companies to invest in new equipment, plant and factories. The result would be a huge step forward for productivity because of new equipment and factories equipped with labor saving devises and fast digital solutions that further reduce production costs and save limited resources.

You would expect that Finland would be a champion in the export markets because we have relatively lower increases in wages than our main competitors according to recent studies…

You would expect that export orders would be booming because this low interest rate scenario has been continuing for many years… and because we are a small country we could expect to be more agile in seeking out sales opportunities…

But no, banks have reduced their lending, because companies are not investing. They do borrow but most of the cash is used for share buybacks and mergers… 

Finland’s export performance is even below the EU average of 46% relative to GDP. In other words the volume of exports expressed as a percentage of GDP is around 40% and that is really low compared to Sweden, Denmark, Germany and many other countries.

Naturally people say that we are in the middle of a Pandemic, but that does not explain the low level of export performance for 2018 and 2019, the numbers for the whole year of 2020 are not yet in…

One reason is that we have relatively few middle-sized and small companies exporting. In fact the statistics reveal that we have far too many really small companies, and these really small companies just cannot expand because they either lack the means to grow, meaning they lack the human resources to grow, lack knowledge on how to export, or do not have access to funding from banks. 

A quick glance of bank lending will reveal that small companies are not regarded by banks as being good customers. These customers are small and every lending decision requires heavy costs to make sure that the company has a viable business plan, and that the bank will get its loan repaid…. And if the bank makes a loan to these companies you can be sure that the rate of interest is not anywhere near 1%, but closer to 7% to 10%. They have to do that to “cover costs”… It takes a brave entrepreneur to sign such a loan agreement especially when your home is security for the loan.

Low interest rates could disappear really quickly when we are least expecting it. Those people who have large loans relative to their income will find life to be very uncomfortable when interest rates go to more normal levels… and they will. 

In fact this correspondent is willing to bet that inflation is not far away, especially when governments have taken on such huge debts in relation to GDP. Inflation will mean that taxpayers will be faced with extra burdens of to cover the costs of these debts. Too many debts have been financed with short-term loans by the public sector.

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