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.
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.
> 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
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.
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.
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.
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.
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).
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.
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!).
There doesn't need to be deflation. As long as the real return on cash (around -2% when interest rates are zero) is higher than market safe return on investment (which can be lower than -2%) it can cause a gridlock in the investment market.
>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!).
I don't follow at all. Inflation means prices are rising with time. So the investment early in time is made when prices are lower and the revenues are made later when prices are higher and thus you make higher revenues relative to what you paid for your investment. Inflation helps you here!
Insufficient inflation would be the problem. You make your investment when prices are high so you pay a lot, then when it comes to sell your product you get a insufficiently high price and low profit.
It's all part of the cost of capital calculation: https://en.wikipedia.org/wiki/Cost_of_capital
That way holding cash is better than buying a government bond but you're still loosing purchasing power holding cash, so why not spending it?
The real problem is when holding cash increases your purchasing power over time.
> So the investment early in time is made when prices are lower and the revenues are made later when prices are higher and thus you make higher revenues relative to what you paid for your investment. Inflation helps you here!
You reason as if you make the first investment and then that's it. It's not what really happens in most businesses.
Imagine you make an investment every year which produces the revenue for the year after.
You want all retirees to spend all their money at once? What if they planned to live for another while?
Safely carrying value into the future is a service that can sometimes cost you. There is nothing unnatural about negative returns. If cash has zero returns when when market rates on private safe investment is negative, savers start accumulating pieces of paper or electrons in accounts instead of things that have real world value and create economic activity. This puts the real investment market into a gridlock and production drops.
>Imagine you make an investment every year which produces the revenue for the year after.
Yes and it always helps you when the prices are higher when you sell than when you buy.