CHAPTER ONE
Inflation-Proofing the Company
EVERY WEEK, IT SEEMS, another book comes out announcing the one sure way to protect the individual and his money against inflation. But no one seems to pay much attention to protecting business. And yet little individual wealth is likely to survive unless the economy’s wealth-generating assets, its businesses, retain their capacity to produce. And that this capacity is endangered by prolonged inflation—let alone by chronic inflation at high rates such as the whole world is now experiencing—everyone accepts, including even the “progressive” economists for whom inflation is very much the lesser evil.
It is impossible for a business—and indeed for an individual as well—to acquire total immunity against the ravages of inflation. But it is possible to “inflation-proof” a business so as to give it both a fair degree of resistance against the pandemic disease and the power to recover. And it can be done quite cheaply and with moderate efforts.
The first thing to do—indeed the absolute prerequisite—is to get the facts. A business that does not adjust its figures to inflation—and only a few big companies are so far doing so in the U.S.—cannot fight inflation but becomes its victim. It is bound to do things that greatly increase inflation’s damage for the simple reason that it bases its decisions on misinformation and self-delusion. Without inflation-adjusted accounting, businesses must believe that their sales go up when in effect both sales and market standing go down. They must believe that they are making record profits when, in effect, profit-ability goes down or disappears entirely. They must believe that they are financially strong when, in effect, they are on the brink of insolvency and have no power of resistance against “credit crunch” and “liquidity crisis”—both endemic in an inflationary period. Sales and market standing; receivables and inventory; depreciation, capital, and debt-service requirements; and profits need to be restated continuously in inflation-adjusted figures to enable the business to inflation-proof itself.
The next step is systematic money management. One of the inevitable distortions of an inflationary period is overemphasis on finance. Manipulating money comes to be seen as more important than making and marketing goods or services when, with interest rates at 17 percent, an inept or inexperienced treasurer can lose the firm more money in a week than marketing can make in three months. But to inflation-proof a company more is needed than clever manipulation of cash and speculation in interest rates (though both, alas, are needed in inflationary times). The business has to be managed to satisfy at the same time two essentially incompatible requirements. It has to have minimum exposure to loss through the depreciation of the currency, which implies having the minimum of cash and the maximum of short-term debt. But at the same time an inflationary period demands a high degree of liquidity. In any inflationary period sudden attacks of “liquidity crisis” and “credit crunch” will occur without any warning. And contrary to what all politicians promise, there is no “soft landing” after inflationary bouts—at least there has been none in any of the attacks of inflation in modern economic history since the first one, the hundred-plus years of steady worldwide and corrosive inflation in the sixteenth century.
To inflation-proof a business thus requires a careful, principled, long-range policy of balance between the risk of loss from too much liquidity and the risk of catastrophe from too little. How high a risk premium does this company with its own specific financial characteristics have to pay to be able to ride out a liquidity crisis or a credit crunch? The financial panics of an inflationary period can be likened to a September hurricane in the Caribbean: They blow themselves out fast as a rule. But that is scant comfort if the boat has turned over and sunk at the first hard blow.
And finally, inflation-proofing the business requires deliberate contempt for the madness that in an inflationary period passes for sanity: the focus on the very short and the immediate. This focus is “rational” in an inflationary period. For with an interest rate of 17 percent or so, nothing further away than four years has any present value at all—and if there is any risk at all, the timespan beyond which investments in the future shrink to a present value of zero goes down to two years or so. This means that it becomes “rational” in an inflationary period to forgo any expenditure returns for which are both less than “certain” and a few years away. It becomes “rational” to rob the future. But as we were reminded by the environmental crisis a few years back, this is not “rationality” but madness, and the most wasteful and expensive thing conceivable.
In every inflation since the sixteenth century the “smart boys” managed short-term. They always were the “miracle workers” and the “hot pistols” for a while. But the moment the inflation stopped—or even paused—they always crashed in flames. The “magician” of the German hyperinflation of the twenties was a certain Hugo Stinnes, who, in three feverish years, built what was then Europe’s largest and apparently most powerful “conglomerate.” Six months after the German mark had been stabilized in October 1923, Stinnes was bankrupt and his empire in liquidation.
The ones who survive are the “dumb” ones who prepare for the future. The best example is again a German one—Siemens. During the German inflation Siemens was considered “hopeless.” But the company emerged as the world’s number-two electrical apparatus giant (second only to America’s GE). Its old European rival, the (also German) AEG, was “smart” during the inflation and the darling of securities analysts and financial writers; it has never recovered its competitive strength but has been slipping further and further behind ever since. And what Siemens did was quite simple. Its day-to-day operation, including money management, was run in accordance with the reality of inflation. Everything to do with the making of tomorrow was run as if inflation did not exist.
To inflation-proof the business, the activities that make tomorrow—scientific and technical research, product and process innovation and development; maintenance of plant and equipment; market development; customer service; and the development and training of professional, managerial, and skilled people—are run as if the interest rate were 3 percent, that is with disregard for the inflation charge. These activities account for at least one tenth of total expenditures in any business—in some they account for much more. But to inflation-proof the business they must be given priority over everything, with the exception of the cash flow necessary to protect the business against the pressures of the liquidity crunch.
And incidentally, maintaining their own “wealth-producing capacity,” that is their skill and knowledge, may be the best way for individuals to make themselves inflation-proof. History makes one doubt all and any of the clever schemes to beat inflation—whether investing in real estate or in diamonds, in commodities, in gold or in antiques—which today’s best-selling books so persuasively promote. Governments have somehow always found ways to get the better of the cleverest inflation-beating scheme. But while the German farmers, shopkeepers, and industrialists had still not recovered ten years later from the inflation of 1920 to 1923—a major factor, of course, in Hitler’s rise—the doctors, lawyers, and engineers were back on their old income levels within six months after the mark was stabilized. The professionals who now flock to executive management programs and to refresher courses in engineering, accounting, law, and medicine may, in the end, turn out to be the only ones who are most nearly inflation-proof.
(1981)