ABC Guide to Beating Inflation in Singapore and Elsewhere, Part 4

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Tuesday May 20, 2008

ABC Guide to Beating Inflation in Singapore and Elsewhere, Part 4

You are looking at a bunch of Zimbabwe $500,000 banknotes. These were announced in Dec 2007. You may be aware that there has been rampant hyperinflation going on in that country. These banknotes are now useless, but do you know just how useless? The Zimbabwe government has introduced $500 million notes, and at the point of writing, one of those $500 million Zimbabwe dollar notes buys around 2 loaves of bread.

Inflation is for real. If the central banks of the world are not careful with the printing presses, we will be moving down the hyperinflationary path blazed by Zimbabwe. And Yugoslavia before that. And then Argentina. The history of the world is littered with the corpses of failed fiat currencies destroyed by hyperinflation.

Inflation is taking off and going exponential. Everywhere. Hence, part 4 of this ABC guide to fighting inflation continues with more practical tips on how to beat inflation in Singapore, or just about anywhere else for that matter.

Liabilities. Loans.

What's the link between debt and inflation? In an inflationary environment, existing debt tends to get inflated away. This is because, all else being equal, as you are paying off your debt (whether it's a home loan, car loan, credit card debt or whatever), you are paying it off in increasingly worthless dollars. Actually, as in most other cases in real life, all else is not equal. The reason is interest rates. That's the trillion-dollar wild card. Don't think that lenders will stand idly by and let you continue to pay off your debt with increasingly inflated dollars for the remaining, say 10 or 20 years of your mortgage loan. Sure, you can keep refinancing but at some point the lenders are going to demand increasing interest rates to compensate them for the erosion of their asset base (i.e. your loans) via inflation.

Hence, while inflation does reduce the apparent value of your payments, it is still a good idea to get out of debt in all its forms. Avoid debt if you can, and try to pay it down if you already are in it.

The central banks may have unlimited powers to print money and they may control the short end of the interest rate curve, but the long end of that curve, where the longer-term bonds and longer-term loans are being created, is mostly controlled by the markets. A bank is not a charity, unlike the way some central banks have been acting. You shouldn't make plans on interest rates being low forever - if you do, at some point you may have a rather unpleasant surprise.

There is a possible exception (isn't there always?). If you have a long-term, fixed-rate loan, and you have good reason to believe that this fixed rate will remain throughout the term of your loan, by all means take your time to pay it down, and use the spare capacity you have to invest wisely. A couple of examples include 30-year HDB home loans at 2.6% and 7-year or 10-year car loans for which the exact rates are known and fixed at the point of purchase.

Lighting.

Lighting is often overlooked but it is an important way to help to reduce your electricity bill, which if you have been paying attention, has probably been going up recently, driven by the forces of inflation. Use energy-saving, fluorescent-based lighting, particularly compact fluorescent lamps (CFL's) whenever you can. Throw away old incandescent bulbs and never buy these again. The traditional bulb is becoming an endangered species anyway. Do remember to recycle those CFL's though, they contain mercury which should not be haphazardly released into the environment.

LED lighting is still comparatively expensive at the point of writing but as with most technology, with increased production and economies of scale, prices are expected to come down and at that point they may start to become a worthy competitor to CFL's.

LCD displays.

If you are still holding on to CRT TV's or CRT monitors, consider recycling them to switch to LCD TV's and LCD monitors. LCD panels use about half the energy required to power equivalent CRT displays of a similar size. But therein lies the caveat - if you thought you were going to save some energy and you are upgrading from say a 21" CRT to a 42" LCD, you'd be about right back where you started. Perhaps even worse off. Full HD displays (1920x1080) also consume more power than partial HD displays (1366x768) of the same size - for some models it could be actually almost double. Remember that there is a price to pay for all the extra pixels and extra brightness.

So if you are going to upgrade, do so prudently. Case in point - I could have afforded a 40", 42" or 46" LCD TV but instead I chose to switch from a 29" Sony CRT TV to a 37" Samsung LCD TV. And partial HD at that. I could have chosen to switch from 17" CRT monitors to 22" or 24" LCD monitors but instead I chose to buy 17" and 19" models. All for the sake of reducing power consumption. It's something most people overlook when drooling at the latest and largest display panels, but it's something you should keep in mind. Always check the power consumption before you buy. Compare, compare and compare some more.

Multiple sources of income.

One unfortunate aspect of escalating inflation is that in general people have to work harder in order to make ends meet, or in fact just to maintain their current standard of living. The ongoing advice out there generally talks about substitution - that is, to substitute what you currently buy for cheaper and perhaps less desirable or reliable products. That might be a coping strategy but it is in fact trading in for a lower standard of living.

So the question should be, what can people do in order to maintain their current standard of living? One could work harder - but that is both a questionable strategy and a recipe for karoshi. One could have another member of the household join the workforce, but many women are already in the workforce (also, read "The Two-Income Trap" by Elizabeth Warren). One could take up a second or even a third job (which some are doing), but then again, it's a one-way karoshi ticket.

One way out of this conundrum is multiple sources of income. Don't roll your eyes yet - I am not talking about those questionable tactics such as MLM's or pyramid selling or whatnot that unscrupulous businessmen have foisted on the people over the years. I'm talking about legitimate channels. And not just multiple sources of income but hopefully passive or at least semi-passive ones.

What might these legitimate passive incomes be? It could be a rental property (or two). But if you have the capital to play real-life Monopoly ("buy 4 houses and trade them in for a hotel"), you wouldn't have that much to worry about in this department, would you. By all means, buy a house or apartment or condo and rent it out, but beware the housing bubble bust, beware rising interest rates, and beware the looming recession (there will be less renters and lower rental rates in a recessionary environment, obviously).

Besides property, you could also go for dividend-paying stocks (see Part 2 of this guide). Myself, as I mentioned earlier, I am getting several hundred dollars a month from energy income trusts yielding 10% to 12% per year - they're obvously not for everybody though (and this post explains why).

You could try to start a small business. But be aware that the statistics are not on your side - something like 90% of all small businesses fail eventually. Unless you prove to be a really great entrepreneur or something, don't bet all your capital on starting a business. Don't bet the whole house - which many people apparently literally have.

Another way might be trying to use the Internet to make money in some way. You could start with something small and relatively risk-free, like putting up ads on an existing blog or website that you already run (I did, and I got my first Google Adsense cheque recently, and I'm on my way to getting the second one). Besides ads, you could also try setting up an online store or you could try your hand trading items on eBay, buying low and hopefully selling for a profit. Other people sell virtual items they obtained in virtual worlds - massive online gaming and the like. These sound a lot more active than putting up ads and in fact they are. If you work at these, they just might turn out to be more of full-time jobs, and some people have been pretty successful there.

Talking about trading, you might also try trading the markets on your own. This is not exactly passive either - in fact it is as active as you can get. Trading in the markets nowadays is more like a contact sport compared to sitting there passively collecting monthly dividends. The odds are long - you'll be up against not only fellow traders who are likely to be more experienced, more talented *and* have more capital to burn through, you'll be up against thousands of hedge funds and sophisticated computer algorithms which are in all probability good enough to hand you your head on a platter. If you think you have the skills, by all means. People *have* succeeded in this arena and from time to time, I hear of people quitting their day jobs to go full time into online trading.

But like I said, the odds are long. It calls for a schizophrenic personality, it calls for quick reflexes, and it calls for the ability to pay attention to 20, maybe 30 different things going on at once. Try this one as a semi-hypothetical example, say you're trading crude oil and : a. Goldman Sachs puts out a press release talking about $150-200 oil (bullish), b. another press release talks about the Saudi's increasing oil output when Bush visits them (bearish), c. the recent inventory numbers are down (bullish), d. Brazil talks about hiring thousands of geologists and oil workers for their newly-discovered oil fields (bearish). Ok. You have about two seconds to decide before the prices start running away. What do you do? What do you do? That's what I'm talking about. I could also quote this sort of push-pull factors for forex trading but I'd suppose you get the idea. Minute-by-minute, second-by-second trading is not really my style, but it might suit some people.

Money supply.

The growth in the money supply is the root cause of all inflation. Or rather, growth in the money supply which is faster than the growth of the economy causes inflation. It's not escalating crude oil prices, it's not escalating food prices. These are symptoms, not causes.

Who controls the money supply? The government, through the actions of the central bank. If the central bank "prints" more money than is currently needed by the economy, inflation is the result. The converse is also true, but like you might suspect, inflation is the default operating mode for governments throughout history. There is plenty of historical evidence in this department. The initial effects of inflation seem good - increasing asset prices, property values, wages. The dark side comes some time later - increasing commodity prices, runaway price inflation outstripping wage growth, exponential growth of money supply apparently being required to keep the economy running, leading to an escalating inflationary spiral - in other words, where we are now.

There seems to be nothing we can do about the money supply. After all the government, through the central bank, controls it. But this is not really the whole story. You too, have the ability to indirectly contribute to creating and destroying the money supply. Sounds too good to be true? All you have to do is to follow the advice in the "Liabilities" section above. When you pay down your debt, you are contributing to the destruction of the money supply. When you obtain a new home loan or car loan or whichever loan, you are indirectly contributing to creation of new money, which enters the monetary system, and eventually manifests itself as asset or price inflation of one kind or another. So simply by paying down existing debt and not getting yourself into new loans, you are helping in your own small way. If enough people do that, the central bank should (by right) notice the lowered demand for money and contract the money supply accordingly. Most likely, the economy will head straight into a recession as people slow down spending to pay down loans. Of course the government can still continue to inflate even then in a wrong-headed move to try to prop up the slowing economy and if that happens (which is likely), then we will continue to be headed for worsening inflation. At that point, if the government still persists in doing the wrong thing, the citizens might want to consider a change of government. I am not referring to any specific government here. Examples of runaway inflation leading to political changes abound in the history of humankind (you can read more about these in "Gold : The Once and Future Money" by Nathan Lewis).

Medical expenses.

Alongside education, medical expenses is one of the areas that are inflating faster than the rest of the general economy. For Singapore, earlier figures went something like this : education expenses up 6% per year, medical expenses up 8%, while general CPI inflation was around 4% or less. Again, these are earlier figures - this year and beyond, you could expect more. A whole lot more.

What can you do? You could look for a job (see Part 3) which gives you reasonably good medical coverage - look in terms of general family-doctor type outpatient care, group term insurance and hospitalization benefits. Don't count too much on your job coverage however - you could be in between jobs, suddenly retrenched, or whatever. You need your own medical coverage. But do not put too much money into the so-called living, or whole-life insurance policies. Whole life policies have always been a good racket for the insurance companies but they are not a very good idea in the long run in an environment of escalating inflation.

Get just one whole-life policy, hopefully from a younger age when you would have had less pre-existing medical conditions, and stick to it for the critical illness coverage. That's about all you really want from that. Get a term insurance policy or two, and use that to bulk up your remaining coverage. You won't get back your premiums but buying term insurance is the most efficient way to go. In fact, some investors have this rather unwieldy term that we use : BTAITR - "Buy Term And Invest The Rest". I would add to that the single whole-life policy for the reason as stated above, and throw in a modest hospitalization plan, perhaps a CPF-based shield plan such as NTUC IncomeShield so that you don't touch your cash portion. And that's about it. I mean, really. Invest the rest.

Natural gas.

What does natural gas have to do with inflation? You may be surprised. 80% of singapore's electricity is generated from natural gas. And by the look of things, we are going to be even more dependent on it, not less. Singapore is building an LNG terminal and by 2012, when it is supposed to be completed, we will be bidding against major countries such as the USA and Japan for dwindling global supplies. Indonesia, one of our main suppliers of piped natural gas, is building their own LNG terminal - because their own gas fields are rapidly running out.

Natural gas prices are expected to rise. Explosively. Pardon the pun. It *is* cheap right now on an energy content basis, being priced as if it were the crude oil equivalent of $66 per barrel (crude oil is over $126 per barrel at the point of writing). That's half price, and a great discount for the many countries and regions relying on it to generate electrical power. Including Singapore.

As you know, discounts don't last forever. Natural gas prices have apparently bottomed and are on the verge of a tremendous rebound. I can write many paragraphs about the many reasons why but let's just put it this way - as a depleting fossil fuel source for electrical power generation, it isn't exactly the best idea. But as an investment theme, natural gas makes for a very interesting and potentially highly profitable case. But do your own homework, don't just take my word for it.

One last thing. If you do buy enough natural gas-related investments, you could be well on your way to hedging your own electrical bills - i.e. as your electrical bills go up, your gas-related investments also go up. I think it's rather appropriate for us folks here in Singapore. But once again, do your own homework and don't come running if another Amaranth-style blow-up occurs. Best of luck on your personal inflation fighting strategy.