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Monday, 14 January 2008

What you can do about... Inflation

By Larry Haverkamp (Doc Money)

OH no! Inflation is coming. And lots of it. Check out the trend: Inflation in 2005 was 0.5 per cent. It doubled to 1 per cent in 2006. This year, it will be about 2 per cent. Last month, the Government forecast 2008 inflation to be 2 to 3 per cent. Now, the official forecast is 3.5 to 4.5 per cent. What is going on? We haven't seen inflation this high since 1980 and 1981 when it hit 8.5 and 8.2 per cent. The all-time record was back in 1973 and 1974 when prices rose 20 and 22 per cent. For hyper-inflation, check out Zimbabwe, Africa. Its annual inflation rate is 9,000 per cent. An expat there complained that the price he paid for his home 10 years ago will buy only one bunch of bananas today.

THE BAD NEWS

There are two reasons why inflation could come roaring back: demand and supply. Demand: Li Xinru lives with his wife and son on a small farm in China. Last month, the family bought their first car. Of course, the car uses petrol which adds to the world's demand for oil. While it doesn't add much, there are millions of Li Xinrus out there. We only see the final effects: A surge of oil exports going to China, India and other developing countries. Supply: The problem is the earth. It is too small. It is unable to support all of us and no one wants to leave. Our planet's natural resources will eventually decline to zero. And it may happen sooner than you think. Take oil. Matthew Simmons' book, Twilight In The Desert, details why Saudi oil reserves are probably less than what they report. The extraction rate may also be too aggressive. It can cause wells to be permanently capped with as much as 60 per cent of the oil still in the ground. How long until the last well runs dry is anyone's guess. No Opec nation has ever permitted an independent audit of its oil fields. It isn't just oil. All natural resources are being used up. It results in sky-high prices for oil, tin, zinc, palladium, nickel, iron ore, gold and natural gas. Can anything save us? Ethanol - made from corn - is the leading substitute for oil. But now, scientists at Cornell University in the US have shown that ethanol production actually uses more energy than it creates. It leaves us with no good long-run solutions. About all we can do is to ration what remains, with resources going to the highest bidder.

THE GOOD NEWS

The short-run offers more hope. Our strong dollar helps a lot to lower the price of imports, which holds down inflation. But you can do more: Set your own inflation rate in seven easy steps.

Step 1: Inflation is the increase in the consumer price index (CPI). It is a weighted average of 5,170 goods sold at 3,000 outlets in Singapore. But watch out. It is only an average and Mark Twain has shown how averages can be misleading. Each of us is unique so we can create our own personal inflation rate. To keep it low, buy only the cheap stuff. For example, inflation ticks up when luxury watch prices rise. That inflation is easy to avoid: Simply leave the $10,000 watches for the rich tourists. A $100 Casio keeps time as accurately as a Rolex costing 100 times more. The same goes for holiday travel. Make day trips to Sentosa and save big.

Step 2: A home is a big part of our monthly budget. In fact, housing makes up 20 per cent of the CPI. But if you already own a home, as do 90 per cent of Singaporeans, then inflation doesn't hurt. In fact, it helps by increasing the value of your home, which is likely to be your biggest asset.

Step 3: Inflation boosts interest rates and that raises mortgage costs. You can solve it by borrowing long-term now, while rates are low. The best deal is a 30-year HDB mortgage at 2.6 per cent interest.

Step 4: For lending, do the opposite. Don't get locked into investments that pay only 1 to 2 per cent. Inflation is going to push those rates much higher. Especially avoid whole-life and endowment policies, including education policies. They lock you into guaranteed returns of only 1 or 2 per cent for up to 25 years.

Step 5: Go easy on unit trusts and stock investments. Studies show they do not perform well in periods of high inflation.

Step 6: In contrast, commodities and property do well in inflationary times.

Step 7: Money market funds are a safe investment. Best of all, they have no lock-in period. So the return will increase instantly when inflation pushes interest rates higher.

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