By Daniel Archibald | CFA
For most of the 1970's and the 80's, inflation in Australia was consistently above 5% and often above 10% per annum. Even though inflation in the U.S. was more subdued in this period, it still managed to spike to 15%, year-on-year, in the early 80's.
The more recent history has seen inflation pegged down at low levels for an extended period in most of the world's developed economies. Since the depths of the global financial crisis, euro debt crisis and great recession the U.S., U.K. and Europe have experienced average annual inflation of below 2%, with deflation (negative inflation) seen in a number of periods.
One country with a longer experience with low or no price growth is Japan. In the late 80's/early 90's, following the bursting of the Japanese asset bubble, inflation was driven into the ground. Over the last 25 years, prices in Japan have average annual growth of below 1%, which means that the cost of many common goods in Japan cost little more in Yen, than they did back when Bob Hawke was still our Prime Minister.
To most of us, low inflation, or even deflation, sounds like an appealing prospect. Paying less for food, or fuel, or housing is generally good for consumers. However, the cause of deflation is often a low growth environment, and even recession. Though buyers may be happy, sellers tend to struggle in deflationary periods. And as much as sellers are employers, deflation can quickly cause unemployment to rise and economic growth to retreat. Over the same 25 year period, annual growth in Japanese GDP has consistently been below 2% and often in negative territory.
But deflation is only one end of the scale. The other end, high inflation, or even hyperinflation, can be an even greater problem. The period of high inflation in the 70's and 80's was accompanied by high interest rates and greater swings in economic fortunes. And hyperinflation has had crippling consequences for many countries that have experienced large losses in wealth. Zimbabwe and, more recently, Venezuela have been prime examples of the perils of printing money and losing control of price and currency.
Coming out of a period of ultra-low interest rates and quantitative easing (effectively money printing), the risks of high inflation have started to become of great concern to markets. The Japanese experience teaches that inflation can stay low for a very long time. However, should the tide turn the other way, high inflation and interest rates could hit home, which would likely see asset prices devalue back accordingly.