Investors beware – inflation is on the way

Last week I was chatting to a friend who’s been pumping serious money into some crowd-funded businesses.

“You see Bengt, I’ve been too careful over the last few years. I’ve had too much cash sitting on the sidelines earning sod all. And where’s all that inflation I was supposed to be worried about? It doesn’t seem to be coming, so I’m fixing in some decent rates on new loans in the real economy.”

He makes a good point: where exactly is all this inflation we were told to worry about?

The central banks have pumped so much money into the system – why hasn’t that produced inflation?

Well, it has. And where is it? Exactly where you would expect it to be – where all the money is, in financial assets.

In the real world we’ve been insulated from it, so far. But if I’m right, at some point soon you’ll be seeing inflation come to a town near you.

Crowdfunding is on the up

So, crowdfunding and peer-to-peer (P2P) lending are taking the world by storm. City analyst Liberum estimates P2P lending in Britain could grow from around £1bn today to over £45bn within the next ten years.

These blistering growth prospects are why the MoneyWeek team has prepared a report on the phenomenon for our readers.

It’s little wonder that P2P lending is taking off, really. With banks paying next to nothing on savings and cutting down on lending, of course borrowers and savers will cut out the banks, if they can.

It’s all aided by the internet, which has allowed direct lending to individuals (peer-to-peer) and business (crowdfunding) to prosper.

Just last week a brand new investment trust launched, targeting a yield of 6-8% by lending on online marketplaces such as Funding Circle, Zopa, Ratesetter and Crossflow.

All very interesting. But what’s it got to do with inflation?

How inflation spreads into the economy

It’s quite simple really: where money flows, inflation follows.

Just think about it: over recent years, untold amounts of newly-created money has poured into the financial system from the central banks.

And yet we haven’t seen any excessive consumer inflation, because the money has been too busy inflating financial assets instead.

Just take a look at the corporate bond and stock markets. Hell, let’s include London’s housing stock too.

Money has flowed into bonds, stocks, houses. And in each case, prices have rocketed.

Inflation occurs wherever the money goes to work. Simple.

But now it’s leaking out into the real world

Peer-to-peer lending has certainly made a timely entrance on the scene. But here’s the thing: all of this crowd-funding and peer-to-peer stuff is by itself opening new channels for inflation to leak out.

Put simply, all that printed money coming out of the central banks that wound up inflating financial assets, is now being let loose on the real economy.

My friend was telling me about the bike hire company, the gift shop, the fashion retailer… (the list went on, and on) that he’d loaned money to.

These aren’t arcane financial instruments – they’re investments in the real economy.

And as this money chases about the system, prices will push up. That’s inflation. Remember, inflation follows the money.

Inflation in the real economy could spell disaster

Now, I have absolutely no problem with crowdfunding. I think it’s a wonderful thing – as does the government, which has invested £40m in Funding Circle, a peer-to-peer lending marketplace.

What I’m saying is that increased peer-to-peer lending could be just the beginning.

Sure, it may be mostly confined to P2P lenders right now. But do you really think that the big commercial banks, forced for years to lock up their money in low-paying financial assets, don’t want to get involved too?

For the time that it’s just niche lenders, the inflationary effect will be relatively small. But once the commercial banks start lending out the money the central banks have given them – once those billions of pounds start entering the real economy – then we might have a problem.

What sort of problem? Well, a trickle of inflation can quickly turn into a downpour. All you then need are a few untimely global developments, like rising energy and food prices, suddenly you’ve got an inflation problem.

When that happens, watch the central bank belatedly raise interest rates to subdue inflation and keep the pound from tumbling.

And then you’ve got real problems – especially if you’re over-borrowed. Rising interest rates would make your loans much more expensive to service.

As it unfolds, investors will lament the day they tied up money in loans made to strangers on the web.

Now, I’m not saying inflation will strike tomorrow. But the mechanism is surely in place to let it out soon enough. As investors, we need to keep our eyes peeled.

On Friday we’ll catch up with our classic inflation hedge, gold.

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  • Pinkers Post

    Of course, it is. When everybody is talking about deflation, it can only mean one thing: The opposite!

    Pinkers was clearly wrong to assume the ideology behind the Five-Year Plans for the National Economy of the former Soviet Union, first created in 1928, had long been ditched and, indeed, forgotten.

    In response to the last official inflation report released by the BoE on 14 May 2014, the FT carried an interesting in-depth analysis on the subject of Mr Carney’s interpretation, hilariously entitled: “Confusion reigns over what lies ahead”.
    Confusion will reign as long as policy makers continue crystal ball gazing. Stanley Fisher, the Fed’s incoming vice chairman, last year wisely commented on the merits of forward guidance: “You can’t expect the Fed to spell out what it’s going to do. Why? Because it doesn’t know.”

    OK… we all love a bit of soothsaying… but Pinkers would like to suggest appointing the fox in the garden of former FT columnist Kevin Goldstein-Jackson who (the fox!) has widely been acknowledged as one of the more reliable forecasters!
    More, including link to FT article mentioned above, can be found in various entries dated 16 Jan, 13 Feb, 4 & 15 May: on… (please scroll down).

    As for gold, surely the MW favourite investment of all time… sorry… but that really is in need of a polish: Entry 11 April (pls scroll down):

  • Texas Pete

    It can only be a matter of time before all the extra money created by QE sloshes into the real economy. Anyone who has glanced at a school history textbook should know that money printing/QE leads to high inflation or worse hyperinflation Weimar style. I’m sure plenty of people will disagree but I felt the whole QE program was totally unnecessary. Left to its own devices, I strongly believe the market will ultimately deliver its own solutions without the interference of busy body meddlers and world savers. Crowdfunding is an example of a market innovation to address a funding gap left by the effective withdrawal of the banks from the real economy. The problem is all the newly minted cash created to keep the great and good of the banking world in their Chelsea homes won’t disappear any time soon and will eventually find its way into the real economy, especially as new market innovations create transmission mechanisms (until now mostly broken following the near collapse of the banking sector) enabling the extra QE cash to find its way into the real economy. Time to start looking at inflation protection, or at least to invest in a couple of large suitcases and a wheelbarrow…

  • mikeT

    Isn’t it misleading to talk about “money printing” and “giving money to banks”? I’m not sure what has really happened in the UK but it is well documented that all the “new” money the Fed created is deposited straight back with the Fed; none has leaked into the real economy and asset-price inflation was caused by a relative lack of supply (because the Fed was busy buying Government bonds)! It follows that asset-price deflation will occur if and when the central banks start to unwind QE (I assume by selling same bonds, gradually and with market sensitivity, one hopes) and repatriate the (electronic) money. In other words, it all stays within a tight financial loop between banks, central banks and the Treasury. The “wall of money” is myth! A realistic article on QE unwinding would be more useful. Please.

  • McP7

    Are you seriously suggesting that banks have been dying to lend but didn’t have the oportunity and once they discover crowd lending will shower the economy with money? And do you really think 1 billion or even the 45 billion you anticipate in 10 years will make any difference to the economy? Honestly, I wasn’t expecting such nonsense from you, Bengt. (Btw I agree that prices will go up, but due to declining production, increasing taxes and energy costs and perhaps fx).

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