Friday, November 05, 2010

Whither the dollar?

I heard an economist on NPR last night, a former Federal Reserve governor, who spoke of the latest quantitative easing as if it poses absolutely no threat. He said something to the effect that "We are faced with, at best, 1% inflation; the Federal Reserve would prefer at least 2% if we are to have a healthy economy."

For some reason, I have a feeling he and Mr. Bernanke, and the federal government of the United States are all in serious denial.

I just wrote a letter to our CPA:
A couple of days ago, I purchased a copy of The Hyperinflation Survival Guide, a compendium of insights from businesspeople in Argentina, Brazil and Bolivia who survived the hyperinflations those countries experienced in the mid to late '80s. It was published at the behest of Harry E Figgie, Jr, the CEO of Figgie International, Inc., back in the late '80s. Interesting: the cover illustration is primarily composed of a graph of US government debt from 1780-2000.

Of course, since the book was written in 1988, the debt for the last 12 years on this chart was merely a prediction. In essence, the debt line went virtually straight up. In 1988, the debt was at $2.5 trillion, more or less (working solely from the chart). They predicted the total debt to be $13 trillion in 2000. Mr. Figgie wrote in the preface: "At that point, our annual deficit would be as much as $2 trillion, and $1.6 trillion of that would simply be interest on the debt!"

Obviously, Figgie and company missed the mark by about 10 years. But considering how alarmist such talk would have sounded back in 1988, I'm astonished how prescient he sounds. And as for that graph line: The angle of the line hardly shifts if you account for those extra 10 years. It is still almost straight up.

I'm finding the book quite eye-opening. Especially as our government, in the form of, or by means of, the (yes, non-governmental) Federal Reserve, keeps inflating the currency, I think we need to be on our toes.

I have long been aware of the hyperinflation of Germany in the early 1920s. I have heard anecdotes of what that inflation meant for private citizens. But it is hard to imagine oneself in those circumstances. And I have never read any real practical advice.

What I like about The Hyperinflation Survival Guide is the very nuts-and-bolts illustrations of what 20% to 25% monthly inflation (experienced by Argentina and Brazil) or 50% average monthly inflation (experienced by Bolivia in 1985) does to the value of money and/or the prices of goods. But even more valuable, I think, are the strategies the book offers for what a business needs to do to survive under such circumstances.

I'm writing you today partially to get your take on a couple of the strategies mentioned. They sound very reasonable in hyperinflationary times, but I am wondering what the legal limitations may be for us to implement them.
  1. "Base your inventory valuation on NIFO rather than LIFO."

    I had never heard of NIFO. It stands for Next In First Out.
    NIFO valuation is, in effect, a company's best guess as to the impact of the future rate of inflation on the cost of the materials it uses.

    If a company were to use LIFO during high inflationary periods, it would be greatly underpricing the value of its inventory and therefore eroding its profit margin. At Brazil's [then] current 20% monthly inflation rate, and inventory evaluated at $1 million with LIFO would have an actual replacement cost of $1.2 million after just one month. In such a case, NIFO would have avoided a potential $200,000 undervaluation of inventory.

    --p. 30

  2. "Develop an appropriate inflationary adjustment for capital replacement."
    Taxed appreciation deductions are normally based on original purchase costs rather than replacement costs. However, high inflation has a major impact on a firm's capital replacement costs and failure to take this into account during such times can be suicidal, because it can cause the firm's capital base to disappear.

    For example, if a Brazilian company purchases a piece of equipment for 300,000 cruzados, it might be allowed to deduct 100,000 per year from its taxable income for three years. But at 400 percent per year inflation, the replacement cost three years later would be more in the neighborhood of 37,500,000 cruzados. Unless the company increases its annual depreciation to account for this inflationary effect, the value of its capital stock for tax purposes will decline to virtually zero.

    Under such circumstances, inflation will not only eliminate a company's ability to recapture its capital base, but will also cause the firm to have virtually no depreciation deductions for tax purposes.

    The inability of a country's businesses to recapture the true cost of the capital will obviously have a very negative impact on capital formation within the country as a whole.

    --pp. 30-31

So, ________: I wrote in the margin concerning the second item: "Can one do this unilaterally? Is there a good legal basis [for developing an inflationary adjustment for capital replacement]?" But I would say the same question can be asked about NIFO, too: Is there anything standing in our way of using NIFO when that becomes necessary?

. . . [T]here's a whole lot more in this book and I intend to pass it along to [our company's staff]. I think we need to begin flexing our mental muscles to be prepared for the hyperinflation just around the corner.

Lest you think I am being alarmist, . . . let me note the input I have seen in just the last few hours:
  • From Mike Larson of Weiss Research's Safe Money Report (November 2010 issue):

    The Dollar Index has plunged as much as 14 percent since June. Meanwhile, crude oil has surged as much as 31 percent ... soybeans have climbed up to 32 percent ... cotton has skyrocketed 72 percent ... corn has jumped 75 percent ... and wheat has shot up 85 percent. Gold, silver, copper, and other metals are flying higher, too.
    That doesn't sound like 1% inflation to me.
  • From The Hyperinflation Survival Guide:

    "A . . . sobering discovery the team made in South America was that inflation can accelerate without warning into hyperinflation--or severe, debilitating inflation--in a period as short as a few days. (p. iii)

    "The problem with hyperinflation is that it happened so fast. We never realized what was happening until it was too late." --South American bank director (p. 1)
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