Is inflation the remedy?

ANYONE over 40 will be having trouble keeping track of the latest screeching U-turn by expert opinion. Hardly had the National Trust decided that dusting is bad for houses, while cobwebs are environmentally sound, than diet books urging a regime of steak and red wine were topping the bestseller list.

And then there is inflation. Low inflation, it seems, is rotting our nest-eggs away. Again and again we read and hear of low rates of return caused, in part, by low interest rates, which can only reflect low rates of inflation.

Of course, there are other factors, chiefly the slump in share values since 2000 and, on the pension side, the impressive failure of the actuarial profession to notice that people are living longer.

But low inflation is very much in the frame, for all that the spokespeople for the personal finance industry prefer to talk of low interest rates. Given that interest rates change solely in relation to the need to control inflation, this is a distinction without a difference.

In this light, a spot of inflation is just what the doctor ordered to pep-up your unit trusts, pension scheme and endowments. At this point, the oldies will be scratching their heads, quite sure that, once upon a time, the opposite was said to be the case.

They are right. Margaret Thatcher spelled it out in September 1975: 'Inflation is the death of savings.'

It was hard to disagree. If inflation is destroying the value of money, then saving is a mug's game and borrowing is sensible, given that the debt will be repaid in sharply devalued pounds.

Inflation was roaring up at 24.2% as Thatcher was speaking. Today it is 3.1%. The mystery, then, is working out why low inflation has prompted such gnashing of teeth among the thrifty. The first step in solving the puzzle is distinguishing saving from investment, the former lacking the speculative element of the latter.

Yes, inflation is bad for savings - £100 parked with a building society in January 1975 would have had a real ( inflation-adjusted) value of just £92 by the end of December 1980. But thanks to the latest edition of Barclays' Equity Gilt Study, we can see that those six years would have been much kinder to £100 invested in shares, whose real value would have risen to £132.

Even during less ferocious inflation, savings accounts fare poorly compared with shares: £100 in a building society in 1985 would have seen a real gain of 20% by the end of 1990, while shares grew by 40%.

As mentioned above, shares are riskier than savings accounts, so those that do well ought to pay higher rewards, otherwise nobody would buy them. But these figures do not apply only to shares that do well - they apply to all shares, the duds as well as the winners.

And bonds, including gilts, are far less risky than shares, yet £100 invested in Government stock in January 1975 became £108 in real terms by the end of 1980.

So somehow, equity investors, and, to a lesser extent, bond investors, have had a helping hand from inflation.

Why? Surely rises in inflation and rises in share values or interest rates ought to cancel each other out?

On the same swings and roundabouts principle, today's lower investment yields ought to be balanced out by lower inflation. Monetary conditions simply should not matter to investors - yet clearly they do.

In part, this is a case of 'money illusion' - the fact that people feel richer with a ten% rise in income alongside ten% inflation than with a one% rise in income alongside one% inflation. Money illusion covers investments as well --100 invested at the 1972 stock-market peak would not be worth £100 again, in real terms, until 1983.

But this is far from the whole story. More important is the fact that inflation silently redistributes wealth.

Gains for shareholders in the high-inflation Seventies were paid for by those with savings accounts, anyone living on a fixed income, and to some extent by those in work - between 1975 and 1978, real incomes fell 13% while shares rose 18%.

This would have been self-feeding. As investors spotted that shareholders were taking a bigger real share of profits at the expense of employees, then the shares would have risen further.

Today, investors have lost this agreeable top-up, paid by people whose consent was never sought and who were probably unaware of their own generosity.

The answer is not a return to high inflation and its unfair transfers of wealth, but the emergence of a new Lord Beveridge to create safe, predictable and guaranteed vehicles for savings, investment and retirement, leaving a speculative fringe for freer spirits.

Don't hold your breath.