How Inflation Is Controlled By Government

By Derek Beese

I had lots of requests mainly from very young people about the post: “So How Does The Government Control Inflation?” They were asking for the article to be written in a way which was easier to understand.

That is a very difficult task because Economics, which deals with inflation, is a highly complicated subject but getting right down to the basic principle here it is explained in very simple terms.

I hope it makes sense to you.

Assume an imaginary world with two people. One of them owns a tree which every year produces a good crop of lovely eating apples. The other one owns a water spring that flows at a constant rate. Both need food and water to live so have to exchange apples for water so that each of them has both food and water to survive.

Now, what is the value of the apples and what is the value of the water in this exchange?

There is no money as we know it so the value can only be expressed in terms of the other thing (called a commodity). So if the tree produces 1000 kilograms of apples in a year and the spring produces 1000 litres of water then one kilo of apples is worth one litre of water. This establishes the quantities for any exchange.

So if the apple man wants to buy 50 litres of water then he has to give (pay) 50 kilos of apples. If he wants 100 litres he pays 100 kilos. Similarly if the water man wants apples he has to pay the same quantities in water. This has now fixed a value for water and apples.

Unfortunately, whilst the spring flows at a constant rate and delivers 1000 litres of water every year, the apple tree crop varies from year to year. If this variation is very small it will not matter and both people will still be happy to keep the value the same, but let us say that the apple crop is gradually getting less each year. Both people start to worry that there might be a shortage of food.

The apple man wants to keep his apples but he must exchange some of them or he will die of thirst – he must have some water. The water man has his normal supply of water but he becomes desperate to buy some food.

Now what are the values for apples and water?

Let us say that the apple crop was only 500 kilos for the year. There are still 1000 litres of water so the value of one kilo of apples is now two litres of water and both will have to use this new value to stay alive. In other words the price for a kilo of apples has doubled from one year to the next and that is called inflation.

If the apple crop had increased then the price would have gone down and that is the opposite of inflation called disinflation. (Deflation is a word that is only used in economics for a massive dose of disinflation when prices drop dramatically and sometimes for a long period)

In the real world Governments cannot cope with wild fluctuations in values because it upsets their plans so they do everything they can to keep things as unchanged as possible, so back in our imaginary world what do we have to do to keep the values stable?

Well, when the apple crop fell to 500 kilos, the water supply would have to be cut to 500 litres thereby keeping the same values of one kilo of apples for one litre of water.

If there was a government in our imaginary world then they would have installed a tap in the spring so that the water supply could be balanced with the food supply to keep the prices constant and they would open or close this tap as necessary to do this.

Back to the real world

For the apples, substitute the whole of the things produced by the country from manufactured goods, services, mined goods, pop songs, food and everything else.

For the water substitute the monetary currency of the country (in the UK pounds sterling). The Government wants to keep prices stable and to do this it must control the supply of the currency (money) and regulate it so that it balances with the produce.

When prices start to rise too much then it chokes off the money supply by making it more expensive to borrow it.

When prices start to drop too much then it increases the supply by making it cheaper to borrow. This is like increasing or slowing the water supply in our imaginary world.

The means of doing this is the rate of interest charged to borrow money. (This is like the tap in the water supply in our imaginary world).

If interest rates rise then the supply of money is reduced and if they fall then the money supply increases.

The big problem is that when dealing with a thing as complicated as a whole country it takes a long time for the effect of any change to be seen (like six months or a year) so a Government is always trying to guess what is happening.

The Government interest rate is called the Base Rate and if they get this wrong as at present in most countries in the world then things become very unstable and difficult for the people for quite a long time.

Building Society or Bank?

By Derek Beese

What’s the difference you will probably say. They do the same thing. To some extent that is true but to say that they are the same is totally incorrect and the best way to understand the difference is to go back to the start for each.

The origin of banks has been seen in a previous post on this blog and the purpose of their formation was to act as middlemen to make trade easier. Their aim was to give credit, effectively temporary loans, to businesses so that trade could be done and these were then repaid when the whole deal was finished. This type of financing was essentially of a short term nature rarely extending beyond say, one year. They later became places which were trusted, so people and businesses who had surplus money used them as a safe place to keep it - that is to store their wealth. They were able to withdraw this at any time unless they had entered into an agreement to leave it there for an agreed time (term) for which they received a better rate of interest. If this was done then the bank could use this money to lend to businesses provided it was repaid before the bank had to pay it back to its owner and thereby the bank earned a higher rate of interest than it was paying. This process became known as “borrowing long and lending short”. That means lending for a time that is shorter than the borrowing time so that repayment can be made on the due date. Over the centuries as banks grew to the enormous size that they now are this principle has been diluted somewhat so that banks do in fact lend for longer times for a proportion of their business, but the basic rule of banking is, and must be, to “borrow long and lend short”.

There is one difficulty with this however and that is if a person wants to buy or build himself a house, he cannot borrow any money to do so, because that is a very long term affair. This was the situation in the mid 1700’s in the UK when people were starting to want their own homes rather than renting them from their employers. This was the early Industrial Revolution when money was becoming more plentiful and living standards were rising.

So in 1775 a group of workers banded together to form a self-help group with the aim of paying money into a fund which was used to build each of them a house, at the end of which the group would be disbanded. A very good idea and it worked so well that within 50 years there were hundreds of these groups. Then someone had the bright idea that these worked so well that they should be permanent, not temporary. This was the start of Building Societies trading as separate businesses, helping anyone who joined them, to obtain their own home. They paid interest to the people who deposited money with them and lent this to member borrowers at a higher rate and any surplus left over after paying their own expenses was kept in the business to build up additional funds to help members and to ensure that they were able to repay any withdrawals on demand. Lending members were happy to leave their money in the group for as long as possible because it kept them in the group with its associated benefits.

Now in theory this system should not work because the business is lending long term and borrowing short term, that is, it is “borrowing short and lending long”. That is the opposite of bank policy. But it was successful because it was a closed group of members who all had the same aim. Additional people could join but they must be like minded and with each year the society grew stronger and stronger because its funds were growing, built up by the annual surpluses. A basic rule was also laid down that a minimum cash “readiness” fund had to be kept to make sure that any sudden cash calls could be paid. Hundreds of the societies grew up and they banded together in an Association to help each other in times of difficulty and over time many of them merged to form much larger organisations. This Building Societies Association still controls the standards of the societies to ensure that they are sound financially.

Some important points emerge from this evolution:

1.     Building Societies lend only to buy domestic properties ( with very few exceptions ).

2.     They are “ring fenced” containing only their own members who all own a part of the society. (This is called a Mutual Society).

3.     The raising of funds to lend is restricted to the members and the society cannot borrow from outside.

4.     Each society has to keep a strict minimum level of ready cash to meet repayments to savers even if this is a restriction on the amount of mortgages they can offer.

5.     The societies grew stronger each year because annual surpluses accumulated and created an ever increasing fund which could not be withdrawn by members on demand.

The only disadvantage was that the society could only grow relatively slowly and there was always a backlog of requests for mortgages for houses. Building Societies do not finance businesses and will not normally grant mortgages on business property,

Then in the 1980’s some bright spark had a “brilliant” idea  - ” Why not allow Building Societies to convert to banks so that they could borrow money in the same way as banks and this would enable them to make far more loans on domestic mortgages?”. The necessary law was passed after sorting out the technicalities and a number of B Socs converted into banks. This however was a problem in the making because here was a bank that was now operating a principle of “borrowing short and lending long for all of its business”! Not a good idea!  In fact a bomb waiting to explode!!

When the current housing bubble burst all of these “building society banks” failed, starting with Northern Rock and also spread to those smaller true banks who had bought up the larger B Soc Banks like ”Halifax”; in this case the Halifax Bank of Scotland. So all of the B Soc Banks have now gone leaving the situation back at square one – the true mutual building societies and the true banks. The latter have a hangover however because they have become far more involved in the domestic housing market as a result of all this disruption and now have a greater lend long element in their business.

The outcome of all this is that in the UK, (because building societies are a uniquely British creation that do not occur anywhere else) the situation has now returned to sanity with good Building Society principles and true Banks operating under the sound rules forged over hundreds of years. All of the hybrids have gone except where they have been taken over by true banks or have been nationalized by the government with the aim of winding them up in due course.

There is one fly in the ointment however. The law enabling building societies to convert to banks still exists and at some time in the far future when all of this present turmoil has died down and been forgotten, a “bright spark” is again going to erupt and think of this brilliant idea.

The basic problem is that in general people do not learn from history, or from other people’s mistakes, and politicians are unfortunately the foremost examples of this failing in the human race.

An Interesting Subject?

By Derek Beese

In some of my previous posts I have discussed Interest, but perhaps we should ask ourselves “What is Interest?” Forgive the pun but it is a very uninteresting topic for non – financial people, though everyone really should take a moment to think about it because it affects all of us for the majority of our lives. If it is so fundamental to our lives shouldn’t we learn to understand its effect on us and how to use it, rather than be used by it?

Firstly, what is it?  Easy – we all know that it is the exorbitant charge that we have to pay on the money we borrow to buy our houses or it is that pittance that we are given on our savings. Two apparently different things, but in reality one and the same thing confused by that thing called Human Perception!  It is simply the “cost of borrowing money”.

Any transaction to lend money involves two people (parties), the one who lends and the one who borrows. The lender receives the agreed interest based upon the amount lent and the borrower pays it. Because the amount lent (the principal sum) can vary from very small amounts to extremely large amounts, a custom grew up over the centuries to make it easy to deal with all sizes of transaction in a way that is easily understood. This is called the “Rate of Interest” (or Interest Rate) and is normally stated as a percentage rate per annum.

As we have seen before the word percentage is derived from Latin, as are so many words in the English language, and means “for every hundred”. The words “per annum” are also from the Latin meaning “for each year”. So 1% per annum (one percent for each year) will be “one for every hundred for a period of one year”. 2% pa is two for every hundred for every year. 3% pa is three for every hundred for every year, and so on. The kind of money whether it is Dollars, Pounds, Euros or whatever then defines what currency is involved. So if Mr A wants to borrow from Mr B let’s say $1000 for one year at 5%pa then at the end of that year he has to pay back the $1000 plus $50 as the cost of borrowing the principal amount. If the term ( duration of the agreement) is say two years then the repayment will be $50 at the end of year one and $1000 plus $50 at the end of year two. Easy.

What happens though if Mr A wants to borrow $1,000,000 and Mr B doesn’t have that much? Then Mr A either has to find someone with enough money or has to find a group of different people who will lend him enough small amounts to make up his total. That makes life difficult, so as we have seen before in these blogs, the custom of a middleman grew up, whereby the middleman (a bank) paid the interest to people who had spare money  and then lent this money in larger chunks to businesses so that they were able to trade and collected interest from them. The first group are the “savers” and the latter group are the “borrowers” However the middlemen incurred expenses of their own in giving this service which they could only recover by creating a “spread” into the rates offered. For example, the rate offered to savers would be say 4%pa and the rate charged to borrowers would be 5%pa and the 1%pa difference was used to pay all of their own costs and give them a payment for the service.

But then the governments step in, in the nature of the taxman, and say ” I want a bit if that too” so the rates have to widen to say 4%pa and 5.5%pa so that the tax can be paid.

A word of warning though to all of you borrowers. Most lenders are very reputable organisations but there are always some unscrupulous people out there whose sole aim is to take you for a very expensive ride and these people avoid using the standard custom wherever they can. For example, if Mr A wants to borrow £120 he may be offered it for 24 monthly repayments of £7. It sounds reasonable because it is only £7 per month, but 24 x 7 = 168 so the interest charge is £48 over two years. A simple calculation would be one half of 48 for each year = 24 based on a loan of 120 therefore the annual rate of interest would be 24 divided by 120 multiplied by 100 = 20%pa. That is a very expensive loan!  BUT, the true position is much worse because the original loan was being paid off at the rate of $5 each month within the £7, so the true rate has to be calculated on the average value of the loan over the two year term. This was 120 for the first month, 115 for the second month, 110 for the third month, 105 for the fourth month, and so on until the final payment is made to clear it on the last day of the two years. The real rate of interest charged is therefore £24 per annum based on the AVERAGE amount lent and this is £60. So the real rate charged is 24 divided by 60 multiplied by 100 = 40%pa!!

Because many people in the UK were being caught like this, particularly poorer people who could not afford it anyway, a law was introduced which says that ALL loan offers have to quote what is called an APR. This means Annual Percentage Rate and is the true annual rate of interest being charged on the loan. ( In the illustration above it would be 40%pa) So look out for that APR it is very important to your financial health.

Then for savers there are two types of interest – Simple and Compound. Simple interest says that at the end of each calculation period ,usually one year, the amount of interest will be paid out in cash leaving the principal sum to start earning interest again. So it becomes a regular source of income of a regular amount provided the rate and the principal do not change.

Compound interest does not pay out the interest but leaves it to be added to the principal amount so that the principal grows bigger and bigger each year and consequently earns an increasing amount of interest each year. In other words it earns interest upon interest and grows more rapidly as time progresses.

Compound is obviously the better if the money is not needed but many pensioners rely upon simple interest to boost their pension income when they retire from regular work.

Finally, the rate offered is affected by a number of things. Two of the most important are Risk and Supply. The greater the risk that the principal will not be repaid promptly by a borrower then the higher will be the interest rate charged, until very high risk means no chance of a loan at all.

The other thing – supply – we have seen before when discussing inflation. If there are too few lenders and money is consequently in short supply then the rates will increase to persuade people to save more and this increase will deter borrowers and bring supply and demand back into balance.

So you see, interest does affect you and your finances, so think about it and try to use your knowledge to make your life easier.

So Does This ‘Interest’ Thing Always Work?

By Derek Beese

In some of my previous posts I have commented on money, value and inflation and that governments use interest rates as the first and principal means of stopping monetary inflation, or to be more accurate, to control the degree of inflation to a level that they want.

Does this always work? A good question and the answer is yes and no. It depends on where you are standing at the time. A man, who had lost his way, met another man along the road and asked him how to get to his intended destination. The answer he got was “that is very difficult and if I were you I wouldn’t start from here”! So the short answer for interest rates is, yes it will always work given enough time — but — if you are so far off course that everything is going pear shaped it will not work quickly enough to get back to where you should be.

Ha – Ha, very clever but what does that mean?  Well, if the supply of money is well balanced with the amount of product and both are growing at the same rate the amount of inflation will be negligible and under control and small tweaks in interest rates, up or down, will keep everything rosy. But if the national interest rates have been kept too low for too long this will encourage the country’s people (and businesses) to borrow more and more money to spend which increases the money supply but not necessarily the amount of product. Result = inflation. If this goes on for too long without being reversed then the result is very high inflation and people begin to chase after their belief that this illusion of increasing value is real and will last forever. The Emperor’s New Clothes Syndrome or the Tulip Mania again.

House prices raising so rapidly that people can no longer afford them – very bad news. Increase interest rates to slow demand and get things back towards a balanced situation and those people who have borrowed right up to their absolute financial limits cannot afford the new increased repayments and in time their homes are forfeited and sold to repay the debt. At the same time the demand for houses goes down because the borrowing cost has gone up meaning, fewer buyers, houses for sale are more plentiful and the prices start to drop. Those people who have borrowed the full value of the house now have a problem because their borrowings are more than the value of the house —a thing called Negative Equity. This sequence is like a snowball rolling down a hill, it gathers pace and size as it goes and becomes unstoppable until it eventually reaches the bottom and loses its energy. People lose confidence in the value of the product and that means its monetary value sinks.

When this “fully inflated balloon” situation has been reached, the necessary reduction in demand has very bad side effects because people lose their jobs, which reduces the demand still further and the problem spreads to other product items and affects shops, motor vehicles, transport, holidays and most other things The money supply is contracting dramatically because no-one wants to lend and no-one wants to buy (they are all saving for all they are worth to make sure they do not run out of money to meet their debts). So what is the government to do? The immediate response is to reduce the interest rate rapidly and keep on reducing it until the position stabilizes again. If this does not work and it is unlikely to do so for a long time because confidence has been lost and the rate cannot in any case go below 0%, then the powers that be must start flooding money into the system to support the businesses and services that otherwise will not survive. But the government has to borrow this money which will make the present position easier but at the same time makes “tomorrow” much more difficult when these borrowings have to be repaid. It is a repeat of the original cause of the problem.

If this move fails to stop the slide then lack of confidence in the value of the country’s money will mean that the government will be unable to borrow any more and the last resort is to print its own money which, as has been explained in a previous blog, is self defeating.

This is the point where recession becomes slump as in 1929 and the early 1930s and can only be followed by a surge in inflation many years later when the effect becomes apparent.

This is the present situation in the USA and UK and many other countries throughout the world because in these days of globalisation, the problem spreads worldwide like a disease, but those countries that have been more vigilant and careful can now reap the benefit by being less badly affected.

So this interest thing does indeed always work but it is slow and takes a long time to take effect. If the ship has gone off course too far for any reason and is heading for the rocks there is no time to wait and coarse action must be taken. This can make it heel to an alarming extent and throw all of its contents and people onto the decks and some people will get hurt in the process. But when the correct course has been recovered everything settles down again and it is time to start picking up the pieces. Recessions and even slumps do not last forever but they certainly are not comfortable while they last.

So How Does a Government Control Inflation?

By Derek Beese

Well, a fairy godmother with her magic wand to put everything right would be marvellous, but unfortunately, real life doesn’t work like that. In real life when things get out of control they can only be brought back under control by straightforward blood, sweat and tears, and it is the people of the country who have to pay the price.

A small degree of inflation, say 1% or 2%, is used by the powers that be to keep industry and commerce rolling along nicely and to give all the people a “feel good factor”. Industry produces hard goods like tools, machines, cars, food and clothing whilst Commerce produces services like banking, transport, postal services and so on. Governments in a democracy have an immense desire to keep the people content because that means they keep their vote and stay in government. But this can influence thinking and lure them into making bad policy that as the saying goes “looked good at the time”!

A sound policy will keep inflation of the country’s money under very strict control and to do this it is necessary to keep the supply of money in balance with the product. If the money supply grows too rapidly the result is inflation, or if the product grows too quickly there is disinflation or deflation.

The difference between these two words is very important because it describes the degree of severity felt by the people. Disinflation is letting the air out of an inflated balloon slowly and in a controlled way so that nothing drastic happens, whereas deflation is letting go altogether when the balloon flies off in all directions and is totally out of control. The former is using policies which correct the situation gradually and brings everything back to the required normality over an extended timeframe and makes life easier for the people by protecting the maximum number of jobs possible. Deflation is the crash, course, kill or cure, and usually means that a large part of the population loses their jobs and their livelihood, giving great stress and anguish. If bad policies are followed for too long then the only way out is deflation - not good and normally called a “slump”. The last slump started in 1929 and continued until the late 1930’s. The result of disinflation is a “recession” which is a slowdown but not a case of falling off the edge of the precipice.

So how is this controlled?

Firstly, we have to understand that all countries want to keep expanding their output of product because that provides the people with jobs to earn a decent living. Provided there is someone to buy all of this “growth” all will be well. You will see growth factors quoted in the financial news all the time and this is what they mean. If the factor is positive then that means the product is getting bigger and if it goes negative then the output is shrinking.

Secondly, we have to keep the money supply expanding at the same rate as the product growth. There are a number of ways of doing this and some are very complex and difficult to understand but the predominant method is to persuade all of the people in the country either to use more of it (that is to spend more) or to use less of it (to spend less and save more). If they spend more, that means a greater demand for product and if they save more that means a reduction in demand for product. When the former gets out of hand the result is not enough product to supply the demand and scarcity makes the price rocket as recently happened in house prices. There was too much money easily available at very low cost chasing after a much more slowly growing product output. (It takes a number of years to plan, acquire land, obtain planning permission, and then build a house). This was exaggerated to an alarming extent because the policies in the countries affected encouraged people to borrow money to do so even when those people could never pay back the loan from their income. The lenders believed that provided the borrowers could pay the interest charges there was no problem because the house prices would keep rising and eventually take care of the repayment of the loan itself. Another case like the “Tulip Mania” and the fable of the “Emperor’s New Clothes” where people saw what they wanted to see until someone broke the rose tinted spectacles.

The method most used to control this demand is the rate of interest paid on borrowed money. The national bank sets a rate which periodically moves up or down and this normally is taken as a guide by all financial institutions for the rates they offer to borrowers and savers. A reduction in rate encourages borrowers because they do not have to pay so much for their loans but at the same time discourages savers because they receive less on their savings. An increase in the rate does exactly the opposite. The big problem associated with this system is that the decision has to be made after seeing what the effect of the current rate has been (that is, in hindsight) and it takes about six months for the statisticians to make their report on this. A lot of damage can be done in six months of the wrong policy when the ship is already off course.

An example of this can be seen in the current financial turmoil. Most governments kept their base rates (national interest rate guidelines ) too low for too long which encouraged people to borrow money and also made it cheaper for them (as governments ) to borrow money themselves. (That will be discussed in another blog post). The end result was an unacceptable increase in the money supply relative to product which was seen as inflation for those products home grown like houses but was offset in the overall assessment by the increasing volume of product being obtained (imported) from overseas countries like China where the prices were to our eyes phenomenally cheap. So, house values going up at 10% each year, and children’s toys, televisions, washing machines, refrigerators, cookers etc going down at 10% per annum, resulted in a net increase of around 2%. Everything looks rosy and people are happy.

BUT, wait a minute, we said earlier that in any one country the amount of money in circulation in that country must be kept in balance with its own product to control its money inflation, so whose product are all those toys, televisions, washing machines etc? The answer must be China’s and so do not reflect in the value of other countries’ currency values. So the real rate of currency inflation was the 10% affected by the indigenous housing prices! In reality it was dropping in value and would buy less and less as time progressed. The 2% net figure is another thing called the “Cost of Living index” and measures what anyone has to pay in their own currency to buy a range of goods deemed to be essential for a comfortable life regardless of where these are made.

Over the course of many years the money inflation rate is the vital one but the quickest and easiest to see is the cost of living inflation which is why more attention is paid to this. Ultimately though, it is the value of a country’s money and the confidence that people have in it that controls how much people have to pay for that acceptable standard of living.

Oh dear, where is that fairy godmother when you really need her?

What Does Inflation Mean to You?

By Derek Beese

Take a balloon and blow air into it so it expands and there you have inflation!

Quite so, but there is also a much more sinister meaning which eats away at our monetary worth by stealthily dipping its hand into our pocket. Usually we do not feel it but we do see its effect in the way prices keep rising.

If prices rise we need more money to buy the goods and if we cannot get more money then we can only buy less. What causes this to happen? This is a very complex question and because it is so complex, people outside the world of finance block it out as something they cannot understand. BUT it affects all of us every day of our lives so we should at least try. If we understand the cause then we can do something to correct it.

I have talked on this blog in the past about money and value; inflation is all about the value of money. Search out those previous articles and it will help you to follow this one.

The value of money is simple, isn’t it? A Dollar is a dollar, a Euro is a euro, a Pound is a pound, and a Yen is a yen. If each of these countries were totally isolated, with a great wall around them, so that they could not communicate with each other then everything used in each country would have to be produced within its own walls and would be paid for in its own money (currency). This money is issued and guaranteed by the government of the country and the total amount at any one time is controlled by that government and passes around from person to person and business to business to settle debts. This is called “money in circulation”.

Now this isolated country that we have invented has to produce all of its own food and drink for its people to live and also everything that the people use in their daily lives. This is the “product”, and if the number of people and the product remains constant and the money in circulation remains constant then the cost of everything used will remain constant because the cost is “the money divided by the product”. For example, if the total money in this wonderland is 100,000 and we have a total produce of 1,000 identical items then the cost of each one is 100 (100,000 divided by 1,000).

So far so good, but if the balance is disturbed, say by transferring some of the people making this product onto other jobs which do not make any product, then the amount of product will drop, let’s say to 500 and the cost of each will then be 200 (100.000 divided by 500).

In simple terms the product has become scarcer and its value has increased to reflect this based upon the “human perception” principle mentioned in one of the previous posts. Similarly if the product remains the same but the powers that be, increase the money supply, then the cost of each item will increase. (200,000 to produce 1,000 = 200 each).

An example of this occurred in Germany after the First World War. The armistice agreement imposed on the German people a liability to repay France for all the damage done. This was payable in German currency which the French would convert to their own currency to make good the damage by using their own people. Germany however was a bankrupt nation after the cost of the war, like most of the others, and could not earn enough by selling its produce to pay the debt, so the easy way out was for the Government to print additional quantities of its currency every time a payment became due. Thus they increased the supply of money without an equal increase in product and the result was that the money bought less and less. The debt to France was paid as required by the agreement (in German currency), but the value of the payment when converted to French Francs became more and more worthless so they had no real benefit. Eventually there was so much German money around for no compensating increase in product (that is, the money became so valueless) that no-one including all of the German people wanted it, and in Germany a single loaf of bread cost a wheelbarrow full of money to pay for it. This imposed enormous hardship on the German people who found themselves unable to buy the necessities for them to live. Prices were doubling by the day and money became completely useless so the only solution was to go back to barter. In these conditions a week’s load of food was worth more than the most valuable diamond in the world and would be exchanged for it provided the food owner was willing.

A similar situation is taking place today in Zimbabwe. The produce (output) of the country has been shrinking for many years and the money supply has been progressively increased by the national bank to pay for the government’s liabilities with the result that the currency is totally worthless. A recent report said that a new Z$10,000,000 (that’s right, ten million)note has been issued but all that it will buy is a loaf of bread. This is inflation on a massive scale and is devastating for the people who live there.

So inflation is not a good thing but governments and borrowers flirt with it because it makes it easier to pay off debt. At one or two percent per annum it does some harm but not enough to cause any serious hardship. As it gets above this level however we all begin to feel the pinch because our money will, quite visibly, not buy what it would before. The end result is to penalise the careful, thrifty people and to make life easier for those who run up big debts. That is not a result that is that is either wanted or just but is convenient for those who have borrowed and have to make repayment.

So keep an eye on those figures announced every month in your country. It is the policies exercised by the government that affect them and if the trend is upwards that is not a good sign. Trends are important because these actions take a long time to become apparent and by that I mean years not months, but if the wrong policies are followed for too long then inflation will happen just as surely as night will follow day.

Of course there are a vast number of complexities mixed into the pot to make the issue difficult to understand clearly, even for financiers, but the basic principle remains the same whatever the “confusers” tell you.

Like the balloon at the beginning, inflation causes monetary things to get bigger and bigger until eventually BANG!!!

Cost, Price and Value

By Derek Beese

We all know what these are, don’t we? Even so it is worthwhile to just think about these three words in a little more depth.

The cost of anything, whether manufactured or not, is measured by the amount of money spent on producing it. Easy! You find a stone lying on the ground, pick it up, and its cost is zero apart from the expenditure of your energy which has no monetary cost. So no cost!

The Price. Well, this is not a particularly pretty stone but it did sparkle a little bit which made you notice it, so perhaps someone will buy it from you. You assess what that someone might pay for it in money and try to sell it to obtain a little monetary benefit for yourself. That is its price.

Both of these are easy to understand, and will vary depending upon the cost of raw material, the amount of effort that has to be put in by people to make the final article, the complexity of the item, the quality and the final bit added on to make the whole thing worthwhile for the maker.

Good. Now we have the basis for doing business with other people. So what is this Value thing and how does it affect what has just been said? It is reasonable to think that the value of the product is the price that has been established by the above method. Well, not necessarily. That stone that we found and sold for the price we wanted, making us feel quite happy, was later found to be a gem class diamond and the price now is 10,000 times what we sold it for. Are we still happy? The stone is still just a stone so what suddenly gives it a “value” of such an enormous monetary sum? If it had turned out to be a piece of glass your assessment of price may well have been ok.

So what is value? The answer is very complex but can be distilled down to one basic thing and that is “Human Perception”. Value is what human beings believe. It is no more than that. You will probably react by saying “that is rubbish” and you are entitled to that opinion but look at some examples.

Diamonds are just stones which are found in the ground, but which are rare and when polished in a precise way sparkle brilliantly. The large ones are gem stones because people wish to use them to decorate themselves and to display how wealthy they are. The larger the stone the greater the rarity and the more it is perceived to be valuable. Millions of small diamonds and all the dust waste from the polishing process is used in industry for cutting tools because diamond is the hardest substance known to man, yet the price placed on this application is minimal even though it is far more useful.

A motor car is a very useful thing, it provides thousands of people with jobs to make it and when finished is good transport and continues to give people work to maintain it. A painting gives work to the producer and thereafter hangs on a wall and does nothing other than give some people pleasure when looking at it. Why then is a painting of sunflowers in a vase worth thousands of times more than a motor car? Why is a pile of house bricks stacked neatly in an exhibition valued at over a million dollars or a dead animal painted and preserved in an embalming fluid said to be worth millions? The answer is simply human perception of what these things are supposed to represent. In themselves they are worth peanuts.

A single tulip bulb at one time was so highly valued that people mortgaged all of their possessions and then borrowed more to buy just one single bulb. Fine until the mood changed and no-one wanted them any more. Very much a case of “The Emperor’s New Clothes”. People saw what they wanted to see even though it was not there.

Value is a very nebulous thing and is affected by the human perception of rarity, history and age when considering things but though we normally ignore it, it also applies to people. Sometimes the phrase “he/she is worth his/her weight in gold” is heard. This is a metaphorical statement not a literal one. It does not mean that because gold has a price of $700 an ounce today and the person weighs 200 pounds that his value is 200 x 16 x 700 = $2.24 million, it means that he is of inestimable value to humanity and all living things.

How do you place a value on that? Again it is a case of perception. The words associated with the assessment of human value are those such as kindness, helpfulness, compassion, consideration, charity, love, cheerfulness, happiness, honesty, cleanliness, trust. Those associated with a lack of value or even zero value are such as cruelty, unhelpfulness, evil, inconsiderate, egotistical, hateful, depressing, dishonest, dirty, backstabbing, untrustworthy.

So this simple word “value” is not as simple as it may seem. It is something that all people should take time to think about and to try to understand. What value do you place on the people you know or meet in this journey through life? What is even more important is what value do they place upon you and how do you improve their assessment of you?

Money or Barter?

By Derek Beese

What is money? That is a stupid question you might think. Everyone knows what it is. It’s those pieces of paper and those metal coins that we all use to buy what we need or want. Ye-e-es, but what makes that piece of paper whether it is Dollars, Pounds, Euro, Yen or any currency you wish to name, worth anything at all? It is after all just a piece of paper – very pretty but just paper. It has no scarcity value because there are trillions of them all precisely the same and the same thing goes for the coinage.

So, I ask again, what is money? It is important that we understand because we all use it every day!

To explain, the story must start many thousands of years ago, before man invented this thing called money. When early man saw that another man had something that he wanted he had two ways to acquire that thing (say some food). Method one – bash him over the head with a jolly heavy club and steal it, or method two – give him some thing that he will find useful by way of exchange. The latter is the most satisfactory because that way both parties go away happy and there is always the chance to do the same thing again in the future. He has made a friend, not an enemy. The latter method is barter and is where goods of any nature which are of relatively equal value to the owners can be exchanged to the satisfaction of both parties. The goods can also be services, such as: I will dig your vegetable patch if I can have an agreed amount of the veg. grown.

Barter is a very good system for trading and served the people worldwide for a very long time. For thousands of years it was the sole method of doing friendly trade and has survived right into the present time. It is still widely used. For example, two gardeners one of whom grows superb potatoes and the other who grows marvellous soft fruits frequently will exchange produce at harvest time to their mutual benefit. It is also used for much larger transactions.

But – and there is often a ‘but’ – the system has its limitations! As bigger industry developed the exchange items became and frequently are, totally unbalanced. Let’s say that a man who has a thriving business producing garden spades wants to obtain a Jaguar car. Does he go to the car manufacturer and say – your car is worth £40,000 and my spades are worth £1 so I will give you 40,000 spades for one of your cars. I leave you to imagine the answer!

So barter had to be extended somehow and the method developed was to create a middleman who acted as an intermediary to enable the two parties to do the deal. Initially these were business people who would say (in the spades example), “I will take your spades and trade them on to someone else but I cannot pay you for them immediately so I will give you a note promising to pay you at an agreed time in the future”. This middleman had to be someone (or a business) that was trusted by everyone and had total integrity so that other people( in this case the Jaguar manufacturer) would accept his promissory note in payment and was then able to use it himself to pay for goods to carry on his business. This transfer from person to person (or business to business) carried on until the due date for payment when the note was presented to the originating middleman and payment was made, thereby settling the debts of everyone who had traded the note.

Ah, you will say, but what if the middleman had bartered the spades for some other product that the end promissory note holder did not want, – the system would all fall down. Correct. So a product which had universal acceptance and an accepted standard value common to everyone had to be found so that final payment would be in this product and would be accepted by all together with its value. That product was Gold because it was so scarce and everyone valued it, supported by the second most valued metal Silver. The standard unit of gold was subdivided into smaller units which became silver coins and could be passed from person to person very easily.

That is why in the UK the more valuable coins are silver coloured (they are no longer made of pure silver) and in the USA they had the Silver Dollar. The number of silver coins making up the gold basic unit was evaluated by weight, each coin having a precise weight of pure silver depending upon its value. In the UK a one shilling coin was exactly half the weight of a two shilling coin, and if you   collected together one pound weight of the silver coins it was worth one gold basic unit. Hence the Pound of Sterling Silver or the Pound Sterling.

The middlemen over time evolved away from dealing in product and dealt only in what had become known as money and became what we now know as Banks. They still perform the same function today and are the organisations that oil the wheels of business. The notes that they issued were centralised in virtually all countries of the world into the nationalized banks of each country. For example look closely at a Bank of England £5 note and it says, Bank of England, I promise to pay the bearer on demand the sum of five pounds. But this is no longer five pounds weight of sterling silver because the link between all currencies of the world and gold was terminated during the World War 2 for very pragmatic reasons. The backing for the promissory note has now become the government of the country issuing that note. So the value of any currency is now wholly dependant upon the financial stability and the integrity of the government of that country.

Now, one other development grew out of the creation of money. It was found that not only was it ideal for settling financial debts but it also created a means of security. If a person or business receiving money could put some of this aside he/she/it had a recognized store of wealth which was acceptable to all people across the globe. This could not be done with barter. Hence money became dual purpose: 

1. To buy things made or produced by others and to settle debts.
2. To provide security for those who could same some of it and have it available to meet unexpected adversity. 

Item 2 is commonly called saving and is something that all people should do, each according to his or her circumstances.

Who is in Control? You or Your Money

By Derek Beese

This may seem to be a very silly question but do you ever wonder at the end of the week where all your money went and left you with nothing? Many people do just that and it usually means that the money is in control. There is no plan and the money says “here I am, spend me on whatever takes your fancy”. There is a very old saying that “money burns a hole in his pocket” which is another way of saying that the money is in control!

This is a difficult thing to correct and for some people are almost impossible because they just will not admit that they are not in control themselves and until this fact is admitted to oneself, the cure cannot begin.

The cure is simple to say but often very hard to apply because it means that you have to make a set of rules and stick to them. In time they become second nature and the more you stick to them the easier they become because they become a habit.

What are these rules that give you the control over money? 

First you have to make a plan – usually called a budget by financial people. The Government makes an annual budget and all businesses make annual budgets and all charities make annual budgets and everyone who has to deal with money on a professional basis makes a budget. This is the first essential step to being in control of money. In simple words, it is their Plan for the year ahead. The estimate of what they are going to receive and how much they can spend and how much they have to put aside to meet unforeseen events. So rule one is make yourself a plan.

Rule two is to make sure that this plan sets aside a small amount of money which will not be spent – a regular amount. You decide how much because the plan is yours but those who are best at this try for about £5 out of every £100. This in financial jargon is five percent (5%). The word percent comes from the Latin Per Centum which means “for every hundred” so five percent means five for every hundred. If your income is two hundred then 5% percent is 2×5=10. If three hundred then 3×5=15.

Rule three is to open a savings account with a building society or the post office which is easy to do. Just go in and ask and they will lead you through the procedure. Make it one which has a branch office which you pass every week. Then rule three says that every week when you pass this office you go in and deposit your planned amount and leave it in the account. It is still your money but do not draw it back out. Try to make it the same day every week so that it becomes a habit to go in there for that purpose. Do not put it in a jam jar or a box for two reasons. One is that this makes it too easy to “borrow” and is a temptation that breaks rule two and the second is that money saved should be made to work for you. All the time it is in the savings account it will earn interest for you and if it stays untouched it will slowly grow larger without any action by you.

By the magic of compound interest the more that is in the account and the longer it is left untouched the faster it grows. In a building society there is no charge for this and your money is guaranteed safe by the Government up to £50,000.

Rule four is to stick to your plan.

Then you can say that you are in control of your money and your money does not control you.

By Russell Beese

www.beeseproperties.com

Out Of Debt FOREVER!

If I could show you a system which would help you pay off ALL your debts in just a few short years, would you be interested?

Would you believe me if I said I could show you a way to pay off a total debt (including a mortgage) of £125,000 in under 9 years?

What if I said I could show you a way to pay off the same debt in under 7 years?

All of the people I asked these questions have replied positively and of those people I personally know who are implementing the system, all are well on their way to achieving their ultimate dream…debt free forever!

The system which I am about to show you is really very simple and straight forward. Absolutely anybody can follow it.

(Note: The numbers used in this example are not in any particular currency. Therefore, no monetary sign is associated with the figures).

Here’s how it works.

1. Write out a list of all your expenses (needs vs. wants). Don’t miss anything out as this is the most important part. You need to know EXACTLY where you are before you can ever begin to get where you want to go.

2. Now take those expenses you have listed and separate ALL the debt from the usual monthly expenses which cannot be avoided. For example utility bills, telephone, TV licence are considered to be monthly expenses whereas mortgage, credit cards and student loans are considered debt.

3. Once a list of all the debt has been established, we can start to put them into a table along with the total amount owed for each debt and also the minimum monthly payment.

(Note: The following types of debt and figures have been made up for the purpose of this exercise)

4. Calculate how many months it will take to pay off each individual debt. Take the figure in column 2 and divide it by the figure in column 3. Put this number in column 4.

(Note: For the purpose of this example interest rates have not been included)

5. Prioritize column 4 from the least amount of months it takes to pay off the debt to the highest. Put this into column 5.

Now we get to the part where we can see the debt being paid off. To help with paying off the debt quicker, an accelerator is used. The accelerator used is a percentage of your income. For this example we will use 10%, however it can be as much or as little as you like. Therefore if you earn £2,000 per month we will use £200 as the accelerator.

6. The Store Card payment (#1) has the highest priority so this is paid off first.

1. Monthly payment = 250. (#1 monthly payment of 50 + accelerator at 200)
2. Debt paid off in 5 months. (Total Owed ÷ Accelerated Monthly Payment)

NOTE: ALL OTHER MINIMUM PAYMENTS MUST BE PAID AS BEFORE.

7. Once monthly payment #1 has been fully paid off you can start to pay off payment #2 (Visa Card).

8. 

1. Add the monthly payment from #1 (250) to the minimum payment for #2 (140).
2. The new monthly payment is now 390.
3. To pay off the entire debt of 2,300 it will take 6 months.

9. Repeat steps 6 and 7 of adding the previous monthly payment to the next debt in sequence after each individual debt has been paid off in full.

The final table will look as follows:

(Note: No other loans are to be taken out from any source as this will greatly affect the time it will take to pay off all the existing debt).

Calculation Summary

1. Detail list of expenses (needs vs. wants)
2. “Accelerator” (10% of income)
3. List all:
   1. Debts
   2. Balances
   3. Minimum Monthly Payments
4. Debt balance divided by minimum monthly payment
5. Prioritize least to most
6. Monthly payment #1 plus Accelerator Base
7. Monthly payment #2 plus #1 plus Accelerator Base
8. Pay minimum monthly payments except Accelerator Debt
9. Pay off Debt

Special Note:

This example is based upon a single person with a monthly income of 2,000 using an accelerator of 200, (10% income) and no interest added to the loans each month.

The accelerator figure should be adjusted to a suitable figure for each person applying this strategy. The more of an accelerator which can be used, the quicker the entire debt will be paid.

• A couple with a joint income may be able to pay 400 as an accelerator. If so the same debt would be paid off in 83 months or 6.9 years

• A person with no accelerator would be able to pay off the same debt in 138 months or 11.5 years.

This is a simple illustration of how to apply the strategy and the figures will be different when applying interest rates from the lender.

It is strongly advised to use an accelerator when using this system as interest does have a great affect in the duration of time it takes to pay off a debt when simply paying off the minimum amount each month.

A quick illustration of how interest will affect your payments can be seen in the amount of time it will take to pay off debt #1 using an interest rate of 1.3% per month.

• Without an accelerator it will take 38 months (3.2yrs) to pay off in full
  • 1880 paid in total, an extra 380 (25%)
• An accelerator of 200 will see the same payment paid off in 8 months
  • 1565 paid in total, an extra 65 (4.5%)
• An accelerator of 400 will see the same payment paid off in 4 months
  • 1525 paid in total, an extra 25 (1.5%)

By Russell Beese

www.beeseproperties.com