Inflation – Can you afford to sit and do nothing?

The article is an educational piece about the potential impact of Inflation. For informational purposes only.

Have you noticed that the price of a car wash at your neighbourhood petrol station is now S$12, up from S$10 last year, and a pack of pork ribs now costs over S$6, up from S$5 at the start of 2020? That is inflation at work. Current inflation, measured by Consumer Price Index (CPI), may be more painful than what the headline CPI may suggest.

A hot topic of late has been around how inflation erodes the value of one’s savings and wealth. From a historical perspective, Singapore’s inflation averaged 2.5% from 1962 until 2021, and during this period, inflation ranged from an all-time high of 34.3% in March 1974 to a record low of -3.10%¹ in September 1976. The most recent data by the Monetary Authority of Singapore showed overall inflation levels hitting seven-year highs with headline CPI coming in at 2.5%.² Think of it as our hard-earned cash savings evaporating at almost 2% just by sitting in our bank accounts, based on an assumption that the CPI stays constant at current levels and given that time deposit rates are now averaging at about 0.5%.

Yet, many of us do not realise that we should be concerned about this trend instead of choosing to keep most of our savings in cash or time deposits which currently offer yields that are significantly less than 1%. A likely explanation for this is that people are taking comfort in the fact that there has been an overall decline in inflation levels, with inflation averaging less than 1% between 2015-2020³ compared with 2008 when inflation was averaging 6.5%.

Current outlook: a “transitory” inflation

The US Federal Reserve (Fed), along with many other central banks and experts, believes that the current rising inflationary pressures are “transitory” – think of the train arriving at a station and departing after a short stop. Most arguments in support of the “transitory” inflation centres on an impending alleviation of price pressures once demand and supply chains returns to normal.

Firstly, central banks can gradually unwind their monetary stimulus and remove excess liquidity which has fuelled inflation (i.e. more money chasing fewer goods) as global growth recovers. Secondly, disrupted global supply chains due to pandemic lockdowns are expected to abate once countries hit acceptable vaccination rates and begin the process of reopening their economies. Thirdly, added price pressures from demand boost due to large-scale fiscal policies will start to fade as most social-related benefits and stimulus will be ending soon. Finally, we will likely see further lowering of costs and increase in efficiency and productivity levels given the constantly rising rates of adoption and innovation in technology – think about how e-commerce has enabled many of us to buy things at a lower price.

In short, it does sounds like a strong case for inflation to track back lower.

Consider: a more persistent inflation

So far, “transitory” inflation has yet to abate. What if inflation turns out more sustained and stickier than expected? If you have noticed, gas prices tend to stay elevated for longer when it goes up before heading back lower.

Most social-focused fiscal policies are set to end in 2022 but current governments may find it difficult to completely withdraw their support due to possible reshuffles in administration after the mid-term elections in the US and presidential elections in Germany and France.

Private consumption also could decline, assuming we do not see a buying binge by consumers post-reopening of economies. But this should be offset by the demand generated by massive fiscal spending on infrastructure plans and climate-change agendas as both of which are expected to be in the hundreds of billions in dollars. For economies such as China and Singapore who are looking to drive wage growth, we may see higher demand which can drive prices of goods and services up.

Global trade wars and disruptions in global supply chains due to the pandemic could also lead to existing global supply chains moving towards a more geographically diversified source of supply as well as having production capabilities closer to home and away from low-cost production centres. Along with higher and tighter regulation on mega-tech companies and monopolies, it can and will only add to costs. Businesses may initially do their best to absorb as much of the higher costs but inevitably it will filter down to consumer prices.

Expounding looks to be much easier than execution

Even the best laid plans are easier said than done, especially when it comes to the withdrawal of monetary support by central banks. Prior to the Global Financial Crisis in 2008, the balance sheet of the Fed stood at US$900 billion⁴ or 6% of GDP based on 2008 figures at US$14.7 trillion.⁵ Since then, it has ballooned to US$8.2 trillion⁶ or 38% of GDP based on 2019 figures at US$21.4 trillion.⁷ The last time the Fed attempted to unwind its stimulative policies, it was forced to make a sharp policy reversal and cut rates three times in 2019 – this was when the unemployment rate in the US was at a 50-year low at 3.5%.⁸ If the Fed could not do it then with a significantly smaller balance sheet and a much stronger economy, how would they do it now?

Interestingly, Fed Chairman Jerome Powell recently made it clear that employment data, not inflation, will be the key deciding factor when it comes to polices⁹ since it is already running well above the Fed’s 2% objective (even though the Fed thinks it will decline going forward). With the unemployment rate now standing at 5.2%,¹⁰ it looks like any reduction in monetary support is a long way off.

So, can we afford to sit in cash?

Former Fed Chairman Ben Bernanke once signalled that the Fed’s monetary tools stoke asset price inflation. In his post-Federal Open Market Conference press conference in September 2012, he opined that the Fed’s monetary tools involve affecting financial asset prices and that there are several different channels to which it could target, such as mortgage rates, corporate bond rates, other interest rates, as well as various other assets, highlighting that rising home and stock prices could compel people to spend more due to rising wealth effects.¹¹ With the expanding balance sheets of central banks, financial assets have indeed been rising – just look at where the stock market is currently.

This time, price appreciation is not just confined to financial assets but is also flowing to real assets such as commodities and even alternative assets like cryptocurrencies and non-fungible tokens. In other words, inflation is now everywhere. Therefore, whether “transitory”, sustained or perhaps even disinflationary where inflation is still rising but at a slower pace, the question is whether we can afford to do nothing – if you suspect that a robber may be in the vicinity, wouldn’t you choose to take action to protect yourself?

Low inflation does not mean no inflation. You could just leave your money in your savings account and/or time deposits, but how about also keeping regular tabs on your accounts and ensuring that you are not only growing your money but also having sufficient protection against uncertainties.

About the writer

Prior to venturing into wealth advisory, Jamie was an equity sales trader for two decades covering global financial markets and servicing both institutional and retail clients. Having seen many market cycles, booms and busts, a key lesson that Jamie learnt is to never underestimate human ingenuity and its ability to adapt, improvise and overcome. Jamie hopes he can help to free the mind of others on the complexities and inter-connectedness of the financial markets, just like Morpheus in the “Matrix” movies.

References

[1] https://tradingeconomics.com/singapore/inflation-cpi

[2] https://tradingeconomics.com/singapore/inflation-cpi

[3] https://tradingeconomics.com/singapore/inflation-cpi
[4] https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm

[5] https://data.worldbank.org/country/US

[6] https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
[7] https://data.worldbank.org/country/US
[8]https://www.bls.gov/opub/mlr/2020/article/job-market-remains-tight-in-2019-as-the-unemployment-rate-falls-to-its-lowest-level-since-1969.htm#:~:text=The%20U.S.%20labor%20market%20remained,rate%20increased%20over%20the%20year
[9] https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20210728.pdf
[10] https://www.bls.gov/news.release/pdf/empsit.pdf

[11] https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20120913.pdf

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