After allowing scandals to hog the headlines over the past year, editors at The Straits Times moved into a pensive mood and put out two headliers on the economy. On the last day of 2012, the front page read ‘Slow growth next year: Economists’. The next day’s headlines read ‘Economy grew a slower 1.2%’. The contents were similar and bleak. In a nutshell:
‘Singapore will face another bout of slow growth and high inflation next year as the painful process of economic restructuring continues to bite. Even the employment market, which has held up relatively well this year, is likely to see fewer jobs created.’ Straits Times 31Dec12
Economists continue to banish inflation forecast figures like the Sword of Democales. The thought of one’s money losing value by the day is enough to strike fear in people’s heart. Let us take a step back and discuss what inflation really means. Let’s also examine the genesis of this inflationary policy and consider our options to battle the monster.
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What is inflation?
We all know that Inflation is a rise in the general level of prices of goods and services over a period of time. When your dollar today gets you less than what your dollar could get you a year ago, you are at the receiving end of inflation.
In 1998, a copy of the Straits Times would cost 60 cents. Present day, the exact same publication is available in the newsstands for 90 cents. Price has increased 150% over a period of 15 years. While a 30 cent increase over such a long period of time is hardly significant by anybody’s terms, I intentionally used it as an example rather than HDB or COE prices (housing and transport are the major causes of inflation in Singapore) to show that while the main causes of inflation is normally attributed to rises in the price of big ticket items in the housing and transport category, they need not only apply to big ticket items but also to pertinent everyday spendings.
How is inflation measured in Singapore?
There are two measures of inflation applicable to Singapore.
Headline inflation is the more commonly available metric, and it is measured by an indicator known as the Consumer Price Index. What the CPI does is to track consumption expenditure by resident households and also representative items most commonly purchased by majority of households. Each individual item/category is weighted and their prices monitored. Measured against a base year (2009), an increase in prices across the board will result in an increase in the CPI. According the data from Singstats, the CPI increased from 102.8 in 2010. The resultant increase of 2.8% is taken to be the inflation figure for 2010 implying that the cost of maintaining a typical household in Singapore has increased by 2.8%. In other words, the value of money has decreased by 2.8% in 2011.
Besides headline inflation, the Monetary Authority of Singapore also monitors an additional indicator known as Core Inflation, which is the CPI minus components that are affected by administrative policies and are volatile. This series exclude private road transport and accommodation costs. Interestingly, core inflation for 2010 checks in at 1.5%. According to MAS, this is close to half of headline inflation because much of the rise in CPI is attributed to the manyfold increase in COE prices for the year.
How does the MAS monitor and control inflation?
I remembered visiting Turkey in the early 2000s and being confronted with millions of dollars worth of lira banknotes. At that time, the country was battling hyperinflation and the lira was losing its value by the minute. When left unchecked, inflation becomes hyper and the consequence is that of a currency being worth less than the paper it is printed on.
Twice yearly in April and October, the MAS releases press statements stating the direction of the Singapore’s monetary policy for the next six months. The central bank could either allow the Singapore Dollar to appreciate or weaken against a basket of currencies (Singapore Nominal Effective Exchange Rate, $NEER). The implications are as follows. If the SGD weakens, our exports becomes more competitive, trade volume increases and growth is spurred. On the other hand, a weak SGD would cause imports such as food and fuel to become relatively more expensive compared to the previous time period, hence resulting in inflation. The converse is true. To put it across in an extremely simplistic fashion, the MAS can either choose to contain inflation by strengthening the SGD at the expense of growth, or promote growth but at the same time run the risk of inflationary pressures for the country.
What can the retail investor do to protect his money against inflation?
In an inflationary condition, cash is the biggest loser while physical commodities will inflate and hold their value well. The conventional commodity that is used to hedge against inflation is gold, while in the local context, properties are highly regarded as an effective hedge. As retail investors, it is crucial to be more aware of the naunces associated with both instruments before jumping in.
Gold in any form is always dominated in or pegged to the USD. In order to buy gold, one would need to sell SGD, purchase USD and use that USD to exchange for gold. Recall that a strengthening SGD gives rise to inflationary pressures. In other words, to be vested in gold, one would need to contend with a foreign exchange factor that is highly likely to be negatively correlated with gold price. To me, it seems pretty much like a zero sum game.
Considering that accomodation is a main component of the CPI and headline inflation, prices should rise in tandem and exposure to property should protect against inflation eroding the value of money. However, we need to be cogent of the timeline involved. Purchasing a property involves hefty transaction costs and properties are highly illiquid assets. Should the inflationary conditions give way to a different economic climate such as a deflationary one that Japan has experienced over the past two decades (Japanese property prices fell is now more than half below their peak, and Japanese investors would do so much better to hold on to cash all this while), it might be tough to dispose and rebalance a portfolio with properties involved without significant costs.
In conclusion, inflation looks to be a feature of 2013. Headline inflation figures look menacing but if one is not looking to purchase a car or house in the near future, core numbers are a better indicator. The MAS manages inflationary pressure via a monetary policy and there is no perfect hedge for inflation.