- Inflation.
Over the last two decades here in the UK,
it has not been too problematic
overall to you or your business.
However, what are the effects
of higher than normal inflation on your business?
And most importantly,
what can you do to protect your business from it?
In part one of this series,
we will cover what exactly is inflation and its causes?
What is purchasing power and how inflation erodes this?
How is inflation measured here in the UK at least?
Historical inflationary trends and future forecasts
and why they matter.
And in part two, we will cover the relationship
between your business and inflation.
The relationship between taxation and inflation.
And finally, four ways you can protect your business
against inflation.
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(bright upbeat music)
Inflation can be simply described
as a general and sustained rise
in prices of goods and services in an economy.
But what type of price is you may be asking.
Well, for example, common household expenses,
such as your utility bills, that is gas, electric,
and water, food and drink shopping,
the cost of fuel like petrol or diesel
to run your motor vehicle, to name but a few.
The causes of inflation can be explained
simply by basic economics, and that is demand and supply.
So imagine your favorite trainers and in a normal economy,
only 1,000 pairs are bought or demanded every year.
So therefore only 1,000 pairs are produced
to meet this demand.
As a result, the price is set at 50 pounds.
All of a sudden,
the demand for the trainers increases to 1,500 per year,
but the production remains at 1,000 per year
as the factory does not have enough resources
to increase the number of trainers made.
So, what happens next?
Quite simple, because more people
are chasing fewer trainers,
the trainers end up being sold to the higher bidders.
In other words, the price starts to rise,
let's say to 60 pounds.
At this price point, the demand will fall,
let's say to 1,300, as 200 people cannot afford
or not willing to meet the new price point of 60 pounds.
And so on.
The price will continue to increase
until it reaches a sort of equilibrium.
So let's assume 70 pounds
is where the demand meets a supply of 1,000 trainers.
And this is what is known as demand pull inflation.
The reverse is also inflationary,
that is when supply of trainers is decreased,
let's say from 1,000 to 800,
and the demand remains at 1,000.
An increase in the money supply
such as quantitative easing here in the UK
and across the world.
If governments decide to effectively print more money,
they are increasing the money supply,
and therefore more money is chasing fewer goods and services
in the economy.
But this is all a very simplified view of inflation
as there are other factors that are going into the mix
that trigger and cause sustained inflation.
(bright upbeat music)
What exactly is purchasing power?
Well, let me explain this concept with an example.
Suppose your business sold candles online
and earn 10,000 pounds in January
and you banked it after paying all business taxes.
In January 20X1, this 10,000 pounds
could buy your business 1,000 new candles
from your supplier, that is at 10 pounds each.
But, you sit on the money and do nothing with it for a year.
During the year, the official rate of inflation
tracked at 15%.
So in January 20X2,
you decide to use this 10,000 pounds and buy some candles
to markup and sell.
However, your supplies raise price by 15%
in line with inflation,
and now your 10,000 pounds can only buy 870 candles,
that's 130 candles less than this time last year.
And this is what effectively inflation does,
it erodes the purchasing power of your money over time.
So if you are a saver of money,
then higher than normal rates of inflation
can harm your overall financial wealth over time.
(bright upbeat music)
In simple terms,
inflation is measured by the basket of goods principle.
In formal terms, the basket of goods
are referred to as representative items.
So the UK government takes a basket
of common goods and services
that the likes of you and me purchase and consume,
measures the prices over a period of time,
and as a result works out the rate of inflation at a point
and period of time.
That is as simple as I can make it.
In the UK, the two main rates of inflation are the CPI,
this is a measure produced to international standards
and in line with European regulations.
First published in 1997,
CPI is the inflation measure used for the Bank of England's
inflation target, which I'll discuss in the next section.
Next is the CPIH,
this is the most comprehensive measure
of consumer price inflation,
which extends the CPI to include
owner occupiers' housing costs and council tax.
This is probably more accurate reflection of inflation
for you and I as
how can you simply ignore your gas and electric costs
and your council tax?
But, that's what the UK government does with CPI.
And I'll tell you why later on.
And unsurprisingly, the CPIH rate of inflation
is normally higher than the CPI rate.
There is also the RPI measurement,
and for those of you who are perhaps in their 30s
and above, you'll remember this was the main measurement
back in the day.
It's a legacy measure that is continually published
in accordance with the Statistics
and Registration Services Act of 2007.
And because of its use in long-term contracts
and index-linked gilt, these are government bonds,
is still being measured today.
It includes property expenses,
such as mortgage interest costs.
The table on screen shows how the CPIH is collated
through what is known as representative items in categories,
with a particular weighting.
So for example, household and household services
has an overall weighting of 29.8% towards the CPIH index.
As it is deemed that this on average
represents a proportion of income
that is spent on this category.
It include items like your council tax for example.
Finally, the CPI is used by the government
to determine government provided things,
such as your state pension, income support benefits,
housing benefits, universal credit,
SSP, that is statutory sick pay, statutory maternity pay
and paternity pay.
Now, can you see the dichotomy of this?
The government uses the lowest CPI rate
to raise government provided money.
But in reality,
you and your business are more likely to be impacted
by inflation at the CPIH or even the RPI rate,
which are invariably higher.
(bright upbeat music)
Now to make sure you get things into context,
inflation in itself is not a major problem
for you or your business,
that is low or soft levels of inflation,
which here in the UK is deemed at around 2%.
You see, the Bank of England,
that is the Central Bank here in the UK
is mandated to control inflation,
that is the CPI rate to this level.
But, why?
The Bank of England ultimately controls monetary policy,
this is essentially the money supply
of Great British Pounds.
And like all Central Banks in the world,
the Bank of England are acutely aware
that excessively high rates of inflation
can lead to catastrophic economic effects.
And in the worst case scenario,
the collapse of the currency, that is GBP pounds itself.
Now this may seem farfetched,
but history has witnessed many empires and countries
that have collapsed as a result of runaway hyperinflation.
Examples include the Roman Empire,
the Weimar Republic, that is pre-World War II Germany,
and more recently Zimbabwe.
You see, once you and the general population
loses confidence in the currency you hold,
in this case Great British Pound Sterling,
then you will seek an alternative medium of exchange,
perhaps the US Dollar or gold,
or more recently cryptocurrencies.
And once enough the population does this,
it normally spells the end of the government in power
or even the monetary system itself.
Now there's an excellent video on this by Mike Maloney
that is worth watching,
which you can access by clicking in the link
on the description box below.
So when should you be concerned about inflation
and how much thought and energy should you give it
with regards to your business?
Historically, you see inflation has not been a major problem
at all here in the UK.
The graph shows that the inflation trend since 1989
and in 1990, it peaked at 9.2%.
Aside from a couple of further peaks,
inflation has been kept on the tight control
and really has popped up above 2 1/2%,
with recent history showing rates of 1% and below.
However, in recent months,
due to the copious amounts of money printed
by the UK government, and perhaps many governments
across the world to combat the coronavirus crisis,
now the money supply has likely increased,
and there is always a time lag between turning on the money,
printing taps and inflation.
Through an increasing energy prices
and the predictions for inflation in the near term
are pointing towards 4%,
and some commentators and analysts are predicting
well upwards of this.
You can access the Bank of England's Monetary Policy Report
by clicking on the link in the description box below.
Inflation is often controlled
by a monetary tool known in simple language
as interest rates.
This is the first thing the Bank of England will consider
should inflation start to rise above their mandated target
level of 2%.
A rise in interest rates has the effect
of reducing your disposable income.
Therefore, in theory at least,
slow down the rate of your spending and thus inflation.
In part two, I go into the relationship
between your business and inflation,
between taxation and inflation
and provide you with four actionable ways