Beware: Inflation Running on a Full Tank

Inflation is probably not a new term to you if you have been in touch with the news. But, have you ever paused for a moment and really thought of how it might impact you? For those who have been treating this as another fascinating topic to be discussed over coffee, here's something for you. At JNP Kakis, we've prepared a special news brew that will keep you wide awake:


2010 ended well for many of our clients, families and friends. Employment opportunities have picked up, bonuses that were frozen in previous years were paid out and many even got a pay raise. All in all, things seem to have thawed out and many feel richer this year. Caught up in the festivities, they have embraced this Chinese New Year with more warmth and thicker red packets than the years before.



But, is this feeling of prosperity real?


Like the proverbial frog in a simmering hot pot, many are comfortably unconscious of rising prices. And while you may not drive, the escalating oil price is a telling indicator of where inflation is going. Imperceptibly, inflation begins turning up the heat when economies first emerge out of recessions. The trick is to jump out of the hot pot before you're cooked!


As Warren Buffet recounts,"The world went mad. What we learn from history is that people don't learn from history."


So let's backtrack in time to glean a lesson or two from history. In the year 2000, the world was badly hit by the burst of the dot com bubble. Still reeling from its impact, September 11 packed another punch to the world economy in 2002. In those three years, crude oil prices hovered at an average of US$25 per barrel.


In 2003, when the bull first reared its head for a rally, crude oil prices quickly responded. Initially, the rise was modest as many Asian countries were still battling against SARS at that point. But by 2004, most if not all major economies were gaining momentum. Consequently, the average crude oil price for 2004 scaled up to US$37 per barrel. And by 2008, it had hit a historic peak of US$145 per barrel!


Common sense would tell anyone that this increase in oil prices would have something to do with why bus fares increased in 2005. Oil prices had indeed crossed the US$50 per barrel mark by then. As a result, SBS Transit reported that costs had increased by $16 million within 3 years from 2002 to 2005. This was due mainly to (surprise, surprise) the rising fuel prices. SBS had no choice but to increase its fares to stay profitable. So what could one expect when oil prices hit its historic peak in 2008? Its simple mathematics- both SBS Transit and SMRT further increased their fares so as to stay in business.


Bus fare hikes were not the only things affected by rising fuel prices. Rising costs of transport translates into rising costs of production for just about everything. Food, utilities, goods and services have all become more expensive as well.


We have yet to experience the full impact of an economic recovery. But this has not stopped oil prices from rising steadily over the past months. In fact, oil prices have crossed the US$100 per barrel mark once again. Concurrently, the local rate of inflation also advanced steadily, hitting a two-year high of 4.6 percent in December 2010.


If history has taught us anything, it is that the oil price usually finds room to not only stretch its legs. It also has the power to take a steep upward hike. And with the emergence of China, it most probably will. This is what will make this recovery different from the rest. This time, the key driver of oil prices will come largely from China, which has now overtaken Japan as the world's second largest economy. This hungry economic giant has an appetite for growth so huge that it will be consuming crude oil at a rate incomparable to rest of the world.


The emergence of China simply implies that we are possibly being chased at the heels by hyper-inflation. Are we prepared for another round of possible bus and train fare hikes? Will we be able to swallow an increase in prices at hawker centers and foodcourts? The truth is that Singapore is an economy dependent on imported resources. Such adjustments are simply inevitable.


Before you throw your hands up in despair, feigning nonchalance or harbouring a sour attitude doesn't really help anyone. What we must do is to actively seek for ways to hedge against these inflationary pressures. And if we look hard enough, money-making opportunities are just around the corner.



Inflation Risk Management

It is our strong belief that non-investors will be seriously affected by inflation. The quality of their lives can only deteriorate in tandem with the rise in their living costs. Just ask any bank what interest they pay for saving your money with them and you'll understand the importance of wise investments. If we assume the rate on interest to be at 0.125% per annum, with inflation estimated at 3% per annum, our money is devaluing at -2.88% per annum.


Let's do a little experiment. Let's say you have $100,000 in the bank today, and you leave it there for 25 years. At the end of this tenure, your $100,000 will have shrunk to an estimated $48,000. Do you realise that you would have effectively thrown away half your cash by leaving it idle in the bank? How many months or even years of hard-earned pay is that for you?


Trying to make up for it by working harder and waiting for a pay increase is not the solution. For most, the average estimated yearly growth rate in wages is about 3-4 % only. Taking inflation into consideration, the real wage becomes zero or even negative. Unwilling though we may be to accept this fact above, it is a harsh reality we must all face. If we do not grow our money aggressively, our financial future is most likely to be bleak. For the sake of our future-selves and our loved ones, we must invest our money today, and continue doing so. Whether we like it or not, the fact remains that inflation will impact us as long as we are consumers of goods and services.



Turning inflationary pressures into opportunities


With the big bad wolf of inflation out there, we wanted to arm you with a few battle strategies. So, we've roped in the ancient war-adviser, Sun Tze for his expertise. Among his battle strategies, Sun Tze has one called 以攻为守, which means 'attack, in order to defend'.


When the big bad wolf of inflation begins to huff and puff, retreat is not an option. We must examine what makes the wolf tick. It is akin to windsurfing. An experienced windsurfer knows when the wave is coming, and where is it coming from. He can then ride the wave blissfully and graciously. A good surfer will not allow himself to get swept under the wave. Similarly, what we have done for our clients, is to position their monies like a stake, through to the heart and source of inflation. Our calls for China and energy, to name a few, exemplify how we turn the defeat of inflation into an opportunity for victory. When the Shanghai Composite Index collapsed by 70% from its peak, we continued to believe its potential. We knew the upside could easily offset the devaluation of our money owed to inflation.


Whether we give it its due attention or not, inflation will dog our every step. It will not go away. By not facing up to it, we have made the decision to be victims. For the many hours we put into making money through physical toil, it is pure foolishness to leave our doors wide open for inflation to rob us. Let's take the proper safety precautions if we haven't already done so, and start taking control of our lives and our future.