The Road Ahead: Nixon-Carter Redux, Part 3

March 16th, 2010

I remember the 70’s.  The 16-month recession of 1975-76 was personally very painful–I almost lost everything.  My firm was five years old, barely past startup and starting to cash flow–nearly wiped out.  The second half of the decade was good, and in its turn all the gain was nearly undone by the recession of the early 80’s.  But the second time around, I did not suffer, I gained.

My first-hand observation is that one can gain as well as lose in downturns.  This marks the beginning of my obsession with the effects of economics on business.

In 1971 Nixon devalued the dollar.  At first US exports scarcely kept pace with inflation.  Then in 1974 exports jumped, quadrupling by the end of the decade.   Net food and grain exports rose a whopping 1700%.  The mark and the yen rose 2 and 3 times the dollar, respectively.  The presumed trade imbalance was “fixed.”

GDP increased 150%, too.

Inflation was good in the 70’s.  Producers could raise prices with little resistance.  People expected to pay more.  Even as costs for companies started to increase, inflation still worked in their favor.  Their big investments in plant, property and equipment were in old dollars.  They were fixed.  The increases in other costs were easily passed along.

Company P&L’s looked good.  Profits, sales, and even margins were up.  Foreign competition from imports was restrained by our weak dollar.

People came to understand that higher interest rates were actually low.  Interest rates less inflation made the “true” cost of money cheap.  Loans could be paid with depreciated dollars.  It is true that property and equipment cost more, but the view was that it would be even more expensive later.

Besides, business was good.  People thought profits would continue to rise.  If you didn’t invest, you missed the chance for higher sales and profits.

Inflation cured higher costs, proving the view that real estate and property were a sound inflation hedge.  The rate of investment in 1979 was triple that of 1970.

No one (at least not many) argued otherwise.  Business was good.  Accounting reports proved it.

The decade ended with Chrysler needing a bailout.

The economy crashed.  Business failure rates tripled.  Accounting profits were proven to be what they were–vapor.   Our dollar couldn’t fall forever.  Inflation couldn’t continue to rise.  So interest rates popped up, way up, taming inflation and re-valuing [strengthening] the dollar.  Inflation no longer padded banks’ loan collateral, so borrowing got tougher and tougher.  Climbing sales prices no longer covered rising costs.  People who invested heavily in those last days got burned.

Reality is everything going on outside your business.   Knowing what is going on inside your business is a function of good management, and I freely admit it is often enough in ordinary times.  But when it isn’t enough, it really isn’t enough, and inside information will never warn you when.  When the economy gets extreme, what we can judge by looking inside is at least misleading and often dangerous.

Is there another lesson–make that another useful, practical, critical lesson–from what we are going through now?

For me, I wasn’t going be nailed again.  I wasn’t about to have clients nailed simply because they didn’t look.  Or nailed because I was too busy or too unwilling to ask unpopular questions.

Here it is then.  In good times think about bad events; in bad times plan for good.  A redux of the 70’s?  It is for me.