Taking charge of your own finances

Retirement will be no fun without enough money to enjoy it. Unfortunately most of us are being kicked out of our company's defined benefit funds, can't rely too much on the government for help, don't understand the defined contribution funds we've been put into and are not saving enough anyway. To make matters worse we are being ripped off by a savings and retirement industry that is skimming of the top of our investment returns while giving us very little good advice or value.
This blog contains some of my thoughts on taking control of retirement and pension savings. It will look at ways of cutting costs by using cheap online stockbrokers and share dealing combined with cheap index funds and Exchange Traded Funds (ETFs) to build diversified portfolios. This is a work in progress so I welcome your thoughts.

Wednesday, September 29, 2010

The Case for More Quantative Easing

Like most people who follow markets, I've spent the past two years vacillating between concerns that inflation will take off again as a result of the easy money being pumped into the economy and between the opposite anxiety that we may in fact slip into deflation because of the depth of the economic slowdown.
Markets themselves have yet to reach consensus on this subject. Bond markets seem to be pricing in a prolonged period of deflation with yields on 10 year government bonds at wafer-thin levels, yet when one looks at the prices of inflation-linked bonds, it also becomes clear that a fair number of investors are buying protection against inflation.

The strongest case I've read so far that we face a prolonged period of deflation comes from a speech by Adam Posen in his capacity as a member of the Bank of England's Monetary Policy Committee (MPC). His talk lays out a compelling argument as to why we are not at risk of inflation at the moment and why more aggressive action is needed from central banks.
In short his main points are:
1) there is little risk of inflation because so much productive capacity (labour and machinery) has been idled but it has not been destroyed.  In Britain, for instance, he cites research showing that without the crisis total output (ie the size of the economy) would now be 10% bigger than it currently is. The ability to produce goods and services to that extent is not completely gone. Workers are still able to work and many factories have simply closed a single production line or gone to shorter hours. But they have not scrapped many factories. So the economy could grow at a cracking pace without putting pressure on wages and prices.
2) Central Banks need to do more, but can't do much more with interest rates alone, so they need to start buying assets and keep doing so until they start seeing the economy moving in the right direction (ie focus on the outcome, not the amount spent).

For more detail you really need to read Posen's talk in full. It runs to 38 pages so will take a little while, but makes for compelling reading.

As for the investment conclusion - if you believe as he does that we face prolonged deflation then the assets you want to be holding are government bonds, perhaps even really long term ones. If Central Banks push interest rates down (ie yields) by even a quarter of a percentage point then there is big money to be made. Bonds may be in a bubble, especially if you are thinking of holding them for a very long period of time, but for now with economies slowing, deflation a threat and central banks moving more aggressively it seems that there may still be some legs left in yields.