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There is an important aspect which is not well remarked in the article: high fixed-costs businesses are the ones that really suffer inflation. If every time yo

by simo7 9y ago

There is an important aspect which is not well remarked in the article: high fixed-costs businesses are the ones that really suffer inflation. If every time you want to expand you need to make significant investments (and there will always be a delay before it starts making money), inflation will affect your costs way before it will affect your revenue. Even worse, because fixed assets need to be replaced due to obsolescence every once in a while, you'll end up increasing your costs way more than you're increasing your revenue just to maintain the current production level. TL;DR: The more the delay between investment and revenue generation and the more capital intensive it is, the worst.

tomjohnneill 9y ago
Depends how you fund the investments. If you fund them by taking on more debt, then higher inflation is a benefit - it reduces the value of your debt compared to your product.
- simo7 9y ago
  In a context of _constant_ high inflation that's not true: the interest rates will already be discounting the future inflation. You have a positive gain of that type in case inflation grows more than expected. Enough to offset the negative impact given by the delay costs-revenue? Probably not in most cases. In fact the positive effect applies to debt made in the past which precisely because of inflation is likely to be lower than the new debt you need to take on (on which the negative effect applies). Of course also the opposite could happen: inflation grows less than expected after you took on a lot of debt. So for a capital intensive business it'd just be better to operate in a context of constant low inflation.
  - BenoitEssiambre 9y ago
    Economists usually say that with constant predictable inflation money is "neutral" meaning that the interest rates adjust to offset any higher cost so that businesses shouldn't be affected by inflation (except for a bit of "menu cost", that is the overhead cost of having to update price lists more often. Low inflation has huge potential downsides in that fiat money can't have negative nominal return while it is quite normal for private investment returns to go negative sometimes (thermodynamics says that things, including stores of value, tend to degrade with time unless you put work and energy into them). This is the famous zero lower bound problem. It means that when private market rates go negative, people transfer their savings to cash, the world switches from producing real stuff and building real businesses to people hoarding intrinsically worthless pieces of paper (pieces of paper that might not be able to buy that much in the future because production will have gone down. On top of this, if you keep interest rates above market rates and inflation too low for a long enough time, that is if you keep rates high at 0% when they should be at -3%, market pressure will build for an uncontrolled inflation rebound when all the cash hoarded on the sidelines start flowing in an economy with lowered production. It is much easier to keep inflation stable if you keep it high enough so that the investment market can always clear and never hits the zero lower bound.
    - simo7 9y ago
      Low inflation is usually desirable, just think that achieving 2% inflation annually is the main mandate for the European Central Bank. That's because even at 1%-2% inflation a year is difficult to spark the so-called thesaurisation phenomenon you're implying. In general I agree with you, I'd just change "low inflation" with "deflation". On the "money" being neutral with constant inflation. Yes, sure. It's the business dynamics that are not neutral. Quick example: - Say you have 10$ costs and 10$ revenue every year. - One year you expand production and you have to pay an additional 10$: so 20$ costs and 10$ revenue for that year. - With 0% inflation you have a 10$ loss (20-10), while with 10% inflation you have (20 * 1,1 - 10) = 12$ (about 11$ on constant prices terms) in loss (revenue won't grow till next year).
      - BenoitEssiambre 9y ago
        First, the ECB has nearly destroyed western civilization with their overly tight stance during the past decade. They destroyed the economy of their weaker members like Greece, eliminated the means of subsistence for their vulnerable workers which emboldened fascists and geopolitical foes like Russia. It was not difficult to spark the "thesaurisation". Excess reserves at the ECB and the Fed shot up by trillions. Natural market rates for investment were estimated by some around -4% and the central banks kept their rates very high at close to 0%. Yes deflation is worst but low inflation can be terrible in some situations. "With 0% inflation you have a 10$ loss (20-10), while with 10% inflation you have (20 * 1,1 - 10) = 12$ (about 11$ on constant prices terms) in loss (revenue won't grow till next year)." Not true, inflation means that revenues are constantly rising faster and financing costs are lower in real terms.
        simo7 9y ago
        > Yes deflation is worst but low inflation can be terrible in some situations. Agreed. But not because of what you are implying: "...people transfer their savings to cash, the world switches from producing real stuff...". That is rather a risk resulting from deflation. I agree because higher inflation can help an economy plagued with insolvent debt to "assimilate" it gradually and create new room for healthy debt. > Not true, inflation means that revenues are constantly rising faster. That's precisely what I'm denying: there's often a significant delay between the outflows of money and the inflows they generate (typically in high fixed-costs businesses). If you're expanding production every year and you see the added revenue only the year after it's not difficult to see how inflation would have a negative impact (even if constant!).
- fwdpropaganda 9y ago
  The article says just the opposite. > Cheaper leverage? Not likely. High rates of inflation generally cause borrowing to become dearer, not cheaper. Galloping rates of inflation create galloping capital needs; and lenders, as they become increasingly distrustful of long-term contracts, become more demanding. But even if there is no further rise in interest rates, leverage will be getting more expensive because the average cost of the debt now on corporate books is less than would be the cost of replacing it. And replacement will be required as the existing debt matures. Overall, then, future changes in the cost of leverage seem likely to have a mildly depressing effect on the return on equity. To be honest my intuiton is like yours. I still haven't managed to reconciliate my intuition with the above quote. I guess it would be something like this: It is true that inflation means that the stream of cash you will pay back is worth less, but the costs of keeping your business running (which in turn is what generate those stream of cash) also goes up. When this happened, lenders become more strict. You can read further down: > Nevertheless, given inflationary conditions, many corporations seem sure in the future to turn to still more leverage as a means of shoring up equity returns. Their managements will make that move because they will need enormous amounts of capital — often merely to do the same physical volume of business
  - HillaryBriss 9y ago
    In this light, it's interesting as a counterpoint to look at inflation's systemic effects. After the 2008 real estate loan bust, many economists hoped for more inflation so that the existing pool of loans would be a little more manageable for the debtors. (In Japan, they've been trying to increase inflation for decades). Even today, on financial news feeds and Bloomberg, when economic observers talk about "good news on inflation" they usually mean inflation going up, not down. I guess, overall, there's a sweet spot for inflation. Or what's good for corporate profits and banks is sort of opposed to what's good for the overall collection of people in the economy.
    - fwdpropaganda 9y ago
      > Even today, on financial news feeds and Bloomberg, when economic observers talk about "good news on inflation" they usually mean inflation going up, not down. Indeed, the sweet spot is believed to be 2%. It's good news because we've been under that for so long, not because the more the better. > After the 2008 real estate loan bust, many economists hoped for more inflation so that the existing pool of loans would be a little more manageable for the debtors. I'm not an expert, but I'll just point out that debt from a loan that you've put into a house probably doesn't have the same mechanics as debt from a company trying to fund its capital requirements. Not saying I agree or disagree with those economists, just pointing out maybe they're different.
danmaz74 9y ago
> TL;DR: The more the delay between investment and revenue generation and the more capital intensive it is, the worst. I think you're talking about high interest rates, not high inflation. High inflation means that, when you start generating income, you'll generate a higher income than with lower inflation. This, by itself, helps you repay the cost of your machinery faster. Usually high inflation also comes high interest rates, and that creates a problem if you have a delay between investment and revenue, but not inflation itself.
- simo7 9y ago
  I'm precisely referring to inflation. See the example I'm making here: https://news.ycombinator.com/item?id=16459396 https://news.ycombinator.com/item?id=16459396

by simo7 9y ago

tomjohnneill 9y ago

Depends how you fund the investments. If you fund them by taking on more debt, then higher inflation is a benefit - it reduces the value of your debt compared to your product.

simo7 9y ago
In a context of _constant_ high inflation that's not true: the interest rates will already be discounting the future inflation. You have a positive gain of that type in case inflation grows more than expected. Enough to offset the negative impact given by the delay costs-revenue? Probably not in most cases. In fact the positive effect applies to debt made in the past which precisely because of inflation is likely to be lower than the new debt you need to take on (on which the negative effect applies). Of course also the opposite could happen: inflation grows less than expected after you took on a lot of debt. So for a capital intensive business it'd just be better to operate in a context of constant low inflation.
- BenoitEssiambre 9y ago
  Economists usually say that with constant predictable inflation money is "neutral" meaning that the interest rates adjust to offset any higher cost so that businesses shouldn't be affected by inflation (except for a bit of "menu cost", that is the overhead cost of having to update price lists more often. Low inflation has huge potential downsides in that fiat money can't have negative nominal return while it is quite normal for private investment returns to go negative sometimes (thermodynamics says that things, including stores of value, tend to degrade with time unless you put work and energy into them). This is the famous zero lower bound problem. It means that when private market rates go negative, people transfer their savings to cash, the world switches from producing real stuff and building real businesses to people hoarding intrinsically worthless pieces of paper (pieces of paper that might not be able to buy that much in the future because production will have gone down. On top of this, if you keep interest rates above market rates and inflation too low for a long enough time, that is if you keep rates high at 0% when they should be at -3%, market pressure will build for an uncontrolled inflation rebound when all the cash hoarded on the sidelines start flowing in an economy with lowered production. It is much easier to keep inflation stable if you keep it high enough so that the investment market can always clear and never hits the zero lower bound.
  - simo7 9y ago
    Low inflation is usually desirable, just think that achieving 2% inflation annually is the main mandate for the European Central Bank. That's because even at 1%-2% inflation a year is difficult to spark the so-called thesaurisation phenomenon you're implying. In general I agree with you, I'd just change "low inflation" with "deflation". On the "money" being neutral with constant inflation. Yes, sure. It's the business dynamics that are not neutral. Quick example: - Say you have 10$ costs and 10$ revenue every year. - One year you expand production and you have to pay an additional 10$: so 20$ costs and 10$ revenue for that year. - With 0% inflation you have a 10$ loss (20-10), while with 10% inflation you have (20 * 1,1 - 10) = 12$ (about 11$ on constant prices terms) in loss (revenue won't grow till next year).
    - BenoitEssiambre 9y ago
      First, the ECB has nearly destroyed western civilization with their overly tight stance during the past decade. They destroyed the economy of their weaker members like Greece, eliminated the means of subsistence for their vulnerable workers which emboldened fascists and geopolitical foes like Russia. It was not difficult to spark the "thesaurisation". Excess reserves at the ECB and the Fed shot up by trillions. Natural market rates for investment were estimated by some around -4% and the central banks kept their rates very high at close to 0%. Yes deflation is worst but low inflation can be terrible in some situations. "With 0% inflation you have a 10$ loss (20-10), while with 10% inflation you have (20 * 1,1 - 10) = 12$ (about 11$ on constant prices terms) in loss (revenue won't grow till next year)." Not true, inflation means that revenues are constantly rising faster and financing costs are lower in real terms.
      - simo7 9y ago
        > Yes deflation is worst but low inflation can be terrible in some situations. Agreed. But not because of what you are implying: "...people transfer their savings to cash, the world switches from producing real stuff...". That is rather a risk resulting from deflation. I agree because higher inflation can help an economy plagued with insolvent debt to "assimilate" it gradually and create new room for healthy debt. > Not true, inflation means that revenues are constantly rising faster. That's precisely what I'm denying: there's often a significant delay between the outflows of money and the inflows they generate (typically in high fixed-costs businesses). If you're expanding production every year and you see the added revenue only the year after it's not difficult to see how inflation would have a negative impact (even if constant!).
fwdpropaganda 9y ago
The article says just the opposite. > Cheaper leverage? Not likely. High rates of inflation generally cause borrowing to become dearer, not cheaper. Galloping rates of inflation create galloping capital needs; and lenders, as they become increasingly distrustful of long-term contracts, become more demanding. But even if there is no further rise in interest rates, leverage will be getting more expensive because the average cost of the debt now on corporate books is less than would be the cost of replacing it. And replacement will be required as the existing debt matures. Overall, then, future changes in the cost of leverage seem likely to have a mildly depressing effect on the return on equity. To be honest my intuiton is like yours. I still haven't managed to reconciliate my intuition with the above quote. I guess it would be something like this: It is true that inflation means that the stream of cash you will pay back is worth less, but the costs of keeping your business running (which in turn is what generate those stream of cash) also goes up. When this happened, lenders become more strict. You can read further down: > Nevertheless, given inflationary conditions, many corporations seem sure in the future to turn to still more leverage as a means of shoring up equity returns. Their managements will make that move because they will need enormous amounts of capital — often merely to do the same physical volume of business
- HillaryBriss 9y ago
  In this light, it's interesting as a counterpoint to look at inflation's systemic effects. After the 2008 real estate loan bust, many economists hoped for more inflation so that the existing pool of loans would be a little more manageable for the debtors. (In Japan, they've been trying to increase inflation for decades). Even today, on financial news feeds and Bloomberg, when economic observers talk about "good news on inflation" they usually mean inflation going up, not down. I guess, overall, there's a sweet spot for inflation. Or what's good for corporate profits and banks is sort of opposed to what's good for the overall collection of people in the economy.
  - fwdpropaganda 9y ago
    > Even today, on financial news feeds and Bloomberg, when economic observers talk about "good news on inflation" they usually mean inflation going up, not down. Indeed, the sweet spot is believed to be 2%. It's good news because we've been under that for so long, not because the more the better. > After the 2008 real estate loan bust, many economists hoped for more inflation so that the existing pool of loans would be a little more manageable for the debtors. I'm not an expert, but I'll just point out that debt from a loan that you've put into a house probably doesn't have the same mechanics as debt from a company trying to fund its capital requirements. Not saying I agree or disagree with those economists, just pointing out maybe they're different.

danmaz74 9y ago

> TL;DR: The more the delay between investment and revenue generation and the more capital intensive it is, the worst. I think you're talking about high interest rates, not high inflation. High inflation means that, when you start generating income, you'll generate a higher income than with lower inflation. This, by itself, helps you repay the cost of your machinery faster. Usually high inflation also comes high interest rates, and that creates a problem if you have a delay between investment and revenue, but not inflation itself.

simo7 9y ago
I'm precisely referring to inflation. See the example I'm making here: https://news.ycombinator.com/item?id=16459396 https://news.ycombinator.com/item?id=16459396