Understanding Inflation For The Ex Pat

[m_right]

I thought I would share this from a differnt board with permission of the author:

[quote name='eyenitnoy' date='Feb 20 2011, 07:22 PM' post='2052413']
For the Ex-Pat there is nothing more frightening than the thought of inflation. Over time, the erosion of one's purchasing power can turn a comfortable retirement into poverty. In this post I attempt to give the reader a feel for just how inflation will change their life.


Part I: HISTORICAL DATA.

In order to begin to understand what inflation may be like in the future, we must first understand what it has been in the past. Inflation is very difficult to get a feel for because it is a discontinous array. What I mean by that is prices move in steps. The cost of a barfine, for example, does not go from 300 baht to 315 baht in one year if the inflation is 5%. It stays the same for a period of time and then jumps to, say, 400 baht. Thus, the price does not move continuously. It moves in steps. Added to this is the fact that the consumer will alter their behavior based on price. A person may switch brands of ice cream if one brand goes up, or they may give up ice cream altogether and, instead, eat pie. And as all of this is going on at the same time it becomes very hard to get a "feel" for the effects of inflation. As a result, people's guesses on inflation and how it will effect them are often very wrong.

So what is the history? Here is a chart of Thai inflation:

http://www.indexmundi.com/thailand/infl ... ices).html


This chart is very interesting. It gives ACTUAL data for inflation from 1980 until today. I use a good source, the international monetary fund. So we have actual data on a 30 year time period. And while the next 30 years may be different from the last 30 years, this still will function as a baseline. The range of inflation goes from 19.7% in 1980 to -9.4 in 1990. Thus, this 30 year period captured the high inflation time period coming out of the 70's as well as the recent deflationary depression we are still struggling with and will still likely keep inflation down for a few more years; This period covered economic booms and downturns, political unrest and stablity and everything inbetween. And what is the average?


AVERAGE THAI INFLATION 1980-2010: 3.99%

TOTAL PRICE CHANGE IN THAT 30 YEAR WINDOW: 300% (rounded)


So, if a fellow named Joe retired in 1980 with $1,000 dollars per month he would need $3,000 30 years later. Wait, you might say! I added up those percentages and they only came to 114%! Yes, but over time inflation compounds so you have to multiply them over time. Looking again over that timeline it takes from 1980 until about 1997, or about 17 years, for the prices to reach that first double. From there, the curve goes up more steeply in price. But wait again, you might say! If Joe's money is in dollars you also have to look at the ratio of Thai baht to the dollar. And this is correct.


Part II: Historical Data on Thai Baht to the Dollar.

If your currency is anything other than baht, you must also calculate how the currency will change over time. This is due to the fact that the change of your base currency relative to the Thai baht behaves EXACTLY the same as inflation. In other words, if your base currency, in this case the dollar, FALLS by 10% relative to the baht then prices, in baht, have INCREASED by 10% even if the number of baht in the asking price stays the same. Of course, it works the other way too. If your base currency RISES 10% relative to the baht, then prices, in baht, have FALLEN by 10% even if the number of baht in the asking price stays the same. And this effect compounds (multiples) over time with inflation. This tends to make the actual inflation of a person who uses a different base currency feels seem much more pronounced-it seems to rise or fall in larger spikes. And this feeling is correct. Since currency changes work exactly like inflation their price spikes ARE larger than those felt by a Thai.

So, again, what is the historical date?

Well, the history is interesting. For most of Thai history the baht was pegged to another currency. Thus, it's value was set relative to another currency. From the 19th century until the end of World War II, the baht was set as 8 Baht to one Pound Sterling. From the end of World War II until the 1980's it was set at 20 Baht to 1 Dollar. From the 1980's until July of 1997 it was set at 25 Baht to 1 dollar. And after July of 1997 the Baht was allowed to float and it has fluctuated since that time. The baht fell to a low of 56 to the dollar during the financial crisis of the late 90's and then rose to a high of about 29.5 to the dollar a few months back.

This is why most Ex-Pat's sense of inflation is so high. If you retired in 1997 with the baht at 56 to the dollar and it has dropped to about 30 to the dollar, you have an inflation multiplier of 1.86 (186%). Thus, prices have almost doubled just based on the exchange of currency in that time period. But what about over a longer time period? Well, compared to 1980 things are actually better. (And, I assume no black market for dollars in the pegged era, which may not be true. I use the pegged rate for this discussion.) In 1980 you were looking at 20 baht to the dollar. Now it is at 30. So Joe, from 1980, would actually still have a net deflationary effect from currency. But he still really liked 1997!

So what do we do going forward? Well, this is tricky. The data suggests that we should not factor in currency changes and suggests over long periods of time it evens out. But long periods of time can be very long-just ask anyone who retired in the last 15 years. In the short term the change in currency can have a huge effect. The best thing to do is to guess, that's right, guess, what the currency ratio will be in the future. If you think the dollar is going to Hell in a handbasket you could set the rate at 20:1 in the future or even lower. When I first made my retirement plan years back the dollar was sitting around 50:1 and I used 30 Baht to the dollar in my plan. I was laughed at and called crazy. But I predicted a lower rate because of history. The financial panic in Thailand of the late 90's was an unusual event and I did not expect it to last. I was correct. Today I am close to retirement and there sits the Baht, right around 30. (Told You So, Old Timers who Laughed at Me! )

My prediction for the future is a slow APPRECIATION of the Baht relative to the Dollar and other currencies over time. I base this on my theory that the Thai economy will grow more rapidly than the economies of the developed nations as well as the dreadful financial position of the U.S. government's balance sheet. In the 10-15 year time window I use 20-25 baht to the dollar; At 30 years I use 15-20 to the dollar. But you can use any assumption you want. In order to protect my retirement, I not only plan as to what I think the exchange rate will be in the future but I hedge against currency changes. This is a complicated matter and something I will not go into in this post. But if you are worried about currency and it's effects on your retirement (and you should be) remember there are things you can do. Even if you are on a fixed income, you can hedge or diversify in ways to counteract a falling base currency relative to the Baht.

Currency inflation multiplier: (Baht-Dollar today)/(Baht-Dollar in the future.)

If I predict 22.5 baht to the dollar in 15 years then the multiplier is 30/22.5=1.33. This number must be MULTIPLIED into whatever effect inflation has. Thus, if inflation was 4% over that same time period, the net increase in prices would be=1.8 (The coumpound effect of 15 years of inflation) * 1.33 (the currency multiplier)=2.39. Thus, if over the next 15 years inflation averages 4% per year AND the dollar falls to 22.5 the NET price change (in dollar purchasing power) is 240%. Prices will increase more than double. A barfine in a GoGo in 2025 will be 1500 baht. (600 today.) A Beach Road short time will be 1200 baht (500 today.) in today's Purchasing Power. (Remember, the Baht Price will actually be lower as it is denominated in Baht. But the "effect" of the dollar based purchasing power will be as listed.)


Part III: Inflation over time:

EYE'S PREDICTION: I use an inflation number of 5%. This is higher than the historical average. I will now make a 10, 20 and 30 year table showing the effect of 5% inflation. I will also make a 3% table and a 7% table. You can make your own table or pick one of the rates I use.

How to Use the Table: Once you settle on a percent inflation, you can look at the year number (1-30) for that percent inflation and you will see a multiplier. This is the number you multiply today's price by. Let us say you used 5% and you picked year X and saw the multiplier was 2.1. For the price of, say, a beach road short time you would expect that in that year the price would be 2.1X today's price.


TEN YEAR TABLE:

3%

Year:
1: 1.03
2: 1.06
3: 1.09
4: 1.125
5: 1.159
6: 1.19
7: 1.22
8: 1.26
9: 1.30
10: 1.34


5%

Year:
1: 1.05
2: 1.10
3: 1.157
4: 1.215
5: 1.276
6: 1.34
7: 1.40
8: 1.477
9: 1.551
10: 1.628


7%:
Year
1: 1.07
2: 1.14
3: 1.225
4: 1.31
5: 1.402
6: 1.500
7: 1.605
8: 1.718
9: 1.838
10: 1.967

Comparision: 4% historical average after ten years: 1.48


Summary: In ten years things actually go pretty well. Unless you use the highest number price increases seem manageable. At the 3% level prices are about by about 1/3 higher in ten years, at 5% prices are up about 60% and at 7% prices have doubled. And that is over ten years-most of the final increase comes at the very end. Using historical 4% data, the increase is 48%. So using historical data prices have gone up by about half in ten years. That Beach Road short time is 750 baht instead of 500. But ten years is an important inflection point in the retirement of the ex-pat. After about 5 years, all the guys who have retired with too little money are gone. These are the "stash guys" who come out with a lump of money and are going to make a go of it with a business or just "live off their investments" but they either have bad investments or just not enough cash. In five years, these guys are all gone. But at 10 years another cohort starts to disappear. These are the guys who had enough, but are victims of inflation. Maybe they have a fixed income pension that did not keep up with their Thailand based inflation. Or maybe their nest egg should have been good enough but it underperformed. (See why I hate fees!) In any event, the ten year time period is where they begin to drop off. It's sad and people often wonder why a long term Ex-Pat leaves. The answer is often inflation.


20 YEAR TABLE:

3%:
11: 1.38
12: 1.425
13: 1.468
14: 1.512
15: 1.557
16: 1.60
17: 1.65
18: 1.70
19: 1.75
20: 1.806


5%:
11: 1.71
12: 1.795
13: 1.885
14: 1.979
15: 2.078
16: 2.182
17: 2.292
18: 2.406
19: 2.526
20: 2.653


7%:
11: 2.10
12: 2.25
13: 2.40
14: 2.57
15: 2.75
16: 2.95
17: 3.15
18: 3.37
19: 3.61
20: 3.86

Comparision: 4% historical average after 20 years: 2.19

Summary: In twenty years, things get interesting. This is where inflation's hand really begins to show up. First, look at the 3% chart. This chart is lower than historical norms and when you compare it to the 7% chart you see that at the end of 20 years you are at the same point in price as you are after only 10 years at the higher number. The compounding effect of inflation REALLY adds up. At the 5% level prices have almost tripled and at the 7% level prices have almost quadrupled. And this is at a time where most retirees are older. If you retired at 50, in 20 years you are 70. Health and medical costs become more of an issue, as do things like housing (you probably want a nicer home than when you were a 20 something kid and could crash out anywhere) and food. And if you retired at 62 well you are now in your 80's. You may see much larger health costs. This chart shows why so few people are retired in Thailand after 20 years. It's not just that many of them have died-unless they started out well funded the effects of inflation have really hurt their purchasing power and with rising costs they may have had to draw too much from their nest egg. And, thus, their nest egg ran out. And don't think you can cost cut your way out of this problem either. For while you might be able to cut back on barfines in order to save money, you may not find it so easy to do so for medications, food or housing. As a result, you end up drawing too high a percent of your nest egg per year and then you run out of money. It is called extinction. And just like with the dinosaurs, going extinct is no fun at all.


30 YEAR TABLE:

3%:
21: 1.86
22: 1.91
23: 1.97
24: 2.03
25: 2.09
26: 2.15
27: 2.22
28: 2.28
29: 2.35
30: 2.42



5%:
21: 2.78
22: 2.92
23: 3.07
24: 3.22
25: 3.38
26: 3.55
27: 3.73
28: 3.92
29: 4.11
30: 4.31

7%:

21: 4.14
22: 4.43
23: 4.74
24: 5.07
25: 5.42
26: 5.80
27: 6.21
28: 6.64
29: 7.11
30: 7.61

Comparison: 4% historical average after 30 years: 3.24



Summary: Look how the 7% inflation has taken off after 30 years. In that time, prices have increased by a factor of 8! That is remarkable. If you started with a 100,000 baht per month budget in this scenerio you would need 800,000 per month to maintain the same lifestyle. I point out, this is likely a too high estimate. History does not support picking this number but past history does not guarantee future performance. At the 5% levels, prices have quadrupled and at the 3% level prices have increased by 2.5X. And, using the historical average, which is probably the best guess of the future, one gets 3.24 as a multiplier after 30 years. This clearly shows the huge impact inflation has on a person's retirement plans over time. In the first ten years, even if inflation is high, it generally can be weathered. But as the years past it becomes a huge issue. This is why, if you are retired and not working and have no pension, you need a million plus dollars in your nest egg at the start if you want a MODEST lifestyle for 30 years. With, for example, a million dollars a person could start out in year one with 100,000 baht per month as a draw and-assuming certain things-they would have a reasonable chance of their nest egg lasting the whole 30 years. But it is not a guarantee. Even with this huge starting nest egg you could run out. With less than that you are almost sure to run out.

FINAL THOUGHTS:

If you are retiring to Thailand you really need to think about how inflation will impact you over time. It is important. To figure out YOUR impact, do the following:

a) Give you starting budget, in Baht. Let's use Joe. He's a modest guy and he is starting with a budget of 75,000 baht per month.

b.) Decide how long you are going to live. I know, it's a guess. Joe figures 20 years. He is 60 years old and he uses this table to get his remaining life expectancy. While no one knows for sure how long they have, this table is a good basis for your guess:

http://www.ssa.gov/oact/STATS/table4c6.html

c) Pick an assumption for inflation. Joe decides to use 5%, a little higher than the historical average.

d) Go to the table of 5% at year 20. Joe finds the multiplier as 2.653

e) Guess what the currency will be worth in 20 years. Joe figures in 2031 it will be 20 baht to the dollar just like it was when his grand-pappy retired in 1980.

f) Calculate the currency multiplier effect. For Joe it is 30/20=1.5

g) Multiply the numbers in (d) and (f). for Joe it equals 2.653*1.5=3.979


Thus, for Joe, in 2031 he will need to draw just shy of 300,000 baht per month from his nest egg to maintain the same lifestyle that he buys today for 75,000 baht per month. (using dollar purchasing power)


If you have made it this far, I ask that you do the following. Post your own "Joe's Excercise". I would be appreciative if you plugged in your own assumptions, whatever they may be, just like Joe did and see what number you will be drawing after whatever number of years. It will be interesting for the readers.

And I hope, if you have made it this far, that you are looking at your own retirement savings in a new way. If you are, then my efforts have paid off. It is my hope that I might at least one person from retirement disaster brought on by a lack of understanding of inflation's invisible hand.

I wish you the best of luck in your retirement.


Eye
[/quote]

[richard]

WOW that was mind-blowing

Now I'm sh1t scared. I am retired and at the ripe old age of 65. My father lived until he was 99 and my mother 95.

Can't afford to live here another 30 years. Better pump up the fags and booze intake

[HAPPYGOLFER]

I,m not scared, but it was very interesting, In one way I,ll think you are looking into future the correct way, but painting the future it too black, I hope.

[migrant]

I made a excel spreadsheet as part of my retirement plan. It's amazing (and I work with numbers all day) how inflation can affect your plans

So between that, and falling real estate prices, I've postponed retirement for a few years

[Homer]

Thanks for the tables of historical Thai inflation rates and the baht/usd exchange rate. Now I can use a more meaningful inflation number, which will still make me go

Any idea of how the Thai inflation numbers are calculated? I'm cynical enough to think that any economic number that comes from a government has built in bias or a politically useful definition. Ignoring cynicism, I'd still like to see how it's calculated to see what portion of the goods and services I consume here are included and excluded from the calculations.

[bozzman101]

i think i will have to go back to work after i die!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

[margaretcarnes]

That really is mind boggling info - well done - but the puzzle to me is always figuring why retirees so often shell out what must be a significant chunk of their retirement pot on buying property!
Especially if it is going to leave them with a potential deficit in day to day living a few years down the line.
Is this a status thing? 'I've got a huge pension so I will buy a flash new house in paradise'
How many of us would even consider such an outlay back home at that stage in our lives?

Granted that is a very personal opinion, but the fact is that some retirees - based on your calculations - will end up having to leave the LOS anyway at some point. Then they will be faced with having a property there to sell. Not easy. And it does happen. Just as it has happened with, for example, Brits living in Spain etc.

Back 'home' things are different. Inflation is easier to cope with. We don't have the added exchange rate factor to cope with so what you see is what you get - and pay for. And above all there isn't the perceived pressure to try to live up to the dream. We can see more clearly where savings can be made. We can question overcharging for things like utilities much more easily. We can spread our outgoings by means of direct debits of equal monthly payments for practically everything. In other words we know exactly what we need for a month and how much will be left over before the month even starts. We can budget much more efficiently as a result and don't end up living an almost hermit like existance of the sort which is becoming all too common amongst expats these days.

[Pagey]

Excellent informative post Eye/ m_right. Still trying to take it all in and apply some of your logic to my scenario.

I am 50 and intend to retire at the end of this year to HH. I have my own spreadsheet detailing spend per month and income from investments and I try to use worst case scenario. Investments are all safe fixed term deposits which 2 years ago were earning over 6% and now only attract around 3.5% which is another scenario to consider if you want to live mainly of your investment income !! I don't intend drawing my company pension until I am 65 (paid into in with a large blue chip company for over 30 years) and I am fully paid up for a UK pension which I can draw at age 66 and is currently around GBP 5k per annum.

I already own a small property in HH so initially I will live rent free.

I nearly retired 2 years ago as I stated the interest rate was over 6% and the Thai Baht was nearly 70 to the GBP which is now below 50 so I am glad I did not or I would be struggling to make my stash last for 15 years until I can draw my pension.

Now wheres my calculator....................

[lomuamart]

Inflation here and bad exchange rates have certainly made a difference to how my wife and I live. However, we don't spend any more money (in Baht) than we did 6 years ago. Yes, prices have gone up, but the actual spend is the same overall. So, we've cut back on things without noticing them. It's been a gradual thing, but some form of financial discipline has been necessary and trying to work out where the money's being spent hasn't hurt either. (That was obvious to us, it was booze).
We eat better than we used to because we remember to cook, I play more golf than I did 6 years ago, I'm marginally fitter than I was before and so is my wife. All good things that have actually been brought about by a change in circumstances - for the better.
Ten odd years ago, I was seriously thinking about selling my property in central London, banking the money offshore and living the "good life" at about 6.5% interest. I was so lucky I didn't do it because we'd be stuffed now.
I realise that I'm trying to be upbeat about the economic situation, but the two of us are "cutting our cloth" and feeling better for it. There are positive angles that can always be eked out of a negative situation.
And the main thing is to try and be happy - no matter what!!
(BTW, with a glass of beer in hand and some "Black Grape" on the music, life isn't too bad. I'm going to clean my golf clubs now and look forward to lunch and a siesta).
EDIT: Pagey, our posts crossed.

[hhfarang]

For years (if not decades) before the crash in the late 90's the exchange rate seemed to be stable (pegged ?) at around 25 baht to the dollar.

Then the Asian crash happened and within a couple of years the baht was in the low 50's to the dollar. Ever since then it has been slowly and steadily creeping back to the 25/$1 that it had been for years before that.

Now at around 30 baht to the dollar the exchange rate is still better than it was in the early 90's but the cost of living has increased dramatically from what I've experienced to the point that you get much less for your 30 baht now than you did for your 25 baht before the crash.

[deepee]

m_right,
interesting analysis of an issue that is hitting many hard in LOS but it's all so academic and there lies the rub unfortunately.The world's economy is just too dynamic and the rules of today are old rules in just a couple short of years.Where Thailand will sit on any economic/political graph in 5 years time is just sheer speculation.I think deep down that the Thais do have it right after all and it's all about living for today. Don't get me wrong here in that I think you should be out every night blowing the lot on good booze and bad women, for some that red bus wobbling down the road towards us might just have your number on it . Sure we gotta be prepared but please don't let it burden your chance to enjoy Thailand as I have seen with many in recent times.

[Super Joe]

That really is mind boggling info - well done - but the puzzle to me is always figuring why retirees so often shell out what must be a significant chunk of their retirement pot on buying property! Especially if it is going to leave them with a potential deficit in day to day living a few years down the line.

When you work the figures out, it seems far more costly renting long term, as opposed to buying, ie: 30 year lease. Who knows whats going to happen over the next few decades once we've got out of the current mess, but these are historical averages from the UK for the past 50 years:
- Rental increases above inflation (generally track property values), ave. nearly 6% p.a.
- Inflation and bank interest rates (growth value of your savings) ave. 4% p.a.

Based on a 5m Baht, 3 bed, pool villa in Hua Hin, which rents for say 25k/month... I reckon this would cost 4.7 times as much by renting. Even if you invested the 5m purchase capital and managed to get a 4% return each year, it would still all get used up by rent payments within 15 years. So then you are having to use other income to carry on with the rent, which after 15 years has more than doubled to 56,000 Baht/month.

Year 20: 75k/month or 900k/year ... year 25: 100k/month or 1.2m/year ... year 30: 135k/month or 1.6m/year.
Altogether after year 15 and the initial 5m Baht has gone, you'll pay another 16.7m Baht in rents, and presumably if you bought in the first place, you would now have saved that 16.7m!?


"Halifax found prices rose by 273%, in real terms, between 1959 & 2009. Over the same period, the growth in real earnings was only 169%."

SJ

[PeteC]

...... Sure we gotta be prepared but please don't let it burden your chance to enjoy Thailand as I have seen with many in recent times.

I agree with that. We can think ourselves into a closet sometimes and never come out for fear of the unknown. You play the cards you're dealt and hope for the best. Pete

[margaretcarnes]

For years (if not decades) before the crash in the late 90's the exchange rate seemed to be stable (pegged ?) at around 25 baht to the dollar.

Then the Asian crash happened and within a couple of years the baht was in the low 50's to the dollar. Ever since then it has been slowly and steadily creeping back to the 25/$1 that it had been for years before that.

Now at around 30 baht to the dollar the exchange rate is still better than it was in the early 90's but the cost of living has increased dramatically from what I've experienced to the point that you get much less for your 30 baht now than you did for your 25 baht before the crash.

Maybe so HHF - but has inflation really hit Thailand as much as some Western countries? I think Lomu makes a good point - you gradually rein in spending when necessary - as I am doing in the UK - and it's amazing how many things you don't really need, and how many everyday products can be replaced with cheaper versions. All without any pain or suffering!
BUT - and this is a big but and perhaps makes the difference wherever you live - running a car these days costs. I've got used to living without one and looking back over the years can see where a lot of my money went in the past.

[Super Joe]

We can think ourselves into a closet sometimes and never come out for fear of the unknown. Pete

Well you're amongst friends here Pete, you know that, is there something you would like to tell us ......

SJ