Sunday, October 16, 2011

Is A CPI Adjustment What It Looks Like?

Last week’s article (Savers Are Losers) generated the most number of queries and comments from readers so far on this column. For the sake of people who may not have read the article, the four main reasons people who save money end up losing instead of making money are:

1. Banks charge account keeping fees;
2. Interest rates on deposits are very low;
3. The government charges interest withholding tax at 15%; and
4. Inflation wipes out most if not all of what savers may earn from interest after taking account of the above three reasons.

One thing about the effect of inflation is that it cannot be seen. Savers can see from their monthly statements the fees that are charges by banks; they can easily see the interest rates that are offered by banks for various types of saving accounts; and they can easily see the amounts the government collects in taxes on interest earned. But they cannot see how inflation works to wipe out the ‘purchasing power’ of both their savings and the interest they earn on deposits.

Savers with the super funds, for instance, may get excited that their so-called retirement savings been growing in recent times. They may have received double-digit returns, but what they may not realize is that high inflation means reduced real returns.

Let me now look at upwards adjustments in salaries working people see in their salaries on account of increases in the Consumer Price Index or CPI.

I have met many people in my personal financial management and investing seminars who have admitted that they have raised expenses or borrowed money when they have received CPI adjustments in their salaries. They have been misled into thinking that their salaries have been increased (so they can now afford to spend more or borrow), whereas the truth is that they have merely been compensated for the reduction in their real incomes on account of rising costs of living.

Such CPI adjustments used to be by the full rate of inflation as announced by the National Statistical Office. In recent times adjustments have gone only part of the way, and that only after employees have raised the issue with their employers. Rising costs also affect employers so they are not so keen to talk about CPI adjustments. My prediction is that CPI will be a thing of the past in PNG as inflation goes into double-digits in the coming years. I also predict that there will be more calls for pay increases as workers find their salaries buying less and less. It will come to a point where workers have to decide between fighting for higher salaries and losing their jobs, or keeping their jobs and being content with stagnating nominal (cash) incomes and falling real incomes, and hence living standards.

The other thing about CPI adjustments is that it has the potential to push workers into higher income brackets, with the result that they end up paying more income tax. Effectively the government gets a raise in income tax every time workers get compensated for rising costs of living. The twin effects of inflation and income tax usually pushes workers back in terms of their standards of living.

So in answer to the question “Is a CPI adjustment really what it looks like?”, the answer is “No”. You simply cannot take things at face value. You have to look deeper at the inflation rate as well as the income tax implications before getting excited whenever the employer announces that you will receive a CPI adjustment in your salaries.

Thursday, October 6, 2011

He Who Produces Food Shall Rule And Reign!

In several past articles I have discussed the food shortage situation in the country. The articles were based on what was presented at the recent National Food Security Policy conference at the National Research Institute.

In this article I would like to look at a story in the Bible. It is about Egypt’s food security program under Joseph’s stewardship.

The story starts with King Pharaoh having two consecutive dreams. In the first, the king saw seven fat cows coming out of the Nile River. While they were grazing by the river, seven ugly and bony cows also came out of the river, and ate up the fat cows. Pharaoh woke up, and when he slept again, he saw seven heads of grain on one stalk that were plump and good looking. Then he saw another seven heads which were blighted by the wind. While he watched, the seven blighted heads of grain ate up the seven good ones.

Pharaoh woke up and immediately called all the wise men and magicians of Egypt together and told them his dreams, but none of the men could interpret it for him. Finally Joseph was called out of the dungeons of Egypt, and he told Pharaoh that the dreams meant the same thing. There were going to be seven years of abundance in Egypt, followed by seven years of famine. The famine would be such that the good years would be obliterated from peoples’ memories.

Joseph therefore advised the king as what he should do to ensure the country’s food security during the famine years. His advice was basically that the king should establish warehouses in every city in the country where the excess food from the good years would be collected and stored under the stewardship of a wise and prudent man. This food would be available to the people during the seven years of famine.

The king accepted the advice and appointed Joseph to take charge of the program. In fact Pharaoh appointed Joseph as his second-in-charge, or Prime Minister of the country. Joseph therefore went throughout the country, built large warehouses, and collected the excess food and stored them. There was so much food that Joseph’s officials gave up trying to keep records!
The story gets interesting as the famine begins. It goes that the people came to Joseph to buy the food which they had initially given away to be stored during the years of plenty. Joseph gathered up all the gold and silver in the land of Egypt by selling food. When all the money was transferred from the people to Pharaoh, the people came and offered their livestock in exchange for food. So Joseph gathered up all the animals in the country for Pharaoh. In the following year, the people came and told Joseph: “All our money and livestock is gone from us. There is nothing left but our bodies and our land.”

Joseph told the people to trade their land for food, which the people were more than willing to do (when survival is at stake, people can get desperate). So Joseph bought up every piece of real estate in Egypt for Pharaoh, and he moved the people off the land into the cities. The foot note in one of the translations of the Bible says that Joseph ‘made the people virtual slaves.’ The only people who were given free food and whose land Joseph didn’t buy were the priests.

By the time the good times returned again, the people had been displaced from their land. They were all at Pharaoh’s mercy. They were then given seed to sow – on Pharaoh’s land – and told to return 20% of the harvest to the landlord while they kept 80% for themselves. So the people of Egypt went from being land owners to peasants with a 20% tax on the produce of the land. Pharaoh’s rule over them therefore became more entrenched.

If you are not familiar with the Bible, the story is found in the book of Genesis chapters 41 and 47. To summarise the story, we can say that the people of Egypt traded their money for food, then they traded their livestock for food, followed by exchanging their land for food, and finally their lives for food. In short, it was:

• Gold and silver (money) for food;
• Livestock for food;
• Land for food; and
• Lives for food.

One important lesson we can deduce from this story which took place thousands of years ago is that one can never go wrong producing or trading in food. If you have food, you get sell it for money. In a situation where the demand for food exceeds its supply, you can sell at very high prices. And if you are the only one selling food, you can sell at monopoly prices.

With the money you can buy and own livestock, which is another form of wealth. This is especially so in the Highlands region, where pigs in particular are in very high demand such as to cause prices to triple in the past few years.

You can also use the money to buy land anywhere in the country. Can food empower you to become a real estate owner? According to this Biblical story, the answer is ‘Yes’. You start by producing food on your own land in the village, and slowly make you way into the urban areas.

And you can use the money from your farm to buy slaves (also known as employees). It doesn’t matter whether you have been to school or not. If you use your knowledge of gardening which you have received from your primitive ancestors, you can eventually make very highly-educated people work for you.

The ultimate result? You rule and reign over the land and other people. You become a Pharaoh in your own way.

If you are a landowner reading this, I hope you get the lesson from this ancient story. I hope you start producing food tomorrow. If you are unemployed and looking for a job in town or just hanging around in your community, I am telling you that there is hope and money – and it is in your land in the village. There is more than enough money in the land for you to build a high-covenant house or buy the latest model Toyota Land Cruiser with cash!

If you have a job, you will realize that the bulk of the money you earn goes to buying food and keeping yourself alive. You are working, buying food, and working – without getting anywhere financially. It is probably time for you to cast aside your educational qualifications and your job, and return to the village to till the land. You can start from scratch as a farmer, then work your way back into town as a real estate investor and an employer.

I have said this several times on different occasions, and I will say it again: In the kind of economy we are living in today, the people who are going to make the most money are business people and farmers. Working class people are the ones who will become poor while farmers and those in business become rich.

Savers Are Losers

In a previous article I described money as a faithful servant but a terrible master. In another, I stated that rich people don’t work for money. In other words, they have learnt how to make money become their servant. While money works for them, they live the life of their dreams.

I have received a lot of feedback on the articles. One question readers have asked is whether saving money in the bank is a way to make money work for you. I would like to respond to this query in this article.

You can save for different reasons. Most people save for a ‘rainy day’, meaning that they put money aside to meet unexpected expenses. Others save for school fees, to buy household items, meet customary obligations, etc. In other words, they save for consumption. They save to spend.

Other people save for their retirement. In PNG, the majority of working people save with one of the superannuation funds or savings and loans societies. Currently the law says that workers are to contribute 6% of their gross salaries towards their super fund savings while employers contribute 8.4%, for a total of 14.4% every fortnight. Some employees save more than 6% of their salaries in their super fund accounts.

A third group, and I would say a very small minority at that, save for the purpose of investment. That is to say, they save money to start businesses, purchase investment property, shares etc.

For whatever reason you save, what you need to realize is that you could be losing money by just saving it, for several reasons.

Firstly, banks charge account keeping fees. You essentially pay them for maintaining an account with them. The result is that the balance in your account drops even though you have not made any withdrawals. Your bankers will tell you how much it charges if you care to ask them.

Secondly, interest rates are so low that you could in fact not be making any money from your savings account. Current interest rates for deposits with the country’s leading bank range from 0% to 3% per year for amounts ranging from K9,999 to K100,000 respectively. Interest rates for deposits are at an historical low because of very high liquidity in the banking system.

Thirdly, the Government charges an interest withholding tax of 15% per year. This means that for every Kina you earn in interest, 15 toea goes to the Government and you receive 85 toea. It makes no sense to penalize people for saving, but that is as the law stands today.

Finally, in times of high prices for goods and services, such as we are faced with currently, the purchasing power of both the principal and interest earned on savings is reduced by inflation. The Bank of PNG has reported that inflation for the June quarter of 2011 was 9.6%, and it is forecast that inflation will exceed 10% by the end of the year and beyond.

Let us see what this means for savers. The interest being paid by the leading bank for term deposits for 12 months is 3%. If you had earned this kind if interest, and with inflation at 9.6%, your real income would be minus or negative 6.6%. You would have lost money instead of making it. It would have been like taking one step forward and three steps backwards. In the meantime, the bank would have made money using your money by lending at interest in excess of 14%.

This article is titled ‘savers are losers’ because people who save money, even in super funds, do not realize that they actually lose money by doing so – unless the interest rates they earn on their money are higher than the rate of inflation. In today’s economy, interest on deposits are actually very low, rendering it difficult for savers to really make money work for them.

Most people would say that saving money is good because of compound interest, which works as follows: You save some money which earns interest, then the interest earns interest. So it goes that money grows over time without any effort from savers. But for the reasons given above, compound interest does not work as it used to in the past. Even if the cash or nominal amount increases, the real interest income would be either very low or negative.

Given that this is the case, you would be wise to save whatever you can, then invest your savings in a business. A business is a vehicle that can empower you to either ride on or beat inflation. More on this later.