Money: The big question is whether, in voting for Labour, investors are also voting for higher inflation

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The Independent Online
Less than one week to go to the election, and disappointingly we have had only one rogue poll to disturb what otherwise appears to be a smooth transition towards a Labour government.

Even the spread betting market, which attracts some of the smartest money, seems stuck in a narrow trading range as far as estimates of the outcome go, pointing to a Labour majority of around 70 (though I am told some shrewd money has been heading in the direction of backing the Liberal Democrats and Scottish Nationalists to do better than expected).

As an unreconstructed contrarian, I shall be disappointed if the actual result does not confound the pundits once more, but with no inside knowledge of any sort to call on, my personal ambition remains the more modest one of surviving until polling day without committing any money to the outcome.

As in so many things, however, the real bet that faces everyone this week is how much they are effectively wagering by doing nothing. For investors, in particular, the big unreserved question is whether, in voting for a Labour government they are also, whether deliberately or not, voting for higher inflation.

This is a subject I have been chewing over again this week with Roger Bootle, the chief economist at HSBC James Capel. Roger is one of the leading exponents of the school of thought, once considered dangerously wild, now increasingly influential, which says that inflation is yesterday's bogeyman. His argument, expounded now over the past seven years, is that the world is in the grip of some powerful forces which are wiping inflation out of our economic system, and which are far more powerful than most people, including the world's economic policymakers, have yet realised. The danger now, he argues, is not that inflation is set to revive, but that we may tip over into worldwide deflation.

Although it suits central bankers and finance ministers to play up their own role in killing inflation, the truth is, claims Roger, that there are more powerful forces at work which explain why inflation has fallen so dramatically not just in Britain, but all around the world. He lists the growth of low-cost economic competitors in emerging market countries, the transforming power of computers and the gradual erosion of "producer power" across the developed world.

Deregulation, privatisation and the curbs on organised labour adopted by many governments have also played their part. "Throughout the industrialised world," he writes in his book The Death of Inflation, "the old cost plus bureaucratic system of interlocking quasi monopolies is collapsing."

With markets opening to competition all round the world, and consumers everywhere in the ascendant, it is little surprise, he concludes, that inflation continues to fall faster and more durably than everyone expects.

One small but telling example is what is happening to telephone charges in hotels. Time was when the hotel added a huge mark-up to the cost of phone calls and turned a nice profit. Now, when many hotel users have mobile phones and competition is driving down the cost of charges, those easy pickings are a thing of the past. Hotels have to look elsewhere for their margins.

Even the central bankers, claims Roger, are not immune: they have lost some of their traditional producer power too. Although Wall Street still appears to dance to a tune set by the Federal Reserve, the reality is that Alan Greenspan and his counterparts at the other central banks are now just as much followers of world-wide economic forces as they are trend- setters. (It is no surprise that the book has not received a warm welcome in the central banking fraternity.)

When Roger started expounding his thesis that inflation was yesterday's problem, around 1990, he was greeted with incredulity, especially in the City. When he repeated the thesis in 1992, when Britain was bounced out of the ERM and into a compulsory devaluation of the pound, most institutional investors "laughed even louder" he recalls.

The conventional view was that devaluation would import inflation again, as it had always done in the past. But miraculously, the opposite proved to be the case. Inflation is the dog that has so far failed to bark. In the UK, although the Government has failed to hit its election-day target of 2.5 per cent inflation, it is only a hair's breadth away from it, and this despite four years of steady economic growth and a sharp fall in unemployment.

Where are we now in the inflationary cycle? According to Roger, while the UK's inflation record is still remarkable by recent historical standards, it is by no means the most impressive performance around. The latest data shows that inflation in Germany is down to 1.5 per cent, in France to 1 per cent, and in Japan to zero. Both Italy and Spain have inflation under 2.5 per cent, while Sweden, even more remarkably, is experiencing falling prices. Small wonder that those who took Roger's advice and invested in European and Scandinavian bonds have reaped a windfall in the past three to five years.

Is the great disinflation game over? As usual, the markets are still fretting about a resurgence of inflation, but Roger thinks there is still more good news to come. He remains a bull of bonds, including gilts. But even he admits to having had some nervousness about the way that asset prices have started to rise recently in the UK.

Fortunately, sterling's strength is more than countering the inflationary threat for the moment, and that in turn should be enough to prevent a Labour government from doing too much damage, even if it tried.

Longer term, the thesis of a low- price world remains very much intact. Anyone planning their finances and future savings would do well to ponder the implications of a low-inflation future carefully.

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