If you assume that saving is equal to investing, you might be in for a nasty surprise. You are also living with a big delusion because you don’t understand the ‘rules of money’. The rules of money permanently changed in 1971 when the then US president Richard Nixon took the US off the gold standard and granted itself the licence to print money. Since then, the US dollar and other world ‘currencies’ have depreciated while prices of all commodities measured against it—be it precious metals like gold, silver or industrial metals like steel, copper, aluminium or agricultural commodities—have gone up and will continue to go up over the long term. That’s why we call money as currency.
Although we all love money but, invariably, we are all fooled by it. The problem is that, while most of us love money, we don’t realise how to value it. If you think hard, you will realise that money is nothing but paper and has no value in itself except that it can be exchanged for goods and services. Thus, the value of money is not intrinsic; it is what it can be exchanged for in return. Which is why money, today, is nothing but a currency which can be exchanged for other goods and services. And the more the goods and services we derive for a given amount of money, the more the value of money and vice versa. This is what I meant by knowing the value of money.
If you are still confused, let me give you a simple but a very common and practical example. As I mentioned earlier, most of us have illusions about money—the more the money we get, the better off we think we are and vice versa. But this may not always be the case. Let us consider a simple example of an employee
Mr X who got a 10% salary increment when inflation was 12% while, in another year, he got 5% increment when inflation was 3%. Which one would he prefer and which one should he prefer? In all likelihood, he will prefer the first case of 10% increment, although the second one is superior. The reason is very simple and logical. In the first case, the employee is getting negative real increment since inflation is higher than the salary increase; while, in the second case, he is getting positive real increment since inflation is lower than the salary raise. Thus, in the first case, the value of money in his hand is lower while, in the second case, the value of money in hand is higher. Again, I repeat that money is just a currency with no real intrinsic value. Its value is derived from how much of goods and services one can buy with it; the more the amount of goods and services which can be bought with a given amount of money, the more is its value and vice versa. This is called the money illusion and one of the main reasons why people prefer investment in fixed deposit at negative real interest rates after tax rather than long-term tax-free gains through stocks.
One of the other facets of the money illusion is tax as it eats into your gross income. Although almost everybody hates to pay tax but people, often, don’t realise how they can legally reduce their tax liability. It’s very simple. The government has made very discriminative tax laws. The rich know it and take advantage of it, while the poor and middle-class become its victims. The government’s tax system is regressive, i.e., it puts maximum taxes on ‘earned income’—the income that you work hard for like, say, salary. At the same time, it totally exempts from income-tax certain other forms of income, such as dividends, long-term capital gains, etc, which constitute all passive and portfolio income—the income derived from your investment assets whether it be shares, real estate, etc. The tax is also regressive because it taxes the rich at a much lower rate. For example, the ‘net marginal tax rate’ after deductions is much lower on a business than it is on salary. A salaried employee hardly gets any deductions and most of his earned income is almost fully taxed, while a businessman gets all kinds of expenses—whether he actually spends or not—as deduction and the net taxed money is lower. I say whether he spends or not because there are certain expenses which the businessman actually spends money on, like staff salaries, telephone bills, electricity bills, etc, which are allowed as a deduction from income; but there are certain other items, such as deprecation, which is not a cash expense but is still a deductible business expense. That is why the tax system is regressive and favours the rich, i.e., middle-class people buy assets in their individual names while the rich buy assets in their businesses; typically, the companies which they own buy the assets for them and enjoy all the legally allowed benefits on it. Thus, the rules of money are not fair and give the rich an unfair advantage.
Coming back to inflation, unlike income-tax which goes out from our pocket and pinches us; hence, we know it, inflation is a hidden monster with a double-edged sword. Although we may know it, we simply fail to recognise it and accept its presence. As the famous economist Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon.” That is why it is very important to understand the concept of ‘fiat money’ as currency. Those who are ‘savers of money’ and hold their savings as currency will be big losers over a period of time. The government can, and will, keep printing money which will result in larger and larger amounts of money chasing the same limited quantity of goods and services. And as we know from the basic premise of economics—demand and supply—when the supply of a particular item (money) increases without actual increase in output (goods and services), it invariably results in a fall in the value of money. The simple rule is that more the money chasing a fixed supply of goods and services, the more will the rise in price of those goods and services get expressed in terms of ever increasing money supply. Thus, by printing money, the government is, in effect, ‘stealing money from your pocket’ by diminishing its value.
If you still don’t believe how income-taxes and inflation are eating into your wallet, then consider this simple example. Say, today, you have Rs100 and the price of your favourite slice of cake is Rs100. So, with your Rs100, you can buy and eat the cake. Now, if you ‘save’ that money in a bank fixed deposit at 8%pa (per annum) rate of interest and are subject to, say, between 20% to 30% rate of tax, your Rs100 adds up to around Rs106 after one year. Now, assuming the current inflation rate in the economy is 10%, your favourite cake now costs Rs110 and, hence, out of your reach. Therefore, while, today, you were able to enjoy your cake with the Rs100, you are not able to enjoy it after one year, in spite of having ‘saved’ your money, thanks to tax and inflation. You can neither have nor eat your cake!
Therefore, in today’s fast changing technological currency age, savers are losers. Instead, invest in assets like equities, real estate, commodities, etc, which actually benefit with inflation and also give you tax breaks. No doubt, nothing is linear and every asset goes through its own cycles, but the long-term compounding benefits will ensure that your purchasing power remains intact and you can have as well as eat your cake.