Inflation is the angst de jure. Around the world, screaming headlines shout of a cost-of-living crisis and legions of increasingly frazzled politicians and, until recently, relaxed central bankers are scrambling to dampen the din. In a scattergun that smacks more of hope than coherence, the former are cutting indirect taxes, while the latter are raising interest rates. Meanwhile, the clamour for understanding grows louder.

Charlie Munger is the long-time business partner of Warren Buffett at Berkshire Hathaway and is also a spectacularly successful investor in his own right. Like his more illustrious partner, Munger regularly shares his insights on investing and the wider world.

A particularly insightful nugget from a speech he made in 1986 sheds some helpful light on the current angst.

Referring to the famous algebraist Jacobi, Munger said:

“It is in the nature of things, as Jacobi knew, that many hard problems are best solved only when they are addressed backwards. Invert, always invert.“

My brother-in-law is a mortgage broker in Leixlip. I asked him recently about his business and he answered that not only has there been a sharp pick-up in volume but there has also been a continuing rise in house prices. He cited the example of a client who bought a 3-bedroomed semi-detached house in Leixlip just over a year ago for €350,000 and noted that an equivalent house in the same housing estate sold recently for €420,000.

Instead of seeing this as just another story of rising house prices, we should also see it as a story of falling money value. In this example, the same house in Leixlip can buy €70,000 more today than it could a year ago.

Of course, the process of money getting cheaper has also been evident in other asset markets. For example, to buy 100 shares in the ETF tracking the S&P 500 Index of US stocks cost $28,430 two years ago, while today it costs $41,361. In Munger terms, 100 shares in the S&P tracker bought $28,430 two years ago, while today those 100 shares buy $41,361.

Clearly, this fall in money value hasn’t happened in a vacuum. The gold standard was the effective global monetary regime from well before its formal adoption by Great Britain in 1717 to the shutting of the gold window by US President Richard Nixon in 1971.

While its operation was sometimes suspended, or tweaked, in response to war, revolution or depression, the general adherence of most of the globe to this fixed intrinsic anchor was a largely unquestioned constant in political, economic, and social life.

The reason for this was the widespread belief summarised by Keynes in his 1919 book, The Economic Consequences of the Peace:

“Lenin was right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction and does it in a manner which not one man in a million can diagnose.“

Whatever about society, the destruction of money value since that dramatic night in the White House is clear. Simply put, the smashing of the global monetary anchor in 1971 has dramatically devalued the purchasing power of money:

More recently, in the wake of the Lehman collapse in September 2008, the global economy and banking system faced meltdown. Many feared a re-run of the great depression. Monetary policymakers confronting the greatest financial crisis since 1929, and shocked by the post-Lehman collapse in global trade and activity, responded by loosening policy aggressively. Interest rates and bond yields have been hovering close to historic lows since, and central banks have executed waves of asset buying. The full freedom of unanchored money has been deployed with gusto.

For the simple procedure at the heart of this response, the term quantitative easing is unfortunately opaque. Quantitative easing by the Bank of England, for example, has simply seen it create an irredeemable, zero interest rate obligation on itself in the form of many billions of pounds sterling, and use this extraordinary promise to purchase many billions of pounds of interest-bearing UK government debt.

As Jo Owen put it memorably in The Financial Times:

“As a result of QE, the public sector (the Treasury) is paying interest to itself (the BOE) on debt that it owes to itself…“

The BOE is now the proud owner of over 33 per cent of the outstanding debt of Her Majesty’s government. With slight variation, the same procedure has been deployed extensively in Tokyo, Washington, Frankfurt and elsewhere. Consequently, in Europe bond investors at every maturity out to 30 years have been all but paying for the privilege of loaning money to many Eurozone governments. More generally, and notwithstanding the recent rise in nominal rates, negative real long-term interest rates remain embedded globally.

The economist Milton Friedman famously said: “Inflation is always and everywhere a monetary phenomenon.” While dismissed by some as reflecting a crude and inaccurate quantity theory of money, his pithy insight goes to the heart of the current moment. The fall in money value, the destruction of purchasing power or the rise in prices – choose your description – is fundamentally a monetary phenomenon. To help understand it, we need to ponder our post-Nixon monetary system and listen to Charlie: “Invert always invert”!

Further reading

Stephen Kinsella: We are on alert over inflation. But what would stagflation mean for Ireland?

Sean Keyes on investing: I enjoy sniping at the ECB. But I’d hate to be running it now