Is the safer financial strategy to swim against the current or to turn around and float downstream?

Have you heard stories about how a Coke used to cost 5 cents?  As anyone who has shopped for groceries, renewed their health insurance, or filled up their tank lately knows, inflation is back in a big way.  How bad is inflation?  That depends on if you trust the government’s Consumer Price Index more than the pain you feel in your own wallet.

Since too big to fail does not apply to your business there are very few ways to get the government to hedge your risks for you.  There is no sense in complaining about it, but we can share with you one way that you can strengthen your business while making it safer at the same time – by recognizing inflation for what it is and positioning your business to benefit from its destructive impact on the purchasing power of your dollars.

Inflation is a thief which robs from the old and gives to the young.  It steals from the saver and gives to the borrower.  Are you a target?  Do you know how to protect yourself?  The answer is a bit counterintuitive – you protect yourself by having the right kind of debt – fixed rate debt, never variable.  If your payments never vary over time then you unlock the privilege of letting inflation work for you instead of against you.

When you pay cash for a $50,000 product, say a piece of productive equipment, you are by definition forgoing the ability to spend that money on $50,000 worth of other goods or services.  Whether those other options include an expanded marketing budget, staffing up to meet demand, or even a well deserved year end bonus, those other uses for the money are necessarily foregone.  In addition you are paying out those 50,000 dollars at the absolute height of their value, they will never be worth more.  Yet when you borrow with the right kind of debt you set yourself up to let inflation work for you by attacking the real value of your repayment stream.

For example, at a steady 5% rate of inflation today’s dollar becomes worth only 77 cents in 5 years.

At a 10% rate of inflation today’s dollar is worth a mere 59 cents in 5 short years.

These inflation rates aren’t at all hypothetical to people who operated businesses in the 70′s and early 80′s.  In fact many argue that the monetary policies that preceded that highly inflationary decade are being deployed once again today on an even broader scale.  I for one agree.

In either scenario above the business that uses someone else’s fully valued dollars to acquire their equipment leverages inflation to secure the very real benefit of paying back a fixed monthly payment stream of ever less valuable dollars.  If you recognize the reality of government monetary policy you can make a conscious decision to take advantage of the main area where it can work for you.  Additionally you are able to piggyback on the tax benefits of writing off any borrowing premiums against your income.

Between accelerating inflation and rising tax rates in the years ahead it is only going to take even more effort to stay in place, much less get ahead.  There are simpler ways to get where you want to go if you are open to a slightly different perspective.

We submit that the business that works so diligently to stack up their piles of fully valued cash, only to turn and dump them into quickly depreciating equipment, is one which is working so very hard to swim up stream.  We suggest that there is a less strenuous means to the same productive end – turn around.  The current is only getting stronger my friends.

Josh Splinter
President
American Capital Group