Inflation Is Killing Our Future : Prices Aren’t Going Up, The Ringgit Is Going Down – The Ringgit Is A Currency Masquerading As Money

Recently, the domestic trade and consumer affairs ministry put out what I thought was a rather odd statement. The ministry said it would question the maker of Massimo bread about the recent hike in its price.

Apparently, the ministry did the same when the maker of Gardenia raised the price of the bread on Dec 1, 2021. Unsurprisingly, the maker of Gardenia responded by saying it was forced to do so as the cost of raw goods had risen. However, to appease the ministry, it promised to come up with a new product that would be sold at the previous lower price.

Gardenia’s promise of cheaper bread might seem like a win for the government but I can’t imagine how they would achieve this without cutting corners. Is this really a win?

This is a case of shooting the messenger instead of addressing the underlying problem. The hiking of prices by the makers of Gardenia and Massimo, and countless other companies, is merely a canary in the coalmine – a signal that something has gone awry in the local and global economy.

One of the main reasons – and I argue the underlying reason (in addition to the reasons put forth by Malaysia’s ministry of domestic trade and consumer affairs, which I covered in my previous column) – is summed up by the chart below:

The chart above shows the incredible increase in the ringgit’s M2 money supply (a measure of the money supply including cash, current accounts and easily convertible near money) over the years.

To illustrate how drastic the money printing has been, we can see that in the mid 2000’s, there was only around RM0.5 trillion in circulation but now it’s hovering around RM 2.1 trillion.

That’s a quadrupling in money supply in a mere 15 years.

If this looks bad, let’s look at the US dollar’s M2 money supply – the most dominant currency in the world and the currency in which much of world’s trade is priced:

The chart above looks more like a booming startup boasting exponential growth than the monetary expansion of the world’s most dominant currency. The sudden uptick in 2020 is due to the trillions of dollars printed to fund the 2020 Covid-instigated stimulus.

But to be fair, this swelling in money supply isn’t all due to Bank Negara Malaysia (and the US Federal Reserve) literally printing money (also referred to as quantitative easing). Sure, they do that too, but as all central banks do, they have two more tools in their toolbox – reducing the interest rate and their fractional reserve lending requirements.

A central bank’s interest rate is the rate at which commercial banks borrow and lend money to each other. The lower the interest rate, the more they are likely to borrow, with the inverse also being true.

Meanwhile, the fractional reserve lending requirement is the minimum amount of customer funds that commercial banks need to keep in their coffers at any one point. Similar to the interest rate, the lower the fractional reserve lending requirement, the more liquidity the banks have – allowing them to move money around in order to earn interest on it.

The table below contrasts the pre pandemic interest rate and fractional reserve lending requirements of both Malaysia and the US to the rates as they stand now.

As is evident, Malaysia, the US and most other nations reduced both the interest rate and the fractional reserve lending requirements to provide additional liquidity to the market. By doing this, they encouraged banks to give out more loans and seek out more investment opportunities, instead of having their cash reserves sit in their coffers and serve as the inclement economic conditions’ buttress they are intended to be.

This in turn increased the total money supply thanks to the money multiplier effect.

This ballooning of the money supply makes every unit of it ever less valuable over time. It is therefore more accurate to say the value of money has dropped rather than to say the price of goods and services have risen.

If you think about it, pretty much every food item that we buy today is produced more efficiently, faster and with far less labour than it was 50 years ago. By right, this Cambrian leap should have resulted in cheaper food.

However, due to the increase in money supply, what we’re left with is food costing more even though the energy required to produce them has gone down drastically over the years.

For example, the cup of coffee that cost my father 20 sen 50 years ago costs me RM2.50 today although the amount of energy expanded in growing, producing and brewing the coffee has decreased considerably due to such factors as better technology, more efficient production methods and less labour.

Some economists provide plenty of reasons why this surge in money supply is justified, with some even encouraging it.

But as an engineer, this doesn’t make sense to me (the reasons for which will be elucidated in my column tomorrow). If it were that easy, every country would do it – as some have tried to with disastrous effect (recent examples include Venezuela, Turkey and Zimbabwe).

The reason the US has been able to print so much money (almost 40% of all US dollars in circulation today was printed in the past two years) and yet not collapse under hyperinflation is due to its primacy as the world’s reserve currency and the currency in which most of the world’s trade is conducted.

This has essentially allowed the US to export its inflation problem to the world.

So, we’re stuck in a situation where the governments of the world, including Malaysia’s, gradually increase their money supply, debasing it. It generally happens slowly enough that we don’t notice it too much, but the Covid-19 stressor has acted as a catalyst, accelerating this trend and transforming what is usually a gradual pinch into a walloping punch.

In a nutshell, we’re like unsuspecting frogs in a pan of water, with Bank Negara and the US Federal Reserve slowly increasing the temperature (expanding the monetary base). The rise in temperature might be insignificant enough within a short period of time that we might not notice it but given a long enough time frame, we will be boiled to death.

Source : FMT

The ringgit is a currency masquerading as money

In my previous article, we looked at how money is created and how increasing amounts of it are being created these days. That, as we’ve seen, contributes to inflation and poses problems.

However, some people argue that printing money is normal and nothing to scoff at.

This “print and don’t be damned” approach has seen a renaissance in recent times, thanks to the popularity of Modern Monetary Theory (MMT) – a school of economic thought that posits that “governments with a fiat currency system under their control can and should print as much money as they need to spend because they cannot go broke or be insolvent”.

In fact, at the end of 2020, two popular economists advancing the virtues of money printing commented optimistically that since Malaysia’s headline inflation was negative and the forecast was for low inflation well into 2021, the real risk was deflation and not inflation. I wonder what they have to say about the rising, even skyrocketing, prices of many essential goods since mid-last year.

I think a useful way of diagnosing the problem is by using a physics-based mental model. To do this, let’s undertake a first principles approach by asking ourselves what money is.

For something to be considered money, it needs to be these three things:

A medium of exchange;
A unit of account; and
A store of value.
Most fiat currencies – meaning central bank-issued currencies that are unbacked by an asset such as gold (which include the ringgit, the US dollar and most currencies in the world) – satisfy both the first and second criteria. For instance, the ringgit is widely accepted in Malaysia and so is a good medium of exchange. It is also a good unit of account as it does its job of pricing goods and services without fluctuating wildly.

However, I would argue that the single most important characteristic of money is its ability to store value, in other words, to be able to transport value without any loss across space and time. Without this crucial element, we would have to consume everything we produce in the present. Money allows us to store the products of our labour so it can be used at a future time.

But, as I’ve demonstrated in my previous two articles, fiat currencies are poor stores of value as they rapidly lose their purchasing power due to today’s prolific money printing.

To evaluate this in a physics-based framework, we can think of money as an energy battery. Sure, it’s also a unit of account and a medium of exchange but fundamentally, if it fails at storing energy effectively, it fails as money.

For instance, as an engineer, I am paid a salary (monetary energy) for converting food (chemical energy) into ideas that eventually become engineering products (kinetic, electrical and thermal energy). Every person in the world earns money (accumulates energy) by converting different forms of energy into others.

This money then becomes something like a lifeforce – the energy that sustains us and allows us to live a comfortable life or lack thereof.

The most important aspect of this concept is the law of conservation of energy, or more commonly known as the first law of thermodynamics. It states that the “total energy of any isolated system is constant; energy can be transformed from one form to another, but can be neither created nor destroyed”.

Inflation via money printing transgresses this fundamental law of physics.

The implicit assumption behind money printing is that banks and governments can issue pieces of paper without a corresponding increase in economic productivity (conversion or transfer of energy) and still have it hold value.

They are trying to create energy out of thin air.

But of course, the rising cost of goods that accompanies money printing is proof positive that you can’t do this. The result of trying to create monetary value (energy) out of thin air is inflation – a relentless reduction in our purchasing power, and lifeforce, over time.

It’s akin to having a battery that leaks energy until it eventually empties out. What good is such a battery?

So, the ringgit – which, in getting inflated has failed at being a store of value – is merely a currency masquerading as money.

Sure, some economists might say that we can’t apply the laws of physics to economics. And some others might say that a certain level of inflation (1% – 3% per annum) is sustainable and in fact should be welcomed as it encourages spending, thereby stimulating the economy.

I might not agree with their arguments but nonetheless see their point of view, considering how the current financial system is designed. However, what is indisputable is that the levels of money printing now are unsustainable.

And I’m not the only one saying this. Sun Guofeng, head of the People’s Bank of China’s (China’s central bank) monetary policy department pulled no punches as he described Modern Monetary Theory as “specious” before stating: “It will impact the price system, distort economic decision making and mark the opposite direction against the goal of economic and financial stability”.

Unfortunately, central banks and governments around the world are now stuck in this ghastly spiral. People are accustomed to getting cash handouts whenever a crisis strikes and governments become desperate for money. Banks want lower interest rates so they can borrow and lend more liberally to ensure their customers don’t default on payments – and cause the financial house of notes to crash.

The problem is, the government is paying for it with our future – a future in which things become increasingly more expensive and out of reach for most of us.

Source : FMT

Inflation is killing your future

I’ve noticed something peculiar happening over the years. When I was a teenager, I would accompany my parents to the Giant hypermarket in our neighbourhood to pick up groceries. The month’s haul – which would fill up the shopping cart – would cost my dad around RM500 or so. And every so often, he would lament about how when he was a teenager growing up in the 60s, things were so much cheaper.

But of course, as most teenagers do, I brushed off my dad’s comments and just accepted this increase in prices over the years as a natural phenomenon. In my mind, price hikes were just something that happened, like gravity or growing old – no explanations were needed.

But as I got older, and especially after I started working, I began taking this seemingly natural phenomenon much more seriously. After all, it was thinning my own wallet and I didn’t like it. I wondered why I had to pay increasingly higher prices for goods that pretty much remained the same over the years? I mean, how much can you improve sugar or spinach or milk? And yet, I was asked to cough up more and more money for it over the years.

But again, this wasn’t an urgent enough matter for me to merit a deep dive – until now, that is. The RM500 that would fill up my parents’ shopping cart 15 years ago barely fills up a quarter of mine today. Most alarmingly, this increase in prices seems to be accelerating, all while wages remain largely stagnant.

The logical first step when conducting this inquiry is to look at the data put out by Malaysia’s authoritative but decidedly conservative department of statistics (DOSM). Its rather comprehensive Consumer Price Index (CPI) report in November 2021 pointed to some troubling trends.

The CPI is a weighted average of the prices of a basket of consumer goods such as food, transportation and electricity. It’s not a perfect metric as it is susceptible to manipulation, but it is nonetheless still a useful tool to ascertain the inflation rate.

However, simply looking at the headline CPI (inflation) number is often uninformative and sometimes even misleading. Instead, looking at the change in prices of specific important goods provides a better read on the inflation rate.

For instance, headline inflation (from November 2020 to November 2021) was 3.3%. Is it ideal? No, but it is still not alarming enough to be a source of consternation for most. However, when we look at the price inflation of specific important goods, the situation is a lot more dire (and in line with what our everyday experience tells us). The table below makes this painfully clear:

Sure, many other goods not included in the table above didn’t inflate by as much but these are some of the most important goods that we Malaysians consume on a regular basis and the headline inflation rate of 3.3% doesn’t capture the much more sinister reality we live in. The useful graphic from DOSM shown below visualises this well:

cMany items underwent drastic inflation, with some of the most important goods undergoing the most inflation (chicken, electricity and petrol) while some less important and/or lower value goods underwent the most deflation (ginger and fabric softener).

Crucially, CPI numbers are often lower than reality as it’s in the best interest of the powers that be to convince the populace that the situation isn’t as dire as it seems, a view that is given credence by a 2020 International Monetary Fund paper by economist Marshall Reinsdorf that argues that inflation is underestimated.

So, it’s extra worrying that even official CPI numbers can and are being underestimated.

Another metric that can be used to get a read on inflation is the Producer Price Index (PPI), which is a measure of the inflation of the input costs of local producers. The higher the input costs for producers, the more they have to pass on this cost burden to consumers. Due to this, the PPI is often considered a leading indicator of CPI and hence inflation. In simple terms, higher PPI now equals higher CPI in the future.

The PPI infographic from DOSM below shows an alarming situation.

Even headline PPI is a whopping 12.6%, with mining, agriculture and manufacturing undergoing the most amount of inflation at 71.2%, 19.1% and 8.4% respectively. Remember, their price hike today is often our price hike tomorrow.

To illustrate this, the table below shows the 2021 PPI and CPI rates in China. As can be seen, once the PPI spikes, the CPI follows suit a month or two later.

So, if I were to venture an educated guess, I would say that real CPI in Malaysia is probably around 5-7% – double the official government number. I am basing this on a few things:

Even though the headline CPI is only 3.3%, inflation in some essential goods has far exceeded this (as shown above);
PPI, which is an indicator of future CPI, has skyrocketed;

The US has an officially reported inflation rate of 7%, the highest it’s been in 40 years. With the US dollar being the world’s reserve currency and a currency that Bank Negara holds billions of, its inflation becomes the ringgit’s inflation;

The ringgit (RM) is depreciating against the US dollar. US$1 was worth RM3 ten years ago (2012) but now it’s worth RM4.20; and

More speculatively, there is some data to suggest that the US inflation rate might be double the reported number, which would put it at a whopping 15%. This figure was arrived at by using the 1980’s inflation calculation methodology, instead of the watered down one used today.

At this rate (5-7%), you will lose half of your wealth’s purchasing power in a mere 10 years if you hold it in ringgit. And even if you would rather believe official CPI numbers (3.3%), that means you will lose a quarter of your wealth’s purchasing power in 10 years.

Unsurprisingly, this grim reality has not gone unnoticed. Malaysia has many issues, but this ghastly increase in prices has been front and centre of national conversation recently, and for good reason. This situation affects everyone but as is usual, it disproportionately affects the poor and disenfranchised as they are the ones likely to be reliant on stagnant, low wages.

The past year has seen their expenses increasing, their bank accounts dwindling and their standard of living plunging.

This double whammy of Covid-induced career realignment (to put it mildly) and drastic price inflation has already pushed many over the brink. The devastating recent floods have only added another stressor to a system and society still reeling from Covid-19 and inflation’s one-two punch.

But why is this happening? Why are prices going through the roof?

The factors it cites for inflation are:

Price manipulation by middlemen;
Increase in the cost of logistics and transportation;
The ringgit’s depreciation compared with major currencies;
Rise in oil prices, especially petroleum;
Rise in import prices, especially food;
Activity of cartels and monopolies;
Greed of businesses and their focus on profits;
Rise in production costs; and
Imbalance between demand and supply.
Sure, these reasons are valid and are partially to blame for the inflation we’re seeing. However, oddly enough, there is one reason the ministry failed to include – the one reason that underlies and rules them all.

Source : FMT

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