Playing Footsie !

It isn't difficult...

... to understand how it works, but to just reiterate what happened before the 2008 crash, it was built on the assumption that imaginary money has a real value.

THE MYTH: As stock markets and commodities increase, so the wealth of the country increases.

Even after all what we've gone through, that myth still prevails. I see politicians and pundits gauging what the economy will be like in the future by the value of stocks, commodities and in particular the Footsie (FTSE) index. They watch the Footsie climb, along with others like the CAC, DAX, DOW, NIKKEI etc and it gives the false impression that the global ecomony is healthy, but this is absolute nonsense.

Inflation.

If inflation is nominal, say at 2% and the FTSE rises then that is a reasonable assumption, using the financial paradigm we are in, that the economy is fairly healthy. It still doesn't show actual value because it is creating imaginary money on paper.

If inflation is running at 5% and the FTSE climbs 10% then in real terms, it has only risen 5% because inflation has to be countered. For example in very simplistic terms for ease of explanation:

Company A on Jan 1st is worth £1,000,000, over the course of a year it turns a profit of £50,000. It's shares rise from £1.00 on Jan 1st to £1.05 on Dec 31st of the same year. It's share price on the FTSE index has risen, and along with all other companies making a 5% profit in a year, the FTSE rises 5%.

This company on paper has made a perceived profit of 5%. The shareholders are happy as they're savings are only getting 1% in the bank, so a 5% increase is quite adequate.

However, inflation is running at 5% per year. The value of £100,000 on Jan 31st falls in real terms (spending power) by 5%, so on December 31st, it's actually only worth £95,000. Prices throughout the year have risen 5% which means you can buy 5% less of goods and services. On Jan 1st you could buy 100 loaves of bread at £1 each with £100, now you can only get 95.

This is inflation.

So getting back to our "successful" company, it is actually worth exactly the same despite it's balance sheet showing a profit and it's share price on a steady increase.

This is why we MUST NOT put weight on the FTSE as an indicator of the health of an economy. It's really amateurish and to see politicians doing this is quite appalling and unnerving. It would be easy to assume that they are knowledgable about these things but in fact they aren't. Economics are a complete mystery to them, but they listen to financiers and advisors, and look at the FTSE index as a yardstick.

Realise yourself, that an increase in the FTSE index in times of high inflation is not good. If inflation increases very soon in 2011 (and it will), then expect the FTSE to go up and everyone to assume we are in recovery. We aren't. If inflation is at 5%, we would need a FTSE increase of 20% to counter inflation.

Inflation is a killer, be very careful where you put your savings.


As a footnote, it is well known that inflation is a wonderful "Stealth Tax" by Government. It decreases citizens spending power (remember the bread example above?) and lessens debt. If you have inflation at 5% per year and owe a friend £100, within 14 years the debt is change you would find down the back of a sofa because of inflation.

Governments increase inflation so they pay out less to their debtors who hold their bonds when they mature.