Money Matters: Inflation or a Price Bubble?

The inflation rate for the U.S. is 4.2% for the 12 months ended April 2021 after rising 2.6% previously, according to U.S. Labor Department data published in May. Annualized, it would be the highest rate of increase since 2008. The U.S. Congress is debating a spending bill and has discussed another stimulus package. With that much more money pumped into the economy, we should prepare for further inflation.
 
Not a Repeat of the 1970s

I have heard this debate for some time, but I think most would agree that we are in a period of inflation. Prices for most every commodity have soared, and there are more buyers for nearly everything than there is supply. That includes food, homes, lumber, automobiles (new and used), farm equipment, land and steel Recent reports from the Kansas City Federal Reserve report Iowa farmland values up 10% from one year ago and surrounding states at similar increases.

Inflation rates have been between 0% and 4% over that past 20 years, so this is a very different business environment than many have experienced in a long time. Inflation averaged over 7% in the 1970s, with inflation over 10% in three years (1974, 1979, 1980). High rates of inflation encouraged land purchases as a hedge against inflation. Very low real interest rates fueled acquisition. Inflation came to an end when the Federal Reserve stepped in to curb the run-up. Higher interest rates effectively brought inflation down in the early 1980s, but caused the resulting farm crisis. 

We are in a very different place than the 1970s with leverage, commodity prices and global demand for commodities. Current macroeconomic conditions are very different today. 

Manage Inflation
 Managing inflation starts by forecasting what might happen to your business. You will have to make an estimate of how long inflation will last, or whether current prices will be a new normal. There is some risk in making the wrong forecast, but there is likely more risk in not forecasting at all.

Understand the impact that rising interest rates (if that is your forecast) will have on your business, and what you can do to mitigate that cost. Forecasting rising labor cost will be another challenge for your business, but in the current environment, it is likely a current and future inflation issue. Another option for some will be to lock in inputs at more opportune times, so it might be in order to adjust some risk management strategies.

Finally, what got agriculture in trouble in the 1980s was not using GAAP accounting to make decisions. Using “cost” on land and depreciated values on improvements places the emphasis on long-term earnings and capacity to service debt, instead of leveraging inflated values on assets to further leverage the business.