This is How You Protect The Value Of Your Money [TFC 127]

But yes, it is a lot more dynamic and complicated. There are many angles to look at this thing. How will it affect us? I think that’s the main idea that nobody’s talking about. A lot of people talking about how to keep rates low, how will it affect investments but hey, come on, your life is not just investments. 

So today, I’m going to attempt to share with you a more rounded way of looking at inflation and how do we manage this inflation risk, going ahead.

Good morning, everyone! I welcome you to another day with The Financial Coconut. In our podcast, we’ll be debunking financial myths, discovering best financial practices and discussing financial strategies that fit our unique life. You get it, ultimately empowering us to create a life we love while managing our finances well.

My name is Reggie. I’m your host and I must remember to say this. We have many hosts now. So my name is Reggie, I’ll be sharing with you a little bit more today about how to mitigate inflation risk.

Okay… Like I said in the opening, inflation’s a lot more complicated than what most of us would like to believe and most of the media people would like to talk about. I’m not claiming that I know everything or I know a lot. The reality is I’m not an economist and even economists out there… the leading economists, they cannot tell you the causality of things, it’s very hard to predict cause. 

People can tell you correlation, people can tell you based on historical situations, this is how we can go about… so conventional wisdom based on a lot of correlation data but nobody can tell you really the cause. That is not our goal today, to predict causalities like what is actually causing inflation?

The market is highly complicated and dynamic. I think we have established that by now. If the smartest people out there, spending their day in, day out, their life, their reputation trying to understand this thing, cannot even give us accurate causality or what is actually causing inflation, then we don’t need to endlessly go on this banter. It’s like “oh, maybe it’s because money printing. Maybe because asset prices (are) going up, maybe because of the supply chain issue”. 

I was like yeah, yeah, yeah. Everything is a little bit so just take it that everything is a little bit of the cause, especially those that are being talked about: supply chain issues, increased liquidity causing futures market going crazy, bringing prices up unnecessarily, interest rates… All these things are affecting inflation. They’re causing inflation. Nobody has the exact formulas “oh, this is 30%, 20%, 10% cause”. No, but some of these things they exist and they’re here for a reason.

We’re not here to discuss the reason. We’re here to discuss how to mitigate some of these effects that will happen to us. Before we begin the discussion on how to mitigate the risk, I want to first plug Dalio’s video. Dalio, macam (like) my friend… Ray, how are you? Ray Dalio is the founder of Bridgewater, which is the largest fund house in the world. I think they are still the largest, but yes, either way, please go and check out the video: How the Economic Machine Works by Ray Dalio. 25 million views… it’s been eight years since the video went out into public. Check the video out. I think it’s a great video to begin your preliminary understanding of how the economy works.

In his frame of discussion, the economy is essentially a summation of all the transactions that are happening out there. All these transactions will then be denoted as GDP, Gross Domestic Product. We are not here to talk about GDP today but I think what is important for a lot of us to recognize is that, total transactions can actually be broken down into velocity times volume: velocity of money being transacted in the market and the volume of money out there.

This is important. Which is why when the velocity of money slows down… like during the pandemic, people spend less, the uncertainties are making companies wary, on the fence, they don’t know what to do, investors are cautious. When the velocity comes down, central banks and governments will try to push up the volume, the money supply. They want more money in the market to make up for the slower transactions so they can keep the total transactions more or less consistent. In other words, trying to keep GDP consistent which is why this is important. When the world bank try to get a country to cut their spending, it’s directly going to affect their GDP.

Because they have lesser transactions in the market, their economy is going to shrink. It’s not exactly very helpful when the world bank sets a lot of these kinds of regulations to say “oh yeah, we can lend you money but you must spend less, you must cut fiscal”. All these terms and ideas, I’m sure you’ve heard it somewhere here and there and I hope that these put all the ideas together. 

When velocity slows, volume needs to go up to keep total transactions consistent which is why a lot of people when they talk about “oh, we’re spending too much, we’re printing too much money, blah, blah, blah”, it’s a bit iffy. I don’t dare to take a position on this thing but you kind of get it right? The lesser of two evils… if velocity shrinks a lot and the volume stays consistent, it does not change, we don’t release money supply, then total transactions will come down. 

GDP is going to shrink like crazy and it’s going to affect asset prices. It’s going to affect unemployment. It’s going to affect a lot of all these other things that will leave the economy in shambles. This is the modern day of the financial economy. So yes, once again, I plug Dalio’s video… Ray’s video. Yeah, my good friend, Ray: How the Economy Machine Works. Check (it) out on YouTube. 

Also, if you want to double down and be even geekier, you should check out MIT’s (Massachusetts Institute of Technology) open source programs. They have MIT economics, just search on YouTube: MIT Economics. That one (is) even more detailed. Step by step, they’ll try to explain to you. The professor there explicitly says the economist cannot fundamentally give you very accurate prediction but it’s quite close already. Please go check some of those videos out and I hope it makes you a little bit… more understanding of what is going on. 

But yes, when we’re talking about inflation rates or mitigating inflation risk, instead of seeing it as a one big bubble, inflation… One number out there, I want us to break it down into three buckets, which I’ve talked about previously in my review of the pandemic.

The three buckets are goods, services and assets. Yes, it’s a very big bucket. It’s a very big generalization. It’s just here to help us understand better what’s going on. It’s not specific. So goods, services, and assets. When you see them in these three buckets, you start to question: how do they work?

How do prices of these three things work? When do they inflate? When do they deflate? With this segregation, it gives you a better grasp of the situation rather than “oh 2%, 5%, 10%”. It’s like what the hell are you saying? With that, we’re going to talk about some of the major reasons why some of these buckets move. It can be a causality, it can be a correlation. It’s a bit iffy here, but either way, there are some proven ideas as to why these different buckets move in prices and they inflate. With that, how do you then mitigate the risk? 

We’re going to start number one: goods. I think the main reason why goods inflate or massively inflate… because people are okay with small inflation at 1%, 1.5%, 2%. Over time, it is okay. Inflation inherently is not a problem. It’s just a phenomenon but when inflation rise massively and very quickly, a lot of social problems will happen. 

Goods… one of the biggest reason why goods inflate or massively inflate is when the home currency collapse. I am currently in Turkey. I am seeing the lira collapse. From the day I came to where I am now… today, recording in January, the lira has came down by 25%. I literally see people… the shop owners, they change their prices. Milk prices were changing. It was 8 lira, now it’s 10 lira.

But to me, because I hold external currency, (it) does not affect me. You get the idea? If this is my home currency, jialat (a dire situation), a lot of problems which is why, the biggest solution for this is to hold a basket of currencies or hold multiple currencies. At least the ones that are more stable and what we call “hard” currencies. In the market today, there are a few “hard” currencies, the US dollar, Euro, Yen. 

I think RMB (Renminbi) can be considered a hard currency. I’m a big China bull. Yeah, some of these currencies. Of course, the Swiss Franc… You want to be all nitty gritty and all but the idea here is instead of holding a soft home currency, you can consider holding a basket of currencies to mitigate the potential crash of your home currency. 

I would say for all of us, if your home currency is already holding a basket of currencies and it has a lot of reserves to mitigate currency fluctuation, then you’re in a very good position aka the Singapore dollar. The Singapore dollar is very strong with the amount of reserves relative to the total money supply.

This gets a little bit technical, but you can go and read up on what is called M2. M2 is essentially the total amount of money in the market… total amount of Sing dollars in the market held in savings, held in investments, held in different currency, foreign reserves or what have you.

Essentially that is M2. Usually, the bigger the size of the M2, the bigger the economy because essentially, like what we have talked about in front, total number of transactions is velocity times volume, right? So volume essentially is what M2 is trying to measure: the total amount of money out there.

The bigger the economy, it tends to be that volume is quite high. But of course, Singapore is a small economy relative to China, which has a total M2 size, wait for it… RMB$236 trillion. That is the M2 of China during the time of recording. Singapore is very small by the economic size but what is interesting is the proportion to the reserves.

Singapore has $730 billion in M2. Reserves is $480 billion which are held in foreign currencies like, US dollar, Euro, Yen, RMB, and all that. I know it’s a bit hard to imagine these days about “why got all these foreign currencies? What’s happening?” because we just (shop on) TaoBao, we just buy online or we just shop and… Visa, Master and all these digital payment companies, PayPal, Wise, what have you… They make it so simple and so digitalized that you don’t even feel that there’s this currency exchange going around. 

But let me try to wind you back a little bit. In ancient China… when your ancestors or ancient India… Your ancestors, they come here to Singapore and they want to exchange. They want to work here in Singapore and they want to buy something. They want to trade so they bring something from China. They come here, they want to trade. 

Say, they bring their kiam chye (salted vegetables), they bring their salted vegetables. They come all the way here… I don’t know why they bring salted vegetable but anyway, in the past, they used to trade tea and silk and all those things. But yes, let’s say, got this weird guy… (He) wants to bring the salted vegetable from China, come to Singapore to trade. What do you think they can get in exchange? 

When they trade in the Singapore economy, they get the Singapore dollar or banana notes during the Japanese time. What happens with these banana notes? Can these banana notes be used back in China where they come from? Cannot. They have to go to a money changer or they have to go to some sort of currency exchange to change the RMB to bring back to spend in China. 

This is what the currency exchange really exists for at that point in time. All these middle people trying to help you change currency here and there, they charge you… essentially the guest fees. They make the difference. But today, of course, it’s very hard to imagine because everything is so systematic and so automated, so lean, that you don’t vividly feel the exchange.

Your currency can only operate in your economy. If you want to go into another economy, you have to change which is why if your home currency collapse… that means your own currency devalues and become useless, it’s going to be very hard for you to trade with other people because people do not want your currencies. For me to sell you something in your home currency, I want to charge a premium.

There are many ways to look at this thing but at the core, if your home currency drops, it is going to directly affect the prices of goods in where you’re living which is your home. Of course, I want to reiterate that different governments will have different economic policies. Some government actually wants to devalue their currency so that they can sell more because maybe they’re export-driven. Some governments want to inflate their currency because they want to… they are import-driven economy. They want to buy more goods. So that one, we’re not here to discuss today.

You just need to know that different governments will have different economic goals and different economic strategies that they participate in but the very premise is if the government does not have sufficient reserves, foreign currency reserves relative to the size of their money market, which is M2, it will make their currency relatively volatile.

It’s unsafe because they don’t have reserves to play around in the exchange rate to make sure that the exchange rate stays consistent. I want you to remember this and also remember that one of the biggest cause of goods inflation is when your home currency collapse so hold a basket of currencies or make sure your home currency has the ability to mitigate that risk and fluctuation. 

Which brings me to point number two and that is services. This is the second bucket and services really move relative to median income. We will talk a little bit more after a word from our sponsor. 

Okay…. Services are relatively unaffected by international currency movement unless they are exported services like interest rates, loans, business services, accounting services, those… or universities. Some of those services may be affected because they have more international exposure but a lot of the services like your gyms, your haircut, your janitor, your home keeper and what have you… some of the more localized services that we do not export, their prices are very much tied to median income.

Which is why, if you go to Whampoa, you still can get $5 haircut, $30 massage. Shout out to our Whampoa friends, (I am a) big fan, big fan. I love to go to Whampoa. Previously, I was staying in Serangoon so I always go to Whampoa. Wow. Very nice, this place. A bit stuck in the past, but yes… 

The goal here is to help us understand that the price of services, they inflate in tandem with median income which is why in areas where median income are higher, the same services are much higher like Orchard Road. You go and cut hair, what have you. It’s more expensive than if you’re in Tampines or let’s say Whampoa. Good friend of Whampoa… 

But yes. That is the idea here that you need to recognize that as long as… so the mitigating strategy is quite simple, right? As long as your median income growth is aligned with the country’s median income growth or the city or the town that you’re in… As long as your growth of your own income is aligned with the median income growth, then you are fine.

You will more or less not face much services inflation risk. I think this is something that all of us should recognize. Too often, we just look at ourselves, we look at our previous wage, we try to sense the market value of our labour and then we price ourselves like that. When the company tells us, “okay, this year increment is 2%, 3%, 5%”, we feel like “huh, not a lot leh” but we don’t really have a very strategic idea of what is a fair… or at least what is a good wage increment so that we can continue to live the life that we want to live and so this is one of the core benchmarks that directly affects the price of services, especially the services that we cannot export. 

I want to point out specifically that recent data that came out from the government is that we have a 3.2% increase of median income in 2021. Assuming this 3.2% continue to stay intact, we will eventually reach a $6,000 median income over the course of the next decade or even shorter.

In other words, I want you to recognize that if your income growth is not 3.2% or more, then the services are going to catch up to you. You’ll be like, “wow, why are things more expensive?”. Please go and make sure that your income growth is 3.2%. I know the team is going to come to me “hey, then our income also need to grow”, but yes, I know, I get it.

I think this is something for us to recognize that it is not always just about you, yourself, like “oh, what can I do? Value productivity, blah, blah, blah”, not just that. Whether can you grow in tandem with the broader economy will directly affect your quality of life so please go and check that your wage growth is in tandem with median wage growth. If not, you’ve got to think of how to go about doing this. 

Which brings me to the third bucket which is assets. I think assets inflation risk is not that big a problem. People don’t really care that this is a problem, right? Because to them, you are invested, your assets grow, that is good. To a lot of people, this is not risk. I just want to point out that in an environment that we are in now, where there’s a lot of liquidity, interest rates are very low, M2 is very high, a lot of money slushing around in the market, there is a high tendency for assets to inflate. 

You see it in the market but with the news of “oh, we’re going to cut down on this whole money supply. We’re going to cut down on liquidity”, you see some of these asset prices coming down also. There is definitely some people that hold for the longer term, and there’s a big part of the market that is slushing in and out of different asset class.

With that, it’s about your price, what price you pay. In today’s price, it’s definitely quite a premium relative to a lot of what the fundamentalist believe. At the core, what I want to reiterate is that, depending on your investment goals, depending on your investment strategies, there’re different ways to play this thing… just so happen that inflation is quite a positive for assets, at least from a personal level but from a social level, it’s quite problematic because it further exacerbates the haves and the haves-not, social tension and all that stuff, which you are seeing. 

I mean… let’s just put it out there that they’re so many million dollar HDB (Housing and Development Board) today and the government is stepping up with new regulations to curb the market which is making it harder for newer entrants to come in so there’s a lot of all these social tensions that come along with asset inflation, especially at the very high rate. 

So yes… In closing, I think what is important is to recognize that the inflation or deflation, they are phenomenon. They are not exactly problematic if they take time to happen. Over time, it is okay, so… 1%, 2% a year or negative 1 to 2% a year, it’s okay. People will work around some of these things, they will find a way to go about. It’s when there’s a sudden surge or, when it compounds over time and you suddenly be like “huh, wow, what’s happening?”, all these things start to become a big problem in your life.

Today we’ve covered quite a repertoire of topics and I’m going to reiterate. Number one is goods inflation. Goods go massively crazy in that inflation pressure when the home currency collapses especially in a highly globalized economy where people trade international, currency risks is a big problem. If your home currency collapse, it’s going to directly affect the prices of goods in where you live so hold a basket of currencies, or at least make sure that your currency that you’re living in, Singapore, Malaysia, Taiwan, what have you, have a big enough reserves relative to the M2 so that they can protect you. They can protect your home currency if let’s say, there are all these fluctuations happening out there. 

Point number two, is that services grow relative to the median income growth rate. Just make sure that your income growth rate is alongside the median income growth rate then you are more or less okay. If you are always going to the barber and… it will not suddenly become (you) going to a salon. Or, if you every time go to Anytime Fitness, you will not suddenly go to Virgin Fitness. 

But the idea here is, as long as your income growth rate is alongside or same as the median income growth rate, then the services that you’re familiar and used to will not be a scary thing to you. You will not be priced out of it. It’s very easy to search. Just go to SingStat, they have all the information there of all the different median income growth rate over the past decade. 

Point number three is assets. To a lot of people, asset inflation risk is not a problem because that’s exactly why people invest so that they can inflate together. They want to see the asset prices go up but I just want to reiterate that in today’s climate, there is a very big tendency that asset prices are up because of high liquidity. In this situation, your biggest risk is if you pay too much. The price you pay matters, the strategy that you adopt matters. Understand what you’re doing, understand what you’re investing and eventually, I hope your strategy plays up. 

With that, I hope you learnt something useful today. See ya.

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Okay, yes… I know we covered quite a repertoire of topics, I try to squeeze everything in because yeah, like I said, I want us to recognize that inflation happens in different things and we try to break them down and understand them in different buckets. With that, you get a clearer idea how to mitigate some of these inflation risks.

Singapore is relatively fine, I would say. Inflation is not very big problem but if your income growth rate is not the same as the median income growth, then you see the problem. I think that is the problem that a lot of people are facing because if the median income growth is growing at 3.2% and you are only growing at 2% and you think, “it’s okay, 2% wage growth”, but compounded over an extended period of time, the difference is huge. So, recognize that. 

That’s something that I think we all can do: track our income growth rate relative to median income and yeah… Hustle a little bit and try to flex and get the growth rate that we want. That’s it for today. 

Next week, we’re going to talk a little bit about compounding effect because I think a lot of people are talking about compounding, compounding, compounding. I want to be able to put out some thoughts about compounding. It’s a lot more sophisticated than you would like to believe.

And yeah, we will chat more next week. Take care.