Understanding Inflation (Part 2)

As a financial advisor, my watch on inflation is not only on CPI, but also on the strength of currency (i.e. Sing dollar). This is because the “mother of all inflation” is the devaluation of currency. As explained in my earlier blog, the Sing dollar is backed by 100% foreign reserves and gold. If for whatever reason, the government decides to spend away its foreign reserves to finance popular policies or to enrich a few individuals, then very soon the value of Sing dollar will slide dramatically.

Let me illustrate how you can “feel” the impact of inflation as a result of weak currency. Imagine your current income is in Malaysian Ringgit, and your living expenses in Sing dollar. Or, book a tour to Tokyo and live there for 3 weeks with Sing dollars. Can you feel the pain?

There is a school of economic thought that supports devaluation of currency to increase the competitiveness of export. I don’t discount the merit of such thoughts, but I have my reservation. In recent times, countries (like Argentina and Mexico) who adopted this strategy actually devalue themselves into poverty. Worse, it takes double the effort to reverse the strategy, and some countries never recover. (It requires a very strong political will to do this. If a country do not have sufficient "value" to the world, then it will simply disappear.)

Therefore, for a small country like Singapore, what’s the retirement planning implication? My view is that, if we are looking at a 20 years or so time frame, it is prudent to diversify the portfolio into a few strong currencies. One can do that by having a foreign currency-based annuity, or professional managed funds. If for whatever reason, the based currency got into trouble, then at least there is some back up. This is the main reason that many Indonesians are fond of parking their money in Singapore in Sing or US dollars.

Understanding Inflation (Part 1)

I was explaining the workings of variable annuity to a young couple recently, the gentleman asked: “Allen, what is your view of inflation (in Singapore)?”

Indeed, inflation is an important assumption for retirement planning. An overly optimistic figure (low inflation) would lead to an acceptance for a lower expected investment portfolio rate of return (with lower investment risk); on the other hand an overly pessimistic figure (high inflation) would lead to an acceptance of a higher investment risk to generate the required portfolio rate of return.

In a more serious note, un-controlled inflation could lead to social unrest and toppling of existing government. In 1949, Chiang Kai-shek did not lose China to Mao Zedong because of inferior military might, Chiang lost the right to govern because of (un-controlled) inflation afflicting millions of ordinary folks. Price situation were so bad that many folks could not afford ordinary goods and food items. These folks then decided to support Mao and his party. Much blood were shed in that process.

Let me explain how inflation is computed in Singapore (officially). The department of statistics computes the average change in price of a basket of goods and services commonly purchased by the majority of households over time. It is classified into 7 main groups: Food (23%), Clothing & footwear (4%), Housing (21%), Transport (22%), Education & Stationery (8%), Healthcare (5%), Recreation & others (17%). This figure is commonly known as Consumer Price Index (CPI). The current inflation factor is around 6%.

It is also important to understand that Singapore practically import most of its goods and raw materials for domestic consumption. Therefore, whenever there is a price hike in commodity or food items (i.e. oil & rice), this increase will also be “imported” into Singapore. This is exactly what’s happening to the current inflationary situation.

Like it or not, inflation is a (negative) by product of a growing economy. The logic is simple; things become more expensive when demand of goods is more than supply. During economic growth, the demand generated by affluent usually outrun the supply, hence the price increase. The demand of oil (or energy) by India and China is one factor of the current oil price hike.

Understanding Money (Part 2)

Money is the life blood of any capitalist economy, but the management of money defers from country to country.

How is money managed in Singapore? The Sing Dollar was born on 1967. Almost 2 years after separation from Malaysia, the Government decides to issue Sing Dollars. To establish confidence in the new currency, every dollar would be 100% backed by gold and foreign exchange reserves. On this basis, the Currency Act (Chapter 69) was formulated, passed in the Parliament and endorsed by the President of Singapore as law.

The Sing Dollar is printed and issued by the currency board, which was known as Board of Commissioners of Currency Singapore. The number of Sing Dollar to be printed is regulated strictly by the Currency Act (Chapter 69). For example, section 21 of the Currency Act demands that a currency fund* be set up to back up 100% of the face value of every Sing Dollar. The asset allocation of this currency fund consists of gold, silver, foreign exchange in the form of deposits, government and corporate bonds, equities, treasury bills etc. Therefore, whenever the Singapore government receives its revenue from taxes and service fees, the cash flow will go towards the currency fund. Any excess cash flow will then go to the state reserve account. This is to ensure the value of Sing Dollar is (always) tangible. In other word, each Sing Dollar is back up by its appropriate value of tangible assets. (*The exact asset allocation of the currency fund is not privy to the public. Mr Lee Kuan Yew does wrote in page 97 of his memoirs, "From 3rd world to 1st", that by 1987, the GIC was able to manage the reserves of the currency board, which could be referring to the currency fund.)

Since 1/10/2002, the currency board function has been transferred to MAS (Singapore’s de facto central bank). Prior to 1/10/2002, the Sing Dollar note is signed by the Chairman of currency board, now the notes are signed by Chairman of MAS.

This prudent approach restricts the number of Sing Dollars at the international level. This is advantage to Singapore because it prevents the currency speculators from launching an easy attack on the Sing Dollar.

Many people take the relative strength of Sing dollar for granted. In 1998, at the height of Asian currency crisis, where the Thai, Malaysian, Indonesian currencies suffered massive fall in value. Both the Thai and Malaysian government leaders suggested that Sing Dollar be used as the base currency to be pegged by regional currencies. The Singapore government wisely accepted the compliment and declined the suggestion.

First, the relative size of Singapore’s economy is not large enough to support the Sing Dollar as the regional currency. Second, if Sing Dollar is the regional currency, it will experience massive outflow of Sing Dollars into the central banks of the regional countries to be kept as reserves (to square off regional trade imbalance), this would mean the loss of control of our currency. This is something the “old guard of Minister for Finance” (people like Goh Keng Swee & Hon Sui Sen) fought hard to prevent it from happening. As the Chinese saying goes: “A dollar in the pocket is better (and feels safer) than 2 dollars due to me but in other people’s hands.”

Understanding Money (Part 1)

It has been a challenging March for me. As a financial advisor, managing clients' expectation during economic down turn is a position attracts no envy. During the client meeting process, i was asked a challenging question: "Are all money (currency) the same, and how does money work?" The answer is no. In fact, every country operates its currency quite differently.

Money has three basic functions: as a unit of account, as a medium of exchange and as a store of value.

Let me illustrate further on each of this function. First, money is commonly used in the world as a unit of account. One simple example is we describe our income in dollar value. For example, when Peter needs to impress his potential mom in law, he will say:"I earn $20K per month..." instead of "I earn 3 kg worth of gold per month..." All accounting statements in the world use money as unit of account instead of commodity.

Second, money is used as a medium of exchange. Peter goes to supermarket to buy vegetables and food items. At the cashier counter Peter use money to exchange the appropriate value of the food items. Peter cannot say:"ok these foods cost $200, I have 10 shares of DBS bank, i use that to exchange the food." The cashier will probably call the security guard to entertain Peter. The whole world's trade is done using money as a medium to exchange goods and raw materials.

Third, money is a storage of value. Peter, who is a Malaysian, needs to save for his retirement. He consistently saves $1000 per month in a dependable and favorable currency based on future exchange rate. He choose to park 50% of $1000 in Singapore dollars and 50% in US dollars, because he feels that in future, the value in these two currencies store better value than Malaysian Ringgit. (With all due respect to Malaysia currency, I am describing current common practice amongst Malaysian in Singapore. At the time of this writing, S$1 is about RM$2.3, US$1 is about RM$3)

The first two functions are usually taken for granted by ordinary folks, but they have great implications on the value of the currency. I will write more on this in my next blog entry.