Sunday, April 27, 2008

More on inflation

In the last post, we talked about how inflation will hurt us badly. Today we shall discuss some countermeasures.

So inflation is a major issue if you think hard about it. All your savings goes down the drain and you are back to square one. You think you save S$1mn for your retirement and that should be enough. But hey 30 yrs from now, S$1mn cannot even buy HDB, Bcos the value of S$1mn in 2038 is worth only S$300,000 in 2008 and basically you might even have lost money even though you saved like mad for the past 30 yrs. What the heck! What should we do?

Actually there is nothing much we can do, except to invest in stocks and real estate properties. Historically these are the only two asset classes that can keep up with inflation. With stocks, you are buying pieces of companies and good companies will create value for their shareholders, inflation or not. The same goes for real estate.

There are some other unconventional methods to beat inflation completely original from this blogger so just read for fun and implement at your own risk!

1) You can increase your debt! Inflation helps debtors bcos the money they owe also decline in value, so if you borrow tons of money before inflation kicks in, next time you only need to pay back less than what you borrowed in real terms. But you must not put them in your bank and earn fixed D bcos then your fixed D also decline in value and you suck thumb. So you must borrow money and spend them asap, like buying Prada bags and Ferragamo shoes and satisfy your immediate desires! So maybe not much help to build your retirement nest.

2) Buy stuff that will retain its value over time, this means buying things like limited edition Rolex watches, silver, gold, white gold, platinum jewellery or other maybe pure gold bars. (Not diamonds btw, if the real supply of diamonds are released into the global markets, 1 carat diamond is worth as much as 1g of sand, the perceived high value of diamonds can be regarded as the biggest marketing gimmick in our times. Sorry girls, diamonds are worthless, contrary to what you think).

So back to the original solution: nothing beats buying stocks and properties to combat inflation, so keep your savings in these asset classes. The rest of the asset classes like cash, bonds, other currencies sadly will not help much.

Monday, April 14, 2008

The return of inflation

Most of us never really lived through periods of high inflation, thanks to very effective central banks throughout the 80s until today. But with recent rise in commodity prices translating to higher food prices, higher raw material prices, higher property prices, higher taxi fare, higher this, that and everything else, inflation may be coming back to haunt us. And believe me it's gonna be scary.

It is generally accepted that mild inflation is actually good for the economy bcos it helps increase wages, improve productivity, encourage employment and keeps the economy churning along and all is well. But usually this means inflation of 2-3% per yr or something. And if wages increase by 5% per yr then it is a real increase over inflation and everybody is happy!

However, this time round, the world, and hence Singapore (or maybe more Singapore) may be going into a period of not-so-mild inflation. This means inflation of maybe 5-10% per yr. Although not as bad as hyperinfation, this has very drastic consequences for value investors, or rather, everybody.

A bit of digression here. Hyperinflation refers to inflation getting totally out of whack and hence the value of the currency of the sovereign entity goes down the drain. This means that in people's eyes, the currency has no value and becomes as good as banana money (read further down to know more abt this) or simply worthless paper. The worst case of hyperinflation is of course Germany in the 1920s when the inflation rate was 10^27 times.

For those who fail to comprehend the significance of this, it means that $1 today get reduced to 1/1,000,000,000,000,000, 000,000,000,000 of its value. To put it in another way, even if you are a gozillionaire in Deutsche Mark, ie you have 1 million billion trillion Mark, all you have becomes $1 at the end of the day.

Basically your money is worth even less that the paper used to manufacture the note.

In Singapore, of course, we have our infamous case of the banana money issued by the Japanese military during WWII. Luckily or unluckily $1 of banana money becomes only 1/1,000 of its value by the end of Japanese occupation.

Well all these seems a bit far-fetched and probably we will not see such dramatic times again. So back to the real story, if inflation hits us at 5-10% per yr what happens? Well let's work with 8%pa (I like my blog name you see). This means that your money loses 8% of its value every year. Basically in 6 yrs, every dollar you save becomes 50c. Even if you invest wisely and earn 8%pa return, it only means that your $1 stays at its original purchasing power.

In reality $1 you invest becomes $1.08 after 1 yr but your Kopi-O also jump from $1 to $1.08 so effectively your investment did not help you build up your wealth.