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Supply, demand and prices #finance

Basic economics tell us that supply and demand dictate prices. The current over-supply of oil has reduced the price to under $50 a barrel but is this rule always true and what drives demand? If everyone gets a pay rise, demand is increased but where does the money come from? All money comes from central banks, of course, and so it is the central banks that create demand by printing money.

The supply of money

The Bank of England has printed more money through its quantitative easing programme since the crash of 2008, but where is that money going? With increased demand we should see prices rise and that was true after the crash of 2008 as we saw fuel and food prices rocket. It wasn’t all prices that went up, though. Some prices fell or were fairly stable. Prices of mass-produced products that seem to have an unlimited supply didn’t go up but house prices in London and other cities soared as demand increased. This ‘new’ money was used to buy up government bonds and so it increased demand in the stock market driving up share prices and driving up the housing market in London. Young people desperate for jobs and homes continued to be attracted by the booming London economy and added to the demand for housing driving up prices even more. The government now plans to build HS2 offering easier access to London and the south-east creating even more demand for London property at the expense of the rest of the country. I think it is no coincidence that many members of parliament own ‘buy to let’ properties in London financed by mortgages they are able to easily service because that same central bank that supplies all the easy money has cut the base rate to just 0.25%.

The supply of goods

The supply of many goods that are produced by automation does seem to be unlimited but they are limited by the supply of the natural resources that they consume. Electronic goods continue to be made cheaper and cheaper but they do consume relatively rare minerals and metals like gold. This increases price pressure. The increased supply of money and the loss of confidence in the British economy and its politicians has led to a devaluation of the pound against other currencies. It is now trading about 20% lower against the US dollar. Great for exporters you might say and as a temporary phenomenon that is true. In the long-term it will mean higher fuel and food prices once again as the importing of oil, gas and food raises prices that affect the poorest in society most. The price of fresh fruit will rise while the price of iPhones will be relatively untouched.

Investments

How will this changing economic landscape affect our investments? Obviously, it is a good idea to be invested in housing and in those companies that mass produce, the latter however are mostly overseas. Companies like Taylor Wimpey and Barrett would seem to have prospects for growth as house prices in the south continue to inflate. Will there be more quantitative easing by our central bank? It seems likely the money supply will be expanded both in the UK and in the European community driving up house prices and share prices but what if the United States increases interest rates? An interest rate rise in the US could see the value of the pound fall even further and it could push the Bank of England towards a small rate rise too. A normalisation of interest rates would be good for both economies in the long-term but painful in the short-term as consumer demand is cut. There is a housing shortage and so although demand for housing will be high, demand for shares will drop off. So the stock market could see prices fall and major companies could see investment dry up. Higher interest rates would be good for banks and so are they good investments?  Lloyd’s Banking Group at 55p seems to undervalue the bank compared to when the price was 90p not so long ago. Barclay’s seems under priced too.

Oil

I am monitoring the oil price and commodity prices. An agreement by OPEC to cut production could see shares in oil companies like Royal Dutch Shell appreciate and shares in debt-ridden Premier Oil could soar to previous high levels as they once again return to profit.

Volatile

The market is volatile and so there are increased risk. The need to diversify is clear but that doesn’t negate all the risk. Investors are looking for better returns and less risk and so the large multinationals that mass-produce their products and pay dividends look increasingly attractive. For this reason, large pharmaceuticals seem a good investment but prices might fall if the pound gains value on an interest rate increase.

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