what WB said about inflation..

I fret every time a value guy talks about macroeconomic conditions, but here I am talking about inflation. Swarmed by the talking heads, I went up on the Himalayas (BRK shareholder letters) to get some real advice from the guru (Warren Buffett). 1978-1982 was a time where real inflation actually took place, before the then fed chairman Paul Volcker raised rates to as high as 21.5% (can you imagine that) to reign in inflation. Fortunately, we have WB's 1978-1982 shareholder letters to decipher the time and his strategy (which as always he just lists out!).

While you and I talk about commodities and real estate etc., he was still looking for businesses but with the following characteristics, " Such favored business must have two characteristics: (1) an ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital." Essentially, business like See's Candy. When talking about commodities, he favors the lowest cost producers. We want to watch the downside, we want to make sure we make money even if inflation does not take hold.

Any fixed income security is likely to produce real term loses in a high inflation environment. He was absolutely against long term bonds, and mostly looked for bonds with conversion rights or distressed securities. When talking about return on capital you have to figure the inflation effects and then the taxation effects. A 10% bond with 8% inflation and taxes would not make any real return! In case of equities, the corporations will be paying taxes on nominal income and not real income. Considering owners can only use real income, this means the corporations would pay taxes on deficits!

I can only say so much and not a fraction as good as WB, so I would highly recommend the Berkshire Hathaway shareholder letters from 1978-1981.